UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
EXCHANGE ACT OF 1934.
For the quarterly period ended June 30, 2006
Commission File Number 000-33009
MEDCATH CORPORATION
(Exact name of registrant as specified in its charter)
Delaware | ||||
(State or other jurisdiction of | 56-2248952 | |||
incorporation or organization) | (IRS Employer Identification No.) |
10720 Sikes Place, Suite 300
Charlotte, North Carolina 28277
(Address of principal executive offices, including zip code)
Charlotte, North Carolina 28277
(Address of principal executive offices, including zip code)
(704) 708-6600
(Registrant’s telephone number, including area code)
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o | Accelerated filer þ | Non-accelerated filer o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No þ
As of July 28, 2006, there were 18,682,305 shares of $0.01 par value common stock outstanding.
MEDCATH CORPORATION
FORM 10-Q
TABLE OF CONTENTS
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
MEDCATH CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
June 30, | September 30, | |||||||
2006 | 2005 | |||||||
(Unaudited) | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 144,561 | $ | 140,842 | ||||
Accounts receivable, net | 91,840 | 86,138 | ||||||
Medical supplies | 20,987 | 18,943 | ||||||
Deferred income tax assets | 11,012 | 12,391 | ||||||
Prepaid expenses and other current assets | 5,693 | 6,982 | ||||||
Current assets of discontinued operations | 13,476 | 11,546 | ||||||
Total current assets | 287,569 | 276,842 | ||||||
Property and equipment, net | 363,395 | 368,782 | ||||||
Investments in affiliates | 7,798 | 6,669 | ||||||
Goodwill | 65,540 | 65,540 | ||||||
Other intangible assets, net | 7,334 | 8,091 | ||||||
Other assets | 11,367 | 12,190 | ||||||
Long-term assets of discontinued operations | 24,512 | 25,091 | ||||||
Total assets | $ | 767,515 | $ | 763,205 | ||||
Current liabilities: | ||||||||
Accounts payable | $ | 38,994 | $ | 36,971 | ||||
Income tax payable | 711 | 1,416 | ||||||
Accrued compensation and benefits | 22,763 | 21,045 | ||||||
Accrued property taxes | 4,581 | 6,456 | ||||||
Other accrued liabilities | 16,863 | 13,832 | ||||||
Current portion of long-term debt and obligations under capital leases | 40,068 | 54,885 | ||||||
Current liabilities of discontinued operations | 8,129 | 7,135 | ||||||
Total current liabilities | 132,109 | 141,740 | ||||||
Long-term debt | 296,190 | 296,391 | ||||||
Obligations under capital leases | 1,897 | 3,010 | ||||||
Deferred income tax liabilities | 13,628 | 15,673 | ||||||
Other long-term obligations | 319 | 497 | ||||||
Long-term liabilities of discontinued operations | 93 | 253 | ||||||
Total liabilities | 444,236 | 457,564 | ||||||
Minority interest in equity of consolidated subsidiaries | 23,799 | 22,900 | ||||||
Commitments and contingencies | ||||||||
Stockholders’ equity: | ||||||||
Preferred stock, $0.01 par value, 10,000,000 shares authorized; none issued | — | — | ||||||
Common stock, $0.01 par value, 50,000,000 shares authorized; 18,745,872 issued and 18,676,972 outstanding at June 30, 2006; 18,562,635 issued and 18,493,735 outstanding at September 30, 2005 | 187 | 186 | ||||||
Paid-in capital | 383,912 | 368,849 | ||||||
Accumulated deficit | (84,287 | ) | (85,924 | ) | ||||
Accumulated other comprehensive income | 62 | 24 | ||||||
Treasury stock, 68,900 shares at cost | (394 | ) | (394 | ) | ||||
Total stockholders’ equity | 299,480 | 282,741 | ||||||
Total liabilities and stockholders’ equity | $ | 767,515 | $ | 763,205 | ||||
See notes to consolidated financial statements.
1
MEDCATH CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
Three Months Ended June 30, | Nine Months Ended June 30, | |||||||||||||||
2006 | 2005 | 2006 | 2005 | |||||||||||||
Net revenue | $ | 189,832 | $ | 179,787 | $ | 554,156 | $ | 524,156 | ||||||||
Operating expenses: | ||||||||||||||||
Personnel expense | 58,033 | 53,893 | 181,211 | 159,874 | ||||||||||||
Medical supplies expense | 52,657 | 51,047 | 154,735 | 148,813 | ||||||||||||
Bad debt expense | 14,228 | 13,874 | 44,405 | 36,063 | ||||||||||||
Other operating expenses | 37,916 | 36,286 | 114,123 | 107,316 | ||||||||||||
Depreciation | 9,366 | 9,034 | 27,801 | 27,214 | ||||||||||||
Amortization | 252 | 290 | 756 | 870 | ||||||||||||
Loss (gain) on disposal of property, equipment and other assets | (296 | ) | 148 | (237 | ) | 204 | ||||||||||
Impairment of long-lived assets | 451 | — | 451 | — | ||||||||||||
Total operating expenses | 172,607 | 164,572 | 523,245 | 480,354 | ||||||||||||
Income from operations | 17,225 | 15,215 | 30,911 | 43,802 | ||||||||||||
Other income (expenses): | ||||||||||||||||
Interest expense | (7,870 | ) | (8,440 | ) | (25,828 | ) | (24,129 | ) | ||||||||
Interest and other income, net | 2,977 | 868 | 5,748 | 1,870 | ||||||||||||
Equity in net earnings of unconsolidated affiliates | 1,408 | 899 | 3,883 | 2,554 | ||||||||||||
Total other expenses, net | (3,485 | ) | (6,673 | ) | (16,197 | ) | (19,705 | ) | ||||||||
Income from continuing operations before minority interest, income taxes and discontinued operations | 13,740 | 8,542 | 14,714 | 24,097 | ||||||||||||
Minority interest share of earnings of consolidated subsidiaries | (4,742 | ) | (3,956 | ) | (12,350 | ) | (12,357 | ) | ||||||||
Income from continuing operations before income taxes and discontinued operations | 8,998 | 4,586 | 2,364 | 11,740 | ||||||||||||
Income tax expense | 3,649 | 1,952 | 993 | 4,814 | ||||||||||||
Income from continuing operations | 5,349 | 2,634 | 1,371 | 6,926 | ||||||||||||
Income (loss) from discontinued operations, net of taxes | (439 | ) | 115 | 266 | 4,166 | |||||||||||
Net income | $ | 4,910 | $ | 2,749 | $ | 1,637 | $ | 11,092 | ||||||||
Earnings (loss) per share, basic | ||||||||||||||||
Continuing operations | $ | 0.28 | $ | 0.14 | $ | 0.07 | $ | 0.38 | ||||||||
Discontinued operations | (0.02 | ) | 0.01 | 0.01 | 0.23 | |||||||||||
Earnings per share, basic | $ | 0.26 | $ | 0.15 | $ | 0.08 | $ | 0.61 | ||||||||
Earnings (loss) per share, diluted | ||||||||||||||||
Continuing operations | $ | 0.27 | $ | 0.13 | $ | 0.07 | $ | 0.36 | ||||||||
Discontinued operations | (0.02 | ) | 0.01 | 0.01 | 0.21 | |||||||||||
Earnings per share, diluted | $ | 0.25 | $ | 0.14 | $ | 0.08 | $ | 0.57 | ||||||||
Weighted average number of shares, basic | 18,630 | 18,425 | 18,583 | 18,216 | ||||||||||||
Dilutive effect of stock options and restricted stock | 661 | 1,248 | 921 | 1,193 | ||||||||||||
Weighted average number of shares, diluted | 19,291 | 19,673 | 19,504 | 19,409 | ||||||||||||
See notes to consolidated financial statements.
2
MEDCATH CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(In thousands)
(Unaudited)
Accumulated | ||||||||||||||||||||||||||||||||
Other | ||||||||||||||||||||||||||||||||
Common Stock | Paid-in | Accumulated | Comprehensive | Treasury Stock | ||||||||||||||||||||||||||||
Shares | Par Value | Capital | Deficit | Income | Shares | Amount | Total | |||||||||||||||||||||||||
Balance, September 30, 2005 | 18,494 | $ | 186 | $ | 368,849 | $ | (85,924 | ) | $ | 24 | 69 | $ | (394 | ) | $ | 282,741 | ||||||||||||||||
Exercise of stock options, including income tax benefit | 183 | 1 | 2,683 | — | — | — | — | 2,684 | ||||||||||||||||||||||||
Share-based compensation | — | — | 12,380 | — | — | — | — | 12,380 | ||||||||||||||||||||||||
Comprehensive income: | ||||||||||||||||||||||||||||||||
Net income | — | — | — | 1,637 | — | — | — | 1,637 | ||||||||||||||||||||||||
Change in fair value of interest rate swaps, net of income tax expense | — | — | — | — | 38 | — | — | 38 | ||||||||||||||||||||||||
Total comprehensive income | 1,675 | |||||||||||||||||||||||||||||||
Balance, June 30, 2006 | 18,677 | $ | 187 | $ | 383,912 | $ | (84,287 | ) | $ | 62 | 69 | $ | (394 | ) | $ | 299,480 | ||||||||||||||||
See notes to consolidated financial statements.
3
MEDCATH CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended June 30, | ||||||||
2006 | 2005 | |||||||
Net income | $ | 1,637 | $ | 11,092 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Income from discontinued operations, net of taxes | (266 | ) | (4,166 | ) | ||||
Bad debt expense | 44,405 | 36,063 | ||||||
Depreciation and amortization expense | 28,557 | 28,084 | ||||||
Income tax benefit on exercised stock options | (399 | ) | — | |||||
(Gain) loss on disposal of property, equipment and other assets | (237 | ) | 204 | |||||
Share-based compensation expense | 12,380 | — | ||||||
Impairment of long-lived assets | 451 | |||||||
Amortization of loan acquisition costs | 2,526 | 1,201 | ||||||
Equity in earnings of unconsolidated affiliates, net of dividends received | (1,060 | ) | 134 | |||||
Minority interest share of earnings of consolidated subsidiaries | 12,350 | 12,357 | ||||||
Change in fair value of interest rate swaps | (128 | ) | (837 | ) | ||||
Deferred income taxes | (293 | ) | 8,081 | |||||
Change in assets and liabilities that relate to operations: | ||||||||
Accounts receivable | (50,107 | ) | (39,621 | ) | ||||
Medical supplies | (2,044 | ) | 606 | |||||
Prepaids and other assets | 1,207 | 2,335 | ||||||
Accounts payable and accrued liabilities | 4,449 | (1,010 | ) | |||||
Net cash provided by operating activities of continuing operations | 53,428 | 54,523 | ||||||
Net cash provided by (used in) operating activities of discontinued operations | 685 | (6,705 | ) | |||||
Net cash provided by operating activities | 54,113 | 47,818 | ||||||
Investing activities: | ||||||||
Purchases of property and equipment | (23,735 | ) | (13,624 | ) | ||||
Proceeds from sale of property and equipment | 1,110 | 809 | ||||||
Proceeds from sale of discontinued operations | — | 42,500 | ||||||
Other investing activities | — | 6 | ||||||
Net cash provided by (used in) investing activities of continuing operations | (22,625 | ) | 29,691 | |||||
Net cash used in investing activities of discontinued operations | (690 | ) | (665 | ) | ||||
Net cash provided by (used in) investing activities | (23,315 | ) | 29,026 | |||||
Financing activities: | ||||||||
Proceeds from issuance of long-term debt | 60,000 | 2,159 | ||||||
Repayments of long-term debt | (74,683 | ) | (4,778 | ) | ||||
Repayments of obligations under capital leases | (1,505 | ) | (1,777 | ) | ||||
Payments of loan acquisition costs | (1,879 | ) | — | |||||
Investments by minority partners | — | 3,675 | ||||||
Distributions to minority partners | (12,069 | ) | (8,781 | ) | ||||
Repayments from minority partners, net | 618 | 205 | ||||||
Income tax benefit on exercised stock options | 399 | — | ||||||
Proceeds from exercised stock options | 2,285 | 7,435 | ||||||
Net cash used in financing activities of continuing operations | (26,834 | ) | (1,862 | ) | ||||
Net cash used in financing activities of discontinued operations | (245 | ) | (4,521 | ) | ||||
Net cash used in financing activities | (27,079 | ) | (6,383 | ) | ||||
Net increase in cash and cash equivalents | 3,719 | 70,461 | ||||||
Cash and cash equivalents: | ||||||||
Beginning of period | 140,842 | 69,855 | ||||||
End of period | $ | 144,561 | $ | 140,316 | ||||
Supplemental schedule of noncash investing and financing activities: | ||||||||
Capital expenditures financed by capital leases | $ | — | $ | 514 |
See notes to consolidated financial statements.
4
MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All tables in thousands, except per share data)
1. Business and Organization
MedCath Corporation (the Company) is a healthcare provider focused primarily on the diagnosis and treatment of cardiovascular disease. The Company owns and operates hospitals in partnership with physicians as well as with community hospital systems. Each of the Company’s majority-owned hospitals (collectively, the Hospital Division) is licensed as a general acute care hospital that provides a wide range of health services, and the medical staff at each hospital includes qualified physicians in various specialties. Also included in the Hospital Division are arrangements whereby the Company manages the cardiovascular program of various hospitals operated by other parties. The Company opened its first hospital in 1996 and as of June 30, 2006, had ownership interests in and operated eleven hospitals, together with its physician partners, who own an equity interest in the hospitals where they practice. These hospitals have a total of 667 licensed beds and are located in eight states: Arizona, Arkansas, California, Louisiana, New Mexico, Ohio, South Dakota, and Texas.
See Note 3 –Discontinued Operationsfor details concerning the Company’s pending disposition of Tucson Heart Hospital. Unless specifically indicated otherwise, all amounts and percentages presented in these Notes are exclusive of the Company’s discontinued operations.
The Company accounts for all but one of its hospitals as consolidated subsidiaries. The Company owns a minority interest in Avera Heart Hospital of South Dakota and neither has substantive control over the hospital nor is its primary beneficiary under Financial Accounting Standards Board Interpretation No. 46R,Consolidation of Variable Interest Entities, an interpretation of ARB No. 51. Therefore, the Company does not consolidate the hospital’s results of operations and financial position, but rather accounts for its minority ownership interest in the hospital as an equity investment.
In addition to its hospitals, the Company owns and/or manages cardiac diagnostic and therapeutic facilities (the Diagnostics Division). The Company began its cardiac diagnostic and therapeutic business in 1989, and as of June 30, 2006 owned and/or managed twenty-six cardiac diagnostic and therapeutic facilities. Ten of these facilities are located at hospitals operated by other parties and offer invasive diagnostic and, in some cases, therapeutic procedures. The remaining sixteen facilities are not located at hospitals and offer only diagnostic services.
2. Summary of Significant Accounting Policies
Basis of Presentation- The Company’s unaudited interim consolidated financial statements as of June 30, 2006 and for the three and nine months ended June 30, 2006 and 2005 have been prepared in accordance with accounting principles generally accepted in the United States of America (hereafter, generally accepted accounting principles) and pursuant to the rules and regulations of the Securities and Exchange Commission (the SEC). These unaudited interim consolidated financial statements reflect, in the opinion of management, all material adjustments (consisting only of normal recurring adjustments) necessary to fairly state the results of operations and financial position for the periods presented. All intercompany transactions and balances have been eliminated. The results of operations for the three and nine months ended June 30, 2006 are not necessarily indicative of the results expected for the full fiscal year ending September 30, 2006 or future fiscal periods.
Certain information and disclosures normally included in the notes to consolidated financial statements have been condensed or omitted as permitted by the rules and regulations of the SEC, although the Company believes the disclosure is adequate to make the information presented not misleading. The unaudited interim consolidated financial statements and notes thereto should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2005. During the three and nine months ended June 30, 2006, the Company has not made any material changes in the selection or application of its critical accounting policies as set forth in its Annual Report on Form 10-K for the year ended September 30, 2005, except for the accounting for share-based compensation as further described below.
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 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.
Share-Based Compensation- On October 1, 2005, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123R (revised 2004),Share-Based Payment, which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors based on estimated fair values.SFAS No. 123R requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the
5
MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
Company’s statement of operations. Prior to the adoption of SFAS No. 123R, the Company accounted for stock options issued to employees and directors using the intrinsic value method in accordance with Accounting Principles Board (APB) Opinion No. 25,Accounting for Stock Issued to Employees, as permitted under SFAS No. 123,Accounting for Stock-Based Compensationand provided pro forma net income and pro forma earnings per share disclosures for stock option grants made as if the fair value method of measuring compensation costs for stock options granted had been applied. Under the intrinsic value method, no share-based compensation expense was recognized for options granted with an exercise price equal to the fair value of the underlying stock at the grant date.
The Company adopted SFAS No. 123R using the modified prospective transition method, which requires the application of the accounting standard as of October 1, 2005, the first day of the Company’s fiscal year 2006. The Company’s financial statements as of and for the three and nine months ended June 30, 2006 reflect the impact of SFAS No. 123R. In accordance with the modified prospective transition method, the financial statements from prior periods have not been restated to reflect, and do not include, the impact of SFAS No. 123R.
Under SFAS No. 123R, share-based compensation expense recognized for the three and nine months ended June 30, 2006 was $1.8 million and $12.4 million, respectively, which had the effect of decreasing net income by $1.0 million or $0.05 per diluted share and $7.2 million or $0.37 per diluted share, respectively, for the periods. The compensation expense recognized represents the compensation related to restricted stock awards over the vesting period, as well as the value of all stock options issued during the periods as all such options were immediately vested and all unvested options outstanding prior to October 1, 2005 were cancelled during the period. Since all options granted during the three and nine months ended June 30, 2005 had an exercise price equal to the market value of the underlying shares of common stock at the date of grant, no compensation expense was recorded for the three and nine months ended June 30, 2005.
The following table illustrates the effect on reported net income and earnings per share as if the Company had applied SFAS No. 123R during the periods indicated.
Three Months Ended | Nine Months Ended | |||||||
June 30, 2005 | June 30, 2005 | |||||||
Net income, as reported | $ | 2,749 | $ | 11,092 | ||||
Deduct: Total share-based employee compensation expense determined under fair value based method for all awards, net of related tax effects | (420 | ) | (1,464 | ) | ||||
Pro forma net income | $ | 2,329 | $ | 9,628 | ||||
Earnings per share, basic: | ||||||||
As reported | $ | 0.15 | $ | 0.61 | ||||
Pro forma | $ | 0.13 | $ | 0.53 | ||||
Earnings per share, diluted: | ||||||||
As reported | $ | 0.14 | $ | 0.57 | ||||
Pro forma | $ | 0.12 | $ | 0.50 |
As required under SFAS No. 123R in calculating the share-based compensation expense for the three and nine months ended June 30, 2006 and as required under SFAS No. 123 and SFAS No. 148,Accounting for Stock Based Compensation, in calculating the share-based compensation expense for the three and nine months ended June 30, 2005, the fair value of each option grant was estimated on the date of grant. The Company used the Black-Scholes option pricing model with the range of weighted-average assumptions used for option grants noted in the following table. The expected life of the stock options represents the period of time that options granted are expected to be outstanding and the range given below results from certain groups of employees exhibiting different behavior with respect to the options granted to them and was determined based on an analysis of historical exercise and cancellation behavior. The risk-free interest rate is based on the US Treasury yield curve in effect on the date of the grant. The expected volatility is based on the historical volatilities of the Company’s common stock and the common stock of comparable publicly traded companies.
For the Three Months Ended June 30, | For the Nine Months Ended June 30, | |||||||||
2006 | 2005 | 2006 | 2005 | |||||||
Expected life | 6-8 years | 8 years | 6-8 years | 8 years | ||||||
Risk- free interest rate | 4.85% - 5.20% | 3.84% - 4.44% | 4.26% -5.20% | 3.80% - 4.48% | ||||||
Expected volatility | 40% - 44% | 47% | 40% - 44% | 47% - 48% |
6
MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
Goodwill and Long-Lived Assets— Goodwill represents acquisition costs in excess of the fair value of net tangible and intangible assets of businesses purchased. In accordance with SFAS No. 142,Goodwill and Other Intangible Assets, the Company evaluates goodwill annually on September 30 for impairment, or earlier if indicators of potential impairment exist. Long-lived assets, other than goodwill, are evaluated for impairment when events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. The determination of whether or not goodwill and/or long-lived assets have become impaired involves a significant level of judgment in the assumptions underlying the approach used to determine the value of the Company’s reporting units. Changes in the Company’s strategy and or market conditions could significantly impact these judgments and require adjustments to recorded amounts of intangible assets.
During the nine months ended June 30, 2006, and subsequent to such date, the Department of Health and Human Services has changed, and has proposed to further refine, the diagnosis-related group (DRG) system under the Medicare hospital inpatient prospective payment system. The stated intent of these refinements to the DRG system is to better capture differences in the severity of illness among patients and to base Medicare reimbursement upon the estimated costs of providing care, rather than actual charges for care. Implementation of these proposals could, or future federal and state legislation or action by government agencies may, materially and adversely reduce the payments the Company receives for services to patients covered by Medicare, Medicaid and commercial plans indexed to Medicare. The payment reductions would in turn negatively impact the Company’s financial position and results of operations. As the Company is currently evaluating the impact of recent changes to the DRG system, no impairment charge was recorded during the nine months ended June 30, 2006; however, the financial impact on certain individual hospitals may result in a future write-off of long-lived assets.
Further, Heart Hospital of Lafayette is currently not producing positive cash flows due to weaker than anticipated volumes and higher than budgeted expenses. The Company is reviewing the long-term outlook to determine plans and strategic direction as it relates to this facility, which may result in a future write-off or impairment of long-lived assets.
3. Discontinued Operations
On June 20, 2006, the Company announced that it intends to sell its 58.8% interest in Tucson Heart Hospital (THH) to Carondelet Health Network, a southern Arizona-based not-for-profit health care organization and part owner of THH. The terms of the sale are subject to the signing of a definitive agreement and customary closing conditions. Pursuant to the provisions of SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets, THH’s financial position, operating results and cash flows have been presented as discontinued operations in the interim consolidated financial statements.
On November 5, 2004, the Company and local Milwaukee physicians, who jointly owned The Heart Hospital of Milwaukee (HHM), entered into an agreement with Columbia St. Mary’s, a Milwaukee-area hospital group, to close HHM and sell certain assets primarily comprised of real property and equipment to Columbia St. Mary’s for $42.5 million. The sale was completed on December 1, 2004.
The results of operations of THH and HHM were as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
June 30, 2006 | June 30, 2005 | June 30, 2006 | June 30, 2005 | |||||||||||||
Net revenue | $ | 13,849 | $ | 15,415 | $ | 43,178 | $ | 49,823 | ||||||||
Restructuring and write-off charges | — | — | — | (8,535 | ) | |||||||||||
Operating expenses | (14,584 | ) | (14,108 | ) | (42,728 | ) | (45,475 | ) | ||||||||
Income (loss) from operations | (735 | ) | 1,307 | 450 | (4,187 | ) | ||||||||||
Gain (loss) on sale of assets | (1 | ) | (218 | ) | (24 | ) | 13,966 | |||||||||
Other income (expenses) | 14 | 92 | 30 | (582 | ) | |||||||||||
Income (loss) income before income taxes | (722 | ) | 1,181 | 456 | 9,197 | |||||||||||
Income tax benefit (expense) | 283 | (1,066 | ) | (190 | ) | (5,031 | ) | |||||||||
Net income (loss) | $ | (439 | ) | $ | 115 | $ | 266 | $ | 4,166 | |||||||
The principal balance sheet items of THH, excluding intercompany debt and including allocated goodwill, are as follows:
7
MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
June 30, | September 30, | |||||||
2006 | 2005 | |||||||
Cash and cash equivalents | $ | 1,326 | $ | 782 | ||||
Accounts receivable, net | 10,486 | 9,262 | ||||||
Other current assets | 1,664 | 1,502 | ||||||
Current assets | $ | 13,476 | $ | 11,546 | ||||
Property and equipment, net | $ | 19,405 | $ | 19,985 | ||||
Goodwill | 4,560 | 4,560 | ||||||
Other intangible assets, net | 547 | 546 | ||||||
Noncurrent assets | $ | 24,512 | $ | 25,091 | ||||
Accounts payable | $ | 5,481 | $ | 3,988 | ||||
Accrued liabilities | 2,436 | 2,851 | ||||||
Current portion of obligations under capital leases | 212 | 296 | ||||||
Current liabilities | $ | 8,129 | $ | 7,135 | ||||
Obligations under capital leases | $ | 93 | $ | 253 | ||||
Long-term liabilities | $ | 93 | $ | 253 | ||||
4. Accounts Receivable
Accounts receivable, net, consists of the following:
June 30, | September 30, | |||||||
2006 | 2005 | |||||||
Receivables, principally from patients and third-party payors | $ | 110,773 | $ | 97,448 | ||||
Receivables, principally from billings to hospitals for various cardiovascular procedures | 3,849 | 4,358 | ||||||
Amounts due under management contracts | 2,651 | 3,757 | ||||||
Other | 2,406 | 3,070 | ||||||
119,679 | 108,633 | |||||||
Less allowance for doubtful accounts | (27,839 | ) | (22,495 | ) | ||||
Accounts receivable, net | $ | 91,840 | $ | 86,138 | ||||
5. Equity Investments
The Company owns minority interests in Avera Heart Hospital of South Dakota and certain diagnostic ventures and neither has substantive control over the ventures nor is the primary beneficiary. Therefore, the Company does not consolidate the results of operations and financial position of these entities, but rather accounts for its minority ownership interest in the hospital and other ventures as equity investments.
8
MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
The following represents summarized financial information of Avera Heart Hospital of South Dakota:
Three Months Ended June 30, | Nine Months Ended June 30, | |||||||||||||||
2006 | 2005 | 2006 | 2005 | |||||||||||||
Net revenue | $ | 15,765 | $ | 15,128 | $ | 47,016 | $ | 45,186 | ||||||||
Operating income | $ | 4,176 | $ | 2,942 | $ | 11,687 | $ | 8,798 | ||||||||
Net income | $ | 3,823 | $ | 2,411 | $ | 10,666 | $ | 7,107 |
June 30, | September 30, | |||||||
2006 | 2005 | |||||||
Current assets | $ | 17,471 | $ | 17,721 | ||||
Non-current assets | $ | 34,049 | $ | 35,205 | ||||
Current liabilities | $ | 8,348 | $ | 10,003 | ||||
Non-current liabilities | $ | 23,335 | $ | 26,001 |
6. Long-Term Debt
Long-term debt consists of the following:
June 30, | September 30, | |||||||
2006 | 2005 | |||||||
Senior notes | $ | 138,135 | $ | 150,000 | ||||
Notes payable to various lenders | 155,976 | 100,144 | ||||||
Senior secured credit facility | 40,148 | 98,750 | ||||||
334,259 | 348,894 | |||||||
Less current portion | (38,069 | ) | (52,503 | ) | ||||
Long-term debt | $ | 296,190 | $ | 296,391 | ||||
During the nine months ended June 30, 2006, the Company entered into the following debt transactions:
Mortgage Loan— On February 9, 2006, Heart Hospital of Austin (HHA) completed the refinancing of its mortgage loan of $35.3 million, which was scheduled to mature during the second quarter of fiscal 2006. Under the terms of the new financing, the loan requires monthly, interest-only payments for ten years, at which time the loan is due in full. The interest rate on the loan is 8 1/2%. The loan is secured by substantially all assets of HHA, except equipment, and is subject to certain financial and other restrictive covenants.
Repurchase of Senior Notes—In connection with the sale of HHM and as stipulated by the indenture governing the senior notes, during the nine months ended June 30, 2006, the Company offered to repurchase up to $30.3 million of senior notes. The tender offer for the notes expired during the period and the Company accepted for purchase and paid for $11.9 million principal amount of notes tendered prior to the expiration of the tender offer.
Convertible Notes Payable— On December 28, 2005, Harlingen Medical Center (HMC) entered into two, $10.0 million convertible notes with a third-party health system. The first note can be voluntarily converted by the health system into a 13.2% ownership interest in HMC after the third anniversary date or it will automatically be converted into an ownership interest in HMC upon the achievement of specified financial targets of the agreement, up until the third anniversary date of the agreement or the fourth anniversary date of the agreement, if extended by HMC. The second note is convertible into the same ownership interest percentage as the first note at the discretion of the health system after the conversion of the first note. The potential ownership interest in HMC by the health system is capped at 49%. The notes bear interest at 5% up until the third anniversary date, after which time the interest rate increases to 8% if the notes have not been converted. Interest payments are due quarterly. If the notes are not converted, the notes are then payable annually in equal principal payments, plus quarterly interest payments, over five years. The notes cannot be prepaid without the consent of the health system and are secured by a second lien on all assets of HMC, except accounts receivable. In accordance with the provisions of EITF 99-1,Accounting for Debt Convertible into the Stock of a Consolidated Subsidiary, EITF 00-19,Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock, and EITF 01-6,The Meaning of Indexed to a Company’s Own Stock, the convertible notes are accounted for as convertible debt in the accompanying consolidated balance sheet and the embedded conversion option in the convertible notes has not been accounted for as a separate derivative.
9
MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
Mortgage Loan— Concurrent with the issuance of the convertible notes, HMC also entered into a $40.0 million, ten year mortgage loan with a third-party lender. The loan requires quarterly, interest-only payments until the maturity date. The interest rate on the loan is 8 3/4%. The loan is secured by substantially all the assets of HMC and the loan is subject to certain financial and other restrictive covenants. In addition, the Company guarantees $10.0 million of the loan balance.
Of the proceeds received as a result of these agreements, $58.0 million was used to pay down a portion of the outstanding balance of the term loan under the Company’s senior secured credit facility (the Senior Secured Credit Facility). In connection with the payments of the Senior Secured Credit Facility and the senior notes, the Company expensed approximately $1.4 million of deferred loan acquisition costs during the nine months ended June 30, 2006.
Under the Senior Secured Credit Facility, the Company also has a revolving credit facility (Revolving Facility) in the amount of $100.0 million, which includes a $25.0 million sub-limit for the issuance of stand-by and commercial letters of credit and a $10.0 million sub-line for swing-line loans. There were no borrowings under the Revolving Facility at June 30, 2006; however, the Company had letters of credit outstanding of $2.5 million, which reduces availability under the Revolving Facility to $97.5 million.
Debt Covenants— At June 30, 2006, the Company was in violation of a financial covenant under an equipment loan to Heart Hospital of Lafayette and anticipates continuing to be in violation of this covenant in future periods. Accordingly, the total outstanding balance of this loan of $10.2 million has been included in current portion of long-term debt and obligations under capital leases as of June 30, 2006. As of June 30, 2006, the Company was working with the lender to amend the financial covenant. The Company was in compliance with all other covenants in the instruments governing its outstanding debt at June 30, 2006.
Unconsolidated Affiliate’s Debt— On February 10, 2006, Avera Heart Hospital of South Dakota, the one affiliate hospital in which the Company has a minority interest position, refinanced its then outstanding long-term debt. Prior to the fee refinancing, the Company had guaranteed portions of the debt. Concurrent with the refinancing, these guarantees and the related arrangements were terminated.
7. Liability Insurance Coverage
During June 2005, the Company entered into a one-year claims paid policy providing coverage for medical malpractice claims in excess of $3.0 million of retained liability per claim. The Company also purchased additional insurance to reduce the retained liability per claim to $250,000 for the Diagnostics Division. During June 2006, the Company entered into a one-year claims-made policy providing coverage for medical malpractice claim amounts in excess of $2.0 million of retained liability per claim. The Company also purchased additional insurance to reduce the retained liability per claim to $250,000 for the Diagnostics Division.
Because of the self-insured retention levels, the Company is required to recognize an estimated expense and liability for the amount of the Company’s retained liability applicable to each malpractice claim. As of June 30, 2006 and September 30, 2005, the total estimated liability for the Company’s self-insured retention on medical malpractice claims, including an estimated amount for incurred but not reported claims, was approximately $5.6 million and $5.4 million, respectively, which is included in current liabilities in the consolidated balance sheet.
8. Contingencies and Commitments
Contingencies —Laws and regulations governing the Medicare and Medicaid programs are complex, subject to interpretation and may be modified. The Company believes that it is in compliance with such laws and regulations. However, compliance with such laws and regulations can be subject to future government review and interpretation as well as significant regulatory action including substantial fines and criminal penalties, as well as repayment of previously billed and collected revenue from patient services and exclusion from the Medicare and Medicaid programs.
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 June 30, 2006. These claims and legal actions are in various stages, and some may ultimately be brought to trial. Moreover, additional claims arising from services provided to patients in the past and other legal actions may be asserted in the future. The Company is protecting its interests in all such claims and actions.
Management does not believe, based on the Company’s experience with past litigation and taking into account the applicable liability insurance coverage and the expectations of counsel with respect to the amount of potential liability, the outcome of any such claims and litigation, individually or in the aggregate, will have a materially adverse effect on the Company’s financial position or results of operations.
10
MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
Commitments —Some of the Company’s hospitals provide guarantees to certain physician groups for funds required to operate and maintain services for the benefit of the hospital’s patients including emergency care services and anesthesiology services, among others. These guarantees extend for the duration of the underlying service agreements and the maximum potential future payments that the Company could be required to make under these guarantees was approximately $3.0 million as of June 30, 2006. The Company would only be required to pay this maximum amount if none of the physician groups collected fees for services performed during the guarantee period.
9. Per Share Data
The calculation of diluted net income (loss) per share considers the potential dilutive effect of options to purchase 2,995,181 and 2,368,243 shares of common stock at prices ranging from $4.75 to $28.79, which were outstanding at June 30, 2006 and 2005, respectively, as well as 220,124 shares of restricted stock which were outstanding at June 30, 2006. Of the outstanding stock options, 631,717 have not been included in the calculation of diluted net income per share for the three months ended June 30, 2006, and 1,429,467 and 120,000 shares have not been included in the calculation of diluted net income per share for the nine months ended June 30, 2006 and 2005, respectively, because the options were anti-dilutive.
10. Stock Compensation Plans
At the annual meeting on March 1, 2006, stockholders approved the MedCath Corporation 2006 Stock Option and Award Plan (the Stock Plan), which provides for the issuance of stock options, restricted stock and restricted stock units to employees of the Company. The plan was approved by the board of directors to be effective as of October 1, 2005, subject to approval and ratification by the stockholders of the Company at the annual meeting. A total of 1,750,000 shares of stock were reserved for issuance under the Stock Plan. The Stock Plan will be administered by the compensation committee of the board of directors (the Committee). The Committee will have the authority to select the employees eligible to receive awards. The Committee also has the authority under the Stock Plan to determine the types of awards, select the terms and conditions attached to all awards, and, subject to the limitation on individual awards in the Stock Plan, determine the number of shares to be awarded. The Stock Plan will expire, and no awards may be granted thereunder, after September 30, 2015.
Stock options granted to employees and directors under the Stock Plan and the Company’s existing options plans have an exercise price per share that represents the fair market value of the common stock of the Company on the respective dates that the options were granted. The options expire ten years from the grant date, are fully vested and are exercisable at any time. Subsequent to the exercise of the stock option, the shares of stock acquired upon exercise may be subject to certain sales restrictions depending on the optionee’s employment status and length of time the option was held prior to exercise.
Activity for the stock option plans was as follows:
11
MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
For the Three Months Ended | ||||||||||||||||
June 30, 2006 | June 30, 2005 | |||||||||||||||
Weighted- | Weighted- | |||||||||||||||
Number of | Average | Number of | Average | |||||||||||||
Stock Options | Exercise Price | Stock Options | Exercise Price | |||||||||||||
Outstanding stock options, beginning of period | 2,914,318 | $ | 16.37 | 2,492,543 | $ | 13.40 | ||||||||||
Granted | 166,000 | 15.68 | — | — | ||||||||||||
Exercised | (50,937 | ) | 15.17 | (122,800 | ) | 17.89 | ||||||||||
Cancelled | (34,200 | ) | 20.13 | (1,500 | ) | 10.80 | ||||||||||
Outstanding stock options, end of period | 2,995,181 | $ | 16.31 | 2,368,243 | $ | 13.17 | ||||||||||
For the Nine Months Ended | ||||||||||||||||
June 30, 2006 | June 30, 2005 | |||||||||||||||
Weighted- | Weighted- | |||||||||||||||
Number of | Average | Number of | Average | |||||||||||||
Stock Options | Exercise Price | Stock Options | Exercise Price | |||||||||||||
Outstanding stock options, beginning of period | 2,409,618 | $ | 13.50 | 2,730,493 | $ | 13.09 | ||||||||||
Granted | 1,030,500 | 20.80 | 209,000 | 22.73 | ||||||||||||
Exercised | (183,237 | ) | 11.91 | (470,225 | ) | 15.81 | ||||||||||
Cancelled | (261,700 | ) | 11.13 | (101,025 | ) | 18.60 | ||||||||||
Outstanding stock options, end of period | 2,995,181 | $ | 16.31 | 2,368,243 | $ | 13.17 | ||||||||||
The following table summarizes information for stock options outstanding at June 30, 2006:
Number | Weighted- | |||||||||||
Outstanding | Average | Weighted- | ||||||||||
and | Remaining | Average | ||||||||||
Range of Prices | Exercisable | Life (years) | Exercise Price | |||||||||
$4.75 - 9.95 | 807,736 | 7.26 | $ | 9.61 | ||||||||
10.55 - 12.15 | 340,228 | 7.05 | 10.73 | |||||||||
14.89 - 15.80 | 244,500 | 8.58 | 15.21 | |||||||||
15.91 - 18.60 | 163,250 | 8.91 | 16.52 | |||||||||
18.63 - 20.19 | 454,967 | 3.91 | 19.04 | |||||||||
20.90 - 21.49 | 510,000 | 9.62 | 21.48 | |||||||||
22.50 - 28.79 | 474,500 | 9.41 | 24.06 | |||||||||
$4.75 - 28.79 | 2,995,181 | 7.67 | $ | 16.31 | ||||||||
During the three and nine months ended June 30, 2006, the Company granted to employees 32,813 and 270,836 shares of restricted stock, which vest at various dates through March 2009. The compensation expense, which represents the fair value of the stock measured at the market price at the date of grant, less estimated forfeitures, is recognized on a straight-line basis over the service period.
11. Reportable Segment Information
The Company’s reportable segments consist of the Hospital Division and the Diagnostics Division. Financial information concerning the Company’s operations by each of the reportable segments as of and for the periods indicated is as follows:
12
MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
Three Months Ended June 30, | Nine Months Ended June 30, | |||||||||||||||
2006 | 2005 | 2006 | 2005 | |||||||||||||
Net revenue: | ||||||||||||||||
Hospital Division | $ | 176,536 | $ | 165,739 | $ | 512,791 | $ | 482,807 | ||||||||
Diagnostics Division | 12,739 | 12,971 | 39,201 | 38,427 | ||||||||||||
Corporate and other | 557 | 1,077 | 2,164 | 2,922 | ||||||||||||
Consolidated totals | $ | 189,832 | $ | 179,787 | $ | 554,156 | $ | 524,156 | ||||||||
Income (loss) from operations: | ||||||||||||||||
Hospital Division | $ | 19,339 | $ | 15,451 | $ | 44,912 | $ | 44,317 | ||||||||
Diagnostics Division | 2,320 | 2,016 | 8,203 | 6,321 | ||||||||||||
Corporate and other | (4,434 | ) | (2,252 | ) | (22,204 | ) | (6,836 | ) | ||||||||
Consolidated totals | $ | 17,225 | $ | 15,215 | $ | 30,911 | $ | 43,802 | ||||||||
Depreciation and amortization: | ||||||||||||||||
Hospital Division | $ | 7,946 | $ | 7,484 | $ | 23,706 | $ | 22,621 | ||||||||
Diagnostics Division | 1,474 | 1,567 | 4,327 | 4,618 | ||||||||||||
Corporate and other | 198 | 273 | 524 | 845 | ||||||||||||
Consolidated totals | $ | 9,618 | $ | 9,324 | $ | 28,557 | $ | 28,084 | ||||||||
Interest expense (income), net: | ||||||||||||||||
Hospital Division | $ | 8,920 | $ | 8,375 | $ | 26,554 | $ | 23,484 | ||||||||
Diagnostics Division | 7 | 50 | 47 | 183 | ||||||||||||
Corporate and other | (2,619 | ) | (850 | ) | (5,053 | ) | (1,392 | ) | ||||||||
Consolidated totals | $ | 6,308 | $ | 7,575 | $ | 21,548 | $ | 22,275 | ||||||||
Capital expenditures: | ||||||||||||||||
Hospital Division | $ | 3,559 | $ | 1,969 | $ | 15,043 | $ | 10,230 | ||||||||
Diagnostics Division | 2,404 | 330 | 6,912 | 1,730 | ||||||||||||
Corporate and other | 577 | 747 | 1,780 | 1,664 | ||||||||||||
Consolidated totals | $ | 6,540 | $ | 3,046 | $ | 23,735 | $ | 13,624 | ||||||||
June 30, | September 30, | |||||||
2006 | 2005 | |||||||
Aggregate identifiable assets: | ||||||||
Hospital Division | $ | 575,455 | $ | 572,991 | ||||
Diagnostics Division | 40,605 | 39,430 | ||||||
Corporate and other | 151,455 | 150,784 | ||||||
Consolidated totals | $ | 767,515 | $ | 763,205 | ||||
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, general overhead and administrative expenses, financing activities, cash and cash equivalents, prepaid expenses, other assets and operations of the business not subject to separate segment reporting.
12. Guarantor/Non-Guarantor Financial Statements
The following tables present the condensed consolidated financial information for each of MedCath Corporation (the Parent), MedCath Holdings Corp. (the Issuer), all 95% or greater owned domestic subsidiaries of the Issuer (the Guarantors) and the subsidiaries of the Issuer that are not Guarantors (the Non-Guarantors), together with consolidating eliminations, as of and for the periods indicated.
13
MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
MEDCATH CORPORATION
CONDENSED CONSOLIDATING BALANCE SHEET
June 30, 2006
CONDENSED CONSOLIDATING BALANCE SHEET
June 30, 2006
Non- | ||||||||||||||||||||||||
Parent | Issuer | Guarantors | Guarantors | Eliminations | MedCath | |||||||||||||||||||
Current assets: | ||||||||||||||||||||||||
Cash and cash equivalents | $ | — | $ | — | $ | 129,434 | $ | 15,127 | $ | — | $ | 144,561 | ||||||||||||
Accounts receivable, net | — | — | 4,614 | 87,226 | — | 91,840 | ||||||||||||||||||
Other current assets | — | — | 26,542 | 24,029 | (12,879 | ) | 37,692 | |||||||||||||||||
Current assets of discontinued operations | — | — | 1,099 | 13,476 | (1,099 | ) | 13,476 | |||||||||||||||||
Total current assets | — | — | 161,689 | 139,858 | (13,978 | ) | 287,569 | |||||||||||||||||
Property and equipment, net | — | — | 22,464 | 340,931 | — | 363,395 | ||||||||||||||||||
Investments in subsidiaries | 299,480 | 299,480 | (23,395 | ) | (62 | ) | (575,503 | ) | — | |||||||||||||||
Goodwill | — | — | 65,540 | — | — | 65,540 | ||||||||||||||||||
Intercompany notes receivables | — | — | 222,044 | — | (222,044 | ) | — | |||||||||||||||||
Other long-term assets | — | — | 20,134 | 6,365 | — | 26,499 | ||||||||||||||||||
Long-term assets of discontinued operations | — | — | 44,331 | 19,952 | (39,771 | ) | 24,512 | |||||||||||||||||
Total assets | $ | 299,480 | $ | 299,480 | $ | 512,807 | $ | 507,044 | $ | (851,296 | ) | $ | 767,515 | |||||||||||
Current liabilities: | ||||||||||||||||||||||||
Accounts payable | $ | — | $ | — | $ | 769 | $ | 38,225 | $ | — | $ | 38,994 | ||||||||||||
Accrued compensation and benefits | — | — | 8,307 | 14,456 | — | 22,763 | ||||||||||||||||||
Other current liabilities | — | — | 10,292 | 24,742 | (12,879 | ) | 22,155 | |||||||||||||||||
Current portion of long- term debt and obligations under capital leases | — | — | 1,504 | 38,564 | — | 40,068 | ||||||||||||||||||
Current liabilities of discontinued operations | — | — | — | 9,228 | (1,099 | ) | 8,129 | |||||||||||||||||
Total current liabilities | — | — | 20,872 | 125,215 | (13,978 | ) | 132,109 | |||||||||||||||||
Long- term debt | — | — | 177,759 | 118,431 | — | 296,190 | ||||||||||||||||||
Obligations under capital leases | — | — | 1,068 | 829 | — | 1,897 | ||||||||||||||||||
Intercompany notes payable | — | — | — | 222,044 | (222,044 | ) | — | |||||||||||||||||
Deferred income tax liabilities | — | — | 13,628 | — | — | 13,628 | ||||||||||||||||||
Other long- term obligations | — | — | — | 319 | — | 319 | ||||||||||||||||||
Long-term liabilities of discontinued operations | — | — | — | 39,864 | (39,771 | ) | 93 | |||||||||||||||||
Total liabilities | — | — | 213,327 | 506,702 | (275,793 | ) | 444,236 | |||||||||||||||||
Minority interest in equity of consolidated subsidiaries | — | — | — | — | 23,799 | 23,799 | ||||||||||||||||||
Total stockholders’ equity | 299,480 | 299,480 | 299,480 | 342 | (599,302 | ) | 299,480 | |||||||||||||||||
Total liabilities and stockholders’ equity | $ | 299,480 | $ | 299,480 | $ | 512,807 | $ | 507,044 | $ | (851,296 | ) | $ | 767,515 | |||||||||||
14
MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
MEDCATH CORPORATION
CONDENSED CONSOLIDATING BALANCE SHEET
September 30, 2005
CONDENSED CONSOLIDATING BALANCE SHEET
September 30, 2005
Non- | ||||||||||||||||||||||||
Parent | Issuer | Guarantors | Guarantors | Eliminations | MedCath | |||||||||||||||||||
Current assets: | ||||||||||||||||||||||||
Cash and cash equivalents | $ | — | $ | — | $ | 122,829 | $ | 18,013 | $ | — | $ | 140,842 | ||||||||||||
Accounts receivable, net | — | — | 4,778 | 81,360 | — | 86,138 | ||||||||||||||||||
Other current assets | — | — | 28,812 | 21,532 | (12,028 | ) | 38,316 | |||||||||||||||||
Current assets of discontinued operations | — | — | 1,170 | 11,546 | (1,170 | ) | 11,546 | |||||||||||||||||
Total current assets | — | — | 157,589 | 132,451 | (13,198 | ) | 276,842 | |||||||||||||||||
Property and equipment, net | — | — | 19,070 | 349,712 | — | 368,782 | ||||||||||||||||||
Investments in subsidiaries | 282,741 | 282,741 | (15,950 | ) | (64 | ) | (549,468 | ) | — | |||||||||||||||
Goodwill | — | — | 65,540 | — | — | 65,540 | ||||||||||||||||||
Intercompany notes receivable | — | — | 275,634 | — | (275,634 | ) | — | |||||||||||||||||
Other long-term assets | — | — | 21,935 | 5,015 | — | 26,950 | ||||||||||||||||||
Long-term assets of discontinued operations | — | — | 41,884 | 20,531 | (37,324 | ) | 25,091 | |||||||||||||||||
Total assets | $ | 282,741 | $ | 282,741 | $ | 565,702 | $ | 507,645 | $ | (875,624 | ) | $ | 763,205 | |||||||||||
Current liabilities: | ||||||||||||||||||||||||
Accounts payable | $ | — | $ | — | $ | 1,052 | $ | 35,919 | $ | — | $ | 36,971 | ||||||||||||
Accrued compensation and benefits | — | — | 6,603 | 14,442 | — | 21,045 | ||||||||||||||||||
Other current liabilities | — | — | 8,107 | 25,625 | (12,028 | ) | 21,704 | |||||||||||||||||
Current portion of long- term debt and obligations under capital leases | — | — | 2,362 | 52,523 | — | 54,885 | ||||||||||||||||||
Current liabilities of discontinued operations | — | — | — | 8,305 | (1,170 | ) | 7,135 | |||||||||||||||||
Total current liabilities | — | — | 18,124 | 136,814 | (13,198 | ) | 141,740 | |||||||||||||||||
Long- term debt | — | — | 247,605 | 48,786 | — | 296,391 | ||||||||||||||||||
Obligations under capital leases | — | — | 1,559 | 1,451 | — | 3,010 | ||||||||||||||||||
Intercompany notes payable | — | — | — | 275,634 | (275,634 | ) | — | |||||||||||||||||
Deferred income tax liabilities | — | — | 15,673 | — | — | 15,673 | ||||||||||||||||||
Other long- term obligations | — | — | — | 497 | — | 497 | ||||||||||||||||||
Long-term liabilities of discontinued operations | — | — | — | 37,577 | (37,324 | ) | 253 | |||||||||||||||||
Total liabilities | — | — | 282,961 | 500,759 | (326,156 | ) | 457,564 | |||||||||||||||||
Minority interest in equity of consolidated subsidiaries | — | — | — | — | 22,900 | 22,900 | ||||||||||||||||||
Total stockholders’ equity | 282,741 | 282,741 | 282,741 | 6,886 | (572,368 | ) | 282,741 | |||||||||||||||||
Total liabilities and stockholders’ equity | $ | 282,741 | $ | 282,741 | $ | 565,702 | $ | 507,645 | $ | (875,624 | ) | $ | 763,205 | |||||||||||
15
MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
MEDCATH CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Three Months Ended June 30, 2006
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Three Months Ended June 30, 2006
Parent | Issuer | Guarantors | Non- Guarantors | Eliminations | MedCath | |||||||||||||||||||
Net revenue | $ | — | $ | — | $ | 8,290 | $ | 183,731 | $ | (2,189 | ) | $ | 189,832 | |||||||||||
Total operating expenses | — | — | 12,711 | 162,085 | (2,189 | ) | 172,607 | |||||||||||||||||
Income (loss) from operations | — | — | (4,421 | ) | 21,646 | — | 17,225 | |||||||||||||||||
Interest expense | — | — | (4,634 | ) | (3,236 | ) | — | (7,870 | ) | |||||||||||||||
Interest and other income, net | — | — | 8,636 | (5,659 | ) | — | 2,977 | |||||||||||||||||
Equity in net earnings of unconsolidated affiliates | 4,910 | 4,910 | 8,609 | — | (17,021 | ) | 1,408 | |||||||||||||||||
Income (loss) from continuing operations before minority interest, income taxes and discontinued operations | 4,910 | 4,910 | 8,190 | 12,751 | (17,021 | ) | 13,740 | |||||||||||||||||
Minority interest share of earnings of consolidated subsidiaries | — | — | — | — | (4,742 | ) | (4,742 | ) | ||||||||||||||||
Income (loss) from continuing operations before income taxes and discontinued operations | 4,910 | 4,910 | 8,190 | 12,751 | (21,763 | ) | 8,998 | |||||||||||||||||
Income tax expense | — | — | (3,649 | ) | — | — | (3,649 | ) | ||||||||||||||||
Income (loss) from continuing operations | 4,910 | 4,910 | 4,541 | 12,751 | (21,763 | ) | 5,349 | |||||||||||||||||
Income (loss) from discontinued operations, net of taxes | — | — | 369 | (808 | ) | — | (439 | ) | ||||||||||||||||
Net income (loss) | $ | 4,910 | $ | 4,910 | $ | 4,910 | $ | 11,943 | $ | (21,763 | ) | $ | 4,910 | |||||||||||
MEDCATH CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Three Months Ended June 30, 2005
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Three Months Ended June 30, 2005
Parent | Issuer | Guarantors | Non- Guarantors | Eliminations | MedCath | |||||||||||||||||||
Net revenue | $ | — | $ | — | $ | 8,301 | $ | 173,873 | $ | (2,387 | ) | $ | 179,787 | |||||||||||
Total operating expenses | 10,941 | 156,018 | (2,387 | ) | 164,572 | |||||||||||||||||||
Income (loss) from operations | — | — | (2,640 | ) | 17,855 | — | 15,215 | |||||||||||||||||
Interest expense | — | — | (5,637 | ) | (2,803 | ) | — | (8,440 | ) | |||||||||||||||
Interest and other income, net | — | — | 6,434 | (5,566 | ) | — | 868 | |||||||||||||||||
Equity in net earnings of unconsolidated affiliates | 2,749 | 2,749 | 7,525 | — | (12,124 | ) | 899 | |||||||||||||||||
Income (loss) from continuing operations before minority interest, income taxes and discontinued operations | 2,749 | 2,749 | 5,682 | 9,486 | (12,124 | ) | 8,542 | |||||||||||||||||
Minority interest share of earnings of consolidated subsidiaries | — | — | — | — | (3,956 | ) | (3,956 | ) | ||||||||||||||||
Income (loss) from continuing operations before income taxes and discontinued operations | 2,749 | 2,749 | 5,682 | 9,486 | (16,080 | ) | 4,586 | |||||||||||||||||
Income tax expense | — | — | (1,952 | ) | — | — | (1,952 | ) | ||||||||||||||||
Income (loss) from continuing operations | 2,749 | 2,749 | 3,730 | 9,486 | (16,080 | ) | 2,634 | |||||||||||||||||
Income (loss) from discontinued operations, net of taxes | — | — | (981 | ) | 1,096 | — | 115 | |||||||||||||||||
Net income (loss) | $ | 2,749 | $ | 2,749 | $ | 2,749 | $ | 10,582 | $ | (16,080 | ) | $ | 2,749 | |||||||||||
16
MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
MEDCATH CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Nine Months Ended June 30, 2006
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Nine Months Ended June 30, 2006
Parent | Issuer | Guarantors | Non- Guarantors | Eliminations | MedCath | |||||||||||||||||||
Net revenue | $ | — | $ | — | $ | 24,190 | $ | 537,027 | $ | (7,061 | ) | $ | 554,156 | |||||||||||
Total operating expenses | — | — | 47,068 | 483,238 | (7,061 | ) | 523,245 | |||||||||||||||||
Income (loss) from operations | — | — | (22,878 | ) | 53,789 | — | 30,911 | |||||||||||||||||
Interest expense | — | — | (16,545 | ) | (9,283 | ) | — | (25,828 | ) | |||||||||||||||
Interest and other income (expense), net | — | — | 22,893 | (17,145 | ) | — | 5,748 | |||||||||||||||||
Equity in net earnings of unconsolidated affiliates | 1,637 | 1,637 | 19,092 | — | (18,483 | ) | 3,883 | |||||||||||||||||
Income (loss) before minority interest, income taxes and discontinued operations | 1,637 | 1,637 | 2,562 | 27,361 | (18,483 | ) | 14,714 | |||||||||||||||||
Minority interest share of earnings of consolidated subsidiaries | — | — | — | — | (12,350 | ) | (12,350 | ) | ||||||||||||||||
Income (loss) before income taxes and discontinued operations | 1,637 | 1,637 | 2,562 | 27,361 | (30,833 | ) | 2,364 | |||||||||||||||||
Income tax expense | — | — | (993 | ) | — | — | (993 | ) | ||||||||||||||||
Income (loss) from continuing operations | 1,637 | 1,637 | 1,569 | 27,361 | (30,833 | ) | 1,371 | |||||||||||||||||
Income (loss) from discontinued operations | — | — | 68 | 198 | — | 266 | ||||||||||||||||||
Net income | $ | 1,637 | $ | 1,637 | $ | 1,637 | $ | 27,559 | $ | (30,833 | ) | $ | 1,637 | |||||||||||
MEDCATH CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Nine Months Ended June 30, 2005
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Nine Months Ended June 30, 2005
Parent | Issuer | Guarantors | Non- Guarantors | Eliminations | MedCath | |||||||||||||||||||
Net revenue | $ | — | $ | — | $ | 24,484 | $ | 506,822 | $ | (7,150 | ) | $ | 524,156 | |||||||||||
Total operating expenses | 32,318 | 455,186 | (7,150 | ) | 480,354 | |||||||||||||||||||
Income (loss) from operations | — | — | (7,834 | ) | 51,636 | — | 43,802 | |||||||||||||||||
Interest expense | — | — | (16,668 | ) | (7,461 | ) | — | (24,129 | ) | |||||||||||||||
Interest and other income (expense), net | — | — | 17,882 | (16,012 | ) | — | 1,870 | |||||||||||||||||
Equity in net earnings of unconsolidated affiliates | 11,092 | 11,092 | 32,155 | — | (51,785 | ) | 2,554 | |||||||||||||||||
Income before minority interest, income taxes and discontinued operations | 11,092 | 11,092 | 25,535 | 28,163 | (51,785 | ) | 24,097 | |||||||||||||||||
Minority interest share of earnings of consolidated subsidiaries | — | — | — | — | (12,357 | ) | (12,357 | ) | ||||||||||||||||
Income before income taxes and discontinued operations | 11,092 | 11,092 | 25,535 | 28,163 | (64,142 | ) | 11,740 | |||||||||||||||||
Income tax expense | — | — | (4,814 | ) | — | — | (4,814 | ) | ||||||||||||||||
Income from continuing operations | 11,092 | 11,092 | 20,721 | 28,163 | (64,142 | ) | 6,926 | |||||||||||||||||
Income (loss) from discontinued operations | — | — | (9,629 | ) | 13,795 | — | 4,166 | |||||||||||||||||
Net income | $ | 11,092 | $ | 11,092 | $ | 11,092 | $ | 41,958 | $ | (64,142 | ) | $ | 11,092 | |||||||||||
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MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
MEDCATH CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Nine Months Ended June 30, 2006
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Nine Months Ended June 30, 2006
Non- | ||||||||||||||||||||
Parent | Guarantors | Guarantors | Eliminations | MedCath | ||||||||||||||||
Net cash provided by operating activities | $ | — | $ | 11,357 | $ | 42,756 | $ | — | $ | 54,113 | ||||||||||
Net cash provided by (used in) investing activities | (2,684 | ) | 14,448 | (15,109 | ) | (19,970 | ) | (23,315 | ) | |||||||||||
Net cash provided by (used in) financing activities | 2,684 | (19,200 | ) | (30,533 | ) | 19,970 | (27,079 | ) | ||||||||||||
Increase (decrease) in cash and cash equivalents | — | 6,605 | (2,886 | ) | — | 3,719 | ||||||||||||||
Cash and cash equivalents: | ||||||||||||||||||||
Beginning of period | — | 122,829 | 18,013 | — | 140,842 | |||||||||||||||
End of period | $ | — | $ | 129,434 | $ | 15,127 | $ | — | $ | 144,561 | ||||||||||
MEDCATH CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Nine Months Ended June 30, 2005
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Nine Months Ended June 30, 2005
Non- | ||||||||||||||||||||
Parent | Guarantors | Guarantors | Eliminations | MedCath | ||||||||||||||||
Net cash provided by operating activities | $ | — | $ | 7,356 | $ | 40,462 | $ | — | $ | 47,818 | ||||||||||
Net cash provided by (used in) investing activities | (8,691 | ) | 14,006 | 26,992 | (3,281 | ) | 29,026 | |||||||||||||
Net cash provided by (used in) financing activities | 8,691 | 46,556 | (64,911 | ) | 3,281 | (6,383 | ) | |||||||||||||
Increase in cash and cash equivalents | — | 67,918 | 2,543 | — | 70,461 | |||||||||||||||
Cash and cash equivalents: | ||||||||||||||||||||
Beginning of period | — | 56,122 | 13,733 | — | 69,855 | |||||||||||||||
End of period | $ | — | $ | 124,040 | $ | 16,276 | $ | — | $ | 140,316 | ||||||||||
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Item 2. 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 interim unaudited consolidated financial statements and related notes included elsewhere in this report, as well as the audited consolidated financial statements and related notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report onForm 10-K for the fiscal year ended September 30, 2005.
Overview
General. We are a healthcare provider focused primarily on the diagnosis and treatment of cardiovascular disease. We own and operate hospitals in partnership with physicians whom we believe have established reputations for clinical excellence as well as with community hospital systems. We also manage the cardiovascular program of various hospitals operated by other parties. We opened our first hospital in 1996 and currently have ownership interests in and operate eleven hospitals, excluding Tucson Heart Hospital, which we intend to sell. We have majority ownership of ten of these hospitals and a minority interest in one. Each of our majority-owned hospitals is a freestanding, licensed general acute care hospital that provides a wide range of health services, and the medical staff at each of our hospitals includes qualified physicians in various specialties. The hospitals in which we have ownership interests have a total of 667 licensed beds and are located in eight states: Arizona, Arkansas, California, Louisiana, New Mexico, Ohio, South Dakota, and Texas.
In addition to our hospitals, we own and/or manage cardiac diagnostic and therapeutic facilities. We began our cardiac diagnostic and therapeutic business in 1989. We currently own and/or manage twenty-six cardiac diagnostic and therapeutic facilities. Ten of these facilities are located at hospitals operated by other parties and offer invasive diagnostic and, in some cases, therapeutic procedures. The remaining sixteen facilities are not located at hospitals and offer only diagnostic procedures.
Basis of Consolidation.We have included in our consolidated financial statements hospitals and cardiac diagnostic and therapeutic facilities over which we exercise substantive control, including all entities in which we own more than a 50% interest, as well as variable interest entities in which we are the primary beneficiary. We have used the equity method of accounting for entities, including variable interest entities, in which we hold less than a 50% interest and over which we do not exercise substantive control, and are not the primary beneficiary. Accordingly, the one hospital in which we hold a minority interest, Avera Heart Hospital of South Dakota, is excluded from the net revenue and operating expenses of our consolidated company and our consolidated hospital division. Similarly, a number of our diagnostic and therapeutic facilities are excluded from the net revenue and operating results of our consolidated company and our consolidated diagnostics division. Our interest in the results of operations for the periods discussed for these entities is recognized as part of the equity in net earnings of unconsolidated affiliates in our statements of operations in accordance with the equity method of accounting.
On June 20, 2006, we announced that we intend to sell our 58.8% interest in Tucson Heart Hospital (THH) to Carondelet Health Network, a southern Arizona-based not-for-profit health care organization and part owner of THH. The terms of the sale are subject to the signing of a definitive agreement and customary closing conditions. In addition, during the first quarter of fiscal 2005, we closed The Heart Hospital of Milwaukee (HHM) and sold substantially all of the hospital’s assets. Accordingly, for the three and nine months ended June 30, 2006 and 2005, the results of operations of THH and HHM, as well as the related gain on the sale of the assets of HHM, have been excluded from continuing operations and are reported in income (loss) from discontinued operations.
Revenue Sources by Division.The largest percentage of our net revenue is attributable to our hospital division. The following table sets forth the percentage contribution of each of our consolidating divisions to consolidated net revenue in the periods indicated below.
Three Months Ended June 30, | Nine Months Ended June 30, | |||||||||||||||
Division | 2006 | 2005 | 2006 | 2005 | ||||||||||||
Hospital | 93.0 | % | 92.2 | % | 92.5 | % | 92.1 | % | ||||||||
Diagnostics | 6.7 | % | 7.2 | % | 7.1 | % | 7.3 | % | ||||||||
Corporate and other | 0.3 | % | 0.6 | % | 0.4 | % | 0.6 | % | ||||||||
Net Revenue | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
Revenue Sources by Payor.We receive payments for our services rendered to patients from the Medicare and Medicaid programs, commercial insurers, health maintenance organizations and our patients directly. Generally, our net revenue is determined by a number of factors, including the payor mix, the number and nature of procedures performed and the rate of payment for the procedures. Since cardiovascular disease disproportionately affects those age 55 and older, the proportion of net revenue we derive from the Medicare program is higher than that of most general acute care hospitals. The following table sets forth the percentage of consolidated net revenue we earned by category of payor in the periods indicated.
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Three Months Ended June 30, | Nine Months Ended June 30, | |||||||||||||||
Payor | 2006 | 2005 | 2006 | 2005 | ||||||||||||
Medicare | 44.9 | % | 48.8 | % | 46.1 | % | 49.2 | % | ||||||||
Medicaid | 4.6 | % | 3.8 | % | 4.5 | % | 3.8 | % | ||||||||
Commercial and other, including self-pay | 50.5 | % | 47.4 | % | 49.4 | % | 47.0 | % | ||||||||
Total consolidated net revenue | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
While commercial and self-pay net revenue has increased in recent periods, significant portion of our net revenue is derived from federal and state governmental healthcare programs, including Medicare and Medicaid and we expect the net revenue that we receive from the Medicare program as a percentage of total consolidated net revenue will remain significant in future periods. However, our payor mix is subject to fluctuations due to changes in reimbursement, market and industry trends with self-pay patients and other similar factors.
The Medicare and Medicaid programs are subject to statutory and regulatory changes, retroactive and prospective rate adjustments, administrative rulings, court decisions, executive orders and freezes and funding reductions, all of which may significantly affect our business. Historically, Congress and some state legislatures have, from time to time, proposed significant changes in the healthcare system. Many of these changes have resulted in limitations on, and in some cases, significant reductions in the levels of, payments to healthcare providers for services under many government reimbursement programs. Most recently, the Department of Health and Human Services has changed and has proposed to further refine the diagnosis-related group (DRG) system under the Medicare hospital inpatient prospective payment system. The stated intent of these refinements to the DRG system is to better capture differences in the severity of illness among patients and to base Medicare reimbursement upon the estimated costs of providing care, rather than actual charges for care. Implementation of these proposals could, or future federal and state legislation or action by government agencies may, materially and adversely reduce the payments we or our facilities receive for our services to patients covered by Medicare, Medicaid and commercial plans indexed to Medicare. The payment reductions would in turn negatively impact our financial position and results of operations. As we are currently evaluating the impact of the changes to the DRG system that were announced on August 1, 2006, no impairment charge was recorded during the nine months ended June 30, 2006; however, the financial impact on certain individual hospitals may result in a future write-off of long-lived assets.
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 possibility that recorded estimates will change by a material amount in the near term.
Results of Operations
Three Months Ended June 30, 2006 Compared to Three Months Ended June 30, 2005
Statement of Operations Data.The following table presents our results of operations in dollars and as a percentage of net revenue for the periods indicated:
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Three Months Ended June 30, | ||||||||||||||||||||||||
Increase / Decrease | % of Net Revenue | |||||||||||||||||||||||
2006 | 2005 | $ | % | 2006 | 2005 | |||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
Net revenue | $ | 189,832 | $ | 179,787 | $ | 10,045 | 5.6 | % | �� | 100.0 | % | 100.0 | % | |||||||||||
Operating expenses: | ||||||||||||||||||||||||
Personnel expense | 58,033 | 53,893 | 4,140 | 7.7 | % | 30.6 | % | 30.0 | % | |||||||||||||||
Medical supplies expense | 52,657 | 51,047 | 1,610 | 3.2 | % | 27.7 | % | 28.4 | % | |||||||||||||||
Bad debt expense | 14,228 | 13,874 | 354 | 2.6 | % | 7.6 | % | 7.7 | % | |||||||||||||||
Other operating expenses | 37,916 | 36,286 | 1,630 | 4.5 | % | 20.0 | % | 20.2 | % | |||||||||||||||
Depreciation | 9,366 | 9,034 | 332 | 3.7 | % | 4.9 | % | 5.0 | % | |||||||||||||||
Amortization | 252 | 290 | (38 | ) | (13.1 | )% | 0.1 | % | 0.1 | % | ||||||||||||||
(Gain) loss on disposal of property, equipment and other assets | (296 | ) | 148 | (444 | ) | (300.0 | )% | (0.2 | )% | 0.1 | % | |||||||||||||
Impairment of long-lived assets | 451 | — | 451 | 100.0 | % | 0.2 | % | — | ||||||||||||||||
Total operating expenses | 172,607 | 164,572 | 8,035 | 4.9 | % | 90.9 | % | 91.5 | % | |||||||||||||||
Income from operations | 17,225 | 15,215 | 2,010 | 13.2 | % | 9.1 | % | 8.5 | % | |||||||||||||||
Other income (expenses): | ||||||||||||||||||||||||
Interest expense | (7,870 | ) | (8,440 | ) | 570 | 6.8 | % | (4.1 | )% | (4.7 | )% | |||||||||||||
Interest and other income, net | 2,977 | 868 | 2,109 | 243.0 | % | 1.6 | % | 0.5 | % | |||||||||||||||
Equity in net earnings of unconsolidated affiliates | 1,408 | 899 | 509 | 56.6 | % | 0.7 | % | 0.5 | % | |||||||||||||||
Total other expenses, net | (3,485 | ) | (6,673 | ) | 3,188 | 47.8 | % | (1.8 | )% | (3.7 | )% | |||||||||||||
Income from continuing operations before minority interest, income taxes and discontinued operations | 13,740 | 8,542 | 5,198 | 60.9 | % | 7.3 | % | 4.8 | % | |||||||||||||||
Minority interest share of earnings of consolidated subsidiaries | (4,742 | ) | (3,956 | ) | (786 | ) | (19.9 | )% | (2.5 | )% | (2.2 | )% | ||||||||||||
Income from continuing operations before income taxes and discontinued operations | 8,998 | 4,586 | 4,412 | 96.2 | % | 4.8 | % | 2.6 | % | |||||||||||||||
Income tax expense | 3,649 | 1,952 | 1,697 | 86.9 | % | 1.9 | % | 1.1 | % | |||||||||||||||
Income from continuing operations | 5,349 | 2,634 | 2,715 | 103.1 | % | 2.9 | % | 1.5 | % | |||||||||||||||
(Loss) income from discontinued operations, net of taxes | (439 | ) | 115 | (554 | ) | (481.7 | )% | (0.2 | )% | — | ||||||||||||||
Net income | $ | 4,910 | $ | 2,749 | $ | 2,161 | 78.6 | % | 2.7 | % | 1.5 | % | ||||||||||||
The following table presents selected operating data on a consolidated basis for the periods indicated:
Three Months Ended June 30, | ||||||||||||
2006 | 2005 | % Change | ||||||||||
Selected Operating Data (a): | ||||||||||||
Number of hospitals | 10 | 10 | ||||||||||
Licensed beds (b) | 612 | 612 | ||||||||||
Staffed and available beds (c) | 595 | �� | 571 | |||||||||
Admissions (d) | 11,115 | 10,364 | 7.2 | % | ||||||||
Adjusted admissions (e) | 14,494 | 13,555 | 6.9 | % | ||||||||
Patient days (f) | 35,508 | 36,281 | (2.1 | )% | ||||||||
Adjusted patient days (g) | 46,318 | 47,202 | (1.9 | )% | ||||||||
Average length of stay (days) (h) | 3.19 | 3.50 | (8.9 | )% | ||||||||
Occupancy (i) | 65.6 | % | 69.8 | % | ||||||||
Inpatient catheterization procedures | 5,838 | 5,457 | 7.0 | % | ||||||||
Inpatient surgical procedures | 2,920 | 2,915 | 0.2 | % |
(a) | Selected operating data includes consolidated hospitals in operation as of the end of the period reported in continuing operations but does not include hospitals which are accounted for using the equity method or as discontinued operations in our consolidated financial statements. | |
(b) | Licensed beds represent the number of beds for which the appropriate state agency licenses a facility regardless of whether the beds are actually available for patient use. | |
(c) | Staffed and available beds represent the number of beds that are readily available for patient use at the end of the period. | |
(d) | Admissions represent the number of patients admitted for inpatient treatment. | |
(e) | Adjusted admissions is a general measure of combined inpatient and outpatient volume. We computed adjusted admissions by dividing gross patient revenue by gross inpatient revenue and then multiplying the quotient by admissions. | |
(f) | Patient days represent the total number of days of care provided to inpatients. | |
(g) | Adjusted patient days is a general measure of combined inpatient and outpatient days. We computed adjusted patient days by dividing gross patient revenue by gross inpatient revenue and then multiplying the quotient by patient days. |
21
(h) | Average length of stay (days) represents the average number of days inpatients stay in our hospitals. | |
(i) | We computed occupancy by dividing patient days by the number of days in the period and then dividing the quotient by the number of staffed and available beds. |
Net Revenue.Net revenue increased 5.6% or $10.0 million to $189.8 million for the three months ended June 30, 2006, the third quarter of our fiscal year 2006, from $179.8 million for the three months ended June 30, 2005, the third quarter of our fiscal year 2005. The increase was entirely attributable to the hospital division as we experienced small decreases in our other divisions for the comparable periods.
The increase in hospital division net revenue of $10.8 million was a result of increases in net revenue at the majority of our facilities period to period, although certain facilities did experience a decline in net revenue. Our three newest facilities, Heart Hospital of Lafayette, Texsan Heart Hospital and Louisiana Heart Hospital comprised 34.2% of the net revenue increase quarter to quarter. Overall, on a consolidated basis, hospital admissions increased 7.2% and adjusted admissions increased 6.9% for the third quarter of fiscal 2006 compared to the third quarter of fiscal 2005. While we experienced increases in both revenue and operating statistics for the hospital division as a whole for the comparable periods, the favorable trends at the majority of our hospitals were partially offset by lower admissions and lower net revenue at certain of our hospitals. On an adjusted admissions basis, revenue declined slightly to $12,098 for the three months ended June 30, 2006 as compared to $12,204 for the three months ended June 30, 2005. Further, Heart Hospital of Lafayette is not performing to management’s expectations due to weaker volumes than we anticipated. We are monitoring the operations of all our facilities and we continue to take actions to improve the performance; however, as net revenue is influenced by a number of factors including payor mix, number and nature of procedures and overall admissions, the revenue trends at individual hospitals may experience unpredictable fluctuations.
During the third quarter of fiscal 2006, we recognized unfavorable contractual adjustments of $0.5 million related to Medicare and Medicaid cost report settlements for prior periods. In addition, we incurred $1.4 million of contractual allowance adjustments that decreased net revenue as a result of our calculation of amounts owed to us by Medicare under disproportionate share hospital (DSH) provisions for fiscal 2005 based on rates published in early August 2006. DSH amounts are provided to facilities that have a high proportion of Medicaid payors and the calculation of the amounts owed is based on formulas that incorporate the number of Medicaid days among other factors. There were no such contractual adjustments during the third quarter of fiscal 2005.
Also, during the third quarter of fiscal 2006, we received the final payment from our insurance carrier related to the temporary suspension of services at Arizona Heart Hospital resulting from a fire at the facility during the first quarter of fiscal 2006. Receipt of this payment increased our third quarter net revenue by $1.2 million.
Personnel expense.Personnel expense increased 7.7% to $58.0 million for the third quarter of fiscal 2006 from $53.9 million for the third quarter of fiscal 2005. The $4.1 million increase in personnel expense was partially due to $1.8 million in non-cash share-based compensation recognized during the third quarter of fiscal 2006. In comparison, there was no non-cash share-based compensation recognized during the third quarter of fiscal 2005. Excluding the non-cash share-based compensation, personnel expense increased $2.3 million, or 4.4%, for the comparable periods and as a percentage of net revenue, personnel expense decreased to 29.6% from 30.0%.
On October 1, 2005, we adopted Statement of Financial Accounting Standards (SFAS) No. 123R (revised 2004),Share-Based Payment, which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors based on estimated fair values. Using this methodology and since all options are immediately vested, the share-based compensation expense recognized for the three months ended June 30, 2006 was $1.4 million, which was a result of filling certain vacant senior management positions during the period. In addition, we recognized $0.4 million of non-cash share-based compensation expense related to the amortization of the expense related to restricted stock awards issued during the second quarter of fiscal 2006. All options granted during the three months ended June 30, 2005 under the Company’s stock option plans had an exercise price equal to the market value of the underlying shares of common stock at the date of grant and therefore, no share-based compensation expense was recorded for the three months ended June 30, 2005. See“Recent Accounting Pronouncements.”
The remaining increase in personnel expense was primarily incurred at our hospitals due to cost of living wage adjustments during the first quarter of fiscal 2006, in addition to increased staffing, permanent and contract, at certain facilities to support the overall growth in admissions in the third quarter of fiscal 2006 compared to the same period in fiscal 2005 for these facilities. On an adjusted patient day basis, personnel expense increased by 6.3% to $1,157 per adjusted patient day for the third quarter of fiscal 2006 compared to $1,088 per adjusted patient day for the third quarter of fiscal 2005. This increase is driven by the cost of living wage increases, as well as the decrease in our average length of stay, which is consistent with our focus on efficient patient care at our facilities. On an adjusted admissions basis, personnel costs actually decreased by 2.2% period to period.
Medical supplies expense.Medical supplies expense increased 3.2% to $52.7 million for the third quarter of fiscal 2006 from $51.0 million for the third quarter of fiscal 2005, which is primarily attributable to the increased volume during the period. On an adjusted patient day basis, medical supplies expense increased to $1,059 per adjusted patient day for the third quarter of fiscal 2006 compared to $999 per adjusted patient day for the third quarter of fiscal 2005, which is a 6.1% increase. As a percentage of net revenue, medical supplies expense decreased to 27.7% as compared to 28.4% for the three months ended June 30, 2006 and 2005, respectively. As a result of a reduction in certain procedures that utilize high-cost medical devices and a decline in the per unit cost for our more expensive supplies, on an adjusted admissions basis, medical supplies expense also decreased 2.6% period to period.
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Bad debt expense.Bad debt expense increased 2.6% to $14.2 million for the third quarter of fiscal 2006 from $13.9 million for the third quarter of fiscal 2005. As a percentage of net revenue, bad debt expense was 7.6% for the third quarter of fiscal 2006 as compared to 7.7% for the third quarter of fiscal 2005. While we experienced a net decrease in bad debt expense as a percentage of net revenue, we continued to incur incremental expense due to the higher number of self-pay patients. Overall, revenue for uninsured patients comprised 8.1% of hospital division net revenue for the third quarter of fiscal 2006 as compared to 7.8% in the same period in the prior year.
Other operating expenses.Other operating expenses increased 4.5% to $37.9 million for the three months ended June 30, 2006 from $36.3 million for the three months ended June 30, 2005. As a percentage of net revenue, other operating expenses decreased to 20.0% for the third quarter of fiscal 2006 from 20.2% for the same period in fiscal 2005. The $1.6 million increase in other operating expenses was primarily due to higher maintenance costs at our newer facilities, as they have completed their second year of operations, as well as incremental advertising costs in several markets period to period.
Impairment of long-lived assets.During the third quarter of fiscal 2006, management decided to discontinue the implementation of certain nurse staffing software and as a result, a $0.5 million impairment charge was recognized to write-off the costs incurred to date on such software. As we are currently reviewing the long-term outlook of Heart Hospital of Lafayette to determine plans and strategic direction, a future write-off or impairment of long-lived assets related to this facility may be necessary. There were no impairments of long-lived assets in the third quarter of fiscal 2005.
Interest expense.Interest expense decreased 6.8% to $7.9 million for the third quarter of fiscal 2006 compared to $8.4 million for the third quarter of fiscal 2005. This decrease in interest expense is primarily due to the overall reduction in outstanding debt period to period as the amount of total debt at June 30, 2006 is approximately 5.2% lower than the total debt outstanding at June 30, 2005.
Interest and other income, net.Interest and other income, net increased to $3.0 million for the third quarter of fiscal 2006 from $0.9 million for the third quarter of fiscal 2005. This $2.1 million is increase primarily due to the receipt of $2.0 million as a part of a settlement agreement related to a lawsuit. The proceeds received from the settlement were partially offset by $0.6 million of legal fees incurred related to the settlement. The remainder of the increase in interest and other income, net period to period is due to higher interest earned on available cash and cash equivalents as well as higher rates of return on our short-term investments.
Equity in net earnings of unconsolidated affiliates.Equity in net earnings of unconsolidated affiliates increased to $1.4 million in the third quarter of fiscal 2006 from $0.9 million in the third quarter of 2005. The majority of the increase is attributable to growth in earnings at the one hospital in which we hold less than a 50% interest, with the remainder being attributable to growth in earnings in various diagnostic entities in which we hold less than a 50% interest.
Minority interest share of earnings of consolidated subsidiaries.Minority interest share of earnings of consolidated subsidiaries was $4.7 million for the third quarter of fiscal 2006 as compared to $4.0 million for the third quarter of fiscal 2005. This $0.8 million increase was due to the net increase in earnings of certain of our established hospitals and diagnostics ventures which were allocated to our minority partners on a pro rata basis. We expect our earnings allocated to minority interests to fluctuate in future periods as we either recognize disproportionate losses and/or recoveries thereof through disproportionate profit recognition. As of June 30, 2006, we had remaining cumulative disproportionate loss allocations of approximately $30.9 million that we may recover in future periods. However, we may be required to recognize additional disproportionate losses depending on the results of operations of facilities with minority ownership interests. We could also be required to recognize disproportionate losses at our other facilities not currently in a disproportionate allocation position depending on their results of operations in future periods. For a more complete discussion of our accounting for minority interests, including the basis for disproportionate allocation accounting, see “Critical Accounting Policies” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2005.
Income tax expense.Income tax expense was $3.6 million for the third quarter of fiscal 2006 compared to $2.0 million for the third quarter of fiscal 2005, which represents an effective tax rate of approximately 40.6% and 42.6%, respectively. The overall change in income taxes expense is due to the respective fluctuation in taxable income for the fiscal periods, while the fluctuation in the effective rate is primarily a result of the impact of certain non-deductible expenses in the periods.
Income (loss) from discontinued operations.During the third quarter of fiscal 2006, we signed a letter of intent to sell our interest in Tucson Heart Hospital. Accordingly, the hospital is accounted for as discontinued operations. The income (loss) from discontinued operations in the respective fiscal periods represents the operating results, net of the related income taxes, of the facility during the period.
Results of Operations
Nine Months Ended June 30, 2006 Compared to Nine Months Ended June 30, 2005
Statement of Operations Data.The following table presents our results of operations in dollars and as a percentage of net revenue
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for the periods indicated:
Nine Months Ended June 30, | ||||||||||||||||||||||||
Increase / Decrease | % of Net Revenue | |||||||||||||||||||||||
2006 | 2005 | $ | % | 2006 | 2005 | |||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
Net revenue | $ | 554,156 | $ | 524,156 | $ | 30,000 | 5.7 | % | 100.0 | % | 100.0 | % | ||||||||||||
Operating expenses: | ||||||||||||||||||||||||
Personnel expense | 181,211 | 159,874 | 21,337 | 13.3 | % | 32.7 | % | 30.5 | % | |||||||||||||||
Medical supplies expense | 154,735 | 148,813 | 5,922 | 4.0 | % | 27.9 | % | 28.4 | % | |||||||||||||||
Bad debt expense | 44,405 | 36,063 | 8,342 | 23.1 | % | 8.0 | % | 6.9 | % | |||||||||||||||
Other operating expenses | 114,123 | 107,316 | 6,807 | 6.3 | % | 20.5 | % | 20.5 | % | |||||||||||||||
Depreciation | 27,801 | 27,214 | 587 | 2.2 | % | 5.1 | % | 5.1 | % | |||||||||||||||
Amortization | 756 | 870 | (114 | ) | (13.1 | )% | 0.1 | % | 0.2 | % | ||||||||||||||
(Gain)/loss on disposal of property, equipment and other assets | (237 | ) | 204 | (441 | ) | (216.2 | )% | — | — | |||||||||||||||
Impairment of long-lived assets | 451 | — | 451 | 100.0 | % | 0.1 | % | — | ||||||||||||||||
Total operating expenses | 523,245 | 480,354 | 42,891 | 8.9 | % | 94.4 | % | 91.6 | % | |||||||||||||||
Income from operations | 30,911 | 43,802 | (12,891 | ) | (29.4 | )% | 5.6 | % | 8.4 | % | ||||||||||||||
Other income (expenses): | ||||||||||||||||||||||||
Interest expense | (25,828 | ) | (24,129 | ) | (1,699 | ) | (7.0 | )% | (4.6 | )% | (4.6 | )% | ||||||||||||
Interest and other income, net | 5,748 | 1,870 | 3,878 | 207.4 | % | 1.0 | % | 0.3 | % | |||||||||||||||
Equity in net earnings of unconsolidated affiliates | 3,883 | 2,554 | 1,329 | 52.0 | % | 0.7 | % | 0.5 | % | |||||||||||||||
Total other expenses, net | (16,197 | ) | (19,705 | ) | 3,508 | 17.8 | % | (2.9 | )% | (3.8 | )% | |||||||||||||
Income from continuing operations before minority interest, income taxes and discontinued operations | 14,714 | 24,097 | (9,383 | ) | (38.9 | )% | 2.7 | % | 4.6 | % | ||||||||||||||
Minority interest share of earnings of consolidated subsidiaries | (12,350 | ) | (12,357 | ) | (7 | ) | (0.1 | )% | (2.2 | )% | (2.4 | )% | ||||||||||||
Income from continuing operations before income taxes and discontinued operations | 2,364 | 11,740 | (9,376 | ) | (79.9 | )% | 0.5 | % | 2.2 | % | ||||||||||||||
Income tax expense | 993 | 4,814 | (3,821 | ) | (79.4 | )% | 0.3 | % | 0.9 | % | ||||||||||||||
Income from continuing operations | 1,371 | 6,926 | (5,555 | ) | (80.2 | )% | 0.2 | % | 1.3 | % | ||||||||||||||
Income from discontinued operations, net of taxes | 266 | 4,166 | (3,900 | ) | (93.6 | )% | 0.1 | % | 0.8 | % | ||||||||||||||
Net income | $ | 1,637 | $ | 11,092 | $ | (9,455 | ) | (85.2 | )% | 0.3 | % | 2.1 | % | |||||||||||
The following table presents selected operating data on a consolidated basis for the periods indicated:
Nine Months Ended June 30, | ||||||||||||
2006 | 2005 | % Change | ||||||||||
Selected Operating Data (consolidated) (a): | ||||||||||||
Number of hospitals | 10 | 10 | ||||||||||
Licensed beds (b) | 612 | 612 | ||||||||||
Staffed and available beds (c) | 595 | 571 | ||||||||||
Admissions (d) | 32,987 | 31,119 | 6.0 | % | ||||||||
Adjusted admissions (e) | 42,822 | 40,349 | 6.1 | % | ||||||||
Patient days (f) | 109,497 | 109,738 | (0.2 | )% | ||||||||
Adjusted patient days (g) | 142,178 | 141,677 | 0.4 | % | ||||||||
Average length of stay (days) (h) | 3.32 | 3.53 | (5.9 | )% | ||||||||
Occupancy (i) | 67.4 | % | 70.4 | % | ||||||||
Inpatient catheterization procedures | 17,029 | 16,220 | 5.0 | % | ||||||||
Inpatient surgical procedures | 8,702 | 8,495 | 2.4 | % |
(a) | Selected operating data includes consolidated hospitals in operation as of the end of the period reported in continuing operations but does not include hospitals which are accounted for using the equity method or as discontinued operations in our consolidated financial statements. | |
(b) | Licensed beds represent the number of beds for which the appropriate state agency licenses a facility regardless of whether the beds are actually available for patient use. | |
(c) | Staffed and available beds represent the number of beds that are readily available for patient use at the end of the period. | |
(d) | Admissions represent the number of patients admitted for inpatient treatment. | |
(e) | Adjusted admissions is a general measure of combined inpatient and outpatient volume. We computed adjusted admissions by dividing gross patient revenue by gross inpatient revenue and then multiplying the quotient by admissions. |
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(f) | Patient days represent the total number of days of care provided to inpatients. | |
(g) | Adjusted patient days is a general measure of combined inpatient and outpatient days. We computed adjusted patient days by dividing gross patient revenue by gross inpatient revenue and then multiplying the quotient by patient days. | |
(h) | Average length of stay (days) represents the average number of days inpatients stay in our hospitals. | |
(i) | We computed occupancy by dividing patient days by the number of days in the period and then dividing the quotient by the number of staffed and available beds. |
Net Revenue.Net revenue increased 5.7% or $30.0 million to $554.2 million for the nine months ended June 30, 2006 from $524.2 million for the nine months ended June 30, 2005. The increase was entirely attributable to the hospital division.
The increase in hospital division net revenue of $30.0 million was a result of increases in net revenue at the majority of our facilities period to period, although certain facilities did experience a decline in net revenue. Our three newest facilities, Heart Hospital of Lafayette, Texsan Heart Hospital and Louisiana Heart Hospital, comprised 56.7% of the net revenue increase period to period. Overall, on a consolidated basis, hospital admissions increased 6.0% and adjusted admissions increased 6.1% for the year to date period in fiscal 2006 compared to fiscal 2005. Revenue per adjusted admission was essentially unchanged at $11,916 for the nine months ended June 30, 2006 as compared to $11,943 for the nine months ended June 30, 2005.
During the nine months ended June 30, 2006, we recognized net negative contractual adjustments to our net revenue of $3.6 million related to the filing of our 2005 Medicare cost reports as well as other Medicare and Medicaid settlement adjustments. By contrast, we recognized adjustments that increased our net revenue by $1.8 million for prior period cost reports in fiscal 2005.
Personnel expense.Personnel expense increased 13.3% to $181.2 million for the nine months ended June 30, 2006 from $159.9 million for the nine months ended June 30, 2005. The $21.3 million increase in personnel expense was partially due to $12.4 million in non-cash share-based compensation recognized during the nine month period in fiscal 2006. In comparison, there was no non-cash share-based compensation during the same period in fiscal 2005. Excluding the non-cash share-based compensation, personnel expense increased $8.9 million, or 5.6%, for the comparable periods and as a percentage of net revenue, personnel expense was unchanged at 30.5% for both periods.
On October 1, 2005, we adopted SFAS No. 123R, which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors based on estimated fair values. Using this methodology and since all options are immediately vested, the share-based compensation expense recognized for the nine months ended June 30, 2006 was $11.9 million, which was a result of the appointment of a new president and chief executive officer as well as a new chief operating officer in addition to the filling of certain vacant senior management positions during the period. In addition, we recognized $0.5 million of non-cash shared-based compensation expense related to the amortization of the expense related to restricted stock awards issued during the second quarter of fiscal 2006. All options granted during the nine months ended June 30, 2005 under the Company’s stock option plans had an exercise price equal to the market value of the underlying shares of common stock at the date of grant and therefore, no share-based compensation expense was recorded for the nine months ended June 30, 2005. See“Recent Accounting Pronouncements.”
The remaining increase in personnel expense was primarily incurred at our hospitals due to cost of living wage adjustments during the first quarter of fiscal 2006, in addition to increased staffing, permanent and contract, at certain facilities to support the overall growth in admissions in nine months ended June 30, 2006 compared to the same period in fiscal 2005 for these facilities. On an adjusted patient day basis, personnel expense increased by 5.0% to $1,130 per adjusted patient day for the nine months in fiscal 2006 compared to $1,076 per adjusted patient day for the nine months in fiscal 2005. This increase is driven by the cost of living wage increases, as well as the decrease in our average length of stay, which is consistent with our focus on efficient patient care at our facilities. On an adjusted admissions basis, personnel costs actually decreased by 0.5% period to period.
Medical supplies expense.Medical supplies expense increased 4.0% to $154.7 million for the nine months ended June 30, 2006 from $148.8 million for the same period in fiscal 2005. On an adjusted patient day basis, medical supplies expense increased to $1,010 per adjusted patient day for the year to date period in fiscal 2006 compared to $968 per adjusted patient day for fiscal 2005, which is a 4.3% increase. As a percentage of net revenue, medical supplies expense decreased to 27.9% as compared to 28.4% for the nine months ended June 30, 2006 and 2005, respectively. Further, on an adjusted admissions basis, medical supplies expense decreased 1.4% period to period.
The increase in medical supplies expense during the nine months ended June 30, 2006 is primarily attributable to the increased procedure volume during the period. While medical supplies expense is down slightly period to period as a percentage of net revenue and on an adjusted admissions basis due to a reduction in the per unit cost for our more expensive supplies, since late in fiscal 2004 and throughout fiscal 2005, we have experienced an increase in cardiac procedures that use high-cost medical devices and supplies. In
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addition, in the latter half of fiscal 2005, we saw an increase in vascular related supply expense due to an increase in vascular procedures. Medical supplies expense in future periods will be influenced by our ability to continue to reduce the per unit cost of our supplies and the volume and types of procedures performed.
Bad debt expense.Bad debt expense increased 23.1% to $44.4 million for the nine months ended June 30, 2006 from $36.1 million for the nine months ended June 30, 2005. As a percentage of net revenue, bad debt expense was 8.0% for the fiscal 2006 period as compared to 6.9% for the fiscal 2005 period. While the majority of the increase in bad debt expense was incurred in the hospital division due to the growth in net revenue at newer hospitals, a significant portion of the increase was due to a higher percentage of uninsured patients period to period. Overall, self-pay patient revenue comprised 7.7% of hospital division net revenue for the nine months ended June 30, 2006 as compared to 7.2% in the same period in the prior year. Consistent with the trends experienced in the second half of fiscal 2005, the increase in self-pay patient revenue has directly impacted the increase in bad debt expense. Further, we saw growth in commercial revenue during the comparable periods and due to increasing deductibles and other amounts that are ultimately the patient’s responsibility, an increase in commercial revenue also has a direct impact on overall bad debt expense. We anticipate that bad debt expense will continue to approximate the levels that we have experienced during fiscal 2006 on a percentage of net revenue basis.
Other operating expenses.Other operating expenses increased 6.3% to $114.1 million for the nine months ended June 30, 2006 from $107.3 million for the nine months ended June 30, 2005. As a percentage of net revenue, other operating expenses was unchanged at 20.5% for comparable periods. The $6.8 million increase in other operating expenses was primarily due to higher maintenance costs at our newer facilities, as they have completed their second year of operations, as well as incremental advertising costs in several markets period-to-period. In addition, we incurred recruitment and relocation fees associated with the hiring of our new president and chief executive officer as well as our new chief operating officer and severance costs for former executives during the nine months ended June 30, 2006.
Interest expense.Interest expense increased 7.0% to $25.8 million for the nine months ended June 30, 2006 compared to $24.1 million for the nine months ended June 30, 2005. The $1.7 million increase in interest expense is primarily attributable to $1.4 million in deferred loan acquisition costs that were expensed during the nine months ended June 30, 2006 as a result of the prepayments of $58.0 million of term debt and $11.9 million of our senior notes. The remainder of the increase is due to the rise in the variable interest rates on portions of our debt, partially offset by overall lower debt balances due to the prepayments. As of June 30, 2006, approximately 15.9% of our outstanding debt bears interest based on variable rates.
Interest and other income, net.Interest and other income, net increased to $5.7 million for the nine months ended June 30, 2006 from $1.9 million for the nine months ended June 30, 2005. This increase is partially due to the receipt of $2.0 million as a part of a settlement agreement related to a lawsuit. The proceeds received from the settlement were offset in part by $0.6 million of legal fees incurred related to the settlement. The remainder of the increase in interest and other income, net, period to period is due to higher interest earned on available cash and cash equivalents as well as higher rates of return on our short-term investments.
Equity in net earnings of unconsolidated affiliates.Equity in net earnings of unconsolidated affiliates increased to $3.9 million for the nine months ended June 30, 2006 from $2.6 million for the nine months ended June 30, 2005. The majority of the increase is attributable to growth in earnings at the one hospital in which we hold less than a 50% interest, with the remainder being attributable to growth in earnings in various diagnostic entities in which we hold less than a 50% interest.
Income tax expense.Income tax expense was $1.0 million for the nine months ended June 30, 2006 compared to $4.8 million for the nine months ended June 30, 2005, which represents an effective tax rate of approximately 42.0% and 41.0%, respectively. The overall change in income tax expense is due to the respective fluctuation in taxable income for the fiscal periods, while the fluctuation in the effective rate is primarily a result of the impact of certain non-deductible expenses in the periods.
Income from discontinued operations.During the third quarter of fiscal 2006, we signed a letter of intent to sell our interest in Tucson Heart Hospital (THH). In addition, during the first quarter of fiscal 2005, we closed and sold substantially all of the assets of The Heart Hospital of Milwaukee (HHM). The income from discontinued operations in the respective fiscal periods represents the operating results of THH, net of the related income taxes, of the facility during the period. In addition, the income from discontinued operations in the nine months ended June 30, 2005 includes the gain on the sale of the assets of HHM of approximately $9.3 million, partially offset by operating losses, shut-down costs and overall income tax expense associated with the facility.
Liquidity and Capital Resources
Working Capital and Cash Flow Activities.Our consolidated working capital was $155.5 million at June 30, 2006 and $135.1 million at September 30, 2005. The increase of $20.4 million in working capital primarily resulted from a decrease in the current portion of long-term debt and obligations under capital leases of $14.8 million combined with an overall increase in net receivables, both of which were partially offset by a net increase in accounts payable and accrued liabilities. The changes in
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receivables, accounts payable and accrued liabilities were driven by overall operations, as further described below. The decrease in the current portion of long-term debt and obligations under capital leases is the result of the $35.3 million mortgage loan at the Heart Hospital of Austin being classified as long term at June 30, 2006 as such amount was refinanced into a 10-year loan during the current period. The loan was originally scheduled to mature during the second quarter of 2006 and therefore, was considered current as of September 30, 2005. This decrease in the current portion of long-term debt was partially offset by a $20.9 million increase in the category due to the scheduled maturity of the mortgage loan at another one of our facilities in October 2006 and therefore, this loan is considered current as of June 30, 2006, whereas the amount was still considered long-term as of September 30, 2005.
The cash provided by operating activities of continuing operations was $53.4 million and $54.5 million for the first nine months of fiscal 2006 and 2005, respectively. While our cash provided by operating activities from continuing operations was relatively unchanged period to period, our cash from operating activities for fiscal 2006 was reduced by the increase in net receivables and inventory, with the overall increase in accounts payable and accrued liabilities partially offsetting this unfavorable change. The increase in receivables and a portion of the increase in payables was driven by the growth in volume during the third quarter of fiscal 2006. The volume increase, as well as the timing of certain bulk purchases, resulted in higher inventories of medical supplies and drove the remainder of the increase in payables. In addition to the volume growth, our receivables were negatively impacted by a slight increase in the days of net revenue in receivables. For the nine months ended June 30, 2006 and 2005, our hospital division had 45 and 43 days, respectively, of net revenue in receivables, which is a result of the overall shift in payor mix to a higher percentage of self-pay and commercial during the current period.
Our investing activities from continuing operations used net cash of $22.6 million for the first nine months of fiscal 2006 compared to net cash provided of $29.7 million for the first nine months of fiscal 2005. The cash used by investing activities in the first nine months of fiscal 2006 was primarily for capital expenditures for the period, whereas the net cash provided by investing activities in the first nine months of fiscal 2005 was principally due to the proceeds from the sale of The Heart Hospital of Milwaukee, offset in part by capital expenditures for the period.
Our financing activities used net cash of $26.8 million for the first nine months of fiscal 2006 compared to net cash used of $1.9 million for the first nine months of fiscal 2005. The net cash used for financing activities for the first nine months of fiscal 2006 is a result of distributions to minority partners of $12.1 million and the repayments, net of borrowings, of long-term debt and obligations under capital leases of $14.7 million. During the nine months ended June 30, 2006, Harlingen Medical Center issued $60.0 million of long-term debt to various third parties. The proceeds from the issuance of this debt, net of loan acquisition costs, were used to prepay $58.0 million of the term loan under our senior secured credit facility. In addition, in connection with the sale of The Heart Hospital of Milwaukee and as stipulated by the indenture governing our senior notes, during the nine months ended June 30, 2006 we offered to repurchase up to $30.3 million of senior notes. The tender offer for the notes expired during the period and we accepted for purchase and paid for $11.9 million principal amount of notes tendered prior to the expiration of the tender offer. The remainder of the payments were made in accordance with the scheduled payment terms. The $1.9 million of net cash used by financing activities for the first nine months of fiscal 2005 was primarily the result of distributions to minority partners of $8.8 million and the repayment of long-term debt of $4.8 million partially offset by proceeds from exercised stock options of $7.4 million and investments by minority partners of $3.7 million.
Capital Expenditures.Expenditures for property and equipment for the first nine months of fiscal years 2006 and 2005 were $23.7 million and $13.6 million, respectively. For both periods, our capital expenditures principally were focused on improvements to existing facilities. The amount of capital expenditures we incur in future periods will depend largely on the type and size of strategic investments we make in future periods.
Obligations and Availability of Financing.At June 30, 2006, we had $338.2 million of outstanding debt, $40.1 million of which was classified as current. Of the outstanding debt, $138.1 million was outstanding under our 9 7/8% senior notes, $40.1 million was outstanding under our senior secured credit facility and $157.3 million was outstanding to lenders to our hospitals. The remaining $2.7 million of debt was outstanding to lenders for diagnostic services under capital leases and other miscellaneous indebtedness.
No amounts were outstanding to lenders under our $100.0 million revolving credit facility at June 30, 2006. At the same date, however, we had letters of credit outstanding of $2.5 million, which reduced our availability under this facility to $97.5 million.
Covenants related to our long-term debt restrict the payment of dividends and require the maintenance of specific financial ratios and amounts and periodic financial reporting. At June 30, 2006, we were in violation of a financial covenant under an equipment loan to Heart Hospital of Lafayette and we anticipate continuing to be in violation of this covenant in future periods. Accordingly, the total outstanding balance of this loan of $10.2 million has been included in current portion of long-term debt and obligations under capital leases as of June 30, 2006. As of June 30, 2006, we were working with the lender to amend the financial covenant. We were in compliance with all other covenants in the instruments governing our outstanding debt at June 30, 2006.
At June 30, 2006, we guaranteed either all or a portion of the obligations of our consolidated subsidiary hospitals for equipment
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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 believe that internally generated cash flows and available borrowings under our senior secured credit facility, together with the remaining net proceeds of our initial public offering and borrowings available under equipment debt commitments will be sufficient to finance our business plan, capital expenditures and our working capital requirements for the next 12 to 18 months.
Intercompany Financing Arrangements.We provide secured real estate, equipment and working capital financings to our majority-owned hospitals. The aggregate amount of the intercompany real estate, equipment and working capital and other loans outstanding as of June 30, 2006 was $282.7 million.
Each intercompany real estate loan is separately documented and secured with a lien on the borrowing hospital’s real estate, building and equipment and certain other assets. Each intercompany real estate loan amortizes based on a 20-year term, matures on June 30, 2011 and accrues interest at variable rates based on LIBOR plus an applicable margin or a fixed rate based on June 2011 treasury yield plus an applicable margin. The weighted average interest rate for the intercompany real estate loans at June 30, 2006 was 8.30%.
Each intercompany equipment loan is separately documented and secured with a lien on the borrowing hospital’s equipment and certain other assets. Amounts borrowed under the intercompany equipment loans are payable in monthly installments of principal and interest over terms that range from 2 to 5 years. The intercompany equipment loans accrue interest at fixed rates ranging from 6.31% to 8.58% or variable rates based on LIBOR plus an applicable margin. The weighted average interest rate for the intercompany equipment loans at June 30, 2006 was 7.17%.
We receive a fee from the minority partners in the subsidiary hospitals as consideration for providing these intercompany real estate and equipment loans.
We also use intercompany financing arrangements to provide cash support to individual hospitals for their working capital and other corporate needs. We provide these working capital and other loans pursuant to the terms of the operating agreements between our physician and hospital investor partners and us at each of our hospitals. These intercompany loans are evidenced by promissory notes that establish borrowing limits and provide for a market rate of interest to be paid to us on outstanding balances. These intercompany loans are subordinated to each hospital’s third-party mortgage and equipment debt outstanding, but are senior to our equity interests and our partners’ equity interest in the hospital venture and are secured, subject to the prior rights of the senior lenders, in each instance by a pledge of the borrowing hospital’s accounts receivable. Also as part of our intercompany financing and cash management structure, we sweep cash from individual hospitals as amounts are available in excess of the individual hospital’s working capital needs. These funds are advanced pursuant to cash management agreements with the individual hospital that establish the terms of the advances and provide for a rate of interest to be paid consistent with the market rate earned by us on the investment of its funds. These cash advances are due back to the individual hospital on demand and are subordinate to our equity investment in the hospital venture. As of June 30, 2006 and September 30, 2005, we held $98.7 million and $93.3 million, respectively, of intercompany working capital and other notes and related accrued interest, net of advances from our hospitals. In connection with the potential sale of Tuscon Heart Hospital, a portion of the real estate and working capital loans will be monetized upon the divestiture.
Recent Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48,Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109(FIN 48). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are currently assessing the impact of FIN 48 on our consolidated financial position and results of operations.
On October 1, 2005, we adopted Statement of Financial Accounting Standards (SFAS) No. 123R (revised 2004),Share-Based Payment, which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors based on estimated fair values. SFAS No. 123R supersedes our previous accounting under Accounting Principles Board (APB) Opinion No. 25,Accounting for Stock Issued to Employees, as permitted under SFAS No. 123,Accounting for Stock-Based Compensation, for periods beginning in fiscal 2006. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 107 relating to SFAS No. 123R. We have applied the provisions of SAB No. 107 in our adoption of SFAS No. 123R.
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SFAS No. 123R requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our statement of operations. Prior to the adoption of SFAS No. 123R, we accounted for stock options issued to employees and directors using the intrinsic value method in accordance with APB 25 as permitted under SFAS No. 123, and provided pro forma net income and pro forma earnings per share disclosures for employee stock option grants made as if the fair value method in measuring compensation costs for stock options granted had been applied. Under the intrinsic value method, no share-based compensation expense was recognized for options granted with an exercise price equal to the fair value of the underlying stock at the grant date.
We adopted SFAS No. 123R using the modified prospective transition method, which requires the application of the accounting standard as of October 1, 2005, the first day of our fiscal year 2006. Our financial statements as of and for the three and nine months ended June 30, 2006, reflect the impact of SFAS No. 123R. In accordance with the modified prospective transition method, the financials statements from prior periods have not been restated to reflect, and do not include, the impact of SFAS No. 123R.
As required under SFAS No. 123R in calculating the share-based compensation expense for the three and nine months ended June 31, 2006 and as required under SFAS No. 123 and SFAS No. 148,Accounting for Stock Based Compensation, in calculating the share-based compensation expense for the three and nine months ended June 30, 2005, the fair value of each option grant was estimated on the date of grant. We used the Black-Scholes option-pricing model, which requires certain assumptions and the same methodologies were employed in both fiscal 2006 and fiscal 2005 to determine the majority of these assumptions. The expected life was determined in fiscal 2006 using an analysis of historical behavior for different groups of similar employees and was determined in fiscal 2005 using a historical behavior analysis for all employees, not segregated into homogenous groups.
Share-based compensation expense recognized for the three and nine months ended June 30, 2006 was $1.8 million and $12.4 million, respectively. The compensation expense recognized represents the compensation related to restricted stock awards over the vesting period, as well as the value of all stock options issued during that period as all such options were immediately vested and all unvested options outstanding prior to October 1, 2005 were cancelled during the period. Since all options granted during the three and nine months ended June 30, 2005 under our stock option plans had an exercise price equal to the market value of the underlying shares of common stock at the date of grant, no compensation expense was recorded for the three and nine months ended June 30, 2005.
Forward Looking Statements
Some of the statements and matters discussed in this report and in exhibits to this report constitute forward-looking statements. Words such as “expects,” “anticipates,” “approximates,” “believes,” “estimates,” “intends” and “hopes” and variations of such words and similar expressions are intended to identify such forward-looking statements. We have based these statements on our current expectations and projections about future events. These forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties that could cause actual results to differ materially from those projected in these statements. Although we believe that these statements are based upon reasonable assumptions, we cannot assure you that we will achieve our goals. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this report and its exhibits might not occur. Our forward-looking statements speak only as of the date of this report or the date they were otherwise made. Other than as may be required by federal securities laws to disclose material developments related to previously disclosed information, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. We urge you to review carefully all of the information in this report and the discussion of risk factors in “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Factors and Forward Looking Statements” in our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2006, before making an investment decision with respect to our debt or equity securities. A copy of this report, including exhibits, is available on the internet site of the SEC athttp://www.sec.govor thorough our website athttp://www.medcath.com.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We maintain a policy for managing risk related to exposure to variability in interest rates, commodity prices and other relevant market rates and prices, which includes considering entering into derivative instruments (freestanding derivatives), or contracts or instruments containing features or terms that behave in a manner similar to derivative instruments (embedded derivatives) in order to mitigate our risks. In addition, we may be required to hedge some or all of our market risk exposure, especially to interest rates, by creditors who provide debt funding to us. To date, we have only entered into the fixed interest rate swaps as discussed below.
Three of our consolidated hospitals entered into fixed interest rate swaps during previous fiscal years. These fixed interest rate swaps effectively fixed the interest rate on the hedged portion of the related debt at 4.92% plus the applicable margin for two of the hospitals and at 4.6% plus the applicable margin for the other hospital. The fixed interest rate swaps are not currently utilized as a hedge of variable debt obligations, and accordingly, changes in the valuation of the interest rate swaps have been recorded directly to
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earnings as a component of interest expense. The fair value of the interest rate swaps at June 30, 2006 and the related unrealized gain/loss for the three and nine months ended June 30, 2006 were not significant to the consolidated financial position or results of operations.
Our primary market risk exposure relates to interest rate risk exposure through that portion of our borrowings that bear interest based on variable rates. Our debt obligations at June 30, 2006 included approximately $53.8 million of variable rate debt at an approximate average interest rate of 6.96%. A one hundred basis point change in interest rates on our variable rate debt would have resulted in interest expense fluctuating approximately $0.4 million for the nine months ended June 30, 2006.
Item 4. Controls and Procedures
The President and Chief Executive Officer and the Executive Vice President and Chief Financial Officer of the Company (its principal executive officer and principal financial officer, respectively) have concluded, based on their evaluation of the Company’s disclosure controls and procedures as of June 30, 2006, that the Company’s disclosure controls and procedures were effective as of June 30, 2006 to ensure that information required to be disclosed by the Company in the reports filed or submitted by it under the Securities Exchange Act of 1934, as amended (the Exchange Act), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files under the Exchange Act is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
No change in the Company’s internal control over financial reporting was made during the most recent fiscal quarter covered by this report that materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II. OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On July 27, 2001, we completed an initial public offering of our common stock pursuant to our Registration Statement on Form S-1 (File No. 333-60278) that was declared effective by the SEC on July 23, 2001. We expect to use the remaining proceeds of approximately $13.8 million from the offering to fund development activities, working capital requirements and other corporate purposes. Although we have identified these intended uses of the remaining proceeds, we have broad discretion in the allocation of the net proceeds from the offering. Pending this application, we will continue to invest the net proceeds of the offering in cash and cash-equivalents, such as money market funds or short-term interest bearing, investment-grade securities.
Item 5. Other Information
On August 4, 2006, MedCath Incorporated, our wholly-owned subsidiary, entered into a consulting agreement (the Agreement) with SSB Solutions. Jacque J. Sokolov, M.D. (Dr. Sokolov) is the principal owner and an officer of SSB Solutions. Dr. Sokolov is also a member of our board of directors.
The agreement contemplates consulting work to be performed by Dr. Sokolov at the discretion of our Chief Executive Officer. The scope and amount of time to complete such work will be determined on an individual project basis and will be billed at an hourly rate of $575. The agreement can be terminated by either party with 30 days written notice.
Item 6. Exhibits
Exhibit | ||
No. | Description | |
10.1 | Consulting Agreement effective August 4, 2006 by and between MedCath Incorporated and SSB Solutions | |
31.1 | Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.2 | Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
32.1 | Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
32.2 | Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
MEDCATH CORPORATION | ||||
Dated: August 9, 2006 | By: | /s/ O. EDWIN FRENCH | ||
O. Edwin French | ||||
President and Chief Executive Officer (principal executive officer) | ||||
By: | /s/ JAMES E. HARRIS | |||
James E. Harris | ||||
Executive Vice President and Chief Financial Officer (principal financial officer) | ||||
By: | /s/ GARY S. BRYANT | |||
Gary S. Bryant | ||||
Vice President — Controller (principal accounting officer) |
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