Summary of SUNLINK HEALTH SYSTEMS INC

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -

(dollars in thousands, except per share and admissions data)

Forward-Looking Statements

This Quarterly Report and the documents that are incorporated by reference in this Quarterly Report contain certain forward-looking statements within the meaning of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Forward-looking statements include all statements that do not relate solely to historical or current facts and may be identified by the use of words such as "may," "believe," "will," "expect," "project," "estimate," "anticipate," "plan" or "continue." These forward-looking statements are based on current plans and expectations and are subject to a number of risks, uncertainties and other factors which could significantly affect current plans and expectations and our future financial condition and results. These factors, which could cause actual results, performance and achievements to differ materially from those anticipated, include, but are not limited to:

General Business Conditions

• general economic and business conditions in the U.S., both nationwide and in the states in which we operate;

• the competitive nature of the U.S. community hospital, nursing home, homecare and specialty pharmacy businesses;

• demographic changes in areas where we operate;

• the availability of cash or borrowings to fund working capital, renovations, replacements, expansions and capital improvements at existing hospital facilities and for acquisitions and replacement hospital facilities;

• changes in accounting principles generally accepted in the U.S.; and,

• fluctuations in the market value of equity securities including SunLink common shares;

Operational Factors

• inability to operate profitability in one or more segments of the healthcare business;

• the availability of, and our ability to attract and retain, sufficient qualified staff physicians, management, nurses, pharmacists and staff personnel for our operations;

• timeliness and amount of reimbursement payments received under government programs;

• restrictions imposed by debt agreements;

• the cost and availability of insurance coverage including professional liability (e.g., medical malpractice) and general liability insurance;

• the efforts of insurers, healthcare providers, and others to contain healthcare costs;

• the impact on hospital services of the treatment of patients in lower acuity healthcare settings, whether with drug therapy or via alternative healthcare services, such as surgery centers or urgent care centers;

• changes in medical and other technology;

• risks of changes in estimates of self insurance claims and reserves;

• increases in prices of materials and services utilized in our hospital and pharmacy operations;

• increases in wages as a result of inflation or competition for management, physician, nursing, pharmacy and staff positions;

• increases in the amount and risk of collectibility of accounts receivable, including deductibles and co-pay amounts; and,

• the functionality or costs with respect to our management information system for our hospitals, including both software and hardware;

• the availability and competition from alternative drugs or treatments provided by our specialty pharmacy segment;

Liabilities, Claims, Obligations and Other Matters

• claims under leases, guarantees and other obligations relating to discontinued operations, including sold facilities, retained or acquired subsidiaries and former subsidiaries;

• potential adverse consequences of known and unknown government investigations;

• claims for product and environmental liabilities from continuing and discontinued operations;

• professional, general and other claims which may be asserted against us; and

• weather-related events such as flooding, wind damage and population evacuations affecting areas in which we operate, including Louisiana and South Georgia.

Regulation and Governmental Activity

• existing and proposed governmental budgetary constraints;

• the regulatory environment for our businesses, including state certificate of need laws and regulations, rules and judicial cases relating thereto;

• anticipated adverse changes in the levels and terms of government (including Medicare, Medicaid and other programs) and private reimbursement for SunLink's healthcare services including the payment arrangements and terms of managed care agreements;

• changes in or failure to comply with Federal, state or local laws and regulations affecting the healthcare industry including healthcare reform proposals currently being debated in Congress; and,

• the possible enactment of Federal healthcare reform laws or reform laws in states where we operate hospital and pharmacy facilities (including Medicaid waivers and other reforms);

Acquisition Related Matters

• the availability and terms of capital to fund additional acquisitions or replacement facilities;

• impairment or uncollectibility of certain acquired assets;

• assumed liabilities discovered subsequent to an acquisition;

• our ability to integrate acquired healthcare businesses and implement our business strategy; and

• competition in the market for acquisitions of hospitals and healthcare businesses.

As a consequence, current plans, anticipated actions and future financial condition and results may differ from those expressed in any forward-looking statements made by or on behalf of SunLink. You are cautioned not to unduly rely on such forward-looking statements when evaluating the information presented in this Form 10-Q. We have not undertaken any obligation to publicly update or revise any forward-looking statements.

Corporate Business Strategy

SunLink's business strategy is to focus its efforts on internal growth of its existing healthcare facilities and its pharmacy business, supplemented by growth from selected rural and exurban healthcare acquisitions, including but not limited to hospitals, nursing homes, home care businesses, and pharmacy businesses. However, as was the case in 2004 with the sale of our Mountainside Medical Center hospital and in September 2009 with the sale of three home health agencies, we do consider disposition of one or more of our facilities or operations based on a variety of factors including asset values, return on investments, competition from existing and potential facilities and capital improvement needs and other corporate objectives. We likewise evaluate our strategic alternatives on an on-going basis.

Our operational strategy is focused on efforts to increase internal growth. Our primary operational strategy for our community hospitals is to improve the profitability of such hospitals by reducing out-migration of patients, recruiting physicians, expanding services and implementing and maintaining effective cost controls. Our operational strategy for our nursing homes and home health agency is similar to that for our community hospitals and is focused on marketing services and implementing and maintaining effective cost controls.

Finally, our operational strategy for our specialty pharmacy segment is focused on continuing the integration of the Carmichael operations acquired in April 2008, increasing collection efforts, marketing services and implementing and maintaining effective cost controls.

Critical Accounting Estimates

The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires us to make estimates and assumptions that affect reported amounts and related disclosures. We consider an accounting estimate to be critical if:

• it requires assumptions to be made that were uncertain at the time the estimate was made; and

• changes in the estimate or different estimates that could have been made could have a material impact on our consolidated results of operations or financial condition.

Our critical accounting estimates are more fully described in our 2009 Annual Report on Form 10-K and continue to include the following areas:

• Receivables - net and provision for doubtful accounts;

• Revenue recognition / Net Patient Service Revenues;

• Goodwill and accounting for business combinations;

• Professional and general liability claims; and

• Accounting for income taxes.

Financial Summary

The results of continuing operations shown in the financial summary below are for our two business segments, Healthcare Facilities and Specialty Pharmacy.

                                                                 THREE MONTHS ENDED
                                                                   September 30,
                                                        2009            2008          % Change
Net Revenues - Healthcare Facilities                  $  37,493       $  37,067            1.1 %
Net Revenues - Specialty Pharmacy                        10,332           9,611            7.5 %

Total Net Revenues                                       47,825          46,678            2.5 %
Costs and expenses                                      (48,119 )       (46,600 )          3.3 %
Gain on sale of Home Health businesses                    2,342              -             N/A

Operating profit                                          2,048              78         2525.6 %
Interest expense                                           (967 )        (1,254 )        -22.9 %
Interest income                                              51               7          628.6 %

Earnings (Loss) from continuing operations before
income taxes                                          $   1,132       $  (1,169 )          N/A


Healthcare Facilities Segment:
Admissions                                                1,850           2,095          -11.7 %
Equivalent admissions                                     6,423           6,123            4.9 %
Surgeries                                                   961             983           -2.2 %
Revenue per equivalent admission                      $   5,837       $   6,054           -3.6 %

Equivalent admissions - Equivalent admissions is used by management (and certain investors) as a general measure of combined inpatient and outpatient volume for our hospital operations. Equivalent admissions are computed by multiplying admissions (inpatient volume) by the sum of gross inpatient revenues and gross outpatient revenues and dividing the result by gross inpatient revenues. The equivalent admissions computation is intended to relate outpatient revenues to the volume measure (admissions) used to measure inpatient volume to result in a general approximation of combined inpatient and outpatient volume (equivalent admissions).

Results of Operations

Our net revenues are from our two business segments, healthcare facilities and specialty pharmacy.

Healthcare Facilities Segment

Net revenues for the quarter ended September 30, 2009 were $37,493 with a total of 6,423 equivalent admissions and revenue per equivalent admission of $5,837 compared to net revenues of $37,067 with a total of 6,123 equivalent admissions and revenue per equivalent admission of $6,054 for the quarter ended September 30, 2008.

The following table sets forth the percentage of net patient revenues from major payor sources for the Company's hospitals during the periods indicated:

                                                Three Months Ended
                                                  September 30,
                                               2009           2008
               Source
               Medicare                          37.6 %         40.8 %
               Medicaid                          15.5 %         14.0 %
               Self pay                          14.0 %         12.6 %
               Commercial Insurance & Other      32.9 %         32.6 %

                                                100.0 %        100.0 %

The increase in net revenues was primarily due to increases in Medicaid and self-pay net revenues. Net Medicaid revenues increased $623, a 12.0% increase from last year to $5,810 for the three months ended September 30, 2009 and increased to 15.5% of net revenues from 14.0% last year. Self-pay revenues increased $592, a 12.7% increase from last year to $5,249 for the three months ended September 30, 2009. Medicaid revenue increased in the current quarter as compared to the prior year's quarter due partially to more patients applying and qualifying for Medicaid coverage. Our healthcare facilities' have increased their efforts to assist such patients qualify for Medicaid. Additionally, with current economic conditions, more patients are in need of coverage and are meeting the criteria for Medicaid qualification. The increase in self-pay net revenues is due to higher self-pay admissions resulting from more uninsured patients, increased coinsurance and deductible amounts that insured person have to pay and overall decreased collections as a percentage of revenues. Commercial insurance and other net revenues remained relatively consistent with the prior year's quarter. Net Medicare revenues decreased $1,031, a 6.8% decrease from last year to $14,099 for the three months ended September 30, 2009 and decreased to 37.6% of net revenues from 40.8% last year. Management believes Medicare net revenues have decreased due to lower Medicare volumes resulting from patients deferring treatment until it is absolutely necessary.

Net revenue for the three months ended September 30, 2009 and 2008, included $437 and $431, respectively, from state indigent care programs. Net revenues included a decrease of $100 and an increase of $248 for the three months ended September 30, 2009 and 2008, respectively, for the settlements and filings of prior year Medicare and Medicaid cost reports.

We added seven net new doctors during the year ended June 30, 2009 and nine net new doctors during the three months ended September 30, 2009. During the three months ended September 30, 2009, SunLink expensed $226 on physician guarantees and recruiting expenses compared to $189 for the same period last year. We also have expended approximately $2,573 for capital expenditures to upgrade services and facilities since July 1, 2008.

We continue to seek increased patient volume by attracting additional physicians to our hospitals, upgrading the services offered by the hospitals on an as-needed basis and improving our hospitals' physical facilities based on the availability of capital resources and our assessment of expected return on capital.

Specialty Pharmacy Segment

Specialty Pharmacy net revenue for the three months ended September 30, 2009 was $10,332, an increase of $721, or 7.5%, from $9,611 for the three months ended September 30, 2008. The increase resulted from increased institutional pharmacy and durable medical equipment sales. The shipments of one seasonal infusion therapy product began late in the first quarter of fiscal 2010 while they began in second quarter in fiscal 2009.

Healthcare Facilities Segment Cost and Expenses

Costs and expenses for our Healthcare Facilities, including depreciation and
amortization, were $36,819 and $35,705 for the three months ended September 30,
2009 and 2008, respectively.



                                                    Costs and Expenses
                                                   As % of Net Revenues
                                                    Three Months Ended
                                                       September 30,
                                                   2009             2008
         Salaries, wages and benefits                46.6 %           47.4 %
         Provision for bad debts                     17.1 %           14.4 %
         Supplies                                    10.2 %            9.9 %
         Purchased services                           7.0 %            7.2 %
         Other operating expenses                    12.3 %           12.2 %
         Rent and lease expense                       1.9 %            1.9 %
         Depreciation and amortization expense        3.1 %            3.3 %

Salaries, wages and benefits expense as a percentage of net revenues decreased in the three months ended September 30, 2009 compared to the prior year due to decreased staffing demands in conjunction with lower volumes as well as lower employee benefits expense.

Provision for bad debts increased as a percentage of net revenue in the quarter ended September 30, 2009 compared to the prior year due to higher self-pay revenues, increased coinsurance and deductible amounts that insured persons have to pay and the overall increased aging of accounts receivable due to self pay receivables taking longer to collect that other payor source receivables. This overall increase in the aging of accounts receivable requires a higher allowance for bad debts. Self-pay revenues increased $592 or 12.7% in the quarter ended September 30, 2009.

Depreciation and amortization expense increased $48 for the three months ended September 30, 2009 compared to the comparable prior year period. The increase in the current year was due primarily to the approximately $2,573 of capital expenditures made since July 1, 2008.

Specialty Pharmacy Segment Cost and Expenses

Cost and expenses for our Specialty Pharmacy Segment, including depreciation and
amortization, were $10,041 and $9,365 for the three months ended September 30,
2009 and 2008, respectively.



                                                    Costs and Expenses
                                                   As % of Net Revenues
                                                    Three Months Ended
                                                       September 30,
                                                   2009             2008
         Cost of Goods Sold                          64.2 %           63.1 %
         Salaries, wages and benefits                17.1 %           17.8 %
         Provision for bad debts                      3.8 %            4.1 %
         Supplies                                     0.5 %            0.5 %
         Purchased services                           4.0 %            4.0 %
         Other operating expenses                     3.3 %            3.4 %
         Rent and lease expense                       0.6 %            0.7 %
         Depreciation and amortization expense        3.8 %            3.9 %

Cost of goods as a percent of net revenue increased in the three months ended September 30, 2009 as compared to the prior year due to sales product mix. Increased sales of one infusion therapy product and durable medical equipment, both of which have higher cost of sales as a percentage of revenue, resulted in the increased costs of goods sold during in the current year. Salaries, wages and benefits decreased as a percent of net revenue in the quarter ended September 30, 2009 as compared to the prior year due to the higher sales volume. The provision for bad debts as a percent of net revenues decreased slightly during the current year due primarily to collection of receivables that had been reserved for in prior quarters.

Corporate Overhead Costs and Expenses

Cost and expenses for Corporate Overhead including depreciation and amortization, was $1,259 and $1,530 for the three months ended September 30, 2009 and 2008, respectively. The decrease in the quarter ended September 30, 2009 was primarily due to lower stock option expense and $0 of strategic alternative expense in the current year's quarter compared to $92 in the same quarter of the prior year.

Operating Profit

SunLink had an operating profit of $2,048 and $78 for the three months ended September 30, 2009 and 2008, respectively. The increase in operating profit in the quarter ended September 30, 2009 compared to operating profit in the prior year was higher due to the pre-tax gain on the sale of three home health businesses during the current year's quarter.

Sale of Home Health Businesses

In September 2009, the Company sold three of its home health businesses for approximately $3,300 resulting in a pre-tax gain of approximately $2,342. Included in the net assets of the three home health businesses sold was $429 of goodwill related to the Healthcare Facilities Segment. The home health businesses were located in Adel, GA, Clanton, AL and Fulton, MO.

Interest expense was $967 and $1,254 for the three months ended September 30, 2009 and 2008, respectively. The decrease in fiscal years 2009 and 2008 interest expense resulted from the accrual of derivative interest expense of $310 recorded in the quarter ended September 30, 2008 related to the Carmichael acquisition. The former owners of Carmichael ('Sellers") received 334,448 common shares of SunLink as partial consideration for the SunLink's purchase of Carmichael in April 2008. SunLink was obligated to pay to the Sellers the difference between the market value at business sale date and the price per share received for any shares sold less $1.00 per share if these shares are sold within a year. The derivative interest expense of $310 for the three months ended September 30, 2008 resulted from the change in the calculated liability for the obligation. In March 2009, SunLink and the Sellers reached an agreement to cancel SunLink's share price guarantee in exchange for a one-year extension of a consulting agreement with one of the Sellers, assumption by SunLink of certain disputed pre-acquisition expenses that SunLink determined were the obligation of the Sellers, and payment by SunLink of certain post closing items.

Income tax expense of $583 ($526 federal tax expense and $57 state tax expense) and income tax benefit of $566 ($519 federal tax benefit and $47 state tax benefit) were recorded for the three months ended September 30, 2009 and 2008, respectively. The high effective income tax rate of 51.5% for the quarter ended September 30, 2009 resulted from the tax non-deductibility of $429 of goodwill included in the net assets of the home health businesses sold during the period.

We had an estimated net operating loss carry-forward for federal income tax purposes of approximately $6,300 at September 30, 2009. Use of this net operating loss carry-forward is subject to the limitations of the provisions of Internal Revenue Code Section 382. As a result, not all of the net operating loss carry-forward is available to offset federal taxable income in the current year. At September 30, 2009, we have provided a partial valuation allowance against the domestic deferred tax asset so that the net domestic tax asset was $3,901. Based upon management's assessment that it was more likely than not that a portion of its domestic deferred tax asset (primarily its domestic net operating losses subject to limitation) would not be recovered, the Company established a valuation allowance for the portion of the domestic tax asset which may not be utilized. The Company has provided a valuation allowance for the entire amount of the foreign tax asset as it is more likely than not that none of the foreign deferred tax assets will be realized through future taxable income or implementation of tax planning strategies.

Earnings from continuing operations were $549 ($0.07 earnings per fully diluted share) for the quarter ended September 30, 2009 compared to loss from continuing operations of $603 ($0.08 loss per fully diluted share) for the quarter ended September 30, 2008. Earnings from continuing operations in the current year's quarter increased from the prior year's quarter due to the sale of three of our home health agencies in September 2009.

Loss from discontinued operations of $53 for the quarter ended September 30, 2009 primarily resulted from $21 of losses attributable to our former Mountainside operations, $21 of losses attributable to our former KRUG UK operations (primarily legal expenses) and $11 of losses resulting from domestic pension items relating to discontinued operations. Loss from discontinued operations of $61 for the quarter ended September 30, 2008 resulted from $40 of losses from Mountainside and $11 of losses from KRUG UK, (primarily legal expenses), and $10 of losses resulting from domestic pension items relating to discontinued operations.

Net earnings for the quarter ended September 30, 2009 were $496 ($0.06 earnings per fully diluted share) compared to net loss of $664 ($0.08 loss per fully diluted share) for the quarter ended September 30, 2009.

Adjusted earnings before income taxes, interest, depreciation and amortization

Earnings before income taxes, interest, depreciation and amortization ("EBITDA") represent the sum of income before income taxes, interest, depreciation and amortization. We understand that certain industry analysts and investors generally consider EBITDA to be one measure of the liquidity of a company, and it is presented to assist analysts and investors in analyzing the ability of a company to generate cash, service debt and meet capital requirements. We believe increased EBITDA is an indicator of improved ability to service existing debt and to satisfy capital requirements. EBITDA, however, is not a measure of financial performance under

accounting principles generally accepted in the United States of America and should not be considered an alternative to net income as a measure of operating performance or to cash liquidity. Because EBITDA is not a measure determined in accordance with accounting principles generally accepted in the United States of America and is thus susceptible to varying calculations, Ebitda, as presented, may not be comparable to other similarly titled measures of other corporations. Where we adjust EBITDA for non-cash charges we refer to such measurement as "Adjusted EBITDA", which we report on a company wide basis. Non-cash adjustments in Adjusted EBITDA are not intended to be identified or characterized in any respect as "non-recurring, infrequent or unusual," if we believe such charge is reasonably likely to recur within two years, or if there was a similar charge (or gain) within the prior two years. Where we report Adjusted EBITDA, we typically also report Hospital Facilities Segment Adjusted EBITDA and Specialty Pharmacy Segment Adjusted EBITDA which is the EBITDA for the applicable segments without any allocation of corporate overhead, which we report as a separate line item, gains on sales of businesses and without any allocation of the non-cash adjustments, which we also report as a separate line item in Adjusted EBITDA. Net cash used in operations for the quarter ended September 30, 2009 and 2008, respectively, is shown below.

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