| SUNLINK HEALTH SYSTEMS INC Item 1A Risk Factors In addition to other information contained in this Annual Report, including certain cautionary and forward-looking statements, you should carefully consider the following factors in evaluating an investment in SunLink: SunLink has a limited operating history in the community hospital business and a limited history of profitability |
| Prior to February 1, 2001, SunLink operated in different business segments |
| SunLink had income from continuing operations of dlra4cmam181 for the fiscal year ended June 30, 2006, dlra4cmam383 for the fiscal year ended June 30, 2005 and dlra1cmam560 for the fiscal year ended June 30, 2003 |
| Conversely, SunLink had losses from continuing operations of dlra1cmam267 for the fiscal year ended June 30, 2004, dlra2cmam080 for the fiscal year ended June 30, 2002, dlra319 for the three month transitional period ended June 30, 2001, dlra881 for the fiscal year ended March 31, 2001, and dlra937 for the fiscal year ended March 31, 2000, respectively |
| SunLink may experience operating losses from continuing operations in the future |
| SunLink’s growth strategy depends in part on making successful acquisitions via mergers or otherwise which may expose SunLink to new liabilities |
| As part of its growth strategy, SunLink will seek further growth through acquisitions, via mergers or otherwise, of community hospitals to stay competitive with its increasingly larger competitors or to enhance its position in its core areas of operation |
| This strategy entails risks that could negatively affect SunLink’s results of operations or financial condition |
| These risks include: • unidentified liabilities of the companies SunLink may acquire or merge with; • the possible inability to successfully integrate and manage acquired operations and personnel; • the potential failure to achieve the economies of scale or synergies sought; and • the diversion of management’s attention away from other ongoing business concerns |
| Acquired businesses may have unknown or contingent liabilities, including liabilities for failure to comply with health care laws and regulations |
| Although SunLink has policies which require acquired facilities to implement SunLink compliance standards, and generally will seek indemnification from prospective sellers covering these matters, SunLink may become liable for past activities of acquired businesses |
| Significant capital investments may be required to achieve SunLink’s operational and growth plans, which may affect SunLink’s competitive position, reduce earnings, and negatively affect the value of your SunLink common stock |
| SunLink’s growth plans require significant capital investments |
| Significant capital investments are required for on-going and planned capital improvements at existing hospitals and may be required in connection with future capital projects either in connection with existing properties or future acquired properties |
| SunLink’s ability to make capital investments depends on numerous factors such as the availability of funds from operations and its credit facility and access to additional debt and equity financing |
| No assurance can be given that the necessary funds will be available |
| Moreover, incurrence of additional debt financing, if available, may involve additional restrictive covenants that could negatively affect SunLink’s ability to operate its business in the desired manner, and raising additional equity may be dilutive to shareholders |
| The failure to obtain funds necessary for the realization of SunLink’s growth plans could prevent SunLink from realizing its growth strategy and, in particular, could force SunLink to forego acquisition opportunities that may arise in the future |
| This could, in turn, have a negative impact on SunLink’s competitive position |
| One element of SunLink’s business strategy is expansion through the selective acquisitions of community hospitals in selected markets |
| The competition to acquire hospitals in the markets that SunLink targets is significant, and SunLink may not be able to make suitable acquisitions on terms favorable to it if other health-care companies, including those with greater financial resources, are competing for the same businesses |
| In order to make future acquisitions SunLink may be required to 22 ______________________________________________________________________ incur or assume additional indebtedness |
| SunLink may not be able to obtain financing, if necessary, for any acquisitions that it might desire to make or it might be required to borrow at higher rates and on less favorable terms than its competitors |
| Many states have enacted or are considering enacting laws affecting sales, leases or other transactions in which control of not-for-profit hospitals is acquired by for-profit corporations |
| These laws, in general, include provisions relating to state attorney general approval, advance notification and community involvement |
| In addition, state attorneys general in states without specific legislation governing these transactions may exercise authority based upon charitable trust and other existing law |
| The increased legal and regulatory review of transactions involving the change of control of not-for-profit entities may increase the costs required, or limit SunLink’s ability, to acquire not-for-profit hospitals |
| SunLink’s success depends on its ability to maintain good relationships with the physicians at its hospitals and, if SunLink is unable to successfully maintain good relationships with physicians, admissions at SunLink hospitals may decrease and SunLink’s operating performance could decline |
| Because physicians generally direct the majority of hospital admissions and outpatient services, SunLink’s success is, in part, dependent upon the number and quality of physicians on the medical staffs of its hospitals, the admissions and referrals practices of the physicians at its hospitals, and its ability to maintain good relations with its physicians |
| Physicians at SunLink hospitals are generally not employees of the hospitals at which they practice and, in many of the markets that SunLink serves, most physicians have admitting privileges at other hospitals in addition to SunLink’s hospitals |
| If SunLink is unable to successfully maintain good relationships with physicians, admissions at SunLink hospitals may decrease and SunLink’s operating performance could decline |
| SunLink depends heavily on its senior and local management personnel, and the loss of the services of one or more of SunLink’s key senior management personnel or SunLink’s key local management personnel could weaken SunLink’s management team and its ability to deliver health care services |
| SunLink has been, and will continue to be, dependent upon the services and management experience of its executive officers |
| If any of SunLink’s executive officers were to resign their positions or otherwise be unable to serve, SunLink’s management could be weakened and operating results could be adversely affected |
| In addition, SunLink’s success depends on its ability to attract and retain managers at its hospitals and related facilities, on the ability of hospital-based officers and key employees to manage growth successfully, and on their ability to attract and retain skilled employees |
| SunLink has not had any material difficulties in attracting senior or local management and, to its knowledge, no key personnel intend to retire or terminate their employment with SunLink in the near future; however, if SunLink is unable to attract and retain affective local management, SunLink’s operating performance could decline |
| SunLink’s success depends on its ability to attract and retain qualified health care professionals, and a shortage of qualified health care professionals in certain markets could weaken our ability to deliver health care services |
| In addition to the physicians and management personnel whom SunLink employs, SunLink’s operations are dependent on the efforts, ability, and experience of other health care professionals, such as nurses, pharmacists and lab technicians |
| Nurses, pharmacists, lab technicians and other health care professionals are generally employees of each individual SunLink hospital |
| SunLink’s success has been, and will continue to be, influenced by its ability to attract and retain these skilled employees |
| A shortage of healthcare professionals in certain markets, the loss of some or all of its key employees or the inability to attract or retain sufficient numbers of qualified health care professionals could cause SunLink’s operating performance to decline |
| While SunLink has experienced occasional delays in the hiring of nurses, pharmacists, certain medical technicians and other healthcare professionals, or in obtaining healthcare professionals with the optimum level of experience or training desired, the material shortages that certain healthcare providers have faced in some markets, particularly in urban areas, to date have not been present in the community hospital markets served by SunLink |
| Accordingly, SunLink, as yet, has not had material difficulty in attracting required healthcare professionals |
| A significant portion of SunLink’s revenue is dependent on Medicare and Medicaid payments, and possible reductions in Medicare or Medicaid payments or the implementation of other measures to reduce reimbursements may reduce our revenues |
| A significant portion of SunLink’s revenues are derived from the Medicare and Medicaid programs, which are highly regulated and subject to frequent and substantial changes |
| SunLink derived approximately 80prca of its patient days and 62prca of its net patient revenues from the Medicare and Medicaid programs for the year ended June 30, 2006 |
| Previous legislative changes, including those enacted as part of the Balanced Budget Act of 1997, have resulted in, and future legislative changes 23 ______________________________________________________________________ may result in, limitations on and reduced levels of payment and reimbursement for a substantial portion of hospital procedures and costs |
| Future health care legislation or other changes in the administration or interpretation of governmental health care programs may have a material adverse effect on SunLink’s business, financial condition, results of operations or prospects |
| Revenue and profitability may be constrained by future cost containment initiatives undertaken by purchasers of health care services if SunLink is unable to contain costs |
| SunLink derived approximately 38prca of its net patient revenues for the fiscal year ended June 30, 2006 from private payors and other non-governmental sources who contributed approximately 20prca of SunLink’s patient days |
| SunLink’s hospitals have been affected by the increasing number of initiatives undertaken during the past several years by all major purchasers of health care, including (in addition to Federal and state governments) insurance companies and employers, to revise payment methodologies and monitor health care expenditures in order to contain health care costs |
| As a result of these initiatives, managed care organizations offering prepaid and discounted medical services packages represent an increasing portion of SunLink’s admissions, resulting in reduced hospital revenue growth nationwide |
| In addition, private payers increasingly are attempting to control health care costs through direct contracting with hospitals to provide services on a discounted basis, increased utilization review and greater enrollment in managed care programs such as health maintenance organizations and preferred provider organizations, referred to as PPOs |
| If SunLink is unable to contain costs through increased operational efficiencies and the trend toward declining reimbursements and payments continues, the results of its operations and cash flow will be adversely affected |
| SunLink’s revenues are heavily concentrated in Georgia which will make SunLink particularly sensitive to economic and other changes in the state of Georgia |
| Accordingly, any change in the current demographic, economic, competitive or regulatory conditions in the state of Georgia could have a material adverse effect on the business, financial condition, results of operations or prospects of SunLink |
| SunLink faces intense competition from other hospitals and health care providers which directly affect our revenues, profitability and market share |
| Although each of our hospitals operates in communities where they are currently the only general, acute care hospital, they do face competition from other hospitals, including larger tertiary care centers |
| Although these competing hospitals may be as far as 30 to 50 miles away, patients in these markets may migrate to these competing facilities as a result of local physician referrals, managed care plan incentives or personal choice |
| The health care business is highly competitive and competition among hospitals and other health care providers for patients has intensified in recent years |
| Some of these competing facilities offer services, including extensive medical research and medical education programs, which are not offered by SunLink’s facilities |
| Some of the competing hospitals are owned or operated by tax-supported governmental bodies or by private not-for-profit entities supported by endowments and charitable contributions which can finance capital expenditures on a tax-exempt basis and are exempt from sales, property, and income taxes |
| In some of these markets, SunLink’s hospitals also face competition from for-profit hospital companies which have substantially greater resources as well as other providers such as outpatient surgery and diagnostic centers |
| The intense competition from other hospitals and other health care providers directly affects SunLink’s revenues, profitability and market share |
| 24 ______________________________________________________________________ SunLink conducts business in a heavily regulated industry; changes in regulations or violations of regulations may result in increased costs or sanctions that could reduce revenue and profitability |
| The health care industry is subject to extensive Federal, state and local laws and regulations relating to: • licensure; • conduct of operations; • ownership of facilities; • addition of facilities and services; • confidentiality, maintenance, and security issues associated with medical records; • billing for services; and • prices for services |
| These laws and regulations are extremely complex and, in many instances, the industry does not have the benefit of significant regulatory or judicial interpretation of these laws and regulations, including in particular, Medicare and Medicaid antifraud and abuse amendments, codified in Section 1128B(b) of the Social Security Act and known as the “anti-kickback statute |
| ” This law prohibits providers and others from soliciting, receiving, offering or paying, directly or indirectly, any remuneration with the intent to generate referrals of orders for services or items reimbursable under Medicare, Medicaid, and other Federal health care programs |
| As authorized by Congress, the United States Department of Health and Human Services, or HHS, has issued regulations which describe some of the conduct and business relationships immune from prosecution under the anti-kickback statute |
| The fact that a given business arrangement does not fall within one of these “safe harbor” provisions does not render the arrangement illegal |
| However, business arrangements of health care service providers that fail to satisfy the applicable safe harbor criteria risk increased scrutiny by enforcement authorities |
| We have a variety of financial relationships with physicians who refer patients to our hospitals |
| We have contracts with physicians providing services under a variety of financial arrangements such as employment contracts and professional service agreements |
| We also provide financial incentives, including loans and minimum revenue guarantees, to recruit physicians into the communities served by our hospitals |
| The Health Insurance Portability and Accountability Act of 1996 broadened the scope of the fraud and abuse laws to include all health care services, whether or not they are reimbursed under a Federal program |
| In addition, provisions of the Social Security Act, known as the Stark Act, also prohibit physicians from referring Medicare and Medicaid patients to providers of a broad range of designated health services in which the physicians or their immediate family members have an ownership interest or certain other financial arrangements |
| In addition, SunLink’s facilities will continue to remain subject to any state laws that are more restrictive than the regulations issued under the Health Insurance Portability and Accountability Act of 1996, which vary by state and could impose additional penalties |
| In recent years, both Federal and state government agencies have announced plans for or implemented heightened and coordinated civil and criminal enforcement efforts |
| Government officials charged with responsibility for enforcing health care laws could assert that SunLink or any of the transactions in which the company or its subsidiaries or their predecessors is or was involved, are in violation of these laws |
| It is also possible that these laws ultimately could be interpreted by the courts in a manner that is different from the interpretations made by each company |
| A determination that either SunLink or its subsidiaries or their predecessors is or was involved in a transaction that violated these laws, or the public announcement that SunLink or its subsidiaries or their predecessors is being investigated for possible violations of these laws, could have a material adverse effect on SunLink’s business, financial condition, results of operations or prospects and SunLink’s business reputation could suffer significantly |
| The laws, rules, and regulations described above are complex and subject to interpretation |
| In the event of a determination that we are in violation of any of these laws, rules or regulations, or if further changes in the regulatory framework occur, our results of operations could be significantly harmed |
| 25 ______________________________________________________________________ SunLink’s hospitals and other health care facilities are subject to, and depend on, certificate of need laws which could affect their ability to operate profitably |
| All states in which SunLink currently owns hospitals have laws affecting acute care hospital facilities and services known as “certificate of need” laws |
| These states require prior approval for the acquisition of major medical equipment or the purchase, lease, construction, expansion, sale or closure of health care facilities, based on determination of need for additional or expanded facilities or services |
| The required approval is known generally as a certificate of need or CON A CON may be required for capital expenditures exceeding a prescribed amount, changes in bed capacity or services, and certain other matters |
| In addition, the elimination or modification of CON laws in states in which SunLink owns or in the future may own hospitals could subject its hospitals to greater competition making it more difficult to operate profitably |
| SunLink could be subject to claims related to discontinued operations and hospitals sold by our HealthMont subsidiary prior to its acquisition |
| Over the past seventeen years, SunLink has discontinued operations carried on by its former Mountainside Medical Center and its former industrial and life sciences and engineering segments, and UK child safety segments, leisure marine, and housewares segments |
| Prior to our acquisition of our HealthMont subsidiaries, HealthMont had sold two hospitals and it also disposed of one additional hospital as a condition to our acquisition of HealthMont |
| We also have disposed of one of our original hospitals |
| SunLink’s reserves relating to discontinued operations represent management’s best estimate of possible liability for property, product liability, and other claims for which SunLink may incur liability |
| These estimates are based on management’s judgments using currently available information as well as, in certain instances, consultation with SunLink’s insurance carriers and legal counsel |
| SunLink historically has purchased insurance policies to reduce certain product liability exposure and anticipates it will continue to purchase such insurance if available at commercially reasonable rates |
| While estimates have been based on the evaluation of available information, it is not possible to predict with certainty the ultimate outcome of many contingencies relating to discontinued operations |
| Furthermore, future events or evaluations could cause us to adjust existing reserves in connection with our operations |
| SunLink intends to adjust our estimates of required reserves from time to time as additional information is developed and evaluated |
| However, SunLink believes that the final resolution of known contingencies will not have a material adverse impact on its financial position, cash flows, or results of operations |
| We are subject to potential claims for professional liability, including claims based on the acts or omissions of third parties, which claims may not be covered by insurance |
| We are subject to potential claims for professional liability (medical malpractice), both in connection with our current operations, as well as acquired operations |
| To cover these claims, we maintain professional malpractice liability insurance and general liability insurance in amounts that we believe are sufficient for our operations, although some claims may exceed the scope or amount of the coverage in effect |
| The assertion of a significant number of claims, either within our self-insured retention (deductible) or individually or in the aggregate in excess of available insurance, could have a material adverse effect on our results of operations or financial condition |
| Premiums for professional liability insurance have increased substantially in recent times and we can not assure you that professional liability insurance will continue to be available on terms acceptable to us, if at all |
| The operations of our hospitals also depend on the professional services of physicians and other trained health care providers and technicians in the conduct of their respective operations, including independent laboratories and physicians rendering diagnostic and medical services |
| There can be no assurance that any legal action stemming from the act or omission of a third party provider of health care services, would not be brought against one of our hospitals or SunLink, resulting in significant legal expenses in order to defend against such legal action or to obtain a financial contribution from the third-party whose acts or omissions occasioned the legal action |
| SunLink may issue additional equity in the future which could dilute the value of shares of existing shareholders |
| SunLink’s working capital is limited to cash generated from operations and borrowings available under our dlra30cmam000 credit facility (of which approximately dlra20cmam000 is available to borrow at June 30, 2006) and our additional debt capacity is limited |
| Management and the board of directors of SunLink periodically have discussed the need to raise equity in the future and periodically have considered certain transactions which might be available to SunLink to raise equity |
| However, SunLink has not engaged any underwriter or placement agent with respect to any potential equity offering, nor has SunLink’s management made any specific proposal or recommendation to the SunLink board of directors with respect to the type of securities to be offered or of the price at which any securities might be offered |
| Such transactions might include one or more of the sale of common shares to outsiders, the offer to existing shareholders of the right to acquire additional shares, or the 26 ______________________________________________________________________ reduction in the exercise price of SunLink’s outstanding warrants to a level and on terms that would be expected to result in their immediate exercise |
| While the board of directors has not decided to effect any of these transactions at this time, it may do so in the future |
| Any of these transactions could result in dilution in the value of existing shares |
| Forward-looking statements in this annual report may prove inaccurate |
| This document contains forward-looking statements about SunLink that are not historical facts but, rather, are statements about future expectations |
| Forward-looking statements in this document are based on management’s current views and assumptions and may be influenced by factors that could cause actual results, performance or events to be materially different from those projected |
| These forward-looking statements are subject to numerous risks and uncertainties |
| Important factors, some of which are beyond the control of SunLink, could cause actual results, performance or events to differ materially from those in the forward-looking statements |
| These factors include those described above under “Risk Factors” and elsewhere in this report under “Forward-Looking Statements |