e10vk

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-K


(Mark One)
þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the fiscal year ended September 30, 2010
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 (I.R.S. Employer Identification No.)

10720 Sikes Place

Charlotte, North Carolina 28277

(Address of principal executive offices, including zip code)

(704) 815-7700

(Registrant’s telephone number, including area code)

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

None

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

Common Stock, $0.01 par value

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

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

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

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” 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 December 10, 2010 there were 20,469,305 shares of the Registrant’s Common Stock outstanding. The aggregate market value of the Registrant’s common stock held by non-affiliates as of March 31, 2010 was approximately $206.0 million (computed by reference to the closing sales price of such stock on the Nasdaq Global Market^® on such date).

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s proxy statement for its annual meeting of stockholders to be held in 2011 are incorporated by reference into Part III of this Report.

FORWARD-LOOKING STATEMENTS

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


	•	our examination of strategic alternatives,

	•	the impact of federal and state healthcare reform initiatives,

	•	changes in Medicare and Medicaid reimbursement levels,

	•	the impact of governmental entity audits,

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

	•	difficulties in executing our strategy,

	•	our ability to consummate asset sales and other transactions,

	•	our relationships with physicians who use our facilities,

	•	competition from other healthcare providers,

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

	•	our information systems,

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

	•	liabilities and other claims asserted against us,

	•	changes in medical devices or other technologies, and

	•	market-specific or general economic downturns.

Although these statements are made in good faith based upon assumptions our management believes are reasonable on the date they are made, we cannot assure you that we will achieve our goals. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this report and its exhibits might not occur. Our forward-looking statements speak only as of the date of this report or the date they were otherwise made. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. We urge you to review carefully all of the information in this report and the discussion of risk factors before making an investment decision with respect to our debt and equity securities.

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


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

	•	references to fiscal years are to our fiscal years ending September 30. For example, “fiscal 2010” refers to our fiscal year ended September 30, 2010.

PART I


Item 1.	*Business*

Overview

We were incorporated as MedCath Corporation in Delaware in 2001. We are a healthcare provider and are focused primarily on providing high acuity services, including the diagnosis and treatment of cardiovascular disease. We own and operate hospitals in partnership with physicians whom we believe have established reputations for clinical excellence. We opened our first hospital in 1996 and as of September 30, 2010, had ownership interests in and operated ten hospitals, including eight in which we owned a majority interest. Each of our majority-owned hospitals is a freestanding, licensed general acute care hospital that provides a wide range of health services with a majority focus on cardiovascular care. Each of our hospitals has a 24-hour emergency room staffed by emergency department physicians.

As noted below under “Our Strategic Options Review” on March 1, 2010, we announced our intention to sell the Company, our individual assets or a combination thereof. Since this announcement, we have sold two of our majority owned hospitals that were classified as discontinued operations as of September 30, 2010, our equity interest in one of our minority owned hospitals, and a minority venture owned by our MedCath Partners division. As a result, we currently own interests in seven hospitals, including six in which we own a majority interest. In addition, we have an agreement to sell one of the seven remaining hospitals.

The hospitals in which we had an ownership interest as of September 30, 2010 had a total of 825 licensed beds, 117 of which are related to Arizona Heart Hospital (“AzHH”) and Heart Hospital of Austin (“HHA”) whose assets, liabilities, and operations are included within discontinued operations. AzHH and HHA were sold on October 1, 2010 and November 1, 2010, respectively. Our seven hospitals that currently comprise our continuing operations have 653 licensed beds and are located in six states: Arizona, Arkansas, California, Louisiana, New Mexico, and Texas.

In addition to our hospitals, we currently own and/or manage eight cardiac diagnostic and therapeutic facilities. Seven of these facilities are located at hospitals operated by other parties. These facilities offer invasive diagnostic and, in some cases, therapeutic procedures. The remaining facility is not located at a hospital and offers only diagnostic procedures. We refer to our diagnostics division as “MedCath Partners.” For financial data and other information of this and other segments of our business see Note 20 to our audited consolidated financial statements in this report on Form 10-K for financial information by segment.

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

We maintain a website at www.medcath.com that investors and interested parties can access and obtain copies, free-of-charge, our proxy statements, annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.

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

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

Our Strategic Options Review

On March 1, 2010, we announced that our Board of Directors had formed a Strategic Options Committee to consider the sale either of our equity or the sale of our individual hospitals and other assets. We retained Navigant Capital Advisors as our financial advisor to assist in this process. Since announcing the exploration of strategic alternatives on March 1, 2010, we have completed several transactions, including:


	•	The disposition of Arizona Heart Hospital (Phoenix, Arizona) in which we sold the majority of the hospital’s assets to Vanguard Health Systems for $32.0 million, plus retained working capital. The transaction was completed effective October 1, 2010. We anticipate that we will receive final net proceeds of approximately $31.5 million from the transaction after payment of retained known liabilities, payment of taxes related to the transaction and collection of the hospital’s accounts receivable. The $31.5 million in estimated net proceeds is prior to any reserves, if any, required in management’s judgment to address any potential contingent liabilities.

	•	The disposition of our wholly owned subsidiary that held 33.3% ownership of Avera Heart Hospital of South Dakota located in Sioux Falls, SD to Avera McKennan for $20.0 million, plus a percentage of the hospital’s available cash. The transaction was completed October 1, 2010. We estimate that we will receive final net proceeds from the transaction of approximately $16.0 million, after closing costs and payment of estimated taxes related to the transaction and prior to reserves, if any, required in management’s judgment to address any potential contingent liabilities.

	•	The disposition of Heart Hospital of Austin (Texas) in which we and the physician owners sold substantially all of the hospital’s assets to St. David’s Healthcare Partnership L.P. for approximately $83.8 million, plus retained working capital. The transaction was completed effective November 1, 2010. We anticipate that we will receive final net proceeds of approximately $24.1 million from the transaction after repayment of third party debt and a related prepayment fee, payment of all known retained liabilities of the partnership, payment of taxes related to the transaction, collection of the partnerships accounts receivable, and distributions to the hospital’s minority partners. The $24.1 million in estimated net proceeds is prior to reserves, if any, required in management’s judgment to address any potential contingent liabilities.

	•	The disposition of our approximate 27.0% ownership interest in Southwest Arizona Heart and Vascular, LLC (Yuma, AZ) to the joint venture’s physician partners for $7.0 million. The transaction was completed effective November 1, 2010. We estimate that final net proceeds from the transaction will total approximately $6.9 million, after closing costs and income tax benefit related to a tax loss on the transaction, but prior to reserves, if any, required in management’s judgment to address any potential contingent liabilities.

In addition, we announced on November 8, 2010, that we, along with our physician investors, had entered into a definitive agreement to sell substantially all the assets of TexSan Heart Hospital (San Antonio, Texas) to Methodist Healthcare System of San Antonio for $76.25 million, plus retained working capital. The transaction, which is subject to regulatory approval and other customary closing conditions, is anticipated to close during our second quarter of fiscal 2011, which ends March 31, 2011. We anticipate that we will receive approximately $58.0 million from the transaction after payment of all retained known liabilities of the partnership, payment of taxes related to the transaction, collection of the partnership’s accounts receivable, and distributions to the hospital’s minority partners. The $58.0 million in estimated net proceeds is prior to reserves, if any, required in management’s judgment to address any potential contingent liabilities.

We cannot assure our investors that our continuing efforts to enhance stockholder value will be successful, or whether future transactions will involve a sale of our equity, a sale of our remaining individual hospitals or other assets, or a combination of these alternatives. We continue to consider all practicable alternatives to maximize stockholder value. Although the strategic alternatives process is on-going and expected to continue during our fiscal 2011 and potentially beyond, we have begun to consider a number of scenarios for distributing available cash to our stockholders such as special cash dividends, and/or distributions to stockholders following future sales of individual hospitals or other assets, in the context of a dissolution of the Company and following repayment of all bank debt and termination of our credit facility. If our common equity is sold in a merger or other similar transaction, then stockholders would receive consideration in exchange for their shares in accordance with terms of that transaction.

Many unknown variables, including those related to seeking any approvals which may be required, will affect the amount, timing and mechanics of any potential distributions to stockholders. Until further progress is made in the strategic alternative process, we are unable to determine the approach that best meets the interests of MedCath’s stockholders. In addition, the summary of net proceeds from the asset and other sales described in this annual report are only preliminary estimates relating to those transactions. Final amounts available to stockholders will be diminished by asset and corporate wind-down related operating and other expenses, our continued debt service obligations, tax treatment, inability to collect all amounts owed to us, any required reserves to address potential liabilities, including retained and contingent liabilities and/or other unforeseen events.

Our Hospitals

As of September 30, 2010 we had ownership interests in and operated ten hospitals. Since September 30, 2010, we have sold our interests in three of these hospitals and have entered into an agreement to sell one additional hospital. The following table identifies key characteristics of our hospitals as of September 30, 2010.


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

Arkansas Heart Hospital	Little Rock, AR		70.3	%	March 1997		112			6		3
Bakersfield Heart Hospital	Bakersfield, CA		53.3	%	October 1999		47			4		3
Heart Hospital of New Mexico	Albuquerque, NM		74.8	%	October 1999		55			5		4
Harlingen Medical Center(1)	Harlingen, TX		34.8	%	October 2002		112			2		10
Louisiana Heart Hospital	St. Tammany Parish, LA		89.2	%	February 2003		137			3		7
Texsan Heart Hospital(4)	San Antonio, TX		69.0	%	January 2004		120			4		4
Hualapai Mountain Medical Center	Kingman, AZ		82.5	%	October 2009		70	(2)		1		4
Hospitals Disposed Subsequent to September 30, 2010
Arizona Heart Hospital(3)	Phoenix, AZ		70.6	%	June 1998		59			3		4
Heart Hospital of Austin(3)	Austin, TX		70.9	%	January 1999		58			6		4
Avera Heart Hospital of South Dakota(1) (3)	Sioux Falls, SD		33.3	%	March 2001		55			4		3


(1)		We did not have a majority ownership interest in these hospitals as of September 30, 2010. We use the equity method of accounting for these hospitals, which means that we include in our consolidated statements of income a percentage of the hospitals’ reported net income (loss) for each reporting period.

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

(3)		The Company disposed of its interest in Avera Heart Hospital of South Dakota and substantially all of the assets of Arizona Heart Hospital on October 1, 2010. The Company sold substantially all of the assets of Heart Hospital of Austin on November 1, 2010.

(4)		In November 2010, the Company entered into an agreement to dispose of its interest in TexSan Heart Hospital. We expect this transaction to close during our second fiscal quarter of 2011, which ends March 31, subject to required approvals and customary closing conditions.

Diagnostic and Therapeutic Facilities

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

Managed Diagnostic and Therapeutic Facilities. As of September 30, 2010 we owned and/or managed the operations of eight cardiac diagnostic and therapeutic facilities (two are located at Coastal Carolina Heart, LLC). On November 1, 2010, we disposed of our interest in Southwest Arizona Heart and Vascular, LLC. The following table provides information about our facilities.

MedCath

Termination

Management

or Next

MedCath

Commencement

Renewal

Facility/Entity

Location

Ownership

Date

Joint Ventures:

Blue Ridge Cardiology Services, LLC(1)

Morganton, NC

50.00

2004

Dec. 2014

Central New Jersey Heart Services, LLC(1)

Trenton, NJ

14.80

2007

Mar 2017

Coastal Carolina Heart, LLC(1)

Wilmington, NC

9.20

2007

July 2013

Managed Ventures:

Margaret R. Pardee Memorial Hospital(1)

Hendersonville, NC

100

%(2)

2004

Month-to-month

Duke Health Raleigh Hospital(1)

Raleigh, NC

100

%(2)

2006

Dec. 2012

Caldwell Cardiology Services

Lenoir, NC

100

%(2)

2006

Mar. 2012

Presbyterian Hospital Matthews

Matthews, NC

100

%(2)

2010

May 2015


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

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

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

Interim Mobile Catheterization Labs. We maintain a rental fleet of mobile cardiac catheterization laboratories. We lease these laboratories on a short-term basis to hospitals while they are either adding capacity to their existing facilities or replacing or upgrading their equipment. We also lease these laboratories to hospitals that experience a higher demand for cardiac catheterization procedures during a particular season of the year and choose not to expand their own facilities. Our rental laboratories are manufactured by leading original equipment manufacturers and have advanced technology and enable cardiologists to perform both diagnostic and interventional therapeutic procedures. Each of our rental units is generally in service for an average of nine months of the year. These units enable us to be responsive to immediate demand and create flexibility in our operations.

Major Procedures Performed at Our Facilities

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

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

Invasive Procedures

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

Percutaneous cardiac intervention, including the following:


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

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

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

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

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

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


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

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

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

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

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

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

Non-Invasive Procedures

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

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

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

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

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

Employees

As of September 30, 2010, we employed 2,362 persons, including 1,678 full-time and 684 part-time employees. None of our employees is a party to a collective bargaining agreement and we consider our relationships with our employees to be good. There currently is a nationwide shortage of nurses and other medical support personnel, which makes recruiting and retaining these employees difficult. We believe we offer our employees competitive wages and benefits and offer a professional work environment that we believe helps us recruit and retain the staff we need to operate our hospitals and other facilities.

We have experienced attrition at our corporate office as a result of our strategic alternatives process. We have offered stay bonuses to many of our employees to encourage them to remain during the process.

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

Environmental Matters

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

Insurance

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

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

Competition

We compete primarily with other cardiovascular care providers, principally for-profit and not-for-profit general acute care hospitals. In most of our markets we compete for market share of cardiovascular procedures with two to three hospitals. Some of the hospitals that compete with our hospitals are owned by governmental agencies or not-for-profit corporations supported by endowments and charitable contributions and can finance capital expenditures and operations on a tax-exempt basis. Some of our competitors are larger and are more established than we are and, have greater geographic coverage, offer a wider range of services or have more capital or other resources than we do. If our competitors are able to finance capital improvements, recruit physicians, expand services or obtain favorable managed care contracts at their facilities, we may experience a decline in market share. In operating our hospitals, particularly in performing outpatient procedures, we compete with free-standing diagnostic and therapeutic facilities located in the same markets.

Reimbursement

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

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

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

On August 22, 2007, CMS issued its final inpatient hospital prospective payment system rule for fiscal year 2008, which began October 1, 2007. The final rule continues major DRG reforms designed to improve the accuracy of hospital payments. As introduced in the fiscal year 2007 final rule, CMS will continue to use hospital costs rather than charges to set payment rates. For fiscal year 2008, hospitals were paid based upon a blend of 1/3 charge-based weights and 2/3 hospital cost-based weights for DRGs. Additionally, CMS adopted its proposal to restructure the current 538 DRGs to 745 MS-DRGs (severity-adjusted DRGs) to better recognize severity of patient illness. These MS-DRGs were phased in over a two-year period.

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

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

CMS published an updated IPPS for 2010 on May 21, 2010 which included a 0.25% market basket reduction and a related reduction to the outlier threshold. The market basket adjustment applies to discharges on or after April 1, 2010 and before October 1, 2010.

CMS published the IPPS for 2011 on July 30, 2010, which includes the following payment and policy changes effective for discharges on or after October 1, 2010, the beginning of the Company’s fiscal 2011: a net inflation update of 2.35%; a net increase of 1.25% for MS-DRG capital payments; an additional reduction of 2.9% to the operating and capital rate updates to recoup 50% of the estimated overpayments in 2008 and 2009 due to hospital coding and documentation processes in connection with the transition to MS-DRGs; a decrease in the cost outlier threshold from $23,135 to $23,075; and the addition of 12 new quality measures to the RHQDAPU program set and the retirement of one measure (10 of the new measures will be considered in determining a hospital’s 2012 update; the remaining two measures to be reported in 2011 will be considered in a hospital’s 2013 update).

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

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

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

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

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

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

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

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

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

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

Regulation

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

The Medicare Modernization Act

The Medicare Prescription Drug Improvement and Modernization Act of 2003 (the “Medicare Modernization Act”) made significant changes to the Medicare program, particularly with respect to the coverage of prescription drugs. These modifications also include provisions affecting Medicare coverage and reimbursement to general acute care hospitals, as well as other types of providers.

Health Care Reform Laws

In March 2010, President Obama signed the Patient Protection and Affordable Care Act as amended by the Health Care and Education Reconciliation Act of 2010 (“Health Care Reform Laws”) thereby making it effective.

The new law will result in sweeping changes across the health care industry. The primary goal of this comprehensive legislation is to extend health coverage to approximately 32 million uninsured legal U.S. residents through a combination of public program expansion and private sector health insurance reforms. To fund the expansion of insurance coverage, the legislation contains measures designed to promote quality and cost efficiency in health care delivery and to generate budgetary savings in the Medicare and Medicaid programs. As described below, the Health Care Reform Laws effectively prevents new physician-owned hospitals after March 23, 2010 and limits the capacity and amounts of physician ownership in existing physician-owned hospitals. We are unable to predict the full impact of the Health Care Reform Laws at this time due to the law’s complexity and current lack of implementing regulations or interpretive guidance. However, we expect that several provisions of the Health Care Reform Laws will have a material effect on our business as further described under Item 1A. Risk Factors.

The healthcare industry continues to attract much legislative interest and public attention. Recent proposals that have been considered include changes in Medicare, Medicaid, and other state and federal programs and cost controls on hospitals. We cannot predict the final impact of the Health Care Reform Laws or other future healthcare legislation or other changes in the administration or interpretation of governmental healthcare programs and the effect that any legislation, interpretation, or change may have on us. Such effects may include material and adverse changes to the amounts of reimbursement received by our facilities.

Licensure and Certification

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

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

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

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

requirements. However, we cannot assure you that government officials will agree with our interpretation of these laws.

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

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

Fraud and Abuse Laws

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

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

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

The OIG is primarily responsible for enforcing the anti-kickback statute and generally for identifying fraud and abuse activities affecting government programs. In order to fulfill its duties, the OIG performs audits and

investigations. In addition, the agency provides guidance to healthcare providers by issuing Special Fraud Alerts and Bulletins that identify types of activities that could violate the anti-kickback statute and other fraud and abuse laws. The OIG has identified the following arrangements with physicians as potential violations of the statute:


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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The Health Care Reform Laws also made changes to the Stark Law, effectively preventing new physician-owned hospitals after March 23, 2010 and limiting the capacity and amount of physician ownership in existing physician-owned hospitals. As revised, the Stark law prohibits physicians from referring Medicare patients to a hospital in which they have an ownership or investment interest unless the hospital has physician ownership and a Medicare provider agreement as of March 23, 2010 (or, for those hospitals under development, as of December 31, 2010). A physician-owned hospital that meets these requirements will still be subject to restrictions that limit the hospital’s aggregate physician ownership and, with certain narrow exceptions for high Medicaid hospitals, prohibit expansion of the number of operating rooms, procedure rooms or beds. The legislation also subjects a physician-owned hospital to reporting requirements and extensive disclosure requirements on the hospital’s website and in any public advertisements.

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

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

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

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

Healthcare Industry Investigations

The federal government, private insurers and various state enforcement agencies have increased their scrutiny of providers’ business arrangements and claims in an effort to identify and prosecute fraudulent and abusive practices. There are ongoing federal and state investigations in the healthcare industry regarding multiple issues

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

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

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

We are the subject of a civil investigative demand and an investigation by the Department of Justice as further described under Item 1A — Risk Factors — Companies within the healthcare industry continue to be the subject of federal and state investigations.

Clinical Trials at Hospitals

Our hospitals serve as research sites for physician clinical trials sponsored by pharmaceutical and device manufacturers and therefore may perform services on patients enrolled in those studies, including implantation of experimental devices. Only physicians who are members of the medical staff of the hospital may participate in such studies at the hospital. All trials are approved by an Institutional Review Board (“IRB”), which has the responsibility to review and monitor each study pursuant to applicable law and regulations. Such clinical trials are subject to numerous regulatory requirements.

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

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


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

	•	obtaining specific written commitments from the investigators,

	•	disclosure of financial conflicts-of-interest,

	•	verifying that patient informed consent is obtained,

	•	instructing investigators to maintain records and reports,

	•	verifying drug or device safety and efficacy,

	•	complying with applicable safeguards concerning patient protected health information, and

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

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

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

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

Privacy and Security Requirements

HIPAA requires the use of uniform electronic data transmission standards for healthcare claims and payment transactions submitted or received electronically. These provisions are intended to encourage electronic commerce in the healthcare industry. HHS has adopted final regulations establishing electronic data transmission standards that all healthcare providers must use when submitting or receiving certain healthcare transactions electronically. We believe we have complied in all material respects with these electronic data transmission standards.

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

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

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

Compliance Program

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

We have established a reporting system, auditing and monitoring programs, and a disciplinary system to enforce the code of ethics, and other compliance policies. Auditing and monitoring activities include claims preparation and submission, and cover numerous issues such as coding, billing, cost reporting, and financial arrangements with physicians and other referral sources. These areas are also the focus of training programs.

Our policy is to require our officers and all employees to participate in compliance training programs. The board of directors has established a compliance committee, which oversees implementation of the compliance program. The committee consists of three outside directors, and is chaired by Jacque Sokolov. The compliance committee of the board meets at least quarterly.

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

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


Item 1A.	*Risk Factors*

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

Our efforts to enhance stockholder value may not be successful.

On March 1, 2010, we announced that our Board of Directors had formed a Strategic Options Committee to consider the sale of either MedCath or the sale of our individual hospitals and other assets. Since March 2010, we have announced the completion of sales involving MedCath’s interests in Arizona Heart Hospital, Avera Heart Hospital of South Dakota, Heart Hospital of Austin and the minority ownership interest our MedCath Partners division held in Southwest Arizona Heart and Vascular, LLC. We have also announced a definitive agreement to sell

substantially all of the assets of TexSan Heart Hospital, which is expected to close during the fiscal quarter ending March 31, 2011, subject to required approvals and customary closing conditions.

We cannot assure you that our continuing efforts to enhance stockholder value will succeed. The strategic alternatives process is on-going and we continue to consider all practicable alternatives, including the sale of MedCath, a sale of MedCath’s individual hospitals or other assets, or a combination of these alternatives. There will be risks associated with any alternative, including whether we will obtain approvals that may be required in order to sell an individual hospital or a sale or transaction involving the entire company and the total proceeds received thereof. Moreover, the timing and terms of any transaction will depend on a variety of factors, some of which are beyond our control. Until further progress is made in the strategic alternatives process, we are unable to determine the approach that best meets the interests of our stockholders and whether the approach we select will be successful. A delay in or failure to complete one or more transactions could have a material adverse effect on our stock price and the amount of any potential distributions to our stockholders.

We cannot predict the timing, amount or mechanics of any potential distributions to our stockholders.

We have begun to consider a number of scenarios for distributing available cash to our stockholders such as special cash dividends, distributions to stockholders following future sales of individual hospitals or other assets or distributions in the context of a dissolution. If MedCath’s common equity is sold in a merger or other similar transaction, stockholders would receive consideration in exchange for their shares in accordance with the terms of that transaction.

Although our Amended Credit Facility permits the payment of dividends and the repurchase of our stock under certain circumstances, we believe these circumstances are not achievable at this time. Therefore, any dividend or stock repurchase can only occur once the outstanding amount is repaid and the Amended Credit Facility is terminated.

Many unknown variables will affect the amount, timing and mechanics of any potential distributions to stockholders. Factors that could have a material adverse effect on the amount of any potential distributions include, but are not limited to, a failure to obtain any required approvals, asset and corporate wind-down related operating and other expenses, MedCath’s debt service obligations, tax treatment, inability to collect amounts owed to MedCath and any required reserves to address potential liabilities, including retained and contingent liabilities of both MedCath and of its individual hospitals, and/or other unforeseen events. These and other factors, such as the procedures established under Delaware law for the dissolution of a Delaware corporation, could also delay the timing of any potential distributions.

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

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

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

Material decisions regarding the operations or sale of our facilities require consent of our physician and community hospital partners, which may limit our ability to take actions that we believe are in our best interest.

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

Unfavorable or unexpected results at one of our hospitals or in one of our markets could significantly impact our consolidated operating results and the value received upon an asset disposition.

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

We may continue to incur impairment losses on our long lived assets

Long-lived assets of the Company are reviewed for impairment annually and whenever events or changes in circumstances indicate that their carrying value has become impaired. An impairment loss would be recognized when the carrying amount of an asset exceeds the estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition. The amount of the impairment loss to be recorded is calculated by the excess of the asset’s carrying value over its fair value. Fair value is generally determined by the Company using a discounted cash flow analysis and/or independent third party market offers. Our strategic alternatives process and operating results may provide information in the future that may indicate additional impairment of our long-lived assets.

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

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

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

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

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

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

The Health Care Reform Laws also made changes to the Stark Law, effectively preventing new physician-owned hospitals after March 23, 2010, and limiting the capacity and amount of physician ownership in existing physician-owned hospitals. As revised, the Stark law prohibits physicians from referring Medicare patients to a hospital in which they have an ownership or investment interest unless the hospital has physician ownership and a Medicare provider agreement as of March 23, 2010 (or, for those hospitals under development, as of December 31, 2010). A physician-owned hospital that meets these requirements will still be subject to restrictions that limit the hospital’s aggregate physician ownership and, with certain narrow exceptions for high Medicaid hospitals, prohibit expansion of the number of operating rooms, procedure rooms or beds. The legislation also subjects a physician-owned hospital to reporting requirements and extensive disclosure requirements on the hospital’s website and in any public advertisements. Possible further amendments to the Stark Law, including any modification or revocation of the whole hospital exception upon which we rely in establishing many of our relationships with physicians, could require us to change or adversely impact the manner in which we establish relationships with physicians to develop and operate a facility, as well as our other business relationships such as joint ventures and physician practice management arrangements. There also can be no assurance the CMS will not promulgate additional regulations under the Stark Law that may change or adversely impact our arrangements with referring physicians.

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

Historically, Congress and some state legislatures have, from time to time, proposed significant changes in the healthcare system, including the Health Care Reform Laws. Many of these changes have resulted in limitations on, and in some cases, significant reductions in the levels of, payments to healthcare providers for services under many government reimbursement programs. In addition, many payors, including Medicare and other government payors, are increasingly developing payment policies that result in more procedures being performed on an outpatient basis rather than on an inpatient basis. Such policies will result in decreased revenues for our hospitals, since outpatient procedures are generally reimbursed at a lower rate than inpatient procedures. Recent budget proposals, if enacted in their current form, would freeze and/or reduce reimbursement for inpatient and outpatient hospital services. The Medicare hospital inpatient prospective payment system is evaluated on an annual basis. On August 22, 2007, CMS issued its final inpatient hospital prospective payment system rule for fiscal year 2008, which began October 1, 2007. The final rule continues major DRG reforms designed to improve the accuracy of hospital payments. As introduced in the fiscal year 2007 final rule, CMS will continue to use hospital costs rather than charges to set payment rates. For fiscal year 2008, hospitals will be paid based upon a blend of 1/3 charge-based weights and 2/3 hospital cost-based weights for DRGs. Additionally, CMS adopted its proposal to restructure the current 538 DRGs to 745 MS-DRGs (severity-adjusted DRGs) to better recognize severity of patient illness. These MS-DRGs were phased in over a two-year period. Effective fiscal year 2009, CMS has identified eight conditions that will not be paid at a higher rate unless they were present on admission, including three serious preventable events deemed “never events.” CMS published the inpatient prospective payment system rule for 2009 on August 19, 2008. Due to the late enactment of the Medicare Improvements for Patient and Providers Act (“MIPPA”), CMS did not publish the final wage indices and payment rates for the 2009 IPPS final rule until October 2008. CMS issued the IPPS rule for 2010 on July 31, 2009. The Final IPPS rule for 2010 provides acute care hospitals with an inflation update of 2.1 percent in their 2010 payment rates. The Final IPPS rule also adds four new measures for which hospitals must submit data under the RHQDAPU program to receive the full market basket update.

CMS published an amended IPPS for 2010 on May 21, 2010 which included a 0.25% market basket reduction and a related reduction to the outlier threshold. The market basket adjustment applies to discharges on or after April 1, 2010 and before October 1, 2010.

During the fiscal years ended September 30, 2010 and 2009, we derived 55.5% and 54.3%, respectively, of our net revenue from the Medicare and Medicaid programs. Changes in laws or regulations governing the Medicare and Medicaid programs or changes in the manner in which government agencies interpret them could materially and adversely affect our operating results or financial position.

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

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

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


	•	licensure, certification and accreditation,

	•	billing, coverage and reimbursement for supplies and services,

	•	relationships with physicians and other referral sources,

	•	adequacy and quality of medical care,

	•	quality of medical equipment and services,

	•	qualifications of medical and support personnel,

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

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

	•	building codes,

	•	environmental protection,

	•	clinical research,

	•	operating policies and procedures, and

	•	addition of facilities and services.

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

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


	•	criminal penalties,

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

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

Current or future legislative initiatives, government regulations or other government actions may have a material adverse effect on us.

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

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

In addition, the Office of Inspector General and the U.S. Department of Justice have, from time to time, undertaken national enforcement initiatives that focus on specific billing practices or other suspected areas of abuse. Moreover, healthcare providers are subject to civil and criminal false claims laws, including the federal False Claims Act, which allows private parties to bring what are called whistleblower lawsuits against private companies

doing business with or receiving reimbursement under government programs. These are sometimes referred to as “qui tam” lawsuits.

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

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

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

During fiscal years 2008 and 2007 we refunded certain reimbursements to CMS related to carotid artery stent procedures performed during prior fiscal years at two of the Company’s consolidated subsidiary hospitals. The DOJ initiated an investigation related to our return of these reimbursements. As a result of the DOJ’s investigation, the Company began negotiating settlement agreements during the second quarter of fiscal 2009 with the DOJ whereby we are expected to pay approximately $0.8 million to settle and obtain releases from any federal civil false claims liability related to the DOJ’s investigation. The DOJ allegations do not involve patient care, and relate solely to whether the procedures were properly reimbursable by Medicare. The settlement does not include any finding of wrong-doing or any admission of liability. As of September 30, 2010, both settlement agreements have been executed and we have paid the United States $0.8 million related to this matter.

In March 2010, the DOJ issued a civil investigative demand (“CID”) pursuant to the federal False Claims Act to one of our hospitals. The CID requested information regarding Medicare claims submitted by our hospital in connection with the implantation of implantable cardioverter defibrillators (“ICDs”) during the period 2002 to the present. We have complied with all information requested by the DOJ for this hospital. Because we are in the early stages of this investigation, we are unable to evaluate the outcome of this investigation.

In September 2010, we received a letter from the DOJ advising us of an investigation that will assess whether certain of our other hospitals have submitted ICD claims excluded from Medicare coverage. As a follow-up to its letter, the DOJ has provided us with additional information regarding claims which potentially may be excluded from coverage. We understand that the DOJ has delivered similar CIDs and letters to many other hospitals and

hospital systems across the country as well as to the ICD manufacturers themselves. We are fully cooperating and have entered into a tolling agreement with the government in this investigation. Our revenue arising from ICD procedures is material. However, to date, the DOJ has not asserted any claims against any of our hospitals. Because we are in the early stages of this investigation, we are unable to evaluate the outcome of this investigation.

Future audits by Recovery Audit Contractors (“RAC”) could have a material adverse effect on our reported financial results.

In 2005, the CMS began using RACs to detect Medicare overpayments not identified through existing claims review mechanisms. The RAC program relies on private auditing firms to examine Medicare claims filed by healthcare providers and fees are paid to the RACs on a contingency basis.

RACs perform post-discharge audits of medical records to identify Medicare overpayments resulting from incorrect payment amounts, non-covered services, incorrectly coded services, and duplicate services. The CMS has given RACs the authority to look back at claims up to three years old, provided that the claim was paid on or after October 1, 2007. Claims identified as overpayments will be subject to the Medicare appeals process. The Health Care Reform Laws expand the RAC program’s scope to include Medicaid claims by requiring all states to enter into contracts with RACs by December 31, 2010.

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

Audits by Third-party Payors could also have a material adverse effect on our reported financial results.

Third-party payors have the right in some cases under contract to conduct post payment audits in order to detect potential overpayments. While we believe that our claims submitted to these third-party payors are in compliance with our contractual arrangements, we are unable to predict whether such payors will identify overpayments and seek to recover such payments and if so, what the potential results would be.

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

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


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

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

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

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

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

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

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

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

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

A hospital system with which one of our established hospitals competes recently announced a collaboration with one of the leading cardiac services physician groups in that market, some of whose physicians have historically used our hospital and are investors in that hospital. It is possible that similiar collaboration at our other hospitals could result in a decrease in the use of our hospitals by physicians, with a resulting decrease in the revenue and financial performance of our hospitals.

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

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


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

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

	•	suffered any damage to their reputation,

	•	exited the market entirely,

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

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

Historically, the medical staff at each hospital ranges from approximately 100 to 400 physicians depending upon the size of the hospital and the number of practicing physicians in the market. If we fail to maintain our relationships with the physicians in this group at a particular hospital, many of whom are investors in our hospitals, the revenues of that hospital would be reduced. None of the physicians practicing at our hospitals has a legal

commitment, or any other obligation or arrangement that requires the physician to refer patients to any of our hospitals or other facilities.

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

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

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

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

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

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

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

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

We have established a reserve for malpractice claims based on actuarial estimates using our historical experience with malpractice claims and assumptions about future events. Due to the considerable variability that is inherent in such estimates, including such factors as changes in medical costs and changes in actual experience, there is a reasonable possibility that the recorded estimates will change by a material amount in the near term. Also,

there can be no assurance that the ultimate liability we experience under our self-insured retention for medical malpractice claims will not exceed our estimates. It is also possible that such claims could exceed the scope of coverage, or that coverage could be denied.

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

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

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

California state law could have a material adverse impact on our financial results or cause significant changes to our existing approach to control of patient medical information.

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

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

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

A purported class action law suit was recently filed by an individual against the Bakersfield Heart Hospital. In the complaint the plaintiff alleges that under California law, and specifically under the Knox-Keene Healthcare Service Plan Act of 1975, and under the Health and Safety Code of California that California prohibits the practice of “balance billing” patients who are provided “emergency services” as defined under California law. On November 24, 2010, the court granted the Bakersfield Heart Hospital’s motion to strike plantiff’s class allegations.

Texas state law may adversely impact our results of operations by causing reductions in our reimbursements under the Medicaid program administered by the Texas Health and Human Services Commission.

The Texas Health and Human Services Commission is in the process of rebasing the Medicaid Standard Dollar Amount (“SDA”) rates for all Texas acute care hospitals. The rebased SDA rates will be implemented for admissions occurring on or after November 1, 2010. The state released preliminary data in May 2010 with a deadline of June 21, 2010 for hospitals to request a review. Based on comments received from hospitals, the state has implemented a “10/38” plan for the state fiscal year that began September 1, 2010 under which decreases in individual hospital reimbursement levels will be capped at 10% and increases will be capped at 38%. We estimate that the rebasing will decrease net revenues for our continuing operations in Texas by $0.1 million in the fiscal 2011. The state intends to eliminate the “10/38” plan for the state fiscal year beginning September 1, 2011. The impact on future years may be material to our net revenues due to the elimination of the caps starting in our fiscal 2012.

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

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


Item 1B.	*Unresolved Staff Comments*

None.


Item 2.	*Properties*

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

Each of the ventures we have formed to develop a hospital owns the land and buildings of the hospital, with the exception of the land underlying the Heart Hospital of Austin and the land and building at Harlingen Medical Center (a minority owned hospital), which are leased. As previously noted, the Company disposed of its interest in the Heart Hospital of Austin on November 1, 2010. Each hospital has pledged its interest in the land and hospital building to secure the long-term debt incurred to develop the hospital, and substantially all the equipment located at these hospitals is pledged as collateral to secure long-term debt. Each entity formed to own and operate a diagnostic and therapeutic facility leases its facility.


Item 3.	*Legal Proceedings*

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

PART II


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

Our common stock trades on the Nasdaq Global Market^® under the symbol “MDTH.” At December 10, 2010, there were 20,469,305 shares of common stock outstanding, the sale price of our common stock per share was $13.60, and there were 63 holders of record. The following table sets forth, for the periods indicated, the high and low sale prices per share of our common stock as reported by the Nasdaq Global Market ^®:


Year Ended September 30, 2010	High		Low

First Quarter	$	9.99	$	6.69
Second Quarter		12.94		6.62
Third Quarter		11.20		7.75
Fourth Quarter		10.24		7.00


Year Ended September 30, 2009	High		Low

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

During August 2007, our board of directors approved a stock repurchase program of up to $59.0 million. Since the Board’s approval of the stock repurchase program, the Company has repurchased 1,885,461 shares of common stock at a total cost of $44.4 million, with a remaining $14.6 million available to be repurchased under the approved stock repurchase program. No shares were repurchased during fiscal 2010.


Item 6.	*Selected Financial Data*

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

The following table sets forth our selected consolidated financial data as of and for the years ended September 30, 2010, 2009, 2008, 2007 and 2006.


	Year Ended September 30,
	2010			2009			2008			2007			2006

Consolidated Statement of Operations Data:
(in thousands, except per share data)
Net revenue	$	442,496		$	419,733		$	414,155		$	474,290		$	444,841
Impairment of long-lived assets and goodwill	$	66,822		$	51,500		$	—		$	—		$	458
(Loss) income from continuing operations before income taxes	$	(67,672	)	$	(42,644	)	$	32,140		$	32,307		$	(377	)
(Loss) income from continuing operations, net of taxes	$	(51,956	)	$	(51,655	)	$	10,645		$	10,983		$	(7,579	)
Income from discontinued operations, net of taxes	$	3,585		$	1,373		$	10,345		$	544		$	20,155
Net (loss) income	$	(48,371	)	$	(50,282	)	$	20,990		$	11,527		$	12,576
(Loss) earnings from continuing operations attributable to MedCath Corporation common stockholders per share, basic	$	(2.62	)	$	(2.62	)	$	0.53		$	0.53		$	(0.41	)
(Loss) earnings from continuing operations attributable to MedCath Corporation common stockholders per share, diluted	$	(2.62	)	$	(2.62	)	$	0.53		$	0.51		$	(0.39	)
(Loss) earnings per share, basic	$	(2.44	)	$	(2.55	)	$	1.05		$	0.56		$	0.67
(Loss) earnings per share, diluted	$	(2.44	)	$	(2.55	)	$	1.04		$	0.54		$	0.64
Weighted average number of shares, basic(a)		19,842			19,684			19,996			20,872			18,656
Weighted average number of shares, diluted(a)		19,842			19,684			20,069			21,511			19,555

Balance Sheet and Cash Flow Data:
(in thousands)
Total assets	$	494,538		$	590,448		$	653,456		$	678,567		$	785,849
Total long-term obligations	$	99,841		$	115,231		$	121,989		$	148,484		$	286,928
Net cash provided by operating activities	$	43,294		$	63,633		$	52,008		$	58,225		$	65,634
Net cash (used in) provided by investing activities	$	(16,956	)	$	(63,790	)	$	(5,805	)	$	(28,591	)	$	10,064
Net cash used in financing activities	$	(41,009	)	$	(50,210	)	$	(78,028	)	$	(80,116	)	$	(22,165	)

Selected Operating Data (consolidated)(b):
Number of hospitals		6			5			5			5			6
Licensed beds(c)		541			471			392			304			416
Staffed and available beds(d)		455			385			347			287			399
Admissions(e)		22,010			19,894			20,962			26,497			27,482
Adjusted admissions(f)		32,567			28,692			28,337			36,311			37,061
Patient days(g)		82,105			75,817			75,185			89,100			91,420
Adjusted patient days(h)		121,940			109,281			101,383			121,689			123,229
Average length of stay(i)		3.73			3.81			3.59			3.36			3.33
Occupancy(j)		49.4	%		54.0	%		59.4	%		85.1	%		62.8	%
Inpatient catheterization procedures(k)		10,219			10,167			11,922			13,418			13,151
Inpatient surgical procedures(l)		5,234			5,064			4,732			5,978			6,042
Hospital net revenue	$	428,122		$	400,170		$	392,775		$	449,835		$	418,039


(a)		See Note 15 to the consolidated financial statements included elsewhere in this report.

(b)		Selected operating data includes consolidated hospitals in operation as of the end of the period reported in continuing operations but does not include hospitals which were accounted for using the equity method or as discontinued operations in our consolidated financial statements. During the fourth quarter of fiscal 2007,


		Harlingen Medical Center ceased to be a consolidated subsidiary due to the sale of a portion of our interests in the hospital.

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

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

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

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

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

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

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

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

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

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


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

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

Overview

We were incorporated as Medcath Corporation in Delaware in 2001 as a healthcare provider and are focused primarily on providing high acuity services, including the diagnosis and treatment of cardiovascular disease. We own and operate hospitals in partnership with physicians whom we believe have established reputations for clinical excellence. We opened our first hospital in 1996 and as of September 30, 2010, had ownership interests in and operated ten hospitals, including eight in which we owned a majority interest.

As noted below, we sold two of our majority owned hospitals that were classified as discontinued operations as of September 30, 2010 and our equity interest in one of our minority owned hospitals. As a result, we currently own interests in seven hospitals. In addition, we have an agreement to sell one of the seven remaining hospitals. Each of our majority-owned hospitals is a freestanding, licensed general acute care hospital that provides a wide range of health services with a majority focus on cardiovascular care. Each of our hospitals has a 24-hour emergency room staffed by emergency department physicians. During May 2009 we completed our 79 licensed bed expansion at Louisiana Medical Center and Heart Hospital (“LMCHH”) and built space for an additional 40 beds at that hospital. During October 2009, we opened a new acute care hospital, Hualapai Mountain Medical Center (“HMMC”), in Kingman, Arizona. This hospital is designed to accommodate a total of 106 licensed beds, with an initial opening of 70 of its licensed beds. The hospitals in which we had an ownership interest as of September 30, 2010 had a total of 825 licensed beds, 117 of which are related to Arizona Heart Hospital (“AzHH”) and Heart Hospital of Austin (“HHA”) whose assets, liabilities, and operations are included within discontinued operations. AzHH and HHA were sold on October 1, 2010 and November 1, 2010, respectively. Our seven hospitals that currently comprise our continuing operations have 653 licensed beds and are located in six states: Arizona, Arkansas, California, Louisiana, New Mexico, and Texas.

In addition to our hospitals, we currently own and/or manage eight cardiac diagnostic and therapeutic facilities. These facilities offer invasive diagnostic and, in some cases, therapeutic procedures. The remaining facility is not located at a hospital and offers only diagnostic procedures. We refer to our diagnostics division as “MedCath Partners.”

Pursuant to a settlement (“Settlement Agreement”) that we entered into on August 14, 1995 with the State of North Carolina Department of Human Resources (now known as the Division of Health Service Regulation (“DHSR”)), we obtained authority to operate nine cardiac catheterization laboratories anywhere in the state of North Carolina without obtaining a CON. The rights under the Settlement Agreement were subsequently assigned to MedCath Partners in connection with a reorganization by us. MedCath Partners is required to comply with certain notice requirements for replacement of any equipment comprising these labs and has historically notified the DHSR when MedCath Partners is changing the location of any labs located within the State. However, the DHSR takes the position that MedCath Partners must own and provide the services of the equipment which comprises each lab — the CON exemption applies only when MedCath Partners is operating one of these specific nine labs. For financial data and other information of this and other segments of our business see Note 20 to our audited consolidated financial statements in this report on Form 10-K for financial information by segment.

On March 1, 2010, we announced that our Board of Directors had formed a Strategic Options Committee to consider the sale either of the Company or the sale of our individual hospitals and other assets. We retained Navigant Capital Advisors as our financial advisor to assist in this process. Since announcing the exploration of strategic alternatives on March 1, 2010, we have completed several transactions, including:


	•	The disposition of Arizona Heart Hospital (Phoenix, Arizona) in which we sold the majority of the hospital’s assets to Vanguard Health Systems for $32.0 million, plus retained working capital. The transaction was completed effective October 1, 2010. We anticipate that we will receive final net proceeds of approximately $31.5 million from the transaction after payment of retained known liabilities, payment of taxes related to the transaction and collection of the hospital’s accounts receivable. The $31.5 million in estimated net proceeds is prior to reserves, if any, required in management’s judgment to address any potential contingent liabilities.

	•	The disposition of our wholly owned subsidiary that held 33.3% ownership of Avera Heart Hospital of South Dakota located in Sioux Falls, SD to Avera McKennan for $20.0 million, plus a percentage of the hospital’s available cash. The transaction was completed October 1, 2010. We estimate that we will receive final net proceeds from the transaction of approximately $16.0 million, after closing costs and payment of estimated taxes related to the transaction and prior to reserves, if any, required in management’s judgment to address any potential contingent liabilities.

	•	The disposition of Heart Hospital of Austin (Texas) in which we and our physician owners sold substantially all of the hospital’s assets to St. David’s Healthcare Partnership L.P. for approximately $83.8 million, plus retained working capital. The transaction was completed effective November 1, 2010. We anticipate that it will receive final net proceeds of approximately $24.1 million from the transaction after repayment of third party debt and a related prepayment fee, payment of all known retained liabilities of the partnership, payment of taxes related to the transaction, collection of the partnerships accounts receivable, and distributions to the hospital’s minority partners. The $24.1 million in estimated net proceeds is prior to reserves, if any, required in management’s judgment to address any potential contingent liabilities.

	•	The disposition of our approximate 27.0% ownership interest in Southwest Arizona Heart and Vascular, LLC (Yuma, Az) to the joint venture’s physician partners for $7.0 million. The transaction was completed effective November 1, 2010. We estimate that final net proceeds from the transaction will total approximately $6.9 million, after closing costs and income tax benefit related to a tax loss on the transaction, but prior to reserves, if any, required in management’s judgment to address any potential contingent liabilities.

In addition, we announced on November 8, 2010, that we, along with physician partners, had entered into a definitive agreement to sell substantially all the assets of TexSan Heart Hospital (San Antonio, Texas) to Methodist Healthcare System of San Antonio for $76.25 million, plus retained working capital. The transaction, which is subject to regulatory approval and other customary closing conditions, is anticipated to close during our second

quarter of fiscal 2011, which ends March 31, 2011. We anticipate that we will receive approximately $58.0 million from the transaction after payment of all retained known liabilities of the partnership, payment of taxes related to the transaction, collection of the partnership’s accounts receivable, and distributions to the hospital’s minority partners. The $58.0 million in estimated net proceeds is prior to reserves, if any, required in management’s judgment to address any potential contingent liabilities.

We cannot assure our investors that our continuing efforts to enhance stockholder value will be successful, or whether future transactions will involve a sale of the Company, a sale of our individual hospitals or other assets, or a combination of these alternatives. We continue to consider all practicable alternatives to maximize stockholder value. Although the strategic alternatives process is on-going and expected to continue during our fiscal 2011 and potentially beyond, we have begun to consider a number of scenarios for distributing available cash to our stockholders such as special cash dividends, and/or distributions to stockholders following future sales of individual hospitals or other assets, in the context of a dissolution and following repayment of all bank debt and termination of our credit facility. If our common equity is sold in a merger or other similar transaction, then stockholders would receive consideration in exchange for their shares in accordance with the terms of that transaction.

Many unknown variables, including those related to seeking any approvals which may be required, will affect the amount, timing and mechanics of any potential distributions to stockholders. Until further progress is made in the strategic alternative process, we are unable to determine the approach that best meets the interests of our stockholders. Final amounts available to stockholders could be diminished by asset and corporate wind-down related operating and other expenses, continued debt service obligations, tax treatment, inability to collect all amounts owed, any required reserves to address liabilities, including retained and contingent liabilities and/or other unforeseen events.

Basis of Consolidation. We have included in our consolidated financial statements hospitals and cardiac diagnostic and therapeutic facilities over which we exercise substantive control, including all entities in which we own more than a 50% interest, as well as variable interest entities in which we are the primary beneficiary. We have used the equity method of accounting for entities, including variable interest entities, in which we hold less than a 50% interest and over which we do not exercise substantive control, and are not the primary beneficiary. Accordingly, the hospitals in which we hold a minority interest are excluded from the net revenue and operating results of our consolidated company and our consolidated hospital division. During the fourth quarter of fiscal 2007, we sold a portion of our equity interest in Harlingen Medical Center; therefore, beginning in July 2007, we began excluding this hospital from net revenue and operating results of our consolidated company and our consolidated hospital division. Similarly, a number of our diagnostic and therapeutic facilities are excluded from the net revenue and operating results of our consolidated company and our consolidated MedCath Partners division. Our minority interest in the results of operations for the periods discussed for these entities is recognized as part of the equity in net earnings of unconsolidated affiliates in our statements of income in accordance with the equity method of accounting.

As described above, we entered into definitive agreements to sell certain assets and liabilities of Arizona Heart Hospital, LLC and Heart Hospital IV, LP (Heart Hospital of Austin), during fiscal 2010. We sold our equity interests in Heart Hospital of Lafayette and Cape Cod Cardiology Services LLC in fiscal 2008 and 2009, respectively, and the net assets of Dayton Heart Hospital and Sun City Cardiac Center Associates in fiscal 2008 and 2009, respectively. Accordingly, for all periods presented, the results of operations for these entities have been excluded from continuing operations and are reported in income (loss) from discontinued operations, net of taxes.

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


	Year Ended September 30,
Division	2010			2009			2008

Hospital		97.3	%		95.9	%		95.5	%
MedCath Partners		2.6	%		4.0	%		4.4	%
Corporate and other		0.1	%		0.1	%		0.1	%

Net Revenue		100.0	%		100.0	%		100.0	%

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


	Year Ended September 30,
Payor	2010			2009			2008

Medicare		51.2	%		51.4	%		52.1	%
Medicaid		4.3	%		2.9	%		3.2	%
Commercial and other, including self-pay		44.5	%		45.7	%		44.7	%

Total consolidated net revenue		100.0	%		100.0	%		100.0	%

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

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

Critical Accounting Policies and Estimates

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

assumptions on a regular basis and make changes as experience develops or new information becomes known. Actual results may differ from these estimates under different assumptions or conditions.

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

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

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

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

We provide care to patients who meet certain criteria under our charity care policy without charge or at amounts less than our established rates. Patients that receive charity care discounts must provide a complete and accurate application, be in need of non-elective care and meet certain federal poverty guidelines established by the U.S. Department of Health and Human Services. Because we do not pursue collection of amounts determined to qualify as charity care, they are not reported as net revenue.

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

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

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

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

Long-Lived Assets. Long-lived assets, which include finite lived intangible assets, are evaluated for impairment when events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of an asset and its eventual disposition are less than its carrying amount. The determination of whether or not long-lived assets have become impaired involves a significant level of judgment in the assumptions underlying the approach used to determine the estimated future cash flows expected to result from the use of those assets. Changes in our strategy, assumptions and/or market conditions could significantly impact these judgments and require adjustments to recorded amounts of long-lived assets. See Notes 4 and 13 for a discussion of impairment charges that the Company has recorded to write-down certain long-lived assets.

Basis of Presentation — Effective October 1, 2009, the Company adopted a new accounting standard which 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 interests, changes in a parent’s ownership interest and the valuation of any retained noncontrolling equity investment when a subsidiary is deconsolidated. This new accounting standard also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. This new accounting standard generally requires the Company to clearly identify and present ownership interests in subsidiaries held by parties other than the Company in the consolidated financial statements within the equity section but separate from the Company’s equity. However, in instances in which certain redemption features that are not solely within the control of the issuer are present, classification of noncontrolling interests outside of permanent equity is required. It also requires the amounts of consolidated net income attributable to the Company and to the noncontrolling interests to be clearly identified and presented on the face of the consolidated statements of operations; changes in ownership interests to be accounted for as equity transactions; and when a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary and the gain or loss on the deconsolidation of the subsidiary to be measured at fair value. The implementation of this accounting standard results in the cash flow impact of certain transactions with noncontrolling interests being classified within financing activities. Such treatment is consistent with the view that under this new accounting standard, transactions between the Company

and noncontrolling interests are considered to be equity transactions. The adoption of this new accounting standard has been applied retrospectively for all periods presented.

Upon the occurrence of certain fundamental regulatory changes, the Company could be obligated, under the terms of certain of its investees’ operating agreements, to purchase some or all of the noncontrolling interests related to certain of the Company’s subsidiaries. While the Company believes that the likelihood of a change in current law that would trigger such purchases was remote as of September 30, 2010, the occurrence of such regulatory changes is outside the control of the Company. As a result, these noncontrolling interests totaling $11,554 and $7,448 as of September 30, 2010 and 2009, respectively, that are subject to this redemption feature are not included as part of the Company’s equity and are carried as redeemable noncontrolling interests in equity of consolidated subsidiaries on the Company’s consolidated balance sheets.

Profits and losses are allocated to the noncontrolling interest in the Company’s subsidiaries in proportion to their ownership percentages and reflected in the aggregate as net income attributable to noncontrolling interests. If, however, the cumulative net losses of a hospital exceed its initial capitalization and committed capital obligations of our partners, then we recognize a disproportionately higher share, up to 100%, of the hospital’s losses, instead of the smaller pro-rata share of the losses that normally would be allocated to us based upon our percentage ownership (with the exception of losses incurred at Harlingen Medical Center, which are shared proratably based on each investors ownership percentage). The disproportionate allocation to us of a hospital’s losses would reduce our consolidated net income in that reporting period. When the same hospital has earnings in a subsequent period, a disproportionately higher share, up to 100%, of the hospital’s earnings will be allocated to us to the extent we have previously recognized a disproportionate share of that hospital’s losses. The disproportionate allocation to us of a hospital’s earnings would increase our consolidated net income in that reporting period.

The determination of disproportionate losses to be allocated is based on the specific terms of each hospital’s operating agreement, including each partner’s contributed capital, obligation to contribute additional capital to provide working capital loans, or to guarantee the outstanding obligations of the hospital. During each of our fiscal years 2010, 2009 and 2008, our disproportionate recognition of earnings and losses in our hospitals had a net (negative)/positive impact of $(12.2) million, $(2.2) million, and $0.6 million, respectively, on our reported income from continuing operations before income taxes and discontinued operations.

We expect our earnings allocated to minority interests to fluctuate in future periods as we either recognize disproportionate losses and/or recoveries thereof through disproportionate profits of our hospitals. As of September 30, 2010, we have $13.4 million of cumulative disproportionate losses allocated to us. We could also be required to recognize disproportionate losses at our other hospitals not currently in a disproportionate allocation position depending on their results of operations in future periods.

The physician partners of the Company’s subsidiaries typically are organized as general partnerships, limited partnerships or limited liability companies that are not subject to federal income tax. Each physician partner shares in the pre-tax earnings of the subsidiary in which it is a partner. Accordingly, the income or loss attributable to noncontrolling interests in each of the Company’s subsidiaries are generally determined on a pre-tax basis. In accordance with this new accounting standard, total net income attributable to noncontrolling interests are presented after net (loss) income.

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

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

The Company is required to file federal and state tax returns in the United States. The preparation of these tax returns requires the Company to interpret the applicable tax laws and regulations in effect in such jurisdictions, which could affect the amount of tax paid by the Company. The Company, in consultation with its tax advisors, bases its tax returns on interpretations that are believed to be reasonable under the circumstances. The tax returns, however, are subject to routine reviews by the various taxing authorities in the jurisdictions in which the Company files its returns. As part of these reviews, a taxing authority may disagree with respect to the interpretations the Company used to calculate its tax liability and therefore require the Company to pay additional taxes and associated penalties and interest.

The Company accrues an amount for its estimate of probable additional income tax liability. The Company recognizes the impact of an uncertain income tax position on the income tax return at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant tax authority. An uncertain income tax position will not be recognized if it has less than 50% likelihood of being sustained. As of September 30, 2010, the Company does not have accruals for any uncertain income tax positions.

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

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

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

During fiscal 2009 and 2010 we granted shares of restricted stock and restricted stock units to employees and directors, respectively. Restricted stock granted to employees, excluding executives of the Company, vest in equal annual installments over a three year period. Executives of the Company (defined by us as vice president or higher) received two restricted stock grants. The first grant of restricted stock vests in equal annual installments over a three year period. The second grant of restricted stock vests over a three year period based on established performance conditions. All unvested restricted stock granted to employees becomes fully vested upon a change in control of the Company as defined in the Company’s 2006 Stock Option and Award Plan. Restricted stock units granted to directors are fully vested at the date of grant and are paid in the form of common stock upon each applicable director’s termination of service on the board.

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

Results of Operations

Fiscal Year 2010 Compared to Fiscal Year 2009

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


	Year Ended September 30,
													% of Net
							Increase/(Decrease)						Revenue
	2010			2009			$			%			2010			2009
	(In thousands except percentages)

Net revenue	$	442,496		$	419,733		$	22,763			5.4	%		100.0	%		100.0	%
Operating expenses:
Personnel expense		151,990			141,315			10,675			7.6	%		34.3	%		33.7	%
Medical supplies expense		113,588			111,253			2,335			2.1	%		25.7	%		26.5	%
Bad debt expense		46,887			39,068			7,819			20.0	%		10.6	%		9.3	%
Other operating expenses		104,327			90,603			13,724			15.1	%		23.6	%		21.6	%
Pre-opening expenses		866			3,563			(2,697	)		(75.7	)%		0.2	%		0.9	%
Depreciation		26,895			22,818			4,077			17.9	%		6.1	%		5.4	%
Amortization		32			891			(859	)		(96.4	)%		—			0.2	%
Impairment of long-lived assets and goodwill		66,822			51,500			15,322			29.8	%		15.1	%		12.3	%
Loss on disposal of property, equipment and other assets		57			192			(135	)		(70.3	)%		—			—

Loss from operations		(68,968	)		(41,470	)		(27,498	)		66.3	%		(15.6	)%		(9.9	)%
Other income (expenses):
Interest expense		(4,548	)		(3,746	)		(802	)		21.4	%		(1.0	)%		(0.9	)%
Loss on early extinguishment of debt		—			(6,702	)		6,702			100.0	%		—			(1.6	)%
Interest and other income		84			217			(133	)		(61.3	)%		—			0.1	%
Loss on note receiveable		(1,507	)		—			(1,507	)		(100.0	)%		(0.3	)%		—
Equity in net earnings of unconsolidated affiliates		7,267			9,057			(1,790	)		(19.8	)%		1.5	%		2.1	%

Loss from continuing operations before income taxes		(67,672	)		(42,644	)		(25,028	)		58.7	%		(15.3	)%		(10.2	)%
Income tax benefit		(26,662	)		(362	)		(26,300	)		7265.2	%		(6.0	)%		(0.1	)%

Loss from continuing operations		(41,010	)		(42,282	)		1,272			(3.0	)%		(9.4	)%		(10.1	)%
Income from discontinued operations, net of taxes		5,028			9,527			(4,499	)		(47.2	)%		1.2	%		2.3	%

Net loss		(35,982	)		(32,755	)		(3,227	)		9.9	%		(8.1	)%		(7.8	)%
Less: Net income attributable to noncontrolling interest		(12,389	)		(17,527	)		5,138			(29.3	)%		(2.8	)%		(4.2	)%

Net loss attributable to MedCath Corporation	$	(48,371	)	$	(50,282	)	$	1,911			(3.8	)%		(10.9	)%		(12.0	)%

Amounts attributable to MedCath Corporation common stockholders:
Loss from continuing operations, net of taxes	$	(51,956	)	$	(51,655	)	$	(301	)		0.6	%		(11.7	)%		(12.3	)%
Income from discontinued operations, net of taxes		3,585			1,373			2,212			161.1	%		0.8	%		0.3	%

Net loss	$	(48,371	)	$	(50,282	)	$	1,911			(3.8	)%		(10.9	)%		(12.0	)%

Net revenue. Below is selected procedural and net revenue data for the fiscal years ended September 30, 2010 and 2009.


	Hospital Division Continuing Operations
	Year Ended September 30,
													Increase
	2010			%			2009			%			(Decrease)

Admission and Principal Procedures(1):
Inpatient admissions		22,010			27	%		19,894			30	%		10.6	%
Outpatient procedures(2)		26,050			31	%		21,933			33	%		18.8	%
ED and heart saver program		35,084			42	%		24,256			37	%		44.6	%

Total procedures		83,144			100	%		66,083			100	%		25.8	%

MDC 5 procedures(3)		14,862						14,420						3.1	%
IP Drug Eluting Stents		2,382						2,141						11.3	%
IP Bare Metal Stents		1,357						1,588						(14.5	)%
OP Drug Eluting Stents		1,151						1,027						12.1	%
OP Bare Metal Stents		778						796						(2.3	)%
Non MDC 5 procedures		68,282						51,663						32.2	%
ED visits		30,017						19,769						51.8	%
Net Revenue(1):
Inpatient net revenue		70.1	%					72.1	%					(2.8	)%
Outpatient net revenue		21.5	%					21.4	%					0.5	%
ED and HeartSaver CT program		8.4	%					6.5	%					29.2	%

Total net revenue		100.0	%					100.0	%

Total charity care	$	7,538					$	4,266						76.7	%


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

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

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

Same Facility Hospitals. Same facility hospitals include only those facilities that were open and operational during the full current and prior fiscal year comparable periods. For example, on a same facility basis for our consolidated hospital division for the year ended September 30, 2010, we exclude the results of operations of Hualapai Mountain Medical Center, which opened in October 2009. During the years ended September 30, 2010 and 2009, the Company incurred $0.9 million and $3.6 million, respectively, in pre-opening expenses related to projects under development at Hualapai Mountain Medical Center.

Net revenue increased 5.4% to $442.5 million for our fiscal year ended September 30, 2010 from $419.7 million for our fiscal year ended September 30, 2009. Of this $22.8 million increase in net revenue, our Hospital Division generated a $28.0 million increase, our MedCath Partners Division decreased by $5.2 million, and the Corporate and other division remained flat. The Hospital Division increase was attributable to an increase in our net patient revenue while the hospital division other operating revenue remained the same during the 2010 fiscal year compared to the 2009 fiscal year. Net revenue on a same facility basis was as follows:


	Fiscal Year Ended September 30,
					Increase/						% of Net
					(Decrease)						Revenue
	2010		2009		$			%			2010			2009
	(In thousands except percentages)

Net revenue	$	415,424	$	419,733	$	(4,309	)		(1.0	)%		100.0	%		100.0	%

Net revenue is comprised of net patient revenue and other operating revenue. Our same facility net patient revenue increased approximately $1.1 million during fiscal 2010 compared to fiscal 2009 while our other operating revenue decreased approximately $5.4 million, of which $5.2 million was experienced in our MedCath Partners Division. Beginning in our first quarter of fiscal 2010, our MedCath Partners Division renegotiated certain management contracts. As a result, certain personnel expenses once incurred by and reimbursed to our MedCath Partners Division, were no longer incurred as a result of employees no longer being employed by MedCath Partners. Therefore, the decline in other operating revenue was offset by a reduction in salary expenses due to this change.

Our same facility hospital division inpatient net revenue decreased approximately $6.4 million while our inpatient admissions increased by 2.3%. The inpatient net revenue decrease was offset by an increase in outpatient revenue, including emergency department revenue of approximately $4.2 million, driven by an increase in outpatient cases of approximately 7.4%.

Our inpatient net revenue decline was primarily due to a $9.6 million decrease in open heart revenue, a $4.6 million decrease in non-drug eluting stent net revenue, and a $2.1 million decrease in AICD net revenue offset by a $2.6 million increase in drug-eluting stent revenue and a $8.3 million increase in non-cardiovascular net inpatient revenue. We believe the decline in open heart surgeries and the use of AICD’s is indicative that less invasive cardiac procedures, such as stents, and pharmaceutical treatments have been successful for patients at our hospitals. Our non-cardiovascular net inpatient revenue has increased as we have diversified our services and have provided musculoskeletal procedures at certain of our hospitals and also experienced an increase in patient cases related to respiratory and digestive care.

Our same facility emergency department visits and net revenue increased 9.5% and 10.1%, respectively, during fiscal 2010 compared to fiscal 2009, driven primarily by our expansion and marketing efforts. In addition, we experienced an increase in outpatient AICD implants, pacer implants and EP studies/ablations, which experienced a 5.2% increase in cases and a 9.1% increase in net revenue.

Our same facility net revenue was impacted by an overall increase in deductions for uncompensated care of $3.3 million. We commonly refer to these deductions as charity care. Charity care was $7.5 million for fiscal 2010 compared to $4.3 million for fiscal 2009. Charity care is recorded for patients that meet certain federal poverty guidelines and request charity consideration in line with our policy. The number of patients that qualified for charity care increased during fiscal 2010 compared to fiscal 2009.

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

Personnel expense. Personnel expense increased 7.6% to $152.0 million for fiscal 2010 from $141.3 million for fiscal 2009. As a percentage of net revenue, personnel expense increased slightly from 33.7% to 34.3% for the comparable periods. Personnel expense on a same facility basis was as follows:


	Fiscal Year Ended September 30,
					Increase/						% of Net
					(Decrease)						Revenue
	2010		2009		$			%			2010			2009
	(In thousands except percentages)

Personnel expense	$	137,433	$	141,315	$	(3,882	)		(2.7	)%		33.1	%		33.7	%

We recognized share-based compensation expense of $3.1 million and $2.4 million for the fiscal years ended September 2010 and 2009, respectively. The $0.7 million increase in share-based compensation expense was offset by a $6.2 million decrease in personnel expense. $2.1 million of the personnel expense decrease was the result of a reduction in workforce in our Partners Division as a result of renegotiating certain management contracts whereby we no longer employed the employees of certain ventures. In addition, the Hospital Division’s contract labor has declined as we align our expenses with our patient revenues and admissions. Our bonus expense increased approximately $1.1 million during fiscal 2010 compared to fiscal 2009 as the criteria for the attainment of bonuses were met during fiscal 2010 for certain of our hospitals.

Medical supplies expense. Medical supplies expense increased 2.1% to $113.6 million, or 25.7% of net revenue, for fiscal 2010 from $111.3 million, or 26.5% of net revenue, for fiscal 2009. Medical supplies expense on a same facility basis was as follows:


	Fiscal Year Ended September 30,
					Increase/						% of Net
					(Decrease)						Revenue
	2010		2009		$			%			2010			2009
			(In thousands except percentages)

Medical supplies expense	$	108,579	$	111,253	$	(2,674	)		(2.4	)%		26.1	%		26.5	%

Our same facility medical supplies expense decreased as a result of a 9.9% reduction in open heart surgeries and a 10.1% reduction in AICD implantations, procedures that have higher net revenue per case as compared to other procedures performed at our hospitals. With less open heart and AICD net revenue, medical supplies will increase as a percentage of net revenue. The supply expense decrease was partially offset by an increase in the utilization of higher cost per unit devices.

Bad debt expense. Bad debt expense increased 20.0% to $46.9 million for fiscal 2010 from $39.1 million for fiscal 2009. Bad debt expense on a same facility basis was as follows:


	Fiscal Year Ended September 30,
					Increase/					% of Net
					(Decrease)					Revenue
	2010		2009		$		%			2010			2009
	(In thousands except percentages)

Bad debt expense	$	43,206	$	39,068	$	4,138		10.6	%		10.4	%		9.3	%

We have experienced an increase in bad debt expense primarily related to an increase in the uncollectibility of the self-pay balance after insurance and an 8.1% increase in self-pay net revenue during fiscal 2010 compared to fiscal 2009.

Total uncompensated care, which includes charity care deductions recorded as a reduction to patient revenue and bad debt expense, was $50.7 million for fiscal 2010, or 12.5% of same facility Hospital Division net patient revenue, compared to $43.3 million, or 10.8% of same facility Hospital Division net patient revenue for fiscal 2009.

Other operating expenses. Other operating expenses increased 15.1% to $104.3 million for fiscal 2010 from $90.6 million for fiscal 2009. Other operating expense on a same facility basis was as follows:


	Fiscal Year Ended September 30,
					Increase/					% of Net
					(Decrease)					Revenue
	2010		2009		$		%			2010			2009
	(In thousands except percentages)

Other operating expense	$	94,028	$	90,603	$	3,425		3.8	%		22.6	%		21.6	%

Notable increases and (decreases) in our same facility other operating expenses were as follows:


Professional fees	$	2,575
Employee benefits	$	2,343
Repairs and maintenance	$	825
Corporate salaries and bonuses, net	$	(234	)
Professional liability insurance	$	(992	)
Advertising	$	(1,045	)

Our professional fees increased $2.6 million during fiscal 2010 compared to fiscal 2009. Professional fees increased $3.8 million due to the expenses incurred related to the review and implementation of our strategic alternatives as well as fees incurred related to entering into definitive agreements to sell the Heart Hospital of Austin, Arizona Heart Hospital and Avera Heart Hospital of South Dakota, which were all completed subsequent to September 30, 2010, and TexSan Heart Hospital, which was announced subsequent to September 30, 2010. This

increase was partially offset by a decline in professional fees associated with growth initiatives and other non-recurring internal projects that were incurred during fiscal 2009.

Corporate employee benefits expense has increased due to an increase in specific claims expense for our employees during fiscal 2010 compared to the same period of the prior year. Since we are self-insured for medical claims and our medical claims expense can fluctuate based on the total number of claims we experience for any given period.

Corporate salaries and wages have declined $1.7 million due to attrition in employees related to the announcement that we are considering our strategic alternatives and a reduction in hiring of new employees offset by a $0.7 million increase in severance expense as a result of exploring these options. The alternatives include, but are not limited to, the possible sale of all or parts of the Company. This decline was offset by a $0.5 million increase in stay-on bonus expense incurred to retain employees during the strategic alternatives process.

We incurred specific large dollar professional liability insurance claims for certain of our hospitals during fiscal 2009. In contrast, we experienced favorable claim experience during fiscal 2010. As a result of the reduction in specific claims during fiscal 2010 and favorable claim experience for the current policy year, our overall professional liability insurance cost has declined $1.0 million.

We increased our marketing and advertising budget during fiscal 2009 to promote several of our facility expansions and certain direct mailing and radio programs to increase market share. Our advertising expenses declined $1.0 million during fiscal 2010 to better align our operating expenses with our revenues and also as a result of the review of our strategic alternatives.

Depreciation. Depreciation increased 17.9% to $26.9 million for the fiscal year ended September 30, 2010 as compared to $22.8 million for the fiscal year ended September 30, 2009. The increase in depreciation is the direct result of expansion at several of our facilities, the opening of Hualapai Mountain Medical Center on October 15, 2009, as well as the purchase of newer computer equipment to replace outdated hardware.

Impairment of long-lived assets and goodwill. Impairment of long-lived assets and goodwill increased 29.8% to $66.8 million for fiscal 2010 compared to $51.5 million for fiscal 2009. In fiscal 2010, the Company recognized impairments of property and equipment primarily related to the Hospital Division due to declines in operating performance as well as the ongoing review of strategic alternatives for the Company. When a cash flow projection or independent third party market offers indicated impairment existed, the Company reduced long-lived assets to their estimated fair value. In fiscal 2009, the Company recognized an impairment indicator relative its goodwill which was all related to the Hospital Division due to the overall financial performance of the Company and resulting decline in market capitalization. Subsequent analysis determined that the Hospital Division’s carrying value was in excess of its fair value and that the implied fair value of the goodwill was zero.

Interest expense. Interest expense increased 21.4% to $4.5 million for fiscal 2010 compared to $3.7 million for fiscal 2009. The Company would have experienced a decrease due to capitalization of $2.7 million of interest on our capital expansion projects in fiscal 2009. The Company did not capitalize any interest in fiscal 2010. The decrease in pre-capitalization interest expense is primarily attributable to the overall reduction in our outstanding debt.

Loss on early extinguishment of debt. During December 2008, we redeemed all of our outstanding 97/8% Senior Notes for $111.2 million, which included the payment of a repurchase premium of $5.0 million and accrued interest of $4.2 million. The Senior Notes were redeemed through borrowings under the Senior Secured Credit Facility and available cash on hand. In addition, we incurred $2.0 million in expenses related to the write-off of previously incurred financing costs associated with the Senior Notes. There was no loss on early extinguishment of debt for fiscal 2010.

Interest and other income, net. Interest and other income, net decreased 61.3% to $0.1 million for fiscal 2010 compared to $0.2 million for fiscal 2009. The decrease is a result of the decrease in cash balances and the decrease in interest earned on cash balances during fiscal 2010.

Loss on note receivable. Our corporate and other division entered into a note receivable agreement with a third party during 2008. The note receivable was deemed uncollectable and a loss of $1.5 million was recorded in fiscal 2010 due to our determination of the third party’s inability to repay the note and the insufficiency of the value of the collateral securing the note. There were no similar losses recorded in fiscal 2009.

Equity in net earnings of unconsolidated affiliates. Equity in net earnings of unconsolidated affiliates decreased to $7.3 million in fiscal 2010 from $9.1 million in fiscal 2009. Earnings from operating activity of our unconsolidated affiliates remained relatively flat during fiscal 2010 compared to fiscal 2009 and our ownership interest in those entities remained materially the same for the two periods. However, the Company recognized a $1.9 million writedown of its investment in Southwest Arizona Heart and Vascular, LLC in fiscal 2010 based on the expected proceeds from the disposition of the Company’s interest to be received in fiscal 2011. Also, the Company expects a decline in future equity in net earnings of unconsolidated affiliates due to the disposition of its interest in Avera Heart Hospital of South Dakota on October 1, 2010 and the disposition of its interest in Southwest Arizona Heart and Vascular, LLC on November 1, 2010.

Net income attributable to noncontrolling interest. Noncontrolling interest share of earnings of consolidated subsidiaries decreased $5.1 million in fiscal 2010 compared to fiscal 2009. Net income attributable to noncontrolling interests on a same facility basis was as follows:


	Fiscal Year Ended September 30,
					Increase/						% of Net
					(Decrease)						Revenue
	2010		2009		$			%			2010			2009
	(In thousands except percentages)

Net income attributable to noncontrolling interest	$	10,502	$	17,527	$	(7,025	)		(40.1	)%		2.5	%		4.2	%

Net income attributable to noncontrolling interest represents the portion of net income allocated to the minority owners of our consolidated subsidiaries. We allocate earnings to the minority owners based on their pro-rata share of earnings for the given period unless we are in disproportionate share accounting. During fiscal 2010 we allocated more losses disproportionate to our ownership interest where the minority owner’s capital balance has been reduced to zero per the partnership operating agreements. As a result of absorbing more losses during fiscal 2010, the total share of income allocated to minority owners has increased relative to our total net income. 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.

In addition, we incurred approximately $2.9 million in expense, net of tax, related to the redemption feature of a redeemable noncontrolling interest put option entered into with the minority interest holders at one of our hospitals during the fourth quarter of fiscal 2010. We classified the redeemable noncontrolling interest as temporary equity in the Consolidated Balance Sheets, outside of stockholders’ equity. We recorded the redeemable noncontrolling interest at the redemption value, net of tax, as prescribed in the operating agreement and accounting literature.

Income tax (benefit) expense. Income tax benefit was $(26.7) million for fiscal 2010 compared to $(0.4) million for fiscal 2009, which represented an effective tax rate of (39.4%) and (0.8%), respectively. The fiscal 2010 effective rate is above our federal statutory rate of (35.0%) primarily due to the effect of the adoption of a new accounting pronouncement regarding noncontrolling interest (see Note 2), which requires the net income or loss attributable to noncontrolling interest be including in the determination of pretax income or loss in the Company’s effective rate calculation. The fiscal 2009 effective rate is below our federal statutory rate of 35.0% primarily due to the non-deductibility for income tax purposes of a majority of the $51.5 million impairment expense related to goodwill.

AzHH. Income from discontinued operations, net of taxes, includes the gains on the sale of Cape Cod and Sun City during fiscal 2009 and income from operations of HHA, partially offset by operating losses of other discontinued entities, principally losses at AzHH.

Fiscal Year 2009 Compared to Fiscal Year 2008

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


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

Net revenue	$	419,733		$	414,155		$	5,578			1.3	%		100.0	%		100.0	%
Operating expenses:
Personnel expense		141,315			136,009			5,306			3.9	%		33.7	%		32.8	%
Medical supplies expense		111,253			104,616			6,637			6.3	%		26.5	%		25.3	%
Bad debt expense		39,068			33,070			5,998			18.1	%		9.3	%		8.0	%
Other operating expenses		90,603			84,230			6,373			7.6	%		21.6	%		20.3	%
Pre-opening expenses		3,563			786			2,777			353.3	%		0.9	%		0.2	%
Depreciation		22,818			21,714			1,104			5.1	%		5.4	%		5.3	%
Amortization		891			32			859			2684.4	%		0.2	%		0.0	%
Impairment of long-lived assets and goodwill		51,500			—			51,500			100.0	%		12.3	%		—
Loss on disposal of property, equipment and other assets		192			124			68			54.8	%		—			0.0	%

(Loss) income from operations		(41,470	)		33,574			(75,044	)		(223.5	)%		(9.9	)%		8.1	%
Other income (expenses):
Interest expense		(3,746	)		(11,242	)		7,496			(66.7	)%		(0.9	)%		(2.7	)%
Loss on early extinguishment of debt		(6,702	)		—			(6,702	)		(100.0	)%		(1.6	)%		—
Interest and other income		217			1,917			(1,700	)		(88.7	)%		0.1	%		0.5	%
Equity in net earnings of unconsolidated affiliates		9,057			7,891			1,166			14.8	%		2.1	%		1.9	%

(Loss) income from continuing operations before income taxes		(42,644	)		32,140			(74,784	)		(232.7	)%		(10.2	)%		7.8	%
Income tax (benefit) expense		(362	)		8,296			(8,658	)		(104.4	)%		(0.1	)%		2.0	%

(Loss) income from continuing operations		(42,282	)		23,844			(66,126	)		(277.3	)%		(10.1	)%		5.8	%
Income from discontinued operations, net of taxes		9,527			19,004			(9,477	)		(49.9	)%		2.3	%		4.6	%

Net (loss) income		(32,755	)		42,848			(75,603	)		(176.4	)%		(7.8	)%		10.3	%
Less: Net income attributable to noncontrolling interest		(17,527	)		(21,858	)		4,331			(19.8	)%		(4.2	)%		(5.3	)%

Net (loss) income attributable to MedCath Corporation	$	(50,282	)	$	20,990		$	(71,272	)		(339.6	)%		(12.0	)%		5.1	%

Amounts attributable to MedCath Corporation common stockholders:
Loss from continuing operations, net of taxes	$	(51,655	)	$	10,645		$	(62,300	)		(585.3	)%		(12.3	)%		2.6	%
Income from discontinued operations, net of taxes		1,373			10,345			(8,972	)		(86.7	)%		0.3	%		2.5	%

Net (loss) income	$	(50,282	)	$	20,990		$	(71,272	)		(339.6	)%		(12.0	)%		5.1	%

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


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

Admission and Principal Procedures(1):
Inpatient admissions		19,894			30	%		20,962			34	%		(5.1	)%
Outpatient procedures(2)		21,933			33	%		18,757			31	%		16.9	%
ED and heart saver program		24,256			37	%		21,147			35	%		14.7	%

Total procedures		66,083			100	%		60,866			100	%		8.6	%

MDC 5 procedures(3)		14,420						15,909						(9.4	)%
IP Drug Eluting Stents		2,141						2,165						(1.1	)%
IP Bare Metal Stents		1,588						2,645						(40.0	)%
OP Drug Eluting Stents		1,027						471						118.0	%
OP Bare Metal Stents		796						445						78.9	%
Non MDC 5 procedures		51,663						44,957						14.9	%
ED visits		19,769						17,127						15.4	%
Net Revenue(1):
Inpatient net revenue		72.1	%					77.4	%					(6.8	)%
Outpatient net revenue		21.4	%					16.7	%					28.1	%
ED and HeartSaver CT program		6.5	%					5.9	%					10.2	%

Total net revenue		100.0	%					100.0	%

Total charity care	$	4,266					$	12,176						(65.0	)%


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

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

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

Net revenue increased 1.3% to $419.7 million for our fiscal year ended September 30, 2009 from $414.2 million for our fiscal year ended September 30, 2008. Of this $5.5 million increase in net revenue, our Hospital Division generated a 1.8%, or $7.0 million increase, our MedCath Partners Division generated a $1.4 million decrease and our Corporate and other Division generated a $0.1 million decrease.

We continued to experience a shift from inpatient to outpatient procedures in our Hospital Division during fiscal 2009. Our inpatient admissions were down 5.1% for the 2009 fiscal year compared to the 2008 fiscal year; however our outpatient procedures, excluding emergency department visits, increased 16.0% as a result of the shift from inpatient to outpatient procedures. Our emergency department visits increased 15.4% during fiscal 2009 compared to fiscal 2008, driven primarily by our expansion and marketing efforts. Total outpatient net patient revenue excluding emergency department and our Heart Saver program net revenue increased from 22.6% of total hospital net revenue for fiscal 2008 to 27.9% for fiscal 2009.

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

Our net revenue was positively impacted by an overall decrease in deductions for uncompensated care of 65.0% or $7.9 million. We commonly refer to these deductions as charity care. Charity care was $4.3 million for fiscal 2009 compared to $12.2 million for fiscal 2008. Charity care is recorded for patients that meet certain federal

poverty guidelines and request charity consideration in line with our policy. The number of patients that qualified for charity care decreased during fiscal 2009 compared to fiscal 2008.

During fiscal 2009 and 2008, we recognized net negative contractual adjustments to our net revenue of $4.5 million and $0.4 million, respectively, related to the filing of prior years Medicare cost reports as well as other Medicare and Medicaid settlement adjustments. Therefore, these adjustments had a year over year negative impact of $4.1 million to net revenue.

Personnel expense. Personnel expense increased 3.9% to $141.3 million for fiscal 2009 from $136.0 million for fiscal 2008. As a percentage of net revenue, personnel expense increased from 32.8% to 33.7%.

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

Medical supplies expense. Medical supplies expense increased 6.3% to $111.3 million, or 26.5% of net revenue, for fiscal 2009 from $104.6 million, or 25.3% of net revenue, for fiscal 2008. We experienced an increase in expense related to AICD’s, heart valves, drug-eluting stents and vascular graft supplies during fiscal 2009 offset by a reduction in expense for bare metal stents, orthopedic and chargeable medical supplies. The increase in AICD’s, heart valves, drug-eluting stents and vascular graft supplies was directly related to a combination of a higher utilization of supplies per procedure, an increase in the number of procedures performed or the use of higher cost supplies for these procedures. Conversely, the reduction in bare metal stents and orthopedic supplies is the direct result of lower utilization of supplies per procedure and lower cost for the units used per procedure.

Bad debt expense. Bad debt expense increased 18.1% to $39.1 million for fiscal 2009 from $33.1 million for fiscal 2008. Total uncompensated care, which includes charity care deductions recorded as a reduction to patient revenue and bad debt expense, was $43.3 million for fiscal 2009, or 10.8% of Hospital Division net patient revenue, compared to $45.2 million, or 11.2% of Hospital Division net patient revenue for fiscal 2008. We have experienced an increase in bad debt expense primarily related to an increase in the uncollectibility of the self-pay balance after insurance and a reduction in patients that qualify for charity care and/or government assistance. The reduction in total uncompensated care to net revenue is due to improved collections during fiscal 2009.

Other operating expenses. Other operating expenses increased 7.6% to $90.6 million for fiscal 2009 from $84.2 million for fiscal 2008. This increase is mainly driven by clinical and non-clinical contract services due to the growth in volume at several of our facilities, particularly emergency department visits, as well as increased maintenance costs at our hospitals as machinery warranties have expired at several of our facilities. These increases have been offset by a decline in administrative contract services and collection agency fees as these services are brought in-house to control costs and gain efficiencies. In addition, we incurred a $1.3 million increase in costs related to a new primary care physician group at one of our hospitals.

Pre-opening expenses. We incurred $3.6 million and $0.8 million in pre-opening expenses during fiscal 2009 and 2008. Pre-opening expenses represent costs specifically related to projects under development. As of September 30, 2009 and 2008, we had one hospital under development, Hualapai Medical Center in Kingman, Arizona, which opened on October 15, 2009. The amount of pre-opening expenses, if any, we incur in future periods will depend on the nature, timing and size of our development activities.

Depreciation. Depreciation increased 5.1% to $22.8 million for the fiscal year ended September 30, 2009 as compared to $21.7 million for the fiscal year ended September 30, 2008. The increase in depreciation is the direct result of expansion at several of our facilities as well as the purchase of newer computer equipment to replace outdated hardware.

Impairment of goodwill. Impairment of long-lived assets increased 100.0% to $51.5 million for fiscal 2009 as compared to zero for fiscal 2008. In fiscal 2009, the Company recognized an impairment charge to write off its goodwill which was all related to the Hospital Division due to the overall financial performance of the Company and recent appraisals indicating that the Hospital Division’s carrying value was in excess of its fair value. Such analyses

resulted in an implied value of the goodwill as zero. There were no such similar impairment charges recognized in fiscal 2008.

Interest expense. Interest expense decreased 66.7% to $3.7 million for fiscal 2009 compared to $11.2 million for fiscal 2008. This $7.5 million decrease in interest expense is primarily attributable to the overall reduction in our outstanding debt, a decrease in the interest rate on our outstanding debt, and the capitalization of interest on our capital expansion projects. Capitalized interest was $2.7 million for fiscal 2009 compared to $1.3 million for fiscal 2008.

Interest and other income, net. Interest and other income, net decreased 88.7% to $0.2 million for fiscal 2009 compared to $1.9 million for fiscal 2008. The decrease is a result of the decrease in cash balances and the decrease in interest earned on cash balances during fiscal 2009.

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

Net income attributable to noncontrolling interest. Noncontrolling interest share of earnings of consolidated subsidiaries decreased $4.3 million in fiscal 2009 compared to fiscal 2008. The decline is the result of an overall net decrease in income before minority interest of certain of our established hospitals. We expect our earnings allocated to minority interests to fluctuate in future periods as we either recognize disproportionate losses and/or recoveries thereof through disproportionate profit recognition.

Income tax (benefit) expense. Income tax benefit was $(0.4) million for fiscal 2009 compared to an income tax expense of $8.3 million for fiscal 2008, which represented an effective tax rate of (0.8%) and 25.8%, respectively. The fiscal 2009 effective rate is below our federal statutory rate of 35.0% primarily due to the non-deductibility for income tax purposes of a majority of the $51.5 million impairment expense related to goodwill.

Income from discontinued operations, net of taxes. Income from discontinued operations, net of taxes, principally reflects the operating results of Heart Hospital IV, LP (a/ka/ Heart Hospital of Austin, “HHA”), Arizona Heart Hospital LLC (“AzHH”), Dayton Heart Hospital, Cape Cod Cardiology Services LLC (“Cape Cod”), Sun City Cardiac Center Associates (“Sun City”) and the Heart Hospital of Lafayette. Net income from discontinued operations was $9.5 million for fiscal 2009 compared to $19.0 million for fiscal 2008. Income from discontinued operations, net of taxes, includes the gains on the sale of Cape Cod and Sun City during fiscal 2009 and income from operations of HHA, partially offset by operating losses of other discontinued entities, principally losses at AzHH. Income from discontinued operations, net of taxes, for fiscal 2008 includes the gain recorded as a result of the sale of certain assets of Dayton Heart Hospital, the income from operations of HHA, Cape Cod and Sun City partially offset by operating losses of Dayton Heart Hospital prior to the sale and AzHH.

Selected Quarterly Results of Operations

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


	Three Months Ended
	September 30,			June 30,			March 31,			December 31,			September 30,
	2010			2010			2010			2009			2009
	(In thousands)

Statement of Operations Data:
Net Revenue	$	110,527		$	111,963		$	114,007		$	106,000		$	103,600
Impairment of long-lived assets and goodwill		29,257			22,813			14,752			—			51,500
Loss from operations		(29,547	)		(22,667	)		(13,366	)		(3,388	)		(54,616	)
Equity in net earnings of unconsolidated affiliates		397			2,262			3,092			1,516			2,013
Net income attributable to noncontrolling interest		(6,671	)		(2,354	)		(2,524	)		(840	)		(7,646	)
Loss from continuing operations, net of taxes		(25,722	)		(14,360	)		(9,351	)		(2,523	)		(53,214	)
Income (loss) from discontinued operations, net of taxes		4,034			1,544			(1,858	)		(133	)		(5,392	)
Net loss	$	(21,688	)	$	(12,816	)	$	(11,209	)	$	(2,656	)	$	(58,606	)
Earnings (loss) per share, basic
Continuing operations	$	(1.29	)	$	(0.72	)	$	(0.47	)	$	(0.13	)	$	(2.70	)
Discontinued operations		0.20			0.08			(0.10	)		—			(0.27	)

Earnings (loss) per share, basic	$	(1.09	)	$	(0.64	)	$	(0.57	)	$	(0.13	)	$	(2.97	)

Earnings (loss) per share, diluted
Continuing operations	$	(1.29	)	$	(0.72	)	$	(0.47	)	$	(0.13	)	$	(2.70	)
Discontinued operations		0.20			0.08			(0.10	)		—			(0.27	)

Earnings (loss) per share, diluted	$	(1.09	)	$	(0.64	)	$	(0.57	)	$	(0.13	)	$	(2.97	)

Weighted average number of shares, basic		19,898			19,897			19,829			19,743			19,740
Dilutive effect of stock options and restricted stock		—			—			—			—			—

Weighted average number of shares, diluted		19,898			19,897			19,829			19,743			19,740

Cash Flow Data:
Net cash provided by operating activities	$	12,113		$	12,273		$	15,373		$	3,535		$	9,805
Net cash provided by provided by (used in) investing activities	$	384		$	(1,996	)	$	(6,108	)	$	(9,236	)	$	858
Net cash (used in) financing activities	$	(4,509	)	$	(9,119	)	$	(5,960	)	$	(21,421	)	$	(1,871	)

Our results of operations historically have fluctuated on a quarterly basis and can be expected to continue to be subject to quarterly fluctuations. Cardiovascular procedures can often be scheduled ahead of time, permitting some patients to choose to undergo the procedure at a time and location of their preference. Some of the types of trends that we have experienced in the past and may experience again in the future include:


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


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

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

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

Liquidity and Capital Resources

The cash provided by continuing operations from operating activities decreased $15.6 million to $30.4 million for fiscal 2010 from $46.0 million for fiscal 2009, respectively. The decrease is primarily attributed to an increase in outstanding net accounts receivable due to the addition of Hualapai Mountain Medical Center, our new hospital which opened during fiscal 2010 and an increase in net patient revenues.

Our investing activities from continuing operations used net cash of $14.9 million for fiscal 2010 compared to net cash used of $82.1 million for fiscal 2009. Net cash used by investing activities for fiscal 2009 was primarily capital expenditures for the development of our hospital in Kingman, Arizona and expansion projects at two of our existing hospitals. There were no similar large scale expansions or developments in fiscal 2010.

Our financing activities from continuing operations used net cash of $31.8 million during fiscal 2010 compared to net cash used of $43.8 million during fiscal 2009. The $12.0 million decrease of net cash used for financing activities is principally due to the net overall long-term debt payments in fiscal 2009 related to the repurchase of our outstanding Senior Notes as further discussed in Note 9 of the consolidated financial statements included elsewhere in this report.

Capital Expenditures. Cash paid for property and equipment for fiscal years 2010 and 2009 was $16.4 million and $87.0 million, respectively. The decrease is primarily related to the development of our hospital in Kingman, Arizona which opened in October 2009 and the expansion projects at two of our existing hospitals, which were completed during fiscal 2009. The cash paid for property and equipment during fiscal year 2010 represents $8.0 million related to payments on the completion of the hospital in Kingman, Arizona and $8.4 million related to maintenance capital expenditures.

Obligations, Commitments and Availability of Financing. As described more fully in the notes to our consolidated financial statements included elsewhere in this report, we had certain cash obligations at September 30, 2010, which are due as follows (in thousands):


	Payments Due by Fiscal Year
	2011		2012		2013		2014		2015		Thereafter		Total

Long-term debt	$	14,063	$	52,500	$	—	$	—	$	—	$	—	$	66,563
Obligations under capital leases		2,609		2,266		1,884		1,589		761		—		9,109

Total debt		16,672		54,766		1,884		1,589		761		—		75,672
Other long-term obligations(1)		7,946		3,640		752		—		—		—		12,338
Interest on indebtedness		2,511		946		220		119		23		—		3,819
Operating leases		1,724		1,601		1,562		1,300		397		99		6,683

Total	$	28,853	$	60,953	$	4,418	$	3,008	$	1,181	$	99	$	98,512


(1)		Other long-term obligations include revenue guarantees related to contracts for physician services or to physician recruiting arrangements. In addition, the Company has deferred some of the costs associated with these guarantees, see Note 12.

During November 2008, we amended and restated our Senior Secured Credit Facility (the “Amended Credit Facility”). The Amended Credit Facility provides for a three-year term loan facility in the amount of $75.0 million (the “Term Loan”) and a revolving credit facility in the amount of $85.0 million (the “Revolver”), which includes a $25.0 million sub-limit for the issuance of stand-by and commercial letters of credit and a $10.0 million sub-limit

for swing-line loans. At our request and approval from our lenders, the aggregate amount available under the Amended Credit Facility may be increased by an amount up to $50.0 million. Borrowings under the Amended Credit Facility, excluding swing-line loans, bear interest per annum at a rate equal to the sum of LIBOR plus the applicable margin or the alternate base rate plus the applicable margin.

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

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

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

On August 13, 2010, the Company and its lenders amended and restated the Senior Secured Credit Facility (the “First Amendment”). The Company entered into the First Amendment to provide additional financial and liquidity flexibility in connection with its previously announced effort to explore strategic alternatives. The First Amendment contains modifications of certain financial covenants and other requirements of the Amended Credit Facility, including, but not limited to: modifications to certain definitions contained in the Amended Credit Facility, including the definitions of certain financial terms to permit additional add backs (such as an add back for charges and professional expenses incurred in connection with asset dispositions), subject to maximum amounts in certain cases, and to the multiple applied to certain of the financial metrics derived in accordance with such definitions, for certain financial covenant calculations; increasing the amount of permitted guarantees of indebtedness by $10 million; amending the asset dispositions covenant to permit additional asset dispositions subject to no events of default and require that any net cash proceeds from an asset disposition or series of asset dispositions in excess of $50 million from the date of the First Amendment be applied 50% to repay the outstanding Term Loan amounts under the Amended Credit Facility and 50% to repay amounts outstanding under the Revolver or cash collateralize letters of credit to the extent outstanding and permanently reduce the Revolver by 50% of the net cash proceeds, which could shorten the term of the Revolver based on the amount of such permanent commitment reductions. In addition, any mandatory prepayments of the Revolver will also reduce the revolving credit commitment by a corresponding amount. The Revolver including letters of credit will not be permitted to remain outstanding after the full repayment of the Term Loan. The First Amendment also provides for a reduction in amount of the Revolver from $85 million to $59.5 million as of the date of the First Amendment. Under terms of the First Amendment, the fixed charge coverage ratio is not tested at either September 30, 2010 or December 31, 2010, and will be retested at the fiscal quarter ending March 31, 2011 and subsequent fiscal quarters. The maturity date of both the Term Loan and Revolver is November 10, 2011.

During the third quarter of fiscal 2010, we repaid the remaining $4.2 million note payable obligations to certain equipment lenders on behalf of its consolidated subsidiary, TexSan Heart Hospital.

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

At September 30, 2010, we had $75.7 million of outstanding long-term debt and obligations under capital leases, of which $16.7 million was classified as current. Our Term Loan under our Amended Credit Facility had an outstanding amount of $66.6 million as of September 30, 2010. The remaining outstanding long-term debt and obligations under capital leases of $9.1 million was due to various lenders to our Hospital Division and MedCath Partners Division. No amounts were outstanding under our Revolver. The maximum availability under our Revolver is $59.5 million which was reduced by outstanding letters of credit totaling $1.7 million as of September 30, 2010.

Covenants related to our long-term debt restrict the payment of dividends and require the maintenance of specific financial ratios and amounts and periodic financial reporting. At September 30, 2009, TexSan Heart Hospital was in violation of financial covenants which govern its equipment loans outstanding. Accordingly, the total outstanding balance of $6.1 million has been included in the current portion of long-term debt and obligations under capital leases in our consolidated balance sheet at that date. These loans were fully repaid as of September 30, 2010. The covenant violations did not result in any other non-compliance related to the covenants governing our other outstanding debt arrangements. At September 30, 2010 we were in compliance with all of our covenants.

At September 30, 2010, we guaranteed either all or a portion of the obligations of our subsidiary hospitals for equipment. 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. Access to available borrowings under our Amended Credit Facility is dependent on the Company’s ability to maintain compliance with the financial covenants contained in the Amended Credit Facility. Deterioration in the Company’s operating results could result in failure to maintain compliance with these covenants, which would restrict or eliminated access to available funds.

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

We believe that internally generated cash flows from operations and asset sales will be sufficient to finance our strategic plans, capital expenditures and our working capital requirements for the next 12 to 18 months. Repayment of the outstanding balance under our Amended Credit Facility prior to its November 2011 maturity date will be dependent on existing cash, cash flow from operations and cash from asset sales.

Intercompany Financing Arrangements. We provide secured real estate, equipment and working capital financings to our majority-owned hospitals.

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 13 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 3 to 7 years. The intercompany equipment loans accrue interest at rates ranging from 4.87% to 8.58%. The weighted average interest rate for the intercompany equipment loans at September 30, 2010 was 7.21%.

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 often subordinate to each hospital’s mortgage and equipment debt outstanding, but are senior to our equity interests and our partners’ equity interests in the hospital venture and are secured, subject to the prior rights of the senior lenders, in each instance by a pledge of certain of the borrowing hospital’s assets. Also as part of our intercompany financing and cash management structure, we sweep cash from individual hospitals as amounts are available in excess of the individual

hospital’s working capital needs. These funds are advanced pursuant to cash management agreements with the individual hospital that establish the terms of the advances and provide for a rate of interest to be paid consistent with the market rate earned by us on the investment of its funds. These cash advances are due back to the individual hospital on demand and are subordinate to our equity investment in the hospital venture.

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

Retained Obligations Subsequent to Disposition. Included in discontinued operations are certain liabilities that the Company has retained upon the disposition of the related entity, including those that have been disposed since September 30, 2010. As the Company’s hospitals are organized as partnerships, upon disposition of the related operations, assets and certain liabilities, the partnerships are responsible for the resolution of outstanding payables, remaining obligations, including those related to cost reports, obligations and wind down of the respective tax filings of the partnership. The Company has reported all known obligations in its consolidated balance sheets as of September 30, 2010 and 2009. However, as the ultimate resolution of the outstanding payables and obligations may take in excess of one year, our estimates may prove incorrect and result in the Company paying amounts in excess of those recorded at the respective balance sheet date.

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

Reimbursement, Legislative and Regulatory Changes

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

Inflation

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


Item 7A.	*Quantitative and Qualitative Disclosures About Market Risk*

We maintain a policy for managing risk related to exposure to variability in interest rates, commodity prices, and other relevant market rates and prices which includes considering entering into derivative instruments (freestanding derivatives), or contracts or instruments containing features or terms that behave in a manner similar to derivative instruments (embedded derivatives) in order to mitigate our risks. In addition, we may be required to hedge some or all of our market risk exposure, especially to interest rates, by creditors who provide debt funding to us. Currently one of our hospitals in which we have a minority interest and account for under the equity method entered into an interest rate swap during fiscal 2006 for purposes of hedging variable interest payments on long term debt outstanding for that hospital. The interest rate swap is accounted for as a cash flow hedge by the hospital whereby changes in the fair value of the interest rate swap flow through comprehensive income of the hospital. Potential losses of earnings and cash flows due to the market risk of the aforementioned interest rate swap are immaterial.

Interest Rate Risk

Our Amended Credit Facility borrowings expose us to risks caused by fluctuations in the underlying interest rates. The total outstanding balance of our Amended Credit Facility was $66.6 million at September 30, 2010. A change of 100 basis points in the underlying interest rate would have caused a change in interest expense of approximately $0.7 million during the fiscal year ended September 30, 2010.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

MedCath Corporation

Charlotte, North Carolina

We have audited the accompanying consolidated balance sheets of MedCath Corporation and subsidiaries (the “Company”) as of September 30, 2010 and 2009, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended September 30, 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.

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

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company at September 30, 2010 and 2009, and the results of its operations and its cash flows for each of the three years in the period ended September 30, 2010, in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 2 to the consolidated financial statements, the Company changed the manner in which it accounts for non-controlling interests effective October 1, 2009.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of September 30, 2010, based on Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated December 14, 2010 expressed an unqualified opinion on the Company’s internal control over financial reporting.

DELOITTE & TOUCHE LLP

Charlotte, North Carolina

December 14, 2010

MEDCATH CORPORATION

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


	September 30,
	2010			2009

Current assets:
Cash and cash equivalents	$	34,835		$	28,267
Accounts receivable, net (See Note 6)		48,540			49,314
Income tax receivable		6,188			—
Medical supplies		13,481			13,001
Deferred income tax assets		13,327			12,161
Prepaid expenses and other current assets		13,583			13,077
Current assets of discontinued operations		38,356			61,045

Total current assets		168,310			176,865
Property and equipment, net (See Note 7)		223,182			302,717
Other assets		15,653			24,796
Deferred income tax assets		9,063			—
Non-current assets of discontinued operations		78,330			86,070

Total assets	$	494,538		$	590,448


Current liabilities :
Accounts payable	$	19,267		$	26,838
Income tax payable		—			297
Accrued compensation and benefits		18,153			14,314
Other accrued liabilities		18,291			21,750
Current portion of long-term debt and obligations under capital leases		16,672			21,074
Current liabilities of discontinued operations		28,130			32,358

Total current liabilities		100,513			116,631
Long-term debt		52,500			66,563
Obligations under capital leases		6,500			4,255
Deferred income tax liabilities		—			13,874
Other long-term obligations		5,053			8,533
Long-term liabilities of discontinued operations		35,968			36,062

Total liabilities		200,534			245,918

Commitments and contingencies (See Note 12)

Redeemable noncontrolling interest (See Note 2)		11,534			7,448

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; 22,423,666 issued and 20,469,305 outstanding at September 30, 2010 21,595,880 issued and 20,150,556 outstanding at September 30, 2009		216			216
Paid-in capital		457,725			455,259
Accumulated deficit		(139,791	)		(91,420	)
Accumulated other comprehensive loss		(444	)		(360	)
Treasury stock, at cost; 1,954,361 shares at September 30, 2010 1,445,324 shares at September 30, 2009		(44,797	)		(44,797	)

Total MedCath Corporation stockholders’ equity		272,909			318,898
Noncontrolling interest		9,561			18,184

Total equity		282,470			337,082

Total liabilities and equity	$	494,538		$	590,448

See notes to consolidated financial statements.

MEDCATH CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)


	Year Ended September 30,
	2010			2009			2008

Net revenue	$	442,496		$	419,733		$	414,155
Operating expenses:
Personnel expense		151,990			141,315			136,009
Medical supplies expense		113,588			111,253			104,616
Bad debt expense		46,887			39,068			33,070
Other operating expenses		104,327			90,603			84,230
Pre-opening expenses		866			3,563			786
Depreciation		26,895			22,818			21,714
Amortization		32			891			32
Impairment of long lived assets and goodwill		66,822			51,500			—
Loss on disposal of property, equipment and other assets		57			192			124

Total operating expenses		511,464			461,203			380,581

(Loss) income from operations		(68,968	)		(41,470	)		33,574
Other income (expenses):
Interest expense		(4,548	)		(3,746	)		(11,242	)
Loss on early extinguishment of debt		—			(6,702	)		—
Interest and other income		84			217			1,917
Loss on note receiveable		(1,507	)		—			—
Equity in net earnings of unconsolidated affiliates		7,267			9,057			7,891

Total other income (expense), net		1,296			(1,174	)		(1,434	)

(Loss) income from continuing operations before income taxes		(67,672	)		(42,644	)		32,140
Income tax (benefit) expense		(26,662	)		(362	)		8,296

(Loss) income from continuing operations		(41,010	)		(42,282	)		23,844
Income from discontinued operations, net of taxes		5,028			9,527			19,004

Net (loss) income		(35,982	)		(32,755	)		42,848
Less: Net income attributable to noncontrolling interest		(12,389	)		(17,527	)		(21,858	)

Net (loss) income attributable to MedCath Corporation	$	(48,371	)	$	(50,282	)	$	20,990

Amounts attributable to MedCath Corporation common stockholders:
(Loss) income from continuing operations, net of taxes	$	(51,956	)	$	(51,655	)	$	10,645
Income from discontinued operations, net of taxes		3,585			1,373			10,345

Net (loss) income	$	(48,371	)	$	(50,282	)	$	20,990

(Loss) earnings per share, basic
(Loss) income from continuing operations attributable to MedCath Corporation common stockholders	$	(2.62	)	$	(2.62	)	$	0.53
Income from discontinued operations attributable to MedCath Corporation common stockholders		0.18			0.07			0.52

(Loss) earnings per share, basic	$	(2.44	)	$	(2.55	)	$	1.05

(Loss) earnings per share, diluted
(Loss) income from continuing operations attributable to MedCath Corporation common stockholders	$	(2.62	)	$	(2.62	)	$	0.53
Income from discontinued operations attributable to MedCath Corporation common stockholders		0.18			0.07			0.51

(Loss) earnings per share, diluted	$	(2.44	)	$	(2.55	)	$	1.04

Weighted average number of shares, basic		19,842			19,684			19,996
Dilutive effect of stock options and restricted stock		—			—			73

Weighted average number of shares, diluted		19,842			19,684			20,069

See notes to consolidated financial statements.

MEDCATH CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands)


																											Redeemable
												Accumulated															Noncontrolling
												Other			Treasury									Total			Interest
	Common Stock					Paid-in			Accumulated			Comprehensive			Stock						Noncontrolling			Equity			(Temporary
	Shares			Par Value		Capital			Deficit			Loss			Shares			Amount			Interest			(Permanent)			Equity)

Balance, September 30, 2007		21,271		$	213	$	447,688		$	(61,821	)	$	(62	)		69		$	(394	)	$	21,141		$	406,765		$	8,596
Cumulative impact of change in accounting principle		—			—		—			(307	)		—			—			—			—			(307	)		—
Exercise of stock options, including income tax benefit		282			3		4,741			—			—			—			—			—			4,744			—
Share buy back		—			—		—			—			—			1,885			(44,403	)		—			(44,403	)		—
Share-based compensation expense		—			—		4,978			—			—			—			—			—			4,978			—
Tax impact of cancellation of stock options		—			—		(1,913	)		—			—			—			—			—			(1,913	)		—
Acquisitions and other transactions impacting noncontrolling interest		—			—		—			—			—			—			—			344			344			(115	)
Distributions to noncontrolling interest		—			—		—			—			—			—			—			(23,152	)		(23,152	)		(4,005	)
Comprehensive income:																									—
Net income		—			—		—			20,990			—			—			—			17,290			38,280			4,568
Change in fair value of interest rate swaps, net of income tax benefit(*)		—			—		—			—			(117	)		—			—			—			(117	)		—

Total comprehensive income																									38,163

Balance, September 30, 2008		21,553			216		455,494			(41,138	)		(179	)		1,954			(44,797	)		15,623			385,219			9,044
Stock awards, including cancelations and income tax effects		43			—		(1,826	)		—			—			—			—			—			(1,826	)		—
Restricted stock awards, inlcuding cancelations		—			—		1,591			—			—			(509	)		—			—			1,591			—
Distributions to noncontrolling interest		—			—		—						—			—			—			(11,436	)		(11,436	)		(4,895	)
Acquisitions and other transactions impacting noncontrolling interest		—			—		—			—			—			—			—			(118	)		(118	)		(102	)
Comprehensive loss:
Net (loss) income		—			—		—			(50,282	)		—			—			—			14,115			(36,167	)		3,401
Change in fair value of interest rate swaps, net of income tax benefit(*)		—			—		—			—			(181	)		—			—			—			(181	)		—

Total comprehensive loss																									(36,348	)

Balance, September 30, 2009		21,596			216		455,259			(91,420	)		(360	)		1,445			(44,797	)		18,184			337,082			7,448
Stock awards, including cancelations and income tax benefit		363			—		2,646			—			—			—			—			—			2,646			—
Tax withholdings for vested restricted stock awards		(44	)		—		(293	)		—			—			—			—			—			(293	)		—
Transfer of restricted shares from treasury stock		509														509
Distributions to noncontrolling interest		—			—		—			—			—			—			—			(14,956	)		(14,956	)		(3,560	)
Acquisitions and other transactions impacting noncontrolling interest		—			—		—			—			—			—			—			72			72			(77	)
Sale of equity interest		—			—		113			—			—			—			—			27			140			—
Comprehensive loss:
Net (loss) income		—			—		—			(48,371	)		—			—			—			6,234			(42,137	)		7,723
Change in fair value of interest rate swap, net of income tax benefit(*)		—			—		—			—			(84	)		—			—			—			(84	)		—

Total comprehensive loss																									(42,221	)		7,723

Balance, September 30, 2010		22,424		$	216	$	457,725		$	(139,791	)	$	(444	)		1,954		$	(44,797	)	$	9,561		$	282,470		$	11,534


(*)		Tax benefits were $0.1 million for each of the years ended September 30, 2010, 2009 and 2008.

See notes to consolidated financial statements.

MEDCATH CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)


	Year Ended September 30,
	2010			2009			2008

Net (loss) income	$	(35,982	)	$	(32,755	)	$	42,848
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
Income from discontinued operations, net of taxes		(5,028	)		(9,527	)		(19,004	)
Bad debt expense		46,887			39,068			33,070
Depreciation		26,895			22,818			21,714
Amortization		32			891			32
Excess income tax benefit on stock awards and options		—			—			(608	)
Loss on disposal of property, equipment and other assets		57			192			124
Share-based compensation expense		3,148			2,390			4,978
Loss on early extinguishment of debt		—			6,702			—
Amortization of loan acquisition costs		994			937			828
Impairment of long-lived assets and goodwill		66,822			51,500			—
Equity in earnings of unconsolidated affiliates, net of distributions received		4,089			928			(224	)
Deferred income taxes		(22,982	)		(3,322	)		3,032
Change in assets and liabilities that relate to operations:
Accounts receivable		(46,112	)		(30,248	)		(27,137	)
Medical supplies		(480	)		(3,093	)		(1,178	)
Prepaid and other assets		(6,854	)		(389	)		960
Accounts payable and accrued liabilities		(1,050	)		(27	)		(20,740	)

Net cash provided by operating activities of continuing operations		30,436			46,065			38,695
Net cash provided by operating activities of discontinued operations		12,858			17,568			13,313

Net cash provided by operating activities		43,294			63,633			52,008
Investing activities:
Purchases of property and equipment		(16,368	)		(86,990	)		(58,083	)
Proceeds from sale of property and equipment		611			1,750			975
Changes in cash restricted for investment		—			3,154			(3,154	)
Investments in affiliates		—			—			(9,530	)
Purchase of equity interest		—			—			(3,694	)
Sale of interest in equity method investment		836			—			—

Net cash used in investing activities of continuing operations		(14,921	)		(82,086	)		(73,486	)
Net cash (used in) provided by investing activities of discontinued operations		(2,035	)		18,296			67,681

Net cash used in investing activities		(16,956	)		(63,790	)		(5,805	)
Financing activities:
Proceeds from issuance of long-term debt		—			83,479			—
Repayments of long-term debt		(19,491	)		(116,300	)		(2,879	)
Repayments of obligations under capital leases		(1,951	)		(933	)		(945	)
Distributions to noncontrolling interest		(10,285	)		(10,294	)		(16,366	)
Investment by noncontrolling interest		109			207			—
Sale of equity interest in subsidiary		140			—			—
Proceeds from the exercise of stock options		—			77			4,317
Purchase of treasury shares		—			—			(44,403	)
Tax withholding of vested restricted stock awards		(293	)		—			—
Excess income tax benefit on stock awards and options		—			—			608

Net cash used in financing activities of continuing operations		(31,771	)		(43,764	)		(59,668	)
Net cash used in financing activities of discontinued operations		(9,238	)		(6,446	)		(18,360	)

Net cash used in financing activities		(41,009	)		(50,210	)		(78,028	)

Net decrease in cash and cash equivalents		(14,671	)		(50,367	)		(31,825	)
Cash and cash equivalents:
Beginning of period		61,701			112,068			143,893

End of period	$	47,030		$	61,701		$	112,068

Cash and cash equivalents of continuing operations		34,835			28,267			92,844
Cash and cash equivalents of discontinued operations		12,195			33,434			19,224

See notes to consolidated financial statements.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(All tables in thousands, except per share amounts)


1.	Business and Organization

MedCath Corporation (the “Company”) primarily focuses on providing high acuity services, including the diagnosis and treatment of cardiovascular disease. The Company owns and operates hospitals in partnership with physicians. As of September 30, 2010, the Company had ownership interests in and operated ten hospitals, including eight in which the Company owned a majority interest.

As noted below under “Our Strategic Options Review”, subsequent to year end the Company sold two of its majority owned hospitals that were classified as discontinued operations as of September 30, 2010 and its equity interests in one of its minority owned hospitals. As a result, the Company currently owns interests in seven hospitals. In addition, the Company has an agreement to sell one of the seven remaining hospitals. Each of the Company’s majority-owned hospitals is a freestanding, licensed general acute care hospital that provides a wide range of health services with a majority focus on cardiovascular care. Each of our hospitals has a 24-hour emergency room staffed by emergency department physicians. During May 2009 the Company completed a 79 licensed bed expansion at Louisiana Medical Center and Heart Hospital (“LMCHH”) and built space for an additional 40 beds at that hospital. During October 2009, the Company opened a new acute care hospital, Hualapai Mountain Medical Center (“HMMC”), in Kingman, Arizona. This hospital is designed to accommodate a total of 106 licensed beds, with an initial opening of 70 of its licensed beds. The hospitals in which the Company had an ownership interest as of September 30, 2010 had a total of 825 licensed beds, 117 of which are related to Arizona Heart Hospital (“AzHH”) and Heart Hospital of Austin (“HHA”) whose assets, liabilities, and operations are included within discontinued operations. AzHH and HHA were sold on October 1, 2010 and November 1, 2010, respectively. The Company’s seven hospitals that currently comprise continuing operations have 653 licensed beds and are located in six states: Arizona, Arkansas, California, Louisiana, New Mexico, and Texas.

In addition to the hospitals, the Company currently owns and/or manages eight cardiac diagnostic and therapeutic facilities. Seven of these facilities are located at hospitals operated by other parties. These facilities offer invasive diagnostic and, in some cases, therapeutic procedures. The remaining facility is not located at a hospital and offers only diagnostic procedures. The Company refers to its diagnostics division as “MedCath Partners.” For financial data and other information of this and other segments of our business see Note 20.

The Company accounts for all but two of its owned and operated hospitals as consolidated subsidiaries. The Company owns a noncontrolling interest in the Avera Heart Hospital of South Dakota (which was sold on October 1, 2010) and Harlingen Medical Center as of September 30, 2010. Therefore, the Company is unable to consolidate these hospitals’ results of operations and financial position, but rather is required to account for its noncontrolling interests in these hospitals as equity investments.

During fiscal 2010, the Company entered into definitive agreements or sold its interests in AzHH, HHA and certain assets of the MedCath Partners Division. During fiscal 2009 the Company sold its equity interest in Cape Cod Cardiology Services, LLC (“Cape Cod”) and the net assets of Sun City Cardiac Center Associates (“Sun City”). During fiscal 2008, the Company sold its equity interest in Heart Hospital of Lafayette and certain assets of Dayton Heart Hospital. The results of operations of these entities are reported as discontinued operations for all periods presented. The Company uses judgment in determining whether an entity will be reported as continuing or discontinued operations under the provisions of accounting principles generally accepted in the United States (“GAAP”). Such judgments include whether an entity will be sold, the period required to complete the disposition and the likelihood of changes to a plan for sale. If in future periods the Company determines that an entity should be either reclassified from continuing operations to discontinued operations or from discontinued operations to continuing operations, previously reported consolidated statements of income are reclassified in order to reflect the current classification. See Note 3.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Our Strategic Options Review Process

On March 1, 2010, the Company announced that its Board of Directors had formed a Strategic Options Committee to consider the sale either of its equity or the sale of its individual hospitals and other assets. The Company retained Navigant Capital Advisors as its financial advisor to assist in this process. Since announcing the exploration of strategic alternatives on March 1, 2010, the Company has completed several transactions, including:


	•	The disposition of Arizona Heart Hospital (Phoenix, Arizona) in which the Company sold the majority of the hospital’s assets to Vanguard Health Systems for $32.0 million, plus retained working capital. The transaction was completed effective October 1, 2010.

	•	The disposition of the Company’s wholly owned subsidiary that held 33.3% ownership of Avera Heart Hospital of South Dakota located in Sioux Falls, SD to Avera McKennan for $20.0 million, plus a percentage of the hospital’s available cash. The transaction was completed October 1, 2010.

	•	The disposition of Heart Hospital of Austin (Texas) in which the Company and the physician owners sold substantially all of the hospital’s assets to St. David’s Healthcare Partnership L.P. for approximately $83.8 million, plus retained working capital. The transaction was completed effective November 1, 2010.

	•	The disposition of the Company’s approximate 27.0% ownership interest in Southwest Arizona Heart and Vascular, LLC (Yuma, AZ) to the joint venture’s physician partners for $7.0 million. The transaction was completed effective November 1, 2010.

In addition, the Company announced on November 8, 2010, that it, along with physician investors, had entered into a definitive agreement to sell substantially all the assets of TexSan Heart Hospital (San Antonio, Texas) to Methodist Healthcare System of San Antonio for $76.25 million, plus retained working capital. The transaction, which is subject to regulatory approval and other customary closing conditions, is anticipated to close during the second quarter of fiscal 2011, which ends March 31, 2011. This facility does not qualify for discontinued operations treatment at September 30, 2010.


2.	Summary of Significant Accounting Policies and Estimates

Changes in Basis of Presentation — Effective October 1, 2009, the Company adopted a new accounting standard which 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 interests, changes in a parent’s ownership interest and the valuation of any retained noncontrolling equity investment when a subsidiary is deconsolidated. This new accounting standard also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. This new accounting standard generally requires the Company to clearly identify and present ownership interests in subsidiaries held by parties other than the Company in the consolidated financial statements within the equity section but separate from the Company’s equity. However, in instances in which certain redemption features that are not solely within the control of the issuer are present, classification of noncontrolling interests outside of permanent equity is required. It also requires the amounts of consolidated net income attributable to the Company and to the noncontrolling interests to be clearly identified and presented on the face of the consolidated statements of operations; changes in ownership interests to be accounted for as equity transactions; and when a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary and the gain or loss on the deconsolidation of the subsidiary to be measured at fair value. The implementation of this accounting standard results in the cash flow impact of certain transactions with noncontrolling interests being classified within financing activities. Such treatment is consistent with the view that under this new accounting standard, transactions between the Company and noncontrolling interests are considered to be equity transactions. The adoption of this new accounting standard has been applied retrospectively for all periods presented.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Upon the occurrence of certain fundamental regulatory changes, the Company could be obligated, under the terms of certain of its investees’ operating agreements, to purchase some or all of the noncontrolling interests related to certain of the Company’s subsidiaries. While the Company believes that the likelihood of a change in current law that would trigger such purchases was remote as of September 30, 2010, the occurrence of such regulatory changes is outside the control of the Company. As a result, these noncontrolling interests totaling $11,534 and $7,448 as of September 30, 2010 and 2009, respectively, that are subject to this redemption feature are not included as part of the Company’s equity and are carried as redeemable noncontrolling interests in equity of consolidated subsidiaries on the Company’s consolidated balance sheets.

Profits and losses are allocated to the noncontrolling interest in the Company’s subsidiaries in proportion to their ownership percentages and reflected in the aggregate as net income attributable to noncontrolling interests. The physician partners of the Company’s subsidiaries typically are organized as general partnerships, limited partnerships or limited liability companies that are not subject to federal income tax. Each physician partner shares in the pre-tax earnings of the subsidiary in which it is a partner. Accordingly, the income or loss attributable to noncontrolling interests in each of the Company’s subsidiaries are generally determined on a pre-tax basis. In accordance with this new accounting standard, total net income attributable to noncontrolling interests are presented after net (loss) income.

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

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

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

The Company grants credit without collateral to its patients, most of whom are insured under payment arrangements with third party payors, including Medicare, Medicaid and commercial insurance carriers. The Company has not experienced significant losses related to receivables from individual patients or groups of patients in any particular industry or geographic area. Accounts receivable of the Hospital Division represents 96.2% and 90.3% of total accounts receivable for the Company as of September 30, 2010 and 2009, respectively. The following table summarizes the percentage of net accounts receivable from all payors for the Hospital Division at September 30:


	2010			2009

Medicare and Medicaid		46	%		42	%
Commercial and other		42	%		43	%
Self-pay		12	%		15	%

		100	%		100	%

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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

Allowance for Doubtful Accounts — Accounts receivable primarily consist of amounts due from third-party payors and patients in the Company’s Hospital Division. The remainder of the Company’s accounts receivable principally consists of amounts due from billings to hospitals for various cardiovascular care services performed in its MedCath Partners Division. To provide for accounts receivable that could become uncollectible in the future, the Company establishes an allowance for doubtful accounts to reduce the carrying value of such receivables to their estimated net realizable value. The Company estimates this allowance based on such factors as payor mix, aging and the historical collection experience and write-offs of its respective hospitals and other business units.

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

Property and Equipment — Property and equipment are recorded at cost and are depreciated principally on a straight-line basis over the estimated useful lives of the assets, which generally range from 25 to 40 years for buildings and improvements, 15 to 25 years for land improvements, and from 3 to 10 years for equipment, furniture and software. Repairs and maintenance costs are charged to operating expense while betterments are capitalized as additions to the related assets. Retirements, sales, and disposals are recorded by removing the related cost and accumulated depreciation with any resulting gain or loss reflected in income from operations. Amortization of property and equipment recorded under capital leases is included in depreciation expense. Interest expense incurred in connection with the construction of hospitals is capitalized as part of the cost of construction until the facility is operational, at which time depreciation begins using the straight-line method over the estimated useful life of the applicable constructed assets. The Company did not capitalize interest during the year ended September 30, 2010. The Company capitalized interest of $2.7 million and $1.3 million, respectively, during the years ended September 30, 2009 and 2008.

Goodwill — Goodwill represents acquisition costs in excess of the fair value of net identifiable tangible and intangible assets of businesses purchased. All of the Company’s goodwill was recorded within the Hospital Division segment, see Note 20. The Company evaluated goodwill annually on September 30 for impairment, or earlier if indicators of potential impairment exist. The determination of whether or not goodwill has become impaired involves a significant level of judgment in the assumptions underlying the approach used to determine the value of the Company’s reporting unit. See Note 4 for additional disclosure related to the Company’s annual impairment evaluation of goodwill.

Other Assets — Other assets primarily consist of investments in affiliates (see Note 8), loan acquisition costs and assets associated with management contracts and physician related revenue guarantees (see Note 12). Loan acquisition costs (“Loan Costs”) are costs associated with obtaining long-term financing. Loan Costs, net of accumulated amortization, were $1.1 million and $2.1 million as of September 30, 2010 and 2009, respectively. Loan Costs are being amortized using the straight-line method, which approximates the effective interest method, as a component of interest expense over the life of the related debt. Amortization expense recognized for Loan Costs totaled $1.0 million, $1.0 million, and $0.9 million for the years ended September 30, 2010, 2009 and 2008, respectively.

Long-Lived Assets — Long-lived assets, such as property, equipment, and purchased intangible assets subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If circumstances require a long-lived asset be tested for possible impairment, the Company first compares undiscounted cash flows expected to be generated by an asset to the carrying value of the asset. If the carrying value of the long-lived asset is not recoverable on an undiscounted cash flow basis, impairment is recognized to the extent that the carrying value exceeds its fair value. Fair value is determined by management through various valuation techniques including, but not limited to, discounted cash

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

flow models, quoted market comparables and third party indications of value obtained in conjunction with the Company’s evaluation of Strategic Alternatives. The determination of whether or not long-lived assets have become impaired involves a significant level of judgment in the assumptions underlying the approach used to determine the estimated future cash flows expected to result from the use of those assets. Changes in the Company’s strategy, assumptions and/or market conditions could significantly impact these judgments and require adjustments to recorded amounts of long-lived assets. See Note 4 for the impairment charges recorded to property and equipment and Note 13 for further discussions as to the Company’s determination of fair value.

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

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

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

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

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

The Company continually reviews the contractual estimation process to consider and incorporate updates to the laws and regulations and any changes in the contractual terms of its programs. Final settlements under some of these programs are subject to adjustment based on audit by third parties, which can take several years to determine. From a procedural standpoint, for governmental payors, primarily Medicare, the Company recognizes estimated settlements in its consolidated financial statements based on filed cost reports. The Company subsequently adjusts those settlements as new information is obtained from audits or reviews by the fiscal intermediary and, if the result of the fiscal intermediary audit or review impacts other unsettled and open cost reports, the Company recognizes the impact of those adjustments. As such, the Company recognized adjustments that decreased net revenue by $0.3 million, $5.1 million and $0.7 million for continuing operations in the years ended September 30, 2010, 2009

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

and 2008, respectively. The Company recognized adjustments that decreased net revenue by $0.1 million and $0.9 million for discontinued operations in the years ended September 30, 2009 and 2008, respectively. The Company recognized immaterial adjustments to net revenue for discontinued operations for the year ended September 30, 2010.

The Company records charity care deductions as a reduction to gross revenue. Patients that receive charity care discounts must provide a complete and accurate application, be in need of non-elective care and meet certain federal poverty guidelines established by the U.S. Department of Health and Human Services.

A significant portion of the Company’s net revenue is derived from federal and state governmental healthcare programs, including Medicare and Medicaid, which, combined, accounted for 55.5%, 54.3% and 55.3% of the Company’s net revenue during the years ended September 30, 2010, 2009 and 2008, respectively. Medicare payments for inpatient acute services and certain outpatient services are generally made pursuant to a prospective payment system. Under this system, hospitals are paid a prospectively-determined fixed amount for each hospital discharge based on the patient’s diagnosis. Specifically, each discharge is assigned to a diagnosis-related group (“DRG”). Based upon the patient’s condition and treatment during the relevant inpatient stay, each DRG is assigned a fixed payment rate that is prospectively set using national average costs per case for treating a patient for a particular diagnosis. The DRG rates are adjusted by an update factor each federal fiscal year, which begins on October 1. The update factor is determined, in part, by the projected increase in the cost of goods and services that are purchased by hospitals, referred to as the market basket index. DRG payments do not consider the actual costs incurred by a hospital in providing a particular inpatient service; however, DRG payments are adjusted by a predetermined adjustment factor assigned to the geographic area in which the hospital is located.

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

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

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

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

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Company’s reportable segments, consistent with how business results are reported internally to management and the disclosure of segment information is discussed in Note 20.

Advertising — Advertising costs are expensed as incurred. During the years ended September 30, 2010, 2009 and 2008, the Company incurred $2.2 million, $2.6 million and $2.0 million of advertising expenses, respectively.

Pre-opening Expenses — Pre-opening expenses consist of operating expenses incurred during the development of new ventures prior to opening for business. Such costs specifically relate to the Company’s development of the Hualapai Mountain Medical Center in Kingman, Arizona and are expensed as incurred. The Company incurred $0.9 million, $3.6 million and $0.8 million, respectively, of pre-opening expenses during the years ended September 30, 2010, 2009 and 2008.

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

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

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

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

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

historical volatilities of the Company’s common stock and the common stock of comparable publicly traded companies.


	Year Ended September 30,
	2009	2008

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

During fiscal 2010 and 2009 the Company granted shares of restricted stock and restricted stock units to employees and directors, respectively. Restricted stock granted to employees, excluding executives of the Company, vest in equal annual installments over a three year period. Executives of the Company defined by the Company as vice president or higher, received two separately equal grants. The first grant of restricted stock vests in equal annual installments over a three year period, the second grant of restricted stock vests over a three year period based on established performance conditions. All unvested restricted stock granted to employees becomes fully vested upon a change in control of the Company as defined in the Company’s 2006 Stock Option and Award Plan. Restricted stock units granted to directors are fully vested at the date of grant and are paid in the form of common stock upon each applicable director’s termination of service on the board.

Subsequent Events — In connection with preparation of the consolidated financial statements for fiscal year ended September 30, 2010, the Company has evaluated subsequent events for potential recognition and disclosures through the date these consolidated financial statements were issued, as filed in Form 10-K with the Securities and Exchange Commission (“SEC”).

Recent Accounting Pronouncements — The following is a summary of new accounting pronouncements that have been adopted or that may apply to the Company.

Recently Adopted Accounting Pronouncements — In December 2007, the FASB issued a new accounting standard that establishes accounting and reporting standards pertaining to ownership interests in subsidiaries held by parties other than the parent, the amount of net income attributable to the parent and to the noncontrolling interests, changes in a parent’s ownership interest, and the valuation of any retained noncontrolling equity investment when a subsidiary is deconsolidated. This new accounting standard also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. The Company adopted this new standard on October 1, 2009. Upon adoption, a portion of noncontrolling interests was reclassified to a separate component of total equity within our consolidated balance sheets.

In April 2008, the FASB issued a new accounting standard which amends the list of factors an entity should consider in developing renewal or extension assumptions used in determining the useful life of recognized intangible assets. The new accounting standard applies to intangible assets that are acquired individually or with a group of other assets and intangible assets acquired in both business combinations and asset acquisitions. The Company adopted this new standard on October 1, 2009 with no impact to its consolidated financial statements.

Effective the first quarter of fiscal 2009, the Company adopted a new accounting standard issued by the FASB that defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measures required under other accounting pronouncements, but does not change existing guidance as to whether or not an instrument is carried at fair value. In February 2008, the FASB delayed the effective date of this new standard for all nonfinancial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The Company elected to defer implementation of this standard

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

until October 1, 2009 as it relates to the Company’s non-financial assets and non-financial liabilities that are not permitted or required to be measured at fair value on a recurring basis. The Company adopted this standard on October 1, 2009 with no impact to its consolidated financial statements. See Note 13.

Recent Accounting Pronouncements:

In June 2009, the FASB issued a new accounting standard that amends the consolidation guidance that applies to variable interest entities (“VIE”). The amendments will significantly affect the overall consolidation analysis. The provisions of this new accounting standard revise the definition and consideration of VIEs, primary beneficiary, and triggering events in which a company must re-evaluate its conclusions as to the consolidation of an entity. This new accounting standard is effective as of the beginning of the first fiscal year after November 15, 2009, fiscal 2011 for the Company. The adoption of this standard is not expected to have any impact on our consolidated financial position or results of operations.

In August 2010, the FASB issued Accounting Standard Updates (“ASU”) 2010-24, “Health Care Entities (Topic 954): Presentation of Insurance Claims and Related Insurance Recoveries,” which clarifies that a health care entity should not net insurance recoveries against a related claim liability. The guidance provided in this ASU is effective as of the beginning of the first fiscal year beginning after December 15, 2010, fiscal 2012 for the Company. The Company is evaluating the potential impacts the adoption of this ASU will have on our consolidated financial statements.

In August 2010, the FASB issued ASU 2010-23, “Health Care Entities (Topic 954): Measuring Charity Care for Disclosure,” which requires a company in the healthcare industry to use its direct and indirect costs of providing charity care as the measurement basis for charity care disclosures. This ASU also requires additional disclosures of the method used to identify such costs. The guidance provided in this ASU is effective for fiscal years beginning after December 15, 2010, fiscal 2012 for the Company. The adoption of this ASU is not expected to have any impact on our consolidated financial position or results of operations.

In December 2010, the FASB approved the issuance of an ASU whereby a health care entity is required to present the provision for bad debts as a component of net revenues within the revenue section of the statement of operations. However, on December 8, 2010, due to implementation and operational concerns, the FASB decided to re-expose the issue for a 60-day comment period. As currently drafted, a health care entity is required to disclose the following by major payor sources of revenue:

a. Its policy for considering collectability in the timing and amount of revenue and bad debt recognized

b. Patient service revenue (net of contractual allowances and discounts) before any provision for bad debts

c. A tabular reconciliation, describing the material activity in the allowance for doubtful accounts for the period.

Public entities will be required to provide the new disclosures and statement of operations presentation in fiscal years beginning after December 15, 2010, and interim periods within those years, with early adoption permitted. Nonpublic entities will be required to provide the new disclosures and statement of operations presentation in fiscal years beginning after December 15, 2011, with early adoption permitted. The requirement to report the provision for bad debts as a component of net revenue will be applied retrospectively for all periods presented, while the new disclosure requirements will be applied prospectively. The Company is evaluating the potential impacts the adoption of this ASU will have on our financial statements.


3.	Discontinued Operations

As required under GAAP, the Company has classified the results of operations of the following entities within income from discontinued operations, net of taxes and the assets and liabilities of these entities have been classified

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

within current and non-current assets and current and long-term liabilities of discontinued operations on the consolidated balance sheets.

During September 2010, the Company entered into an agreement to sell its subsidiary that provided consulting and management services tailored primarily to cardiologists and cardiovascular surgeons. Such subsidiary’s operations had historically been included in the Corporate and other division. Such subsidiary was sold in October 2010 for an immaterial loss.

During July, August and September 2010, the MedCath Partners Division of the Company sold or entered into agreements to sell certain assets of the Division, which, net of taxes resulted in immaterial losses. The associated losses from these sales that have closed as of September 30, 2010 have been included in income (loss) from discontinued operations on the consolidated statement of operations for the year ended September 30, 2010.

During August 2010, the Company entered into a definitive agreement to sell certain of the hospital assets, plus certain net working capital of AzHH for $32.0 million and the assumption of capital leases of $0.3 million. The transaction closed on October 1, 2010 with the limited liability company which owned AzHH retaining all accounts receivable and the hospital’s remaining liabilities. The final purchase price is subject to certain post-closing working capital and other adjustments. As part of its assessment of long-lived assets in June 2010, the Company recognized an impairment charge of $5.2 million based on the potential sales value of AzHH. Accordingly, the Company expects to recognize a nominal gain/loss on the sale in fiscal 2011.

During February 2010, the Company entered into an agreement to sell substantially all of the assets of HHA for $83.8 million plus retention of working capital to St. David’s Healthcare Partnership, L.P. The transaction closed on November 1, 2010.

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

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

During May 2008, the Hospital Division of the Company sold the net assets of Dayton Heart Hospital (“DHH”) to Good Samaritan Hospital for $47.5 million pursuant to a definitive agreement. The total gain recognized, net of taxes, was $3.4 million and is included in income (loss) from discontinued operations on the consolidated statement of operations for the year ended September 30, 2008. As part of the gain resulting from the disposition of DHH, $4.6 million of goodwill was written off.

In accordance with the terms of the sale, DHH and Good Samaritan Hospital entered into an indemnification agreement for a period of eighteen months from the date of the sale. DHH agreed to indemnify Good Samaritan Hospital from certain exposures arising subsequent to the date of sale, including environmental exposure and exposure resulting from the breach of representations or warranties made in accordance with the sale. The indemnification period expired in November 2010 without the Company incurring any payments under this agreement.

As of September 30, 2010 and 2009 the Company had reserved $9.8 million and $9.6 million, respectively, for Medicare outlier payments received by DHH during the year ended September 30, 2004, which are included in current liabilities of discontinued operations in the consolidated balance sheets.

During fiscal 2007, the Company entered into an agreement to dispose of its interest in the Heart Hospital of Lafayette (“HHLf”). The sale of HHLf was completed during the year ended September 30, 2008, resulting in an

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

immaterial loss recorded as part of income (loss) from discontinued operations for the year ended September 30, 2008.

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


	Year Ended September 30,
	2010			2009			2008

Net revenue	$	169,757		$	195,778		$	235,453
Gain (loss) from dispositions, net		(151	)		12,055			3,399
Income before income taxes		2,462			16,655			21,588
Income tax (benefit) expense		(2,566	)		7,128			2,584

Net income		5,028			9,527			19,004
Less: Net income attributable to noncontrolling interest		(1,443	)		(8,154	)		(8,659	)

Net income attributable to MedCath Corporation	$	3,585		$	1,373		$	10,345


	Year Ended September 30,
	2010		2009

Cash and cash equivalents	$	12,195	$	33,434
Accounts receivable, net		18,868		21,419
Other current assets		7,293		6,192

Current assets of discontinued operations	$	38,356	$	61,045

Property and equipment, net	$	74,711	$	83,209
Other intangible assets, net		—		37
Other assets		3,619		2,824

Long-term assets of discontinued operations	$	78,330	$	86,070

Accounts payable	$	21,828	$	24,037
Accrued liabilities		5,987		8,151
Current portion of long-term debt and obligations under capital leases		315		170

Current liabilities of discontinued operations	$	28,130	$	32,358

Long-term debt and obligations under capital leases	$	35,302	$	35,700
Other long-term obligations		666		362

Long-term liabilities of discontinued operations	$	35,968	$	36,062

Included in the Company’s discontinued liabilities is a Real Estate Investment Trust Loan (the “REIT Loan”) aggregating $34.6 million and $35.3 million as of September 30, 2010 and 2009, respectively. Borrowings under this REIT Loan are collateralized by a pledge of the Company’s interest in the related hospital’s property, equipment and certain other assets. The REIT Loan required monthly, interest-only payments for ten years, at which time the loan was due in full, maturing January 2016. The interest rate on this loan is 81/2%. Upon the disposition of the Company’s interest in the related hospital, the REIT Loan was repaid in full in November 2010.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


4.	Asset Impairment Charges

2010 Impairment Charges

During the year ended September 30, 2010, as more fully discussed in Note 1, the Company’s Board of Directors was in the process of conducting a review of strategic alternatives for the Company. Additionally, management noted a decline in operating performance at certain facilities during 2010. The Company performed impairment analyses using undiscounted cash flows at the end of each respective reporting period in 2010 to determine if the carrying amounts of fixed assets were not recoverable. As a result of the decline in operating performance as well as changes in the timing and source of anticipated cash flows for certain facilities the Company determined that the carrying value of these facilities was not fully recoverable. The Company then compared the fair value of those assets to their respective carrying values in order to determine the amount of the impairment. As a result approximately $66.8 million of fixed asset impairment charges were recorded during the year ended September 30, 2010. The Company’s fair value estimates were determined by management based on discounted cash flow models, market comparables, signed letters of intent to sell certain facilities, and third party indications of value obtained in conjunction with the Company’s evaluation of strategic alternatives.

The Company’s fair value estimates could change by material amounts in subsequent periods. Many factors and assumptions can impact the estimates, including the hospitals’ future financial results, the impact of future decisions relative to the Company’s Strategic Alternatives Review, and changes in health care industry trends and regulations. The impairments do not include the costs of closing or selling the hospitals or other future operating costs, which could be substantial. See Note 13 for further discussions as to the Company’s determination of fair value.

In addition, the MedCath Partners Division recorded charges to earnings of $0.1 million and $1.8 million for the write-down of the Company’s investment in Tri-County Heart New Jersey, LLC and Southwest Arizona Heart and Vascular Center, LLC, respectively. The MedCath Partners Division received indicators of value in relation to selling the Company’s interests in these businesses, evaluated the carrying values and determined that there was a loss in value that was other than temporary. Accordingly, the Company recorded an impairment charge of $1.9 million against the Company’s investments, which has been included in equity in net earnings of unconsolidated affiliates.

2009 Goodwill Impairment Charge

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

The second step of the Company’s impairment analysis involved allocating the fair value of the Hospital Division reporting unit, as derived in the first step discussed above, to the assets and liabilities of the Hospital Division reporting unit. This process requires significant management estimates and judgments, and is used to determine the implied fair value of the Hospital Division reporting unit’s goodwill. The Company incorporated recent appraisals and other information in its analysis, and concluded the implied fair value of goodwill was zero. As a result the entire balance of $60.2 million of goodwill (including $8.7 million related to businesses classified as discontinued operations in 2010) was impaired in the fourth quarter of fiscal 2009.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


5.	Business Combinations and Hospital Development

Purchase of Additional Interests in Hospitals — During September 2008, the Company purchased an additional 3.7% ownership interest in the TexSan Heart Hospital for $1.2 million. Additionally, during June 2008 the Company acquired an additional 14.29% ownership interest in the TexSan Heart Hospital, by converting $9.5 million of intercompany debt to equity. As discussed in Note 4, the Company wrote-off all its goodwill in the year ended September 30, 2009.

During July 2008, the Company purchased an additional 3.0% interest in the Heart Hospital of New Mexico for $2.5 million. As discussed in Note 4, the Company wrote-off all its goodwill in the year ended September 30, 2009.

Change in Ownership Due to Cancellation of Stock Subscription Receivable — Upon the formation of Hualapai Mountain Medical Center the minority owners entered into stock subscription agreements whereby they paid for their ownership in two installments. At the date of formation, the amount due from the minority owners was recorded as a stock subscription receivable. During the fourth quarter of fiscal 2010, several minority owners did not submit the final installment. As a result, and per the partnership operating agreement, the proportionate ownership was transferred to the Company and the stock subscription receivable was reduced accordingly. As a result, the Company’s ownership in HMMC increased from 79.00% to 82.49%.

Diagnostic and Therapeutic Facilities Development — During April 2008, the Company paid $8.5 million to acquire a 27.4% interest in Southwest Arizona Heart and Vascular LLC a joint venture with the Heart Lung Vascular Center of Yuma. The joint venture provides cardiac catheterization lab services to Yuma Regional Medical Center in Arizona.

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

New Hospital Development — In August 2007, the Company announced a venture to construct a new 106 inpatient bed capacity general acute care hospital, Hualapai Mountain Medical Center, which is located in Kingman, Arizona. The hospital is accounted for as a consolidated subsidiary since the Company, through its wholly-owned subsidiary, owns 82.49% of the interest in the venture with physician partners owning the remaining 17.51%. Further, the Company exercises substantive control over the hospital. Construction of Hualapai Mountain Medical Center began during fiscal year 2007. The facility was completed and opened during October 2009 with 70 licensed beds, and the capacity for an additional 36 beds to facilitate future growth.

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

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


6.	Accounts Receivable

Accounts receivable, net, consists of the following:


	September 30,
	2010			2009

Receivables, principally from patients and third-party payors	$	119,869		$	109,901
Receivables, principally from billings to hospitals for various cardiovascular procedures		1,027			1,494
Other		2,667			5,280

		123,563			116,675
Less allowance for doubtful accounts		(75,023	)		(67,361	)

Accounts receivable, net	$	48,540		$	49,314

Activity for the allowance for doubtful accounts is as follows:


	Year Ended September 30,
	2010			2009

Balance, beginning of year	$	67,361		$	42,648
Bad debt expense		46,887			39,068
Write-offs, net of recoveries		(39,225	)		(14,355	)

Balance, end of year	$	75,023		$	67,361


7.	Property and Equipment

Property and equipment, net, consists of the following:


	September 30,
	2010			2009

Land	$	22,001		$	26,694
Buildings		186,806			227,914
Equipment		186,983			188,903
Construction in progress		25			17,362

Total, at cost		396,815			460,873
Less accumulated depreciation		(172,633	)		(158,156	)

Property and equipment, net	$	223,182		$	302,717

As further discussed in Note 4, during the year ended September 30, 2010 the Company recorded impairment charges of $66.8 million for the write down of certain property and equipment.

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


8.	Investments in Affiliates

The Company’s determination of the appropriate consolidation method to follow with respect to investments in affiliates is based on the amount of control the Company has and the ownership level in the underlying entity. Investments in entities that the Company does not control, but over whose operations the Company has the ability to

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

exercise significant influence (including investments where the Company has a less than 20% ownership), are accounted for under the equity method. The Company additionally considers if it is the primary beneficiary of (and therefore should consolidate) any entity whose operations the Company does not control. At September 30, 2010, all of the Company’s investments in unconsolidated affiliates are accounted for using the equity method.

Variable Interest Entities

Investments in unconsolidated affiliates accounted for under the equity method (which are included in Other assets on the consolidated balance sheets) consist of the following:


	Year Ended September 30,
	2010			2009

Avera Heart Hospital of South Dakota	$	8,730		$	9,143
Harlingen Medical Center		5,839			5,621
HMC Realty, LLC		(14,044	)		(11,909	)
Southwest Arizona Heart and Vascular, LLC		7,000			8,757
Other		1,465			2,443

	$	8,990		$	14,055

In August 2010, the Company entered into an agreement with Avera McKennan for the sale of its interest in Avera Heart Hospital of South Dakota whereby Avera McKennan would purchase a MedCath subsidiary which was the indirect owner of a one-third ownership interest and which held management rights in Avera Heart Hospital of South Dakota. The transaction closed on October 1, 2010.

As further discussed in Note 22, the Company sold its equity interest in Southwest Arizona Heart and Vascular Center, LLC on November 1, 2010. Pursuant to such pending sale, the Company recognized a write down of its investment of $1.8 million to record the Company’s investment in such business at its net realizable value expected from the sale proceeds.

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


Investee	Ownership

Avera Heart Hospital of South Dakota(a)		33.3	%
Harlingen Medical Center(a)		34.8	%
HMC Realty LLC(a)		36.1	%
Southwest Arizona Heart and Vascular, LLC(b)		27.0	%
All Other:
Blue Ridge Cardiology Services, LLC(b)		50.0	%
Austin Development Holding, Inc.(a)		50.0	%
Central New Jersey Heart Services, LLC(b)		14.8	%
Coastal Carolina Heart, LLC(b)		9.2	%


(a)		Included in the Hospital Division

(b)		Included in MedCath Partners Division

Accumulated deficit includes $9.3 million, $9.3 million, and $10.3 million of undistributed earnings from unconsolidated affiliates accounted for under the equity method at September 30, 2010, 2009, and 2008, respectively. Distributions received from unconsolidated affiliates accounted for under the equity method were $11.4 million, $10.0 million and $7.7 million during the years ended September 30, 2010, 2009 and 2008, respectively.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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


	Year Ended September 30,
	2010		2009		2008

Net revenue	$	219,561	$	225,843	$	215,707
Income from operations	$	45,142	$	47,736	$	43,053
Net income	$	36,065	$	38,797	$	34,004


	September 30,
	2010		2009

Current assets	$	58,690	$	68,174
Long-term assets	$	144,402	$	148,993
Current liabilities	$	23,922	$	25,770
Long-term liabilities	$	121,524	$	122,629


9.	Long-Term Debt

Long-term debt consists of the following:


	September 30,
	2010			2009

Amended Credit Facility	$	66,563		$	80,000
Notes payable to various lenders		—			6,054

		66,563			86,054
Less current portion		(14,063	)		(19,491	)

Long-term debt	$	52,500		$	66,563

Senior Secured Credit Facility — During November 2008, the Company amended and restated its then outstanding senior secured credit facility (the “Amended Credit Facility”). The Amended Credit Facility provides for a three-year term loan facility in the amount of $75.0 million (the “Term Loan”) and a revolving credit facility in the amount of $85.0 million (the “Revolver”), which includes a $25.0 million sub-limit for the issuance of stand-by and commercial letters of credit and a $10.0 million sub-limit for swing-line loans. At the request of the Company and approval from its lenders, the aggregate amount available under the Amended Credit Facility may be increased by an amount up to $50.0 million. Borrowings under the Amended Credit Facility, excluding swing-line loans, bear interest per annum at a rate equal to the sum of LIBOR plus the applicable margin or the alternate base rate plus the applicable margin. At September 30, 2010 the Term Loan bore interest at 3.26%. The $66.6 million outstanding under the Amended Credit Facility at September 30, 2010 related to the Term Loan. No amounts were outstanding under the Revolver as of September 30, 2010. At September 30, 2009, $75.0 million was outstanding under the Term Loan and $5.0 million was outstanding under the Revolver.

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

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

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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

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

On August 13, 2010, the Company and its lenders amended and restated the Senior Secured Credit Facility (the “First Amendment”). The Company entered into the First Amendment to provide additional financial and liquidity flexibility in connection with its previously announced effort to explore strategic alternatives. The First Amendment contains modifications of certain financial covenants and other requirements of the Amended Credit Facility; including, but not limited to: modifications to certain definitions contained in the Amended Credit Facility, including the definitions of certain financial terms to permit additional add backs (such as an add back for charges and professional expenses incurred in connection with asset dispositions), subject to maximum amounts in certain cases, and to the multiple applied to certain of the financial metrics derived in accordance with such definitions, for certain financial covenant calculations; increasing the amount of permitted guarantees of indebtedness by $10 million; amending the asset dispositions covenant to permit additional asset dispositions subject to no events of default and require that any net cash proceeds from an asset disposition or series of asset dispositions in excess of $50 million from the date of the First Amendment be applied 50% to repay the outstanding Term Loan amounts under the Amended Credit Facility and 50% to repay amounts outstanding under the Revolver or cash collateralize letters of credit to the extent outstanding and permanently reduce the Revolver by 50% of the net cash proceeds, which could shorten the term of the Revolver based on the amount of such permanent commitment reductions. In addition, any mandatory prepayments of the Revolver will also reduce the revolving credit commitment by a corresponding amount. The Revolver including letters of credit will not be permitted to remain outstanding after the full repayment of the Term Loan. The First Amendment also provides for a reduction in amount of the Revolver from $85 million to $59.5 million as of the date of the First Amendment. Under terms of the First Amendment, the fixed charge coverage ratio is not tested at either September 30, 2010 or December 31, 2010, and will be retested at the fiscal quarter ending March 31, 2011 and subsequent fiscal quarters.

Senior Notes — During December 2008, the Company redeemed its then outstanding 97/8% senior notes (the “Senior Notes”) issued by MedCath Holdings Corp., a wholly owned subsidiary of the Company, for $111.2 million, which included the payment of a repurchase premium of $5.0 million and accrued interest of $4.2 million. The Senior Notes were redeemed through borrowings under the Credit Facility and available cash on hand. In addition to the aforementioned repurchase premium, the Company incurred $2.0 million in expense related to the write-off of previously incurred financing costs associated with the Senior Notes. The repurchase premium and write off of previously incurred financing costs have been included in the consolidated statements of operations as loss on early extinguishment of debt for the year ended September 30, 2009.

Notes Payable to Various Lenders — The Company acquired various medical and other equipment for a hospital with installment notes payable to an equipment lender collateralized by the related equipment. Amounts borrowed under these notes are payable in monthly installments of principal and interest over a 7 year term with fixed interest rates of 6.74% to 7.71%. The Company had guaranteed these equipment loans. The Company received a fee from the minority partners in the subsidiary hospitals as consideration for providing guarantees in excess of the Company’s ownership percentage in the subsidiary hospitals, see Note 12. These guarantees expired concurrent with the repayment of the related equipment loans. During June 2010, the Company repaid the remaining $4.2 million note payable obligations to certain equipment lenders on behalf of its consolidated subsidiary, TexSan Heart Hospital. At September 30, 2010, there are no notes payable to various lenders outstanding.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Debt Covenants — At September 30, 2009, the Company was in violation of financial covenants under equipment loans at its consolidated subsidiary TexSan Heart Hospital. Accordingly, the total outstanding balance for these loans of $6.1 million was included in the current portion of long-term debt and obligations under capital leases on the Company’s consolidated balance sheet. The covenant violations did not result in any other non-compliance related to the remaining covenants governing the Company’s outstanding debt; therefore the Company was in compliance with all other covenants. Furthermore, these loans were paid in-full as of September 30, 2010. As of September 30, 2010, the Company was in compliance with all covenants governing its outstanding debt.

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

Future Maturities — Presented below are the future maturities of long-term debt at September 30, 2010.


	Debt
Fiscal Year	Maturity

2011	$	14,063
2012		52,500

	$	66,563


10.	Obligations Under Capital Leases

The Company currently leases several diagnostic and therapeutic facilities, mobile catheterization laboratories, office space, computer software and hardware, equipment and certain vehicles under capital leases expiring through fiscal year 2015. Some of these leases contain provisions for annual rental adjustments based on increases in the consumer price index, renewal options, and options to purchase during the lease terms. Amortization of the capitalized amounts is included in depreciation expense. Total assets under capital leases (net of accumulated depreciation of $3.2 million and $3.0 million) at September 30, 2010 and 2009, respectively, are $9.2 million and $2.7 million, respectively, and are included in property and equipment on the consolidated balance sheets. Lease payments during the years ended September 30, 2010, 2009, and 2008 were $2.3 million, $1.1 million and $1.1 million, respectively, and include interest of $0.4 million, $0.2 million, and $0.1 million, respectively.

Future minimum lease payments at September 30, 20010 are as follows:


	Minimum
Fiscal Year	Lease Payment

2011	$	3,106
2012		2,607
2013		2,104
2014		1,708
2015		789

Total future minimum lease payments		10,314
Less amounts representing interest		(1,205	)

Present value of net minimum lease payments		9,109
Less current portion		(2,609	)

	$	6,500

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


11.	Liability Insurance Coverage

During June 2010 and 2009, the Company entered into a one-year claims-made policy providing coverage for medical malpractice claim amounts in excess of $2.0 million of retained liability per claim. The Company also purchased additional insurance to reduce the retained liability per claim to $250,000 for the MedCath Partners Division, for each respective fiscal year. Because of the Company’s self-insured retention levels, the Company is required to recognize an estimated expense/liability for the amount of retained liability applicable to each malpractice claim. As of September 30, 2010 and September 30, 2009, 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 $3.1 million and $4.0 million, respectively, which is included in other accrued liabilities in the consolidated balance sheets. The Company maintains this reserve based on actuarial estimates using the Company’s historical experience with claims and assumptions about future events.

In addition to reserves for medical malpractice, the Company also maintains reserves for self-insured workman’s compensation, healthcare and dental coverage. The total estimated reserve for self-insured liabilities for workman’s compensation, employee health and dental claims was $3.5 million and $3.1 million as of September 30, 2010 and September 30, 2009, respectively, which is included in other accrued liabilities in the consolidated balance sheets. The Company maintains this reserve based on historical experience with claims. The Company maintains commercial stop loss coverage for health and dental insurance program of $175,000 per plan participant.


12.	Commitments and Contingencies

Operating Leases — The Company currently leases several cardiac diagnostic and therapeutic facilities, mobile catheterization laboratories, office space, computer software and hardware equipment, certain vehicles and land under noncancelable operating leases expiring through fiscal year 2017. Total rent expense under noncancelable rental commitments was approximately $1.5 million, $2.2 million and $2.3 million for the years ended September 30, 2010, 2009 and 2008, respectively, and is included in other operating expenses in the accompanying consolidated statements of income.

The approximate future minimum rental commitments under noncancelable operating leases as of September 30, 2010 are as follows:


	Rental
Fiscal Year	Commitment

2011	$	1,724
2012		1,601
2013		1,562
2014		1,300
2015		397
Thereafter		99

	$	6,683

Put and Call Options — During August 2010, the Company amended its partnership agreement with one of its hospitals, whereby call and put options were added relative to the Company’s noncontrolling interest in the hospital. The call option will allow the Company to acquire all of the noncontrolling interest in the hospital owned by physician investors for the net amount of the physician investors unreturned capital contributions adjusted upward for any proportionate share of additional proceeds upon a disposition transaction. The put option allows the Company’s noncontrolling shareholders in the hospital to put their shares to the Company for the net amount of the physician investors unreturned capital contributions at any time before August 31, 2011. The noncontrolling shareholders’ recorded basis in their partnership interest was zero prior to the amendment of this agreement.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Accordingly, the Company has recognized a redeemable noncontrolling interest of $2.9 million (net of taxes of $1.6 million) as of September 30, 2010 and included the corresponding expense as a loss allocable to noncontrolling interests.

During September 2010, the Company entered into a call agreement with one of its hospitals whereby the Company may exercise the call right to purchase the noncontrolling interest owned by physician investors for an amount equal to the net amount of the physician investors unreturned capital contributions ($2.7 million at September 30, 2010).

Contingencies — The Medicare and Medicaid programs are subject to statutory and regulatory changes, retroactive and prospective rate adjustments, administrative rulings, court decisions, executive orders and freezes and funding reductions, all of which may significantly affect the Company. In addition, reimbursement is generally subject to adjustment following audit by third party payors, including commercial payors as well as the contractors who administer the Medicare program for the Centers for Medicare and Medicaid Services (“CMS”).

Final determination of amounts due providers under the Medicare program often takes several years because of such audits, as well as resulting provider appeals and the application of technical reimbursement provisions. The Company believes that adequate provisions have been made for any adjustments that might result from these programs; however, due to the complexity of laws and regulations governing the Medicare and Medicaid programs, the manner in which they are interpreted and the other complexities involved in estimating net revenue, there is a possibility that recorded estimates will change by a material amount in the future.

In 2005, CMS began using recovery audit contractors (“RAC”) to detect Medicare overpayments not identified through existing claims review mechanisms. RACs perform post-discharge audits of medical records to identify Medicare overpayments resulting from incorrect payment amounts, non-covered services, incorrectly coded services, and duplicate services. CMS has given RACs the authority to look back at claims up to three years old, provided that the claim was paid on or after October 1, 2007. Claims identified as overpayments will be subject to the Medicare appeals process. The Health Care Reform Laws expand the RAC program’s scope to include Medicaid claims by requiring all states to enter into contracts with RACs by December 31, 2010. The Company believes the claims for reimbursement submitted to the Medicare and Medicaid programs by the Company’s facilities have been accurate, however the Company is unable to reasonably estimate what the potential result of future RAC audits or other reimbursement matters could be.

The Company is involved in various claims and legal actions in the ordinary course of business, including malpractice claims arising from services provided to patients that have been asserted by various claimants and additional claims that may be asserted for known incidents through September 30, 2010. 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.

During fiscal years 2008 and 2007, the Company refunded certain reimbursements to CMS related to carotid artery stent procedures performed during prior fiscal years at two of the Company’s consolidated subsidiary hospitals. The U.S. Department of Justice (“DOJ”) initiated an investigation related to the Company’s return of these reimbursements. As a result of the DOJ’s investigation, the Company began negotiating settlement agreements during the second quarter of fiscal 2009 with the DOJ whereby the Company was expected to pay $0.8 million to settle and obtain releases from any federal civil false claims liability related to the DOJ’s investigation. The DOJ allegations do not involve patient care, and relate solely to whether the procedures were properly reimbursable by Medicare. The settlement does not include any finding of wrong-doing or any admission of liability. During fiscal 2010, the Company paid $0.8 million initially accrued within other accrued liabilities on

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

the consolidated balance sheet as of September 30, 2009. As of September 30, 2010, both settlement agreements have been executed.

In March 2010, the DOJ issued a civil investigative demand (“CID”) pursuant to the federal False Claims Act to one of the Company’s hospitals. The CID requested information regarding Medicare claims submitted by the hospital in connection with the implantation of implantable cardioverter defibrillators (“ICDs”) during the period 2002 to the present. The Company has complied with all information requested by the DOJ for this hospital.

In September 2010, the Company received a letter from the DOJ advising it that an investigation is being conducted to determine whether certain of their other hospitals have submitted claims excluded from coverage. The period of time covered by the investigation is 2003 to the present. The letter states that the DOJ’s data indicates that many of the Company’s hospitals have claims for the implantation of ICD’s which were not medically indicated and/or otherwise violated Medicare payment policy. The Company understands that the DOJ has submitted similar requests to many other hospitals and hospital systems across the country as well as to the ICD manufacturers themselves. The Company is fully cooperating and has entered into a tolling agreement with the government in this investigation; to date, the DOJ has not asserted any claim against the Company’s other hospitals. Because the Company is in the early stages of this investigation, the Company is unable to evaluate the outcome of this investigation. The Company’s total ICD net revenue is a material component of total net patient revenue.

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

During October, 2009, a purported class action law suit was filed by an individual against the Bakersfield Heart Hospital, a consolidated subsidiary of the Company. In the complaint the plaintiff alleges that under California law, and specifically under the Knox-Keene Healthcare Service Plan Act of 1975 and under the Health and Safety Code of California, California prohibits the practice of “balance billing” for patients who are provided emergency services. On November 24, 2010, the court granted the Bakersfield Heart Hospital’s motion to strike plaintiff’s class allegations.

The Company has evaluated the provisions of the Health Care Reform Laws. The Company is unable to predict at this time the full impact of the Health Care Reform Laws on the Company and its consolidated financial statements.

Commitments — The Company’s consolidated subsidiary hospitals provide guarantees to certain physician groups for funds required to operate and maintain services for the benefit of the hospital’s patients including emergency care and anesthesiology services, among other services. These guarantees extend for the duration of the underlying service agreements. As of September 30, 2010, the maximum potential future payments that the Company could be required to make under these guarantees was approximately $28.2 million ($0.7 million related

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

to discontinued operations) through June 2013. At September 30, 2010 the Company had total liabilities of $13.0 million ($0.7 million related to discontinued operations) for the fair value of these guarantees, of which $7.9 million is in other accrued liabilities and $0.3 million is in current liabilities of discontinued operations, and $4.4 million is in other long term obligations and $0.4 million is in long-term liabilities of discontinued operations. Additionally, the Company had assets of $13.3 million ($0.7 million related to discontinued operations) representing the future services to be provided by the physicians, of which $7.8 million is in prepaid expenses and other current assets and $0.3 million in current assets of discontinued operations, and $4.8 million is in other assets and $0.4 million in non-current assets of discontinued operations.


13.	Fair Value Measurements

As described in Note 2 Recently Adopted Accounting Pronouncements, the Company adopted the accounting standard issued by the FASB that defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measures required under other accounting pronouncements. The Company is required to provide additional disclosures about fair value measurements for each major category of assets and liabilities measured at fair value on a non-recurring basis. Our non-financial assets and liabilities not permitted or required to be measured at fair value on a recurring basis typically relate to long-lived assets held and used and long-lived assets held for sale (including investments in affiliates). Fair values were determined as follows:


	•	Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities, which generally are not applicable to non-financial assets and liabilities.

	•	Level 2 inputs utilize data points that are observable, such as independent third party market offers.

	•	Level 3 inputs are unobservable data points for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability, such as internal estimates of discounted cash flows or third party appraisals.


			Significant
	Quoted		Other		Significant		Year Ended
	Market		Observable		Unobservable		9/30/10
	Price		Inputs		Inputs		Total
	(Level 1)		(Level 2)		(Level 3)		Impairments

Continuing Operations
Hospital Division certain long-lived assets	$	—	$	33,545	$	33,122	$	63,678
Partners Division certain long-lived assets		—		—		7,935		800
Partners Division Investments in Affiliates		—		7,400		—		1,915
Corporate and other certain long-lived assets		—		—		4,880		2,344
Discontinued Operations
Hospital Division certain long-lived assets	$	—	$	32,000	$	—	$	5,249
Partners Division certain long-lived assets		—		—		—		—
Corporate and other certain long-lived assets		—		—		—		—

As described in Note 4, we recorded $63.7 million, $0.8 million and $2.3 million impairment charges in continuing operations in the fiscal year ended September 30, 2010 for the write-down of buildings, land, equipment and other long-lived assets in the Hospital Division, Partners Division and Corporate and other, respectively. The Hospital Division charge relates to one of our hospitals due to a decline in the fair value of real estate in the market in which the hospitals operate and a decline in the estimated fair value of equipment based on discounted cash flows. In addition, the Hospital Division charge relates to one of our hospitals that received a letter of intent from a third party buyer. As described in Note 8, we recorded a $1.9 million write-down of investments in affiliates related to

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

two of the Partners Division affiliates in which the Company has entered into agreements or disposed of its interest in such affiliates. As described in Note 3, we recorded a $5.2 million impairment charge in discontinued operations related to a hospital in which the Company entered into an agreement to dispose of its interest.

Based on Level 3 inputs, the estimated fair value of long-term debt, including the current portion, at September 30, 2010 was $108.1 million ($41.5 million related to discontinued operations) as compared to a carrying value of $101.2 million ($34.6 million related to discontinued operations). Based on Level 3 inputs, at September 30, 2009, the estimated fair value of long-term debt, including the current portion, was $127.6 million ($41.4 million related to discontinued operations) as compared to a carrying value of $121.4 million ($35.3 million related to discontinued operations). Fair value of the Company’s fixed rate debt was estimated using discounted cash flow analyses, based on the Company’s current incremental borrowing rates for similar types of arrangements and market information. The fair value of the Company’s variable rate debt was determined to approximate its carrying value due to the underlying variable interest rates.

The Company’s cash equivalents are measured utilizing Level 1 or Level 2 inputs.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


14.	Income Taxes

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


	Year Ended September 30,
	2010			2009			2008

Current tax expense (benefit)
Federal	$	(7,255	)	$	1,864		$	3,931
State		747			899			2,758

Total current tax expense (benefit)		(6,508	)		2,763			6,689
Deferred tax expense (benefit)
Federal		(19,179	)		(3,302	)		2,365
State		(975	)		177			(758	)

Total deferred tax expense (benefit)	$	(20,154	)	$	(3,125	)	$	1,607

Total income tax expense (benefit)	$	(26,662	)	$	(362	)	$	8,296

The components of net deferred taxes are as follows:


	Year Ended September 30,
	2010			2009

Deferred tax liabilities:
Property and equipment	$	6,794		$	24,481
Equity investments		2,151			2,151
Accrued liabilities		1,060			—
Gain on sale of partnership units		2,461			2,461
Other		—			568

Total deferred tax liabilities		12,466			29,661

Deferred tax assets:
Net operating and economic loss carryforward	$	5,118		$	4,447
Basis difference in investment in subsidiaries		15,768			5,642
Allowances for doubtful accounts and other reserves		7,396			8,859
Accrued liabilities		3,830			3,736
Intangibles		2,185			2,293
Share based compensation expense		4,623			4,531
Management contracts		330			586
Other		216			545

Total deferred tax assets		39,466			30,639
Valuation allowance		(4,610	)		(2,691	)

Net deferred tax asset (liability)	$	22,390		$	(1,713	)

As of September 30, 2010 and 2009, the Company had recorded a valuation allowance of $4.6 million and $2.7 million, respectively, primarily related to state net operating loss carryforwards. The valuation allowance increased by approximately $1.9 million during the year ended September 30, 2010 due to a current year loss incurred in certain states.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The Company has state net operating loss carryforwards of approximately $116.3 million that began to expire in 2009.

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


	Year Ended
	September 30,
	2010			2009			2008

Statutory federal income tax rate		(35.0	)%		(35.0	)%		35.0	%
State income taxes, net of federal effect		(2.9	)%		0.8	%		4.6	%
State valuation allowances on NOLs		2.8	%		1.3	%		(2.0	)%
Noncontrolling interest		(4.1	)%		(7.7	)%		(14.4	)%
Share-based compensation expense		0.0	%		0.0	%		1.2	%
Penalties		0.0	%		0.1	%		0.0	%
Goodwill		0.0	%		39.9	%		0.0	%
Other non-deductible expenses and adjustment		(0.2	)%		(0.2	)%		1.4	%

Effective income tax rate		(39.4	)%		(0.8	)%		25.8	%

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

The Company adopted the new accounting standard effective October 1, 2007. As a result of the implementation, the Company recognized a $0.3 million net increase to the reserves for uncertain tax positions. This increase was accounted for as a cumulative effect adjustment and recognized as a reduction in beginning retained earnings in the consolidated balance sheet. Including the cumulative effect adjustment, the Company had approximately $2.4 million of unrecognized tax benefits as of October 1, 2007 and $0.5 million as of September 30, 2009 recorded in other accrued liabilities on the consolidated balance sheets. There is no unrecognized tax benefit as of September 30, 2010. Of the balance at September 30, 2009 $0.3 million represented the amount of unrecognized tax benefits that, if recognized, would favorably impact the effective income tax rate in any future periods. It is not expected that the amount of unrecognized tax benefits will change in the next twelve months.

The Company includes interest related to tax issues as part of interest expense in the consolidated financial statements. The Company records applicable penalties, if any, related to tax issues within the income tax provision. The Company did not have an accrual for interest as of September 30, 2010 and had $0.2 million accrued for interest as of September 30, 2009. The interest impact for the unrecognized tax liabilities was $(0.2) million to the consolidated financial results for fiscal 2010. There were no penalties recorded for the unrecognized tax benefits.

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


	Year Ended
	September 30,
	2010			2009			2008

Beginning Balance	$	519		$	1,234		$	2,424
Additions based on tax positions of prior years		—			—			640
Settlements		—			(514	)		—
Reductions for positions of prior years		(519	)		(201	)		(1,830	)

Ending Balance	$	—		$	519		$	1,234

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Under the normal three year federal statute of limitations, the Company may be subject to examination by the Internal Revenue Service (“IRS”) back to September 30, 2007. 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, 2007; however, due to existing net operating loss carryforwards, the state can audit back to September 30, 1998 and September 30, 1999 in a few significant states.

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


15.	Per Share Data

Basic — The calculation of basic earnings per share includes 150,900 and 101,500 of restricted stock units that have vested but as of September 30, 2010 and 2009, respectively, have not been converted into common stock. No restricted stock units vested as of September 30, 2008. See Note 16 as it relates to restricted stock units granted to directors of the Company.

Diluted — The calculation of diluted earnings per share considers the potential dilutive effect of options to purchase 932,137, 1,027,387, and 1,776,837 shares of common stock at prices ranging from $9.95 to $33.05, which were outstanding at September 30, 2010, 2009 and 2008, respectively, as well as 694,322, 552,827 and 123,982 shares of restricted stock which were outstanding at September 30, 2010, 2009 and 2008, respectively. Of the outstanding stock options and restricted stock, 1,580,214, and 947,000 have not been included in the calculation of diluted earnings (loss) per share at September 30, 2009 and 2008, respectively, because the options and restricted stock were anti-dilutive. No options or restricted stock were included in the calculation of diluted earnings per share at September 30, 2010, as the consideration of such shares would be anti-dilutive due to the loss from continuing operations, net of tax.


16.	Stock Compensation Plans

On July 28, 1998, the Company’s board of directors adopted a stock option plan (the “1998 Stock Option Plan”) under which it may grant incentive stock options and nonqualified stock options to officers and other key employees. Under the 1998 Stock Option Plan, the board of directors may grant option awards and determine the option exercise period, the option exercise price, and other such conditions and restrictions on the grant or exercise of the option as it deems appropriate. The 1998 Stock Option Plan provides that the option exercise price may not be less than the fair value of the common stock as of the date of grant and that the options may not be exercised more than ten years after the date of grant. Options granted during the year ended September 30, 2008 were granted at an option exercise price equal to or greater than fair market value of the underlying stock at the date of the grant and become exercisable on grading and fixed vesting schedules ranging from 4 to 8 years subject to certain performance acceleration features. Effective September 30, 2005, the compensation committee of the board of directors approved a plan to accelerate the vesting of substantially all unvested stock options previously awarded to employees, subject to a Restriction Agreement. No options may be granted under the 1998 Stock Option Plan after July 31, 2008. At September 30, 2010, 420,137 options were outstanding under the 1998 Option Plan.

On July 23, 2000, the Company adopted an outside director’s stock option plan (the “Director’s Plan”) under which nonqualified stock options may be granted to non-employee directors. Under the Director’s Plan, grants of 2,000 options were granted to each new director upon becoming a member of the board of directors and grants of 2,000 options were made to each continuing director on October 1, 1999 (the first day of the fiscal year ended September 30, 2000). Effective September 15, 2000, the Director’s Plan was amended to increase the number of options granted for future awards from 2,000 to 3,500. Further, effective September 30, 2007, the Director’s Plan was amended to increase the number of options granted for future awards from 3,500 to 8,000. All options granted under the Director’s Plan through September 30, 2010 have been granted at an exercise price equal to or greater than

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

the fair market value of the underlying stock at the date of the grant. Options are exercisable immediately upon the date of grant and expire ten years from the date of grant. Effective March 5, 2008, the Director’s Plan was amended to increase the maximum number of common stock shares which can be issued under the Director’s Plan to 550,000, of which 192,900 were outstanding as of September 30, 2010.

Effective October 1, 2005, the Company adopted the MedCath Corporation 2006 Stock Option and Award Plan (the “Stock Plan”), which provides for the issuance of stock options, restricted stock and restricted stock units to employees of the Company. The Stock Plan is administered by the compensation committee of the board of directors, who has the authority to select the employees eligible to receive awards. This committee also has the authority under the Stock Plan to determine the types of awards, select the terms and conditions attached to all awards, and, subject to the limitation on individual awards in the Stock Plan, determine the number of shares to be awarded. At September 30, 2010, the maximum number of shares of common stock which can be issued through awards granted under the Stock Plan was 1,750,000 of which 1,203,385 were outstanding as of September 30, 2010.

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

The Company recognized share-based compensation expense for the fiscal years ended September 30, 2010, 2009 and 2008 of $3.1 million, $2.4 million and $5.0 million, respectively. The associated tax benefits related to the compensation expense recognized for fiscal 2010, 2009 and 2008 was $1.3 million, $1.0 million and $2.0 million, respectively. No options were granted during the fiscal year ended September 30, 2010. The weighted-average grant-date fair value of options granted during the fiscal years ended September 30, 2009 and 2008 was $9.75 and $10.53, respectively. No options were exercised during fiscal 2010. The total intrinsic value of options exercised during fiscal 2008 was $1.4 million. The total intrinsic value of options exercised during fiscal 2009 was immaterial. There was no intrinsic value of options outstanding at September 30, 2010.

Stock Options

Stock option activity for the Company’s stock compensation plans during the years ended September 30, 2010, 2009 and 2008 was as follows:


				Weighted-
	Number of			Average
	Options			Exercise Price

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

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

Outstanding options, September 30, 2009		1,027,387		$	22.25
Cancelled		(95,250	)		25.86

Outstanding options, September 30, 2010		932,137		$	21.89

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The following table summarizes information for options outstanding and exercisable at September 30, 2010:


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

$ 9.95 - 15.80		108,137		4.24	$	13.69
16.10 - 18.26		20,500		4.05		17.15
19.00 - 21.01		59,500		3.20		19.48
21.49 - 21.49		500,000		5.39		21.49
21.66 - 23.65		30,500		5.04		22.35
23.79 - 27.71		142,000		6.60		26.56
27.80 - 29.68		36,500		6.30		29.06
30.35 - 33.05		35,000		6.64		32.89

$ 9.95 - 33.05		932,137		5.34	$	21.89

Restricted Stock Awards

During the year ended September 30, 2006, the Company granted to employees 270,836 shares of restricted stock units, which vested 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, was recognized on a straight-line basis over the vesting period.

During fiscal 2010 and 2009, the Company granted to employees 401,399 and 599,645 shares of restricted stock, respectively. There were no grants to employees during fiscal 2008. Restricted stock granted to employees, excluding executives of the Company, vest annually on December 31 over a three year period. Executives of the Company (defined by the Company as vice president or higher) received two equal grants of restricted stock. The first grant vests annually in equal installments on December 31 over a three year period. The second grant vests annually on December 31 over a three year period if certain performance conditions are met. All unvested restricted stock granted to employees becomes fully vested upon a change in control of the Company as defined in the Company’s 2006 Stock Option and Award Plan. During fiscal 2010 and 2009, the Company granted 89,600 and 101,500 shares of restricted stock units to directors. There were no grants to directors during fiscal 2008. Restricted stock units granted to directors are fully vested at the date of grant and are paid in shares of common stock upon each applicable director’s termination of service on the board. At September 30, 2010 the Company had $3.0 million of unrecognized compensation expense associated with restricted stock awards.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Activity for the Company’s restricted stock issued under the Stock Plan during the years ended September 30, 2010, 2009 and 2008 was as follows:


	Number of
	Restricted			Weighted-
	Stock Awards			Average
	and Units			Grant Price

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

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

Outstanding restricted stock awards and units, September 30, 2009		654,327		$	9.64
Granted		490,999			7.24
Vested		(181,214	)		8.48
Cancelled		(79,827	)		8.21

Outstanding restricted stock awards and units, September 30, 2010		884,285		$	8.67


17.	Employee Benefit Plan

The Company has a defined contribution retirement savings plan (the “401(k) Plan”) which covers all employees. The 401(k) Plan allows employees to contribute from 1% to 50% of their annual compensation on a pre-tax basis. The Company, at its discretion, may make an annual contribution of up to 40% of an employee’s pretax contribution, up to a maximum of 6% of compensation. The Company’s contributions to the 401(k) Plan for the years ended September 30, 2010, 2009 and 2008 were approximately $1.9 million, $1.8 million and $1.7 million, respectively.


18.	Related Party Transactions

As compensation for the Company’s guarantee of certain unconsolidated affiliate hospitals long term debt, the Company receives a debt guarantee fee; see Note 9 for further discussion. Debt guarantee fees recorded in net revenues in the consolidated statement of operations were $0.4 million for the years ended September 30, 2010, 2009 and 2008. Additionally the Company receives a management fee from unconsolidated affiliates. Management fees recorded within net revenues in the consolidated statement of operations were $4.4 million, $5.0 million, and $5.4 million for the years ended September 30, 2010, 2009 and 2008, respectively. At September 30, 2010 and 2009 the Company had $1.3 million and $1.6 million of outstanding fees recorded of which $0.4 million and $1.0 million was recorded within accounts receivable, net and $0.9 million and $0.5 million within prepaid expenses and other current assets, respectively, in the consolidated balance sheets primarily related to management, insurance and legal fees charged to unconsolidated affiliates, see Note 8 for further discussion regarding unconsolidated affiliates of the Company.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


19.	Summary of Quarterly Financial Data (Unaudited)

Summarized quarterly financial results were as follows:


	Year Ended September 30, 2010
	First			Second			Third			Fourth
	Quarter			*Quarter ()**			*Quarter ()**			*Quarter ()**

Net revenue	$	106,000		$	114,007		$	111,963		$	110,527
Operating expenses		109,388			127,373			134,630			140,074
Loss from operations		(3,388	)		(13,366	)		(22,667	)		(29,547	)
Loss from continuing operations, net of taxes		(2,523	)		(9,351	)		(14,360	)		(25,722	)
(Loss) income from discontinued operations, net of taxes		(133	)		(1,858	)		1,544			4,034

Net loss	$	(2,656	)	$	(11,209	)	$	(12,816	)	$	(21,688	)

(Loss) earnings per share, basic
Continuing operations	$	(0.13	)	$	(0.47	)	$	(0.72	)	$	(1.29	)
Discontinued operations		—			(0.10	)		0.08			0.20

(Loss) earnings per share, basic	$	(0.13	)	$	(0.57	)	$	(0.64	)	$	(1.09	)

(Loss) earnings per share, diluted
Continuing operations	$	(0.13	)	$	(0.47	)	$	(0.72	)	$	(1.29	)
Discontinued operations		—			(0.10	)		0.08			0.20

(Loss) earnings per share, diluted	$	(0.13	)	$	(0.57	)	$	(0.64	)	$	(1.09	)

Weighted average number of shares, basic		19,743			19,829			19,897			19,898
Dilutive effect of stock options and restricted stock		—			—			—			—

Weighted average number of shares, diluted		19,743			19,829			19,897			19,898


(*)		The second, third and fourth quarters of fiscal 2010 includes $14.7 million; $22.8 million; and $29.3 million, respectively, impairment of property and equipment as discussed in Note 4.

As a result of the classification of certain businesses as discontinued operations as discussed in Note 3, the Company has recast the presentation of the results of such businesses for all periods as compared to the presentation in the respective quarterly report as filed on Form 10-Q. In fiscal year 2010, this resulted in (i) a reduction in revenues of $41,260 in the first quarter, $20,902 in the second quarter and $19,884 in the third quarter; (ii) a reduction in operating expenses of $40,715 in the first quarter, $25,168 in the second quarter and $19,676 in the third quarter; (iii) an increase in loss from operations of $545 in the first quarter, a decrease of $4,266 in the second quarter and an increase of $208 in the third quarter; (iv) an increase in loss from continuing operations, net of taxes of $12 in the first quarter, a decrease of $2,648 in the second quarter and an increase of $205 in the third quarter; and (v) a decrease in loss from discontinued operations, net of taxes of $12 in the first quarter, an increase in loss of $2,648 in the second quarter and an increase in income of $205 in the third quarter.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


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

Net revenue	$	105,717		$	107,156	$	103,260		$	103,600
Operating expenses		100,566			100,311		102,109			158,216
Income (loss) from operations		5,151			6,845		1,151			(54,616	)
(Loss) income from continuing operations, net of taxes		(2,538	)		3,597		500			(53,214	)
Income (loss) from discontinued operations, net of taxes		4,784			1,985		(4	)		(5,392	)

Net income (loss)	$	2,246		$	5,582	$	496		$	(58,606	)

Earnings (loss) per share, basic
Continuing operations	$	(0.13	)	$	0.18	$	0.03		$	(2.70	)
Discontinued operations		0.24			0.10		—			(0.27	)

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

Earnings (loss) per share, diluted
Continuing operations	$	(0.13	)	$	0.18	$	0.03		$	(2.70	)
Discontinued operations		0.24			0.10		—			(0.27	)

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

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

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


(*)		The fourth quarter of fiscal 2009 includes $51.5 million impairment of goodwill as discussed in Note 4.

As a result of the classification of certain businesses as discontinued operations as discussed in Note 3, the Company has recast the presentation of the results of such businesses for all periods as compared to the presentation in the respective quarterly report as filed on Form 10-Q for fiscal 2010. In fiscal year 2009, this resulted in (i) a reduction in revenues of $44,528 in the first quarter, $23,611 in the second quarter, $21,328 in the third quarter and $44,366 in the fourth quarter; (ii) a reduction in operating expenses of $42,687 in the first quarter, $22,324 in the second quarter, $22,334 in the third quarter and $52,544 in the fourth quarter; (iii) a decrease in income from operations of $1,841 in the first quarter, a decrease of $1,287 in the second quarter, an increase of $1,006 in the third quarter and a increase of $8,178 in the fourth quarter; (iv) an increase in loss from continuing operations, net of taxes of $623 in the first quarter, a decrease in income of $623 in the second quarter, an increase in income of $477 in the third quarter and a decrease in loss of $8,686 in the fourth quarter; and (v) an increase in income from discontinued operations, net of taxes of $623 in the first quarter, an increase in income of $623 in the second quarter and a decrease in income of $477 in the third quarter and a decrease in income of $8,686 in the fourth quarter.


20.	Reportable Segment Information

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

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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

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


	Year Ended September 30,
	2010			2009			2008

Net revenue:
Hospital Division	$	430,625		$	402,671		$	395,626
MedCath Partners Division		11,440			16,645			18,070
Corporate and other		431			417			459

Consolidated totals	$	442,496		$	419,733		$	414,155

(Loss) income from operations(*):
Hospital Division	$	(53,470	)	$	(39,891	)	$	64,387
MedCath Partners Division		(1,536	)		7,203			(361	)
Corporate and other		(13,962	)		(8,782	)		(30,452	)

Consolidated totals	$	(68,968	)	$	(41,470	)	$	33,574

Depreciation and amortization:
Hospital Division	$	23,084		$	18,350		$	16,939
MedCath Partners Division		3,186			4,708			4,066
Corporate and other		657			651			741

Consolidated totals	$	26,927		$	23,709		$	21,746

Interest expense (income) including intercompany, net:
Hospital Division	$	15,964		$	14,132		$	16,927
MedCath Partners Division		14			(5	)		—
Corporate and other		(11,586	)		(10,599	)		(7,591	)

Consolidated totals	$	4,392		$	3,528		$	9,336

Equity in net earnings of unconsolidated affiliates:
Hospital Division	$	5,143		$	5,045		$	5,502
MedCath Partners Division		1,969			3,785			2,157
Corporate and other		155			227			232

Consolidated totals	$	7,267		$	9,057		$	7,891

Capital expenditures:
Hospital Division	$	15,371		$	82,995		$	70,079
MedCath Partners Division		209			—			1,890
Corporate and other		788			4,755			3,891

Consolidated totals	$	16,368		$	87,750		$	75,860


(*)		Included in (loss) income from operations for fiscal 2010 are impairment charges of $63.6 million, $0.9 million and $2.3 million in the Hospital Division, MedCath Partners Division and Corporate and other, respectively. Included in (loss) income from operations for fiscal 2009 is an impairment charge of $51.5 million in the Hospital Division as discussed in Note 4.

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


	September 30,
	2010		2009

Aggregate identifiable assets:
Hospital Division	$	414,656	$	517,849
MedCath Partners Division		20,210		27,205
Corporate and other		59,672		45,394

Consolidated totals	$	494,538	$	590,448

Investments in affiliates:
Hospital Division	$	508	$	2,834
MedCath Partners Division		8,382		11,075
Corporate and other		100		146

Consolidated totals	$	8,990	$	14,055

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 includes general overhead and administrative expenses and financing activities as components of (loss) income from operations and certain cash and cash equivalents, prepaid expenses, other assets, and operations of the business not subject to separate segment reporting within identifiable assets.

The Hospital Division assets include $115.2 million and $126.4 million of assets related to discontinued operations as of September 30, 2010 and 2009, respectively. The MedCath Partners Division assets included $1.5 million and $20.8 million of assets related to discontinued operations as of September 30, 2010 and 2009, respectively.


21.	Treasury Stock

During fiscal 2007, the board of directors approved a stock repurchase program of up to $59.0 million. During fiscal 2008 1,885,461 million shares of common stock, with a total cost of $44.4 million, were repurchased by the Company under this program. There were no repurchases of common stock during fiscal 2010 and 2009.


22.	Supplemental Cash Flow Disclosures

Supplemental disclosures of cash flow information for the years ended September 30, 2010, 2009 and 2008 are presented below.


	Year Ended September 30,
	2010		2009		2008

Supplemental disclosure of cash flow information:
Interest paid	$	3,526	$	7,499	$	11,682
Income taxes paid	$	634	$	6,212	$	26,777
Supplemental schedule of noncash investing and financing activities:
Capital expenditures financed by capital leases	$	5,318	$	4,186	$	1,324
Accrued capital expenditures	$	3,847	$	7,826	$	15,229
Subsidiary stock issued in exchange for services at fair market value	$	185	$	—	$	—

MEDCATH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


23.	Subsequent Events

As further discussed in Note 4, the Company disposed of i) its interest in AzHH on October 1, 2010; ii) its interest in a subsidiary that provides consulting services in October 2010; and iii) its interest in HHA on November 1, 2010. Such entities met the requirements under GAAP to be presented as discontinued operations as of September 30, 2010.

In connection with the sale of HHA, $34.8 million of third party long-term debt was repaid with the proceeds along with an $11.1 million prepayment penalty.

In addition to the above dispositions, the Company sold its minority equity interest in Southwest Arizona Heart and Vascular Center, LLC for $7.0 million on November 1, 2010 and its minority equity interest in Avera Heart Hospital of South Dakota on October 1, 2010 for $20.0 million.

The Company entered into a definitive agreement in November 2010 to dispose of its interest in TexSan Heart Hospital. This transaction is expected to close in the second fiscal quarter of 2011, which ends March 31, subject to regulatory approval and customary closing conditions. The entity did not meet the requirements under GAAP to be presented as a discontinued operation as of September 30, 2010, therefore, its operations are included in the current operations of the Company in this annual report. However, commencing with the first quarter of 2011, TexSan Heart Hospital will be classified as a discontinued operation in the Company’s filings.

The Company has entered into transition services agreements with the buyers of its sold assets that extend into fiscal 2011. Additionally, subsequent to September 30, 2010, the Company entered into a Managed Services Agreement with McKesson Technologies, Inc. (McKesson) whereby McKesson would employ the majority of the Company’s information technology employees effective November 1, 2010.

During December 2010, the Company exercised its call right with one of its hospitals under a Put/Call Agreement. The Put/Call Agreement permits the Company to call the minority equity equal to the net amount of the minority equity holders unreturned capital contributions adjusted upward for any proportionate share of additional proceeds upon a disposition of the hospital. The call right is in effect for up to one year upon notice of the Company’s intent to exercise its call right.

INDEPENDENT AUDITORS’ REPORT

To Heart Hospital of South Dakota, LLC:

We have audited the accompanying balance sheets of Heart Hospital of South Dakota, LLC (the Company) as of September 30, 2010, 2009 and 2008, and the related statements of income, members’ capital, and cash flows for each of the three years in the period ended September 30, 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

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

In our opinion, such financial statements present fairly, in all material respects, the financial position of the Company at September 30, 2010 and 2009, and the results of its operations and its cash flows for each of the three years ended September 30, 2010, in conformity with accounting principles generally accepted in the United States of America.

DELOITTE & TOUCHE LLP

Charlotte, North Carolina

December 14, 2010

HEART HOSPITAL OF SOUTH DAKOTA, LLC

STATEMENTS OF MEMBERS’ CAPITAL

(In thousands)


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

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

Total comprehensive income																				15,857

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

Total comprehensive income																				13,333

Balance, September 30, 2009	$	9,734		$	9,734		$	9,734		$	(591	)	$	(591	)	$	(590	)	$	27,430
Distributions to members		(4,689	)		(4,689	)		(4,689	)		—			—			—			(14,067	)
Comprehensive income:
Net income		4,415			4,414			4,414			—			—			—			13,243
Change in fair value of interest rate swap		—			—			—			(139	)		(139	)		(139	)		(417	)

Total comprehensive income																				12,826

Balance, September 30, 2010	$	9,460		$	9,459		$	9,459		$	(730	)	$	(730	)	$	(729	)	$	26,189

See notes to financial statements.

HEART HOSPITAL OF SOUTH DAKOTA, LLC

STATEMENTS OF CASH FLOWS

(In thousands)


	Year Ended September 30,
	2010			2009			2008

Net income	$	13,243		$	14,242		$	16,438
Adjustments to reconcile net income to net cash provided by operating activities:
Bad debt expense		2,144			2,457			1,036
Depreciation		3,196			2,615			2,139
Amortization of loan acquisition costs		39			39			39
Loss on disposal of property, equipment and other assets		22			10			140
Change in assets and liabilities that relate to operations:
Accounts receivable		(1,708	)		(1,294	)		(909	)
Medical supplies		87			(9	)		(90	)
Prepaid expenses and other assets		(182	)		856			(87	)
Accounts payable and accrued liabilities		219			(1,830	)		117

Net cash provided by operating activities		17,060			17,086			18,823
Investing activities:
Purchases of property and equipment		(4,085	)		(3,613	)		(2,112	)
Proceeds from sale of property and equipment		5			6			18

Net cash used in investing activities		(4,080	)		(3,607	)		(2,094	)
Financing activities:
Proceeds from issuance of long-term debt		5,455			1,780			—
Repayments of long-term debt		(2,680	)		(2,032	)		(1,586	)
Distributions to members		(14,067	)		(15,567	)		(12,760	)

Net cash used in financing activities		(11,292	)		(15,819	)		(14,346	)

Net change in cash		1,688			(2,340	)		2,383
Cash:
Beginning of year		14,202			16,542			14,159

End of year	$	15,890		$	14,202		$	16,542

Supplemental cash flow disclosures:
Interest paid	$	1,306		$	1,322		$	1,441

See notes to financial statements.

100

HEART HOSPITAL OF SOUTH DAKOTA, LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.	Organization

Heart Hospital of South Dakota, LLC, doing business as Avera Heart Hospital of South Dakota, (the “Company”) is a North Carolina limited liability company that was formed on June 18, 1999 to develop, own, and operate an acute-care hospital located in South Dakota, specializing in all aspects of cardiology and cardiovascular surgery. The hospital commenced operations on March 20, 2001. At September 30, 2010 and 2009, Sioux Falls Hospital Management, Inc., North Central Heart Institute Holdings, PLLC, and Avera McKennan each held a 33 ^1/3 % interest in the Company. See Note 9 for information relative to the subsequent sale of Sioux Falls Hospital Management, Inc.’s interest, which was effective on October 1, 2010.

Sioux Falls Hospital Management, Inc., an indirectly wholly owned subsidiary of MedCath Corporation (“MedCath”), acted as the managing member in accordance with the Company’s operating agreement through October 1, 2010 (see Note 9). The Company will cease to exist on December 31, 2060, unless the members elect earlier dissolution. The termination date may be extended for up to an additional 40 years in five-year increments at the election of the Company’s board of directors.


2.	Summary of Significant Accounting Policies

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

Fair Value of Financial Instruments — The Company considers the carrying amounts of significant classes of financial instruments on the balance sheets to be reasonable estimates of fair value at September 30, 2010 and 2009.

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

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


	2010			2009

Medicare and Medicaid		38	%		42	%
Commercial and Other		53	%		51	%
Self-pay		9	%		7	%

		100	%		100	%

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

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

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

101

HEART HOSPITAL OF SOUTH DAKOTA, LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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

Long-Lived Assets — Long-lived assets are evaluated for impairment when events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of these assets and their eventual disposition are less than their carrying amount. The determination of whether or not long-lived assets have become impaired involves a significant level of judgment in the assumptions underlying the approach used to determine the estimated future cash flows expected to result from the use of those assets. Changes in the Company’s strategy, assumptions and/or market conditions could significantly impact these judgments and require adjustments to recorded amounts of long-lived assets. No impairment charges of long-lived assets were necessary for the years ended September 30, 2010 and 2009.

Other Assets — Other assets include of loan acquisition costs, which are costs associated with obtaining long-term financing (“Loan Costs”). Loan Costs, net of accumulated amortization, were $0.2 million as of September 30, 2010 and 2009. The Loan Costs are being amortized using the straight-line method, which approximates the effective interest method, as a component of interest expense over the life of the debt. Amortization expense recognized for Loan Costs totaled $39,000 for the years ended September 30, 2010, 2009 and 2008. At September 30, 2009, other assets also included the long-term portion of the asset relating to the benefit for future physician services of $0.5 million. This balance is now classified as current based on the related physician agreement.

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

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

The Company continually reviews the contractual estimation process to consider and incorporate updates to the laws and regulations and any changes in the contractual terms of its programs. Final settlements under some of these programs are subject to adjustment based on audit by third parties, which can take several years to determine. From a procedural standpoint, the Company subsequently adjusts those settlements as new information is obtained from audits or review by the fiscal intermediary, and, if the result of the of the fiscal intermediary audit or review impacts other unsettled and open costs reports, then the Company recognizes the impact of those adjustments. The Company cannot predict at this time what impact the future audits by such third parties will have on the Company.

102

HEART HOSPITAL OF SOUTH DAKOTA, LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

the Company’s net revenue during the years ended September 30, 2010, 2009 and 2008. Medicare payments for inpatient acute services and certain outpatient services are generally made pursuant to a prospective payment system. Under this system, a hospital is paid a prospectively-determined fixed amount for each hospital discharge based on the patient’s diagnosis. Specifically, each discharge is assigned to a Medicare severity diagnosis-related group (“MS-DRG”). Based upon the patient’s condition and treatment during the relevant inpatient stay, each MS-DRG is assigned a fixed payment rate that is prospectively set using national average costs per case for treating a patient for a particular diagnosis. The MS-DRG rates are adjusted by an update factor each federal fiscal year, which begins on October 1. The update factor is determined, in part, by the projected increase in the cost of goods and services that are purchased by hospitals, referred to as the market basket index. MS-DRG payments do not consider the actual costs incurred by a hospital in providing a particular inpatient service; however, MS-DRG payments are adjusted by a predetermined adjustment factor assigned to the geographic area in which the hospital is located.

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

The Company provides care to patients who meet certain criteria under its charity care policy without charge or at amounts less than its established rates. Any discounts provided to these patients are recorded as a reduction to gross patient revenue. During the years ended September 30, 2010, 2009 and 2008, the Company provided charity care of $0.2 million, $0.5 million and $0.1 million, respectively.

Advertising — Advertising costs are expensed as incurred. During the years ended September 30, 2010 and 2009, the Company incurred $0.5 million and for the year ended September 30, 2008 , the Company incurred $0.3 million of advertising expenses.

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

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

Subsequent Events — In connection with preparation of the financial statements for the year ended September 30, 2010, the Company has evaluated subsequent events for potential recognition and disclosures through December 14, 2010, the date these financial statements were issued. See Note 9.

New Accounting Pronouncements — In August 2010, the FASB issued Accounting Standard Updates (“ASU”) 2010-24, “Health Care Entities (Topic 954): Presentation of Insurance Claims and Related Insurance Recoveries,” which clarifies that a health care entity should not net insurance recoveries against a related claim liability. The guidance provided in this ASU is effective as of the beginning of the first fiscal year beginning after December 15, 2010, fiscal 2012 for the Company. The Company is evaluating the potential impacts the adoption of this ASU will have on our financial statements.

103

HEART HOSPITAL OF SOUTH DAKOTA, LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

a. Its policy for considering collectability in the timing and amount of revenue and bad debt recognized


	b.	Patient service revenue (net of contractual allowances and discounts) before any provision for bad debts

	c.	A tabular reconciliation, describing the material activity in the allowance for doubtful accounts for the period.

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


3.	Accounts Receivable

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


	2010			2009

Receivables, principally from patients and third-party payors	$	7,055		$	7,213
Other receivables		112			86

		7,167			7,299
Allowance for doubtful accounts		(1,685	)		(1,381	)

Accounts receivable, net	$	5,482		$	5,918

104

HEART HOSPITAL OF SOUTH DAKOTA, LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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


	2010			2009

Balance, beginning of year	$	1,381		$	764
Bad debt expense		2,144			2,457
Write-offs, net of recoveries		(1,840	)		(1,840	)

Balance, end of year	$	1,685		$	1,381


4.	Property and Equipment

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


	2010			2009

Land and improvements	$	1,384		$	1,384
Buildings and improvements		32,233			32,161
Equipment and software		23,737			23,007
Construction in progress		224			—

		57,578			56,552
Less accumulated depreciation		(22,994	)		(22,783	)

	$	34,584		$	33,769


5.	Long-Term Debt

Long-term debt at September 30 is as follows:


	2010			2009

Bank mortgage loan	$	17,694		$	19,200

Equipment loans		6,535			2,254
		24,229			21,454
Less current portion		(3,126	)		(2,064	)

	$	21,103		$	19,390

Bank Mortgage Loan — The Company’s bank mortgage loan used to finance its building and land, was refinanced during February 2006 to extend its maturity date through December 2015 with an interest rate of the LIBOR rate plus an applicable margin of 1.25%. At September 30, 2010 and 2009, the interest rate on this loan was 1.56%.

During the year ended September 30, 2006 the Company entered into an interest rate swap (the “Swap”), to fix the LIBOR at 5.21% for approximately 80% of the bank mortgage loan’s outstanding balance. The Company accounts for the Swap as a cash flow hedge against changes in interest rates, and therefore the underlying liability reflected in these disclosures is not measured at fair value. At September 30, 2010 and 2009, the Company’s effective interest rate on the notional amount of the Swap is 5.58% and 5.76%, effectively. During fiscal 2010 and 2009, the Company recognized interest expense based upon the fixed interest rate provided under the Swap, while the change in the fair value of the Swap is recorded as other comprehensive income (loss) and as an adjustment to the derivative liability in the balance sheets. The derivative liability was $2.2 million and $1.8 million at September 30, 2010 and 2009, respectively, and is included in other long-term obligations on the balance sheets. Future changes in the fair value of the Swap will be recorded based upon the variability in the market interest rates until maturity in December 2015.

105

HEART HOSPITAL OF SOUTH DAKOTA, LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The bank mortgage loan agreement contains certain restrictive covenants, which require the maintenance of specific financial ratios and amounts. The Company was in compliance with these restrictive covenants at September 30, 2010.

Notes Payable to Equipment Lenders — The Company has acquired equipment under equipment loans collateralized by the related equipment, which had a net book value of approximately $6.3 million and $2.2 million at September 30, 2010 and 2009, respectively. The Company has acquired equipment under the following notes:


Date of Acquisition	Amount

June 2010	$	1,432
March 2010		1,629
October 2009		2,394
October 2008		1,779
January 2008		785
September 2007		348

Amounts borrowed under these notes are payable in monthly installments of principal and interest over five-year terms. The notes have annual fixed rates of interest ranging from 3.7% to 6.4%.

The Company also had a $2.5 million working capital line of credit that was provided by the real estate lender, and was subject to the interest rate, covenants, guarantee and collateral of the real estate loan which was to expire in December 2008. During fiscal 2009 it was extended to December 2010 and during October 2010 it was extended to December 2012. No amounts were outstanding under this line of credit at September 30, 2010 or 2009.

Future maturities of long-term debt, as of September 30, 2010, are as follows:


Fiscal Year:
2011	$	3,126
2012		3,200
2013		3,074
2014		2,703
2015		1,961
Thereafter		10,165

	$	24,229


6.	Commitments and Contingencies

Operating Leases — The Company leases certain medical equipment under noncancelable operating leases. Total rent expense under these operating leases was $94,000 during the year ended September 30, 2010 and is included in other operating expenses. There was no rent expense for noncancelable operating leases during the year ended September 30, 2009. Approximate future minimum payments are $94,000 for fiscal 2011 and nothing thereafter.

Commitments — The Company provides guarantees to certain non-investor physician groups for funds required to operate and maintain services for the benefit of the hospital’s patients. These guarantees extend for the duration of the underlying service agreements and the maximum potential future payments that the Company could be required to make under these guarantees was approximately $1.3 million through March 2011 as of September 30, 2010. At September 30, 2010 the Company has recorded a liability of $0.5 million for the fair value of these guarantees, which is in other accrued liabilities. Additionally, the Company has recorded an asset of $0.5 million representing the future services to be provided by the physicians, which is in prepaid expenses and other current assets.

106

HEART HOSPITAL OF SOUTH DAKOTA, LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Contingencies — Laws and regulations governing the Medicare and Medicaid programs are complex, subject to interpretation and may be modified. The Company believes that it is in compliance with such laws and regulations and it is not aware of any investigations involving allegations of potential wrongdoing. However, compliance with such laws and regulations can be subject to future government review and interpretation as well as significant regulatory action, including substantial fines and criminal penalties, as well as repayment of previously billed and collected revenue from patient services and exclusion from the Medicare and Medicaid programs. Medicare and Medicaid cost reports have been audited by the fiscal intermediary through September 30, 2008 and September 30, 2007, respectively.

In March 2010, the DOJ issued a civil investigative demand (“CID”) pursuant to the federal False Claims Act to one of MedCath’s affiliated hospitals. The CID requested information regarding Medicare claims submitted by that hospital in connection with the implantation of implantable cardioverter defibrillators (“ICDs”) during the period 2002 to the present.

On September 17, 2010, MedCath received a letter from the DOJ advising that an investigation is being conducted to determine whether certain of its hospitals, including the Company, have submitted claims excluded from coverage. The period of time covered by the investigation is 2003 to the present. The letter states that the DOJ’s data indicates that many of MedCath’s hospitals have claims for the implantation of ICD’s which were not medically indicated and/or otherwise violated Medicare payment policy. The Company understands that the DOJ has submitted similar requests to many other hospitals and hospital systems across the country as well as to the ICD manufacturers themselves. MedCath is fully cooperating with the government in this investigation; to date, the DOJ has not asserted any claim against the Company specifically. Because MedCath is in the early stages of this investigation, the Company is unable to evaluate the outcome of this investigation.

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

Management does not believe, taking into account the applicable liability insurance coverage and the expectations of counsel with respect to the amount of potential liability, the outcome of any such claims and litigation, individually or in the aggregate, will have a materially adverse effect on the Company’s financial position or results of operations.


7.	Related-Party Transactions

MedCath provides working capital to the Company under a revolving credit note with a maximum borrowing limit of $12.0 million. The loan is collateralized by the Company’s accounts receivable from patient services. There are no amounts outstanding under the working capital loan as of September 30, 2010 and 2009. No interest was paid in fiscal 2010, 2009 or 2008 because the working capital loan was paid off monthly.

MedCath allocated corporate expenses to the Company for costs in the following categories, which are included in operating expenses in the statements of income, during the years ended September 30:


	2010		2009		2008

Management fees	$	1,318	$	1,330	$	1,349
Hospital employee group insurance		4,196		4,674		4,621
Other		446		104		81

	$	5,960	$	6,108	$	6,051

The other category above consists primarily of support services provided by MedCath and consolidated purchased services paid for by MedCath for which it receives reimbursement at cost in lieu of the Company’s incurring these services directly. Support services include but are not limited to training, treasury, and development.

107

HEART HOSPITAL OF SOUTH DAKOTA, LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Consolidated purchased services include but are not limited to insurance coverage, professional services, software maintenance and licenses purchased by MedCath under its consolidated purchasing programs and agreements with third-party vendors for the direct benefit of the Company. At September 30, 2010 and 2009, $0.4 million and $30,000, respectively, was due for these allocated expenses and is included in other accrued liabilities.

The Company pays Avera McKennan and North Central Heart Institute Holdings, PLLC for various services, including labor, supplies and equipment purchases. The amounts paid during the years ended September 30, were as follows:


	2010		2009		2008

Avera McKennan	$	937	$	1,023	$	999
North Central Heart Institute Holdings		923		391		546

Total	$	1,860	$	1,414	$	1,545


8.	Employee Benefit Plan

The Company participates in MedCath’s defined contribution retirement savings plan (the “401(k) Plan”), which covers all employees. The 401(k) Plan allows eligible employees to contribute from 1% to 50% of their annual compensation on a pretax basis. The Company, at its discretion, may make an annual contribution of up to 40% of an employee’s pretax contribution, up to a maximum of 6% of compensation. The Company’s contributions to the 401(k) Plan were $0.3 million during the years ended September 30, 2010, 2009 and 2008.


9.	Subsequent Events

On October 1, 2010, Sioux Falls Hospital Management, Inc. sold its interest in the Company to Avera McKennan, which then became a 662/3% owner of the Company. In conjunction with this transaction, Sioux Falls Hospital Management, Inc. resigned as managing member of the Company and the Company and MedCath entered into a transitional services agreement whereby MedCath would continue to provide certain management services to the Company through July 31, 2011. In conjunction with the management services agreement, MedCath also remitted $1.23 million for the assumption on October 1, 2010 of employee health insurance claims which had previously been the responsibility of MedCath. MedCath remitted this amount to the Company on September 30, 2010. The Company recorded liabilities of approximately $0.6 million as of September 30, 2010 relative to this payment and the remaining $0.6 million was recorded as a reduction of other operating expense for the year ending September 30, 2010. The Company’s 401(k) Plan was transferred into a new plan as a result of the sale with no impact to plan participants.

108


Item 9.	*Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.*

None.


Item 9A.	*Controls and Procedures.*

The President and Chief Executive Officer and the Executive Vice President and Chief Financial Officer of the Company (its principal executive officer and principal financial officer, respectively) have concluded, based on their evaluation of the Company’s disclosure controls and procedures as of the end of the fiscal year covered by this Annual Report on Form 10-K, that the Company’s disclosure controls and procedures were effective as of the end of the fiscal year covered by this report to ensure that information required to be disclosed by the Company in the reports filed or submitted by it under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files under the Exchange Act is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

No change in the Company’s internal control over financial reporting was made during the most recent fiscal quarter covered by this report that materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Management’s Report on Internal Control Over Financial Reporting.

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company (as defined in Securities Exchange Act Rule 13a-15(f)). The Company’s internal control system was designed to provide reasonable assurance to the Company’s management and board of directors regarding the preparation and fair presentation of published financial statements.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation and the reliability of financial reporting. Moreover, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of September 30, 2010. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment, the Company’s internal control over financial reporting was effective as of September 30, 2010 based on those criteria.

Deloitte & Touche LLP, an independent registered public accounting firm, which audited the consolidated financial statements included in this Annual Report on Form 10-K, has issued an attestation report on our internal control over financial reporting, which is included below.

109

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

MedCath Corporation

Charlotte, North Carolina

We have audited the internal control over financial reporting of MedCath Corporation and subsidiaries (the “Company”) as of September 30, 2010, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 30, 2010, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of the Company as of September 30, 2010 and the related consolidated statements of operations, stockholders’ equity, and cash flows for the year then ended and our report dated December 14, 2010 expressed an unqualified opinion on those financial statements (such report expresses an unqualified opinion and includes an explanatory paragraph regarding the change in accounting for non-controlling interests effective October 1, 2009).

DELOITTE & TOUCHE LLP

Charlotte, North Carolina

December 14, 2010

110

PART III


Item 10.	*Directors and Executive Officers of the Registrant*

The information required by this Item with respect to directors is incorporated by reference to information provided under the headings “Election of Directors,” “Corporate Governance,” “Other Matters-Section 16(a) Beneficial Ownership Compliance”, “Accounting and Audit Matters-Audit Committee Financial Expert”, “Executive Compensation and Other Information”, and elsewhere in the Company’s proxy statement to be filed hereafter in connection with the Annual Meeting of Stockholders in 2011.


Item 11.	*Executive Compensation.*

The information required by this Item is incorporated by reference to information provided under the headings “Executive Compensation and Other Information” and “Corporate Governance-Compensation of Directors” and elsewhere in the 2011 Proxy Statement.


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

The information required by this Item is incorporated by reference to information provided under the headings “Security Ownership of Certain Beneficial Owners and Management” and “Executive Compensation and Other Information-Equity Compensation Plan Information” and elsewhere in the 2011 Proxy Statement.


Item 13.	*Certain Relationships and Related Transactions.*

The information required by this Item is incorporated by reference to information provided under the heading “Certain Transactions” and elsewhere in the 2011 Proxy Statement.


Item 14.	*Principal Accounting Fees and Services.*

The information required by this Item is incorporated by reference to information provided under the heading “Accounting and Audit Matters” and elsewhere in the 2011 Proxy Statement.

PART IV


Item 15.	*Exhibits, Financial Statement Schedules.*

(a) (1) The financial statements as listed in the Index under Part II, Item 8, are filed as part of this report.

(2) Financial Statement Schedules. All schedules have been omitted because they are not required, are not applicable or the information is included in the selected consolidated financial data or notes to consolidated financial statements appearing elsewhere in this report.

(3) The following list of exhibits includes both exhibits submitted with this report and those incorporated by reference to other filings:


Exhibit
No.				Description

	2	.1	—	Asset Purchase Agreement By and Between Heart Hospital of DTO, LLC and Good Samaritan Hospital(14)
	2	.2	—	Assignment and Assumption Agreement by and between MedCath Partners, LLC, Cape Cod Cardiac Cath, Inc., Cape Cod Hospital, and Cape Cod Cardiology Services, LLC.(15)
	2	.3	—	Asset Purchase Agreement by and among Sun City Cardiac Center Associates, Sun City Cardiac Center, Inc., MedCath Partners, LLC, MedCath Incorporated, and Banner Health(17)
	2	.4	—	Asset Purchase Agreement made and entered into as of August 6, 2010 by and between VHS Of Phoenix, Inc., dba Phoenix Baptist Hospital, and Arizona Heart Hospital, LLC

112


Exhibit
No.				Description

	2	.5	—	Equity Purchase Agreement by and between Avera McKennan as Buyer and SFHM, Inc. as Seller dated as of August 27, 2010(19)
	2	.6	—	Asset Purchase Agreement made and entered into as of February 16, 2010 by and between St. David’s Healthcare Partnership, L.P., LLP, and Heart Hospital IV, L.P.(20)
	3	.1	—	Amended and Restated Certificate of Incorporation of MedCath Corporation(1)
	3	.2	—	Amended and Restated Bylaws of MedCath Corporation
	4	.1	—	Specimen common stock certificate(1)
	4	.2	—	Stockholders’ Agreement dated as of July 31, 1998 by and among MedCath Holdings, Inc., MedCath 1998 LLC, Welsh, Carson, Anderson & Stowe VII, L.P. and the several other stockholders (the Stockholders’ Agreement)(1)
	4	.3	—	First Amendment to Stockholder’s agreement dated as of June 1, 2001 by and among MedCath Holdings, Inc., the KKR Fund and the WCAS Stockholders(1)
	4	.4	—	Registration Rights Agreement dated as of July 31, 1998 by and among MedCath Holdings, Inc., MedCath 1998 LLC, Welsh, Carson, Anderson & Stowe VII, L.P., WCAS Healthcare Partners, L.P. and the several stockholders parties thereto (the Registration Rights Agreement)(1)
	4	.5	—	First Amendment to Registration Rights Agreement dated as of June 1, 2001 by and among MedCath Holdings, Inc. and the persons listed in Schedule I attached hereto(1)
	4	.6	—	Amended and Restated Credit Agreement, dated as of November 10, 2008, among MedCath Corporation, as a parent guarantor, MedCath Holdings Corp., as the borrower, certain of the subsidiaries of MedCath Corporation party thereto from time to time, as subsidiary guarantors, Bank of America, N.A., as administrative agent, swing line lender and letter of credit issuer, and each of the lenders party thereto from time to time.(13)
	4	.7	—	Collateral Agreement, dated as of July 7, 2004, by and among MedCath Corporation, MedCath Holdings Corp., the Subsidiary Guarantors, as identified on the signature pages thereto and any Additional Grantor (as defined therein) who may become party to the Collateral Agreement, in favor of Bank of America, N.A., as administrative agent for the ratable benefit of the banks and other financial institutions from time to time parties to the Credit Agreement, dated as of July 7, 2004, by and among the MedCath Corporation, MedCath Holdings Corp. and the lenders party thereto(7)
	4	.8	—	First Amendment dated as of August 13, 2010 to the Amended and Restated Credit Agreement dated as of November 10, 2008, among MedCath, MedCath Holdings Corp., as borrower, certain of the subsidiaries of MedCath party thereto from time to time, as subsidiary guarantors, Bank of America, N.A., as administrative agent, swing line lender and letter of credit issuer, and each of the lenders party thereto from time to time(18)
	10	.1	—	Operating Agreement of the Little Rock Company dated as of July 11, 1995 by and among MedCath of Arkansas, Inc. and several other parties thereto (the Little Rock Operating Agreement)(1)(5)
	10	.2	—	First Amendment to the Little Rock Operating Agreement dated as of September 21, 1995(1)(5)
	10	.3	—	Amendment to Little Rock Operating Agreement effective as of January 20, 2000(1)(5)
	10	.4	—	Amendment to Little Rock Operating Agreement dated as of April 25, 2001(1)
	10	.5	—	Operating Agreement of Arizona Heart Hospital, LLC entered into as of January 6, 1997 (the Arizona Heart Hospital Operating Agreement)(1)(5)
	10	.6	—	Amendment to Arizona Heart Hospital Operating Agreement effective as of February 23, 2000(1)(5)
	10	.7	—	Amendment to Operating Agreement of Arizona Heart Hospital, LLC dated as of April 25, 2001(1)
	10	.8	—	Agreement of Limited Partnership of Heart Hospital IV, L.P. as amended by the First, Second, Third and Fourth Amendments thereto entered into as of February 22, 1996 (the Austin Limited Partnership Agreement)(1)(5)
	10	.9	—	Fifth Amendment to the Austin Limited Partnership Agreement effective as of December 31, 1997(1)(5)
	10	.10	—	Amendment to Austin Limited Partnership Agreement effective as of July 31, 2000(1)(5)
	10	.11	—	Amendment to Austin Limited Partnership Agreement dated as of March 30, 2001(1)
	10	.12	—	Amendment to Austin Limited Partnership Agreement dated as of May 3, 2001(1)

113


Exhibit
No.				Description

	10	.13	—	Guaranty made as of November 11, 1997 by MedCath Incorporated in favor of HCPI Mortgage Corp(1)
	10	.14	—	Operating Agreement of Heart Hospital of BK, LLC amended and restated as of September 26, 2001(the Bakersfield Operating Agreement)(2)(5)
	10	.15	—	Second Amendment to Bakersfield Operating Agreement effective as of December 1, 1999(1)(5)
	10	.16	—	Amended and Restated Operating Agreement of effective as of September 6, 2002 of Heart Hospital of DTO, LLC (the Dayton Operating Agreement)(6)(5)
	10	.17	—	Amendment to New Mexico Operating Agreement and Management Services Agreement) effective as of October 1, 1998(1)(5)
	10	.18	—	Amended and Restated Operating Agreement of Heart Hospital of New Mexico, LLC.(3)(5)
	10	.19	—	Amended and Restated Guaranty made as of October 1, 2001 by MedCath Incorporated, St. Joseph Healthcare System, SWCA, LLC and NMHI, LLC in favor of Health Care Property Investors, Inc.(3)
	10	.20	—	Operating Agreement of Heart Hospital of South Dakota, LLC effective as of June 8, 1999 Sioux Falls Hospital Management, Inc. and North Central Heart Institute Holdings, PLLC (the Sioux Falls Operating Agreement)(1)(5)
	10	.21	—	First Amendment to Sioux Falls Operating Agreement of Heart Hospital of South Dakota, LLC effective as of July 31, 1999(1)(5)
	10	.22	—	Limited Partnership Agreement of Harlingen Medical Center LP effective as of June 1, 1999 by and between Harlingen Hospital Management, Inc. and the several partners thereto(1)(5)
	10	.23	—	Operating Agreement of Louisiana Heart Hospital, LLC effective as of December 1, 2000 by and among Louisiana Hospital Management, Inc. and the several parties thereto (Louisiana Operating Agreement)(1)(5)
	10	.24	—	Amendment to Louisiana Operating Agreement effective as of December 1, 2000(1)(5)
	10	.25	—	Second Amendment to Louisiana Operating Agreement effective as of December 1, 2000(1)(5)
	10	.26	—	Limited Partnership Agreement of San Antonio Heart Hospital, L.P. effective as of September 17, 2001(2)(5)
	10	.27	—	Put/Call Agreement dated as of August 20, 2010 by and among San Antonio Hospital Management, Inc., San Antonio Holdings, Inc., MedCath Incorporated, S.A.H.H. Hospital Management, LLC, and S.A.H.H. Investment Group, Ltd. and S.A.H.H. Management Company, LLC.
	10	.28	—	Operating Agreement of Doctors Community Hospital, LLC effective as of March 15, 2007
	10	.29	—	Call Agreement dated as of October 4, 2010 by and amount Hualapai Mountain Medical Center Management, Inc. and the undersigned Investor Members of Hualapai Mountain Medical Center, LLC.
	10	.30*	—	1998 Stock Option Plan for Key Employees of MedCath Holdings, Inc. and Subsidiaries(1)
	10	.31*	—	Outside Directors’ Stock Option Plan(1)
	10	.32*	—	Amended and Restated Directors Option Plan(4)
	10	.33	—	Form of Heart Hospital Management Services Agreement(1)
	10	.34*	—	Amended and Restated Employment Agreement dated September 30, 2005 by and between MedCath Corporation and Joan McCanless(8)
	10	.35	—	Sample Agreement to Accelerate Vesting of Stock Options and Restrict Sale of Related Stock Effective September 30, 2005(8)
	10	.36	—	Guaranty made as of December 28, 2005 by MedCath Corporation and Harlingen Medical Center Limited Partnership in favor of HCPI Mortgage Corp.(9)
	10	.37*	—	Employment agreement dated February 21, 2006, by and between MedCath Corporation and O. Edwin French(10)
	10	.38*	—	MedCath Corporation 2006 Stock Option and Award Plan effective March 1, 2006(12)
	10	.39	—	Consulting agreement effective August 4, 2006 by and between MedCath Incorporated and SSB Solutions(11)
	10	.40*	—	First Amendment to the September 30, 2005 Amended and Restated Employment Agreement by and between MedCath Corporation and Joan McCanless dated September 1, 2006(12)

114


Exhibit
No.				Description

	10	.41*	—	First Amendment to the February 21, 2006 Employment Agreement by and between MedCath Corporation and O. Edwin French dated September 1, 2006(12)
	10	.42	—	Operating Agreement of HMC Management Company, LLC, effective as of June 29, 2007(5)
	10	.43	—	Amended and Restated Operating Agreement of Coastal Carolina Heart, LLC, effective as of July 1, 2007(5)
	10	.44	—	Amended and Restated Limited Partnership Agreement of Harlingen Medical Center, Limited Partnership, effective as of July 10, 2007(5)
	10	.45	—	Amended and Restated Operating Agreement of HMC Realty, LLC, effective as of July 10, 2007(5)
	10	.46*	—	Amendment to Amended and Restated Outside Directors’ Stock Option Plan(14)
	10	.47*	—	Employment Agreement dated June 23, 2008 by and between MedCath Corporation and David Bussone(16)
	10	.48*	—	Employment, Confidentiality and Non-Compete Agreement by and between MedCath Incorporated and James A Parker (Effective Date February 18, 2001)
	10	.49*	—	Amendment to Employment, Confidentiality and Non-Compete Agreement (Effective Date February 18, 2001) dated August 14, 2009 by and between MedCath Corporation and James A. Parker(16)
	21	.1	—	List of Subsidiaries
	23	.1	—	Consent of Deloitte & Touche LLP, Independent Registered Public Accounting Firm
	23	.2	—	Consent of Deloitte & Touche LLP, Independent Auditors
	31	.1	—	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
	31	.2	—	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
	32	.1	—	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
	32	.2	—	Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002


*		Indicates a management contract or compensatory plan or agreement.

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

(2)		Incorporated by reference from the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2001.

(3)		Incorporated by reference from the Company’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2001.

(4)		Incorporated by reference from the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2002.

(5)		Certain portions of these exhibits have been omitted pursuant to a request for confidential treatment filed with the Commission.

(6)		Incorporated by reference from the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2003.

(7)		Incorporated by reference from the Company’s Registration Statement on Form S-4 (File No. 333-119170).

(8)		Incorporated by reference from the Company’s Annual Report on Form 10-K for the year ended September 30, 2005.

(9)		Incorporated by reference from the Company’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2005.

(10)		Incorporated by reference from the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2006.

(11)		Incorporated by reference from the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2006.

(12)		Incorporated by reference from the Company’s Annual Report on Form 10-K for the year ended September 30, 2006.

(13)		Incorporated by reference from the Company’s Current Report on Form 8-K filed November 14, 2008.

115

SIGNATURES

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

Medcath Corporation


	By:	/s/ O. Edwin French

O. Edwin French

President, Chief Executive Officer

(principal executive officer)

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.


Name	Title	Date


/s/ O. Edwin French O. Edwin French	President and Chief Executive Officer (principal executive officer)	December 14, 2010

/s/ James A. Parker James A. Parker	Executive Vice President and Chief Financial Officer (principal financial officer)	December 14, 2010

/s/ Lora Ramsey Lora Ramsey	Vice President — Controller (principal accounting officer)	December 14, 2010

/s/ Pamela G. Bailey Pamela G. Bailey	Director	December 14, 2010

/s/ Woodrin Grossman Woodrin Grossman	Director	December 14, 2010

/s/ Robert S. Mccoy, Jr. Robert S. Mccoy, Jr.	Director	December 14, 2010

/s/ James A. Deal James A. Deal	Director	December 14, 2010

/s/ Jacque J. Sokolov, Md Jacque J. Sokolov, Md	Director	December 14, 2010

/s/ John T. Casey John T. Casey	Director	December 14, 2010

117


			Page

PART I
	Item 1.	Business		1
	Item 1A.	Risk Factors		17
	Item 1B.	Unresolved Staff Comments		28
	Item 2.	Properties		28
	Item 3.	Legal Proceedings		28

PART II
	Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		29
	Item 6.	Selected Financial Data		31
	Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		32
	Item 7A.	Quantitative and Qualitative Disclosures About Market Risk		55
	Item 8.	Financial Statements and Supplementary Data
	Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		109
	Item 9A.	Controls and Procedures		109
	Item 9B.	Other Information		111

PART III
	Item 10.	Directors, Executive Officers and Corporate Governance		112
	Item 11.	Executive Compensation		112
	Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stock-holder Matters		112
	Item 13.	Certain Relationships and Related Transactions, and Director Independence		112
	Item 14.	Principal Accounting Fees and Services		112

PART IV
	Item 15.	Exhibits, Financial Statements Schedules		112
SIGNATURES				117
EX-2.4
EX-3.2
EX-10.27
EX-10.28
EX-10.29
EX-10.48
EX-21.1
EX-23.1
EX-23.2
EX-31.1
EX-31.2
EX-32.1
EX-32.2


*	$100 invested on 9/30/05 in stock or index, including reinvestment of dividends. Fiscal year ending September 30.


	Page

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM		57
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets as of September 30, 2010 and 2009		58
Consolidated Statements of Operations for the Years Ended September 30, 2010, 2009 and 2008		59
Consolidated Statements of Stockholders’ Equity for the Years Ended September 30, 2010, 2009 and 2008		60
Consolidated Statements of Cash Flows for the Years Ended September 30, 2010, 2009 and 2008		61
Notes to Consolidated Financial Statements		62


	Page

INDEPENDENT AUDITORS’ REPORT		96
FINANCIAL STATEMENTS:
Balance Sheets as of September 30, 2010 and 2009		97
Statements of Income for the Years Ended September 30, 2010, 2009 and 2008		98
Statements of Members’ Capital for the Years Ended September 30, 2010, 2009 and 2008		99
Statements of Cash Flows for the Years Ended September 30, 2010, 2009 and 2008		100
Notes to Financial Statements		101


(14)		Incorporated by reference from the Company’s Quarterly Report on Form 10-Q/A for the quarter ended March 31, 2008.

(15)		Incorporated by reference from the Company’s Current Report on Form 8-K filed January 5, 2009

(16)		Incorporated by reference from the Company’s Current Report on Form 8-K filed August 17, 2009

(17)		Incorporated by reference from the Company’s Current Report on Form 8-K filed October 1, 2009

(18)		Incorporated by reference from the Company’s Current Report on Form 8-K filed August 19, 2010

(19)		Incorporated by reference from the Company’s Current Report on Form 8-K filed September 1, 2010

(20)		Incorporated by reference from the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2010.