Medcath (MDTH) 10-Q 2008 Q1 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended December 31, 2007

Or

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

Commission File Number 000-33009

MEDCATH CORPORATION

(Exact name of registrant as specified in its charter)

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

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

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

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No o

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

Large accelerated filer o	Accelerated filer þ	Non-accelerated filer o	Smaller reporting company o
	(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ

As of January 31, 2008, there were 21,287,085 shares of $0.01 par value common stock outstanding.

MEDCATH CORPORATION
FORM 10-Q
TABLE OF CONTENTS

	Page
PART I. FINANCIAL INFORMATION	1
Item 1. Unaudited Financial Statements	1
Consolidated Balance Sheets as of December 31, 2007 and September 30, 2007	1
Consolidated Statements of Operations for the Three Months Ended December 31, 2007 and 2006	2
Consolidated Statement of Stockholders’ Equity for the Three Months Ended December 31, 2007	3
Consolidated Statements of Cash Flows for the Three Months Ended December 31, 2007 and 2006	4
Notes to Unaudited Consolidated Financial Statements	5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	17
Item 3. Quantitative and Qualitative Disclosures About Market Risk	23
Item 4. Controls and Procedures	23
PART II. OTHER INFORMATION	23
Item 1. Legal Proceedings	23
Item 1A. Risk Factors	23
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	23
Item 6. Exhibits	24
SIGNATURES	24
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

PART I. FINANCIAL INFORMATION

Item 1. Unaudited Financial Statements

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

	December 31,			September 30,
	2007			2007
Current assets:
Cash and cash equivalents	$	114,701		$	140,381
Accounts receivable, net		98,968			86,994
Medical supplies		16,094			15,336
Deferred income tax assets		15,332			12,389
Prepaid expenses and other current assets		7,060			6,527
Current assets of discontinued operations		—			10,786
Total current assets		252,155			272,413
Property and equipment, net		304,063			296,800
Investments in affiliates		2,772			5,718
Goodwill		62,740			62,740
Other intangible assets, net		6,321			6,448
Other assets		6,302			6,547
Long-term assets of discontinued operations		—			18,749
Total assets	$	634,353		$	669,415
Current liabilities:
Accounts payable	$	33,512		$	33,247
Income tax payable		1,988			11,124
Accrued compensation and benefits		17,441			19,557
Other accrued liabilities		16,777			14,137
Current portion of long-term debt and obligations under capital leases		4,063			4,108
Current liabilities of discontinued operations		—			11,199
Total current liabilities		73,781			93,372
Long-term debt		145,654			146,398
Obligations under capital leases		1,514			1,806
Deferred income tax liabilities		11,945			12,018
Other long-term obligations		2,748			460
Total liabilities		235,642			254,054
Commitments and contingencies
Minority interest in equity of consolidated subsidiaries		24,954			29,737
Stockholders’ equity:
Preferred stock, $0.01 par value, 10,000,000 shares authorized; none issued		—			—
Common stock, $0.01 par value, 50,000,000 shares authorized; 21,287,085 issued and 21,218,185 outstanding at December 31, 2007 21,271,144 issued and 21,202,244 outstanding at September 30, 2007		213			213
Paid-in capital		451,478			447,688
Accumulated deficit		(59,064	)		(61,821	)
Accumulated other comprehensive loss		(171	)		(62	)
Treasury stock, at cost;
68,900 shares at December 31, 2006
846,406 shares at December 31, 2007		(18,699	)		(394	)
Total stockholders’ equity		373,757			385,624
Total liabilities and stockholders’ equity	$	634,353		$	669,415

See notes to unaudited consolidated financial statements.

1

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

	Three Months Ended December 31,
	2007			2006
Net revenue	$	163,664		$	175,549
Operating expenses:
Personnel expense		55,941			57,175
Medical supplies expense		43,656			48,170
Bad debt expense		12,173			13,831
Other operating expenses		32,110			36,465
Pre-opening expenses		248			—
Depreciation		7,960			8,869
Amortization		127			252
Loss on disposal of property, equipment and other assets		28			57
Total operating expenses		152,243			164,819
Income from operations		11,421			10,730
Other income (expenses):
Interest expense		(4,032	)		(7,458	)
Loss on early extinguishment of debt		—			(4,480	)
Interest and other income, net		1,172			2,725
Equity in net earnings of unconsolidated affiliates		2,025			1,438
Total other expenses, net		(835	)		(7,775	)
Income from continuing operations before minority interest and incomes taxes		10,586			2,955
Minority interest share of earnings of consolidated subsidiaries		(4,736	)		(2,480	)
Income from continuing operations before income taxes		5,850			475
Income tax expense		2,595			221
Income from continuing operations		3,255			254
Loss from discontinued operations, net of taxes		(191	)		(5,150	)
Net income (loss)	$	3,064		$	(4,896	)
Earnings (loss) per share, basic Continuing operations	$	0.15		$	0.01
Discontinued operations		(0.01	)		(0.25	)
Earnings (loss) per share, basic	$	0.14		$	(0.24	)
Earnings (loss) per share, diluted Continuing operations	$	0.15		$	0.01
Discontinued operations		(0.01	)		(0.25	)
Earnings (loss) per share, diluted	$	0.14		$	(0.24	)
Weighted average number of shares, basic		21,028			20,121
Dilutive effect of stock options and restricted stock		263			—
Weighted average number of shares, diluted		21,291			20,121

See notes to unaudited 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 (Loss)			Shares		Amount			Total
Balance, September 30, 2007		21,202	$	213	$	447,688		$	(61,821	)	$	(62	)		69	$	(394	)	$	385,624
Cumulative impact of change in accounting princple (Note 2)		—		—		—			(307	)		—			—		—			(307	)
Exercise of stock options, including income tax benefit		16		—		328			—			—			—		—			328
Share buyback		—		—		—			—			—			777		(18,305	)		(18,305	)
Share-based compensation expense		—		—		3,709			—			—			—		—			3,709
Tax impact of cancellation of stock options		—		—		(247	)		—			—			—		—			(247	)
Comprehensive income:
Net income		—		—		—			3,064			—			—		—			3,064
Change in fair value of interest rate swaps, net of income tax benefit		—		—		—			—			(109	)		—		—			(109	)
Total comprehensive income																				2,955
Balance, December 31, 2007		21,218	$	213	$	451,478		$	(59,064	)	$	(171	)		846	$	(18,699	)	$	373,757

See notes to unaudited consolidated financial statements.

3 

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

	Three Months Ended December 31,
	2007			2006
Net income (loss)	$	3,064		$	(4,896	)
Adjustments to reconcile net income to net cash provided by operating activities:
Loss from discontinued operations, net of taxes		191			5,150
Bad debt expense		12,173			13,831
Depreciation		7,960			8,869
Amortization		127			252
Excess income tax benefit on exercised stock options		(22	)		(954	)
Loss on disposal of property, equipment and other assets		28			57
Share-based compensation expense		3,709			1,026
Amortization of loan acquisition costs		185			1,260
Equity in earnings of unconsolidated affiliates, net of dividends received		2,837			2,211
Minority interest share of earnings of consolidated subsidiaries		4,736			2,480
Deferred income taxes		(1,885	)		1,939
Change in assets and liabilities that relate to operations:
Accounts receivable		(24,147	)		(11,295	)
Medical supplies		(758	)		625
Prepaids and other assets		(473	)		(3,193	)
Accounts payable and accrued liabilities		(7,032	)		(5,940	)
Net cash provided by operating activities of continuing operations		693			11,422
Net cash provided by (used in) operating activities of discontinued operations		128			(1,535	)
Net cash provided by operating activities		821			9,887
Investing activities:
Purchases of property and equipment		(14,257	)		(3,481	)
Proceeds from sale of property and equipment		29			481
Net cash used in investing activities of continuing operations		(14,228	)		(3,000	)
Net cash provided by (used in) investing activities of discontinued operations		24,285			(112	)
Net cash provided by (used in) investing activities		10,057			(3,112	)
Financing activities:
Repayments of long-term debt		(744	)		(59,016	)
Repayments of obligations under capital leases		(337	)		(498	)
Distributions to minority partners		(10,485	)		(8,632	)
Repayments from (advances to) minority partners, net		966			154
Proceeds from exercised stock options		306			2,540
Purchase of treasury shares		(18,305	)		—
Proceeds from issuance of common stock		—			39,657
Excess income tax benefit on exercised stock options		22			954
Net cash used in financing activities of continuing operations		(28,577	)		(24,841	)
Net cash used in financing activities of discontinued operations		(7,981	)		(391	)
Net cash used in financing activities		(36,558	)		(25,232	)
Net decrease in cash and cash equivalents		(25,680	)		(18,457	)
Cash and cash equivalents:
Beginning of year		140,381			193,654
End of year	$	114,701		$	175,197

See notes to unaudited consolidated financial statements.

4 

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

1. Business and Organization

     MedCath Corporation (the Company) primarily focuses on providing high acuity services, predominantly the diagnosis and treatment of cardiovascular disease. The Company owns and operates hospitals in partnership with physicians, most of whom are cardiologists and cardiovascular surgeons. While each of the Company’s majority-owned hospitals (collectively, the hospital division) is licensed as a general acute care hospital, the Company focuses on serving the unique needs of patients suffering from cardiovascular disease. As of December 31, 2007, the Company owned and operated ten hospitals, together with its physician partners, who own an equity interest in the hospitals where they practice. The Company’s existing hospitals had a total of 635 licensed beds, of which 614 were staffed and available, and were located in eight states: Arizona, Arkansas, California, Louisiana, New Mexico, Ohio, South Dakota, and Texas. The Company is currently in the process of developing a new hospital located in Kingman, Arizona which it expects to open during September 2009.

     See Note 3 —Discontinued Operationsfor details concerning the Company’s sale of its equity interest in Heart Hospital of Lafayette. 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 two of its owned and operated hospitals as consolidated subsidiaries. The Company owns a minority interest in Avera Heart Hospital of South Dakota and Harlingen Medical Center as of December 31, 2007 and is not the primary beneficiary under the revised version of Financial Accounting Standards Board (FASB) Interpretation No. 46,Consolidation of Variable Interest Entities, an interpretation of ARB No. 51(FIN No. 46-R). Therefore, the Company is unable to consolidate these hospitals’ results of operations and financial position, but rather is required to account for its minority ownership interest in these hospitals as an equity investment. Harlingen Medical Center was a consolidated entity for the fiscal year ended September 30, 2006 and for the first three quarters of fiscal 2007. In July 2007, the Company sold a portion of its equity interest in Harlingen Medical Center; therefore, the Company no longer is its primary beneficiary and accounts for its minority ownership interest in the hospital as an equity investment.

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

2. Summary of Significant Accounting Policies

     Basis of Presentation— The Company’s unaudited interim consolidated financial statements as of December 31, 2007 and for the three months ended December 31, 2007 and 2006 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 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 months ended December 31, 2007 are not necessarily indicative of the results expected for the full fiscal year ending September 30, 2008 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, 2007. During the three months ended December 31, 2007, 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 fiscal year ended September 30, 2007, with the exception of the adoption of Financial Accounting Standards Board (FASB) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109” (“FIN 48”) which clarifies the accounting for uncertainty in tax positions This interpretation requires that the Company recognize the impact of a tax position in its consolidated financial statements if that position is more likely than not of being sustained on audit, based on the technical merits of the position.

     Restatements and Reclassifications— In accordance with Statement of Financial Accounting Standards (SFAS) No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets(SFAS No. 144), hospitals sold or classified as held for sale are required to be reported as discontinued operations. During fiscal 2006, the Company decided to seek to dispose of its interest in Heart Hospital of Lafayette and entered into a confidentiality and exclusivity agreement with a potential buyer, therefore classifying the hospital as held for sale. During the first quarter of fiscal 2008, the Company completed the disposition of Heart Hospital of Lafayette to a third party. In accordance with the provisions of SFAS No. 144, the results of operations of this hospital for the three months ended December 31, 2007 and 2006 are reported as discontinued operations.

5 

MEDCATH CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — Continued

     The Company evaluated the carrying value of the long lived assets related to Heart Hospital of Lafayette at December 31, 2006 and it was determined that the carrying value was in excess of the fair value. Accordingly, an impairment charge of $4.1 million was recorded in accordance with SFAS No. 144 during the first quarter of fiscal 2007 and is included in loss from discontinued operations in the consolidated statement of operations for the three months ended December 31, 2006.

     Use of Estimates— The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect 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 SFAS No. 123-R (revised 2004),Share-Based Payment(SFAS No. 123-R), 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. 123-R requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model and to expense the value of the portion of the award that is ultimately expected to vest over the requisite service period in the Company’s statement of operations. On September 30, 2005, the compensation committee of the board of directors approved a plan to accelerate the vesting of substantially all unvested stock options previously awarded to employees with the condition that the optionee enter into a sale restriction agreement which provides that if the optionee exercises a stock option prior to its originally scheduled vesting date while employed by the Company, the optionee will be prohibited from selling the share of stock acquired upon exercise of the option until the date the option would have become vested had it not been accelerated. All new stock options granted since September 30, 2005 have immediate vesting with sales restrictions. As a result, share-based compensation is recorded on the option grant date.

     The Company adopted SFAS No. 123-R 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 months ended December 31, 2007 and 2006 reflect the impact of SFAS No. 123-R.

     On November 10, 2005, the FASB issued Staff Position No. 123-R-3,Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards(Staff Position No. 123-R-3),which provides a simplified alternative method to calculate the pool of excess income tax benefits upon the adoption of SFAS No. 123-R. The Company has elected to follow the provisions of Staff Position No. 123-R-3.

     As required under SFAS No. 123-R, in calculating the share-based compensation expense for the three months ended December 31, 2007 and 2006, 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. This analysis is updated December 31 of each year and at December 31, 2007 the analysis illustrated a change in the range of expected life for subsequent grants, which is reflected in the table below. 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 December 31,
	2007			2006
Expected life	5-8 years			6-8 years
Risk- free interest rate		3.35% — 4.56	%		4.44% — 4.76	%
Expected volatility		34% — 41	%		38% — 43%	%

     Goodwill and Long-Lived Assets— Goodwill represents acquisition costs in excess of the fair value of net identifiable tangible and intangible assets of businesses purchased. In accordance with SFAS No. 142,Goodwill and Other Intangible Assets(SFAS No. 142), the Company evaluates goodwill annually on September 30 for impairment, or earlier if indicators of potential impairment exist. In accordance with SFAS No. 144, 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, assumptions and/or market conditions could significantly impact these judgments and require adjustments to recorded amounts of intangible assets.

     Recent Accounting Pronouncements.In December 2007, the FASB issued SFAS No. 160. “Noncontrolling Interests in Consolidated Financial Statements-an Amendment of ARB No. 51.” SFAS 160 establishes accounting and reporting standards pertaining to ownership interests in subsidiaries held by parties other than the parent, the amount of net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest, and the valuation of any retained noncontrolling equity investment when a subsidiary is deconsolidated. This statement also establishes disclosure requirements that clearly identify and distinguish

6 

MEDCATH CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — Continued

between the interests of the parent and the interests of the noncontrolling owners. SFAS 160 is effective for fiscal years beginning on or after December 15, 2008. The Company has not yet evaluated the potential impact of the adoption of SFAS 160.

3. Discontinued Operations

     During September 2006, the Company decided to seek to dispose of its interest in Heart Hospital of Lafayette (HHLf) and entered into a confidentiality and exclusivity agreement with a potential buyer. During November 2007, the Company completed the disposition of Heart Hospital of Lafayette. Pursuant to the provisions of SFAS No. 144, the consolidated financial statements for the three months ended December 31, 2007 and 2006 present HHLf as a discontinued operation.

     At September 30, 2007, HHLf was in violation of a financial covenant under an $8.6 million equipment loan to HHLf, which is guaranteed by MedCath. HHLf is classified as a discontinued operation. Accordingly, the total outstanding balance of this loan has been included in current liabilities of discontinued operations on the consolidated balance sheet as of September 30, 2007. This debt was paid off with the proceeds from the sale.

     The results of operations of HHLf, excluding intercompany interest expense and intercompany gain as a result of the sale, are as follows:

	Three Months Ended December 31,
	2007			2006
Net revenue	$	4,710		$	7,736
Restructuring and write-off charges		—			(4,100	)
Operating expenses		(4,979	)		(7,992	)
Loss from operations		(269	)		(4,356	)
Loss on sale of assets and equity interest		(310	)		—
Other expenses, net		(91	)		(191	)
Loss before income taxes		(670	)		(4,547	)
Income tax (benefit) expense		(479	)		603
Net loss	$	(191	)	$	(5,150	)

     The principal balance sheet items of HHLf excluding intercompany debt, are as follows:

	September 30,
	2007
Cash and cash equivalents	$	3,512
Accounts receivable, net		5,014
Other current assets		2,260
Current assets	$	10,786
Property and equipment, net	$	18,369
Investments in affiliates		240
Other assets		140
Long-term assets	$	18,749
Accounts payable	$	1,484
Accrued liabilities		1,521
Current portion of long-term debt and obligations under capital leases		8,194
Current liabilities	$	11,199

4. Accounts Receivable

     Accounts receivable, net, consists of the following:

7 

MEDCATH CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — Continued

	December 31,			September 30,
	2007			2007
Receivables, principally from patients and third-party payors	$	147,158		$	125,235
Receivables, principally from billings to hospitals for various cardiovascular procedures		5,723			4,630
Amounts due under management contracts		4,274			1,763
Other		3,963			4,528
		161,118			136,156
Less allowance for doubtful accounts		(62,150	)		(49,162	)
Accounts receivable, net	$	98,968		$	86,994

5. Equity Investments

     The Company owns minority interests in Avera Heart Hospital of South Dakota, Harlingen Medical Center 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.

     The following represents summarized financial information of Avera Heart Hospital of South Dakota for the three months ended December 31, 2006 and Harlingen Medical Center and Avera Heart Hospital of South Dakota for the three months ended December 31, 2007:

	Three Months Ended December 31,
	2007		2006
Net revenue	$	39,555	$	17,319
Income from operations	$	4,504	$	4,477
Net income	$	4,340	$	4,185

	December 31,		September 30,
	2007		2007
Current assets	$	34,860	$	44,331
Long-term assets	$	40,204	$	40,047
Current liabilities	$	16,968	$	17,458
Long-term liabilities	$	21,441	$	21,301

6. Long-term Debt

     Long-term debt consists of the following:

	December 31,			September 30,
	2007			2007
Senior Notes	$	101,961		$	101,961
Notes payable to various lenders		46,575			47,294
		148,536			149,255
Less current portion		(2,882	)		(2,857	)
Long-term debt	$	145,654		$	146,398

     Debt Covenants—At December 31, 2007, the Company was in compliance with all covenants in the instruments governing its outstanding debt.

7. Liability Insurance Coverage

     During June 2006, the Company entered into a new one-year claims-made policy providing coverage for medical malpractice claim amounts in excess of $2.0 million of retained liability per claim. The Company also purchased additional insurance to reduce the retained liability per claim to $250,000 for the MedCath Partners division. During June 2007, the Company entered into a new one-

8 

MEDCATH CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — Continued

year claims-made policy providing coverage for medical malpractice claim amounts 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 MedCath Partners division.

     Because of the Company’s self-insured retention levels, the Company is required to recognize an estimated expense/liability for the amount of retained liability applicable to each malpractice claim. As of December 31, 2007 and September 30, 2007, the total estimated liability for the Company’s self-insured retention on medical malpractice claims, including an estimated amount for incurred but not reported claims, was approximately $4.5 million and $4.2 million, respectively, which is included in other accrued liabilities on the consolidated balance sheets.

8. Accounting for Uncertainty in Income Taxes

     The Company adopted Financial Accounting Standards Board (FASB) Interpretation (FIN) No. 48, “Accounting for Uncertainty in Income Taxes”, effective October 1, 2007. As a result of the implementation, the Company recognized a $0.3 million net increase to the reserves for uncertain tax positions. This increase was accounted for as a cumulative effect adjustment and recognized as a reduction in beginning retained earnings in the consolidated balance sheet (unaudited). Including the cumulative effect adjustment, the Company had approximately $2.4 million of unrecognized tax benefits as of October 1, 2007. Of this total, $0.3 million represents the amount of unrecognized tax benefits that, if recognized, would favorably impact the effective income tax rate in any future periods. The remaining $2.1 million represents the amount of unrecognized tax benefits for which the ultimate deductibility is certain, but for which there is uncertainty about the timing of deductibility. The timing of such deductibility would not impact the effective tax rate. It is expected that the amount of unrecognized tax benefits will change in the next twelve months; however the Company does not expect the change to have a significant impact on the results of operations or the financial position of the Company.

     The Company includes interest related to tax issues as part of net interest in the consolidated financial statements (unaudited). The Company records any applicable penalties related to tax issues within the income tax provision. The Company had $0.2 million accrued for interest and penalties as of October 1, 2007. The interest and penalties impact for the unrecognized tax liabilities was immaterial to the consolidated financial results for the first quarter of fiscal 2008.

     Due to the utilization of all federal net operating losses in the past three years, the Company may be subject to examination by the Internal Revenue Service (IRS) back to September 30, 2000. In addition, the Company files income tax returns in multiple states and local jurisdictions. Generally, the Company is subject to state and local audits going back to years ended September 30, 2004; however, due to existing net operating loss carryforwards, the IRS can audit back to September 30, 1998 and September 30, 1999 in a few significant states.

9. 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 December 31, 2007. These claims and legal actions are in various stages, and some may ultimately be brought to trial. Moreover, additional claims arising from services provided to patients in the past and other legal actions may be asserted in the future. The Company is protecting its interests in all such claims and actions and does not expect the ultimate resolution of these matters to have a material adverse impact on the Company’s consolidated financial position, results of operations or cash flows.

     The U.S. Department of Justice, or DOJ, conducted an investigation of a clinical trial conducted at one of our hospitals. The investigation concerned alleged improper federal healthcare program billings from 1998-2002 because certain endoluminal graft devices were implanted either without an approved investigational device exception or outside of the approved protocol. The DOJ reached a settlement under the False Claims Act with the medical practice whose physicians conducted the clinical trial. The hospital entered into an agreement with the DOJ under which it paid $5.8 million to the United States to settle, and obtain a release from any federal civil false claims related to DOJ’s investigation. The settlement and release cover both the hospital and the physician who conducted the clinical trial, and does not include any finding of wrong doing or any admission of liability. The Company recorded a $5.8 million reduction in net revenue for the year ended September 30, 2007, to establish a reserve for repayment of a portion of Medicare reimbursement related to hospital inpatient services provided to patients from 1998-2002 in accordance with SFAS No. 5,Accounting for Contingencies. The $5.8 million settlement was paid to the United States in November 2007.

     Commitments —On November 10, 2005, the FASB issued Interpretation No. 45-3,Application of FASB Interpretation No. 45 to Minimum Revenue Guarantees Granted to a Business or Its Owners(FIN No. 45-3), FIN No. 45-3 amends FIN No. 45,Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, to expand the scope to include guarantees granted to a business, such as a physician’s practice, or its owner(s), that the revenue of the business for a specified period will be at least a specified amount. Under FIN No. 45-3, the accounting requirements of FIN No. 45 are effective for any new revenue guarantees issued or modified on or after January 1, 2006 and the disclosure of all revenue guarantees, regardless of whether they were recognized under FIN No. 45, is required for all interim and annual periods beginning after January 1, 2006.

9 

MEDCATH CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — Continued

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 $7.9 million through April 2010 as of December 31, 2007. 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.

10. Per Share Data

     The calculation of diluted earnings (loss) per share considers the potential dilutive effect of options to purchase 1,947,171 and 1,848,909 shares of common stock at prices ranging from $4.75 to $33.05, which were outstanding at December 31, 2007 and 2006, respectively, as well as 193,982 and 216,835 shares of restricted stock which were outstanding at December 31, 2007 and 2006,

     respectively. Of the outstanding stock options, 575,500 and 1,848,909 have not been included in the calculation of diluted earnings (loss) per share for the three months ended December 31, 2007 and 2006, respectively, because the options were anti-dilutive.

11. Stock Compensation Plans

     Effective October 1, 2005, the Company adopted the MedCath Corporation 2006 Stock Option and Award Plan (the Stock Plan), which provides for the issuance of stock options, restricted stock and restricted stock units to employees of the Company. The Stock Plan is administered by the compensation committee of the board of directors, who has the authority to select the employees eligible to receive awards. This committee also has the authority under the Stock Plan to determine the types of awards, select the terms and conditions attached to all awards, and, subject to the limitation on individual awards in the Stock Plan, determine the number of shares to be awarded. At December 31, 2007, the maximum number of shares of common stock which can be issued through awards granted under the Stock Plan is 1,750,000, of which 717,018 are outstanding as of December 31, 2007. The Stock Plan will expire, and no awards may be granted there under, after September 30, 2015.

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

     Activity for the Stock Plan and the Company’s other option plans was as follows:

	For the Three Months Ended
	December 31, 2007					December 31, 2006
				Weighted-					Weighted-
	Number of			Average		Number of			Average
	Stock Options			Exercise Price		Stock Options			Exercise Price
Outstanding stock options, beginning of period		1,727,112		$	19.11		2,070,472		$	18.80
Granted		312,000			26.77		44,000			28.59
Exercised		(15,941	)		19.19		(201,999	)		12.58
Cancelled		(76,000	)		27.71		(63,564	)		19.65
Outstanding stock options, end of period		1,947,171		$	21.66		1,848,909		$	19.21

     The following table summarizes information for options outstanding and exercisable at December 31, 2007:

	Number		Weighted-
	Outstanding		Average		Weighted-
	and		Remaining		Average
Range of Prices	Exercisable		Life (years)		Exercise Price
$4.75 — 15.80		246,912		6.38	$	12.40
15.91 — 18.26		116,700		7.88		16.22
19.00 — 19.60		213,559		2.60		19.04
21.49 — 21.49		500,000		8.14		21.49
21.66 — 22.50		320,000		8.26		22.45
23.25 — 27.71		369,500		9.44		26.43
27.80 — 30.24		105,500		9.10		29.26
30.35 — 33.05		75,000		9.26		31.55
$4.75 — 33.05		1,947,171		7.71	$	21.66

10 

MEDCATH CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — Continued

     Under SFAS No. 123-R, share-based compensation expense recognized for the three months ended December 31, 2007 and 2006 was $3.7 million and $1.0 million, respectively, which had the effect of decreasing net income by $2.2 million or $0.10 per basic and diluted share and $0.6 million or $0.03 per basic and diluted share for the respective 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 period as all such options vest immediately. The total intrinsic value of options exercised during the three months ended December 30, 2007 and 2006 was $0.1 million and $2.5 million, respectively, and the total intrinsic value of options outstanding at December 31, 2007 was $5.7 million.

     During the fiscal year ended September 30, 2006, the Company granted to employees 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 vesting period. Unamortized compensation expense related to restricted stock amounted to $1.3 million at December 31, 2007.

12. Reportable Segment Information

     The Company’s reportable segments consist of the hospital division and the MedCath Partners division.

     Financial information concerning the Company’s operations by each of the reportable segments as of and for the periods indicated is as follows:

	Three Months Ended December 31,
	2007			2006
Net revenue:
Hospital Division	$	152,893		$	162,224
MedCath Partners Division		10,161			12,806
Corporate and other		610			519
Consolidated totals	$	163,664		$	175,549
Income (loss) from operations:
Hospital Division	$	50,059		$	11,288
MedCath Partners Division		1,520			2,587
Corporate and other		(40,158	)		(3,145	)
Consolidated totals	$	11,421		$	10,730
Depreciation and amortization:
Hospital Division	$	6,493		$	7,448
MedCath Partners Division		1,317			1,473
Corporate and other		277			200
Consolidated totals	$	8,087		$	9,121
Interest expense (income) including intercompany, net:
Hospital Division	$	6,044		$	7,931
MedCath Partners Division		(19	)		(16	)
Corporate and other		(3,103	)		1,477
Consolidated totals	$	2,922		$	9,392
Capital expenditures:
Hospital Division	$	13,347		$	2,820
MedCath Partners Division		288			134
Corporate and other		1,645			527
Consolidated totals	$	15,280		$	3,481

11 

MEDCATH CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — Continued

	December 31,		September 30,
	2007		2007
Aggregate identifiable assets:
Hospital Division	$	507,883	$	533,675
MedCath Partners Division		35,312		34,021
Corporate and other		91,158		101,719
Consolidated totals	$	634,353	$	669,415

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

     All of the Company’s goodwill is recorded at the Corporate and other segment.

13. Secondary Public Offering

     An additional 1.7 million shares of the Company’s common stock were registered and sold to the public under the Securities Act of 1933, as amended, on a Registration Statement on Form S-3 (File No. 333-137756) that was declared effective by the Securities and Exchange Commission on November 6, 2006. The net proceeds to the Company from the offering were approximately $39.7 million. The proceeds were used to repurchase $36.2 million of the Company’s outstanding 9 7^/8 % senior notes due 2012 and pay approximately $3.5 million in premiums and expenses associated with the note repurchase.

14. Guarantor/Non-Guarantor Financial Statements

     The following tables present the condensed consolidated financial information for each of MedCath Corporation (the Parent), MedCath Holdings Corporation (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.

12 

MEDCATH CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — Continued

MEDCATH CORPORATION
CONDENSED CONSOLIDATING BALANCE SHEET
December 31, 2007

							Non-
	Parent		Issuer		Guarantors		Guarantors			Eliminations			MedCath
Current assets:
Cash and cash equivalents	$	—	$	—	$	66,201	$	48,500		$	—		$	114,701
Accounts receivable, net		—		—		6,705		92,263			—			98,968
Other current assets		—		—		40,289		18,805			(20,608	)		38,486
Total current assets		—		—		113,195		159,568			(20,608	)		252,155
Property and equipment, net		—		—		17,816		286,247			—			304,063
Investments in subsidiaries		373,757		373,757		68,515		(62	)		(815,967	)		—
Goodwill		—		—		62,740		—			—			62,740
Intercompany notes receivable		—		—		233,397		—			(233,397	)		—
Other long-term assets		—		—		11,766		3,629			—			15,395
Total assets	$	373,757	$	373,757	$	507,429	$	449,382		$	(1,069,972	)	$	634,353
Current liabilities:
Accounts payable	$	—	$	—	$	953	$	32,559		$	—		$	33,512
Accrued compensation and benefits		—		—		5,935		11,506			—			17,441
Other current liabilities		—		—		9,867		29,503			(20,605	)		18,765
Current portion of long- term debt and obligations under capital leases		—		—		440		3,623			—			4,063
Total current liabilities		—		—		17,195		77,191			(20,605	)		73,781
Long- term debt		—		—		101,915		43,739			—			145,654
Obligations under capital leases		—		—		276		1,238			—			1,514
Intercompany notes payable		—		—		—		233,399			(233,399	)		—
Deferred income tax liabilities		—		—		11,945		—			—			11,945
Other long- term obligations		—		—		2,341		407			—			2,748
Total liabilities		—		—		133,672		355,974			(254,004	)		235,642
Minority interest in equity of consolidated subsidiaries		—		—		—		—			24,954			24,954
Total stockholders’ equity		373,757		373,757		373,757		93,408			(840,922	)		373,757
Total liabilities and stockholders’ equity	$	373,757	$	373,757	$	507,429	$	449,382		$	(1,069,972	)	$	634,353

13 

MEDCATH CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — Continued

MEDCATH CORPORATION
CONDENSED CONSOLIDATING BALANCE SHEET
September 30, 2007

							Non-
	Parent		Issuer		Guarantors		Guarantors			Eliminations			MedCath
Current assets:
Cash and cash equivalents	$	—	$	—	$	80,044	$	60,337		$	—		$	140,381
Accounts receivable, net		—		—		5,372		81,622						86,994
Other current assets		—		—		20,772		17,542			(4,062	)		34,252
Current assets of discontinued operations		—		—		17,227		9,764			(16,205	)		10,786
Total current assets		—		—		123,415		169,265			(20,267	)		272,413
Property and equipment, net		—		—		17,434		279,366			—			296,800
Investments in subsidiaries		385,624		385,624		64,739		(62	)		(835,925	)		—
Goodwill		—		—		62,740		—			—			62,740
Intercompany notes receivable		—		—		221,838		—			(221,838	)		—
Other long-term assets		—		—		15,045		3,668			—			18,713
Long-term assets of discontinued operations		—		—		18,110		18,749			(18,110	)		18,749
Total assets	$	385,624	$	385,624	$	523,321	$	470,986		$	(1,096,140	)	$	669,415
Current liabilities:
Accounts payable	$	—	$	—	$	1,087	$	32,160		$	—		$	33,247
Income tax payable		—		—		11,124		—			—			11,124
Accrued compensation and benefits		—		—		6,617		12,940			—			19,557
Other current liabilities		—		—		4,077		14,122			(4,062	)		14,137
Current portion of long- term debt and obligations under capital leases		—		—		473		3,635			—			4,108
Current liabilities of discontinued operations		—		—		—		27,404			(16,205	)		11,199
Total current liabilities		—		—		23,378		90,261			(20,267	)		93,372
Long- term debt		—		—		101,904		44,494			—			146,398
Obligations under capital leases		—		—		397		1,409			—			1,806
Intercompany notes payable		—		—		—		221,838			(221,838	)		—
Deferred income tax liabilities		—		—		12,018		—			—			12,018
Other long- term obligations		—		—		—		460			—			460
Long-term liabilities of discontinued operations		—		—		—		18,110			(18,110	)		—
Total liabilities		—		—		137,697		376,572			(260,215	)		254,054
Minority interest in equity of consolidated subsidiaries		—		—		—		—			29,737			29,737
Total stockholders’ equity		385,624		385,624		385,624		94,414			(865,662	)		385,624
Total liabilities and stockholders’ equity	$	385,624	$	385,624	$	523,321	$	470,986		$	(1,096,140	)	$	669,415

14 

MEDCATH CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — Continued

MEDCATH CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Three Months Ended December 31, 2007

	Three Months Ended December 31, 2007
	Parent		Issuer		Guarantors			Non- Guarantors			Eliminations			MedCath
Net revenue	$	—	$	—	$	7,764		$	158,051		$	(2,151	)	$	163,664
Total operating expenses		—		—		32,262			122,132			(2,151	)		152,243
Income (loss) from operations		—		—		(24,498	)		35,919			—			11,421
Interest expense		—		—		(2,911	)		(1,121	)		—			(4,032	)
Interest and other income (expense), net		—		—		6,016			(4,844	)		—			1,172
Equity in net earnings of unconsolidated affiliates		3,064		3,064		27,052			—			(31,155	)		2,025
Income from continuing operations before minority interest, income taxes and discontinued operations		3,064		3,064		5,659			29,954			(31,155	)		10,586
Minority interest share of earnings of consolidated subsidiaries		—		—		—			—			(4,736	)		(4,736	)
Income from continuing operations before income taxes and discontinued operations		3,064		3,064		5,659			29,954			(35,891	)		5,850
Income tax expense		—		—		2,595			—			—			2,595
Income from continuing operations		3,064		3,064		3,064			29,954			(35,891	)		3,255
Loss from discontinued operations, net of taxes		—		—		—			(191	)		—			(191	)
Net income	$	3,064	$	3,064	$	3,064		$	29,763		$	(35,891	)	$	3,064

MEDCATH CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Three Months Ended December 31, 2006

	Three Months Ended December 31, 2006
	Parent			Issuer			Guarantors			Non- Guarantors			Eliminations			MedCath
Net revenue	$	—		$	—		$	8,700		$	169,142		$	(2,293	)	$	175,549
Total operating expenses		—			—			11,821			155,291			(2,293	)		164,819
Income (loss) from operations		—			—			(3,121	)		13,851			—			10,730
Interest expense		—			—			(4,441	)		(3,017	)		—			(7,458	)
Loss on early extinguishment of debt		—			—			(4,480	)		—			—			(4,480	)
Interest and other income (expense), net		—			—			7,572			(4,847	)		—			2,725
Equity in net earnings of unconsolidated affiliates		(4,896	)		(4,896	)		2,969			—			8,261			1,438
Income (loss) from continuing operations before minority interest, income taxes and discontinued operations		(4,896	)		(4,896	)		(1,501	)		5,987			8,261			2,955
Minority interest share of earnings of consolidated subsidiaries		—			—			—			—			(2,480	)		(2,480	)
Income (loss) from continuing operations before income taxes and discontinued operations		(4,896	)		(4,896	)		(1,501	)		5,987			5,781			475
Income tax expense		—			—			221			—			—			221
Income (loss) from continuing operations		(4,896	)		(4,896	)		(1,722	)		5,987			5,781			254
Loss from discontinued operations, net of taxes		—			—			(3,174	)		(1,976	)		—			(5,150	)
Net income (loss)	$	(4,896	)	$	(4,896	)	$	(4,896	)	$	4,011		$	5,781		$	(4,896	)

15

MEDCATH CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — Continued

MEDCATH CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Three Months Ended December 31, 2007

	Three Months Ended December 31, 2007
						Non-
	Parent		Guarantors			Guarantors			Eliminations			MedCath
Net cash (used in) provided by operating activities	$	—	$	(19,323	)	$	20,783		$	(639	)	$	821
Net cash (used in) provided by investing activities		—		38,510			(33,474	)		5,021			10,057
Net cash provided by (used in) financing activities		—		(33,030	)		854			(4,382	)		(36,558	)
(Decrease) increase in cash and cash equivalents		—		(13,843	)		(11,837	)		—			(25,680	)
Cash and cash equivalents:
Beginning of period		—		80,044			60,337			—			140,381
End of period	$	—	$	66,201		$	48,500		$	—		$	114,701

MEDCATH CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Three Months Ended December 31, 2006

	Three Months Ended December 31, 2006
							Non-
	Parent			Guarantors			Guarantors			Eliminations			MedCath
Net cash provided by (used in) operating activities	$	—		$	(18,005	)	$	27,892		$	—		$	9,887
Net cash provided by (used in) investing activities		(3,494	)		18,144			(21,256	)		3,494			(3,112	)
Net cash provided by (used in) financing activities		3,494			(15,251	)		(9,981	)		(3,494	)		(25,232	)
Decrease in cash and cash equivalents		—			(15,112	)		(3,345	)		—			(18,457	)
Cash and cash equivalents:
Beginning of year		—			177,972			15,682			—			193,654
End of year	$	—		$	162,860		$	12,337		$	—		$	175,197

16

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, 2007.

Overview

     General. We are a healthcare provider focused primarily on providing high acuity services, predominantly the diagnosis and treatment of cardiovascular disease. We own and operate hospitals in partnership with physicians whom we believe have established reputations for clinical excellence. We also have partnerships with community hospital systems, and we manage the cardiovascular program of various hospitals operated by other parties. We opened our first hospital in 1996 and currently have ownership interests in and operate ten hospitals, including eight in which we own a majority interest. Each of our majority-owned hospitals is a freestanding, licensed general acute care hospital that provides a wide range of health services with a focus on cardiovascular care. Each of our owned hospitals has a twenty-four hour emergency room staffed by emergency department physicians. The hospitals in which we have ownership interests have a total of 635 licensed beds and are located in predominately high growth markets in eight states: Arizona, Arkansas, California, Louisiana, New Mexico, Ohio, South Dakota, and Texas.We are currently in the process of developing a new hospital in Kingman, Arizona. We expect this hospital to open in late 2009 or early 2010. This hospital is designed to accommodate a total of 106 licensed beds and will initially open with 70 licensed beds. We are expanding our patient beds by 28 at Arkansas Heart Hospital and 80 licensed beds at Louisiana Heart Hospital with the capacity for an additional 40 beds.

     In addition to our hospitals, we currently own and/or manage twenty cardiac diagnostic and therapeutic facilities. Nine of these facilities are located at hospitals operated by other parties and one of these facilities is located at a hospital we own. These facilities offer invasive diagnostic and, in some cases, therapeutic procedures. The remaining ten facilities are not located at hospitals and offer only diagnostic procedures. Effective January 1, 2007, we renamed our diagnostic and therapeutic division “MedCath Partners”.

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

     During November 2007, we completed the disposition of Heart Hospital of Lafayette. Accordingly, for all periods presented, the results of operations for this hospital have been excluded from continuing operations and are reported in income (loss) from discontinued operations, net of taxes.

     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 December 31,
Division	2007			2006
Hospital		93.4	%		92.4	%
MedCath Partners		6.2	%		7.3	%
Corporate and other		0.4	%		0.3	%
Net Revenue		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 December 31,
Payor	2007			2006
Medicare		40.3	%		42.7	%
Medicaid		2.8	%		4.8	%
Commercial and other, including self-pay		56.9	%		52.5	%
Total consolidated net revenue		100.0	%		100.0	%

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

     The Medicare and Medicaid programs are subject to statutory and regulatory changes, retroactive and prospective rate adjustments, administrative rulings, court decisions, executive orders and freezes and funding reductions, all of which may significantly affect our business. In addition, reimbursement is generally subject to adjustment following audit by third party payors, including the fiscal intermediaries who administer the Medicare program for Centers for Medicare and Medicaid Services (CMS). Final determination of amounts due providers under the Medicare program often takes several years because of such audits, as well as resulting provider appeals and the application of technical reimbursement provisions. 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 December 31, 2007 Compared to Three Months Ended December 31, 2006

     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:

	Three Months Ended December 31,
							Increase/Decrease						% of Net Revenue
	2007			2006			$			%			2007			2006
Net revenue	$	163,664		$	175,549		$	(11,885	)		(6.8	)%		100.0	%		100.0	%
Operating expenses:
Personnel expense		55,941			57,175			(1,234	)		(2.2	)%		34.2	%		32.6	%
Medical supplies expense		43,656			48,170			(4,514	)		(9.4	)%		26.7	%		27.4	%
Bad debt expense		12,173			13,831			(1,658	)		(12.0	)%		7.4	%		7.9	%
Other operating expenses		32,110			36,465			(4,355	)		(11.9	)%		19.6	%		20.8	%
Pre-opening expenses		248			—			248			100.0	%		0.1	%		—
Depreciation		7,960			8,869			(909	)		(10.2	)%		4.9	%		5.1	%
Amortization		127			252			(125	)		(49.6	)%		0.1	%		0.1	%
Loss on disposal of property, equipment and other assets		28			57			(29	)		50.9	%		0.0	%		—
Income from operations		11,421			10,730			691			6.4	%		7.0	%		6.1	%
Other income (expenses):
Interest expense		(4,032	)		(7,458	)		3,426			45.9	%		(2.4	)%		(4.2	)%
Loss on early extinguishment of debt		—			(4,480	)		4,480			100.0	%		—			(2.6	)%
Interest and other income, net		1,172			2,725			(1,553	)		(57.0	)%		0.7	%		1.6	%
Equity in net earnings of unconsolidated affiliates		2,025			1,438			587			40.8	%		1.2	%		0.8	%
Income from continuing operations before minority interest, income taxes and discontinued operations		10,586			2,955			7,631			258.2	%		6.5	%		1.7	%
Minority interest share of earnings of consolidated subsidiaries		(4,736	)		(2,480	)		(2,256	)		(91.0	)%		(2.9	)%		(1.4	)%
Income from continuing operations before income taxes and discontinued operations		5,850			475			5,375			1131.6	%		3.6	%		0.3	%
Income tax expense		2,595			221			2,374			1074.2	%		1.6	%		0.1	%
Income from continuing operations		3,255			254			3,001			1181.5	%		2.0	%		0.2	%
Loss from discontinued operations, net of taxes		(191	)		(5,150	)		4,959			(96.3	)%		(0.1	)%		(2.9	)%
Net income (loss)	$	3,064		$	(4,896	)	$	7,960			(162.6	)%		1.9	%		(2.7	)%

Harlingen Medical Center is treated as an unconsolidated equity investment for the first quarter of fiscal 2008 whereas it was consolidated for the first quarter of 2007. For comparison purposes, the selected operating data below are presented on an actual basis and on a same facility basis. Same facility basis reflects Harlingen Medical Center as though it was an equity investment for the first quarter of 2007. The following table presents selected operating data on a consolidated basis and a same facility basis for the periods indicated:

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	Three Months Ended December 31,
										2006 Same
	2007			2006			% Change			Facility			% Change
Selected Operating Data (a):
Number of hospitals		8			9						8
Licensed beds (b)		468			580						468
Staffed and available beds (c)		451			563						451
Admissions (d)		8,055			9,730			(17.2	)%		7,904			1.9	%
Adjusted admissions (e)		10,976			13,345			(17.8	)%		10,311			6.4	%
Patient days (f)		28,584			34,089			(16.1	)%		28,775			(0.7	)%
Adjusted patient days (g)		39,102			46,520			(15.9	)%		37,711			3.7	%
Average length of stay (days) (h)		3.55			3.50			1.4	%		3.64			(2.5	)%
Occupancy (i)		68.9	%		65.8	%					69.4	%
Inpatient catheterization procedures (j)		4,555			4,858			(6.2	)%		4,679			(2.7	)%
Inpatient surgical procedures (k)		2,099			2,516			(16.6	)%		2,098			0.0	%
Hospital net revenue	$	151,965		$	161,058			(5.6	)%	$	142,604			6.6	%

(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. During the fourth quarter of fiscal 2007, Harlingen Medical Center ceased to be a consolidated subsidiary due to the sale of a portion of our equity interest in the hospital.
(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 volume. 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.
(j)	Inpatients with a catheterization procedure represent the number of inpatients with a procedure performed in one of the hospitals’ catheterization labs during the period.
(k)	Inpatient surgical procedures represent the number of surgical procedures performed on inpatients during the period.

     Net Revenue.Net revenue decreased 6.8% or $11.8 million to $163.7 million for the three months ended December 31, 2007, the first quarter of our fiscal year 2008, from $175.5 million for the three months ended December 31, 2006, the first quarter of our fiscal year 2007. During the first quarter of 2007 we consolidated Harlingen Medical Center. Harlingen Medical Center is treated as an unconsolidated equity investment for the first quarter of fiscal 2008. Net revenue on a same facility basis (comparing the first quarter of fiscal 2008 to the first quarter of fiscal 2007 excluding the actual results of Harlingen Medical Center), was as follows:

	Three Months Ended December 31,
					Increase/Decrease					% of Net Revenue
	2007		2006		$		%			2007			2006
Net revenue		163,664		157,095		6,569		4.2	%		100.0	%		100.0	%

     The increase in our hospitals’ net revenue on a same facility basis was a result of the following:

• The first quarter of fiscal 2007 included a $2.7 million reduction in net revenue as a result of recording the potential settlement with the Department of Justice (seecommitment and contingencysection).

• Same facility adjusted admissions increased by 6.4%.

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     Personnel expense.Personnel expense decreased 2.2% to $55.9 million for the first quarter of fiscal 2008 from $57.2 million for the first quarter of fiscal 2007. Personnel expense on a same facility basis was as follows:

	Three Months Ended December 31,
					Increase/Decrease					% of Net Revenue
	2007		2006		$		%			2007			2006
Personnel expense		55,941		51,128		4,813		9.4	%		34.2	%		32.5	%

     The $4.8 million increase in personnel expense on a same facility basis was primarily due to an increase in stock based compensation expense. The total stock based compensation expense was $3.7 million for the first quarter of fiscal 2008 compared to $1.0 million for the first quarter of fiscal 2007. The stock based compensation expense increased $2.7 million as a result of stock options awarded to employees, directors and certain executives by the compensation committee in November 2007. Employee, director and executive stock option expense increased $0.7 million, $0.4 million and $1.6 million, respectively, in the first quarter of fiscal 2008 compared to the first fiscal quarter of 2007. In addition, the 6.4% increase in adjusted admissions on a same facility basis had a direct impact on our personnel expense.

     Medical supplies expense.Medical supplies expense decreased 9.4% to $43.7 million for the first quarter of fiscal 2008 from $48.2 million for the first quarter of fiscal 2007. On a same facility basis, medical supplies expense decreased 4.2% as shown below:

	Three Months Ended December 31,
					Increase/Decrease						% of Net Revenue
	2007		2006		$			%			2007			2006
Medical supplies expense		43,656		45,553		(1,897	)		(4.2	)%		26.7	%		29.0	%

     The 4.2% decrease in medical supplies expense on a same facility basis during the three months ended December 31, 2007 is a result of continued price reductions due to our supply chain initiatives offset by a 6.4% increase in adjusted admissions on a same facility basis. Supplies expense decreased 8.4% per adjusted admission in the first quarter of fiscal 2008 compared to the same period of the prior year.

     Bad debt expense.Bad debt expense decreased 12.0% to $12.2 million for the first quarter of fiscal 2008 from $13.8 million for the first quarter of fiscal 2007. As a percentage of net revenue, bad debt expense decreased to 7.4% from 7.9% for the three months ended December 31, 2007 and 2006, respectively. Bad debt expense on a same facility basis was as follows:

	Three Months Ended December 31,
			Increase/Decrease							% of Net Revenue
	2007		2006		$		%			2007			2006
Bad debt expense		12,173		10,254		1,919		18.7	%		7.4	%		6.5	%

     The 18.7% increase in bad debt expense on a same facility basis is attributable to an overall increase in self-pay patient revenue. Self-pay patient revenue increased $0.9 million in the first quarter of fiscal 2008 compared to the same period for the prior year. Due to our historical collection history related to self-pay patients, we reserve a large portion of self-pay revenue upon discharge.

     Other operating expenses.Other operating expenses decreased 11.9% to $32.1 million for the three months ended December 31, 2007 from $36.5 million for the three months ended December 31, 2006. On a same facility basis, other operating expenses decreased less than 1% as follows:

	Three Months Ended December 31,
					Increase/Decrease						% of Net Revenue
	2007		2006		$			%			2007			2006
Other operating expense		32,110		32,391		(281	)		(0.9	)%		19.6	%		20.6	%

     Other operating expenses are comparable on a same facility basis for the first quarter of fiscal 2008 compared to the first quarter of fiscal 2007.

     Interest expense.Interest expense decreased 45.9% to $4.0 million for the first quarter of fiscal 2008 from $7.5 million for the first quarter of fiscal 2007 or a reduction of 35.7% and $2.2 million on a same facility basis. The $2.2 million decrease in interest expense on a same facility basis is primarily attributable to the overall reduction in our outstanding debt as we repurchased approximately $36.2 million of our senior notes and repaid $21.2 million of our REIT loan at one of our facilities during the first quarter of fiscal 2007.

     Loss on early extinguishment of debt.We incurred approximately $4.5 million in loss on early extinguishment of debt during the first quarter of fiscal 2007, while there was no loss on early extinguishment of debt during the first quarter of fiscal 2008. During the first quarter of fiscal 2007, this loss consisted of a $3.5 million repurchase premium and the write off of approximately $1.0 million of deferred loan acquisition costs related to the prepayment of a portion of our senior notes.

     Interest and other income, net.Interest and other income, net, decreased to $1.2 million for the first quarter of fiscal 2008 from $2.7 million for the first quarter of fiscal 2007. The decrease in interest and other income is a direct result of the approximately $60.5 million decrease in our cash balance from December 31, 2006 to December 31, 2007.

     Equity in net earnings of unconsolidated affiliates.Equity in net earnings of unconsolidated affiliates increased approximately $0.6 million for the first quarter of fiscal 2008 compared to the first quarter of fiscal 2007. For the first quarter of fiscal 2008 we

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reported Harlingen Medical Center as an equity investment and recorded our allocation of the hospital’s income for the first quarter in equity in net earnings of unconsolidated affiliates. Therefore, equity in net earnings of unconsolidated affiliates for the first quarter of fiscal 2008 includes the earnings at two hospitals in which we hold less than a 50% interest as opposed to only one hospital for the first quarter of fiscal 2007. The remainder of equity in earnings of unconsolidated affiliates is attributable to earnings in various MedCath Partners diagnostic ventures in which we hold less than a 50% interest. The impact of reporting Harlingen Medical Center as an unconsolidated affiliate during the first quarter of 2008 was approximately $0.1 million. The remaining $0.5 million increase is attributable to a $0.4 million increase in the MedCath Partners division and a $0.1 million increase in other ventures.

     Minority interest share of earnings of consolidated subsidiaries.Minority interest share of earnings of consolidated subsidiaries increased to $4.7 million for the first quarter of fiscal 2008 from $2.5 million for the first quarter of fiscal 2007. This $2.2 million increase was primarily due to the net increase in earnings of certain of our established hospitals and MedCath Partners’ 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 December 31, 2007, we had remaining cumulative disproportionate loss allocations of approximately $2.8 million at one of our facilities 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, seeCritical Accounting Policiesin our Annual Report on Form 10-K for the fiscal year ended September 30, 2007.

     Income tax expense.Income tax expense was $2.6 million for the first quarter of fiscal 2008 compared to $0.2 million for the first quarter of fiscal 2007, which represents an effective tax rate of approximately 44.4% and 46.5% for the respective periods.

     Loss from discontinued operations, net of taxes.Loss from discontinued operations decreased to $0.2 million for the first quarter of fiscal 2008 from $5.2 million for the first quarter of fiscal 2008. On November 30, 2007 we sold certain assets and liabilities related to the Heart Hospital of Lafayette. As a result, the first quarter of fiscal 2008 reflects only two months of activity for Heart Hospital of Lafayette as a discontinued operation. There was a minimal gain recorded upon the sale as most of the impairment on the assets was recorded in prior quarters during fiscal 2007. We recorded an impairment of $4.1 million related to Heart Hospital of Lafayette during the first quarter of fiscal 2007.

Liquidity and Capital Resources

     Working Capital and Cash Flow Activities. Our consolidated working capital was $178.4 million at December 31, 2007 and $179.0 million at September 30, 2007. During the first quarter of fiscal 2008 we purchased $18.3 million of treasury shares using our cash on hand. The first quarter is also the quarter in which we pay our tax liabilities and accrued bonuses for our employees. The cash outlays were offset by the sale of certain assets and liabilities of Heart Hospital of Lafayette. As a result of the sale, our net cash position increased by approximately $16.2 million during the quarter.

     The cash provided by operating activities of continuing operations was $0.7 million for the first quarter of fiscal 2008 compared to $11.4 million provided by operating activities for the first quarter of fiscal 2007. We experienced an increase in our accounts receivable balance for the first three months of fiscal 2008 compared to the increase that occurred for the first three months of fiscal 2007. In addition, during the first quarter of fiscal 2008, payment was made for a previously announced $5.8 million settlement between one of our hospitals and the United States Department of Justice. This is attributable to an increase in self-pay patient revenue and a 6.4% increase in adjusted admissions on a same facility basis. In addition, we experienced an increase in hospital division days sales outstanding (DSO) for patient accounts receivable.

     Our investing activities from continuing operations used net cash of $14.3 million for the first three months of fiscal 2008 compared to net cash used of $3.0 million for the first three months of fiscal 2007. The total cash used for capital expenditures related to building expansions increased $4.6 million during the first quarter of 2008 compared to the first quarter of fiscal 2007 as a result of the expansion of several of our hospital facilities and the construction of a new acute care hospital in Kingman Arizona. The increase in capital expenditures for continuing operations was offset by the $24.3 million in cash received as a result of the sale of our discontinued operation, Heart Hospital of Lafayette, during the first quarter of fiscal 2008.

     Our financing activities from continuing operations used net cash of $28.6 million for the first three months of fiscal 2008 compared to net cash used of $24.8 million for the first three months of fiscal 2007. The $28.6 million of net cash used for financing activities for the first three months of fiscal 2008 is primarily a result of the $18.3 million purchase of treasury shares and distributions to minority partners of $10.5 million.

     The $24.8 million of net cash used for financing activities for the first three months of fiscal 2007 was for distributions to minority partners and the repayment of long-term debt and obligations under capital leases, including a payment of $39.9 million to pay off our senior secured credit facility, a payment of $21.2 million to pay off one of our facility’s REIT loans, which matured in December 2006, and a payment of $11.1 million to pay off the equipment loan at another of our facilities. Further, during the three months ended December 31, 2007 cash was provided as a result of a secondary public offering in which we sold an additional 1.7 million shares of common stock.

     Capital Expenditures.Expenditures for property and equipment for the first three months of fiscal years 2008 and 2007 were $15.3 million, including cash expenditures of $14.3 million, and $3.5 million, respectively.

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During the three months ended December 31, 2007, we continued the development of our hospital in Kingman, Arizona and the expansion projects at two of our existing hospitals. 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 December 31, 2007, we had $151.2 million of outstanding debt, $4.1 million of which was classified as current. Of the outstanding debt, $102.0 million was outstanding under our 9 7^/8 % senior notes and $48.5 million was outstanding to lenders to our hospitals. The remaining $0.7 million of debt was outstanding to lenders under capital leases and other miscellaneous indebtedness. No amounts were outstanding to lenders under our $100.0 million revolving credit facility at December 31, 2007. At the same date, however, we had letters of credit outstanding of $1.7 million, which reduced our availability under this facility to $98.3 million.

     During the first quarter of fiscal 2007, we sold 1.7 million shares of common stock to the public. The $39.7 million in net proceeds from this offering were used to repurchase approximately $36.2 million of our outstanding senior notes and to pay approximately $3.5 million of associated premiums and expenses associated with the note repurchase.

     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. The Company was in compliance with all covenants in the instruments governing its outstanding debt at December 31, 2007.

     At December 31, 2007, we guaranteed either all or a portion of the obligations of our subsidiary hospitals for equipment and other notes payable. We provide these guarantees in accordance with the related hospital operating agreements, and we receive a fee for providing these guarantees from the hospitals or the physician investors.

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

     Intercompany Financing Arrangements.We provide secured real estate, equipment and working capital financings to our majority-owned hospitals. The aggregate amount of the intercompany real estate, equipment and working capital and other loans outstanding as of December 31, 2007 was $255.0 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 typically matures in 7 to 10 years and accrues interest at variable rates based on LIBOR plus an applicable margin or a fixed rate similar to terms commercially available.

     Each intercompany equipment loan is separately documented and secured with a lien on the borrowing hospital’s equipment and certain other assets. Amounts borrowed under the intercompany equipment loans are payable in monthly installments of principal and interest over terms that range from 5 to 7 years. The intercompany equipment loans accrue interest at fixed rates ranging from 7.95% to 8.58% or variable rates based on LIBOR plus an applicable margin. The weighted average interest rate for the intercompany equipment loans at December 31, 2007 was 7.36%.

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

     We also use intercompany financing arrangements to provide cash support to individual hospitals for their working capital and other corporate needs. We provide these working capital loans pursuant to the terms of the operating agreements between our physician and hospital investor partners and us at each of our hospitals. These intercompany loans are evidenced by promissory notes that establish borrowing limits and provide for a market rate of interest to be paid to us on outstanding balances. These intercompany loans are subordinate to each hospital’s mortgage and equipment debt outstanding, but are senior to our equity interests and our partners’ equity interests in the hospital venture and are secured, subject to the prior rights of the senior lenders, in each instance by a pledge of certain of the borrowing hospital’s assets. Also as part of our intercompany financing and cash management structure, we typically 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 December 31, 2007 and September 30, 2007, we held $45.3 million and $33.0 million, respectively, of intercompany working capital and other notes and related accrued interest, net of advances from our hospitals.

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

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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 inItem 1A. Risk Factorsin our Annual Report on Form 10-K for the year ended September 30, 2007, before making an investment decision with respect to our debt and equity securities. A copy of this report, including exhibits, is available on the internet site of the SEC athttp://www.sec.govor through 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. See Item 7A in the Company’s Annual Report on Form 10-K for further discussions about market risk.

Item 4. Controls and Procedures

     The President and Chief Executive Officer and the interim 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 December 31, 2007, that the Company’s disclosure controls and procedures were effective as of December 31, 2007 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 the interim 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 1. Legal Proceedings

     We are occasionally involved in legal proceedings and other claims arising out of our operations in the normal course of business. See Note 8 —Contingencies and Commitmentsto the consolidated financial statements.

Item 1A. Risk Factors

     Information concerning certain risks and uncertainties appears under the heading “Forward-Looking Statements” in Part I, Item 2 of this report and Part I, Item 1A of our Annual Report on Form 10-K for the year ended September 30, 2007. You should carefully consider these risks and uncertainties before making an investment decision with respect to our debt and equity securities. Such risks and uncertainties could materially adversely affect our business, financial condition or operating results.

     During the period covered by this report, there have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended September 30, 2007 or filings subsequently made with the Securities and Exchange Commission.

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.

     The Board of Directors approved a stock repurchase program of up to $59.0 million in August 2007. Stock purchases can be made from time to time in the open market or in privately negotiated transactions in accordance with applicable federal and state securities laws and regulations. The repurchase program may be discontinued at any time. Subsequent to the approval of the stock repurchase program, the Company purchased 777,506 shares of common stock at a total cost of $18.3 million.

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The following table sets forth, for the months indicated, our purchases of common stock in the first quarter of fiscal year 2008:

ISSUER PURCHASES OF EQUITY SECURITIES

							Approximate
					Total Number		Dollar Value of
					of Shares		Shares that
					Purchased as		May Yet Be
	Total Number		Average		Part of Publicly		Purchased Under
	of Shares		Price Paid		Announced Plans		The Plans
Period	Purchased		per Share		or Programs		or Programs
	(in thousands, except average price paid per share)
October 1, 2007 — October 31, 2007		—	$	—		—	$	59,000
November 1, 2007 — November 30, 2007		229	$	23.01		229	$	53,707
December 1, 2007 — December 31, 2007		548	$	23.70		548	$	40,695
Total		777	$	23.53		777	$	40,695

Item 6. Exhibits

Exhibit
No.	Description
31.1	Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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: February 11, 2008	By:	/s/ O. EDWIN FRENCH
		O. Edwin French
		President and Chief Executive Officer (principal executive officer)
	By:	/s/ JAMES A. PARKER
		James A. Parker
		Interim Chief Financial Officer (principal financial officer)
	By:	/s/ LORA RAMSEY
		Lora Ramsey
		Vice President — Controller (principal accounting officer)

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