MEDCATH CORP - 10-Q Quarterly Report

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 March 31, 2005

Commission File Number 000-33009

MEDCATH CORPORATION

(Exact name of registrant as specified in its charter)


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

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

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

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

Yes þ No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes þ No o

As of April 29, 2005, there were 18,448,710 shares of $0.01 par value common stock outstanding.

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements

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


	March 31,			September 30,
	2005			2004
	(Unaudited)
Current assets:
Cash and cash equivalents	$	129,466		$	72,310
Accounts receivable, net		100,988			92,797
Medical supplies		22,266			22,205
Deferred income tax assets		9,759			11,972
Prepaid expenses and other current assets		7,071			7,938
Current assets of discontinued operations		1,776			2,403

Total current assets		271,326			209,625
Property and equipment, net		402,320			410,908
Investments in and advances to affiliates, net		4,990			6,029
Goodwill		70,100			70,100
Other intangible assets, net		10,166			10,746
Other assets		12,660			13,473
Long-term assets of discontinued operations		296			33,355

Total assets	$	771,858		$	754,236


Current liabilities:
Accounts payable	$	48,749		$	46,372
Income tax payable		1,697			533
Accrued compensation and benefits		24,772			25,914
Accrued property taxes		4,213			6,565
Other accrued liabilities		17,853			15,968
Current portion of long-term debt and obligations under capital leases		49,250			9,872
Current liabilities of discontinued operations		419			1,720

Total current liabilities		146,953			106,944
Long-term debt		308,957			346,006
Obligations under capital leases		4,725			5,641
Deferred income tax liabilities		11,665			9,494
Other long-term obligations		829			7,330

Total liabilities		473,129			475,415

Minority interest in equity of consolidated subsidiaries		20,635			15,173
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $0.01 par value, 10,000,000 shares authorized; none issued		—			—
Common stock, $0.01 par value, 50,000,000 shares authorized; 18,437,610 issued and 18,368,710 outstanding at March 31, 2005; 18,090,186 issued and 18,021,286 outstanding at September 30, 2004		184			181
Paid-in capital		364,668			358,656
Accumulated deficit		(86,372	)		(94,715	)
Accumulated other comprehensive income (loss)		8			(80	)
Treasury stock, 68,900 shares at cost		(394	)		(394	)

Total stockholders’ equity		278,094			263,648

Total liabilities and stockholders’ equity	$	771,858		$	754,236

See notes to consolidated financial statements.

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


	Three Months Ended March 31,						Six Months Ended March 31,
	2005			2004			2005			2004
Net revenue	$	192,014		$	168,680		$	376,774		$	323,803
Operating expenses:
Personnel expense		59,402			52,415			116,615			99,427
Medical supplies expense		55,564			45,980			108,050			87,957
Bad debt expense		11,947			9,475			23,431			23,263
Other operating expenses		37,505			36,595			75,905			68,115
Pre-opening expenses		—			2,087			—			5,103
Depreciation		9,431			10,430			19,167			20,153
Amortization		290			290			580			580
Loss (gain) on disposal of property, equipment and		71			33			74			(51	)
other assets

Total operating expenses		174,210			157,305			343,822			304,547

Income from operations		17,804			11,375			32,952			19,256
Other income (expenses):
Interest expense		(7,775	)		(6,742	)		(15,773	)		(13,062	)
Interest and other income, net		621			161			1,016			396
Equity in net earnings of unconsolidated affiliates		886			1,147			1,655			1,724

Total other expenses, net		(6,268	)		(5,434	)		(13,102	)		(10,942	)

Income from continuing operations before minority interest, income taxes and discontinued operations		11,536			5,941			19,850			8,314
Minority interest share of (earnings) losses of consolidated subsidiaries		(4,402	)		65			(8,401	)		(1,026	)

Income from continuing operations before income taxes and discontinued operations		7,134			6,006			11,449			7,288
Income tax expense		2,856			2,292			4,579			2,809

Income from continuing operations		4,278			3,714			6,870			4,479
Income (loss) from discontinued operations, net of		(475	)		(1,073	)		1,473			(2,771	)

taxes
Net income	$	3,803		$	2,641		$	8,343		$	1,708


Earnings (loss) per share, basic
Continuing operations	$	0.24		$	0.21		$	0.38		$	0.25
Discontinued operations		(0.03	)		(0.06	)		0.08			(0.15	)

Earnings per share, basic	$	0.21		$	0.15		$	0.46		$	0.10

Earnings (loss) per share, diluted
Continuing operations	$	0.22		$	0.20		$	0.36		$	0.24
Discontinued operations		(0.02	)		(0.06	)		0.07			(0.15	)

Earnings per share, diluted	$	0.20		$	0.14		$	0.43		$	0.09


Weighted average number of shares, basic		18,177			17,985			18,110			17,967
Dilutive effect of stock options		1,285			514			1,139			300

Weighted average number of shares, diluted		19,462			18,499			19,249			18,267

See notes to consolidated financial statements.

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


	Six Months Ended March 31,
	2005			2004
Net income	$	8,343		$	1,708
Adjustments to reconcile net income to net cash
provided by operating activities:
Bad debt expense		23,431			23,263
Depreciation and amortization expense		19,747			20,733
Loss (gain) on disposal of property, equipment and other assets		74			(51	)
Amortization of loan acquisition costs		801			845
Equity in earnings of unconsolidated affiliates, net of dividends received		1,033			1,636
Minority interest share of earnings of consolidated subsidiaries		8,401			1,026
Change in fair value of interest rate swaps		(770	)		—
Deferred income taxes		5,098			503
Change in assets and liabilities that relate to operations:
Accounts receivable		(31,622	)		(37,842	)
Medical supplies		(61	)		(3,506	)
Prepaids and other assets		964			555
Accounts payable and accrued liabilities		1,092			9,186

Net cash provided by operating activities of continuing operations		36,531			18,056
Net cash used in operating activities of discontinued operations		(9,501	)		(2,872	)

Net cash provided by operating activities		27,030			15,184


Investing activities:
Purchases of property and equipment		(11,146	)		(33,186	)
Proceeds from sale of property and equipment		184			2,316
Proceeds from sale of discontinued components		42,500			—
Other investing activities		6			90

Net cash provided by (used in) investing activities of continuing operations		31,544			(30,780	)
Net cash used in investing activities of discontinued operations		—			(12,115	)

Net cash provided by (used in) investing activities		31,544			(42,895	)


Financing activities:
Proceeds from issuance of long-term debt		2,150			47,699
Repayments of long-term debt		(4,045	)		(37,624	)
Repayments of obligations under capital leases		(1,355	)		(2,005	)
Payments of loan acquisition costs		—			(227	)
Investments by minority partners		3,639			851
Distributions to minority partners		(7,140	)		(7,052	)
Repayments from minority partners		97			61
Proceeds from exercised stock options		5,236			237

Net cash (used in) provided by financing activities of continuing operations		(1,418	)		1,940
Net cash provided by financing activities of discontinued operations		—			14,111

Net cash (used in) provided by financing activities		(1,418	)		16,051


Net increase (decrease) in cash and cash equivalents		57,156			(11,660	)
Cash and cash equivalents:
Beginning of period		72,310			93,231

End of period	$	129,466		$	81,571


Supplemental schedule of noncash investing and financing activities:
Capital expenditures financed by capital leases	$	505		$	853
Deferred tax asset related to exercised stock options		776			79
Distributions to minority partners declared but not paid		—			359

See notes to consolidated financial statements.

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

1. Business and Organization

MedCath Corporation (the Company) is a healthcare provider focused primarily on the diagnosis and treatment of cardiovascular disease. The Company owns and operates hospitals in partnership with physicians whom it believes have established reputations for clinical excellence as well as with community hospital systems. Each of the Company’s majority-owned hospitals (collectively, the Hospital Division) is a freestanding licensed general acute care hospital, that provides a wide range of health services, and the medical staff at each hospital includes qualified physicians in various specialties. The Company opened its first hospital in 1996, and as of March 31, 2005 has ownership interests in and operates twelve hospitals. These hospitals include eleven majority-owned hospitals and one in which the Company owns a minority interest. The Company’s twelve hospitals have a total of 727 licensed beds, of which 686 were staffed and available at March 31, 2005, and are located in eight states: Arizona, Arkansas, California, Louisiana, New Mexico, Ohio, South Dakota, and Texas.

In addition to its hospitals, the Company owns and/or manages cardiac diagnostic and therapeutic facilities (the Diagnostics Division). The Company began its cardiac diagnostic and therapeutic business in 1989, and as of March 31, 2005 owns and/or manages thirty cardiac diagnostic and therapeutic facilities. Thirteen of these facilities are located at hospitals operated by other parties and offer invasive diagnostic and sometimes therapeutic procedures. The remaining facilities are not located at hospitals and offer only diagnostic services. The Company also provides consulting and management services tailored primarily to cardiologists and cardiovascular surgeons, which is included in the corporate and other division.

2. Summary of Significant Accounting Policies

Basis of Presentation - The Company’s unaudited interim consolidated financial statements as of March 31, 2005 and for the three and six months ended March 31, 2005 and 2004 have been prepared in accordance with accounting principles generally accepted in the United States of America (hereafter, generally accepted accounting principles) and pursuant to the rules and regulations of the Securities and Exchange Commission (the SEC). These unaudited interim consolidated financial statements reflect, in the opinion of management, all material adjustments (consisting only of normal recurring adjustments) necessary to fairly state the results of operations and financial position for the periods presented. All intercompany transactions and balances have been eliminated. The results of operations for the three and six months ended March 31, 2005 are not necessarily indicative of the results expected for the full fiscal year ending September 30, 2005 or future fiscal periods.

Certain information and disclosures normally included in the notes to consolidated financial statements have been condensed or omitted as permitted by the rules and regulations of the SEC, although the Company believes the disclosure is adequate to make the information presented not misleading. The unaudited interim consolidated financial statements and notes thereto should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2004. During the three months and six months ended March 31, 2005, the Company has not made any material changes in the selection or application of its critical accounting policies as set forth its Annual Report on Form 10-K for the year ended September 30, 2004.

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

Stock-Based Compensation - As of March 31, 2005, the Company has two stock-based compensation plans: a stock option plan under which it may grant incentive stock options and nonqualified stock options to officers and other key employees and an outside director’s stock option plan under which it may grant nonqualified stock options to nonemployee directors. The Company accounts for stock options under both of these plans in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, as permitted under Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation. The Company also provides prominent disclosure of the information required by SFAS No. 148, Accounting for Stock-Based Compensation, in its annual and interim financial statements.

Under APB Opinion No. 25, compensation cost is determined based on the intrinsic value of the equity instrument award. No stock-based employee compensation cost is reflected in net income for the three or six months ended March 31, 2005 and 2004, as all options granted during those periods under the Company’s stock option plans had an exercise price equal to the market value of the underlying shares of common stock at the date of grant.

MEDCATH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued

Had compensation expense for the Company’s stock options been recognized based on the fair value of the option award at the grant date under the methodology prescribed by SFAS No. 123, the Company’s net income would have been impacted as follows:


	Three Months Ended March 31,				Six Months Ended March 31,
	2005		2004		2005		2004
Net income, as reported	$	3,803	$	2,641	$	8,343	$	1,708
Deduct: Total stock-based employee compensation expense determined under fair value method, net of related income taxes		424		497		1,043		951

Proforma net income	$	3,379	$	2,144	$	7,300	$	757


Earnings per share, basic
As reported	$	0.21	$	0.15	$	0.46	$	0.10
Pro forma	$	0.19	$	0.12	$	0.40	$	0.04

Earnings per share, diluted
As reported	$	0.20	$	0.14	$	0.43	$	0.09
Pro forma	$	0.17	$	0.12	$	0.38	$	0.04

New Accounting Pronouncement — In December 2004, the Financial Accounting Standard Board (the FASB) issued Statement 123R, Share-Based Payment, to be effective for interim or annual periods beginning after June 15, 2005. This Statement was further revised in April 2005 to be effective for annual periods beginning after June 15, 2005. Accordingly, Statement 123R will become effective during the first quarter of fiscal 2006 for the Company. Statement 123R requires all share-based payments to employees, including grants of employee stock options and purchases under employee stock purchase plans, to be recognized as an operating expense in the statement of operations. The expense is recognized over the requisite service period based on fair values measured on grant dates and the new standard may be adopted using either the modified prospective transition method or the modified retrospective transition method. The Company is currently evaluating its share-based employee compensation programs, alternative adoption methods and the potential impact of Statement 123R on its consolidated financial position and results of operations.

3. Discontinued Operations

On November 5, 2004, the Company and local Milwaukee physicians, who jointly owned The Heart Hospital of Milwaukee (HHM), entered into an agreement with Columbia St. Mary’s, a Milwaukee-area hospital group, to close HHM and sell certain assets, primarily comprised of real property and equipment, to Columbia St. Mary’s for $42.5 million. The sale was completed on December 1, 2004 and the Company recognized a gain on the sale of the assets, net of allocated goodwill, of approximately $9.3 million.

In connection with the agreement to sell the assets of HHM, the Company closed the facility prior to the completion of the sale. As a part of the closure, the Company incurred termination benefits and contract termination costs of approximately $2.2 million. In addition, the Company wrote-off approximately $1.4 million related to the net book value of certain assets abandoned as a part of the closure of the facility.

Transaction proceeds were used by HHM to pay intercompany secured debt, which totaled approximately $37.0 million on the date of the closing, as well as transaction costs and hospital operating expenses of approximately $2.0 million. The remaining proceeds from the divestiture, combined with proceeds from the liquidation of the assets not sold to Columbia St. Mary’s, will be used to satisfy certain liabilities of HHM and to return a portion of the original capital contribution to the investors.


		Page
PART I. FINANCIAL INFORMATION

Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 2005 and September 30, 2004		3

Consolidated Statements of Operations for the Three and Six Months Ended March 31, 2005 and 2004		4

Consolidated Statement of Stockholders’ Equity for the Six Months Ended March 31, 2005		5

Consolidated Statements of Cash Flows for the Six Months Ended March 31, 2005 and 2004		6

Notes to Consolidated Financial Statements		7

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		20

Item 3. Quantitative and Qualitative Disclosures About Market Risk		30

Item 4. Controls and Procedures		31

PART II. OTHER INFORMATION

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		31

Item 4. Submission of Matters to a Vote of Security Holders		31

Item 6. Exhibits		32

SIGNATURES		33


	Six Months Ended March 31,
	2005			2004
Net revenue	$	2,003		$	6,109
Restructuring and write-off charges		(3,635	)		—
Operating expenses		(3,345	)		(11,017	)


Loss from operations		(4,977	)		(4,908	)
Other income (expense):
Gain/(loss) on sale of assets		9,301			(1	)
Minority interest and other, net		(604	)		335
Income tax (expense) benefit		(2,247	)		1,803

Net income (loss)	$	1,473		$	(2,771	)


										Accumulated
										Other
	Common Stock				Paid-in		Accumulated			Comprehensive			Treasury Stock
	Shares		Par Value		Capital		Deficit			Income (Loss)			Shares		Amount			Total
Balance, September 30, 2004		18,022	$	181	$	358,656	$	(94,715	)	$	(80	)		69	$	(394	)	$	263,648
Exercise of stock options		347		3		6,012		—			—			—		—			6,015
Comprehensive income:
Net income		—		—		—		8,343			—			—		—			8,343
Change in fair value of interest rate swaps, net of income tax expense		—		—		—		—			88			—		—			88

Total comprehensive income																			8,431

Balance, March 31, 2005		18,369	$	184	$	364,668	$	(86,372	)	$	8			69	$	(394	)	$	278,094