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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
----------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
COMMISSION FILE NUMBER 000-33009
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MEDCATH CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 56-2248952
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
10720 SIKES PLACE
CHARLOTTE, NORTH CAROLINA 28277
(Address of principal executive offices, including zip code)
(704) 708-6600
(Registrant's telephone number, including area code)
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.
[X] Yes [ ] No
As of July 31, 2002, there were 18,011,520 shares of $0.01 par value common
stock outstanding.
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MEDCATH CORPORATION
FORM 10-Q
TABLE OF CONTENTS
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 2002
and September 30, 2001 3
Consolidated Statements of Operations for the Three Months
and Nine Months ended June 30, 2002 and June 30, 2001 4
Consolidated Statement of Stockholders' Equity for the
Nine months ended June 30, 2002 5
Consolidated Statements of Cash Flows for the Nine Months
Ended June 30, 2002 and June 30, 2001 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition 16
and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk 28
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 29
Item 2. Changes in Securities and Use of Proceeds 29
Item 6. Exhibits and Reports on Form 8-K 29
SIGNATURES 30
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MEDCATH CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(Unaudited)
JUNE 30, SEPTEMBER 30,
2002 2001
-------------- --------------
Current assets:
Cash and cash equivalents $ 117,755 $ 114,357
Accounts receivable, net 75,197 65,634
Medical supplies 12,928 8,196
Due from affiliates 4 273
Deferred income tax assets 3,945 --
Prepaid expenses and other current assets 7,431 4,935
-------------- --------------
Total current assets 217,260 193,395
Property and equipment, net 333,010 265,564
Investments in and advances to affiliates, net 4,206 6,415
Goodwill, net 132,150 115,688
Other intangible assets, net 19,093 20,133
Other assets 4,965 5,424
-------------- --------------
Total assets $ 710,684 $ 606,619
============== ==============
Current liabilities:
Short-term borrowings $ 1,514 $ --
Accounts payable 26,794 26,143
Income tax payable 335 238
Accrued compensation and benefits 14,065 12,949
Accrued property taxes 2,882 3,250
Accrued construction and development costs 11,654 2,200
Other accrued liabilities 9,341 8,302
Current portion of long-term debt and
obligations under capital leases 27,515 25,422
-------------- --------------
Total current liabilities 94,100 78,504
Long-term debt 253,503 201,200
Obligations under capital leases 8,765 9,547
Deferred income tax liabilities 4,828 --
Other long-term obligations 3,924 3,643
-------------- --------------
Total liabilities 365,120 292,894
Minority interest in equity of consolidated
subsidiaries 20,670 12,761
Stockholders' equity:
Preferred stock, $0.01 par value,
10,000,000 shares authorized;
none issued -- --
Common stock, $0.01 par value,
50,000,000 shares authorized;
18,011,520 issued and outstanding 180 180
Paid-in capital 357,414 356,614
Accumulated deficit (32,182) (55,137)
Accumulated other comprehensive loss (518) (693)
-------------- --------------
Total stockholders' equity 324,894 300,964
-------------- --------------
Total liabilities, minority interest
and stockholders' equity $ 710,684 $ 606,619
============== ==============
See notes to consolidated financial statements.
3
MEDCATH CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(UNAUDITED)
THREE MONTHS ENDED JUNE 30, NINE MONTHS ENDED JUNE 30,
---------------------------- ---------------------------
2002 2001 2002 2001
------------- ------------ ------------- -------------
Net revenue $ 120,489 $ 89,727 $ 367,175 $ 284,125
Operating expenses:
Personnel expense 35,155 25,322 104,012 79,538
Medical supplies expense 28,654 21,396 83,113 69,817
Bad debt expense 5,095 4,272 17,669 14,799
Other operating expenses 28,353 20,808 82,496 65,898
Pre-opening expenses 1,969 515 4,112 872
Depreciation 8,734 7,138 26,385 22,173
Amortization 530 1,695 2,060 5,112
Loss (gain) on disposal of property,
equipment and other assets 52 139 (1,065) 5
Gain on sale of business -- -- -- (13,461)
Impairment of long-lived assets -- -- -- 985
------------- ------------ ------------- -------------
Total operating expenses 108,542 81,285 318,782 245,738
------------- ------------ ------------- -------------
Income from operations 11,947 8,442 48,393 38,387
Other income (expenses):
Interest expense (5,723) (5,945) (17,763) (20,593)
Interest income 560 832 1,775 2,414
Other income, net 22 42 78 (309)
Equity in net earnings (losses) of
unconsolidated affiliates 704 (315) 2,414 (2,158)
------------- ------------ ------------- -------------
Total other expenses, net (4,437) (5,386) (13,496) (20,646)
------------- ------------ ------------- -------------
Income before minority interest and income taxes 7,510 3,056 34,897 17,741
Minority interest share of earnings of
consolidated subsidiaries (1,255) (3,112) (9,220) (13,552)
------------- ------------ ------------- -------------
Income (loss) before income taxes 6,255 (56) 25,677 4,189
Income tax expense (2,598) (177) (2,722) (305)
------------- ------------ ------------- -------------
Net income (loss) $ 3,657 $ (233) $ 22,955 $ 3,884
============= ============ ============= =============
Earnings (loss) per share, basic $ 0.20 $ (0.02) $ 1.27 $ 0.33
============= ============ ============= =============
Earnings (loss) per share, diluted $ 0.20 $ (0.02) $ 1.27 $ 0.33
============= ============ ============= =============
Weighted average number of shares, basic 18,012 11,844 18,012 11,842
Dilutive effect of stock options 107 -- 110 99
------------- ------------ ------------- -------------
Weighted average number of shares, diluted 18,119 11,844 18,122 11,941
============= ============ ============= =============
See notes to consolidated financial statements.
4
MEDCATH CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(In thousands)
(UNAUDITED)
ACCUMULATED
COMMON STOCK OTHER
------------------ PAID-IN ACCUMULATED COMPREHENSIVE
SHARES PAR VALUE CAPITAL DEFICIT LOSS TOTAL
--------- -------- ----------- ------------ ------------- -----------
Balance, September 30, 2001 18,012 $ 180 $ 356,614 $ (55,137) $ (693) $ 300,964
Public offering expense tax benefit (Note 1) 800 800
Comprehensive income:
Net income -- -- -- 22,955 -- 22,955
Change in fair value of interest rate swaps,
net of income tax -- -- -- -- 175 175
-----------
Total comprehensive income 23,130
--------- -------- ----------- ----------- ------------- -----------
Balance, June 30, 2002 18,012 $ 180 $ 357,414 $ (32,182) $ (518) $ 324,894
========= ======== =========== =========== ============= ===========
See notes to consolidated financial statements.
5
MEDCATH CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(UNAUDITED)
NINE MONTHS ENDED JUNE 30,
-----------------------------
2002 2001
----------- ---------
Net income $ 22,955 $ 3,884
Adjustments to reconcile net income to net cash
provided by operating activities:
Bad debt expense 17,669 14,799
Depreciation and amortization 28,445 27,285
Gain on disposal of property, equipment and other assets (1,065) 5
Gain on sale of business -- (13,461)
Impairment of long-lived assets -- 985
Interest amortization of loan acquisition costs 956 1,107
Equity in net (earnings) losses of unconsolidated affiliates (2,414) 2,158
Minority interest share of earnings of consolidated
subsidiaries 9,220 13,552
Deferred income taxes 2,480 --
Change in assets and liabilities that relate to operations:
Accounts receivable (18,913) (18,257)
Medical supplies (3,717) (2,090)
Due from affiliates 6 (36)
Prepaid expenses and other current assets (2,388) (3,216)
Other assets (59) 582
Accounts payable and accrued liabilities 6,554 2,932
----------- ---------
Net cash provided by operating activities 59,729 30,229
----------- ---------
Investing activities:
Purchases of property and equipment (60,868) (10,515)
Proceeds from sale of property and equipment 259 1,359
Proceeds from sale of hospital -- 53,798
Loans under management agreements (47) (353)
Repayments of loans under management agreements 420 1,423
Acquisition of management contracts (1,514) --
Proceeds from settlement of management contract 1,825 --
Investments in and advances to affiliates, net 4,818 (7,570)
Cash acquired upon consolidation of equity method investee 151 --
Acquisition of increased ownership in heart hospital (17,377) --
Other investing activities 133 (89)
----------- ---------
Net cash provided by (used in) investing activities (72,200) 38,053
----------- ---------
Financing activities:
Net borrowings of short-term debt $ 1,514 $ (2,127)
Proceeds from issuance of long-term debt 38,148 27,120
Repayments of long-term debt (19,874) (72,634)
Repayments of obligations under capital leases (1,497) (2,851)
Payment of loan acquisition costs (730) (228)
Investments by minority partners 6,259 919
Distributions to minority partners (7,951) (10,662)
Proceeds from exercised stock options -- 150
----------- ---------
Net cash provided by (used in) financing activities 15,869 (60,313)
----------- ---------
Net increase (decrease) in cash and cash equivalents 3,398 7,969
Cash and cash equivalents:
Beginning of period 114,357 7,621
----------- ---------
End of period $ 117,755 $ 15,590
=========== =========
Supplemental schedule of noncash investing and financing activities:
Capital expenditures financed by capital leases $ 628 $ 10,128
Notes received for minority interest in development hospitals 837 --
See notes to consolidated financial statements.
6
MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All tables in thousands, except per share)
1. BUSINESS AND ORGANIZATION
MedCath Corporation (the Company) primarily focuses on the diagnosis and
treatment of cardiovascular disease. The Company designs, develops, owns and
operates heart hospitals in partnership with physicians, including cardiologists
and cardiovascular surgeons. While each of the Company's heart hospitals
(collectively, the Hospital Division) is licensed as a general acute care
hospital, the Company focuses on serving the unique needs of patients suffering
from cardiovascular disease. As of June 30, 2002, the Company owned and operated
eight heart hospitals, together with its physician partners, who own an equity
interest in the heart hospital where they practice. The Company's existing heart
hospitals have a total of 460 licensed beds and are located in Arizona,
Arkansas, California, New Mexico, Ohio, South Dakota and Texas. In addition to
its heart hospitals, the Company provides cardiovascular care services in
diagnostic and therapeutic facilities located in seven states and through mobile
cardiac catheterization laboratories (the Diagnostics Division). The Company
also provides consulting and management services tailored primarily to
cardiologists and cardiovascular surgeons (the Cardiology Consulting and
Management, or CCM Division).
The Company completed its initial public offering of common stock (the
Offering) in July 2001, by issuing 6,000,000 shares of common stock at a price
of $25.00 per share. At the time of the Offering, the Company recognized net
proceeds from the Offering of approximately $135.9 million after the
underwriters' discount and offering expenses. These offering expenses included
approximately $2.1 million, which were determined to be deductible for income
tax purposes during fiscal year 2002. As such, the Company recognized a tax
benefit of approximately $800,000 related to these deductible expenses during
the three months ended June 30, 2002. This tax benefit was recognized to paid-in
capital as an increase in the net proceeds of the public offering of common
stock, and as an increase in net operating loss deferred income tax assets.
Concurrent with the Offering, the Company completed a series of
transactions to prepare for the Offering and to increase its ownership interest
in some of its heart hospitals. First, the Company, MedCath Corporation, was
established as the new holding company by issuing 11,879,918 shares of its
common stock in exchange for all of the outstanding shares of common stock of
the predecessor holding company, MedCath Holdings, Inc. Second, the Company
completed a series of transactions in which it issued 131,602 shares of common
stock valued at the public offering price and paid approximately $25.4 million
cash to acquire additional ownership interests in five of its heart hospitals
from its physician and hospital partners in each of those respective heart
hospitals. As a result of the increase in its ownership interest in Tucson Heart
Hospital from a minority to a majority ownership position, the Company obtained
substantive control of the heart hospital and began to consolidate its results
of operations and financial position from the date of acquisition. The shares of
common stock issued in these transactions were in addition to the shares sold in
the Offering. The cash paid in these transactions was financed with a portion of
the net proceeds from the Offering.
On October 1, 2001, the Company acquired an additional ownership interest
in the Heart Hospital of New Mexico from its physician and hospital partners. As
a result of this transaction (see Note 4), the Company increased its ownership
interest from a minority to a majority ownership position and obtained
substantive control of the heart hospital. Accordingly, the Company began to
consolidate this hospital's results of operations and financial position on
October 1, 2001. Before acquiring this additional ownership interest, the
Company was required to account for its investment in the Heart Hospital of New
Mexico using the equity method of accounting.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation - The Company's unaudited interim consolidated
financial statements as of June 30, 2002 and for the three months and nine
months ended June 30, 2002 and 2001, have been prepared in accordance with
accounting principles generally accepted in the United States of America
(hereinafter, generally accepted accounting principles) and pursuant to the
rules and regulations of the Securities and Exchange Commission (the SEC). These
unaudited interim consolidated financial statements reflect, in the opinion of
management, all material adjustments (consisting only of normal recurring
adjustments) necessary to fairly state the results of operations and financial
position for the periods presented. All intercompany transactions and balances
have been eliminated. The results of operations for the three months and nine
months ended June 30, 2002 are not necessarily indicative of the results
expected for the full fiscal year ending September 30, 2002 or future fiscal
years.
7
MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Certain information and disclosures normally included in the notes to
consolidated financial statements have been condensed or omitted as permitted by
the rules and regulations of the SEC, although the Company believes the
disclosure is adequate to make the information presented not misleading. The
accompanying unaudited interim consolidated financial statements and notes
thereto should be read in conjunction with the Company's audited consolidated
financial statements and notes thereto for the fiscal year ended September 30,
2001 included in the Company's Annual Report on Form 10-K.
Use of Estimates - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the consolidated
financial statements and accompanying notes. Actual results could differ from
those estimates.
Reclassifications - Certain prior period amounts have been reclassified to
conform to the current period presentation.
Pre-opening expenses - Pre-opening expenses consist of operating expenses
incurred during the development of a new venture and prior to its opening for
business. Such costs specifically relate to ventures under development and are
expensed as incurred.
Recent Accounting Pronouncements - In August 2001, the Financial Accounting
Standards Board (the FASB) issued Statement of Financial Accounting Standards
(SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.
This Statement addresses financial accounting and reporting for the impairment
or disposal of long-lived assets and supercedes SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-lived Assets To Be Disposed Of, and
the accounting and reporting provisions of APB Opinion No. 30, Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions. This Statement also amends ARB No. 51, Consolidated Financial
Statements, to eliminate the exception to consolidation for a subsidiary for
which control is likely to be temporary. The provisions of this Statement are
effective for financial statements issued for fiscal years beginning after
December 15, 2001. The provisions are generally to be applied prospectively.
SFAS No. 144 will be effective for the Company's fiscal year 2003 beginning
October 1, 2002. The Company expects that the adoption and application of SFAS
No. 144 will not have any significant impact on its financial position and
results of operations.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. One of the significant changes of SFAS 145 is to change the
accounting for the classification of gains or losses from extinguishment of
debt. Upon adoption, the Company will be required to follow APB Opinion No. 30,
Reporting the Results of Operations - Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions, in determining whether such extinguishment of debt may
be classified as extraordinary. The provisions of this Statement related to the
rescission of SFAS No. 4 shall be applied in fiscal years beginning after May
15, 2003, with early application encouraged. The Company is currently evaluating
the impact of this Statement.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities. This Statement requires that a liability for a
cost associated with an exit or disposal activity be recognized when the
liability is incurred, and it establishes that fair value is the objective for
initial measurement of the liability. This Statement nullifies Emerging Issues
Task Force Issue No. 94-3, Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring). Under the previous guidance of EITF 94-3,
a liability for certain exit costs, as defined in that Issue, was recognized at
the date of an entity's commitment to an exit plan, which is generally before an
actual liability has been incurred. The provisions of this Statement are
effective for exit or disposal activities that are initiated after December 31,
2002, with early application encouraged.
8
MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
3. GOODWILL AND OTHER INTANGIBLE ASSETS - ADOPTION OF SFAS NO. 142
In July 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangibles,
which requires, among other things, the discontinuance of goodwill amortization,
an annual impairment test of goodwill, reclassification of certain existing
recognized intangibles as goodwill, and reassessment of the useful lives of
existing recognized intangibles. The nonamortization and amortization provisions
of SFAS No. 142 were effective for business combinations completed after June
30, 2001. The Company's business combinations completed in July 2001, concurrent
with the Offering, and its acquisition of an additional ownership interest in
Heart Hospital of New Mexico on October 1, 2001 (see Note 4) were subject to
these provisions, and accordingly, none of the approximately $27.4 million and
$16.5 million, respectively, of goodwill arising from these transactions was
amortized during the nine months ended June 30, 2002 and none will be amortized
in future periods.
As permitted, the Company elected to early adopt the remaining provisions
of SFAS No. 142 on October 1, 2001, the beginning of its fiscal year 2002. At
that time, the Company reassessed the useful lives of its intangible assets and
concluded that the existing finite useful lives were reasonable and appropriate.
The Company also completed the transitional goodwill impairment test of all its
reporting units as required by SFAS No. 142, which did not result in any
impairment loss as measured on October 1, 2001. Therefore, the only impact
adopting SFAS No. 142 had on the Company's financial position, results of
operations and cash flows was the immediate discontinuance of goodwill
amortization of the approximately $132.6 million of recorded net goodwill at
October 1, 2001. The Company has designated September 30, its fiscal year end,
as the date it will perform the annual goodwill impairment test for all of its
reporting units as required by SFAS No. 142. Goodwill of a reporting unit will
also be tested between annual tests if an event occurs or circumstances change
that indicate an impairment may exist.
The Company's reported net income for the three months and nine months
ended June 30, 2001, adjusted for amortization expense recognized in that period
related to goodwill that is no longer being amortized, compared to the Company's
reported net income for the three months and nine months ended June 30, 2002 is
as follows:
THREE MONTHS ENDED JUNE 30, NINE MONTHS ENDED JUNE 30,
-------------------------- --------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
NET INCOME (LOSS):
As reported $ 3,657 $ (233) $ 22,955 $ 3,884
Add back: Goodwill amortization -- 709 -- 2,253
------------ ------------ ------------ ------------
Adjusted $ 3,657 $ 476 $ 22,955 $ 6,137
============ ============ ============ ============
DILUTED EARNINGS (LOSS) PER SHARE:
As reported $ 0.20 $ (0.02) $ 1.27 $ 0.33
Add back: Goodwill amortization -- $ 0.07 -- $ 0.19
------------ ------------ ------------ ------------
Adjusted $ 0.20 $ 0.05 $ 1.27 $ 0.52
============ ============ ============ ============
As of June 30, 2002 and September 30, 2001, the Company's other intangible
assets, net, included the following:
JUNE 30, 2002 SEPTEMBER 30, 2001
-------------------------------- ------------------------------
GROSS GROSS
CARRYING ACCUMULATED CARRYING ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
--------------- --------------- -------------- ---------------
AMORTIZED OTHER INTANGIBLE ASSETS:
Management contracts $ 20,853 $ (8,095) $ 22,086 $ (8,462)
Loan acquisition costs 11,125 (4,805) 10,071 (3,711)
Other 715 (700) 715 (566)
--------------- --------------- -------------- ---------------
Total $ 32,693 $ (13,600) $ 32,872 $ (12,739)
=============== =============== ============== ===============
9
MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Amortization expense recognized for the management contracts and other
intangible assets totaled $530,000 and $986,000 million for the three months
ended June 30, 2002 and June 30, 2001, respectively, and $2.1 million and $2.9
million for the nine months ended June 30, 2002 and June 30, 2001, respectively.
The Company recognizes amortization expense for loan acquisition costs as a
component of interest expense. For the three months ended June 30, 2002 and June
30, 2001, amortization expense for loan acquisition costs was $349,000 and
$296,000, respectively, and $956,000 and $1.1 million for the nine months ended
June 30, 2002 and June 30, 2001, respectively. The estimated aggregate
amortization expense, including amortization expense for loan acquisition costs,
for each of the five fiscal years succeeding the Company's most recent fiscal
year ended September 30, 2001 is as follows:
ESTIMATED EXPENSE
-------------------------------------------------
AMORTIZATION INTEREST TOTAL
--------------- --------------- --------------
FISCAL YEAR:
2002 $ 2,367 $ 1,367 $ 3,734
2003 1,749 1,361 3,110
2004 1,749 958 2,707
2005 824 609 1,433
2006 628 237 865
4. BUSINESS COMBINATIONS AND NEW OPERATIONS
Acquisition Completed During the Nine Months Ended June 30, 2002 - On
October 1, 2001, the Company acquired an additional 45.0% ownership interest in
the Heart Hospital of New Mexico from its physician and hospital partners. The
Company paid approximately $17.4 million for this additional ownership interest,
using a portion of the net proceeds from the Offering. As a result of the
increase in the Company's ownership interest from a 24.0% minority ownership
position to a 69.0% majority ownership position, the Company obtained
substantive control of the heart hospital and began to consolidate its results
of operations and financial position as of October 1, 2001. Before acquiring
this additional interest, the Company was required to account for its investment
in the Heart Hospital of New Mexico using the equity method of accounting.
Because the carrying amount of the hospital's net assets underlying the
additional ownership interest the Company acquired, which primarily consisted of
accounts receivable, medical supplies, property and equipment, current
liabilities and long-term debt and capital leases, approximated their fair value
at the date of acquisition, the application of purchase accounting did not
result in any significant adjustment to the carrying amount of those assets. As
part of this transaction, the Company assumed all interests, rights or
obligations of the ownership interest acquired relating to capital investment
and surplus in the heart hospital. In the initial application of purchase
accounting, the Company recognized total goodwill arising from the acquisition
of the additional interest in the Heart Hospital of New Mexico of approximately
$16.9 million. During the three months ended June 30, 2002, the Company adjusted
goodwill to $16.5 million in connection with recognizing additional deferred tax
assets related to the Heart Hospital of New Mexico.
New Hospital Development - During 1999, the Company entered into a venture
to develop and construct the Harlingen Medical Center, which will focus on
cardiovascular care as well as orthopedics, neurology, obstetrics and
gynecology, and will be located in Harlingen, Texas. The Harlingen Medical
Center is accounted for as a consolidated subsidiary because the Company,
through its wholly-owned subsidiaries, owns an approximate 51% interest in the
venture, with physician investors owning the remaining 49%, and the Company
exercises substantive control over the hospital. The Company began construction
on the Harlingen Medical Center in June 2001 and expects to open the hospital
during October 2002. As of June 30, 2002, the Harlingen Medical Center was
committed under a construction contract of $32.6 million to construct the
hospital. The Harlingen Medical Center has paid $24.7 million and accrued an
additional $4.8 million under this construction contract as of June 30, 2002. In
May 2002, Harlingen Medical Center obtained a new debt commitment of $20.0
million to fund equipment for the new hospital, of which $1.4 million had been
borrowed as of June 30, 2002. See Note 5 for additional discussion of the terms
of this debt commitment. As of and for
10
MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
the nine months ended June 30, 2002, the Company had capitalized $627,000 of
interest expense as part of the capitalized construction costs of the hospital.
In April 2001, the Company announced a venture to develop and construct the
Louisiana Heart Hospital, which will be located in St. Tammany Parish just north
of New Orleans, Louisiana. The Louisiana Heart Hospital is accounted for as a
consolidated subsidiary because the Company, through its wholly-owned
subsidiary, owns an approximate 53% interest in the venture, with physician
investors owning the remaining 47%, and the Company exercises substantive
control over the heart hospital. The Company began constructing the Louisiana
Heart Hospital in November 2001 and expects to open the hospital during February
2003. As of June 30, 2002, the Louisiana Heart Hospital was committed under a
construction contract of $19.9 million to construct the hospital. The Louisiana
Heart Hospital has paid $3.9 million and accrued an additional $5.3 million
under this construction contract as of June 30, 2002. As of and for the nine
months ended June 30, 2002, the Company had capitalized $56,000 of interest
expense as part of the capitalized construction costs of the heart hospital.
In October 2001, the Company announced a venture to develop and construct
the Heart Hospital of San Antonio, which will be located in San Antonio, Texas.
The Heart Hospital of San Antonio is accounted for as a consolidated subsidiary
because the Company, through its wholly-owned subsidiary, owns an approximate
51% interest in the venture, with physician investors owning the remaining 49%,
and the Company exercises substantive control over the heart hospital. The
Company began constructing the Heart Hospital of San Antonio in June 2002 and
expects to open the hospital during the late summer of 2003. As of June 30,
2002, the Heart Hospital of San Antonio was committed under a construction
contract with a budget contract sum of $24.5 million to construct the hospital.
The Heart Hospital of San Antonio has paid $404,000 and accrued an additional
$989,000 under this construction contract as of June 30, 2002.
In January 2002, the Company announced a venture to develop and construct
The Heart Hospital of Milwaukee, which will be located in the city of Glendale,
near Milwaukee, Wisconsin. The Heart Hospital of Milwaukee will be accounted for
as a consolidated subsidiary since the Company, through its wholly-owned
subsidiary, will own a 51% or greater interest in the venture, with physician
investors owning up to the remaining 49%, and the Company will exercise
substantive control over the heart hospital. In August 2002, the Company entered
into a construction contact with a preliminary budget contract sum of $12.8
million and began construction of The Heart Hospital of Milwaukee. The Company
expects to open the hospital during the fall of 2003.
In February 2002, the Company announced a venture to develop and construct
the Heart Hospital of Lafayette, which will be located in Lafayette, Louisiana.
The Heart Hospital of Lafayette will be accounted for as a consolidated
subsidiary since the Company, through its wholly-owned subsidiary, will own a
51% or greater interest in the venture, with physician investors owning up to
the remaining 49%, and the Company will exercise substantive control over the
heart hospital. The Company expects to begin constructing the Heart Hospital of
Lafayette in the summer of 2002 and to open the hospital during the fall of
2003.
Diagnostic and Therapeutic Facilities Development - During June 2001, the
Company entered into two new joint ventures with physicians for cardiac
diagnostic and therapeutic facilities, one in Greensboro, North Carolina and the
other in Wilmington, North Carolina. Both facilities opened during March 2002.
The Company owns an approximate 51% interest in and exercises substantive
control over each venture.
During January 2002, the Company acquired a 100% interest in a nuclear
management company, which manages a diagnostic facility that performs nuclear
medical procedures in Metuchen, New Jersey. The Company paid a total of $1.5
million to acquire the interest in this management company and recorded the
acquisition as a management contract, which is a component of other intangible
assets, net.
Termination of Management Contract - During the first nine months of fiscal
2002, the Company recognized a gain on the settlement of a management contract
in the CCM division that was terminated effective December 31, 2001. The gain of
approximately $1.2 million is included in gain on the sale of property,
equipment and other assets in the accompanying consolidated statement of
operations.
11
MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
5. LONG-TERM DEBT
Long-term debt consists of the following:
JUNE 30, SEPTEMBER 30,
2002 2001
------------- -----------
Master credit facility and bank mortgage loans $ 109,145 $ 78,972
Pre-existing bank mortgage loans 22,593 24,069
Real estate investment trust (REIT) loans 77,151 54,886
Revolving credit facility -- --
Notes payable to various lenders 69,845 66,763
------------- -----------
278,734 224,690
Less current portion (25,231) (23,490)
------------- -----------
Long-term debt $ 253,503 $ 201,200
============= ===========
Master Credit Facility and Bank Mortgage Loans - In July 2001, the Company
became a party to a new $189.6 million master credit facility (the Master Credit
Facility), which provided a source of capital to refinance approximately $79.6
million of the real estate indebtedness of three of the Company's existing heart
hospitals and provided the Company with $110.0 million of available debt capital
to finance its hospital development program. Of the $110.0 million initially
available for this purpose, $37.5 million has been designated for use in funding
the development of Harlingen Medical Center, and $25.5 million has been
designated for use in funding the development of Louisiana Heart Hospital (see
Note 4). As of June 30, 2002, $26.8 million had been borrowed to finance the
development of Harlingen Medical Center, and $6.4 million had been borrowed to
finance the development of Louisiana Heart Hospital. As of June 30, 2002, $47.0
million of the initial $110.0 million remains available to finance other
projects in the Company's hospital development program. Each loan under the
Master Credit Facility is separately documented and secured by the assets of the
borrowing hospital only.
The Company guarantees the obligations of its hospital subsidiaries and
unconsolidated affiliates for bank mortgage loans made to them under the Master
Credit Facility and the Company receives a fee for providing that guarantee from
the hospitals or the investors in the hospital companies.
REIT Loans and Notes Payable - The REIT loans and notes payable as of June 30,
2002 includes the Heart Hospital of New Mexico's long-term debt, which the
Company began consolidating on October 1, 2001 and Harlingen Medical Center's
$20.0 million debt commitment for funding new equipment, which was entered into
in May 2002 (see Note 4). The terms of the Heart Hospital of New Mexico's REIT
loans and notes payable are similar to the terms of the Company's other such
debt instruments that are disclosed in the Company's Annual Report on Form 10-K
for the fiscal year ended September 30, 2001. Such terms include the REIT loans
being collateralized by a pledge of the hospital's land, building and fixtures
and certain other assets. The Company guarantees the REIT loans and a portion of
the equipment and other notes payable. Harlingen Medical Center's new debt
commitment allows the hospital to draw up to $20.0 million under this commitment
until April 30, 2003 to finance equipment for the hospital. During this time,
interest will accrue at the prime rate plus 25 basis points. After such date,
amounts funded under the loan shall accrue interest at a fixed rate of interest
equal to a specific Treasury Note yield, plus a margin. The principal amount
outstanding will be repaid over a time period equal to either five or seven
years, depending on the type of equipment originally purchased under the
facility. This debt commitment is collateralized by the underlying hospital's
equipment purchased with loan proceeds, and the Company guarantees the
obligation of the hospital.
Debt Covenants - Covenants related to the Company's long-term debt restrict
the payment of dividends and require the maintenance of specific financial
ratios and amounts and periodic financial reporting. At June 30, 2002, the Heart
Hospital of New Mexico was not in compliance with certain of its financial ratio
covenants. The real estate lender granted a waiver for the breach of the
covenants at June 30, 2002. The Company was in compliance with all other
covenants at June 30, 2002.
Guarantees of Unconsolidated Affiliates' Debt - The Company has guaranteed
approximately 50% of the real estate and equipment debt of the one affiliate
heart hospital in which the Company has a minority ownership interest and
therefore does not consolidate the hospital's results of operations and
financial position. The Company provides these guarantees in exchange for a fee
from that affiliate hospital. At June 30, 2002,
12
MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
the affiliate hospital was in compliance with all covenants in the instruments
governing its debt. The total amount of the affiliate heart hospital's real
estate and equipment debt was approximately $44.2 million at June 30, 2002, and
accordingly the 50% of this debt guaranteed by the Company was approximately
$22.1 million. The total amount of this affiliate heart hospital's debt is
secured by the hospital's underlying real estate and equipment, which were
financed with the proceeds from the debt. Because the Company does not
consolidate the affiliate heart hospital's results of operations and financial
position, neither the assets nor the accompanying liabilities are included in
the value of the assets and liabilities on the Company's balance sheet.
6. INCOME TAXES
At September 30, 2001, the Company had net deferred tax assets that were
fully offset by a valuation allowance as follows:
Total deferred tax liabilities $ (23,424)
Total deferred tax assets 29,836
Valuation allowance on net deferred tax asset (6,412)
-------------
Net deferred tax balance, September 30, 2001 $ --
=============
During the nine months ended June 30, 2002, the Company reassessed the
valuation allowance and determined that such allowance was no longer required as
the deferred tax liabilities, combined with current and projected net earnings,
provided sufficient positive evidence to support the recognition of the gross
deferred tax assets. As such, the Company reversed the valuation allowance on
net deferred tax assets.
As a result of the Company generating income before income taxes of $25.7
million during the nine months ended June 30, 2002 and the reversal of the
valuation allowance, as discussed above, the Company recognized $2.5 million of
deferred income tax expense in addition to $118,000 of current income tax
expense during the three months ended June 30, 2002.
At June 30, 2002, the Company had net deferred tax liabilities as follows:
Total deferred tax liabilities $ (23,046)
Total deferred tax assets 22,163
-------------
Net deferred tax balance, June 30, 2002 $ (883)
=============
7. PER SHARE DATA
The calculation of diluted net income per share considers the potentially
dilutive effect of options to purchase 2,402,262 and 2,332,165 shares of common
stock outstanding at June 30, 2002 and 2001, respectively, at prices ranging
from $4.75 to $25.00.
8. LIABILITY INSURANCE COVERAGE
On June 1, 2002, the Company's three-year combined insurance policy that
provided medical malpractice claims coverage on a claims-made, first-dollar
basis expired, and the Company became partially self-insured under a one-year
policy providing coverage for claim amounts in excess of $2.0 million of
retained liability per claim. At the same time, to provide coverage for claims
incurred prior to June 1, 2002, but not reported as of that date under the
expired claims-made policy, the Company purchased tail insurance coverage, the
full cost of which was recognized as an operating expense in the third quarter
of fiscal 2002, as required by generally accepted accounting principles. Because
the Company has retained up to $2.0 million of liability per claim under the new
policy, the Company is required to recognize up to the first $2.0 million of
estimated expense/liability for each malpractice claim incurred under the new
policy period beginning June 1, 2002. Based on the Company's historical
experience with claims, the actuarially determined estimate of the costs of the
self-insured retention for the current one-year policy period is approximately
$2.9 million for the Company's consolidated operating entities. Accordingly, the
Company has recognized in its financial
13
MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
statements an estimated liability for its self-insured retention on medical
malpractice claims as of June 30, 2002.
9. LITIGATION AND SETTLEMENT OF CONTRACT DISPUTES
Litigation - The Company is involved in other various claims and legal
actions in the ordinary course of business, including malpractice claims arising
from services provided to patients that have been asserted against by various
claimants, and additional claims that may be asserted for known incidents
through June 30, 2002. These claims and legal actions are in various stages, and
some may ultimately be brought to trial. Moreover, additional claims arising
form services provided to patients in the past and other legal actions may be
asserted in the future. The Company is protecting its interests in all such
claims and actions.
Management believes, based on advice of counsel and the Company's
experience with past lawsuits and claims that, taking into account the
applicable liability insurance coverage, the results of those lawsuits and
potential lawsuits will not have a materially adverse effect on the Company's
financial position or future results of operations and cash flows.
Settlement of Contract Disputes - In June 2002, the Company received a
favorable settlement of a lawsuit against a managed care company in which the
Company was seeking payment for services rendered by its Bakersfield Heart
Hospital. Under the terms of the settlement, Bakersfield Heart Hospital
received approximately $7.1 million relating to payment for services and
reimbursement of certain expenses, primarily legal expenses, owed during the
period of dispute. The Company's results of operations for the three months
ended June 30, 2002 included $2.2 million of net revenue and $2.4 million of
income before income taxes, and for the nine months ended June 30, 2002 included
$2.2 million of net revenue and $2.1 of million income before income taxes
attributable to the favorable settlement of this lawsuit.
In March 2002, one of the Company's managed diagnostic centers, Sun City
Cardiac Center, received a favorable settlement of a billing dispute involving
Sun Health Corporation, which owns and operates the hospital where the center is
located. Under the terms of the settlement, Sun City Cardiac Center was awarded
total proceeds of $11.2 million relating to service fees, attorney fees and
interest costs owed during the period of the contractual dispute. The Company
owns a 65% interest in Sun City Cardiac Associates, which manages the Sun City
Cardiac Center and receives a management fee for such services. The Company's
results of operations for the nine months ended June 30, 2002 included $9.7
million of net revenue, $1.2 million of operating expenses and $3.0 million of
minority interest, thereby resulting in $5.5 million of income before income
taxes attributable to this settlement.
In April 2001, the Company received an arbitration award related to a
billing dispute with its joint venture hospital partner in one of its diagnostic
and therapeutic centers. As a result of the award, the Company recognized an
additional $3.2 million of net revenue and $300,000 of expenses in its results
of operations for the three and nine months ended June 30, 2001. Of the net $2.9
million recognized in operations, $1.5 million was allocated to minority
interests during the period, thereby resulting in $1.4 million of income before
income taxes attributable to this award.
10. REPORTABLE SEGMENT INFORMATION
The Company's aggregated reportable segments consist of the Hospital
Division and the Diagnostics Division. The CCM Division, which was previously
disclosed as a reportable segment, has been combined with Corporate and other,
as the CCM Division does not meet the materiality thresholds for separate
disclosure as specified in SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information. For the fiscal year ended September 30,
2001, the CCM Division comprised only 6.0%, 0.3% and 1.3% of the Company's
consolidated net revenue, income from operations and aggregate identifiable
assets, respectively.
14
MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Financial information concerning the Company's operations by each of the
reportable segments as of and for the periods indicated is as follows:
THREE MONTHS ENDED JUNE 30, NINE MONTHS ENDED JUNE 30,
---------------------------------- -------------------------------
2002 2001 2002 2001
---------------- ----------------- --------------- ---------------
Net revenue:
Hospital Division $ 103,521 $ 69,801 $ 305,811 $ 231,269
Diagnostics Division 11,872 13,869 45,175 35,364
Corporate and other 5,096 6,057 16,189 17,492
---------------- ----------------- --------------- ---------------
Consolidated total net revenue $ 120,489 $ 89,727 $ 367,175 $ 284,125
================ ================= =============== ===============
Income (loss) from operations:
Hospital Division $ 11,104 $ 4,891 $ 36,190 $ 35,654
Diagnostics Division 3,299 4,836 17,809 7,397
Corporate and other (2,456) (1,285) (5,606) (4,664)
---------------- ----------------- --------------- ---------------
Consolidated total income from operations $ 11,947 $ 8,442 $ 48,393 $ 38,387
================ ================= =============== ===============
Interest expense (5,723) (5,945) (17,763) (20,593)
Interest income 560 832 1,775 2,414
Other income (expense), net 22 42 78 (309)
Equity in net earnings (loss) of
unconsolidated affiliates 704 (315) 2,414 (2,158)
Minority interest in earnings of
consolidated subsidiaries (1,255) (3,112) (9,220) (13,552)
---------------- ----------------- --------------- ---------------
Consolidated income (loss) before income taxes $ 6,255 $ (56) $ 25,677 $ 4,189
================ ================= =============== ===============
JUNE 30, SEPTEMBER 30,
2002 2001
---------------- -----------------
Aggregate identifiable assets:
Hospital Division $ 539,654 $ 437,010
Diagnostics Division 58,183 57,533
Corporate and other 112,847 112,076
---------------- -----------------
Consolidated totals $ 710,684 $ 606,619
================ =================
Substantially all of the Company's net revenue in its Hospital Division and
Diagnostics Division is derived directly or indirectly from patient services.
The amounts presented for Corporate and other primarily include general overhead
and administrative expenses, cash and cash equivalents, other assets and
operations of the business not subject to separate segment reporting.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and related financial data should be read in
conjunction with the interim unaudited consolidated financial statements and
related notes included elsewhere in this report and the consolidated audited
financial statements and notes thereto for the fiscal year ended September 30,
2001 included in the Company's Annual Report on Form 10-K.
OVERVIEW
We focus primarily on the diagnosis and treatment of cardiovascular
disease. We design, develop, own and operate heart hospitals in partnership with
physicians, including cardiologists and cardiovascular surgeons. While each of
our heart hospitals is a freestanding, licensed general acute care hospital, we
focus on serving the unique needs of patients suffering from cardiovascular
disease. Since January 1994, we have developed nine heart hospitals in seven
states, including Arizona, Arkansas, California, New Mexico, Ohio, South Dakota
and Texas. As of July 31, 2002, we had eight heart hospitals in operation with a
total of 460 licensed beds and had sold one hospital in McAllen, Texas. We have
begun developing our ninth hospital, which will be located in Harlingen, Texas,
our tenth hospital, which will be located in St. Tammany Parish just north of
New Orleans, Louisiana, our eleventh hospital, which will be located in San
Antonio, Texas, and our twelfth heart hospital, which will be located in the
city of Glendale, near Milwaukee, Wisconsin. In February 2002, we also announced
plans to develop our thirteenth heart hospital, which will be located in
Lafayette, Louisiana. These new hospitals are expected to open during October
2002 (Harlingen), February 2003 (St. Tammany Parish), the late summer of 2003
(San Antonio), and the fall of 2003 (Glendale and Lafayette), and are expected
to have a combined total of 282 licensed beds.
In addition to our heart hospitals, we provide cardiovascular care services
in diagnostic and therapeutic facilities located in seven states and through
mobile cardiac catheterization laboratories. We also provide consulting and
management services tailored primarily to cardiologists and cardiovascular
surgeons.
RESULTS OF OPERATIONS
The following table presents, for the periods indicated, selected operating
data.
THREE MONTHS ENDED JUNE 30, NINE MONTHS ENDED JUNE 30,
--------------------------- --------------------------
2002 2001 2002 2001
------------ ------------ ----------- -----------
(expressed as a percentage of net revenue)
Net revenue 100.0% 100.0% 100.0% 100.0%
Operating expenses:
Personnel expense 29.2% 28.2% 28.3% 28.0%
Medical supplies expense 23.8% 23.8% 22.6% 24.6%
Bad debt expense 4.2% 4.8% 4.8% 5.2%
Other operating expenses 23.5% 23.2% 22.5% 23.2%
Pre-opening expenses 1.6% 0.6% 1.1% 0.3%
Depreciation & amortization 7.7% 9.8% 7.7% 9.6%
Loss (gain) on disposal of
property, equipment and
other assets 0.0% 0.2% (0.3)% 0.0%
Gain on sale of hospital -- -- -- (4.7)%
Impairment of long-lived assets -- -- -- 0.3%
Income from operations 9.9% 9.4% 13.2% 13.5%
Other income (expenses):
Interest expense (4.7)% (6.6)% (4.8)% (7.2)%
Interest income 0.5% 0.9% 0.5% 0.8%
Other income (expense), net 0.0% 0.0% 0.0% (0.1)%
Equity in net earnings (losses)
of unconsolidated affiliates 0.6% (0.4)% 0.7% (0.8)%
Income before minority interest
and income taxes 6.2% 3.4% 9.5% 6.2%
Minority interest (1.0)% (3.5)% (2.5)% (4.8)%
Income (loss) before income taxes 5.2% (0.1)% 7.0% 1.5%
Income tax expense (2.2)% (0.2)% (0.7)% (0.1)%
Net income (loss) 3.0% (0.3)% 6.3% 1.4%
16
THREE MONTHS ENDED JUNE 30, NINE MONTHS ENDED JUNE 30,
--------------------------- --------------------------
2002 2001 2002 2001
------------ ------------ ---------- -----------
SELECTED OPERATING DATA (CONSOLIDATED): (DOLLARS IN THOUSANDS)
Number of hospitals 7 5 7 5
Admissions 7,201 5,348 22,132 17,653
Adjusted admissions (1) 8,920 6,513 26,663 21,424
Patient days 25,862 20,838 83,278 72,676
Average length of stay (days) 3.59 3.90 3.76 4.12
Occupancy 69.3% 77.6% 74.4% 75.0%
Inpatient catheterization procedures 4,075 2,710 12,128 8,909
Inpatient surgical procedures 1,851 1,571 5,590 5,214
Hospital Division net revenue $103,521 $69,801 $305,811 $231,269
SELECTED OPERATING DATA (SAME FACILITY) (2):
Number of hospitals 6 6 6 6
Admissions 6,174 6,483 19,138 19,872
Adjusted admissions (1) 7,774 7,796 23,336 23,769
Patient days 21,694 24,095 70,623 77,036
Average length of stay (days) 3.51 3.72 3.69 3.88
Occupancy 67.2% 74.6% 72.9% 79.5%
Inpatient catheterization procedures 3,436 3,125 10,117 9,473
Inpatient surgical procedures 1,606 1,734 4,886 5,372
Hospital Division net revenue $91,251 $81,769 $267,003 $246,764
1 We computed adjusted admissions by dividing gross patient revenue by gross
inpatient revenue and then multiplying the quotient by admissions.
2 Selected operating data (same facility) includes Tucson Heart Hospital and
excludes Heart Hospital of New Mexico and McAllen Heart Hospital (which
was sold March 1, 2001) for the three months and nine months ended June
30, 2002 and 2001.
THREE MONTHS ENDED JUNE 30, 2002 COMPARED TO THREE MONTHS ENDED JUNE 30, 2001
Net revenue increased $30.8 million, or 34.3%, to $120.5 million for the
three months ended June 30, 2002, the third quarter of our fiscal year 2002,
from $89.7 million for the three months ended June 30, 2001, the third quarter
of our fiscal year 2001. Of the $30.8 million increase in net revenue, our
hospital division generated a $33.7 million increase, which was partially offset
by a $2.0 million decrease by our diagnostic services division and a $1.1
million decrease in our cardiology consulting and management division.
The $33.7 million increase in our hospital division's net revenue includes
the effect of three events. In July 2001, we began consolidating the financial
results of our Tucson Heart Hospital, and on October 1, 2001, we began
consolidating the financial results of our Heart Hospital of New Mexico, which
when combined resulted in a $24.2 million increase in net revenue for the third
quarter of fiscal 2002. In June 2002, one of our heart hospitals reached a
favorable settlement of a billing dispute with a managed care provider, which
resulted in that hospital recognizing an additional $2.2 million of net revenue
for the third quarter of fiscal 2002. The remaining $7.3 million increase in our
hospital division's net revenue was primarily attributable to an increase in the
number of procedures performed and rate increases in our heart hospitals during
the third quarter of fiscal 2002 compared to fiscal 2001.
The $2.0 million decrease in our diagnostic services division was primarily
the result of our recognizing $3.2 million of net revenue in the third quarter
of the fiscal year 2001 representing amounts we received in an arbitration award
involving a billing dispute with our hospital joint venture partner in one of
our diagnostic and therapeutic centers. Excluding the effect of this arbitration
award, our diagnostic services division generated a $1.2 million increase in net
revenue for the third quarter of fiscal 2002 compared to fiscal 2001. This $1.2
million increase was primarily due to rate increases resulting from a new
services agreement executed during the second quarter of fiscal 2002 in
connection with the Sun City Cardiac Center settlement (see discussion under
nine-month period) and to the opening of three new diagnostic and therapeutic
centers during our second quarter of fiscal 2002.
17
The $1.1 million decrease in our cardiology consulting and management
division's net revenue was due to the scheduled settlement and expiration of one
management contract during the third quarter of fiscal 2001 and another
management contract during the first quarter of fiscal 2002, offset in part by
an increase in management fees and consulting fees paid to us by physicians
remaining under management in that division.
On a same facility basis in our hospital division, which includes Tucson
Heart Hospital and excludes Heart Hospital of New Mexico, net revenue increased
$8.5 million, or 10.4%, to $90.3 million for the third quarter of fiscal 2002
from $81.8 million for the third quarter of fiscal 2001. Admissions decreased
4.8% and adjusted admissions decreased 0.3%. These operating measures reflect
the impact of certain initiatives at two of our heart hospitals. The first was
our decision to convert the emergency department to a chest pain clinic at one
of our heart hospitals, which as anticipated, resulted in decreasing overall
admissions, but increasing the percentage of cardiovascular admissions. The
second was our decision to terminate several managed care relationships,
primarily associated with our Tucson Heart Hospital, that we determined no
longer met our long-term strategic objectives. As a result of these initiatives,
cardiovascular admissions increased to 71% of admissions at these two heart
hospitals during the third quarter of fiscal 2002 compared to 61% of admissions
during the third quarter of fiscal 2001. Excluding these two heart hospitals
from these same facility operating measures, admissions increased 5.5%, adjusted
admissions increased 7.6%, and net revenue increased 9.4%.
Also on a same facility basis, inpatient catheterization procedures
increased 10.0% while surgical procedures decreased 7.4% for the third quarter
of fiscal 2002 compared to third quarter fiscal 2001. Average length of stay in
our same facility hospitals decreased 5.6% to 3.51 days for the third quarter of
fiscal 2002 compared to 3.72 days for the third quarter of fiscal 2001.
Personnel expense increased $9.8 million, or 38.7%, to $35.2 million for
the third quarter of fiscal 2002 from $25.3 million for the third quarter of
fiscal 2001. Most of the increase in personnel expense occurred in our hospital
division, and included $8.3 million attributable to the consolidations of the
financial results of our Tucson Heart Hospital and our Heart Hospital of New
Mexico. The remaining increase of $1.5 million was due to a higher number of
procedures performed at our heart hospitals and higher wage rates and benefit
costs during the third quarter of fiscal 2002 compared to fiscal 2001. Personnel
expense in our diagnostic services and our cardiology consulting and management
divisions were approximately the same in both fiscal quarters. As a percentage
of net revenue, personnel expense increased to 29.2% for the third quarter of
fiscal 2002 compared to 28.2% for the third quarter of fiscal 2001. Contributing
to this increase were increases in personnel expense as a percentage of net
revenue in our diagnostic services and cardiology consulting and management
divisions, offset in part by a decrease in personnel expense as percentage of
net revenue in our hospital division. Excluding the $2.2 million of net revenue
resulting from the settlement of the billing dispute with a managed care
provider in one of our heart hospitals, personnel expense represented 29.7% of
net revenue for the third quarter of fiscal 2002. Similarly, excluding the $3.2
million of net revenue resulting from the arbitration award in our diagnostic
services division, personnel expense represented 29.3% of net revenue for the
third quarter of fiscal 2001.
Medical supplies expense increased $7.3 million, or 34.1%, to $28.7 million
for the third quarter of fiscal 2002 from $21.4 million for the third quarter of
fiscal 2001. Most of the increase occurred in our hospital division, and
included $6.3 million resulting from the consolidations of the financial results
of our Tucson Heart Hospital and our Heart Hospital of New Mexico. The remaining
$1.0 million increase was due to the increase in number of procedures performed
and changes in our procedural mix involving utilization of more expensive
supplies at our heart hospitals during the third quarter of fiscal 2002 compared
to fiscal 2001, offset in part by the improved pricing we realized from volume
purchasing opportunities and vendor consolidation initiatives in our hospital
division. As a percentage of net revenue, medical supplies remained flat at
23.8% for the third quarter of fiscal 2002 and fiscal 2001. Excluding the $2.2
million of net revenue resulting from the settlement of the billing dispute with
a managed care provider in one of our heart hospitals, medical supplies expense
represented 24.2% of net revenue for the third quarter of fiscal 2002.
Similarly, excluding the $3.2 million of net revenue resulting from the
arbitration award in our diagnostic services division, medical supplies expense
represented 24.7% of net revenue for the third quarter of fiscal 2001.
Bad debt expense increased $824,000, or 18.6%, to $5.1 million for the
third quarter of fiscal 2002
18
from $4.3 million for the third quarter of fiscal 2001. This increase was
primarily attributable to a $1.7 million increase resulting from the
consolidations of our Tucson Heart Hospital and our Heart Hospital of New
Mexico, offset by an $898,000 decrease among our other same facility heart
hospitals. As of June 30, 2002, the end of our third quarter of fiscal 2002, our
hospital division's days of net revenue in accounts receivable were 57 days
compared to 67 days as of June 30, 2001. We attribute this decline in days and
the decrease in our same facility heart hospitals bad debt expense to improved
receivables collection procedures and other processes we have implemented in our
business offices and the decline in aged receivables resulting from the
settlement of a billing dispute with a managed care provider in one of our heart
hospitals. As a percentage of net revenue, bad debt expense decreased to 4.2%
for the third quarter of fiscal 2002 from 4.8% for the third quarter of fiscal
2001. Excluding the $2.2 million of net revenue resulting from the settlement of
the billing dispute with a managed care provider in one of our heart hospitals,
bad debt expense represented 4.3% of net revenue for the third quarter of fiscal
2002. Similarly, excluding the $3.2 million of net revenue resulting from the
arbitration award in our diagnostic services division, bad debt expense
represented 4.9% of net revenue for the third quarter of fiscal 2001.
Other operating expenses increased $7.5 million, or 36.1%, to $28.4 million
for the third quarter of fiscal 2002 from $20.8 million for the third quarter of
fiscal 2001. Other operating expenses include primarily maintenance, rent,
property taxes, insurance, utilities, advertising, travel, professional fees,
contract services and support services provided to operating divisions by our
corporate office. Of the $7.5 million increase in other operating expenses, $6.5
million occurred within our hospital division, of which $5.2 million was due to
the consolidations of the financial results of our Tucson Heart Hospital and our
Heart Hospital of New Mexico. The remaining $1.3 million in our hospital
division's other operating expenses was primarily due to an increase in that
division's medical malpractice insurance costs resulting from a change in our
insurance program during the third quarter of fiscal 2002.
On June 1, 2002, our three-year combined insurance policy that provided
medical malpractice claims coverage on a claims-made, first-dollar basis
expired, and we became partially self-insured under a one-year policy providing
coverage for claim amounts in excess of our $2.0 million of retained liability
per claim. At the same time, to provide coverage for claims incurred prior to
June 1, 2002, but not reported as of that date under our expired claims-made
policy, we purchased tail insurance coverage, the full cost of which we were
required by accounting principles generally accepted in the United States to
recognize as an expense in the third quarter of fiscal 2002. As a result of
increasing premiums for malpractice insurance in recent months, the increase in
premiums we paid for the new policy compared to the premiums we paid for the old
policy was significant. Because we have retained up to $2.0 million of liability
per claim under the new policy, we are required to recognize up to the first
$2.0 million of estimated expense/liability for each malpractice claim incurred
under the new policy period beginning June 1, 2002. Based on our historical
experience with claims, our actuarially determined estimate of the costs of the
self-insured retention for the current one-year policy period is approximately
$2.9 million for our consolidated operating entities. We expect both the
increase in premium costs and the self-insured retention will increase our other
operating expenses during the next twelve months. As we open new heart hospitals
and diagnostic and therapeutic centers, we also expect to incur additional
premium costs and self-insured retention costs to reflect the additional risk.
The diagnostic services division's other operating expenses increased
$362,000 due to the combined effect of the increased costs of medical
malpractice coverage, as discussed above, in that division and the net revenue
growth in its operations, offset in part by cost reductions from exiting certain
low margin services in the division. The remaining $642,000 increase in other
operating expenses was due to an increase in our corporate division to support
the growth in our operating divisions for the third quarter of fiscal 2002
compared to fiscal 2001, offset in part by a decrease in our cardiology
consulting and management division consistent with its decline in operations due
to the scheduled settlement and expiration of management contracts in that
division. As a percentage of net revenue, other operating expenses remained
relatively flat at 23.5% for the third quarter of fiscal 2002 compared to 23.2%
for the third quarter of fiscal 2001. Excluding the $2.2 million of net revenue
resulting from the settlement of the billing dispute with a managed care
provider in one of our heart hospitals during the third quarter of fiscal 2002
and the $3.2 million of net revenue resulting from the arbitration award in our
diagnostic services division during the third quarter of fiscal 2000, other
operating expenses were flat at 24.0% for both fiscal quarters.
19
Pre-opening expenses increased $1.5 million, or 300.0%, to $2.0 million for
the third quarter of fiscal 2002 from $515,000 for the third quarter of fiscal
2001. Pre-opening expenses represent expenses specifically related to projects
under development, primarily new hospitals. As of June 30, 2002, we had five
hospitals under development, including Harlingen Medical Center, Louisiana Heart
Hospital, Heart Hospital of San Antonio, The Heart Hospital of Milwaukee and
Heart Hospital of Lafayette. These new hospitals are expected to open during
October 2002 (Harlingen), February 2003 (Louisiana), late-summer of 2003 (San
Antonio) and the fall of 2003 (Milwaukee and Lafayette). We expect pre-opening
expenses for each of these five hospitals to range between approximately $3.5
million and $6.0 million per hospital. Historically, approximately 45% of our
pre-opening expenses for a new hospital have been for personnel and 8% for
marketing and advertising. The remaining costs have been distributed among
several categories including staff recruitment and relocation, office and
equipment rentals, travel and other operating expenses such as legal expenses
and utilities. While we incur pre-opening expenses throughout the development
process, we expect to incur the majority of these expenses during the six to
eight month period immediately prior to the opening of the hospital.
Depreciation increased $1.6 million, or 22.5%, to $8.7 million for the
third quarter of fiscal 2002 from $7.1 million for the third quarter of fiscal
2001. This $1.6 million increase was primarily due to the increase resulting
from the consolidations of the financial results of our Tucson Heart Hospital
and our Heart Hospital of New Mexico.
Amortization decreased $1.2 million, or 70.6%, to $530,000 for the third
quarter of fiscal 2002 from $1.7 million for the third quarter of fiscal 2001.
This decrease was primarily due to our adoption of Statement of Financial
Accounting Standards No. 142 on October 1, 2001. Under the new accounting rules,
we were required to discontinue goodwill amortization at the beginning of our
fiscal year 2002 and subject our goodwill to an annual impairment test, which we
performed on a transitional basis as of October 1, 2001, and which did not
result in any impairment loss. For the full fiscal year 2001, we recognized
goodwill amortization of approximately $3.0 million, none of which will be
recognized during fiscal 2002.
Interest expense decreased $222,000, or 3.4%, to $5.7 million for the third
quarter of fiscal 2002 from $5.9 million for the third quarter of fiscal 2001.
This decrease in interest expense occurred despite a $1.6 million increase in
interest expense resulting from the consolidations of the financial results of
Tucson Heart Hospital and Heart Hospital of New Mexico. Excluding the effect of
consolidating these two heart hospitals, the decrease in interest expense was
due to a general reduction in our variable rate interest costs and a reduction
in our average total outstanding indebtedness during the third quarter of fiscal
2002 compared to the third quarter of fiscal 2001. The debt reduction was
primarily due to several significant transactions during fiscal 2001. We used a
portion of the proceeds from the sale of McAllen Heart Hospital in March 2001
and from our initial public offering in July 2001 to repay all amounts
outstanding under our revolving credit facility. Also in July 2001, three of our
heart hospitals reduced their interest expense by refinancing approximately
$79.6 million of their mortgage debt. Interest income decreased to $560,000 for
the third quarter of fiscal 2002 from $832,000 for the third quarter of fiscal
2001.
Equity in net earnings of unconsolidated affiliates increased $1.0 million,
or 333.3%, to $704,000 for the third quarter of fiscal 2002 from a loss of
$315,000 for the third quarter of fiscal 2001. In July 2001, we began
consolidating the financial results of Tucson Heart Hospital, and in October
2001, we began consolidating the financial results of Heart Hospital of New
Mexico after completing acquisitions that increased our ownership interests in
each of these heart hospitals to a majority position. We had previously been
required to account for our minority investment in each of these heart hospitals
using the equity method of accounting. We now have only one heart hospital in
which we hold less than a 50.0% equity interest that we are required to account
for as an equity investment during fiscal 2002. This heart hospital commenced
operations in March 2001. We continue to hold a small number of additional
equity investments in our diagnostic services division.
Earnings allocated to minority interests decreased $1.8 million, or 58.1%,
to $1.3 million for the third quarter of fiscal 2002 from $3.1 million for the
third quarter of fiscal 2001. This $1.8 million decrease includes the effect of
$1.5 million of earnings allocated to minority interest recognized in the third
quarter of fiscal 2001 resulting from the amounts we received in an arbitration
award involving a billing dispute with our hospital joint venture partner in one
of our diagnostic and therapeutic centers, as previously discussed.
20
The remaining $300,000 decreases in earnings allocated to minority interests was
due to the consolidations of the financial results of Tucson Heart Hospital and
Heart Hospital of New Mexico and an increase in pre-opening expenses at our
hospitals under development, offset in part by improved operating results in our
other consolidated heart hospitals and improved operating results in certain of
our diagnostic and therapeutic joint ventures in our diagnostic services
division.
Income tax expense increased to $2.6 million for the third quarter of
fiscal 2002 from $177,000 for third quarter of fiscal 2001. During fiscal 2001,
we had net deferred tax assets, primarily resulting from net operating loss
carryforwards, that were fully offset by a valuation allowance. During the nine
months ended June 30, 2002, we determined the valuation allowance was no longer
required and reversed the allowance in accordance with accounting principles
generally accepted in the United States. As a result of our generating income
before income taxes of $25.7 million during the nine months ended June 30, 2002
and the reversal of the valuation allowance, we recognized $2.5 million of
deferred income tax expense along with $118,000 of current income tax expense
during the third quarter of fiscal 2002. Because we continue to have net
operating loss carryforwards available from prior periods, we have no material
current income tax liability.
NINE MONTHS ENDED JUNE 30, 2002 COMPARED TO NINE MONTHS ENDED JUNE 30, 2001
Net revenue increased $83.1 million, or 29.3%, to $367.2 million for the
nine months ended June 30, 2002, the first nine months of our fiscal year 2002,
from $284.1 million for the nine months ended June 30, 2001, the first nine
months of our fiscal year 2001. Of the $83.1 million increase in net revenue,
$74.5 million was generated by our hospital division and $9.8 million by our
diagnostic services division, offset in part by an approximately $1.2 million
decrease in our cardiology consulting and management division. The $74.6 million
increase in our hospital division's net revenue included a $77.1 million
increase resulting from the consolidations of the financial results of Tucson
Heart Hospital and Heart Hospital of New Mexico, offset in part by a $20.2
million decrease resulting from sale of McAllen Heart Hospital. Of the remaining
$17.7 million increase in the hospital division's net revenue, $2.2 was due to
amounts we received in a favorable settlement of a billing dispute with a
managed care provider in one of our heart hospitals during our third quarter of
fiscal 2002. The remaining $15.5 million was primarily attributable to an
increase in the number of procedures performed and rate increases in our heart
hospitals during the first nine months of fiscal 2002 compared to the first nine
months of fiscal 2001.
The $9.8 million increase in our diagnostic services division includes the
effect of two events. In the third quarter of fiscal 2001, we received an
arbitration award involving a billing dispute with our hospital joint venture
partner in one of our diagnostic and therapeutic centers, which increased net
revenues for the first nine months of fiscal 2001 by $3.2 million. In the second
quarter of fiscal 2002 we reached a favorable settlement of a billing dispute
between one of our managed diagnostic centers, Sun City Cardiac Center, and Sun
Health Corporation, which owns and operates the hospital where this center is
located. Under the terms of the settlement, Sun City Cardiac Center was awarded
total proceeds of $11.2 million relating to service fees, attorney fees and
interest costs owed during the period of the contractual dispute. We own a 65%
interest in Sun City Cardiac Associates, which manages Sun City Cardiac Center
and receives management fees for performing such services. Excluding the effect
of these two events, our diagnostic services division generated a $3.3 million
increase in net revenue for the first nine months of fiscal 2002 compared to
fiscal 2001. This $3.3 million increase was primarily due to rate increases over
the prior year period, including those resulting from a new services agreement
executed during the second quarter of fiscal 2002 in connection with the Sun
City Cardiac Center settlement, an increase in the number of diagnostic
procedures over the prior year period in several of our diagnostic and
therapeutic centers, and to the opening of three new diagnostic and therapeutic
centers during our second quarter of fiscal 2002. The $1.2 million decrease in
our cardiology consulting and management division was due to the scheduled
settlement and expiration of one management contract during the third quarter of
fiscal 2001 and another management contact during the first quarter of fiscal
2001, offset in part by an increase in management fees and consulting fees we
received from physicians remaining under management in that division.
On a same facility basis in our hospital division, which includes Tucson
Heart Hospital and excludes Heart Hospital of New Mexico and McAllen Heart
Hospital, net revenue increased $19.2 million, or 7.8%, to $266.0 million for
the first nine months of fiscal 2002 from $246.8 million for the first nine
months of
21
fiscal 2001. Admissions decreased 3.7% and adjusted admissions declined 1.8%.
These operating measures reflect the impact of certain initiatives at two of our
heart hospitals. The first was our decision to convert the emergency room to a
chest pain clinic at one of our heart hospitals, which as anticipated, resulted
in decreasing overall admissions but increasing the percentage of cardiovascular
admissions. The second was our decision to terminate several managed care
relationships, primarily associated with our Tucson Heart Hospital, that we
determined no longer met our long-term strategic objectives. Excluding these two
heart hospitals from these same facility operating measures, admissions and
adjusted admissions increased 3.5% and 3.3%, respectively, and net revenue
increased 5.6%.
Also on a same facility basis, inpatient catheterization procedures
increased 6.8% while surgical procedures decreased 9.0% for the first nine
months of fiscal 2002 compared to fiscal 2001. Average length of stay in our
same facility hospitals decreased 4.9% to 3.69 days for the first nine months of
fiscal 2002 compared to 3.88 days for the first nine months of fiscal 2001.
Personnel expense increased $24.5 million, or 30.8%, to $104.0 million for
the first nine months of fiscal 2002 from $79.5 million for the first nine
months of fiscal 2001. Of the $24.5 million increase in personnel expense, $24.1
million was incurred by our hospital division and included $17.9 million which
was attributable to the net increase resulting from the consolidations of the
financial results of our Tucson Heart Hospital and our Heart Hospital of New
Mexico, offset in part by the decrease resulting from the sale of our McAllen
Heart Hospital. The remaining increase of $6.2 million was due to higher wage
rates and benefit costs at our other heart hospitals, and an increased use of
contract nurses in certain of our heart hospitals during the first nine months
of fiscal 2002 compared to fiscal 2001. The remaining $400,000 increase in our
consolidated personnel expense was due to a $560,000 increase in our cardiology
consulting and management division, offset in part by a $193,000 decrease in our
diagnostic services division. As a percentage of net revenue, personnel expense
increased slightly to 28.3% for the first nine months of fiscal 2002 compared to
28.0% for the first nine months of fiscal 2001. Excluding the $2.2 million of
net revenue resulting from the settlement of the billing dispute with a managed
care provider in one of our heart hospitals and the $9.7 million of net revenue
resulting from the Sun City Cardiac Center settlement in our diagnostic services
division, personnel expense represented 29.3% of net revenue for the first nine
months of fiscal 2002. Similarly, excluding the $3.2 million of net revenue
resulting from the arbitration award in our diagnostic services division,
personnel expense represented 28.3% of net revenue for the first nine months of
fiscal 2001.
Medical supplies expense increased $13.3 million, or 19.1%, to $83.1
million for the first nine months of fiscal 2002 from $69.8 million for the
first nine months of fiscal 2001. This $13.3 million increase was primarily
incurred by our hospital division, and included a net increase of $12.9 million
resulting from the consolidations of the financial results of our Tucson Heart
Hospital and our Heart Hospital of New Mexico, offset in part by the decrease
resulting from the sale of McAllen Heart Hospital. The remaining increase of
$400,000 was due to the increased number of procedures performed and changes in
our procedural mix involving utilization of more expensive supplies at our other
heart hospitals during the first nine months of fiscal 2002 compared to fiscal
2001, offset in part by the improved pricing realized from volume purchasing
opportunities and vendor consolidation initiatives in our hospital division. As
a percentage of net revenue, medical supplies expense decreased to 22.6% for the
first nine months of fiscal 2002 from 24.6% for the first nine months of fiscal
2001. Excluding the $2.2 million of net revenue resulting from the settlement of
the billing dispute with a managed care provider in our heart hospitals and the
$9.7 million of net revenue resulting from the Sun City Cardiac Center
settlement in our diagnostic services division, medical supplies expense
represented 23.4% of net revenue for the first nine months of fiscal 2002.
Similarly, excluding the $3.2 million of net revenue resulting from the
arbitration award in our diagnostic services division, medical supplies expense
represented 24.8% of net revenue for the first nine months of fiscal 2001.
Bad debt expense increased $2.9 million, or 19.6%, to $17.7 million for the
first nine months of fiscal 2002 from $14.8 million for the first nine months of
fiscal 2001. This $2.9 million increase in bad debt expense was due to a $3.5
million net increase resulting from the consolidations of the financial results
of our Tucson Heart Hospital and our Heart Hospital of New Mexico, offset in
part by the decrease resulting from the sale of McAllen Heart Hospital. The
remaining $600,000 decrease was due to lower bad debt expense at our other heart
hospitals, which was due to improved receivables collection procedures and other
22
processes implemented in our business offices. As a percentage of net revenue,
bad debt expense decreased to 4.8% for the first nine months of fiscal 2002 from
5.2% for the first nine months of fiscal 2001. Excluding the $2.2 million of net
revenue resulting from the settlement of the billing dispute with a managed care
provider in our heart hospitals and the $9.7 million of net revenue resulting
from the Sun City Cardiac Center settlement in our diagnostic services division,
bad debt expense represented 5.0% of net revenue for the first nine months of
fiscal 2002. Similarly, excluding the $3.2 million of net revenue resulting from
the arbitration award in our diagnostic services division, medical supplies
expense represented 5.3% of net revenue for the first nine months of fiscal
2001.
Other operating expenses increased $16.6 million, or 25.2%, to $82.5
million for the first nine months of fiscal 2002 from $65.9 million for the
first nine months of fiscal 2001. Other operating expenses include primarily
maintenance, rent, property taxes, insurance, utilities, advertising, travel,
professional fees, contract services and support services provided to operating
divisions by our corporate office. Of the $16.6 million increase in other
operating expenses, $13.4 million occurred within our hospital division. Of the
$13.4 million increase in the hospital division, $10.9 million was due to the
consolidations of the financial results of our Tucson Heart Hospital and our
Heart Hospital of New Mexico, offset in part by the decrease resulting from the
sale of McAllen Heart Hospital. Of the remaining $2.5 million increase in our
hospital division's other operating expenses, $1.5 million was due to an
increase in the division's medical malpractice insurance costs resulting from
the change in our insurance program during the third quarter of fiscal 2001 (see
discussion under three month period). The remaining increase was primarily due
to an increase in maintenance expense in our oldest heart hospital, an increase
in property taxes in certain of our markets and an increase in unreimbursed
costs, primarily legal expense, incurred in connection with the settlement of
the billing dispute with the managed care provider in one of our heart
hospitals.
Other operating expenses in our diagnostic services division increased
$602,000 during the first nine months of fiscal 2002 compared to fiscal 2001.
This $602,000 increase was due to the combined effect of approximately $1.0
million of costs, primarily legal fees, related to the Sun City Cardiac Center
settlement and the increased costs of medical malpractice coverage during the
first nine months of fiscal 2002, offset in part by a decrease in legal fees
related to the billing dispute which was settled in the third quarter of our
fiscal 2001 and cost reductions from exiting certain low margin services in that
division. The remaining $2.6 million increase in other operating expenses was
primarily incurred in our corporate division to support the growth in our
operating divisions for the first nine months of fiscal 2002 compared to fiscal
2001. As a percentage of net revenue, other operating expenses decreased to
22.4% for the first nine months of fiscal 2002 from 23.2% for the first nine
months of fiscal 2001. Excluding the $2.2 million of net revenue resulting from
the settlement of the billing dispute with a managed care provider in our heart
hospitals and the $9.7 million of net revenue and $1.0 million of costs,
primarily legal fees, resulting from the Sun City Cardiac Center settlement in
our diagnostic services division, other operating expenses represented 23.2% of
net revenue for the first nine months of fiscal 2002. Similarly, excluding the
$3.2 million of net revenue resulting from the arbitration award in our
diagnostic services division, other operating expenses represented 23.1% of net
revenue for the first nine months of fiscal 2001.
Pre-opening expenses increased $3.2 million, or 367.0%, to $4.1 million for
the first nine months of fiscal 2002 from $872,000 for the first nine months of
fiscal 2001. Pre-opening expenses represent expenses specifically related to
projects under development, primarily new hospitals.
Depreciation increased $4.2 million, or 18.9%, to $26.4 million for the
first nine months of fiscal 2002 from $22.2 million for the first nine months of
fiscal 2001. Of this $4.2 million increase, $3.6 million was due to the net
increase resulting from the consolidations of the financial results of our
Tucson Heart Hospital and our Heart Hospital of New Mexico, offset in part by
the decrease resulting from the sale of McAllen Heart Hospital. The remaining
increase was primarily due to depreciation on capital expenditures related to
equipment and information systems made since the first nine months of fiscal
2001.
Amortization decreased $3.0 million, or 58.8%, to $2.1 million for the
first nine months of fiscal 2002 from $5.1 million for the first nine months of
fiscal 2001. This decrease was primarily due to our adoption of Statement of
Financial Accounting Standards No. 142 on October 1, 2001. Under the new
accounting rules, we were required to discontinue goodwill amortization at the
beginning of our fiscal year 2002 and subject our goodwill to an annual
impairment test, which we performed on a transitional basis as of October
23
1, 2001 and which did not result in any impairment loss. For the full fiscal
year 2001, we recognized goodwill amortization of approximately $3.0 million,
none of which will be recognized during fiscal 2002.
During the first quarter of fiscal 2002, we recognized an approximately
$1.1 million gain on the partial settlement of a management contract in our
cardiology consulting and management division effective December 31, 2001.
During the second quarter of fiscal 2002, we recognized an additional $140,000
resulting from the final settlement. This gain is included in gain on the sale
of property, equipment and other assets in our consolidated financial
statements.
On March 1, 2001, we sold McAllen Heart Hospital, in which we owned a 50.2%
interest to an affiliate of Universal Health Systems, Inc. for approximately
$56.0 million. After the write-off of approximately $10.3 million of our
goodwill and step-up basis in McAllen Heart Hospital, we recognized a net gain
of $13.5 million in our consolidated results of operations for the second
quarter of fiscal 2001.
Also in March 2001, we recognized an impairment of long-lived assets due to
unfavorable developments with a physician group under a management contract in
our cardiology consulting and management division that caused us to reevaluate
the carrying value of the assets of that management contract. As a result, we
recognized a non-cash impairment charge of $985,000 in March 2001 to adjust the
long-lived assets of that management contract to the anticipated future
discounted cash flows.
Interest expense decreased $2.8 million, or 13.6%, to $17.8 million for the
first nine months of fiscal 2002 from $20.6 million for the first nine months of
fiscal 2001. This decrease in interest expense occurred despite a $3.7 million
net increase in interest expense resulting from the consolidations of the
financial results of our Tucson Heart Hospital and Heart Hospital of New Mexico,
offset in part by the decrease resulting from the sale of McAllen Heart
Hospital. The decrease in interest expense excluding the effect of these three
events was due to a general reduction in our variable rate interest costs and a
reduction in our average total outstanding indebtedness during the first nine
months of fiscal 2002 compared to the first nine months of fiscal 2001. The debt
reduction was primarily due to the use of proceeds from the sale of McAllen
Heart Hospital in March 2001 and our initial public offering in July 2001 to
repay all amounts outstanding under our revolving credit facility. Also in July
2001, three of our heart hospitals reduced their interest expense by refinancing
approximately $79.6 million of their mortgage debt. Interest income decreased to
$1.8 million for the first nine months of fiscal 2002 from $2.4 million for the
first nine months of fiscal 2001.
Equity in net earnings of unconsolidated affiliates increased $4.6 million,
or 209.1%, to $2.4 million for the first nine months of fiscal 2002 from a loss
of $2.2 million for the first nine months of fiscal 2001. In July 2001, we began
consolidating the financial results of Tucson Heart Hospital, and in October
2001, we began consolidating the financial results of Heart Hospital of New
Mexico after completing acquisitions that increased our ownership interests in
each of these heart hospitals to a majority position. We had previously been
required to account for our minority investment in each of these heart hospitals
using the equity method of accounting. We now have only one heart hospital in
which we hold less than a 50.0% equity interest that we are required to account
for as an equity investment during fiscal 2002. This heart hospital commenced
operations in March 2001. We continue to hold a small number of additional
equity investments in our diagnostic services division.
Earnings allocated to minority interests decreased $4.4 million, or 32.4%
to $9.2 million for the first nine months of fiscal 2002 from $13.6 million for
the first nine months of fiscal 2001. This $4.4 million decrease includes the
effect of $8.0 million of earnings allocated to minority interest recognized in
the second quarter of fiscal 2001 resulting from the sale of McAllen Heart
Hospital, $1.5 million recognized in the third quarter of fiscal 2001 resulting
from the amounts we received in the arbitration award involving a billing
dispute with our hospital joint venture partner in one of our diagnostic and
therapeutic centers, and the $3.0 million recognized in the second quarter of
fiscal 2002 resulting from the Sun City settlement. Excluding these three
events, earnings allocated to minority interests increased approximately $2.1
million for the first nine months of fiscal 2002 compared to fiscal 2001. Of
this $2.1 million increase, approximately $1.3 million was due to the
consolidations of the financial results of Tucson Heart Hospital and Heart
Hospital of New Mexico, as previously discussed. The remaining $800,000 increase
was due to improved operating results in our other consolidated heart hospitals
and improved operating results in
24
certain of our diagnostic and therapeutic joint ventures in our diagnostic
services division, offset in part by the increase in pre-opening expenses at our
hospitals under development in our hospital division.
Income tax expense increased to $2.7 million for the first nine months of
fiscal 2002 from $305,000 for the first nine months of fiscal 2001. During
fiscal 2001, we had net deferred tax assets, primarily resulting from net
operating loss carryforwards, that were fully offset by a valuation allowance.
During the nine months ended June 30, 2002, we determined the valuation
allowance was no longer required and reversed the allowance in accordance with
accounting principles generally accepted in the United States. As a result of
our generating income before income taxes of $25.7 million during the nine
months ended June 30, 2002 and the reversal of the valuation allowance, we
recognized $2.5 million of deferred income tax expense along with $243,000 of
current income tax expense during the first nine months of fiscal 2002. Because
we continue to have net operating loss carryforwards available from prior
periods, we have no material current income tax liability.
LIQUIDITY AND CAPITAL RESOURCES
Our consolidated working capital was $123.2 million at June 30, 2002 and $114.9
million at September 30, 2001. The increase of $8.3 million from September 30,
2001 to June 30, 2002 primarily resulted from increases in cash and cash
equivalents, accounts receivable, net, medical supplies, deferred tax assets and
prepaid expenses and other assets combined with a decrease in accrued property
taxes, offset in part by increases in short-term borrowings, accounts payable,
accrued compensation and benefits, other accrued liabilities and current portion
of long-term debt and obligations. The increase in cash and cash equivalents
resulted from cash flows provided by operations, proceeds from the favorable
settlement of the Sun City Cardiac Center billing dispute in our diagnostic
services division, proceeds from the favorable settlement of a billing dispute
with a managed care provider in one of our heart hospitals offset by cash used
to acquire an increased ownership interest in Heart Hospital of New Mexico and
to fund our heart hospital development program. The increase in accounts
receivable, net, resulted from the consolidation of Heart Hospital of New Mexico
beginning October 1, 2001 and growth in our net revenues offset by increased
collections in our hospital division resulting from our improved collection
procedures and other processes implemented in our business offices. Medical
supplies inventory also increased as a result of the consolidation of Heart
Hospital of New Mexico beginning October 1, 2001 and volume purchases of
inventory at several of our heart hospitals. The increase in deferred tax assets
was due to reversing our valuation allowance, which fully offset our deferred
tax assets at September 30, 2001, and recognizing deferred income taxes during
the first nine months of fiscal 2002. The increase in prepaid expense and other
assets was primarily due to the increase in premiums we paid for our new
malpractice insurance. The increase in other accrued liabilities was primarily
due to increased construction activity at our development hospitals. The
consolidation of the Heart Hospital of New Mexico beginning October 1, 2001 also
contributed to the increases in accrued compensation and benefits and current
portion of long-term debt.
Our operating activities provided net cash of $59.7 million during the
first nine months of fiscal 2002 compared to net cash of $30.2 million for the
first nine months of fiscal 2001. The $59.7 million net cash provided by
operating activities during the first nine months of fiscal 2002 was a result of
cash flow provided by our operations and an increase in accounts payable and
accrued liabilities offset by an increase in accounts receivable, net, medical
supplies inventory and prepaid expenses and other current assets. The $30.2
million of net cash provided by operating activities in the first nine months of
fiscal 2001 also resulted from cash flow provided by our operations, an increase
in accounts payable and accrued liabilities and a decrease in other assets
offset by an increase in accounts receivable, net, medical supplies inventory
and prepaid expenses and other current assets.
Our investing activities used net cash of $72.2 million during the first
nine months of fiscal 2002 compared to net cash provided of $38.1 million during
the first nine months of fiscal 2001. The $72.2 million of net cash used by
investing activities during the first nine months of fiscal 2002 was due to
capital expenditures primarily related to hospital development, the acquisition
of an increased ownership interest in Heart Hospital of New Mexico in October
2001, and the acquisition of a nuclear management company in our diagnostic
division, partially offset by decreases in advances made to our one affiliate
heart hospital and proceeds from the settlement of a management contract. During
the first nine months of fiscal 2001, the
25
$38.1 million net cash provided by investing activities primarily resulted from
proceeds from the sale of the McAllen Heart Hospital offset by capital
expenditures and advances made to affiliate heart hospitals.
Expenditures for property and equipment for the nine months ended June 30,
2002 and 2001 were $60.9 million and $10.5 million, respectively. Included in
the $60.9 million of capital expenditures for the first nine months of fiscal
2002, were capital expenditures of $48.7 million for our hospitals under
development. Included in the $10.5 million of capital expenditures for the first
nine months of fiscal 2001 were capital expenditures of $3.3 million for our
hospitals under development.
Our financing activities provided net cash of $15.9 million during the
first nine months of fiscal 2002 and used net cash of $60.3 million during the
same period of fiscal 2001. Net cash provided by financing activities during the
first nine months of fiscal 2002 was a result of proceeds from the issuance of
short-term debt and long-term debt, net of loan acquisition costs and deferred
fees of $39.0 million offset by repayments of long-term debt and capital leasing
obligations of $21.4 million and distributions to, net of investments by,
minority partners of $1.7 million. The net cash used by financing activities
during the first nine months of fiscal 2001 primarily resulted from repayments
of short term debt, long-term debt and capital leasing obligations of $77.6
million and distributions to, net of investments by, minority partners of $9.7
million, including the distributions on the sale of McAllen Heart Hospital,
offset in part by proceeds from the issuance of long-term debt, net of loan
acquisition costs and deferred fees and the issuance of common stock of $27.0
million.
As of June 30, 2002, we had $289.8 million of long-term outstanding debt, $27.5
million of which was classified as current. Of that amount, $276.0 million was
outstanding to lenders to our consolidated hospitals, no amounts were
outstanding to lenders under our revolving credit facility, and $13.8 million
was outstanding under capital leases and other miscellaneous debt instruments.
We expect the level of our long-term indebtedness to increase in the future as
we develop additional hospitals. The development and construction of the five
new hospitals we are developing in Texas, Louisiana and Wisconsin will require
us to incur additional long-term debt of between $139.5 and $173.5 million
during the next 12 to 18 months. As of June 30, 2002, we were committed under
construction contracts for $32.4 million, $19.9 million and $24.5 million,
respectively, for the construction of the Harlingen Medical Center, the
Louisiana Heart Hospital and the San Antonio Heart Hospital. In August 2002, we
entered into a construction contact with a preliminary budget contract sum of
$12.8 million for the construction of The Heart Hospital of Milwaukee. The
Harlingen Medical Center had paid $24.7 million and accrued an additional $4.8
million under its contract as of June 30, 2002. The Louisiana Heart Hospital had
paid $3.9 million and accrued an additional $5.3 million under its contract at
June 30, 2002. The San Antonio Heart Hospital had paid $404,000 and accrued an
additional $989,000 under its contract at June 30, 2002. In May 2002, Harlingen
Medical Center obtained a new debt commitment to finance equipment for the new
hospital. This new debt commitment allows the hospital to borrow up to $20.0
million until April 30, 2003. During this time, interest will accrue at the
Prime rate plus 25 basis points. After such date, amounts funded under the loan
shall accrue interest at a fixed rate of interest equal to a specific Treasury
Note yield, plus a margin. Upon the conversion of the loan to a fixed rate of
interest, the principal amount outstanding will be repaid over a time period
equal to either five or seven years, depending on the type and manufacturer of
equipment originally purchased under the facility. As of June 30, 2002,
Harlingen Medical center had borrowed $1.4 million of the $20.0 million
available.
In July 2001, we became a party to a new $189.6 million master credit facility
(the Master Credit Facility), which provided a source of capital to refinance
approximately $79.6 million of the indebtedness of three of our existing heart
hospitals and provided us with $110.0 million to finance our hospital
development program. Of the $110.0 million initially available for this purpose,
$37.5 million has been designated for use in funding the development of
Harlingen Medical Center, and $25.5 million has been designated for use in
funding the development of Louisiana Heart Hospital. As of June 30, 2002, $26.8
million had been borrowed to finance the development of Harlingen Medical
Center, and $6.4 million had been borrowed to finance the development of
Louisiana Heart Hospital. As of July 31, 2002, $47.0 million of the initial
$110.0 million remains available to finance other projects in the Company's
heart hospital development program. The Master Credit Facility matures on July
27, 2006 and borrowings bear interest at LIBOR plus a margin that ranges 2.5% to
3.5%. We are required to pay a monthly unused commitment fee at a rate of 0.5%.
The Master Credit Facility includes covenants that require maintenance of
certain financial ratios regarding leverage levels and debt service coverage as
well as various restrictive covenants.
26
Separate from our Master Credit Facility, our revolving credit facility
provides $100.0 million in availability, $10.0 million of which is designated
for short-term borrowings. As of June 30, 2002, we had used $12.0 million of
this availability to issue letters of credit and consequently had availability
for additional borrowings of $88.0 million. This revolving credit facility
matures on January 31, 2005 and borrowings under this facility bear interest at
either the LIBOR or the prime rate plus various applicable margins which are
based upon financial covenant ratio tests. We are required to pay a monthly
unused commitment fee at a rate of 0.375%. Our revolving credit facility
includes various restrictive covenants, including restrictions on certain types
of additional indebtedness, investments, asset sales, capital expenditures,
dividends, sale and leasebacks, contingent obligations, transactions with
affiliates, changes in our corporate structure, and fundamental changes. The
covenants also require maintenance of various ratios regarding leverage levels
and debt service coverage.
We were in compliance with the covenants of all of our outstanding debt at
June 30, 2002, with the exception of certain financial ratio covenants related
to Heart Hospital of New Mexico's REIT loan. The real estate lender granted a
waiver for the breach of that hospital's financial ratio covenants at June 30,
2002.
We guarantee the obligations of our hospital subsidiaries for bank
mortgage loans, including those made under the Master Credit Facility or REIT
loans. We also guarantee a portion of the obligations of our hospital
subsidiaries for equipment and other notes payable. We receive a fee for
providing these guarantees from the hospitals or the investors in the hospital
companies.
We also guarantee approximately 50% of the real estate and equipment debt
of the one affiliate heart hospital in which we owned a minority interest at
June 30, 2002, and therefore do not consolidate this hospital's results of
operation and financial position. We provide such guarantee in exchange for a
fee from the affiliate heart hospital. The total amount of this real estate and
equipment debt was approximately $44.2 million at June 30, 2002, and
accordingly, the 50% we guarantee was approximately $22.1 million at June 30,
2002. The affiliate hospital was in compliance with all covenants in the
instruments governing its debt at June 30, 2002. The total amount of this
affiliate hospital's debt is secured by the hospital's underlying real estate
and equipment, which were financed with the proceeds from the debt. Because we
do not consolidate the affiliate heart hospital's results of operations and
financial position, neither these assets nor the accompanying liabilities are
included in the value of the assets and liabilities on our balance sheet.
We believe that internally generated cash flows and available borrowings
under our revolving credit facility of $88.0 million, together with the
remaining net proceeds of our initial public offering of $61.7 million,
borrowings available under the Master Credit Facility not yet designated for a
development hospital of $47.0 million, borrowings available under Harlingen
Medical Center's equipment debt commitment of $18.6 million and cash balances in
our development hospitals of $13.8 million, will be sufficient to finance our
hospital development program, other capital expenditures and our working capital
requirements for the next 12 months.
FORWARD-LOOKING STATEMENTS
Parts of this report, particularly statements made in it that relate to our
expected operating results, our heart hospital development program and our
business prospects, contain forward-looking statements that involve risks and
uncertainties. Statements that are predictive in nature, that depend upon or
refer to future events or conditions or that include words such as "expects,"
"anticipates," "approximates," "believes," "estimates," "intends," "hopes" and
similar expressions are intended to identify such forward-looking statements.
Although our management believes that these forward-looking statements are based
on reasonable assumptions, these assumptions are inherently subject to
significant economic, regulatory and competitive uncertainties and contingencies
that are difficult or impossible to predict accurately and are beyond our
control. Actual results could differ materially from those projected in these
forward-looking statements. Other than as may be required by federal securities
laws to disclose material developments related to previously disclosed
information, we undertake no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise.
These various risks and uncertainties are described in detail in Exhibit 99
- - Risk Factors - to our Annual Report on Form 10-K filed with the SEC. A copy of
this annual report, including exhibits, is available on the internet site of the
SEC at http://www.sec.gov or through our website at http://www.medcath.com.
These risks and uncertainties include, among others, possible reductions or
27
changes in reimbursement from government or third-party payors that would
decrease our revenue, delays in completing construction or delays in or failure
to receive required regulatory approvals for new heart hospitals, greater than
anticipated losses at new hospitals, a negative finding by a regulatory
organization with oversight of one of our heart hospitals, or material changes
in the anti-kickback, physician self-referral or other fraud and abuse laws.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We maintain a policy for managing risk related to exposure to variability
in interest rates, foreign currency exchange rates, commodity prices, and other
relevant market rates and prices which includes considering entering into
derivative instruments or contracts or instruments containing features or terms
that behave in a manner similar to derivative instruments in order to mitigate
our risks. In addition, we may be required to hedge some or all of our market
risk exposure, especially to interest rates, by creditors who provide debt
funding to us. To date, we have only entered into fixed interest rate swaps, as
discussed below.
As required by their mortgage loans, three of our consolidated heart
hospitals entered into fixed interest rate swaps during the fourth quarter of
fiscal year 2001. These fixed interest rate swaps effectively fixed the interest
rate on the hedged portion of the related debt at 4.92% plus the applicable
margin for two of the hospitals and at 4.6% plus the applicable margin for the
other hospital. Both the new mortgage loans and the fixed interest rate swaps
mature in July 2006. At June 30, 2002, the average variable rate on the new
mortgage loans was 4.66%. The fair value of the interest rate swaps at June 30,
2002 was an obligation of $849,000 resulting in an unrealized gain, net of
income taxes of $175,000 for the first nine months of fiscal 2002 which is
included in comprehensive income in our consolidated statement of stockholders'
equity in accordance with accounting principles generally accepted in the United
States.
Our primary market risk exposure relates to interest rate risk exposure
through that portion of our borrowings that bear interest based on variable
rates. Our debt obligations at June 30, 2002 included approximately $99.4
million of variable rate debt at an approximate average interest rate of 5.12%.
A one hundred basis point change in interest rates on our variable rate debt
would have resulted in interest expense fluctuating approximately $632,000 for
the nine months ended June 30, 2002.
28
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Note 9 to the Company's consolidated financial statements for
information concerning contract disputes settled during the periods covered in
this report.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) On July 27, 2001, we completed an initial public offering of
our common stock pursuant to our Registration Statement on
Form S-1 (File No. 333-60278) that was declared effective by
the SEC on July 23, 2001. All 6,000,000 shares of common stock
offered in the final prospectus were sold at a price of $25.00
per share for gross proceeds of $150.0 million. The net
proceeds that we received from the offering after deducting
the underwriting discounts and commissions and the other
offering expenses were approximately $135.9 million. During
the third quarter of our fiscal 2002, there were no changes in
the application of the net proceeds from the offering from the
uses previously disclosed in our Form 10-Q for the quarterly
period ended June 30, 2001, our Annual Report on Form 10-K for
the fiscal year ended September 30, 2001 and our Form 10-Q for
the quarterly period ended March 31, 2002.
We expect to use the remaining approximate $61.7 million of
proceeds from the offering to develop additional hospitals and
for working capital and other corporate purposes, including
the possible acquisition of additional interests in our
existing heart hospitals. Although we have identified these
intended uses of the remaining proceeds, we have broad
discretion in the allocation of the net proceeds from the
offering. Pending this application, we will invest the net
proceeds of the offering in cash, cash-equivalents, money
market funds or short-term interest bearing, investment-grade
securities.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT
NO. DESCRIPTION
10.1 Amended and Restated Loan Agreement dated as of April 24, 2002 by and
among Louisiana Heart Hospital, LLC, Bank of America, N.A., Bankers
Trust Company, Wachovia Bank, National Association, Banc of America
Securities, LLC and Deutsche Banc Alex. Brown Inc.
99.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
99.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
None.
29
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
Dated: August 14, 2002 By: /s/ DAVID CRANE
-----------------------------------------------
David Crane
President, Chief Executive Officer and Director
(principal executive officer)
By: /s/ JAMES E. HARRIS
----------------------------------------------
James E. Harris
Executive Vice President and Chief
Financial Officer
(principal financial officer)
By: /s/ DAVID W. PERRY
----------------------------------------------
David W. Perry
Vice President and Chief Accounting Officer
(principal accounting officer)
30