SUNLINK HEALTH SYSTEMS INC - Quarter Report: 2002 September (Form 10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

FORM 10-Q

For the quarterly period ended September 30, 2002

OR

For the transition period from _______________to _______________

Commission File Number 1-12607

     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 filings requirements for the past 90 days.

Yes [X]     No [  ]

     The number of Common Shares, without par value, outstanding as of November 8, 2002 was 4,997,592.

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SUNLINK HEALTH SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(in thousands, except per share amounts)
(unaudited)

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SUNLINK HEALTH SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

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SUNLINK HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED SEPTEMBER 30, 2002
(dollars in thousands)
(unaudited)

Note 1. – Basis of Presentation

The accompanying unaudited Condensed Consolidated Financial Statements as of and for the three months ended September 30, 2002 have been prepared in accordance with Rule 10-01 of Regulation S-X of the Securities and Exchange Commission and, as such, do not include all information required by accounting principles generally accepted in the United States of America. These Condensed Consolidated Financial Statements should be read in conjunction with the consolidated financial statements included in the SunLink Health Systems, Inc. (“SunLink” or the “Company”) Annual Report on Form 10-K for the fiscal year ended June 30, 2002, filed on September 16, 2002. In the opinion of management, the Condensed Consolidated Financial Statements, which are unaudited, include all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial position and results of operations for the periods indicated. The results of operations for the three months ended September 30, 2002 are not necessarily indicative of the results that may be expected for the entire fiscal year or any other interim period.

Note 2. – Business Operations and Corporate Strategy

SunLink operates six community hospitals and related businesses which were acquired on February 1, 2001. In the fiscal year ended March 31, 2001, SunLink redirected its business strategy toward the operation of community hospitals in the United States and away from European operations. On October 5, 2001, SunLink sold all of the capital stock of what was then its wholly owned United Kingdom housewares subsidiary, Beldray Limited (“Beldray”), ceasing its remaining non-U.S. business operations. See Note 4 - “Discontinued Operations.” In August 2001, the Company changed its name to SunLink Health Systems, Inc. from KRUG International Corp. and changed its fiscal year-end from March 31 to June 30.

Note 3. – Potential Acquisition with HealthMont, Inc.

On October 15, 2002, SunLink announced that it and a wholly owned subsidiary of SunLink had signed a definitive merger agreement to acquire all of the outstanding capital stock of HealthMont, Inc. (“HealthMont”), a privately held operator of community hospitals. Upon consummation of the transaction, SunLink is to acquire two community hospitals: Memorial Hospital of Adel, a 60-bed acute-care facility in Adel, Georgia, which includes a 95-bed nursing home, and Callaway Community Hospital, a 49-bed acute-care hospital in Fulton, Missouri. HealthMont currently operates another community hospital in San Benito, Texas, which is to be sold prior to the completion of the acquisition. Upon completion of the acquisition, the Company would operate eight community hospitals with a total of 442 beds.

Under the terms of the merger agreement, SunLink would issue to the shareholders of HealthMont up to 1,155,000 common shares of SunLink in consideration for all issued and outstanding capital stock of HealthMont. HealthMont currently has approximately 120 shareholders and approximately 6,248,000 HealthMont shares are expected to be outstanding immediately prior to closing. Accordingly, each HealthMont shareholder is expected to receive one common share of SunLink for each 5.4142 HealthMont shares (approximately 0.1847 of a common share of SunLink for each share of HealthMont).

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

In addition, SunLink would issue 95,000 common shares in connection with the transaction to settle certain contractual obligations of HealthMont to its officers and directors. SunLink would also become obligated to issue approximately 20,000 common shares upon exercise of outstanding HealthMont options, approximately 27,000 SunLink common shares upon exercise of outstanding HealthMont warrants and 75,000 SunLink common shares upon exercise of warrants to be issued by SunLink in connection with the financing of the transaction.

In connection with the transaction, SunLink also intends to assume up to a total of $9,800 in HealthMont senior debt and capital lease obligations, and enter into a $3,000, 3-year term loan intended primarily to provide additional working capital.

Based on the closing price of SunLink’s common shares of $2.36 on October 14, 2002, plus the amount of senior debt and capital lease obligations to be assumed, and including estimated transaction costs, the price to SunLink of the transaction would have been approximately $15,300. SunLink’s share price at the transaction closing date will be used to determine the actual transaction cost.

The HealthMont acquisition is expected to be completed in the first calendar quarter of 2003. Completion of the merger is subject to a number of conditions, including regulatory approvals, approval of the transaction by the shareholders of both SunLink and HealthMont and modification of the terms of HealthMont’s existing senior debt or availability to SunLink of alternative financing.

The unaudited net revenues of the two HealthMont facilities to be acquired through the merger were approximately $28,500, as reported by HealthMont for the twelve months ended June 30, 2002. SunLink does not plan to add any corporate staff or to significantly increase its overhead as a result of the acquisition. SunLink will not acquire HealthMont’s corporate staff and facilities in connection with the acquisition.

In connection with the proposed HealthMont acquisition, SunLink expects to assume approximately $9,800 of HealthMont senior debt, consisting of a senior credit facility of approximately $8,900 and capital leases, primarily for equipment, of approximately $900. Subject to a number of conditions, HealthMont obtained the consent of its senior lender to the proposed acquisition of HealthMont by SunLink and the modification of certain terms of HealthMont’s senior debt, including the principal repayment of $600 at the closing of the merger and an extension of the maturity date of the remaining debt through August 31, 2005. Post acquisition, the remaining senior debt is expected to be comprised of term loans of approximately $5,000 with interest at prime plus 2% per annum and revolving credit loans of approximately $3,900 with interest at prime plus 1 ½%. Upon completion of the merger, HealthMont’s senior lender would hold warrants to purchase 27,000 shares of SunLink’s common shares at an exercise price of $0.01 per share.

Certain HealthMont investors have arranged letters of credit which support up to $1,650 of HealthMont’s revolving credit loans. Subject to completion of the acquisition, SunLink has agreed, in the event the letters of credit are drawn and the proceeds reduce the outstanding balance of the revolving credit loans, to issue to those investors 350,000 of SunLink’s common shares in full satisfaction of HealthMont’s reimbursement obligations under the letters of credit.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

In connection with the proposed acquisition of HealthMont, SunLink intends to enter into a $3,000, 3-year secured term loan with a private investment fund. The proceeds of the loan will be used primarily for the repayment of $600 of HealthMont’s senior debt at closing, payment of certain transaction costs and for working capital. The loan will bear interest at 15% per annum and will require SunLink to pay certain fees to the investment fund. SunLink will also issue warrants to purchase 75,000 of its common shares to the investment fund at an exercise price of $0.01 per share.

Upon consummation of the acquisition, the board of directors of SunLink intends to elect Gene Burleson, a current HealthMont director, to the unexpired the term of Ronald J. Vannuki, who would step down from the Company’s board. SunLink also has agreed to nominate Mr. Burleson for election by its shareholders to a two-year term on its board of directors at its 2003 Annual Meeting.

Note 4. – Discontinued Operations

Housewares Segment – SunLink sold its U.K. housewares subsidiary, Beldray, on October 5, 2001 for nominal consideration. During the three months ended September 30, 2001, a gain from discontinued operations of $254 related to the disposal of the housewares segment was reported. The gain resulted from realized currency gains on certain transactions and adjustments to the foreign currency translation adjustment component of SunLink’s shareholders’ equity related to the housewares segment. During the three months ended June 30, 2001, SunLink reported a charge to discontinued operations relating to Beldray of $3,989. The charge was composed of losses from operations of $2,433 (including an asset impairment provision of $2,088 to reduce the carrying value of Beldray’s net assets to net realizable value of $0) and a loss on disposal of Beldray of $1,556, including $687 for operating losses through the disposal date. Revenues of Beldray were $6,098 for the three months ended September 30, 2001.

Noncurrent liabilities of discontinued operations at September 30, 2002 include $1,061 relating to the housewares segment which represents a reserve for a portion of a guarantee by a U.K. subsidiary of SunLink with respect to Beldray’s obligations under a lease covering a portion of Beldray’s manufacturing location. A currently inactive U.K. subsidiary of SunLink has an option to repurchase the capital stock of Beldray for nominal consideration if any U.K. subsidiary of SunLink is called upon to perform under the lease guarantee, or under certain other conditions.

Industrial Segment – In fiscal 1989, SunLink discontinued the operations of its industrial segment and subsequently disposed of substantially all related net assets. However, obligations may remain relating to product liability claims for products sold prior to the disposal. Noncurrent liabilities of discontinued operations at September 30, 2002 and June 30, 2002 of $589 and $637, respectively, relate to the industrial segment.

Over the past thirteen years SunLink has discontinued operations carried on by its former industrial, U.K. leisure marine, life sciences and engineering, and U.K. child safety segments, as well as the U.K. housewares segment. Reserves for losses relating to discontinued operations of these segments represent SunLink’s best estimate of the possible liability for property, product liability, and other claims for which it may incur liability. These estimates are based on SunLink’s judgments using currently available information as well as, in certain instances, consultation with its insurance carriers and legal counsel. SunLink historically has purchased insurance policies to reduce certain of its product liability exposure and may continue to

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

purchase such insurance if available at commercially reasonable rates. While SunLink has based its estimates on its evaluation of available information it is not possible to predict with certainty the ultimate outcome of many contingencies relating to discontinued operations. SunLink intends to adjust its estimates of the reserves as additional information is developed and evaluated. However, management believes that the final resolution of these contingencies will not have a material adverse impact on the financial position, cash flows, or results of operations of SunLink.

Note 5. – Recent Accounting Pronouncements

In August 2001, the FASB issued SFAS No. 144, Impairment or Disposal of Long-Lived Assets. The provisions of this statement provide a single accounting model for the impairment or disposal of long-lived assets. As required by SFAS No. 144, SunLink adopted this new accounting standard on July 1, 2002. During the quarter ended September 30, 2002, there was no impact of adopting SFAS No. 144 reflected in the Company’s financial statements, however SunLink continues to review the impact of the standard on its long-lived assets, in particular the current facility for Mountainside Medical Center in Jasper, Georgia where a replacement hospital is currently being constructed.

In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 requires the recording of costs associated with exit or disposal activities at their fair values when a liability has been incurred. Under previous guidance, certain exit costs were accrued upon management’s commitment to an exit plan, which is generally before an actual liability has been incurred. SFAS No. 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002.

Note 6. – Long-Term Debt

In connection with the acquisition of SunLink’s six existing hospitals, SunLink Healthcare Corp. (“SHC”), a wholly owned subsidiary of the Company, issued an 8.5% senior subordinated note in the face amount of $17,000 and a senior subordinated zero coupon note in the face amount of $2,000, both to the seller. The senior subordinated note is due on January 31, 2006 with interest payable semiannually either in cash or additional promissory notes through February 1, 2003 and in cash thereafter. Additional promissory notes of $1,999 for interest from February 1, 2001 through May 31, 2002 have been issued and the accrued interest payable at September 30, 2002 of $538 is included in the senior subordinated note. The stated interest rate of 8.5% on the senior subordinated note was considered a below-market interest rate at the date of issuance, therefore,

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

the note was discounted to estimated market value at an effective interest rate of 12.3%. The original discount recorded on the senior subordinated note was $2,809.

The purchase agreement for the six hospitals includes a provision for a potential adjustment to the senior subordinated note to the extent working capital at the purchase date is determined to be greater or less than an agreed-upon amount. SunLink has proposed a working capital adjustment which would reduce the balloon note by $1,000. The seller has not agreed to the adjustment and SunLink and the seller currently are seeking to conclude the working capital adjustment under the dispute resolution provisions of the purchase agreement. No adjustment for any working capital settlement has been made to the balloon note at September 30, 2002.

The senior subordinated zero coupon note is due January 31, 2004. The interest rate on the senior subordinated zero coupon note was considered less than the market rate at the date of issuance, therefore, the note was discounted to an estimated market interest rate of 11.3%. The original issue discount on the senior subordinated zero coupon note was $594.

The discounts on the long-term debt were determined by SunLink in consultation with its financial advisor based on high-yield debt instruments of similar health care providers and are being amortized over the term of the related debt instrument using the effective interest method. For the three months ended September 30, 2002 and 2001, SunLink recognized amortization expense on the discounts of $172 and $126, respectively.

The loan agreement pursuant to which the senior subordinated note and the senior subordinated zero coupon note were issued requires that SHC grant to the lender a security interest in and mortgage on collateral consisting of SHC and its subsidiaries’ real and personal property, unless SHC has outstanding senior indebtedness that meets certain conditions. The senior subordinated note and the senior subordinated zero coupon note presently are not collateralized. Each of the individual hospital subsidiaries of SHC is a guarantor of these notes. Further, these notes are subordinate in payment and collateral to all defined senior indebtedness of SHC which in the aggregate does not exceed $15,000, other than debt incurred in connection with certain future acquisitions.

On January 4, 2002, SunLink entered into a $14,000 credit facility comprised of a 36-month secured revolving line of credit for up to $8,000 with interest at prime plus 1.25% and a $6,000 secured term loan repayable over 66 months at an interest rate of 9.78%. The availability of borrowings under the revolving credit facility is based upon, among other things, a borrowing base keyed to the level of SHC receivables which, based upon the Company’s estimates, provides borrowing capacities of approximately $8,000 at September 30, 2002. The revolving credit facility is secured by the patient accounts receivable of SHC. No amount was outstanding on the revolving credit facility at September 30, 2002. The net proceeds from the term loan of $5,800 are being used for working capital and to fund a portion of SunLink’s hospital capital projects which include a new replacement hospital in Jasper, Georgia, and a new emergency room at its hospital in Ellijay, Georgia. The term loan is secured by liens on the real and personal property, except for patient accounts receivables, as well as the capital stock owned by SHC and its subsidiaries. Also, each of the hospital subsidiaries is a guarantor of the loan.

On September 30, 2002, SunLink entered into a $6,000 secured bank financing facility in connection with its Mountainside Medical Center replacement hospital currently under construction in Jasper, Georgia. The replacement hospital is scheduled to open in May 2003. This financing facility includes a construction loan of up to $6,000 with interest at prime plus 1% per annum. SunLink has funded the construction costs from the term loan and internal funds.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

SunLink expects to fund additional construction costs from availability under its revolving credit agreement and expects funding under the construction loan to commence during its third fiscal quarter ending March 31, 2003.

The financing facility also includes a 20-year mortgage loan with interest at prime plus 1% per annum or, at SunLink’s option, interest at the 5-year U.S. Treasury Constant Maturity Yield plus 3 ½%. The mortgage loan interest rate is adjustable every 5 years. The construction loan may be converted to a 20-year mortgage loan three months after completion of construction, subject to certain conditions. The financing facility requires SunLink to comply with certain conditions and covenants including hospital financial and operational covenants, information requirements and limitations on secured debt by the hospital subsidiary.

Note 7. – Comprehensive Earnings (Loss)

Comprehensive earnings (loss) for SunLink includes foreign currency translation and minimum pension liability adjustments. Total comprehensive earnings (loss) for the following periods was as follows:

Note 8. – Contingencies

As discussed in Note 4 – “Discontinued Operations”, a U.K. subsidiary of SunLink remains contingently liable as guarantor of Beldray’s obligations under a lease covering a portion of Beldray’s manufacturing location.

Reserves relating to discontinued operations represent management’s best estimates of possible liability for the contingent liabilities of discontinued operations. While SunLink has based its estimates on its evaluation of available information, it is not possible to predict with certainty the ultimate outcome of many contingencies relating to discontinued operations. SunLink intends to adjust its estimates of the reserves as additional information is developed and evaluated. However, management believes that the final resolution of these contingencies will not have a material adverse impact on the financial position, cash flows, or results of operations of SunLink.

As of September 30, 2002, SunLink had future commitments for capital expenditures relating to the new Jasper, Georgia hospital of approximately $10,300 and for the new emergency room at the North Georgia Medical Center in Ellijay, Georgia, of approximately $1,400. Subject to internal approval of specific capital items and the availability of funds, SunLink expects to spend approximately $1,750 in additional capital expenditures during the remaining nine months of the fiscal year ended June 30, 2003, primarily for new and replacement equipment.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

SunLink is a party to claims and litigation incidental to its business, as to which it is not currently possible to determine the ultimate liability, if any. Based on an evaluation of information currently available and consultation with legal counsel, management believes that resolution of such claims and litigation is not likely to have a material effect on the financial position, cash flows, or results of operations of SunLink.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
(dollars in thousands, except per share and admissions data)

Recent Developments

     On October 15, 2002, SunLink announced that it and a wholly owned subsidiary of SunLink signed a definitive merger agreement to acquire all of the outstanding shares of HealthMont, Inc. (“HealthMont’), a privately held operator of community hospitals. Upon consummation of the transaction, SunLink would acquire two community hospitals: Memorial Hospital of Adel, a 60-bed acute-care facility in Adel, Georgia, which includes a 95-bed nursing home, and Callaway Community Hospital, a 49-bed acute-care hospital in Fulton, Missouri. HealthMont currently operates another community hospital in San Benito, Texas, which is to be sold prior to the acquisition. Upon completion of the acquisition, SunLink would operate eight community hospitals with a total of 442 beds.

     Based on the closing price of SunLink’s common shares of $2.36 on October 14, 2002, plus the amount of senior debt and capital lease obligations to be assumed and including estimated transaction costs, the price of the transaction would be approximately $15,300. SunLink’s share price at the transaction closing date will be used to determine the actual transaction cost.

     Under the terms of the merger agreement, we are to issue to the shareholders of HealthMont up to 1,155,000 of SunLink common shares in consideration for all issued and outstanding stock of HealthMont. HealthMont currently has approximately 120 shareholders and expects to have approximately 6,248,000 shares outstanding immediately prior to closing. Accordingly, each HealthMont shareholder is expected to receive one SunLink common share for each 5.4142 HealthMont shares (approximately 0.1847 of a SunLink common share for each share of HealthMont).

     SunLink is to issue 95,000 additional SunLink common shares in connection with the transaction to settle certain contractual obligations of HealthMont to its officers and directors. We will also reserve for issuance approximately 20,000 common shares in connection with certain outstanding HealthMont options, approximately 27,000 common shares to be issued upon exercise of outstanding HealthMont warrants and 75,000 common shares to be issued upon exercise of warrants which we will issue in connection with the financing of the transaction.

     In connection with the transaction, we will also assume up to $9,800 in HealthMont senior debt and capital lease obligations, and enter into a $3,000, 3-year term loan intended primarily to provide additional working capital.

     The acquisition of HealthMont is expected to close in the first calendar quarter of 2003. Completion of the merger is subject to a number of conditions, including regulatory approvals, approval of the transaction by shareholders of both SunLink and HealthMont and modification of the terms of HealthMont’s existing senior debt or the availability to SunLink of alternative financing.

     The unaudited net revenues of the two HealthMont facilities to be acquired through the merger were approximately $28,500, as reported by HealthMont for the twelve months ended June 30, 2002. HealthMont reported unaudited EBITDA (earnings before interest, taxes, depreciation and amortization) of approximately $3,000 for the twelve months ended June 30, 2002 for the two facilities to be acquired. HealthMont’s corporate staff and facilities will not be acquired in connection with the acquisition and we do not plan to add any corporate staff or to significantly increase our overhead as a result of our proposed acquisition of HealthMont.

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Financial Summary

Results of Operations

     All of our net revenues relate to our U.S. community hospital segment which was acquired February 1, 2001. The operations of our former U.K. housewares business segment, which was disposed of on October 5, 2001, are reported in discontinued operations for the three months ended September 30, 2001.

     Our U.S. community hospital segment reported aggregate net revenues of $23,801, a total of 4,662 equivalent admissions and revenues per equivalent admission of $5,105 for the quarter ended September 30, 2002 compared to net revenues of $21,549, a total of 4,067 equivalent admissions and revenues per equivalent admission of $5,299 for the three months ended September 30, 2001. The 10.4% increase in net revenues in the current year was due to the 14.6% increase in equivalent admissions. Total surgeries increased 9.7% in the current year. We added 13 net new doctors during the year ended June 30, 2002 and six net new doctors during the three months ended September 30, 2002. We also have expended approximately $4,300 for capital expenditures to upgrade services and facilities since the acquisition on February 1, 2001. We believe the upgraded services and facilities and the new doctors contributed to the 10.4% increase in net revenues for the quarter ended September 30, 2002 compared to the same period last year. We continue to seek increased equivalent admissions by attracting additional physicians to our hospitals, further upgrading the services offered by the hospitals and improving the hospitals’ physical facilities. The source of the increase in the current year’s net revenues was primarily Medicare and Medicaid payors while net revenues from commercial and private payors were relatively unchanged. Net outpatient service revenues for the quarter ended September 30, 2002 were $12,001 or 50.4% of total net revenues, an increase of 12.4% from the quarter ended September 30, 2001 which included net outpatient service revenues of $10,673 or 49.5% of total net revenues.

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     The following table sets forth the percentage of net patient revenues from various payors in the Company’s hospitals for the periods indicated:

     Operating expenses, including depreciation, were $22,526 and $21,465 for the quarters ended September 30, 2002 and 2001, respectively.

     Most operating expense categories decreased as a percentage of net revenues in the current year due to the increased net revenues and efforts to control costs in the hospitals. Salaries, wages and benefits expense decreased as a percentage of net revenues for the current quarter due to cost control initiatives undertaken in each facility to reduce labor costs. The provision for bad debts was 11.7% of net revenues in the quarter, a decrease of 1.4% of net revenues from the prior year due to improved collections and increased Medicare and Medicaid net revenues as a percentage of total net revenues. Improved collections were facilitated by the hospitals implementing additional business office systems and procedures designed to minimize bad debts. Supplies expense increased slightly as a percentage of net revenues in the current year due to the 9.7% increase in total surgeries. The increase in other operating expenses as a percent of net revenue in the current year reflects increased physician guarantee expense in the current year resulting from the 19 net new physicians recruited during the last 15 months and increased insurance expense.

     Interest expense was $749 and $709 for the three months ended September 30, 2002 and 2001, respectively. This increase in the current year was due to our increased debt level resulting from the term loan closed on January 4, 2002 and the increasing principal balance of the senior subordinated debt due to the interest paid in kind. Cash interest paid during the three months ended September 30, 2002 was $138, including $87 of interest capitalized in property, plant and equipment.

     We recorded income tax expense of $92, $50 federal and $42 for state, for the three months ended September 30, 2002. We had a U.S. net operating loss carryforward of approximately $6,300 at September 30, 2002. Use of this net operating loss carryforward is subject to the limitations of the provisions of Internal Revenue Service Code Section 382. As a

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result, not all of the net operating loss carryforward is useable to offset federal taxable income in the current year and federal income tax expense results. We have provided a valuation allowance for the entire amount of our deferred tax assets (the majority of which is the U.S. net operating loss carryforward) as it is our assessment based upon the criteria identified in SFAS No. 109 that it is currently more likely than not that none of the deferred tax asset will be realized through future taxable earnings or implementation of tax planning strategies. We recorded no income tax expense in the three months ended September 30, 2001 due to the loss before tax for such prior period.

Liquidity and Capital Resources

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Contractual Obligations

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Impact of Potential Acquisition of HealthMont on Liquidity and Capital Resources

Certain Cautionary Statements

General Business Conditions

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Operational Factors

Liabilities, Claims and Obligations

Regulation and Governmental Activity

Acquisition Related Matters

Critical Accounting Policies and Estimates

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of America. These Condensed Consolidated Financial Statements should be read in conjunction with the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2002, filed with the SEC on September 16, 2002. In the opinion of management, the Condensed Consolidated Financial Statements as of and for the three months ended September 30, 2002, which are unaudited, include all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial position and results of operations for the periods indicated. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from these estimates under different assumptions or conditions.

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and private programs could significantly impact the estimates used to provide the allowance for doubtful accounts.

Recent Accounting Pronouncements

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current facility for Mountainside Medical Center in Jasper, Georgia where a replacement hospital is currently being constructed.

Related Parties

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

ITEM 4. EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

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PART II. OTHER INFORMATION

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

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SIGNATURES

Dated: November 12, 2002

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CERTIFICATION OF CHIEF EXECUTIVE OFFICER
OF SUNLINK HEALTH SYSTEMS, INC.

     I, Robert M. Thornton, Jr., President and Chief Executive Officer of SunLink Health Systems, Inc., certify that:

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CERTIFICATION OF CHIEF FINANCIAL OFFICER
OF SUNLINK HEALTH SYSTEMS, INC.

     I, Joseph T. Morris, Chief Financial Officer of SunLink Health Systems, Inc., certify that:

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