**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION****WASHINGTON, D.C. 20549**

_______________**FORM 10-K**_______________

| **(MarkOne)** |  |                                                                |
|---------------|--|----------------------------------------------------------------|
| ** **    |  |                                                                |
| **x**         |  | **ANNUAL REPORT PURSUANTTO SECTION 13 OR 15(d) OF**            |
|          |  | **THE SECURITIES EXCHANGEACT OF 1934**                         |
|          |  |                                                                |
|          |  | **For the fiscal yearended June 30, 2002**                     |
|          |  |                                                                |
|          |  | **OR**                                                         |
| ** **    |  |                                                                |
| **o**         |  | **TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF**        |
|          |  | **THE SECURITIES EXCHANGEACT OF 1934**                         |
|          |  |                                                                |
|          |  | **For the transitionperiod from ____________ to ____________** |

**Commission File Number: 333-71934**_______________

**VANGUARD HEALTH SYSTEMS, INC.******(Exact name of registrant as specified inits charter)

| **Delaware**                                                   |          | **62-1698183**                        |
|----------------------------------------------------------------|----------|---------------------------------------|
| *(Stateor other jurisdiction of incorporation ororganization)* | * * | *(I.R.S.Employer Identification No.)* |

**20 Burton Hills Boulevard, Suite 100Nashville, TN 37215**(Address and zip code of principalexecutive offices)**(615) 665-6000**(Registrant’s telephone number, includingarea code)

SecuritiesRegistered Pursuant to Section 12(b) of theAct:   None

SecuritiesRegistered Pursuant to Section 12(g) of theAct.   None

     Indicate by checkmark whether the registrant (1) has filed all reports required tobe filed under Section 13 or 15(d) of the Securities Exchange Actof 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90days.     Yesx   Noo

     Indicate by check mark if disclosureof delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of theregistrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-Kor any amendments to this Form10-K.     x

     There were 203,308shares of registrant’s common stock outstanding as ofSeptember 15, 2002 (all of which are privately owned and not tradedon a public market).

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**VANGUARD HEALTH SYSTEMS, INC.ANNUAL REPORT ON FORM 10-KTABLE OF CONTENTS**

| ** **         | ** ** |                                                                                                                                                         | ** ** | **Page** |
|--------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
| **PART I**         |       |                                                                                                                                                         |       |          |
| Item 1.            |       | **Business**......................................................................................                                                      |       |  1  |
| Item 2.            |       | **Properties**...................................................................................                                                       |            | 28       |
| Item 3.            |       | **LegalProceedings**.....................................................................                                                               |       | 28       |
| Item 4.            |       | **Submission of Matters to a Vote of SecurityHolders**.........                                                                                         |            | 28       |
| **PART II**   |       |                                                                                                                                                         |       |          |
| Item 5.            |            | **Marketfor Registrant’s Common Equity and Related StockholderMatters**.................................................................          |            | 29       |
| Item 6.            |       | **Selected FinancialData**............................................................                                                                  |       | 29       |
| Item 7.            |       | **Management’s Discussion and Analysis ofFinancial Condition and Results ofOperations**.....................................                      |       | 31       |
| Item 7A.           |            | **Quantitative and Qualitative Disclosures About MarketRisk**...............................................................................            |            | 47       |
| Item 8.            |            | **Financial Statements and SupplementaryData**...................                                                                                       |            | 47       |
| Item 9.            |            | **Changes in and Disagreements with Accountants on Accounting and FinancialDisclosure**...................................                              |            | 47       |
| **PART III**       |            |                                                                                                                                                         |            |          |
| Item 10.           |            | **Directors and Executive Officers of theRegistrant**............                                                                                       |            | 48       |
| Item 11.           |            | **ExecutiveCompensation**...........................................................                                                                    |            | 51       |
| Item 12.           |            | **Security Ownership of Certain Beneficial Ownersand Management**...............................................................................        |            | 53       |
| Item 13.           |            | **Certain Relationships and RelatedTransactions**................                                                                                       |            | 55       |
| **PART IV**        |            |                                                                                                                                                         |            |          |
| Item 14.           |            | **Exhibits, Financial Statement Schedules, and Reportson Form8-K**..................................................................................... |            | 62       |
| **SIGNATURES**     |       | .......................................................................................................                                                 |       | 65       |
| ** **         |       |                                                                                                                                                    |       |     |
| **CERTIFICATIONS** |            | .......................................................................................................                                                 |            | 66       |

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**Table of Contents**

**VANGUARDHEALTH SYSTEMS, INC.**

**PARTI**

**Item 1.   Business.**

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**CompanyOverview**

               We are an owner and operator of acute care hospitals and otherhealth care facilities principally in urban and suburbanmarkets.  We were incorporated in the State of Delaware inJuly 1997 and acquired our first hospital in 1998.  We havegrown steadily since 1998 through a series of acquisitions. As of June 30, 2002, we owned ten hospitals with a total of 2,207licensed beds and complementary outpatient service facilitiesproviding health care services to the following threemarkets:

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**               •  **metropolitan Phoenix,Arizona               •  metropolitan LosAngeles/Orange County, California               •  metropolitan Chicago,Illinois

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We also owned two healthplans:  a Medicaid managed health plan, Phoenix Health Plan,which served more than 68,500 members in Arizona as of June 30,2002; and MacNeal Health Providers which had responsibility for,under capitated contracts, approximately 54,000 member lives inmetropolitan Chicago, Illinois as of June 30, 2002.

               We selectively acquire hospitals where we identify an opportunityto improve operating performance and profitability and increasemarket share, either through a network of hospitals and othercomplementary health care facilities or a single well-positionedfacility.  We have financed our acquisitions with equitycapital provided by management and various funds controlled byMorgan Stanley Capital Partners and with debt.  During fiscalyear 2002, we acquired the assets of Paradise Valley Hospital, a162-bed acute care hospital located in Phoenix, Arizona, and LouisA. Weiss Memorial Hospital, a 369-bed acute care hospital locatedin Chicago, Illinois.  Concurrently with the acquisition ofLouis A. Weiss Memorial Hospital, our consolidated subsidiary whichpurchased the hospital issued 19.9% of its outstanding capitalstock to the University of Chicago Hospitals.  We own theremaining 80.1% of the consolidated subsidiary which owns Louis A.Weiss Memorial Hospital.

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               Our principal executive offices are located at 20 Burton HillsBoulevard, Suite 100, Nashville, Tennessee, 37215 and our telephonenumber at that address is (615) 665-6000.  Our corporatewebsite address is www.vanguardhealth.com.  Informationcontained on our website does not constitute part of this AnnualReport on Form 10-K.  The terms “we”,“our”, “the Company”, “us”,“registrant” and “Vanguard” as used in thisreport refer to Vanguard Health Systems, Inc. and its subsidiariesas a consolidated entity, except where it is clear from the contextthat such terms mean only Vanguard Health Systems, Inc. “Subsidiaries” means direct and indirect corporatesubsidiaries of Vanguard Health Systems, Inc. and partnerships,joint ventures and limited liability companies in which suchsubsidiaries are partners or members.

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**CompetitiveStrengths**

               *Diversified portfolio of assets with a broad range ofservices*.  We own and operate high-quality facilities inthree separate geographic markets, which diversifies our revenuebase and reduces our exposure to any one market.  Ourhospitals offer general acute care services, including intensivecare and coronary care units, radiology, orthopedic, oncology andoutpatient services and selected tertiary care services, includingopen-heart surgery and level II neonatal intensive care.  Indetermining the types of services we provide, we actively assessthe specific local needs of our communities.  We utilize ourindividual facilities or a network of integrated facilities in thearea to meet these needs.  We believe that our ability toleverage our network of facilities allows us not only to provide abroad range of services in a market, but also to provide them in anefficient and cost-effective manner.  For example, in ourmetropolitan Los Angeles/Orange County, California market, weconsolidated the obstetrics units at two hospitals into one. The combined unit was strengthened through increased patientvolumes, more efficient staffing, higher quality of care and loweroperating costs, while making additional space and resourcesavailable at the discontinued unit which we now use to provideother services.

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**Table of Contents**

               *Concentrated local market positions in attractivemarkets*.  Eight of our ten hospitals are located in themetropolitan Phoenix, Arizona, and metropolitan Los Angeles/OrangeCounty, California, markets.  We entered these markets becauseof their favorable demographics, competitive landscape, payer mixand potential for future complementary acquisitions andexpansion.  The U.S. Census Bureau estimates the populationfor these two markets to grow by 13.4% and 6.2%, respectively,between 2000 and 2005, rates that exceed the projected nationalaverage of 4.5%.  We have further strengthened our presence inthese markets through the acquisitions we have made and thenetworks of facilities we have formed.  Our acquisition ofParadise Valley Hospital in November 2001 has enabled us to broadenour delivery of health care services to the northeast region ofmetropolitan Phoenix.  We entered the metropolitan Chicago,Illinois, market by acquiring a single, well-positioned andhighly-regarded hospital (MacNeal Hospital) and a network ofprimary care centers in a market that has a favorable payerbase.  Moreover, in June 2002, we added a second facility inChicago (Louis A. Weiss Memorial Hospital) by acquiring an 80.1%interest in a distinguished community hospital linked to a leadingacademic medical center, and we are pleased that the health careaffiliate of the University of Chicago has chosen to remain ourjoint venture partner in this hospital.  These two hospitalsin the Chicago area offer us opportunities to improve further thequality and breadth of services being provided, as well as toreduce operating costs.

               *Proven ability to complete and integrate acquisitions*. As of June 30, 2002, we have successfully completed the acquisitionof ten hospitals and related complementary outpatient servicelocations and a prepaid Medicaid managed health plan.  Webelieve our success at completing acquisitions is due in large partto our disciplined approach to making acquisitions.  Before weacquire a facility we carefully review its financial results andoperating environment and develop a strategic plan that willconfirm the feasibility of improving its operatingperformance.  In identifying ways to achieve this improvement,we consider a variety of alternatives such as expanding services,reducing operating costs, upgrading or rationalizing informationsystems, implementing more efficient staffing, improving supplyarrangements and improving billing and collectionprocedures.

               *Strong management team with significant equityinvestment*.  Our senior management has an average of morethan 20 years of experience in the health care industry at variousorganizations, including OrNda Healthcorp and HCA, Inc. Almost all of our senior management has been with us since ourfounding in 1997, and twelve of our fifteen members of seniormanagement have worked together managing health care companies forup to twenty years, either continuously or from time to time. We believe that the experience and continuity of our managementteam greatly enhances the effective operation of the Company. Our senior management also has a history of success in managingprivate and publicly-owned hospital companies through periods ofrapid growth, operating turnaround and financialrestructuring.  As of June 30, 2002, senior management hasinvested over $23 million in the Company and owns more than 18% ofour outstanding shares of common stock.  We also rely onstrong local management teams at each of our facilities.  Ourlocal management teams work with our patients, physicians andpayers to identify the medical service needs of the localcommunities we serve and develop clinical programs and capitalexpenditure plans to meet those needs.  In addition, the localmanagement teams recruit physicians to our hospitals and directlysupervise the quality of patient care.

**BusinessStrategy**

               Our objective is to provide high-quality, cost-effective healthcare services in the communities we serve.  The followingrepresent key elements of our business strategy:

               *Grow Through Selective Acquisitions*.  We will continueto pursue acquisitions that either expand our network and presencein our existing markets or allow us to enter new urban or suburbanmarkets.   In evaluating potential acquisitions, we willcontinue to focus on several important factors including thefollowing:

               •  population growth               •  demographics               •  payer mix               •  existing competition               •  opportunities to improve financialperformance               •  opportunities to expand services

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Further, in entering a newmarket, we evaluate the opportunity to develop a local network ofhospitals through additional acquisitions within the market as wehave done in each of our current markets.  We believe that wewill continue to have substantial acquisition opportunities asother health care providers choose to divest facilities and asindependent hospitals, particularly not-for-profit hospitals, seekto capitalize on the benefits of becoming part of a larger hospitalcompany.  In addition to acquisitions, we will also evaluatethe possibility of constructing new facilities and pursuingstrategic partnerships or joint ventures with existing owners toexpand our existing market presence or enter new markets.  Weare currently constructing a new hospital in the western part ofmetropolitan Phoenix, Arizona, which will expand our presence in agrowing part of the Phoenix market that is currentlyunderserved.

               *Improve Operating Margins and Efficiency*.  We seek toposition ourselves as a cost-effective provider of health careservices in each of our markets.  As a result, we willcontinue to implement initiatives at each of our facilities tofurther improve the financial performance and operating efficiencyof their operations.  Some of our key initiativesinclude:

               •   selectively upgrading information systems toprovide more accurate and timely clinical and financial                   information or rationalizing legacy systems to provide informationon a more cost-effective basis;

               •   improving our billing and collection processesto maximize collections and reduce bad debts;

               •   implementing more efficient staffing, supplyutilization and inventory management; centralizing certain                   administrative and business office functions within a local marketor at the corporate level and reducing                   outsourcing arrangements; and

               •   capitalizing on purchasing efficiencies throughour relationship with HealthTrust Purchasing Group, a                   leading national health care group purchasingorganization.

               *Increase Revenues Through Expansion of Services*.  Wewill continue to expand our facilities and range of services basedon the needs of the communities we serve.  For example, wehave added open-heart surgery at MacNeal Hospital and opened anoutpatient surgery center in Orange County.  Our localmanagement teams work closely with patients, payers, physicians andmedical staff to identify and prioritize the health care needs ofthe individual communities.  We intend to continue to makeinvestments at our facilities to:

               •  expand emergency room and operating roomcapacity;               •  improve the convenience, quality and breadth ofour outpatient services;               •  upgrade and expand specialty services, includingcardiology, oncology and obstetrics; and               •  update our medical equipment technology,including diagnostic and imaging equipment.

               *Recruit New Physicians and Maintain Strong Relationships withExisting Physicians.*  We believe that maintaining strongrelationships with physicians in each of our markets improves thequality of services that our hospitals provide and broadens ouraccess to patients and payers.  We recruit both primary andspecialty physicians who can provide services that we believe arecurrently underserved and in demand at our facilities.  Weintend to sustain and strengthen our recruitment and retentioninitiatives by:

               •  providing physicians high quality facilities inwhich to practice;               •  providing a broad array of services within theintegrated health network ;               •  offering quality training programs;               •  providing remote access to clinical information;and               •  leasing convenient office space adjacent to ourfacilities.

               In the metropolitan Chicago market, we have affiliations with theUniversity of Chicago, since their health care affiliate is ourjoint venture partner in Louis A. Weiss Memorial Hospital and sincewe host some of their medical residency programs at Louis A. WeissMemorial Hospital and MacNeal Hospital.  These affiliationshave been a particularly important element in our ability toattract quality physicians to our hospitals and the localcommunity.  We believe that as we continue to strengthen ourposition in each of our markets, we will be even better positionedto attract physicians to our facilities.

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               *Continue to Develop Favorable Managed CareRelationships.*  We plan to increase the number of patientsat our facilities and improve our profitability by negotiating morefavorable terms with managed care plans and by entering intocontracts with additional managed care plans.  We believe thatwe are attractive to managed care plans because of the geographicand demographic coverage of our facilities in their respectivemarkets, the quality and breadth of our services and the expertiseof our physicians.  Further, we believe that as we increaseour presence and competitive position in our markets, particularlyas we develop our networks of hospitals, we will be increasinglyattractive to managed care plans and will be even better positionedto negotiate more favorable managed care contracts.

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**OurFacilities**

               We owned and operated ten acute care hospitals as of June 30,2002.  The following table contains information concerning ourhospitals:

| **Hospital**                                   |  | **City**        |  | **State** |  | **Licensed Beds** |  | **DateAcquired** |
|------------------------------------------------|--|-----------------|--|-----------|--|-------------------|--|------------------|
|                                                |
| Arrowhead CommunityHospital and Medical Center |  | Glendale        |  | AZ        |  | 115               |  | June 1, 2000     |
| Maryvale Hospital MedicalCenter                |  | Phoenix         |  | AZ        |  | 239               |  | June 1, 1998     |
| Phoenix Baptist Hospitaland Medical Center     |  | Phoenix         |  | AZ        |  | 209               |  | June 1, 2000     |
| Phoenix MemorialHospital                       |  | Phoenix         |  | AZ        |  | 195               |  | May 1, 2001      |
| Paradise ValleyHospital                        |  | Phoenix         |  | AZ        |  | 162               |  | November 1,2001  |
| Huntington BeachHospital                       |  | HuntingtonBeach |  | CA        |  | 131               |  | September 1,1999 |
| La Palma IntercommunityHospital                |  | La Palma        |  | CA        |  | 141               |  | April 1, 2000    |
| West Anaheim MedicalCenter                     |  | Anaheim         |  | CA        |  | 219               |  | September 1,1999 |
| Louis A. Weiss MemorialHospital (1)            |  | Chicago         |  | IL        |  | 369               |  | June 1, 2002     |
| MacNealHospital                                |  | Berwyn          |  | IL        |  | 427               |  | February 1,2000  |

| ____________________ |
|----------------------|
| (1)                  |  | This hospital is operatedby us in a consolidated joint venture corporation in which we own80.1%  of the equity interests and the University of ChicagoHospitals owns 19.9% of the equity interests. |

               In certain circumstances involving the purchase of a not-for-profithospital, we have agreed and in the future may agree to certainlimitations on our ability to sell those facilities.  Inparticular, when we acquired MacNeal Hospital in February 2000, wegranted to the seller for three years after closing a right offirst refusal to purchase the hospital if we agreed to sell it to athird party, at the same price on which we agreed to sell it to thethird party.  In addition, when we acquired Phoenix BaptistHospital and Medical Center and Arrowhead Community Hospital andMedical Center in June 2000, we agreed not to sell either hospitalfor five years after closing and granted to the Foundation forBaptist Health Systems for ten years after closing a right of firstrefusal to purchase either hospital if we agreed to sell it to athird party, at the same price on which we agreed to sell thathospital to the third party.

**HospitalOperations**

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               Our hospitals typically provide the full range of services commonlyavailable in acute care hospitals, such as internal medicine,general surgery, cardiology, oncology, neurosurgery, orthopedics,obstetrics, diagnostic and emergency services, as well as selecttertiary services such as open-heart surgery and level II neonatalintensive care.  Our hospitals also generally provideoutpatient and ancillary health care services such as outpatientsurgery, laboratory, radiology, respiratory therapy and physicaltherapy.  We also provide outpatient services at ourambulatory surgery centers.  Certain of our hospitals have alimited number of psychiatric beds.

               Our senior management team has extensive experience in operatingmulti-facility hospital networks and focuses on strategic planningfor our facilities.  A hospital’s local management teamis generally comprised of a chief executive officer, chieffinancial officer and chief nursing officer.  Local managementteams, in consultation with our corporate staff, develop annualoperating plans setting forth revenue growth strategies through theexpansion of offered services and the recruitment of physicians ineach community, as well as plans to improve

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operating efficiencies andreduce costs.  We believe that the ability of each localmanagement team to identify and meet the needs of our patients,medical staffs and the community as a whole is critical to thesuccess of our hospitals.  We base the compensation for eachlocal management team in part on its ability to achieve the goalsset forth in the annual operating plan.

               Boards of trustees at each hospital, consisting of local communityleaders, members of the medical staff and the hospitaladministrator, advise the local management teams.  Members ofeach board of trustees are identified and recommended by our localmanagement teams and serve three-year staggered terms.  Theboards of trustees establish policies concerning medical,professional and ethical practices, monitor these practices andensure that they conform to our high standards.  We maintaincompany-wide compliance and quality assurance programs and usepatient care evaluations and other assessment methods to supportand monitor quality of care standards and to meet accreditation andregulatory requirements.

               We believe that the most important factors affecting theutilization of a hospital are the quality and market position ofthe hospital and the number, quality and specialties of physiciansand medical staff caring for patients at the facility. Overall, we believe that the attractiveness of a hospital topatients, physicians and payers depends on its breadth of services,level of technology and emphasis on quality of care and conveniencefor patients and physicians.  Other factors that affectutilization include local demographics and population growth, localeconomic conditions and managed care market penetration.

               The following table sets forth certain operating statistics forhospitals owned by us for the periods indicated.  Acute carehospital operations are subject to certain fluctuations due toseasonal cycles of illness and weather, including increased patientutilization during the cold weather months and decreases duringholiday periods.

|                                             |  | **Yearended June 30,** |
|---------------------------------------------|--|------------------------|
|                                             |  |                        |
|                                             |  | **1998**               |  | **1999** |  | **2000** |  | **2001** |  | **2002** |
|                                             |  |                        |
| Number of hospitals at endof period         |  | 1                      |  | 1 |  | 7 |  | 8 |  | 10 |
| Number of licensed beds atend of period (a) |  | 239                    |  | 239 |  | 1,481 |  | 1,676 |  | 2,207 |
| Weighted average licensedbeds (b)           |  | 20                     |  | 239 |  | 771 |  | 1,514 |  | 1,815 |
| Discharges (c)                              |  | 1,191                  |  | 12,447 |  | 31,864 |  | 65,175 |  | 75,364 |
| Adjusted discharges -hospitals (d)          |  | 1,760                  |  | 19,811 |  | 50,661 |  | 96,774 |  | 110,758 |
| Patient days(e)                             |  | 3,611                  |  | 40,906 |  | 101,599 |  | 266,007 |  | 305,370 |
| Adjusted patientdays-hospitals (f)          |  | 5,455                  |  | 64,359 |  | 194,496 |  | 402,353 |  | 452,768 |
| Average length of stay(days) (g)            |  | 3.1                    |  | 3.2 |  | 4.1 |  | 4.1 |  | 4.1 |
| Average daily census(h)                     |  | 120.0                  |  | 112.0 |  | 278.4 |  | 728.8 |  | 837.0 |
| Occupancy rate(i)                           |  | 50.2%                  |  | 46.9% |  | 46.1% |  | 48.0% |  | 46.0% |

| ____________________ |
|----------------------|
| (a)                  |  | Licensed beds are thosebeds for which a facility has been granted approval to operate fromthe applicable state licensing agency. |
|                      |  |  |
| (b)                  |  | Represents the averagenumber of licensed beds, weighted based on periodsowned. |
|                      |  |  |
| (c)                  |  | Represents the totalnumber of patients discharged (in the facility for a period inexcess of 23 hours) from our hospitals and is used by managementand certain investors as a general measure of inpatientvolume. |
|                      |  |  |
| (d)                  |  | Adjusteddischarges-hospitals is used by management and certain investors asa general measure of combined inpatient and outpatient volume andis computed by multiplying discharges by the sum of gross hospitalinpatient and outpatient revenues and then dividing the result bygross hospital inpatient revenues.  This computation“equates” outpatient revenues to the indicator used tomeasure inpatient volume resulting in a general measure of combinedinpatient and outpatient volume. |
|                      |  |  |
| (e)                  |  | Patient days represent thenumber of days in which patients stay overnight at the hospitalduring the respective period (overnight stay defined as patientswho occupy beds as of midnight of any given day).  Managementand certain investors commonly use patient days as an indicator ofhospital volume including length of stay factors. |

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| (f) |  | Adjusted patientdays-hospitals is used by management and certain investors as ageneral measure of combined inpatient and outpatient volumerepresentative of admissions and length of stay data. Adjusted patient days-hospitals is calculated by multiplyingpatient days by the sum of gross hospital inpatient and outpatientrevenues and then dividing the result by gross hospital inpatientrevenues. |
|-----|--|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|     |  |                                                                                                                                                                                                                                                                                                                                                                                                               |
| (g) |  | Average length of stayrepresents the average number of days admitted patients stay in ourhospitals.                                                                                                                                                                                                                                                                                                           |
|     |  |                                                                                                                                                                                                                                                                                                                                                                                                               |
| (h) |  | Average daily censusrepresents the average number of patients in our hospitals each dayduring our ownership.                                                                                                                                                                                                                                                                                                  |
|     |  |                                                                                                                                                                                                                                                                                                                                                                                                               |
| (i) |  | Occupancy rate representsthe percentage of hospital licensed beds occupied bypatients.  Both average daily census and occupancy rateprovide measures of utilization of inpatient rooms.                                                                                                                                                                                                                  |

               The health care industry has seen a general shift during the pastfew years from inpatient services to outpatient services asMedicare, Medicaid and managed care payers have sought to reducecosts by shifting lower-acuity cases to an outpatientsetting.  Advances in medical equipment technology andpharmacology have supported the shift to outpatient utilization,which has resulted in an increase in the acuity of inpatientadmissions.  However, recent trends seem to indicate thatinpatient admissions are starting to recover and will continue toincrease as the baby boomer population reaches ages where inpatientadmissions become more prevalent.  We have responded to theshift to outpatient services through our ambulatory surgery centersin metropolitan Los Angeles/Orange County, California, ouroutpatient diagnostic imaging centers in metropolitan Phoenix,Arizona and our network of primary care and occupational medicinecenters in metropolitan Chicago, Illinois, along with continuedexpansion of emergency and outpatient services at our acutehospitals.  We have the resources in place at our hospitals,including quality physicians and nursing staff and technologicallyadvanced equipment, to support our comprehensive service offeringsto capture inpatient volume from the baby boomers and have focusedon core services including cardiology, neurology, oncology andorthopedics.  We have also implemented sub-acute units such asrehabilitation services, where appropriate, to meet the needs ofour patients while increasing volume and increasing staffingefficiencies.

**Phoenix Health Plan andMacNeal Health Providers**

               Phoenix Health Plan is a prepaid Medicaid managed health plan inthe Phoenix, Arizona area that we acquired in connection with theacquisition of Phoenix Memorial Hospital, effective May 1,2001.  We acquired the Phoenix Health Plan because it enablesus to enroll eligible patients in our hospitals into the healthplan who otherwise would not be able to pay for their hospitalexpenses.  In addition, we believe we will also increase theavailability of medically necessary services to such patients atour hospitals.  We believe the volume of patients generatedthrough the health plan will help attract quality physicians to ourhospitals.

               For the year ended June 30, 2002, we derived approximately $144.9million of our revenues from Phoenix Health Plan.  PhoenixHealth Plan had approximately 68,500 enrollees as of June 30, 2002,and derives substantially all of its revenues through a contractwith the Arizona Health Care Cost Containment System(“AHCCCS”), which is Arizona’s state Medicaidprogram.  The contract requires Phoenix Health Plan to arrangefor health care services for enrolled Medicaid patients in exchangefor fixed periodic payments and supplemental payments fromAHCCCS.  Phoenix Health Plan subcontracts with physicians,hospitals and other health care providers to provide services toits enrollees.  These services are provided regardless of theactual costs incurred to provide these services.  We receivereinsurance and other supplemental payments from AHCCCS to covercertain costs of health care services that exceed certainthresholds.

               We have provided a performance guaranty in the form of a suretybond in the amount of $12.5 million for the benefit of AHCCCS tosupport our obligations under the contract to provide and pay forthe health care services required.  The amount of theperformance guaranty that AHCCCS requires is based upon themembership in the health plan and the related capitation paid tous.  We currently do not expect a material increase in theamount of the performance guaranty during the next fiscalyear.

               Our contract with AHCCCS commenced on October 1, 1997, for aninitial term of one year and originally reserved to AHCCCS theannual option to extend the term of the contract through September30, 2002.  AHCCCS and Phoenix Health Plan amended the contractin October 2001 to extend the term through September 30,2003.  In

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the event the contractwith AHCCCS is discontinued, our revenues would be reduced andprofitability could be adversely affected.

               The operations of MacNeal Health Providers are somewhat integratedwith our MacNeal Hospital in Berwyn, Illinois. For the year endedJune 30, 2002, we derived approximately $39.9 million of ourrevenues from MacNeal Health Providers. Substantially all of therevenues of MacNeal Health Providers arose from its contracts withhealth maintenance organizations under which it took assignment of capitated-member lives from them. As of June 30,2002, MacNeal Health Providers had five such contracts in effectcovering approximately 54,000 capitated-member lives. Suchcapitation is limited to physician services and outpatientancillary services and does not cover inpatient hospital services.We try to capture in MacNeal Hospital and its medical staff membersas much as possible of the physician and outpatient ancillaryservices that are required by such capitation arrangements. In the future we expect the revenues of MacNeal Health Providers todecrease significantly as the health maintenance organizations inthe Chicago metropolitan area have announced that they will bemoving away from assigning capitated-member lives to health planslike MacNeal Health Providers and moving more to directfee-for-service arrangements with health care providers.

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***Proposition204***

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               Proposition 204 was passed by Arizona voters in November 2000 andrequires that tobacco settlement funds be used to increase theAHCCCS eligibility income limits for full acute care medicalcoverage to 100% of the Federal poverty level. Arizona’s share of such settlement funds has been estimatedby the State to be $3.2 billion.  Prior to Proposition 204,AHCCCS coverage generally excluded those persons earning more than34% of the Federal poverty level, but as of October 1, 2001,coverage has been expanded to 100% of the Federal povertylevel.  As a result of this initiative, the State of Arizonaestimates that the AHCCCS will enroll between 137,600 and 185,000new, low-income persons between October 2001 and 2005.  TheFederal poverty level is a Federal standard that changes each yearin April.  Usually, it is adjusted upward by a smallpercentage.  As of June 30, 2002, the Federal poverty levelfor a single individual was $8,860 of income per year.  As weexpected, the effect of Proposition 204 has been to increaseenrollment in the Phoenix Health Plan by our share of the newenrollees, with a corresponding increase in the health plan’srevenues.  In addition, our hospitals in the Phoenix marketare now serving more low-income patients who are covered byAHCCCS.  This has increased paid admissions with agovernmental payer which provides reimbursement for hospitalservices.

**Sources ofRevenues**

****

               We receive payment for patient services from:

               •  the Federal government, primarily under theMedicare program;               •  state Medicaid programs; and               •  health maintenance organizations, preferredprovider organizations, other private insurers and individual       patients.

               The table below presents the approximate percentage of grosspatient revenues we received from the following sources for theperiods indicated:

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|                      |    | **Yearended June 30,** |
|-------------------------------------|--------------|------------------------|
| **Patient revenues bypayer source** |    | **2000**               |  | **2001** |  | **2002** |
|                                |    |                        |
| Medicare                            |    | 22                     | % |  | 20 | % |  | 25 | % |
| Medicaid                            |    | 6                      |  |  | 9 |  |  | 7 |  |
| Managed careplans                   |    | 62                     |  |  | 62 |  |  | 60 |  |
| Indemnity andother                  |    | 10                     |  |  | 9 |  |  | 8 |  |
|                                |    |                        |  |  |  |  |  |  |  |
|      Total |    | 100                    | % |  | 100 | % |  | 100 | % |
|                                |    |                        |  |  |  |  |  |  |  |

               Most of our hospitals offer discounts from established charges toprivate managed care plans if they are large group purchasers ofhealth care services.  These discount programs limit ourability to increase charges in response to increasing costs. Patients generally are not responsible for any difference betweenestablished hospital charges and amounts reimbursed for suchservices under Medicare, Medicaid, some private insurance plans,health maintenance organizations or preferred providerorganizations, but are generally responsible for exclusions,deductibles and co-insurance features of their coverages.  Dueto rising health care costs, many payers have increased the numberof excluded services and the levels of deductibles and co-insuranceresulting in a higher portion of the contracted rate due from theindividual patients.  Collecting amounts due from individualpatients is typically more difficult than collecting fromgovernmental or private managed care plans.

**Competition**

****

               The hospital industry is highly competitive.  We currentlyface competition from established, not-for-profit health carecompanies, investor-owned hospital companies, large tertiary carecenters and outpatient service providers.  In the future, weexpect to encounter increased competition from companies, likeours, that consolidate hospitals and health care companies inspecific geographic markets.  Continued consolidation in thehealth care industry will be a leading factor contributing toincreased competition in our current markets and markets we mayenter in the future.  Due to the shift to outpatient care andmore stringent payer-imposed pre-authorization requirements duringthe past few years, most hospitals have significant unused capacityresulting in increased competition for patients.  Many of ourcompetitors are larger than us and have more financial resourcesavailable than we do.  Other not-for-profit competitors haveendowment and charitable contribution resources available to themand can purchase equipment and other assets on a tax-freebasis.

               One of the most important factors in the competitive position of ahospital is its location, including its geographic coverage andaccess to patients.  A location convenient to a largepopulation of potential patients or a wide geographic coverage areathrough hospital networks can make a hospital significantly morecompetitive.  Another important factor is the scope andquality of services a hospital offers, whether at a single facilityor a network of facilities, compared to the services offered by itscompetitors.  A hospital or network of hospitals that offers abroad range of services and has a strong local market presence ismore likely to obtain favorable managed care contracts.  Weintend to evaluate changing circumstances in the geographic areasin which we operate on an ongoing basis to ensure that we offer theservices and have the access to patients necessary to compete inthese managed care markets and, as appropriate, to form our own, orjoin with others to form, local hospital networks.

               A hospital’s competitive position also depends on the qualityand scope of the practices of physicians associated with thehospital.  Physicians refer patients to a hospital primarilyon the basis of the quality and scope of services provided by thehospital, the quality of the medical staff and employees affiliatedwith the hospital, the hospital’s location and the qualityand age of the hospital’s equipment and physical plant. Although physicians may terminate their affiliation with ourhospitals, we seek to retain physicians of varied specialties onour medical staffs and to recruit other qualified physicians bymaintaining and improving our level of care and providing qualityfacilities, equipment, employees and services for physicians andtheir patients.

               The hospital industry and our hospitals continue to havesignificant unused capacity.  Inpatient utilization, averagelengths of stay and average occupancy rates have historically beennegatively affected by payer-required

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pre-admissionauthorization, utilization review and payer pressure to maximizeoutpatient and alternative health care delivery services for lessacutely ill patients.  Admissions constraints, payer pressuresand increased competition are expected to continue.  Weendeavor to meet these challenges by expanding many of ourfacilities to include outpatient centers, offering discounts toprivate payer groups, upgrading facilities and equipment andoffering new or expanded programs and services.

A number of other factorsaffect our competitive position, including:

               •  our reputation               •  our managed care contracting relationships               •  the amounts we charge for our services               •  parking availability or access to publictransportation               •  the restrictions of state Certificate of Needlaws

**Employees and MedicalStaff**

****

               As of June 30, 2002, we had approximately 9,500 employees,including approximately 3,300 part-time and per diememployees.  Our employees are not subject to collectivebargaining agreements, and we consider our employee relations to begood.  In the industry as a whole, and in our markets, thereis currently a shortage of nurses and other medical supportpersonnel.  We recruit and retain nurses and medical supportpersonnel by creating desirable, professional work environments andoffering competitive wages, benefits and long-termincentives.  In addition, we provide career development andother training programs.  In order to supplement our currentemployee base, we intend to expand our relationship with colleges,universities and other medical education institutions in ourmarkets and recruit nurses and other medical support personnel fromabroad.

               Our hospitals grant staff privileges to licensed physicians who mayserve on the medical staffs of multiple hospitals, includinghospitals not owned by us.  A physician who is not an employeecan terminate his or her affiliation with our hospital at anytime.  Although we employ a limited number of physicians, aphysician does not have to be an employee of ours to be a member ofthe medical staff of one of our hospitals.  Any licensedphysician may apply to be admitted to the medical staff of any ofour hospitals; however, the hospital’s medical staff andboard of trustees must approve the admission request.

****

**ComplianceProgram**

****

               We voluntarily maintain a company-wide compliance program designedto ensure that we maintain high standards of ethics and conduct inthe operation of our business and implement policies and proceduresso that all our employees act in compliance with all applicablelaws, regulations and company policies.  The organizationalstructure of our compliance program includes oversight by our boardof directors and a high-level corporate management compliancecommittee.  The board of directors and compliance committeeare responsible for ensuring that the compliance program meets itsstated goals and remains up-to-date to address the currentregulatory environment and other issues affecting the health careindustry.  Our Senior Vice President of Compliance and Ethicsreports jointly to our Chairman and Chief Executive Officer and toour board of directors, serves as Chief Compliance Officer and ischarged with direct responsibility for the day-to-day management ofour compliance program.  Other features of our complianceprogram include initial and periodic ethics and compliance trainingand effectiveness reviews, a mechanism for employees to report,without fear of retaliation, any suspected legal or ethicalviolations, annual “fraud and abuse” audits to look atall of our payments to physicians and other referral sources andannual “coding audits” to make sure our hospitals billthe proper service codes in respect of obtaining payment from theMedicare and Medicaid programs.

**Our InformationSystems**

****

               We believe that our information systems must cost-effectively meetthe needs of our hospital management, medical staff and nurses inthe following areas of our business operations:

               •  patient accounting, including billing andcollection of revenues;               •  accounting, financial reporting andpayroll;

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               •  coding and compliance;               •  laboratory, radiology and pharmacy systems;               •  medical records and document storage;               •  materials and asset management; and               •  negotiating, pricing and administering ourmanaged care contracts.

               Although we map the information systems from each of our hospitalsto one centralized database, we do not automatically standardizeour information systems among all of our hospitals.  Wecarefully review existing systems at the hospitals we acquire and,if a particular information system is unable to cost-effectivelymeet the operational needs of the hospital, we will convert orupgrade the information system at that hospital to one of severalstandardized information systems that can cost-effectively meetthese needs.

**Insurance**

****

               As is typical in the health care industry, we are subject to claimsand legal actions by patients and others in the ordinary course ofbusiness.  Through May 31, 2002, we maintained third-partyinsurance coverage on a claims-made basis for individualmalpractice claims exceeding $1.0 million and annual aggregateclaims exceeding $13.6 million.  Due to pricing pressures andthe limited availability of carriers willing to underwriteprofessional and general liability coverage, we were unable torenew our previous policy with favorable terms upon its expirationon May 31, 2002.  Effective June 1, 2002, we established awholly owned captive subsidiary to insure our professional andgeneral liability risks at a $10.0 million retention level. We maintain excess coverage for individual claims exceeding $10.0million per occurrence up to $100.0 million in the aggregate. We intend to complete a transfer of the loss portfolio for ourself-insured retention of reported incidents prior to June 1, 2002,to the captive subsidiary during fiscal 2003.  The captivesubsidiary intends to fund claims costs from proceeds of premiumpayments received from us.

               As a result of the unfavorable professional and general liabilitymarket and increased premiums for property insurance, our insuranceexpense increased by $11.5 million during fiscal 2002 comprised ofthe following:  (1) a $5.7 million increase in ourprofessional and general liability reserve for claims incurredprior to June 1, 2002, but reported after June 1, 2002, as a resultof the increased retention limits; (2) a $2.6 million increase inour professional and general liability reserves throughout fiscal2002 due to the lack of maturity of our claims; (3) professionaland general and property insurance premiums increases of $2.1million and (4) an increase in our professional and generalliability reserve of $1.1 million related to the liquidation of aprevious third party carrier.  We expect our insurance expenseto increase by an additional $4.9 million during fiscal2003.

               We believe that the professional and general liability insurancemarket will remain depressed in the near term, and future increasesto excess coverage premiums and captive subsidiary retention levelscould significantly affect our operating margins.  Should weexperience significant adverse claims, our future cash flows maynot be adequate to fund such liabilities and our financialcondition could be materially adversely affected.

**Reimbursement**

****

***               Medicare***

******

               Medicare is a Federal program that provides hospital and medicalinsurance benefits to persons age 65 and over, some disabledpersons and persons with end-stage renal disease.  Under theMedicare program, acute care hospitals generally receivereimbursement under a prospective payment system for inpatient andoutpatient hospital services.  Currently, certain types offacilities such as psychiatric hospitals, long-term care hospitals,specially designated children’s hospitals and certaindesignated cancer research hospitals, as well as psychiatric unitsthat are distinct parts of a hospital and meet the Centers forMedicare and Medicaid Services (“CMS”, formerly theHealth Care Financing Administration) criteria for exemption, areexempt from the prospective payment system and are reimbursed on acost-based system, subject to certain cost limits known as TEFRA(an acronym for the Tax Equity and Fiscal Responsibility Act of1982) limits.  A prospective payment system for rehabilitationhospitals and units began a two year phase-in on January 1,2002.  Also, CMS is in the process of developing rules toimplement a prospective payment system for long term care hospitalsand units to be effective for cost reporting periods

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beginning on or afterOctober 1, 2002.  A prospective payment system has not yetbeen implemented for psychiatric hospitals and units.

               Under the inpatient prospective payment system, a hospital receivesa fixed payment per inpatient discharge based on thepatient’s assigned diagnosis related group.  Diagnosisrelated groups classify treatments for illnesses according to theestimated intensity of hospital resources necessary to provide thetreatment.  While diagnosis related groups are updatedannually to recalibrate the expected treatment cost and areadjusted for wage differentials for different geographic regions,they do not consider a specific hospital’s costs.  Theindex used to adjust diagnosis related groups, the “marketbasket index”, gives consideration to the inflationexperienced by hospitals in purchasing goods and services, but hashistorically fallen short of the actual increased costs incurred byhospitals.  The Benefits Improvement and Protection Act of2000 improved reimbursement rates from the low increases prescribedby the Balanced Budget Act of 1997.  Under the BenefitsImprovement and Protection Act of 2000, hospital reimbursementrates for Federal fiscal year 2001 increased by 2.3% (market basketof 3.4% less 1.1%) from the Federal fiscal 2000 rates, willincrease by 2.75% (market basket of 3.3% less 0.55%) for Federalfiscal year 2002 and will increase by 2.95% (market basket of 3.5%less 0.55%) for Federal fiscal year 2003.  For Federal fiscalyear 2004, hospitals are to receive the full market basketincrease.  However, future legislation may decrease the rateof increase for diagnosis related group payments, which could makeit more difficult for us to increase our revenues and to maintainor improve our operating margin.

               Medicare also reimburses acute care hospitals for their capitalcosts in providing services to inpatients.  The majority ofinpatient capital costs for acute care hospitals are reimbursedunder the Medicare program on a prospective system based ondiagnosis related group weights multiplied by a geographicallyadjusted Federal rate.

               Until August 1, 2000, Medicare typically reimbursed general acutecare hospitals for outpatient services based on a feeschedule.  The Balanced Budget Act of 1997 established aprospective payment system for outpatient hospital services thatcommenced on August 1, 2000.  Nevertheless, CMS is continuingto use existing fee schedules to pay for physical, occupational andspeech therapies, durable medical equipment, clinical diagnosticlaboratory services and nonimplantable orthotics andprosthetics.  Freestanding ambulatory surgery centers are alsoreimbursed on a fee schedule.

               All services paid under the new prospective payment system forhospital outpatient services are classified into groups calledambulatory payment classifications or “APC”s. Services in each APC are similar clinically and in terms of theresources they require.  A payment rate is established foreach APC.  Depending on the services provided, a hospital maybe paid for more than one APC for a patient visit.  The feeschedule for the outpatient prospective payment system was updatedby the market basket index for the calendar year 2001 and were tobe updated by the market basket index minus 1% for the calendaryear 2002 under the Benefits Improvement and Protection Act of2000.  However, CMS delayed the implementation of the 2002rates and reimbursed hospitals under the 2001 rates until April 1,2002.  CMS has recently proposed that the fee schedule beupdated in calendar year 2003 by the market basket index.  Weanticipate that future legislation may decrease the future rate ofincrease for APC payments, but we are unable to predict the amountof the reduction.

               Medicare historically has reimbursed skilled nursing units withinhospitals on the basis of actual costs, subject to limits. The Balanced Budget Act of 1997 required the establishment of aprospective payment system for Medicare skilled nursing units,under which units will be paid a Federal per diem rate forvirtually all covered services.  The new payment system wasphased in during the period July 1998 to June 2002.  Theeffect of the new payment system generally has been tosignificantly reduce reimbursement for skilled nursing services,which has led many hospitals, including some of our hospitals, toclose those units.  We will monitor closely and evaluate thefew remaining skilled nursing units in our hospitals and relatedfacilities to determine whether it is feasible to continue to offersuch services under the new reimbursement policy.

               Payments to prospective payment system-exempt hospitals and units,such as inpatient psychiatric and long-term hospital services, arebased upon reasonable cost, subject to a cost-per-dischargetarget.  These limits are updated annually by a market basketindex.  The Benefits Improvement and Protection Act of 2000increases payments to prospective payment system-exempt hospitalsand units.  In particular, the Benefits Improvement andProtection Act of 2000 increased the incentive payments paid forinpatient psychiatric services from 2% to 3%,

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raised the national cap onlong-term care hospital reimbursement by 2% and increased theindividual long-term care hospital target amounts by35%.

***               Medicaid***

******

               Medicaid is a Federal-state program, administered by the states,which provides hospital and medical benefits to qualifyingindividuals who are unable to afford health care.  Most stateMedicaid payments are made under a prospective payment system orunder programs that negotiate payment levels with individualhospitals.  In Arizona, AHCCCS administers the state Medicaidprogram through the use of prepaid health plans.  AHCCCSreimburses Phoenix Health Plan for health care costs that exceedstated levels at a rate of 75% (85% for catastrophic cases) ofqualified health care costs in excess of the stated levels of$5,000 to $35,000, depending on the rate code assigned to themember.  Qualified health care costs are the lesser of theamount paid by Phoenix Health Plan or the AHCCCS feeschedule.  Phoenix Health Plan then reimburses the hospital atwhich the patient received care.

               Medicaid reimbursement is often less than a hospital’s costof services.  State and Federal governments currently jointlyfund Medicaid.  The Federal government and many states arecurrently considering significant reductions in the level ofMedicaid funding while at the same time expanding Medicaidbenefits.  The Bush administration has announced a proposal toreduce the upper payment limits of Medicaid reimbursements made tothe states.  Any of this could adversely affect future levelsof Medicaid reimbursement received by our hospitals.

***               Annual Cost Reports***

******

               All hospitals participating in the Medicare and Medicaid programs,whether paid on a reasonable cost basis or under a prospectivepayment system, are required to meet specific financial reportingrequirements.  Federal regulations require submission ofannual cost reports identifying medical costs and expensesassociated with the services provided by each hospital to Medicarebeneficiaries and Medicaid recipients.  Annual cost reportsrequired under the Medicare and Medicaid programs are subject toroutine audits, which may result in adjustments to the amountsultimately determined to be due to us under these reimbursementprograms.  The audit process, particularly in the case ofMedicaid, takes several years to reach the final determination ofallowable amounts under the programs.  Providers also have theright of appeal, and it is common to contest issues raised inaudits of prior years’ reports.

               Many prior year cost reports of our facilities are stillopen.  If any of our facilities is found to have been inviolation of Federal or state laws relating to preparing and filingof Medicare or Medicaid cost reports, whether prior to or after ourownership of these facilities, we and our facilities could besubject to substantial monetary fines, civil and criminal penaltiesand exclusion from participation in the Medicare and Medicaidprograms.  If an allegation is lodged against one of ourfacilities for a violation occurring during the time period beforewe acquired the facility, we may have indemnification rightsagainst the seller of the facility to us.  In each of ouracquisitions, we have negotiated customary indemnification and holdharmless provisions for any damages we may incur in theseareas.

***               Managed Care***

               During the past few years, the hospital industry has experienced ashift in admissions and revenues from commercial insurance payersto managed care payers due to pressures to control the cost ofhealth care services.  We expect this industry trend tocontinue although its effect on us may be mitigated due to theheavy managed care penetration that currently exists in the marketswe serve.  Generally, we receive lower payments from managedcare plans than from traditional commercial or indemnity insurers;however, as part of our business strategy, we have been able torenegotiate payment rates on many of our managed care contracts toimprove our operating margin.  While the majority of ouradmissions and revenues are generated from patients covered bymanaged care plans, the percentage may decrease slightly in thefuture due to increased Medicare utilization associated with theaging U.S. population.

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               ***Commercial Insurance***

******

               Our hospitals provide services to individuals covered by privatehealth care insurance.  Private insurance carriers make directpayments to a hospital or, in some cases, reimburse their policyholders, based upon the hospital’s established charges andthe particular coverage provided in the insurancepolicy.

               Commercial insurers are continuing efforts to limit the paymentsfor hospital services by adopting discounted payment mechanisms,including prospective payment or diagnosis related group-basedpayment systems, for more inpatient and outpatient services. To the extent that such efforts are successful and reduce theinsurers’ reimbursement to hospitals for the costs ofproviding services to their beneficiaries, such reduced levels ofreimbursement may have a negative impact on our operatingresults.

**Government Regulationand Other Factors**

****

               ***Overview***

               All participants in the health care industry are required to complywith extensive government regulation at the Federal, state andlocal levels.  In addition, these laws, rules and regulationsare extremely complex and the health care industry has had thebenefit of little or no regulatory or judicial interpretation ofmany of them.  Although we believe we are in compliance in allmaterial respects with such laws, rules and regulations, if adetermination is made that we were in material violation of suchlaws, rules or regulations, our business, financial condition orresults of operations could be materially adversely affected. If we fail to comply with applicable laws and regulations, we canbe subject to criminal penalties and civil sanctions, our hospitalscan lose their licenses and their ability to participate in theMedicare and Medicaid programs.

               ***Licensing, Certification and Accreditation***

******

               Health care facilities are subject to Federal, state and localregulations relating to the adequacy of medical care, equipment,personnel, operating policies and procedures, fire prevention,rate-setting and compliance with building codes and environmentalprotection laws.  Facilities are subject to periodicinspection by governmental and other authorities to assurecontinued compliance with the various standards necessary forlicensing and accreditation.  All of our health carefacilities are properly licensed under appropriate statelaws.

               All of the hospitals affiliated with us are certified under theMedicare and Medicaid programs and are accredited by the JointCommission on Accreditation of Healthcare Organizations(“JCAHO”).  Should any facility lose itsaccreditation from JCAHO or otherwise lose its certification underthe Medicare or Medicaid programs, the facility would be unable toreceive reimbursement from the Medicare and Medicaidprograms.  We believe that our facilities are in substantialcompliance with current applicable Federal, state, local andindependent review body regulations and standards.  Therequirements for licensing, certification and accreditation aresubject to change and, in order to remain qualified, it may benecessary for us to change our facilities, equipment, personnel orservices.

               ***Certificates of Need***

               In some states, the construction of new facilities, acquisition ofexisting facilities or addition of new beds or services may besubject to review by state regulatory agencies under a Certificateof Need program.  Illinois is the only state in which wecurrently operate that requires approval under a Certificate ofNeed program.  These laws generally require appropriate stateagency determination of public need and approval prior to theaddition of beds or services or other capital expenditures. Failure to obtain necessary state approval can result in theinability to expand facilities, add services, acquire a facility orchange ownership.  Further, violation of such laws may resultin the imposition of civil sanctions or the revocation of afacility’s license.

               ***Utilization Review***

******

               Federal law contains numerous provisions designed to ensure thatservices rendered by hospitals to Medicare and Medicaid patientsmeet professionally recognized standards and are medicallynecessary, and that claims for reimbursement are properlyfiled.  These provisions include a requirement that a samplingof admissions

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of Medicare and Medicaidpatients be examined by peer review organizations to review theappropriateness of Medicare and Medicaid patient admissions anddischarges, the quality of care provided, the validity of diagnosisrelated group classifications and the appropriateness of cases ofextraordinary length of stay or cost.  Peer revieworganizations may deny payment for services provided, assess finesand recommend to the Department of Health and Human Services that aprovider that is in substantial noncompliance with the standards ofthe peer review organization be excluded from participation in theMedicare or Medicaid programs.  Utilization review is also arequirement of most non-governmental managed careorganizations.

******

***               The Federal False Claims Act and Similar Laws***

******

               A trend affecting the health industry today is the increased use ofthe Federal False Claims Act, and, in particular, an increasednumber of actions brought by individuals on the government’sbehalf under the False Claims Act’s *qui tam*, orwhistleblower, provisions.  Whistleblower provisions allowprivate individuals to bring actions on behalf of the governmentalleging that the defendant has defrauded the Federalgovernment.  If the government intervenes in the action andprevails, the party filing the initial complaint may share in anysettlement or judgment.  If the government does not intervenein the action, the whistleblower plaintiff may pursue the actionindependently.  When a private party brings a *qui tam*action under the False Claims Act, the defendant generally will notbe made aware of the lawsuit for some time until the governmentmakes a determination whether it will intervene and take the leadin the litigation.

               When a defendant is determined by a court of law to be liable underthe False Claims Act, the defendant must pay three times the actualdamages sustained by the government, plus mandatory civil penaltiesof $5,500 to $11,000 for each separate false claim. Settlements entered into prior to litigation usually involve a lesssevere damages methodology.  There are many potential basesfor liability under the False Claims Act, although liability mostoften arises when an entity knowingly submits a false claim forreimbursement to the Federal government and the False Claims Actdefines the term “knowingly” very broadly.  Anumber of states have adopted their own false claims provisions aswell as their own whistleblower provisions whereby a private partymay file a civil lawsuit in state court.  From time to time,companies in the health care industry, including our company, maybe subject to actions under the False Claims Act or similar statelaws.  We currently are not aware of any actions against usunder the False Claims Act or similar state laws.

               ***Federal and State Fraud and Abuse***

******

               Participation in the Medicare program is heavily regulated byFederal statute and regulation.  If a hospital fails tosubstantially comply with the numerous conditions of participationin the Medicare program or performs certain prohibited acts, thathospital’s participation in the Medicare program may beterminated or civil or criminal penalties may be imposed upon itunder certain provisions of the Social Security Act.  Forexample, the Social Security Act prohibits providers and othersfrom soliciting, receiving, offering or paying, directly orindirectly, any remuneration intended to induce referrals ofpatients to receive goods or services covered by a Federal healthcare program (the “Anti-Kickback Statute”).  Inaddition to felony criminal penalties (fines of up to $25,000 andimprisonment), the Social Security Act establishes civil monetarypenalties and the sanction of excluding violators fromparticipation in the Federal health care programs.

               Federal regulators and the courts have interpreted theAnti-Kickback Statute broadly in order to prohibit the intentionalpayment of anything of value even if only one purpose of thepayment is to influence the referral of Medicare or Medicaidbusiness.  Therefore, many commonplace commercial arrangementsbetween hospitals and physicians could be considered by thegovernment to violate the Anti-Kickback Statute.

               As authorized by Congress, the Office of the Inspector General atthe Department of Health and Human Services has published finalsafe harbor regulations that outline categories of activities thatare deemed protected from prosecution under the Anti-KickbackStatute.  Currently, there are safe harbors for variousactivities, including investment interests, space rental, equipmentrental, practitioner recruitment, personal services and managementcontracts, sale of practice, discounts, waiver of beneficiarycoinsurance and deductibles and investments in group practices andambulatory surgery centers.  The fact that conduct or abusiness arrangement does not fall within a safe harbor does notautomatically render the conduct or business arrangement illegalunder the Anti-Kickback

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Statute.  The conductand business arrangement, however, do risk increased scrutiny bygovernment enforcement authorities.

               The Office of Inspector General is responsible for identifyingfraud and abuse activities in government programs.  In orderto fulfill its duties, the Office of Inspector General performsaudits, investigations and inspections.  In addition, itprovides guidance to health care providers by identifying types ofactivities that could violate the Anti-Kickback Statute.  TheOffice of the Inspector General has identified the followingincentive arrangements with physicians as potentialviolations:

               •   payment of any incentive by the hospital eachtime a physician refers a patient to the hospital;

               •   use of free or significantly discounted officespace or equipment for physicians in facilities usually                   located close to the hospital;

               •   provision of free or significantly discountedbilling, nursing, or other staff services;

               •   free training for a physician’s officestaff (excluding compliance training);

               •   guarantees which provide that, if thephysician’s income fails to reach a predetermined level, thehospital                   will pay any portion of the remainder;

               •   low-interest or interest-free loans, or loanswhich may be forgiven if a physician refers patients to the                   hospital;

               •   payment of the costs of a physician’stravel and expenses for conferences;

               •   payment of services which require few, if any,substantive duties by the physician, or payment for                   services in excess of the fair market value of the servicesrendered;

               •   purchasing goods or services from physicians atprices in excess of their fair market value;

               •   coverage in the hospital’s group healthinsurance plan at an inappropriately low cost to the physician;or

               •   “gainsharing,” the practice ofgiving physicians a share of any reduction in a hospital’scosts for patient                   care attributable in part to the physician’sefforts.

In addition, the Office ofInspector General has encouraged persons having information abouthospitals who offer  to physicians any of the of incentivesdescribed above to report such information to the Office ofInspector General.

               We have a variety of financial relationships with physicians whorefer patients to our hospitals.  We also have contracts withphysicians providing for a variety of financial arrangements,including employment contracts, leases, and professional serviceagreements.  Moreover, we provide financial incentives,including loans and minimum revenue guarantees, to recruitphysicians into the communities served by our hospitals.  Eachof our two free-standing surgery centers has one or more physicianinvestors.  Some of our arrangements with physicians do notmeet all of the requirements for safe harbor protection.  Theregulatory authorities that enforce the Anti-Kickback Statute mayin the future determine that any of these arrangements violate theAnti-Kickback Statute or other applicable laws.  Thisdetermination could subject us to liabilities under the SocialSecurity Act, including criminal penalties of imprisonment orfines, civil penalties up to $50,000, damages up to three times thetotal amount of remuneration and exclusion from participation inthe Medicare, Medicaid or other Federal health care programs, anyof which could have a material adverse effect on our business,financial condition or results of operations.

               The Social Security Act also imposes very broad criminal and civilpenalties for submitting false claims to Medicare andMedicaid.  False claims include, but are not limited to,billing for services not rendered, misrepresenting actual servicesrendered in order to obtain higher reimbursement and cost reportfraud.  Further, the Health Insurance Portability andAccountability Act of 1996 (“HIPAA”) created civilpenalties for impermissible

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conduct, includingimproper coding and billing for unnecessary goods andservices.  HIPAA also broadened the scope of the fraud andabuse laws by adding several criminal provisions for health carefraud offenses that apply to all health benefitprograms.

               The Social Security Act also includes a provision commonly known asthe “Stark Law.”  This law prohibits physiciansfrom referring Medicare and Medicaid patients to entities withwhich they or any of their immediate family members have afinancial relationship if these entities provide certain designatedhealth services that are reimbursable by Medicare, includinginpatient and outpatient hospital services.  Sanctions forviolating the Stark Law include civil monetary penalties up to$15,000 per prohibited service provided, assessments equal to twicethe dollar value of each such service provided and exclusion fromthe Federal health care programs.  There are a number ofexceptions to the self-referral prohibition, including an exceptionfor a physician’s ownership interest in an entire hospital asopposed to an ownership interest in a hospital department. There are also exceptions for many of the customary financialarrangements between physicians and providers, including employmentcontracts, leases and recruitment agreements.

               On January 4, 2001, CMS issued final regulations subject to commentintended to clarify parts of the Stark Law and some of theexceptions to it.  These regulations are considered Phase I ofa two-phase process, with the remaining regulations to be publishedat an unknown future date.  Phase I of the regulationsgenerally became effective January 4, 2002.  However, CMS hasdelayed until January 6, 2003 the effective date of an importantportion of the Phase I regulations related to whetherpercentage-based compensation is deemed to be “set inadvance” for purposes of the relevant exceptions to the StarkLaw.

               We have structured our financial arrangements with physicians tocomply with the statutory exceptions included in the Stark Law andsubsequent regulations.  However, the new Stark regulationsmay interpret provisions of this law in a manner different from themanner with which we have interpreted them.  We cannot predictthe final form that these regulations will take or the effect thatthey will have on our operations.

               Many of the states in which we operate also have adopted laws thatprohibit payments to physicians in exchange for referrals similarto the Anti-Kickback Statute and the Stark Law, some of which applyregardless of the source of payment for care.  These statutestypically provide criminal and civil penalties as well as loss oflicensing.  Little precedent exists for the interpretation orenforcement of these state laws.

               ***Corporate Practice of Medicine and FeeSplitting***

******

               The states in which we operate have laws that prohibit unlicensedpersons or business entities, including corporations, fromemploying physicians or that prohibit direct or indirect paymentsor fee-splitting arrangements between physicians and unlicensedpersons or business entities.  Possible sanctions forviolations of these restrictions include loss of aphysician’s license, civil and criminal penalties andrescission of business arrangements that may violate theserestrictions.  These statutes vary from state to state, areoften vague and seldom have been interpreted by the courts orregulatory agencies.  We exercise care to structure ourarrangements with health care providers to comply with the relevantstate law.  While we believe our arrangements comply withapplicable laws in all material respects, governmental officialscharged with responsibility for enforcing these laws may in thefuture assert that we, or transactions in which we are involved,are in violation of such laws.  In addition, the courts mayultimately interpret such laws in a manner inconsistent with ourinterpretations.

***               Administrative Simplification***

******

               The Administrative Simplification Provisions of HIPAA require theuse of uniform electronic data transmission standards for healthcare claims and payment transactions submitted or receivedelectronically.  On August 17, 2000, CMS published finalregulations establishing electronic data transmission standardsthat all health care providers must use when submitting orreceiving certain health care transactions electronically. Compliance with these regulations was originally required byOctober 16, 2002, but legislation adopted in December 2001 extendedthe compliance date to October 16, 2003 for entities which file acompliance plan with the Department of Health and Human Servicesdemonstrating how the entity intends to comply with the regulationsby the extended deadline.  We have filed compliance plans toobtain this extension for all of our entities covered byHIPAA.  We cannot yet predict the impact that these finalregulations will have on us.

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               HIPAA also requires CMS to adopt standards to protect the securityand privacy of health-related information.  Regulations wereproposed on August 12, 1998, but have not yet been finalized. However, as proposed, these regulations would require health careproviders to implement organizational and technical practices toprotect the security of electronically maintained or transmittedhealth-related information.  In addition, CMS released“final” regulations containing privacy standards inDecember 2000 that require compliance by April 2003.  However,in August 2002 CMS made a substantial number of amendments to thefinal regulations issued in December 2000.  As currently ineffect, the privacy regulations will extensively regulate the useand disclosure of individually identifiable health-relatedinformation.  The security regulations, as proposed, and theprivacy regulations could impose significant costs on ourfacilities and other healthcare businesses in order to comply withthese standards.  Violations of the AdministrativeSimplification provisions of HIPAA could result in civil penaltiesof up to $25,000 per type of violation in each calendar year andcriminal penalties of up to $250,000 per violation.  Inaddition, our facilities will continue to remain subject to anystate laws that are more restrictive than the regulations issuedunder HIPAA, violation of which could result in additionalpenalties.

******

               ***Conversion Legislation***

******

               Many states have enacted or are considering enacting laws affectingthe conversion or sale of not-for-profit hospitals.  Theselaws, in general, include provisions relating to attorney generalapproval, advance notification and community involvement.  Inaddition, state attorneys general in states without specificconversion legislation may exercise authority over thesetransactions based upon existing law.  These legislative andadministrative efforts primarily focus on the appropriate valuationof the assets divested and the use of the proceeds of the sale bythe not-for-profit seller.  In many states there has been anincreased interest in the oversight of not-for-profitconversions.  The adoption of conversion legislation and theincreased review of not-for-profit hospital conversions mayincrease the cost and difficulty of, or prevent the completion oftransactions with, not-for-profit organizations in some states inthe future.  Moreover, as a condition to approving anacquisition, the attorney general of the state in which thehospital is located may require us to maintain specific services,such as emergency departments, or to continue to provide specificlevels of charity care.  While these review and, in someinstances, approval processes can add additional time to theclosing of a hospital acquisition, we have not had any significantdifficulties or delays in completing any of our recent hospitalacquisitions.  There can be no assurance, however, that futureactions on the state level will not seriously delay or even preventour ability to acquire hospitals.  If these activities arewidespread, they could have a negative impact on our ability toacquire additional hospitals.  See “BusinessStrategy.”

               ***Revenue Ruling 98-15***

******

               During March 1998, the Internal Revenue Service issued guidanceregarding the tax consequences of joint ventures between for-profitand not-for-profit hospitals.  We have not determined theimpact of the tax ruling on the development of futureventures.  The tax ruling could limit future joint venturedevelopment with not-for-profit hospitals.

               ***The Emergency Medical Treatment and Active LaborAct***

******

               Congress adopted the Federal Emergency Medical Treatment and ActiveLabor Act in response to reports of a widespread hospital emergencyroom practice of “patient dumping.”  At the timeof the enactment, patient dumping was considered to have occurredwhen a hospital capable of providing the needed care sent a patientto another facility or simply turned the patient away based on thepatient’s inability to pay for his or her care.  ThisFederal law requires any hospital that participates in the Medicareprogram to conduct an appropriate medical screening examination ofevery person who presents to the hospital’s emergencydepartment for treatment, and if the patient is suffering from anemergency medical condition, to either stabilize that condition ormake an appropriate transfer of the patient to a facility that canhandle the condition.  The obligation to screen and stabilizeemergency medical conditions exists regardless of a patient’sability to pay for treatment.  Sanctions for violations ofthis statute are severe and include termination of ahospital’s participation in the Medicare and Medicaidprograms and civil monetary penalties.  In addition, the lawcreates private civil remedies that enable an individual whosuffers personal harm as a direct result of a violation of the law,and a medical facility that suffers a financial loss as a directresult of another participating hospital’s violation of thelaw, to sue the offending hospital for damages and equitablerelief.  The government broadly interprets the reach of thislaw and also has expressed its intent to investigate and enforceviolations of it actively in the future.  Although we believethat our practices are in material compliance with the

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law, we can give noassurance that governmental officials responsible for enforcing thelaw will not assert from time to time that our facilities are inviolation of this statute.

               ***Health Care Reform***

******

               The health care industry, as one of the largest industries in theUnited States, continues to attract much legislative interest andpublic attention.  Changes in Medicare, Medicaid and otherprograms, hospital cost-containment initiatives by public andprivate payers, proposals to limit payments and health carespending and industry-wide competitive factors are highlysignificant to the health care industry.  In addition, aframework of extremely complex Federal and state laws, rules andregulations governs the health care industry and, for manyprovisions, there is little history of regulatory or judicialinterpretation on which to rely.

               Many states have enacted or are considering enacting measuresdesigned to reduce their Medicaid expenditures and change privatehealth care insurance.  Most states, including the states inwhich we operate, have applied for and been granted Federal waiversfrom current Medicaid regulations to allow them to serve some orall of their Medicaid participants through managed careproviders.  We are unable to predict the future course ofFederal, state or local health care legislation.  Furtherchanges in the law or regulatory framework that reduce our revenuesor increase our costs could have a material adverse effect on ourbusiness, financial condition or results of operations.

               ***Health Care Industry Investigations***

******

               Significant media and public attention has focused in recent yearson the hospital industry.  There are numerous ongoing Federaland state investigations regarding multiple issues, including costreporting and billing practices, especially those relating toclinical laboratory test claims and home health agency costs,physician recruitment practices and physician ownership of healthcare providers and joint ventures with hospitals.  Theseinvestigations have targeted hospital companies as well as theirexecutives and managers.  We have substantial Medicare,Medicaid and other governmental billings, which would result inheightened scrutiny of our operations.  We continue to monitorthese and all other aspects of our business and have developed acompliance program to assist us in gaining comfort that ourbusiness practices are consistent with both legal principles andcurrent industry standards.  However, because the law in thisarea is complex and constantly evolving, governmentalinvestigations could result in interpretations that areinconsistent with industry practices, including ours.  Inpublic statements surrounding current investigations, governmentalauthorities have taken positions on a number of issues, includingsome for which little official interpretation previously has beenavailable, that appear to be inconsistent with practices that havebeen common within the industry and that previously have not beenchallenged in this manner.  In some instances, governmentalinvestigations that have in the past been conducted under the civilprovisions of Federal law may now be conducted as criminalinvestigations.

               Many current health care investigations are national initiatives inwhich Federal agencies target an entire segment of the health careindustry.  One example is the Federal government’sinitiative regarding hospital providers’ improper requestsfor separate payments for services rendered to a patient on anoutpatient basis within three days prior to the patient’sadmission to the hospital, where reimbursement for such services isincluded as part of the reimbursement for services furnished duringan inpatient stay.  In particular, the government has targetedall hospital providers to ensure conformity with this reimbursementrule.  Another example involves the Federal government’sinitiative regarding health care providers “unbundling”and separately billing for laboratory tests that should have beenbilled as a “bundled unit.”  The Federalgovernment has also launched a national investigative initiativetargeting the billing of claims for inpatient services related tobacterial pneumonia, as the government has found that many hospitalproviders have attempted to bill for pneumonia cases under morecomplex and expensive reimbursement codes.  Further, theFederal government continues to investigate Medicare overpaymentsto prospective payment hospitals that incorrectly report transfersof patients to other prospective payment system hospitals asdischarges.

               While we are aware that several of our hospitals have been or arebeing investigated in connection with activities conducted prior toour acquisition of them, we are not aware of any governmentalinvestigations involving the operation of those facilities by us,or involving any of our executives or managers.  Under theterms of our various acquisition agreements, the prior owners ofour hospitals are responsible for any liabilities arising frompre-

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closing violations. The prior owners’ resolution of these matters or failure toresolve these matters, in the event that any resolution was deemednecessary, could have a material adverse effect on our business,financial condition or results of operation.  It is possiblethat governmental entities could initiate investigations in thefuture at facilities operated by us and that such investigationscould result in significant penalties to us as well as adversepublicity.  It is also possible that our executives andmanagers, many of whom have worked at other health care companiesthat are or may become the subject of Federal and stateinvestigations and private litigation, could be included ingovernmental investigations or named as defendants in privatelitigation.  The positions taken by authorities in any futureinvestigations of us, our executives or our managers, or otherhealth care providers, and the penalties that may be imposed couldhave a material adverse effect on our business, financial conditionand results of operations.

               ***Health Plan Regulatory Matters***

******

               Our health plans are subject to state and Federal laws andregulations.  CMS has the right to audit our health plans todetermine the plans’ compliance with such standards.  Inaddition, AHCCCS has the right to audit Phoenix Health Plan todetermine the Plan’s compliance with such standards. Also, Phoenix Health Plan is required to file periodic reports withAHCCCS, meet certain financial viability standards, provide itsenrollees with certain mandated benefits and meet certain qualityassurance and improvement requirements.  Our health plans mustalso comply with the standardized formats for electronictransmissions set forth in the Administrative SimplificationsProvisions of HIPAA by October 16, 2003, and each plan has filed acompliance plan demonstrating how it intends to achieve complianceby that extended deadline date.  Our health plans will berequired to comply with Federal privacy standards forhealth-related information and with Federal security standards whenfinal regulations become effective.  We cannot predict thefinal form that these regulations will take or the impact that thefinal regulations, when fully implemented, will have onus.

               The Anti-Kickback Statute has been interpreted to prohibit thepayment, solicitation, offering or receipt of any form ofremuneration in return for the referral of Federal health programpatients or any item or service that is reimbursed, in whole or inpart, by any Federal health care program.  Similar statuteshave been adopted in Illinois and Arizona that apply regardless ofthe source of reimbursement.  The Department of Health andHuman Services has adopted safe harbor regulations specifyingcertain relationships and activities that are deemed not to violatethe Anti-Kickback Statute which specifically relate to managed careincluding:

               •   waivers by health maintenance organizations ofMedicare and Medicaid beneficiaries’ obligations to pay                   cost-sharing amounts or to provide other incentives in order toattract Medicare and Medicaid enrollees;

               •   certain discounts offered to prepaid healthplans by contracting providers;

               •   certain price reductions offered to eligiblemanaged care organizations; and

               •   certain price reductions offered by contractorswith substantial financial risk to managed care                   organizations.

               We believe that the incentives offered by our health plans to theirenrollees and the discounts they receive from contracting healthcare providers satisfy the requirements of the safe harborregulations.  However, the failure to satisfy each criterionof the applicable safe harbor does not mean that the arrangementconstitutes a violation of the law; rather, the safe harborregulations provide that an arrangement which does not fit within asafe harbor must be analyzed on the basis of its specific facts andcircumstances.  We believe that our health plans’arrangements comply in all material respects with the FederalAnti-Kickback Statute and similar state statutes.

               ***Environmental Matters***

******

               We are subject to various Federal, state and local laws andregulations relating to environmental protection.  Ourhospitals are not highly regulated under environmental laws becausewe do not engage in any industrial activities at thoselocations.  The principal environmental requirements andconcerns applicable to our operations relate to:

               •   the proper handling and disposal of hazardousand low level medical radioactive waste;

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               •   ownership or historical use of underground andabove-ground storage tanks;

               •   management of impacts from leaks of hydraulicfluid or oil associated with elevators, chiller units or                   incinerators;

               •   appropriate management of asbestos-containingmaterials present or likely to be present at some                   locations; and

               •   the potential acquisition of, or maintenance ofair emission permits for, boilers or other equipment.

               We do not expect our compliance with environmental laws andregulations to have a material effect on us.  We may also besubject to requirements related to the remediation of substancesthat have been released into the environment at properties owned oroperated by us or at properties where substances were sent foroff-site treatment or disposal.  These remediationrequirements may be imposed without regard to fault and whether ornot we owned or operated the property at the time that the relevantreleases or discharges occurred.  Liability for environmentalremediation can be substantial.

**RiskFactors**

*               If any of the events discussed in the following risks were tooccur, our business, financial position, results of operations,cash flows or prospects could be materially adverselyaffected.  Additional risks and uncertainties not presentlyknown, or currently deemed immaterial by us, may also constrain ourbusiness and operations.*

***Risks Related to OurDebt***

***               Our high level of debt may limit our ability to successfullyoperate our business.***

               We have a substantial amount of debt. On June 30, 2002, we had$314.8 million of outstanding debt, excluding letters of credit andguarantees. Of that amount, $300 million consisted of our 9.75%Senior Subordinated Notes due 2011 (the “9.75% Notes”),and $14.8 million consisted of capitalized lease obligations andother debt, resulting in a percentage of debt-to-totalcapitalization of 50.2%.  For the year ended June 30, 2002,earnings were sufficient to cover fixed charges by $9.2million.  Subject to the restrictions in the indenturerelating to the 9.75% Notes and our current senior secured creditfacility, we and our subsidiaries may be able to incur substantialadditional indebtedness in the future.  Our senior securedcredit facility permits revolving borrowings and letters of creditof up to $125 million in the aggregate outstanding at any one time,and we may borrow substantial additional indebtedness in thefuture.

               Our substantial indebtedness could:

               •   increase our vulnerability to general adverseeconomic, market and industry conditions and limit our                   flexibility in planning for, or reacting to, theseconditions;

               •   increase our vulnerability to interest ratefluctuations because much of our debt may be at variable                   interest rates;

               •   limit our ability to obtain additional financingto fund future acquisitions and working capital, capital                   expenditures or other needs; and

               •   limit our ability to compete with others who arenot as highly-leveraged.

               Our ability to make scheduled payments of principal and interest orto satisfy our other debt obligations, to refinance ourindebtedness or to fund capital expenditures will depend on ourfuture operating performance. Prevailing economic conditions andfinancial, business and other factors, many of which are beyond ourcontrol, will also affect our ability to meet these needs. We maynot be able to generate sufficient cash flow from operations orrealize anticipated revenue growth or operating improvements, orobtain future borrowings in an amount sufficient to enable us topay our debt, or to fund our other liquidity needs. We may need torefinance all or a portion

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of our debt on or beforematurity. We may not be able to refinance any of our debt whenneeded on commercially reasonable terms or at all.

               ***Operating and financial restrictions in our debt agreementswill limit our operational and financialflexibility.***

               Restrictions and covenants in our existing debt agreements, and anyfuture financing agreements, may adversely affect our ability tofinance future operations or capital needs or to engage in otherbusiness activities. Specifically, our debt agreements restrict ourability to:

               •  declare dividends or redeem or repurchase capitalstock;               •  prepay, redeem or repurchase debt;               •  incur liens;               •  make loans and investments;               •  incur additional indebtedness;               •  amend or otherwise change debt and other materialagreements;               •  make capital expenditures;               •  engage in mergers, acquisitions and assetsales;               •  enter into transactions with affiliates;and               •  change our primary business.

               Although it is difficult for us to predict future liquidityrequirements with certainty, we believe that we will be able tomeet our anticipated cash needs for working capital and capitalexpenditures for at least the next 12 months.

               Our acquisition program requires substantial capital resources, andthe operations of our existing hospitals and newly acquiredhospitals require ongoing capital expenditures for renovation,expansion and the addition of medical equipment and technology.More specifically, we are currently, and may in the future be,contractually obligated to make significant capital expendituresrelating to the facilities we acquire. Our debt agreements mayrestrict our ability to incur additional indebtedness to fund theseexpenditures.

               A breach of any of the restrictions or covenants in our debtagreements could cause a default under our current senior securedcredit facility, other debt or the 9.75% Notes. A significantportion of our indebtedness then may become immediately due andpayable. We are not certain whether we would have, or be able toobtain, sufficient funds to make these accelerated payments. If any senior debt is accelerated, our assets may not be sufficientto repay in full such indebtedness and our otherindebtedness.

**Risks Related to OurBusiness**

               ***We may be unable to achieve our acquisition and growthstrategy and we may have difficulty acquiring not-for-profithospitals due to regulatory scrutiny.***

               An important element of our business strategy is expansion byacquiring hospitals in our existing and in new urban and suburbanmarkets and by entering into partnerships or affiliations withother health care service providers. The competition to acquirehospitals is significant, including competition from health carecompanies with greater financial resources than ours, and we maynot be able to make suitable acquisitions on favorable terms, andwe may have difficulty obtaining financing, if necessary, for suchacquisitions on satisfactory terms. In addition, we may not be ableto effectively integrate any acquired facilities with ouroperations. Even if we continue to acquire additional facilitiesand/or enter into partnerships or affiliations with other healthcare service providers, Federal and state regulatory agencies mayconstrain our ability to grow.

               Additionally, many states, including some where we have hospitalsand others where we may in the future attempt to acquire hospitals,have adopted legislation regarding the sale or other disposition ofhospitals operated by not-for-profit entities. In other states thatdo not have specific legislation, the attorneys general havedemonstrated an interest in these transactions under their generalobligations to protect charitable assets from waste. Theselegislative and administrative efforts focus primarily on theappropriate valuation of the assets divested and the use

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of the sale proceeds bythe not-for-profit seller. These review and approval processes canadd time to the consummation of an acquisition of a not-for-profithospital, and future actions on the state level could seriouslydelay or even prevent future acquisitions of not-for-profithospitals. Furthermore, as a condition to approving an acquisition,the attorney general of the state in which the hospital is locatedmay require us to maintain specific services, such as emergencydepartments, or to continue to provide specific levels of charitycare, which may affect our decision to acquire or the terms of anacquisition of these hospitals.

               ***Difficulties with integrating our acquisitions may disruptour ongoing operations.***

               We may not be able to profitably or effectively integrate theoperations of, or otherwise achieve the intended benefits from, anyacquisitions we make or partnerships or affiliations we may form.The process of integrating acquired hospitals may require adisproportionate amount of management’s time and attention,potentially distracting management from its day-to-dayresponsibilities. This process may be even more difficult in thecase of hospitals we may acquire out of bankruptcy or otherwise infinancial distress. In addition, poor integration of acquiredfacilities could cause interruptions to our business activities,including those of the acquired facilities. As a result, we mayincur significant costs related to acquiring or integrating thesefacilities and may not realize the anticipated benefits.

               Moreover, acquired businesses may have unknown or contingentliabilities, including liabilities for failure to comply withhealth care laws and regulations. Although our policy is to conformthe practices of acquired facilities to our standards, andgenerally to obtain indemnification from sellers covering thesematters, we could in the future become liable for past activitiesof acquired businesses and such liabilities could bematerial.

               ***If we are unable to enter into favorable contracts withmanaged care plans, our operating revenues may bereduced.***

               Our ability to negotiate favorable contracts with healthmaintenance organizations, preferred provider organizations andother managed care plans significantly affects the revenue andoperating results of our hospitals. Revenues derived from healthmaintenance organizations, preferred provider organizations andother managed care plans accounted for approximately 50% of our netpatient revenues for the year ended June 30, 2002.  Managedcare organizations offering prepaid and discounted medical servicespackages represent an increasing portion of our admissions, ageneral trend in the industry which has limited hospital revenuegrowth nationwide. In addition, private payers are increasinglyattempting to control health care costs through direct contractingwith hospitals to provide services on a discounted basis, increasedutilization review, including the use of hospitalists, and greaterenrollment in managed care programs such as health maintenanceorganizations and preferred provider organizations. Our futuresuccess will depend, in part, on our ability to renew existingmanaged care contracts and enter into new managed care contracts onterms favorable to us. Other health care companies, including somewith greater financial resources, greater geographic coverage or awider range of services, may compete with us for theseopportunities. If we are unable to contain costs through increasedoperational efficiencies or to obtain higher reimbursements andpayments from managed care or government payers, our results ofoperations and cash flow will be adversely affected.  WestAnaheim Medical Center in Anaheim, California receives paymentsunder a long term “take-or-pay” contract with a managedcare payer which generated approximately $22.9 million, or 2.5%, ofour net revenues for the year ended June 30, 2002.  Under this“take or pay” arrangement the payer has agreed topurchase in each contractual year a fixed amount of patient days ata fixed rate per day primarily from West Anaheim Medical Center,except that a portion of such patient days can also be purchased,at the option of the payer, at our Huntington Beach Hospital inHuntington Beach, California or at our two ambulatory surgerycenters in Orange County, California.  The rate is adjustedannually to reflect any increases in the consumer price index andmay also be adjusted pursuant to a contractual formula if the levelof acuity for the patients which the payer directs to ourfacilities increases.  Under this contract, the payer isobligated to purchase from our facilities patient days which willcost the payer an aggregate of $24.8 million for the contract yearending March 31, 2003.  If annual patient days costing lessthan $24.8 million are purchased during the contract year endedMarch 31, 2003, then the payer must reimburse the West AnaheimMedical Center for the difference between $24.8 million and thetotal amount of patient days purchased even though no additionalpatient days are provided.  The managed care payer of thiscontract has given us notice that it intends to terminate thiscontract, effective May 18, 2005. We do not know at this timewhether we will be able to extend or renew this contract beyondMay 18, 2005, even if we agreed to reduce

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our health care charges tosuch payer, or replace these revenues with other new business. Ifwe are unable to renew or replace this contract, our earnings willbe adversely impacted.

               ***Changes in governmental programs may significantly reduce ourrevenues.***

               Government health care programs, principally Medicare and Medicaid,accounted for approximately 31% of our net revenues for the yearended June 30, 2002.  Recent legislative changes, includingthose enacted as part of the Balanced Budget Act of 1997, haveresulted in limitations on and, in some cases, reductions in levelsof, payments to health care providers for certain services undermany of these government programs. Many changes imposed by theBalanced Budget Act of 1997 have been phased in over a period ofyears. Certain rate reductions resulting from the Balanced BudgetAct of 1997 are being mitigated by the Balanced Budget RefinementAct of 1999 and will be further mitigated by the BenefitsImprovement Protection Act of 2000. Nonetheless, the BalancedBudget Act of 1997 significantly reduced the level of payment underthe Medicare and Medicaid programs. These changes have resulted,and we expect will continue to result, in significant reductions inpayments for our inpatient and outpatient services.  Inaddition, a number of states have adopted or are consideringlegislation designed to reduce their Medicaid expenditures and toprovide universal coverage and additional care, including enrollingMedicaid recipients in managed care programs and imposingadditional taxes on hospitals to help finance or expand thesestates’ Medicaid systems. We believe that hospital operatingmargins across the industry, including ours, have been, and maycontinue to be, under continuing pressure because of limitedpricing flexibility and growth in operating expenses in excess ofthe increase in prospective payments under the Medicareprogram.

               ***We are subject to uncertainties regarding health carereform.***

               In recent years, an increasing number of legislative initiativeshave been introduced or proposed in Congress and in statelegislatures that would result in major changes in the health caresystem, either nationally or at the state level.  Among theproposals that have been introduced are price controls onhospitals, insurance market reforms to increase the availability ofgroup health insurance to small businesses, requirements that allbusinesses offer health insurance coverage to their employees andthe creation of a government health insurance plan or plans thatwould cover all citizens and increase payments bybeneficiaries.  We cannot predict whether any of the aboveproposals or any other proposals will be adopted, and if adopted,no assurance can be given that the implementation of such reformswill not have a material adverse effect on our business, financialposition or results of operations.

               ***Competition from other hospitals or health care providers mayreduce our patient volume and profitability.***

               The hospital industry is highly competitive. Our hospitals facecompetition for patients from other hospitals in our markets, largetertiary care centers and outpatient service providers that providesimilar services to those provided by our hospitals.

               Some of the hospitals that compete with ours are owned bygovernmental agencies or not-for-profit corporations supported byendowments and charitable contributions and can finance capitalexpenditures and operations on a tax-exempt basis. Some of ourcompetitors are larger and more established, have greatergeographic coverage, offer a wider range of services (includingextensive medical research and medical education programs) or havemore capital or other resources than we do. If our competitors areable to finance capital improvements, recruit physicians, expandservices or obtain favorable managed care contracts at theirfacilities, we may experience a decline in patientvolume.

               Phoenix Health Plan, our prepaid Medicaid managed health care plan,also faces competition within the Arizona market which it serves.As in the case of our hospitals, some of our competitors in thismarket are owned by governmental agencies or not-for-profitcorporations with greater financial resources than we have. Other competitors have larger membership bases, are moreestablished and have greater geographic coverage areas which givethem an advantage in competing for a limited pool of eligiblehealth plan members. Moreover, because our leverage in negotiatingwith Arizona’s state Medicaid program for higherreimbursement fees depends, to an extent, upon the number ofenrollees in our health plan eligible for the program, a failure toattract future enrollees may negatively impact our ability tomaintain our profitability in this market.

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               ***Our performance depends on our ability to recruit and retainquality physicians.***

               The success of our hospitals depends in part on the followingfactors:

               •  the number and quality of the physicians on themedical staffs of our hospitals;               •  the admitting practices of those physicians;and               •  the maintenance of good relations with thosephysicians.

               Most physicians at our hospitals also have admitting privileges atother hospitals. If we are unable to provide adequate supportpersonnel or technologically advanced equipment and facilities thatmeet the needs of physicians, they may be discouraged fromreferring patients to our facilities, which could adversely affectour profitability.

               ***Our hospitals face competition for staffing, which mayincrease our labor costs and reduceprofitability.***

               We compete with other health care providers in recruiting andretaining qualified management and staff personnel responsible forthe day-to-day operations of each of our hospitals, includingnurses and other non-physician health care professionals. In thehealth care industry generally, including in our markets, thescarcity of nurses and other medical support personnel has become asignificant operating issue. This shortage may require us toincrease wages and benefits to recruit and retain nurses and othermedical support personnel or to hire more expensive temporarypersonnel. We have raised on several occasions in the past, andexpect to raise in the future, wages for our nurses and othermedical support personnel.  We also depend on the availablelabor pool of semi-skilled and unskilled employees in each of themarkets in which we operate. If our labor costs increase, we maynot be able to raise rates to offset these increased costs. Becauseapproximately 81% of our net patient revenues for the year endedJune 30, 2002, consist of payments based on fixed or negotiatedrates, our ability to pass along increased labor costs isconstrained. Our failure to recruit and retain qualifiedmanagement, nurses and other medical support personnel, or tocontrol our labor costs, could have a material adverse effect onour profitability.

               ***We conduct business in a heavily regulated industry, andchanges in regulations or violations of regulations may result inincreased costs or sanctions that could reduce our revenues andprofitability.***

               The health care industry is subject to extensive Federal, state andlocal laws and regulations relating to licensing, the conduct ofoperations, the ownership of facilities, the addition of facilitiesand services, confidentiality, maintenance and security issuesassociated with medical records, billing for services and pricesfor services.  Although we believe that our facilities are insubstantial compliance with such laws and regulations, if adetermination were made that we were in material violation of suchlaws or regulations, our operations and financial results could bematerially adversely affected. 

               In many instances, the industry does not have the benefit ofsignificant regulatory or judicial interpretations of these lawsand regulations, particularly in the case of Medicare and Medicaidantifraud and abuse amendments, codified under section 1128B(b) ofthe Social Security Act and known as the “Anti-KickbackStatute.” This law prohibits providers and others fromsoliciting, receiving, offering or paying, directly or indirectly,any remuneration with the intent to generate referrals of ordersfor services or items reimbursable under Medicare, Medicaid andother Federal health care programs.  As authorized byCongress, the United States Department of Health and Human Serviceshas issued regulations which describe some of the conduct andbusiness relationships immune from prosecution under theAnti-Kickback Statute. The fact that a given business arrangementdoes not fall within one of these “safe harbor”provisions does not render the arrangement illegal, but businessarrangements of health care service providers that fail to satisfythe applicable safe harbor criteria risk increased scrutiny byenforcement authorities.

               Some of the financial arrangements which we maintain with ourphysicians do not meet all of the requirements for safe harborprotection. The regulatory authorities that enforce theAnti-Kickback Statute may in the future determine that one or moreof these arrangements violate the Anti-Kickback Statute or otherFederal or state laws. A determination that we have violated theAnti-Kickback Statute or other Federal laws could subject us toliability under the Social Security Act, including criminal andcivil penalties, as well as exclusion from participation ingovernment programs such as Medicare and Medicaid or other Federalhealth care programs.

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               In addition, the portion of the Social Security Act commonly knownas the “Stark Law” prohibits physicians from referringMedicare and Medicaid patients to providers of designated healthservices if the physician or a member of his or her immediatefamily has an ownership interest in or compensation arrangementwith that provider.  There are exceptions to the Stark Law forphysicians maintaining an ownership interest in an entire hospital,employment agreements, leases, physician recruitment and certainother physician arrangements.

               All of the states in which we operate have adopted or haveconsidered adopting similar anti-kickback and physicianself-referral legislation, some of which extends beyond the scopeof the Federal law to prohibit the payment or receipt ofremuneration for the referral of patients and physicianself-referrals, regardless of the source of payment for the care.Little precedent exists for the interpretation or enforcement ofthese laws. Both Federal and state government agencies haveannounced heightened and coordinated civil and criminal enforcementefforts.

               Government officials responsible for enforcing health care lawscould assert that we, or any of the transactions in which we areinvolved, are in violation of any of these laws. It is alsopossible that the courts could ultimately interpret these laws in amanner that is different from our interpretations. A determinationthat we have violated these laws, or the public announcement thatwe are being investigated for possible violations of these laws,could have a material adverse effect on our business, financialcondition, results of operations or prospects, and our businessreputation could suffer significantly.

               Some states require prior approval for the purchase of majormedical equipment or the purchase, construction, expansion, sale orclosure of health care facilities, based upon a determination ofneed for additional or expanded health care facilities or services.The governmental determinations, embodied in Certificates of Need,may be required for capital expenditures exceeding a prescribedamount, changes in bed capacity or services and certain othermatters.  Illinois, a state in which we own two hospitals, hasCertificate of Need laws affecting acute care hospitalservices.  We cannot predict whether we will be able to obtainrequired Certificates of Need in the future. A failure to obtainany required Certificates of Need may impair our ability to operateprofitably.

               The laws, rules and regulations described above are complex andsubject to interpretation. In the event of a determination that weare in violation of any of these laws, rules or regulations, or iffurther changes in the regulatory framework occur, our results ofoperations could be significantly harmed.  For a more detaileddiscussion of the laws, rules and regulations described above, see“Government Regulation and Other Factors.”

               ***Providers in the health care industry have been the subjectof Federal and state investigations, and we may become subject toinvestigations in the future.***

               Both Federal and state government agencies have heightened andcoordinated civil and criminal enforcement efforts as part ofnumerous ongoing investigations of hospital companies, as well astheir executives and managers. These investigations relate to awide variety of topics, including:

               •  referral, cost reporting and billingpractices;               •  laboratory and home health care services;and               •  physician ownership and joint ventures involvinghospitals.

               In addition, the Federal False Claims Act permits private partiesto bring *qui tam*, or whistleblower, lawsuits againstcompanies. Some states have adopted similar whistleblower and falseclaims provisions.

               The Office of the Inspector General of the Department of Health andHuman Services and the Department of Justice have, from time totime, established national enforcement initiatives that focus onspecific billing practices or other suspected areas of abuse.Initiatives include a focus on hospital billing for outpatientcharges associated with inpatient services, as well as hospitallaboratory billing practices.

               As a result of these regulations and initiatives, some of ouractivities could become the subject of governmental investigationsor inquiries. For example, we have significant Medicare andMedicaid billings, we provide some durable medical equipment andhome health care services, and we have joint venture arrangementsinvolving physician investors. In addition, our executives andmanagers, many of whom have worked at other health care companiesthat are or may become the subject of Federal and stateinvestigations and private litigation, could be

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included in governmentalinvestigations or named as defendants in private litigation. We areaware that several of our hospitals have been or are beinginvestigated in connection with activities conducted prior to ouracquisition of them. Under the terms of our various acquisitionagreements, the prior owners of our hospitals are responsible forany liabilities arising from pre-closing violations.  Theprior owners’ resolution of these matters or failure toresolve these matters, in the event that any resolution was deemednecessary, may have a material adverse effect on our business,financial condition or results of operation.  Anyinvestigations of us, our executives, managers, facilities oroperations could result in significant liabilities or penalties tous, as well as adverse publicity.

               ***If any one of the regions in which we operate experiences aneconomic downturn or other material change, our overall businessresults may suffer.***

               Among our operations as of June 30, 2002, five hospitals, fivediagnostic imaging centers and a prepaid Medicaid managed healthplan were located in Phoenix, Arizona, three hospitals and twoambulatory surgery centers were located in Orange County,California, and two hospitals and its related clinics were locatedin metropolitan Chicago, Illinois. For the year ended June 30,2002, our revenues and consolidated EBITDA, including corporateoverhead, were generated as follows:

|                           |        |  | **Yearended June 30, 2002** |
|--------------------------------|--------|--|-----------------------------|
|                           |        |  | ****                        |
|                           |        |  | **Revenues**                | ** ** | **EBITDA(1)** |
|                           |        |  | ****                        |
| **Operations**                 |        |  |                             |  |  |  |  |  |   |
| Phoenix                        |   |  | 38.0                        | % |  |  | 42.0 |  % |   |
| Los Angeles/OrangeCounty       |        |  | 16.6                        | % |  |  | 13.6 |  % |   |
| Metropolitan Chicago(2)        |        |  | 29.4                        | % |  |  | 43.1 |  % |   |
| Phoenix Health Plan andother   |        |  | 16.0                        | % |  |  | 17.6 |  % |   |
| Corporate overheadexpenses (3) |        |  | 0.0                         | % |  |  | (16.3 | )% |   |
|                                |        |  |                             |  |  |  |  |  |   |
|                                |        |  | 100                         | % |  |  | 100 | % |   |
|                                |        |  |                             |  |  |  |  |  |   |

| ____________________ |
|----------------------|
| (1)                  |  | EBITDA is defined as netincome before interest expense (net of interest income), incometaxes, depreciation, amortization, minority interest, gain or losson sale of assets, non-cash stock compensation, equity methodincome or loss and debt extinguishment costs.  While youshould not consider EBITDA in isolation or as a substitute for netincome, operating cash flows or other cash flow statement datadetermined in accordance with accounting principles generallyaccepted in the United States, management understands that EBITDAis commonly used as an analytical indicator within the health careindustry and serves as a measure of leverage capacity and debtservice ability.  Because EBITDA is susceptible to varyingcalculations, EBITDA as presented may not be comparable to EBITDAor other similarly titled measures used by othercompanies. |
|                      |  |  |
| (2)                  |  | Includes MacNeal HealthProviders. |
|                      |  |  |
| (3)                  |  | Reflected in ConsolidatedFinancial Statements only. |

               Any material change in the current demographic, economic,competitive or regulatory conditions in any of these regions couldadversely affect our overall business results because of thesignificance of our operations in each of these regions to ouroverall operating performance. Moreover, due to the concentrationof our revenues in only three regions, our business is lessdiversified and, accordingly, is subject to greater regional riskthan that of some of our larger competitors.

               California has a statute and regulations that require hospitals tomeet seismic performance standards, and hospitals that do not meetthe standards may be required to retrofit their facilities. Our estimated cost to comply with the seismic regulations andstandards required by 2008 is $10.1 million.  Upon completionof the $10.1 million in improvements, our California facilitieswill be compliant with the requirements of the seismic regulationsthrough 2029.  We estimate that the majority of the squarefootage in our facilities will be compliant with theseismic

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regulations and standardsrequired by 2030 once we have completed such $10.1 million inimprovements, but we are unable at this time to estimate our costsfor full compliance with the 2030 requirements.

******

***               We are dependent on our senior management team and local managementpersonnel, and the loss of the services of one or more of oursenior management team or key local management personnel could havea material adverse effect on our business.***

               The success of our business is largely dependent upon the servicesand management experience of our senior management team, whichincludes Charles N. Martin, Jr., our Chairman and Chief ExecutiveOfficer; William L. Hough, our President and Chief OperatingOfficer; Joseph D. Moore, our Executive Vice President, ChiefFinancial Officer and Treasurer, and Keith B. Pitts, our ViceChairman.  In addition, we depend on our ability to attractand retain local managers at our hospitals and related facilities,on the ability of our senior officers and key employees to managegrowth successfully and on our ability to attract and retainskilled employees.  We do not maintain key man life insurancepolicies on any of our officers.  If we were to lose any ofour senior management team or members of our local managementteams, or if we are unable to attract other necessary personnel inthe future, it could have a material adverse effect on ourbusiness, financial condition and results of operations.  Ifwe were to lose the services of one or more members of our seniormanagement team or a significant portion of our hospital managementstaff at one or more of our hospitals, we would likely experience asignificant disruption in our operations and failures of theaffected hospitals to adhere to their respective businessplans.

               ***Should we be unable to control our health care costs atPhoenix Health Plan, or if the health plan should lose itsgovernmental contract, our profitability may be adverselyaffected.***

               For the year ended June 30, 2002 our Phoenix Health Plan generatedapproximately 15.9% of our revenues and 17.6% of our EBITDA. Phoenix Health Plan derives substantially all of its revenuesthrough a contract with the AHCCCS, which is the state agency thatadministers Arizona’s state Medicaid program.  AHCCCSpays capitated rates to Phoenix Health Plan, and Phoenix HealthPlan subcontracts with physicians, hospitals and other health careproviders to provide services to its enrollees. If we fail toeffectively manage our health care costs, these costs may exceedthe payments we receive. Many factors can cause actual health carecosts to exceed the capitated rates paid by AHCCCS,including:

               •  our ability to contract with cost-effectivehealth care providers;               •  the increased cost of individual health careservices;               •  the type and number of individual health careservices delivered; and               •  the occurrence of catastrophes, epidemics orother unforeseen occurrences.

               Our contract with AHCCCS expires on September 30, 2003, andalthough by its terms it is renewable annually by AHCCCS, it isterminable for any reason upon 90 days’ notice. If thiscontract were terminated or not renewed or further extended, ourprofitability could be adversely affected by the loss of theserevenues and cash flow.

**               *If we become subject to malpractice and related legal claims, wecould be required to pay significant damages, which may not becovered by our insurance arrangements, and our overall businessresults may suffer.***

               In recent years, physicians, hospitals and other health careproviders have become subject to an increasing number of legalactions alleging malpractice, product liability or related legaltheories. Many of these actions involve large monetary claims andsignificant defense costs. As a result of insurance carrierpayments in recent years of these large claims, the pricing  in the professional and general liability insurancemarkets has risen greatly and there is currently limitedavailability of this type of  insurance. Due to theseunfavorable pricing and availability trends, the Company recentlycreated an insurance subsidiary to assume a substantial portion of the professional and general liability risks of ourfacilities.  Effective June 1, 2002, we maintain professionaland general liability insurance through this insurance subsidiaryfor losses up to $10 million per occurrence. This is in comparisonto a retention of only $1 million per occurrence by the Company orits subsidiaries for the period June 1, 2001 to May 31, 2002. Wealso have purchased, effective June 1, 2002 until May 31, 2003, anumbrella excess policy for  professional and general liabilityinsurance with unrelated commercial carriers for losses in excessof $10 million per occurrence up to $100 million in theaggregate.  However, excess insurance coverage may notcontinue to be

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available at a costallowing us to maintain adequate levels of such insurance. Ifactual payment of claims materially exceed our  projectedestimates of malpractice claims, our financial condition could bematerially adversely affected.

**Item 2.   Properties.**

               A listing of our owned acute hospitals is included in Item 1 ofthis report under the caption“Business-Facilities”.  We also own or lease spacefor outpatient service facilities complementary to our hospitalsand own and operate certain medical office buildings (some of whichare joint ventures) associated with our hospitals that are occupiedprimarily by physicians who practice at our hospitals.  Wealso own approximately 23 acres of vacant land in the western partof metropolitan Phoenix, Arizona, on which we have begun theconstruction of a new 73-bed acute care hospital.

               We currently lease approximately 21,250 square feet of office spaceat 20 Burton Hills Boulevard, Nashville, Tennessee, for ourcorporate headquarters.  We recently amended the corporateoffice lease to lease an additional 20,800 square feet of officespace effective January 1, 2003, with an option to relinquish up toapproximately 8,900 square feet of the original leased space. Our headquarters office lease expires on August 31,2008.

               Our headquarters, hospitals and other facilities are suitable fortheir respective uses and are, in general, adequate for our presentneeds.  Our obligations under our 2001 credit facility aresecured by a pledge of substantially all of our assets, includingfirst priority mortgages on each of our hospitals.  Also, ourproperties are subject to various Federal, state and local statutesand ordinances regulating their operation.  Management doesnot believe that compliance with such statutes and ordinances willmaterially affect our financial position or results fromoperations.

**Item 3.    LegalProceedings.**

               We are subject to claims and lawsuits arising in the ordinarycourse of business, including potential claims related to care andtreatment provided at our hospitals and our complementaryoutpatient service facilities.  Although the results of theseclaims and lawsuits cannot be predicted with certainty, we believethat the ultimate resolution of these claims and lawsuits will nothave a material adverse effect on our business, financial conditionor results of operations.

               We have received a notice objecting to our use of the mark“Vanguard.”  We have also filed an opposition tothe objecting party’s registration of the mark,“Vanguard Healthcare.”  The Patent and TrademarkOffice has approved our service mark application in respect of themark “Vanguard” as it regards hospital and healthcareservices for form and registration, subject to the issuance orabandonment of the objecting party’s application.  We donot brand our hospitals with the Vanguard name, and we do notbelieve that a negative outcome in this administrative proceedingwould have a material effect upon our business, financial conditionor results of operations.

**Item 4.    Submission of Mattersto a Vote of Security Holders.**

               No matters were submitted to a vote of stockholders during thefourth quarter ended June 30, 2002.

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**PARTII**

**Item 5.    Market forRegistrant’s Common Equity and Related StockholderMatters.**

               There is no established public trading market for our commonstock.  At September 15, 2002, there were 43 holders of recordof our common stock.

               The Company has not declared or paid any dividends on its commonstock.  We intend to retain all current and foreseeable futureearnings to support operations and finance expansion.  Oursenior credit facility and the indenture governing our 9.75% Notesrestrict our ability to pay cash dividends on our commonstock.

**Item 6.    Selected FinancialData.**

               The following table sets forth selected consolidated financial dataof our Company or its predecessor for, or as the end of, each ofthe five years ended June 30, 2002.  The selected financialdata for the years ended June 30, 1998, 1999, 2000, 2001 and 2002are derived from our audited financial statements.  Financialdata for the eleven months ended May 31, 1998, has been derivedfrom unaudited financial statements of our predecessor, MaryvaleHospital Medical Center.  The timing of acquisitions completedduring fiscal years 1998, 2000, 2001 and 2002 affects thecomparability of the selected historical financial data. Please read this table in conjunction with the “Item 7. Management’s Discussion and Analysis of Financial Conditionand Results of Operations” and our consolidated financialstatements and related notes, appearing elsewhere in thisreport.

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|                                                                   | **Predecessor**          |          |                                      |          |   |
|------------------------------------------------------------------------|--------------------------|----------|--------------------------------------|----------|--------|
|                                                                   |                          |          |                                      |          |   |
|                                                                   |                          |          | **Eleven Months Ended May 31, 1998** |          |        |  | **YearEnded June 30,** |  |   |
| **1998**                                                               |                          | **1999** |                                      | **2000** |        | **2001** |  | **2002** |  |   |
|                                                                   |                          |          | ****                                 |          |        |  | **** |  |   |
|                                                                        | **(dollarsin millions)** |          |
| **Summary ofOperations:**                                              |                          |          |                                      |          |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |   |
| Revenues                                                               |                          | $        | 82.0                                 |          |        | $ | 7.0 |  |  | $ | 91.5 |  |  | $ | 304.7 |  |  | $ | 667.8 |  |  | $ | 910.6 |  |   |
|                                                                   |                          |          |                                      |          |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |   |
| Salaries andbenefits                                                   |                          |          | 29.8                                 |          |        |  | 3.5 |  |  |  | 39.3 |  |  |  | 146.5 |  |  |  | 323.6 |  |  |  | 384.4 |  |   |
| Supplies                                                               |                          |          | 9.3                                  |          |        |  | 0.9 |  |  |  | 12.5 |  |  |  | 40.5 |  |  |  | 92.9 |  |  |  | 116.1 |  |   |
| Medical claimsexpense                                                  |                          |          | –                              |          |        |  | – |  |  |  | – |  |  |  | 7.4 |  |  |  | 30.8 |  |  |  | 132.0 |  |   |
| Other operatingexpenses                                                |                          |          | 16.5                                 |          |        |  | 2.9 |  |  |  | 15.5 |  |  |  | 56.6 |  |  |  | 111.4 |  |  |  | 152.8 |  |   |
| Provision for doubtfulaccounts                                         |                          |          | 17.4                                 |          |        |  | 1.3 |  |  |  | 17.3 |  |  |  | 33.1 |  |  |  | 56.8 |  |  |  | 53.3 |  |   |
| Depreciation andamortization                                           |                          |          | 2.6                                  |          |        |  | 0.5 |  |  |  | 3.9 |  |  |  | 11.8 |  |  |  | 23.8 |  |  |  | 29.5 |  |   |
| Interest, net                                                          |                          |          | 1.5                                  |          |        |  | 0.2 |  |  |  | 4.2 |  |  |  | 8.8 |  |  |  | 16.6 |  |  |  | 26.7 |  |   |
| Non-cash stockcompensation                                             |                          |          | –                              |          |        |  | 0.5 |  |  |  | 5.0 |  |  |  | – |  |  |  | – |  |  |  | – |  |   |
| Debt extinguishmentcosts                                               |                          |          | –                              |          |        |  | – |  |  |  | – |  |  |  | 1.1 |  |  |  | – |  |  |  | 6.6 |  |   |
| Minority interests andother                                            |                          |          | –                              |          |        |  | (0.1 | ) |  |  | 0.2 |  |  |  | 0.2 |  |  |  | 1.2 |  |  |  | (0.5 | ) |   |
|                                                                   |                          |          |                                      |          |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |   |
|    Totalcosts and expenses                              |                          |          | 77.1                                 |          |        |  | 9.7 |  |  |  | 97.9 |  |  |  | 306.0 |  |  |  | 657.1 |  |  |  | 900.9 |  |   |
|                                                                   |                          |          |                                      |          |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |   |
| Income (loss) beforeincome taxes                                       |                          |          | 4.9                                  |          |        |  | (2.7 | ) |  |  | (6.4 | ) |  |  | (1.3 | ) |  |  | 10.7 |  |  |  | 9.7 |  |   |
| Income taxexpense                                                      |                          |          | –                              |          |        |  | – |  |  |  | – |  |  |  | (0.1 | ) |  |  | (0.5 | ) |  |  | (2.9 | ) |   |
|                                                                   |                          |          |                                      |          |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |   |
| Net income(loss)                                                       |                          |          | 4.9                                  |          |        |  | (2.7 | ) |  |  | (6.4 | ) |  |  | (1.4 | ) |  |  | 10.2 |  |  |  | 6.8 |  |   |
| Accrued preferreddividends                                             |                          |          | –                              |          |        |  | (0.1 | ) |  |  | – |  |  |  | (0.7 | ) |  |  | (1.7 | ) |  |  | (1.8 | ) |   |
|                                                                   |                          |          |                                      |          |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |   |
| Net income (loss)attributable to common    shareholders |                          | $        | 4.9                                  |          |        | $ | (2.8 | ) |  | $ | (6.4 | ) |  | $ | (2.1 | ) |  | $ | 8.5 |  |  | $ | 5.0 |  |   |
| ** **                                                             |                          |          |                                      |          |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |   |
| **Balance Sheet Data (Endof Period) (a):**                             |                          |          |                                      |          |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |   |
| Assets                                                                 |                          | $        | 37.5                                 |          |        | $ | 88.3 |  |  | $ | 98.1 |  |  | $ | 549.9 |  |  | $ | 640.4 |  |  | $ | 851.9 |  |   |
| Long-term debt, includingcurrent portion                               |                          |          | –                              |          |        |  | 47.5 |  |  |  | 56.2 |  |  |  | 153.3 |  |  |  | 163.4 |  |  |  | 314.8 |  |   |
| Payable-In-Kind PreferredStock                                         |                          |          | –                              |          |        |  | – |  |  |  | – |  |  |  | 20.7 |  |  |  | 22.3 |  |  |  | 24.1 |  |   |
| Working capital                                                        |                          |          | 16.1                                 |          |        |  | 5.0 |  |  |  | 11.9 |  |  |  | 39.5 |  |  |  | 15.3 |  |  |  | 87.9 |  |   |
|                                                                   |                          |          |                                      |          |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |   |
| **OtherData:**                                                         |                          |          |                                      |          |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |   |
| EBITDA (b)                                                             |                          | $        | 9.0                                  |          |        | $ | (1.6 | ) |  | $ | 6.9 |  |  | $ | 20.6 |  |  | $ | 52.3 |  |  | $ | 72.0 |  |   |
| Number of hospitals at endof period                                    |                          |          | 1                                    |          |        |  | 1 |  |  |  | 1 |  |  |  | 7 |  |  |  | 8 |  |  |  | 10 |  |   |
| Number of licensed beds atend of period (c)                            |                          |          | 239                                  |          |        |  | 239 |  |  |  | 239 |  |  |  | 1,481 |  |  |  | 1,676 |  |  |  | 2,207 |  |   |
| Weighted average licensedbeds (d)                                      |                          |          | 239                                  |          |        |  | 20 |  |  |  | 239 |  |  |  | 771 |  |  |  | 1,514 |  |  |  | 1,815 |  |   |
| Discharges (e)                                                         |                          |          | 12,200                               |          |        |  | 1,191 |  |  |  | 12,447 |  |  |  | 31,864 |  |  |  | 65,237 |  |  |  | 75,364 |  |   |
| Adjusteddischarges-hospitals (f)                                       |                          |          | 18,086                               |          |        |  | 1,760 |  |  |  | 19,811 |  |  |  | 50,661 |  |  |  | 96,774 |  |  |  | 110,758 |  |   |
| Average length of stay(days) (g)                                       |                          |          | 3.4                                  |          |        |  | 3.1 |  |  |  | 3.2 |  |  |  | 4.1 |  |  |  | 4.1 |  |  |  | 4.1 |  |   |
| Average daily census(h)                                                |                          |          | 125.0                                |          |        |  | 120.0 |  |  |  | 112.0 |  |  |  | 278.4 |  |  |  | 728.8 |  |  |  | 837.0 |  |   |
| Occupancy rate(i)                                                      |                          |          | 52.3                                 | %        |        |  | 50.2 | % |  |  | 46.9 | % |  |  | 46.1 | % |  |  | 48.0 | % |  |  | 46.0 | % |   |

| ___________________ |
|---------------------|
| (a)                 |  | The balance sheet datapresented for the predecessor is not comparable to the balancesheet data of Vanguard due to the capital structure changes relatedto the acquisition by Vanguard of the not-for-profit predecessorand the related effects of purchase accounting. |

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| (b) |  | EBITDA is defined as netincome before interest expense (net of interest income), incometaxes, depreciation, amortization, minority interest, gain or losson sale of assets, non-cash stock compensation, equity methodincome or loss and debt extinguishment costs.  While youshould not consider EBITDA in isolation or as a substitute for netincome, operating cash flows or other cash flow statement datadetermined in accordance with accounting principles generallyaccepted in the United States, management understands that EBITDAis commonly used as an analytical indicator within the health careindustry and serves as a measure of leverage capacity and debtservice ability.  EBITDA as presented may not be comparable toEBITDA or other similarly titled measures used by othercompanies. |
|-----|--|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|                                                        | **Predecessor**          |          | **YearEnded June 30,**               |          |
|--------------------------------------------------------|--------------------------|----------|--------------------------------------|----------|
|                                                        |                          |          | ****                                 |          |
|                                                        |                          |          | **Eleven Months Ended May 31, 1998** |          |  |  | **Historical** |  |
| **1998**                                               |                          | **1999** |                                      | **2000** |  | **2001** |  | **2002** |
|                                                        |                          |          | ****                                 |          |  |  | **** |  |
|                                                        | **(dollarsin millions)** |
| **Calculation ofEBITDA:**                              |                          |          |                                      |          |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|    Income(loss) before income taxes     |                          | $        | 4.9                                  |          |  | $ | (2.7 | ) |  | $ | (6.4 | ) |  | $ | (1.3 | ) |  | $ | 10.7 |  |  | $ | 9.7 |  |
|    Depreciation andamortization         |                          |          | 2.6                                  |          |  |  | 0.5 |  |  |  | 3.9 |  |  |  | 11.8 |  |  |  | 23.8 |  |  |  | 29.5 |  |
|    Interest, net                        |                          |          | 1.5                                  |          |  |  | 0.2 |  |  |  | 4.2 |  |  |  | 8.8 |  |  |  | 16.6 |  |  |  | 26.7 |  |
|    Non-cashstock compensation           |                          |          | –                              |          |  |  | 0.5 |  |  |  | 5.0 |  |  |  | – |  |  |  | – |  |  |  | – |  |
|    Equitymethod loss (income) and other |                          |          | –                              |          |  |  | (0.1 | ) |  |  | 0.2 |  |  |  | 0.1 |  |  |  | (0.1 | ) |  |  | (0.5 | ) |
|    Minorityinterests                    |                          |          | –                              |          |  |  | – |  |  |  | – |  |  |  | 0.1 |  |  |  | 0.8 |  |  |  | 0.8 |  |
|    Loss(gain) on sale of assets         |                          |          | –                              |          |  |  | – |  |  |  | – |  |  |  | – |  |  |  | 0.5 |  |  |  | (0.8 | ) |
|    Debtextinguishment costs             |                          |          | –                              |          |  |  | – |  |  |  | – |  |  |  | 1.1 |  |  |  | – |  |  |  | 6.6 |  |
|                                                        |                          |          |                                      |          |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
| EBITDA                                                 |                          | $        | 9.0                                  |          |  | $ | (1.6 | ) |  | $ | 6.9 |  |  | $ | 20.6 |  |  | $ | 52.3 |  |  | $ | 72.0 |  |
|                                                        |                          |          |                                      |          |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

| ____________________ |
|----------------------|
| (c)                  |  | Licensed beds are thosebeds for which a facility has been granted approval to operate fromthe applicable state licensing agency. |
|                      |  |  |
| (d)                  |  | Represents the averagenumber of licensed beds, weighted based on periodsowned. |
|                      |  |  |
| (e)                  |  | Represents the totalnumber of patients discharged (in the facility for a period inexcess of 23 hours) from our hospitals and used by management andcertain investors as a general measure of inpatientvolume. |
|                      |  |  |
| (f)                  |  | Adjusteddischarges-hospitals is used by management and certain investors asa general measure of combined inpatient and outpatient volume andis computed by multiplying discharges by the sum of gross hospitalinpatient and outpatient revenues and then dividing the result bygross hospital inpatient revenues.  This computation“equates” outpatient revenues to the indicator used tomeasure inpatient volume resulting in a general measure of combinedinpatient and outpatient volume. |
|                      |  |  |
| (g)                  |  | Average length of stayrepresents the average number of days admitted patients stay in ourhospitals. |
|                      |  |  |
| (h)                  |  | Average daily censusrepresents the average number of patients in our hospitals each dayduring our ownership. |
|                      |  |  |
| (i)                  |  | Occupancy rate representsthe percentage of hospital licensed beds occupied bypatients.  Both average daily census and occupancy rateprovide measures of the utilization of inpatient rooms. |

**Item 7.    Management’sDiscussion and Analysis of Financial Condition and Results ofOperations.**

               The following discussion and analysis of financial conditions andresults of operations should be read in conjunction with ourconsolidated financial statements, notes to our consolidatedfinancial statements and other financial information appearingelsewhere in this report.

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**Forward LookingStatements**

               This annual report on Form 10-K contains “forward-lookingstatements” within the meaning of the Federal securities lawsthat are intended to be covered by safe harbors createdthereby.  Forward-looking statements are those statements thatare based upon management’s current plans and expectations asopposed to historical and current facts and are often identifiedherein by use of words including but not limited to“may,” “believe,” “will,”“project,” “expect,”“estimate,” “anticipate,” and“plan.”  These statements are based upon estimatesand assumptions made by the Company’s management that,although believed to be reasonable, are subject to numerousfactors, risks and uncertainties that could cause actual outcomesand results to be materially different from those projected. These factors, risks and uncertainties include, among others, thefollowing:

               •   Our high degree of leverage               •   Our ability to incur substantially moredebt               •   Operating and financial restrictions in our debtagreements               •   Our ability to successfully implement ourbusiness strategies               •   Our ability to successfully integrate any futureacquisitions               •   The highly competitive nature of the health careindustry               •   Governmental regulation of the industryincluding Medicare and Medicaid reimbursement levels               •   Pressures to contain costs by managed careorganizations and other insurers and our ability to negotiate                   acceptable terms with these third party payers               •   Our ability to attract and retain qualifiedmanagement and medical personnel, including physicians and                   nurses               •   Our ability to complete value-added acquisitionsand to effectively and efficiently integrate those                   operations within our corporate goals and objectives               •   Potential Federal or state reform of healthcare               •   Future governmental investigations               •   Costs associated with newly enacted HIPAAregulations and other management information system                   integrations               •   The availability of capital to fund ourcorporate growth strategy               •   Potential lawsuits or other claims assertedagainst us               •   Our ability to maintain or increase patientmembership and control costs of our managed health care                   plans               •   Changes in general economicconditions

               Except as required by law, we undertake no obligation to publiclyupdate any forward-looking statements, whether as a result of newinformation, future events or otherwise.  We advise you,however, to consult any additional disclosures we make in ourfilings with the Securities and Exchange Commission, including,without limitation, the discussion of risks and other uncertaintiesunder the caption “Risk Factors” contained in Item 1 ofthis report under the caption “Business-RiskFactors”.  You are cautioned not to rely on suchforward-looking statements when evaluating the informationcontained in this report.  In light of the significantuncertainties inherent in the forward-looking statements in thisreport, you should not regard the inclusion of such information asa representation by the Company that objectives and plansanticipated by the forward-looking statements will occur or beachieved, or if any of them do occur or are achieved, of the impactthey will have on the Company’s results of operations andfinancial condition.

**Impact ofAcquisitions**

               Acquiring acute care hospitals in urban and suburban markets is akey part of our business strategy.  Since we have grown mostyears through acquisitions, it is difficult to make meaningfulcomparisons between our financial statements for the fiscal periodspresented.  In addition, we own a relatively small number ofhospitals that can cause an individual acquisition to have amaterial effect on our overall operating performance.  When weacquire a hospital, we generally implement a number of measures tolower costs and may also make significant investments in thefacility to expand services, strengthen the medical staff andimprove our overall market position.  The effects of theseinitiatives are not generally realized immediately. Therefore, the financial performance of a newly acquired hospitalmay adversely affect our overall performance in the shortterm.

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***               Fiscal 2000 Acquisitions***

**

               On September 1, 1999, we acquired the West Anaheim Medical Centerin Anaheim, California, and the Huntington Beach Hospital inHuntington Beach, California.  We financed this acquisitionentirely through sales of our common stock to our existingstockholders.  The fiscal 2000 results of operations includeten months of operations for these two hospitals.

               On February 1, 2000, we acquired MacNeal Hospital in Berwyn,Illinois, and its affiliated primary care and occupational medicinecenters located around the metropolitan Chicago area.  Wefinanced this acquisition through sales of our common stock to ourexisting stockholders, by issuing 20,000 shares of ourPayable-In-Kind Preferred Stock to the seller and by borrowingunder our 2000 credit facility.  The fiscal 2000 results ofoperations include five months of operations for thesefacilities.

               On April 1, 2000, we acquired La Palma Intercommunity Hospital inLa Palma, California.  We financed this acquisition primarilythrough sales of our common stock to our existingstockholders.  The fiscal 2000 results of operations includethree months of operations for this hospital.

               On June 1, 2000, we acquired Phoenix Baptist Hospital and MedicalCenter in Phoenix, Arizona, and Arrowhead Community Hospital andMedical Center in Glendale, Arizona.  We financed thisacquisition through sales of our common stock to our existingstockholders and by borrowing under our 2000 credit facility. The fiscal 2000 results of operations include one month ofoperations for these two hospitals.

               We paid a total of approximately $406.8 million for all thefacilities we acquired in fiscal 2000.  We financed theseacquisitions through the sale of approximately $236.7 million ofour common stock to our existing stockholders, the borrowing ofapproximately $88.8 million under our 2000 credit facility, theissuance of 20,000 shares of Payable-In-Kind Preferred Stock valuedat $20.0 million and the assumption of liabilities of $61.3million.

***               Fiscal 2001 Acquisitions***

**

               On May 1, 2001, we acquired Phoenix Memorial Hospital and thePhoenix Health Plan in Phoenix, Arizona.  We financed thisacquisition through sales of our common stock to existingstockholders and the assumption of certain liabilities of theseller.  The fiscal 2001 results of operations include twomonths of operations for the hospital and health plan.

               We also acquired non-significant health care related businessesduring fiscal 2001 through the assumption of certain liabilities ofthe seller and use of available cash.  The fiscal 2001 resultsof operations include operations for each of these acquisitionsfrom the date of acquisition through June 30, 2001.   We paida total of approximately $90.6 million for all of the acquisitionscompleted in fiscal 2001.  We financed these acquisitionsthrough the sale of approximately $32.9 million of our common stockto our existing stockholders and the assumption of certainliabilities of the sellers.

*               **Fiscal 2002 Acquisitions***

               On November 1, 2001, we acquired the assets of Paradise ValleyHospital in Phoenix, Arizona, for approximately $59.8 millioncomprised of cash of $55.3 million and assumed liabilities of $4.5million.  We financed the acquisition with a portion of ourcash proceeds from the July 30, 2001 issuance of our 9.75% SeniorSubordinated Notes due 2011 (the “9.75% Notes”). The fiscal 2002 results of operations include eight months ofoperations for this hospital.

               On June 3, 2002, but effective June 1, 2002, we acquired, through amajority-owned acquisition subsidiary, substantially all of theassets of Louis A. Weiss Memorial Hospital in Chicago, Illinois,for a purchase price of $59.9 million comprised of cash of $41.2million and assumed liabilities of $18.7 million.  The Companyowns 80.1% of the acquiring joint venture corporation with anaffiliate of the seller maintaining a 19.9% ownershipinterest.  The Company received $2.5 million for the minorityjoint venture partner’s 19.9% interest in the acquisitionsubsidiary.  We financed the acquisition with a portion of theproceeds from the July 30, 2001 issuance of the 9.75% Notes. The fiscal 2002 results of operations include one month ofoperations for this hospital.

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*               **Operational Strategies and Related Risks***

**

               In order to increase revenues and enhance operating margins, wehave implemented several operating initiatives including thefollowing:

| • |     | Expanding the spectrum ofhealth care services provided by our facilities.  We believethat a key factor in increasing patient volume is to provide thecommunities we serve a comprehensive medical solution.  Thisstrategy requires effective recruiting and retention programs forgeneral practitioners and specialists and maintaining qualitynursing support as well as a commitment to capital projects toservice the existing facility framework and to provide currenttechnology for expanded services.  Also, we believe completingstrategic acquisitions to allow for consolidation of specialtypractices at certain locations will provide our patients with moreeffective and efficient care while improving the Company’soperating performance.                                                                                                                                                                                                                  |
|--------|--------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| • |     | Providing continuoustraining and education to our hospital management teams to identifyareas in which operating efficiencies can realistically beachieved.  We believe that one of the keys to providingeffective and efficient health care services and administrativesupport lies in effective recruiting and retention programs,including continual training and educational support.  Ourrelationships with the University of Chicago at our MacNeal andWeiss hospitals in metropolitan Chicago, Illinois, demonstrate oneof our many commitments to professional development for both healthcare and administrative staff.                                                                                                                                                                                                                                                                                                                                                       |
|   |               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| • |     | Identifying geographicmarkets that provide a strategic fit with our goals andobjectives.  We expect to continue pursuing acquisitionactivities in markets where we can obtain significant market shareand capture additional volume of the aging U.S. population. According to the U.S. Census Bureau, there are approximately 35million Americans aged 65 or older in the United States today,comprising approximately 13% of the total U.S. population.  Bythe year 2030, the number of these elderly persons is expected toreach 69 million, or 20% of the total population.  We believethat our initiatives will position the Company to capitalize onthis demographic trend.  Obtaining significant market share inkey geographic markets provides opportunities to expand services tothose communities, provides flexibility in negotiations withmanaged care and other third party payers and strengthens our basefor recruitment of health care professionals. |

               Although we expect the initiatives above to increase our patientvolume, the following risk factors could offset those increases torevenues:

| • |     | Managed care, Medicare andMedicaid revenues are significant to our business and are subjectto pricing pressures.  For the year ended June 30, 2002,patient days attributable to managed care, Medicare and Medicaidwere 51%, 35% and 9% of total patient days, respectively.  Forthe year ended June 30, 2002, managed care, Medicare and Medicaidpayers accounted for 60%, 25% and 7% of gross patient revenues,respectively.  These payers receive significant discountscompared to other payers, and these payers continually seek toreduce payments to lower the cost of health care for theirmembers.  We are also at risk for highly acute cases forpayers using a prospective payment system.                                |
|--------|--------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| • |     | Many procedures onceperformed exclusively at hospitals are now being provided on anoutpatient basis.  Advances in technology and the focus ofpayers on treating lower acuity patients in a less expensivesetting have driven the increase in outpatient utilization. For the year ended June 30, 2002, 70.0% of the total surgeriesperformed by our hospitals were outpatient surgeries compared to69.4% for the year ended June 30, 2001.  Typically, thepayments we receive for outpatient procedures are less than thosefor the same procedures performed in an inpatientsetting.                                                                                                                                                     |
|   |               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| • |     | Intense market competitionmay limit our ability to enter choice markets or recruit and retainquality health care professionals.  We face growingcompetition in our industry.  Consolidation of hospitals intofor-profit or not-for-profit systems continues to increase as otherhospital companies realize that regional market strength is pivotalin efficiently providing comprehensive health care services,recruiting and retaining qualified health care professionals andeffectively managing payer relationships.  In addition, thefinancial resources of some of our competitors exceed ourresources.  We anticipate consolidation of hospitals andincreased competition in the market place to continue in the nearfuture. |

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**GeneralTrends**

               As is typical in the health care industry, we are subject to claimsand legal actions by patients and others in the ordinary course ofbusiness.  Through May 31, 2002, we maintained third-partyinsurance coverage on a claims-made basis for individualmalpractice claims exceeding $1.0 million and annual aggregateclaims exceeding $13.6 million.  Due to pricing pressures andthe limited availability of carriers willing to underwriteprofessional and general liability coverage, we were unable torenew our previous policy with favorable terms upon its expirationon May 31, 2002.  Effective June 1, 2002, we established awholly owned captive subsidiary to insure our professional andgeneral liability risks at a $10.0 million retention level. We maintain excess coverage for individual claims exceeding $10.0million per occurrence up to $100.0 million in the aggregate. We intend to complete a transfer of the loss portfolio for ourself-insured retention of reported incidents prior to June 1, 2002,to the captive subsidiary during fiscal 2003.  The captivesubsidiary intends to fund claims costs from proceeds of premiumpayments received from us.

               As a result of the unfavorable professional and general liabilitymarket and increased premiums for property insurance, our insuranceexpense increased by $11.5 million during fiscal 2002 comprised ofthe following:  (1) a $5.7 million increase in ourprofessional and general liability reserve for claims incurredprior to June 1, 2002, but reported after June 1, 2002, as a resultof our increased retention limits; (2) a $2.6 million increase inour professional and general liability reserves throughout fiscal2002 due to the lack of maturity of our claims; (3) professionaland general and property insurance premiums increases of $2.1million and (4) an increase in our professional and generalliability reserve of $1.1 million related to the liquidation of aprevious third party carrier.  We expect our insurance expenseto increase by an additional $4.9 million during fiscal2003.

               We believe that the professional and general liability insurancemarket will remain depressed in the near term, and future increasesto excess coverage premiums and captive subsidiary retention levelscould significantly affect our operating margins.  Should weexperience significant adverse claims, our future cash flows maynot be adequate to fund such liability.

               In February 2002, the Pennsylvania Insurance Commissioner placedPHICO Insurance Company into liquidation.  PHICO provided theCompany’s primary general and professional liability coverageduring the period June 1, 1999 to May 31, 2000.  We are awareof multiple claims for which PHICO is responsible under thispolicy.  Our costs for these claims may be subject to partialreimbursement from state insurance guaranty funds and/orPHICO’s estate.  While we are unable to predict theoutcome of these claims, management believes that the professionaland general liability reserve is adequate to cover such claimsshould PHICO not be able to pay all or a portion of theclaims.

               During the year ended June 30, 2002, the Company renegotiated manyof its contracts with managed care payers to improve reimbursementrates and improve operating results and cash flows.  Managedcare payers are subject to pricing pressures which oftencomplicates our renegotiation efforts.  Even whenrenegotiating contracts with improved reimbursement, we have, insome cases, experienced volume declines from the managed carepayers.  Management continually reviews its portfolio ofmanaged care relationships and attempts to balance pricing andvolume issues; however, as long as strong competition remains inthe markets we serve, these challenges will continue.  Ourfuture operating results and cash flows could be negativelyimpacted to the extent we are unable to achieve positivereimbursement arrangements while maintaining patientvolume.

               Health plan revenues increased from $55.1 million to $184.8 millionduring fiscal 2002.  This significant increase affects ourcomparisons of various expenses to net revenues during 2002 and2001.

**Selected OperatingStatistics**

               The following table sets forth certain operating statistics for theyears ended June 30, 2000, 2001 and 2002.  Same hospitalresults for 2000 are not presented because the acquisitions duringfiscal 2000 affect the comparability between the periods as aresult of how the same hospital indicators are definedbelow.

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|        |                                      | **2000** |        | **2001** |  | **2002** |   |
|--------|--------------------------------------|----------|--------|----------|--|----------|--------|
|        |                                      |          |   |
|   | Number of hospitals at endof period  |          |        | 7        |  |          |        | 8 |  |  |  | 10 |  |
|   | Licensed beds                        |          |        | 1,481    |  |          |        | 1,676 |  |  |  | 2,207 |  |
|   | Discharges (a)                       |          |        | 31,864   |  |          |        | 65,175 |  |  |  | 75,364 |  |
|   | Adjusted discharges -hospitals (b)   |          |        | 50,661   |  |          |        | 96,774 |  |  |  | 110,758 |  |
|   | Average length of stay(c)            |          |        | 4.1      |  |          |        | 4.1 |  |  |  | 4.1 |  |
|   | Patient days(d)                      |          |        | 101,599  |  |          |        | 266,007 |  |  |  | 305,370 |  |
|   | Adjusted patient days -hospitals (e) |          |        | 194,496  |  |          |        | 402,353 |  |  |  | 452,768 |  |

|                                                 |   |   | **2001** |   |   |        | **2002** |        |
|------------------------------------------------------|--------|--------|----------|--------|--------|--------|----------|--------|
|                                                 |   |        |          |
| Same hospitalindicators:                             |   |   |     |   |   |   |     |   |
|    Revenues(in millions) (f)          |   | $      | 640.5    |   |   | $      | 643.4    |   |
|    Discharges (g)                     |   |   | 64,265   |   |   |   | 63,438   |   |
|    Patientdays (h)                    |   |   | 263,295  |   |   |   | 261,714  |   |
|    Adjusteddischarges-hospitals (i)   |   |   | 95,657   |   |   |   | 94,014   |   |
|    Adjustedpatient days-hospitals (j) |   |   | 399,024  |   |   |   | 391,013  |   |

| ____________________ |
|----------------------|
| (a)                  |  | Discharges represent thetotal number of patients discharged (in the facility for a periodin excess of 23 hours) from our hospitals and is used by managementand certain investors as a general measure of inpatientvolume. |
|                      |  |  |
| (b)                  |  | Adjusteddischarges-hospitals  is used by management and certaininvestors as a general measure of combined hospital inpatient andoutpatient volume.  Adjusted discharges-hospitals is computedby multiplying discharges by the sum of gross hospital inpatientand outpatient revenues and then dividing the result by grosshospital inpatient revenues.  This computation enablesmanagement to assess hospital volume by a combined measure ofinpatient and outpatient utilization. |
|                      |  |  |
| (c)                  |  | Average length of stayrepresents the average number of patients in the hospitals each dayduring our ownership. |
|                      |  |  |
| (d)                  |  | Patient days represent thenumber of days (calculated as overnight stays) our beds wereoccupied by patients during the period. |
|                      |  |  |
| (e)                  |  | Adjusted patientdays-hospitals is calculated by multiplying patient days by the sumof gross hospital inpatient and outpatient revenues and thendividing the result by gross hospital inpatient revenues. This computation is an indicator of combined inpatient andoutpatient volume. |
|                      |  |  |
| (f)                  |  | Same hospital revenues arerevenues from facilities that were owned for the entire 2001 and2002 fiscal years. |
|                      |  |  |
| (g)                  |  | Same hospital dischargesare discharges for hospitals owned for the entire 2001 and 2002fiscal years. |
|                      |  |  |
| (h)                  |  | Same hospital patient daysare patient days for hospitals owned for the entire 2001 and 2002fiscal years. |
|                      |  |  |
| (i)                  |  | Same hospital adjusteddischarges-hospitals is calculated by multiplying the sum of grosshospital inpatient and outpatient patient revenues and dividing theresult by gross hospital inpatient revenues for all hospitals ownedfor the entire 2001 and 2002 fiscal years. |
|                      |  |  |
| (j)                  |  | Same hospital adjustedpatient days-hospitals is calculated by multiplying patient days bythe sum of gross hospital inpatient and outpatient revenues anddividing the result by gross hospital inpatient revenues for allhospitals owned for the entire 2001 and 2002 fiscalyears. |

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**Results ofOperations**

               The following table presents a summary of our operating results forthe years ended June 30, 2000, 2001 and 2002.

| ** ** | **Yearended June 30,**           |         |
|------------|----------------------------------|--------------|
| ** ** | ****                             |         |
| ** ** | **2000**                         |         | **2001** |   | **2002** |   |
|       | ** **                       | **Amount**   |   | **%** |   | **Amount** |   | **%** |   | **Amount** |   | **%** |   |
|       | ** **                       |              |   |
|       | ** **                       | (Inmillions) |   |
|       | Revenues                         |              | $ | 304.7 |  |  | 100.0  | % |  | $ | 667.8 |  |  | 100.0 | % |  | $ | 910.6 |  |  | 100.0  | % |
|       | Salaries andbenefits             |              |  | 146.5 |  |  | 48.1  |  |  |  | 323.6 |  |  | 48.5 |  |  |  | 384.4 |  |  | 42.2  |  |
|       | Supplies                         |              |  | 40.5 |  |  | 13.3  |  |  |  | 92.9 |  |  | 13.9 |  |  |  | 116.1 |  |  | 12.7  |  |
|       | Medical claimsexpense            |              |  | 7.4 |  |  | 2.4  |  |  |  | 30.8 |  |  | 4.6 |  |  |  | 132.0 |  |  | 14.5  |  |
|       | Insurance                        |              |  | 5.8 |  |  | 1.9  |  |  |  | 8.2 |  |  | 1.2 |  |  |  | 19.7 |  |  | 2.2  |  |
|       | Other operatingexpenses          |              |  | 50.8 |  |  | 16.6  |  |  |  | 103.2 |  |  | 15.5 |  |  |  | 133.1 |  |  | 14.6  |  |
|       | Provision for doubtfulaccounts   |              |  | 33.1 |  |  | 10.9  |  |  |  | 56.8 |  |  | 8.5 |  |  |  | 53.3 |  |  | 5.9  |  |
|       |                                  |              |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|       | EBITDA (1)                       |              |  | 20.6 |  |  | 6.8  |  |  |  | 52.3 |  |  | 7.8 |  |  |  | 72.0 |  |  | 7.9  |  |
|       | Depreciation andamortization     |              |  | 11.8 |  |  | 3.9  |  |  |  | 23.8 |  |  | 3.5 |  |  |  | 29.5 |  |  | 3.3  |  |
|       | Interest expense,net             |              |  | 8.8 |  |  | 2.9  |  |  |  | 16.6 |  |  | 2.5 |  |  |  | 26.7 |  |  | 2.9  |  |
|       | Debt extinguishmentcosts         |              |  | 1.1 |  |  | 0.4  |  |  |  | ― |  |  | ― |  |  |  | 6.6 |  |  | 0.7  |  |
|       | Minority interests andother      |              |  | 0.2 |  |  | 0.0  |  |  |  | 1.2 |  |  | 0.2 |  |  |  | (0.5 | ) |  | (0.1) |  |
|       |                                  |              |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|       | Income (loss) beforeincome taxes |              |  | (1.3 | ) |  | (0.4) |  |  |  | 10.7 |  |  | 1.6 |  |  |  | 9.7 |  |  | 1.1  |  |
|       | Provision for incometaxes        |              |  | 0.1 |  |  | 0.0      |  |  |  | 0.5 |  |  | 0.1 |  |  |  | 2.9 |  |  | 0.3  |  |
|       |                                  |              |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|       | Net income(loss)                 |              | $ | (1.4 | ) |  | (0.4) | % |  | $ | 10.2 |  |  | 1.5 | % |  | $ | 6.8 |  |  | 0.8  | % |
|       |                                  |              |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

| ____________________ |
|----------------------|
| (1)                  |  | EBITDA is defined asincome before interest expense (net of interest income), incometaxes, depreciation, amortization, minority interests, gain or losson the sale of assets, non-cash stock compensation, equity methodincome and debt extinguishment costs.  While you should notconsider EBITDA in isolation or as a substitute for net income,operating cash flows or other cash flow statement data determinedin accordance with accounting principles generally accepted in theUnited States, management understands that EBITDA is a commonlyused analytical indicator within the health care industry andserves as a measure of leverage capacity and debt serviceability.  EBITDA, as presented, may not be comparable tosimilarly titled measures of other companies. |

***               Year Ended June 30, 2002 Compared to the Year Ended June 30,2001***

               *Revenues*.  The $242.8 million increase in revenuesduring fiscal 2002 was attributable to revenues from acquisitionsof $239.9 million and same hospital revenue improvement of $2.9million.  Although same hospital discharges decreased by 1.3%during fiscal 2002, same hospital revenues increased slightly dueto our ability to negotiate more favorable payment rates withcertain managed care providers in certain markets and improvedMedicare reimbursements.  We expect net revenues on a samehospital basis to improve as our renegotiation efforts continue andthe annual impact of previously negotiated contracts isrealized.

               We continue to develop and implement strategies to increase volumesat our hospitals including physician recruitment, expansion ofspecialty services and resource sharing within geographicmarkets.  We are currently in the process of expandingservices at many of our hospitals including expansion of cardiaccath labs, emergency rooms, obstetrics units, MRI technology andopen heart surgery units.  During fiscal 2002, we recruitedapproximately 600 new physicians to our hospitals, including 430specialists and 170 internal medicine and general

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practitioners.  Wewill continue our physician recruiting and retention strategies toincrease hospital volumes and provide the services needed in themarkets we serve.

               *Salaries and benefits*.  The $60.8 million increase insalaries and benefits is primarily attributable to acquisitions,which account for $58.1 million of the increase.  Salaries andbenefits as a percentage of revenues decreased from 48.5% in 2001to 42.2% in 2002 due to having a full year of Phoenix Health Planoperations during fiscal 2002.  Excluding the impact ofPhoenix Health Plan, salaries and benefits as a percentage ofrevenues decreased to 49.5% during fiscal 2002 from 49.7% duringfiscal 2001.  We successfully managed staffing levels at ourhospitals and improved labor productivity.  However, ourproductivity efficiencies were partially offset by increasednursing compensation.  The hospital industry continues to facea nationwide shortage of nurses.  We have experiencedparticular difficulty in retaining and recruiting nurses in ourPhoenix, Arizona and Los Angeles/Orange County, Californiamarkets.  Recent reports forecast this shortage to continueinto the near future.  We have begun a comprehensiverecruiting and retention plan for nurses that focuses oncompetitive salaries and benefits as well as employee satisfaction,best practices, tuition assistance, effective training programs andworkplace environment.  However, should we be unsuccessful inour attempts to maintain nursing coverage adequate for our presentand future needs, our future operating results could be adverselyimpacted.

               *Supplies*.  Acquisitions accounted for $16.8 million ofthe $23.2 million increase in supplies during fiscal 2002. Increased volume and acuity of surgeries on a same hospital basisaccounted for the remaining increase.  Same hospital surgeriesincreased by 3.0% during fiscal 2002, and same hospital suppliescost per surgical case increased by 3.9% fueled by emergingtechnologies and increased unit prices of surgical supplies andrelated sales taxes.  Surgeries typically require greaterutilization of supplies than do non-surgical admissions, whichexplains the increase in supplies expense during 2002 when samehospital discharges decreased by 1.3% and same hospital surgeriesincreased by 3.0%.

               *Medical claims*.  The $101.2 million increase in medicalclaims is almost exclusively due to the acquisition of PhoenixHealth Plan on May 1, 2001.  Medical claims expense representsthe amounts paid by the health plans for health care servicesprovided to their members,  including an estimate of incurredbut not reported claims that is determined based upon lag data andother actuarial assumptions.  Revenues and expenses betweenthe health plans and the Company’s hospitals and relatedoutpatient service providers of approximately $26.2 million, or16.6% of gross health plan medical claims expense, were eliminatedin consolidation during fiscal 2002.

               *Insurance*.  Acquisitions accounted for $2.1 million ofthe $11.5 million increase in insurance expense during fiscal2002.  Insurance expense on a same hospital basis increased by$9.4 million primarily due to changes in our professional andgeneral liability coverage effective June 1, 2002.  EffectiveJune 1, 2002, we established a wholly owned captive subsidiary toinsure our professional and general liability risks at a $10.0million retention as compared to our $1.0 million self-insuredretention under our previous insurance policy.  Werestructured our coverage due to pricing pressures and the limitedavailability of carriers willing to underwrite professional andgeneral liability insurance.  The $11.5 million increase iscomprised of the following factors:  (1) a $5.7 millionincrease in the professional and general liability reserve for the$10.0 million retention level; (2) a $2.6 million increase in ourprofessional and general liability reserve due to routine increasesrelated to the lack of maturity of our claims; (3) professional andgeneral liability and property premiums increases of $2.1 millionand (4) an increase in our professional and general liabilityreserve of $1.1 million related to the liquidation ofPHICO.

               *Other operating expenses*.  Other operating expensesinclude costs such as rents and leases, professional fees,purchased services, marketing, repairs, utilities, licenses andnon-income taxes.  Acquisitions accounted for $30.8 million ofthe $29.9 million increase in other operating expenses duringfiscal 2002.  Other operating expenses decreased by $0.9million on a same hospital basis between the twoperiods.

               *Provision for doubtful accounts*.  During fiscal 2002,the provision for doubtful accounts increased by $5.5 million dueto acquisitions and decreased by $9.0 million on a same hospitalbasis resulting in a net decrease of $3.5 million.  The samehospital improvement during fiscal 2002 was primarily a result ofour efforts to improve cash collection processes and increaseproductivity of our hospital business offices.  The enactmentof Proposition 204 in Arizona also positively affected our bad debtrate as previously uninsured patients qualified for Medicaid underProposition 204.  Additionally, the provision for doubtfulaccounts was negatively affected during the first quarterof

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fiscal 2001 as wetransitioned the hospitals acquired during 2000 to our corporatepolicy regarding the allowance for doubtful accounts.

               *EBITDA*.  The $19.7 million increase in EBITDA duringfiscal 2002 related to 1) a $29.4 million increase in EBITDA due toacquisitions, 2) a $6.8 million decrease in EBITDA for insuranceadjustments related to the increase in our self-insured retentionof professional and general liability risks and potential exposurefor outstanding PHICO claims as previously discussed and 3) a $2.9million decrease in same hospital EBITDA net of insuranceadjustments.

               Same hospital EBITDA was negatively impacted by operations in themetropolitan Los Angeles/Orange County, California market. EBITDA for this market decreased by $4.8 million during fiscal 2002primarily due to certain payer contracts with unfavorable terms,increased salaries and benefits costs as a result of a nursingshortage in the market and intense competition from other hospitalsin the market.  EBITDA for one of our hospitals in the marketwas significantly impacted by high utilization under globalcapitation plans, including many out-of-network services.  Wehave given these payers notice of our intent to terminate thecapitation contracts effective December 31, 2002.  While themarket experienced a 2.9% increase in discharges and a 3.0%increase in net revenues during 2002, operating expenses during2002 increased by 7.0% including an 11.6% increase in salaries andbenefits.  This market has been especially hard hit by thenursing shortage.  We incurred significant additional salariesand benefits costs during 2002 to maintain quality core services inthis market and have not experienced volume increases necessary tofully absorb the additional costs.  During 2002, salaries andbenefits per full-time equivalent employee increased from $53,510to $59,970.  As previously discussed, we are developingmarket-driven comprehensive recruiting and retention programs tohelp alleviate the nursing shortage and are also developingstrategies to increase patient volumes to increase EBITDA for eachmarket we serve.

               Our health plans segment contributed $12.9 million or 17.9% ofconsolidated EBITDA for fiscal 2002 compared to $2.4 million or4.7% of consolidated EBITDA for fiscal 2001.  The significantincrease in EBITDA is primarily due to a full year of operationsfor Phoenix Health Plan in fiscal 2002 as compared to only twomonths in fiscal 2001.  During fiscal 2002, membership inPhoenix Health Plan increased from 49,500 members to 68,500 membersprimarily due to the enactment of Proposition 204 which broadenedeligibility for Medicaid coverage.

               *Depreciation and amortization*.  The $5.7 millionincrease in depreciation and amortization during fiscal 2002related to acquired fixed assets during the year both fromacquisitions of hospitals and capital expenditures.  On July1, 2001, we adopted the provisions of SFAS 141 and 142 resulting inre-allocations of the excess purchase price over net assetsacquired to goodwill and identifiable intangible assets. Under SFAS 142, goodwill and indefinite-lived intangible assets areno longer amortized but are subject to annual impairmenttests.  The suspension of goodwill amortization and thechanges in classifications of identifiable intangible assets andrelated remaining useful lives resulted in a net decrease inamortization expense of approximately $2.8 million for the yearended June 30, 2002.

               *Interest*.  The $10.1 million increase in net interestexpense during fiscal 2002 primarily relates to the issuance of the9.75% Notes on July 30, 2001, offset by the repayment ofoutstanding term loans under the 2000 credit facility.  Inaddition, the Company incurred deferred loan costs of approximately$11.5 million related to the issuance of the 9.75% Notes and $3.5million for the establishment of the 2001 credit facility. The aforementioned increases to net interest expense were offset byan increase in interest income on invested cash of approximately$2.1 million during fiscal 2002.  On February 15, 2002, weentered into an interest rate swap agreement with Bank of America,N.A. for a notional amount of $100 million of the 9.75%Notes.  Under this agreement, the 9.75% coupon interest rateon the $100 million notional amount is swapped for a variable ratebased upon the 6-month LIBOR rate in effect on each semi-annualsettlement date plus a fixed margin of 3.63%.  The swapagreement resulted in a decrease to net interest expense of $1.5million during fiscal 2002.

               *Debt extinguishment costs*.  During fiscal 2002, weincurred $6.6 million in debt extinguishment costs from the earlybuyout of certain capital leases, the write-off of deferred loancosts incurred as part of the 2000 credit facility and feesincurred to terminate the interest rate collar agreement requiredby the 2000 credit facility.  On April 1, 2002, we adopted theprovisions of SFAS 145 resulting in the treatment of these debtextinguishment costs as operating costs as opposed to extraordinaryitems.

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               *Minority interests and other*.  Minority interestsrepresent the third party portion of earnings of certain of ournon-wholly owned affiliates included in our consolidated statementsof operations.  Minority interests for fiscal 2002 remainedcomparable to fiscal 2001 at $0.8 million.  The $1.6 milliondecrease in minority interests and other expenses during fiscal2002 primarily relates to gains on sales of land and other assetsof $0.8 million during fiscal 2002 as compared to losses on salesof assets of $0.5 million during fiscal 2001.

               *Income taxes.*  The provision for income taxes increasedfrom $0.5 million for 2001 to $2.9 million for 2002 resulting in anincrease in the effective tax rate from 4.7% in 2001 to 29.8% in2002.  The valuation allowance that offsets our deferred taxassets decreased by $4.1 million and $1.4 million for the yearsended June 30, 2001 and 2002, respectively, resulting in a decreasein our effective tax rates.

               *Net income*.  Net income decreased from $10.2 million infiscal 2001 to $6.8 million in fiscal 2002.  The $19.7 millionincrease in EBITDA during 2002 was offset by the significantincreases in depreciation and amortization and interest as a resultof the 2001 and 2002 acquisitions and the issuance of the 9.75%Notes, respectively, as well as the debt extinguishment costs of$6.6 million.  We view these costs as products of theCompany’s strategic growth initiative.

**

*               **Year Ended June 30, 2001 Compared to the Year Ended June 30,2000***

               *Revenues*.  The $363.1 million increase in revenuesduring fiscal 2001 was attributable to revenues from acquiredhospitals of $366.7 million offset by a decrease in same hospitalrevenues of $3.6 million.  The same hospital decrease wasprimarily related to a decrease in revenues at Maryvale HospitalMedical Center that resulted from the loss of several keyphysicians who relocated their practices outside the Maryvaleservice area.  Maryvale has subsequently recruited several newphysicians to the market.  Premium revenues from our healthplans increased by $39.3 million during fiscal 2001 due to theacquisition of Phoenix Health Plan in May 2001 and the full year ofoperations of MacNeal Health Providers during fiscal2001.

               *Salaries and benefits*.  The $177.1 million increase insalaries and benefits during fiscal 2001 was primarily attributableto our acquisitions during fiscal 2001 and the effect of a fullyear of operations for our fiscal 2000 acquisitions during fiscal2001.  Salaries and benefits as a percentage of revenuesincreased to 48.5% for fiscal 2001 compared to 48.1% for fiscal2000.  This increase is attributable to a 1.6% increase due tothe higher level of patient acuity at the hospitals acquired duringfiscal 2000, which had a full year of operations during fiscal2001, offset by a 1.4% decrease due to the acquisition of PhoenixHealth Plan, which requires a much lower human resource cost forits revenue base.

               *Supplies*.  The $52.4 million increase in suppliesexpense during fiscal 2001 was primarily attributable to ouracquisitions during fiscal 2001 and the effect of a full year ofoperations for our fiscal 2000 acquisitions during fiscal2001.  Supplies expense as a percentage of revenues increasedto 13.9% for fiscal 2001 compared to 13.3% for fiscal 2000. Approximately 1.0% of this increase relates to the higher level ofpatient acuity at the facilities we acquired.  For example,MacNeal Hospital and Phoenix Baptist Hospital both provideopen-heart surgical procedures and significant orthopedicprocedures that require more expensive surgical supplies.  Theincrease in supplies expense as a percentage of revenues was offsetby a 0.4% decrease due to the acquisition of Phoenix Health Plan,which utilizes no medical supplies in its operations.

               *Medical claims expense*.  The $23.4 million increase inmedical claims expense during fiscal 2001 is attributable to theacquisition of Phoenix Health Plan on May 1, 2001, and the effectof the full year of operations of MacNeal Health Providers during2001.  Medical claims expense represents the amounts paid bythe health plans for health care services provided to their membersincluding an estimate of incurred but not reported claims. Revenues and expenses between the health plans and theCompany’s wholly owned hospitals and related outpatientservice providers are eliminated in consolidation.

               *Insurance*.  Insurance expense increased by $2.4 millionor 41.4% from fiscal 2000 to fiscal 2001 due to the acquisitionsduring fiscal 2000 and 2001.  On a same hospital basis,insurance expense decreased by $1.1 million from fiscal 2000 tofiscal 2001.

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               *Other operating expenses*.  The $52.4 million increasein other operating expenses, which include professional fees,purchased services, rents and leases, repairs and maintenance,utilities and non-income taxes, was primarily attributable to our2001 and 2000 acquisitions.  Other operating expenses as apercentage of revenues decreased from 16.7% for fiscal 2000 to15.5% for fiscal 2001.  This decrease reflects our efforts toachieve efficiencies and upgrade capital at acquired hospitalsresulting in reduced operating expenses.  Additionally, forhospitals acquired during 2000 with a full year of operationsduring 2001, we were able to reduce costs associated withinformation systems through software conversions and utilization ofcorporate expertise thereby reducing related professionalfees.

               *Provision for doubtful accounts*.  The $23.7 millionincrease in the provision for doubtful accounts was primarilyattributable to the fiscal 2001 and 2000 acquisitions.  Theprovision for doubtful accounts as a percentage of revenuedecreased from 10.9% in fiscal 2000 to 8.5% in fiscal 2001. This decrease is due to a lower bad debt experience rate athospitals acquired during fiscal 2000 and 2001 than that ofMaryvale Hospital.  Maryvale Hospital has an unusually highbad debt expense rate due to the demographics of the market itserves.  We believe that the recent expansion of eligibilityfor the Arizona Medicaid program will help reduce Maryvale’sbad debt expense.

               *Depreciation and amortization*.  The $12.0 millionincrease in depreciation and amortization was attributable to ourfiscal 2001 and 2000 acquisitions.  All of the acquisitionswere accounted for using the purchase method of accounting, and werecorded approximately $74.5 million of goodwill and otherintangible assets for the fiscal 2001 and 2000 acquisitions. Amortization of these intangible assets was $5.3 million and $3.0million during fiscal 2001 and 2000, respectively.

               *Interest expense*.  Interest expense increased by $7.8million from fiscal 2000 to fiscal 2001 due to approximately $95.7million of additional debt incurred in February 2000 and June 2000to fund acquisitions and reduce certain assumed liabilities fromthe acquisitions.  We also incurred approximately $4.5 millionof deferred loan costs during fiscal 2000 that were being amortizedover the life of the 2000 credit facility.

               *Debt extinguishment costs*.  During fiscal 2000, weincurred $1.1 million in debt extinguishment costs related to therefinancing of the 1998 credit facility.  On April 1, 2002, weadopted the provisions of SFAS 145 resulting in the treatment ofthese debt extinguishment costs as operating costs as opposed toextraordinary items.

               *Minority interests and other*.  Minority interestsrepresent the third party portion of certain non-wholly ownedaffiliates of the Company included in the Company’sconsolidated statements of operations.  Minority interestsincreased from $0.1 million to $0.8 million during 2001. Other non-operating expenses include equity method income or lossand gains or losses on the sale of assets.

               *Income taxes*.  The provision for income taxes increasedfrom $0.1 million for 2000 to $0.5 million for 2001.  Theseprovisions reflect effective tax rates of 8.9% and 4.8% for theyears ended June 30, 2000 and 2001, respectively.  Thevaluation allowance that offsets our deferred tax assets decreasedby $4.1 million in 2001, resulting in a decrease in our effectivetax rates.

               *Net income*.  Net income increased to $10.2 million forfiscal 2001 from a loss of $1.4 million for fiscal 2000, anincrease of $11.6 million.  The significant increase is due tothe income from continuing operations of our fiscal 2001 and 2000acquisitions, which enabled us to utilize economies of scale andprovided an additional revenue base to cover corporate overheadexpenses and interest costs and the $1.1 million of debtextinguishment costs incurred during fiscal 2000.  Our healthplans contributed $0.5 million and $2.2 million of pre-tax netincome during fiscal 2000 and 2001, respectively.  We expectrevenues from our health plans to continue to increase asadditional persons become eligible for the Arizona Medicaid programunder Proposition 204.

**Summary Results ofOperations by Quarter**

****

               The following table presents summarized unaudited quarterly resultsof operations for the fiscal years ended June 30, 2001 and2002.  We believe that all necessary adjustments have beenincluded in the amounts stated below for a fair presentation of theresults of operations for the periods presented when read inconjunction with the consolidated financial statements for thefiscal years ended June 30, 2001 and 2002.  Results ofoperations for a

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particular quarter are notnecessarily indicative of results of operations for an annualperiod and are not predictive of future periods.

|             |   | **September 30, 2000** |   | **December31, 2000** |   | **March31, 2001** |   | **June30, 2001** |
|------------------|--------|------------------------|--------|----------------------|--------|-------------------|--------|------------------|
|             |   |                        |
|             |   | *(Inmillions)*         |
| Net revenues     |   | $                      | 158.6  |                 |   | $                 | 155.7  |             |   | $ | 166.3 |   |   | $ | 187.2 |
| EBITDA (a)       |   |                   | 11.2   |                 |   |              | 8.9    |             |   |   | 17.5 |   |   |   | 14.7 |
| Net income(loss) |   |                   | 0.2    |                 |   |              | (1.4   | )                |   |   | 6.8 |   |   |   | 4.6 |

|             |   | **September 30, 2001** |       | **December31, 2001** |        | **March31, 2002** |       | **June30, 2002** |
|------------------|--------|------------------------|-------|----------------------|--------|-------------------|-------|------------------|
|             |   |                        |
|             |   | *(Inmillions)*         |
| Net revenues     |   | $                      | 207.3 |                 |   | $                 | 223.1 |             |   | $ | 235.9 |   |   | $ | 244.3 |
| EBITDA (a)       |   |                   | 15.3  |                 |   |              | 17.1  |             |   |   | 23.0 |   |   |   | 16.6 |
| Net income(loss) |   |                   | (4.2  | )                    |   |              | 2.6   |             |   |   | 6.4 |   |   |   | 2.0 |

| ____________________ |
|----------------------|
| (a)                  |  | EBITDA is defined asincome before interest expense (net of interest income), incometaxes, depreciation, amortization, minority interests, gain or losson the sale of assets, equity method income and debt extinguishmentcosts.  While you should not consider EBITDA in isolation oras a substitute for net income, operating cash flows or other cashflow statement data determined in accordance with accountingprinciples generally accepted in the United States, managementunderstands that EBITDA is a commonly used analytical indicatorwithin the health care industry and serves as a measure of leveragecapacity and debt service ability.  EBITDA, as presented, maynot be comparable to similarly titled measures of othercompanies. |

**Liquidity and CapitalResources**

****

               At June 30, 2002, we had working capital of $87.9 million,including cash and cash equivalents of $55.4 million.  Workingcapital at June 30, 2001 was $15.3 million.  The increase inworking capital is primarily due to operating cash flows duringfiscal 2002.  The increase in cash from the issuance of the9.75% Notes has essentially been utilized through acquisitions,capital expenditures, payments of long-term debt and payments ofloan costs.  Cash provided by operating activities increasedfrom $6.7 million for the year ended June 30, 2001 to $44.7 millionfor the year ended June 30, 2002.  We generated cash flowsfrom operations through improved EBITDA, an improvement incollections of net accounts receivable and the timing of payment ofaccrued expenses and other liabilities.

               Cash used in investing activities increased from $38.1 million forthe year ended June 30, 2001 to $135.4 million for the year endedJune 30, 2002.  Cash used to fund hospital acquisitions, netof cash received, increased from $10.6 million for the year endedJune 30, 2001 to $100.3 million for the year ended June 30, 2002,as a result of the acquisitions of Paradise Valley Hospital andLouis A. Weiss Memorial Hospital.  Cash used for capitalexpenditures also increased by approximately $8.5 million to $35.1million for the year ended June 30, 2002.   The funding ofcapital expenditures is in part subject to the timing of certaincapital projects at Maryvale Hospital Medical Center, ArrowheadCommunity Hospital and Phoenix Baptist Hospital and theconstruction of West Valley Hospital in Goodyear, Arizona.  Asof June 30, 2002, the Company has funded approximately $30.0million of its $65.0 million contractual commitment for thesecapital projects at Maryvale, Arrowhead and Phoenix Baptist. As of June 30, 2002, we have expended approximately $2.5 million ofthe estimated project cost of $50.0 million for the construction ofWest Valley Hospital.  We expect to complete these capitalprojects and commitments during the next two to fiveyears.

               Our 2001 credit facility contains provisions that limit annualcapital expenditures.  For the year ended June 30, 2002, weare in compliance with these capital expenditure provisions. We believe our capital expenditure program is sufficient toservice, expand and improve our existing facilities to meet ourquality objectives.

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               Cash provided by financing activities increased from $26.7 millionfor the year ended June 30, 2001 to $134.0 million for the yearended June 30, 2002.  The increase was primarily attributableto the issuance of the 9.75% Notes, offset by (1) the repayment ofthe 2000 credit facility, (2) early buyouts of certain capitalleases and (3) payments of deferred loan costs incurred inconjunction with the issuance of the 9.75% Notes and the 2001credit facility.

               As of June 30, 2002, we had 23,328 shares of Payable-In-KindPreferred Stock (“PIK Preferred Stock”) outstandingwith a liquidation value of $1,000 per share.  The Companyoriginally issued 20,000 shares of PIK Preferred Stock on February1, 2000 in connection with the acquisition of MacNealHospital.  The Company currently intends to issue and recordpaid-in-kind dividends annually at 8% of the liquidation value ofthe PIK Preferred Stock until January 31, 2008 and to pay cashdividends thereafter until the January 31, 2015 mandatoryredemption date of the PIK Preferred Stock.  The PIK PreferredStock will automatically convert to common stock upon an initialpublic offering of our common stock with gross proceeds to us of atleast $50.0 million at a conversion price equal to the initialpublic offering price.

               We believe that the working capital on hand and the $119.4 millionavailable as of June 30, 2002, under our 2001 credit facility aresufficient to meet our operating and capital needs for theforeseeable future.  Additionally, certain funds controlled byMorgan Stanley Capital Partners (the “MSCP Funds”) haveentered into a subscription agreement with us to purchase anadditional $322.3 million of our common stock to fund futureacquisitions and cash flow needs.  Common stock purchases bythe MSCP Funds are subject to several conditions outside thecontrol of the Company, including the approval of the InvestmentCommittee of Morgan Stanley Capital Partners.  No assurancecan be given that any or all of such conditions to additionalcommon stock purchases will be met.  We intend to acquireadditional hospitals and are actively seeking acquisitions that fitour corporate growth strategy.  These acquisitions may,however, require financing in addition to the working capital onhand, availability of funds under the 2001 credit facility and ourfuture operating cash flows.  We continually assess ourcapital needs and may seek additional financing, including debt orequity, as considered necessary to fund potential acquisitions orfor other corporate purposes.

               We are subject to certain restrictive and financial covenants underthe 2001 credit facility including a required EBITDA to debt ratioand interest coverage ratio.  Should our results of operationsor cash flows decline and result in violation of one or more ofthese covenants, amounts outstanding under the 2001 credit facilitycould become immediately payable and additional borrowings could berestricted.  As of June 30, 2002, the only amounts drawnagainst the 2001 credit facility were letters of credit totalingapproximately $5.6 million.  However, restrictions onadditional borrowings under the 2001 credit facility couldsignificantly impact our acquisition growth objectives.  Weare in compliance with all such covenants as of June 30,2002.

               The following table reflects a summary of obligations andcommitments outstanding, including both the principal and interestportions of long-term debt and capital leases, with payment datesas of June 30, 2002.

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|                             |   | **Paymentsdue by period** | ** ** | ** **   |
|----------------------------------|--------|---------------------------|------------|--------------|
|                             |   | ****                      | ** ** | ** **   |
|                             |   | **Lessthan 1 year**       | ** ** | **1-3years** | ** ** | **4-5years** | ** ** | **After 5 years** | ** ** | **Total** |
|                             |   | **                        |
| **Contractual CashObligations:** |   | *(Inmillions)*            |
| Long-term debt                   |   | $                         | 29.3       |         |   | $ | 58.5 |   |   | $ | 58.5 |   |   | $ | 446.3 |   |   | $  | 592.6 |
| Capital leaseobligations         |   |                      | 4.3        |         |   |  | 5.3 |   |   |   | 1.0 |   |   |   | ― |   |   |   | 10.6 |
| Operatingleases                  |   |                      | 12.2       |         |   |   | 15.3 |   |   |   | 9.4 |   |   |   | 25.5 |   |   |   | 62.4 |
| Other long-termobligations       |   |                      | 0.3        |         |   |   | 0.6 |   |   |   | 0.6 |   |   |   | 1.9 |   |   |   | 3.4 |
|                             |   |                      |            |         |   |   |  |   |   |   |  |   |   |   |  |  |   |   |  |
|    Subtotal       |   | $                         | 46.1       |         |   | $ | 79.7 |   |   | $ | 69.5 |   |   | $ | 473.7 |   |   | $ | 669.0 |
|                             |   |                      |            |         |   |   |  |   |   |   |  |   |   |   |  |   |   |   |  |

|                                                |   | **Amountof commitment expiration per period** | ** ** | ** **   |       |
|-----------------------------------------------------|--------|-----------------------------------------------|------------|--------------|------------|
|                                                |   | ****                                          | ** ** | ** **   |       |
|                                                |   | **Lessthan 1 year**                           | ** ** | **1-3years** | ** ** | **4-5years** | ** ** | **After 5 years** | ** ** | **Total** |   |
|                                                |   | **                                            |
| **OtherCommitments:**                               |   | *(In  millions)*                         |
| Construction andimprovement commitments             |   | $                                             | 47.7       |         |       | $ | 8.7 |   |   | $ | ― |   |   | $ | ― |   |   | $  | 56.4 |
| Guarantees of suretybonds                           |   |                                               | 9.5        |         |       |  | 3.0 |   |   |  | ― |   |   |  | ― |   |   |   | 12.5 |
| Letters ofcredit                                    |   |                                               | ―    |         |       |  | ― |  |   |  | 5.6 |   |   |  | ― |   |   |   | 5.6 |
| Capital expenditurecommitments                      |   |                                          | 7.8        |         |       |   | 13.6 |  |   |  | 13.6 |   |   |   | ― |   |   |   | 35.0 |
| Physiciancommitments                                |   |                                          | 2.9        |         |       |   | ― |  |   |  | ― |   |   |   | ― |   |   |   | 2.9 |
| Othercommitments                                    |   |                                          | 0.1        |         |       |   | 0.1 |   |   |   | 0.1 |   |   |   | 0.7 |   |   |   | 1.0 |
|                                                |   |                                          |            |         |       |   |  |   |   |   |  |   |   |   |  |   |   |   |  |
|    Subtotal                          |   | $                                             | 68.0       |         |       | $ | 25.4 |   |   | $ | 19.3 |   |   | $ | 0.7 |   |   | $ | 113.4 |
|                                                |   |                                          |            |         |       |   |  |   |   |   |  |   |   |   |  |   |   |   |  |
|     Totalobligations and commitments |   | $                                             | 114.1      |         |       | $ | 105.1 |   |   | $ | 88.8 |   |   | $ | 474.4 |   |   | $ | 782.4 |
|                                                |   |                                          |            |         |       |   |  |   |   |   |  |   |   |   |  |   |   |   |  |

               California has a statute and regulations that require hospitals tomeet certain seismic performance standards.  Hospitals that donot meet the standards may be required to retrofit theirfacilities.  We have filed our  required compliance planwith the State of California and expect to comply with the seismicrequirements at all of our California facilities by thestate-imposed deadline of 2008.  We expect to incurapproximately $10.1 million in costs to meet our complianceplan.  Upon completion of the $10.1 million in improvements,our California facilities will be compliant with the seismicregulations and standards through 2029.  We estimate that themajority of the square footage in our California facilities will becompliant with the seismic regulations and standards that come intoeffect during 2030 once we have completed our $10.1 million inimprovements, but we are unable at this time to estimate our costsfor full compliance with the 2030 requirements.

***Critical AccountingPolicies***

******

               The consolidated financial statements have been prepared inaccordance with accounting principles generally accepted in theUnited States.  In preparing the consolidated financialstatements, we make estimates and assumptions that affect thereported amounts of assets, liabilities, revenues and expensesincluded in the financial statements.  Management bases itsestimates on historical experience and other available information,the results of which form the basis of the estimates andassumptions.  We consider the following accounting policies tobe most critical to our operating performance and involve the mostsubjective and complex assumptions and assessments.

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               *Allowance for Doubtful Accounts*

**

               Our ability to collect outstanding receivables from third partypayers is critical to our operating performance and cashflows.  The allowance for doubtful accounts was approximately12.0% of accounts receivable, net of contractual discounts, as ofJune 30, 2002.  The primary collection risk lies withuninsured patient accounts or patient accounts for which primaryinsurance has paid but patient deductibles or co-insurance portionsremain outstanding.  We estimate the allowance for doubtfulaccounts primarily based upon the age of the accounts since patientdischarge date.  We continually monitor our accountsreceivable balances and utilize cash collections data to supportthe basis for our estimates of the provision for doubtfulaccounts.  Significant changes in payer mix or business officeoperations may have a significant impact on our results ofoperations and cash flows.

*               Allowance for Contractual Discounts*

**

               We typically receive payments from third party payers, includingMedicare, Medicaid and managed care payers, that are less thanbilled charges requiring the estimation of contractual discountallowances.  The Medicare and Medicaid regulations and variousmanaged care contracts are often complex and may include multiplereimbursement mechanisms for different types of services providedin our health care facilities and cost settlement provisionsrequiring complex calculations and assumptions subject tointerpretation.  We estimate the allowance for contractualdiscounts on a payer-specific basis given our interpretation of theapplicable regulations or contract terms.  We have madesignificant investments in human resources and information systemsto improve the estimation process.  However, the servicesauthorized and provided and related reimbursement are often subjectto interpretation that may result in payments that differ from ourestimates.  Additionally, updated regulations and contractrenegotiations occur frequently necessitating management’scontinual review and assessment of the estimationprocess.

*               Insurance Reserves*

**

               Given the nature of our operating environment, we may becomesubject to medical malpractice or workers compensation claims orlawsuits.  Through May 31, 2002, we maintained third-partyinsurance coverage for individual malpractice claims exceeding $1.0million and workers compensation claims exceeding $250,000 tomitigate a portion of this risk.  Effective June 1, 2002, weestablished a wholly owned captive subsidiary to insure ourprofessional and general liability risks at a $10.0 millionretention level.  We maintain excess coverage for individualclaims exceeding $10.0 million per occurrence up to $100.0 millionin the aggregate.  We estimate our reserve for self-insuredprofessional and general liability and workers compensation risksusing historical claims data, demographic factors, severityfactors, current incident logs and other actuarial data.  Asof June 30, 2002, our professional and general liability accrualfor asserted and unasserted claims was approximately $16.3million.  The estimated accrual for malpractice and workerscompensation claims could be significantly affected should currentand future occurrences differ from historical claims trends. The estimation process is also complicated by the relatively shortperiod of time in which we have owned our health care facilities asoccurrence data under previous ownership may not necessarilyreflect occurrence data under our ownership.  While managementmonitors current claims closely and considers outcomes whenestimating its reserve, the complexity of the claims and wide rangeof potential outcomes often hampers timely adjustments to theassumptions used in the estimates.

               *Medical Claims Reserves*

               For the year ended June 30, 2002, medical claims expense wasapproximately $132.0 million, primarily representing medical claimson behalf of enrollees in our Medicaid managed health plan inPhoenix, Arizona, Phoenix Health Plan.  We estimate ourreserve for medical claims incurred but not reported usinghistorical claims experience (including severity and payment lagtime) and other actuarial data including number of enrollees, ageof enrollees and certain enrollee health indicators.  Thereserve for medical claims incurred but not reported for our healthplans was approximately $24.4 million as of June 30, 2002. While management believes that its estimation methodologyeffectively captures trends in medical claims costs, actualpayments could differ significantly from our estimates givenchanges in the health care cost structure or adverseexperience.  For the year ended June 30, 2002, approximately$26.2 million of health care plan payments to hospitals and otherhealth care facilities owned by us for services provided toenrollees were eliminated in consolidation.  Our operatingresults and cash flows could be

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materially affected byincreased or decreased utilization of our owned health carefacilities by enrollees of our health plans.

**Contingencies andHealth Care Regulation**

               *Effects of Inflation and Changing Prices*.  Thehealth care industry is labor intensive.  Wages and otherexpenses increase during periods of inflation and when laborshortages occur in the marketplace.  Various Federal, stateand local laws have been enacted that, in certain cases, limit ourability to increase prices.  Revenues for acute care hospitalservices rendered to Medicare patients are established under theFederal government’s prospective payment system.  Webelieve that hospital industry operating margins have been, and maycontinue to be, under significant pressure because of deteriorationin inpatient volumes, changes in payer mix and growth in operatingexpenses in excess of the increase in prospective payment under theMedicare program.

               *Health Care Reform*.  In recent years, anincreasing number of legislative proposals have been introduced orproposed to Congress and in some state legislatures that wouldsignificantly affect the services provided by and reimbursement tohealth care providers in our markets.  The cost of certainproposals would be funded in significant part by reduction inpayments by government programs, including Medicare and Medicaid,to health care providers or by taxes levied on hospitals or otherproviders.  While we are unable to predict which, if any,proposals for health care reform will be adopted, we can not assureyou that proposals adverse to our business will not beadopted.

               *Health Insurance Portability and Accountability Act of1996.*  The Health Insurance Portability andAccountability Act (“HIPAA”) was enacted in August 1996to assure health insurance portability, reduce health care fraudand abuse, guarantee security and privacy of health information andenforce standards for health information.  Generally,organizations were required to be in compliance with certain HIPAAprovisions regarding uniform electronic data transmission standardsfor health care information beginning in October 2002; however,entities may extend the deadline to October 2003 by filing acompliance plan with the Department of Health and HumanServices.  In addition, compliance with privacy standardsissued in December 2000 and amended in August 2002 and electronicdata security standards proposed in August 1998 but not yetfinalized, could result in significant costs for us.  We arein the process of implementing the necessary changes pursuant tothe provisions of HIPAA but are unable to estimate the financialimpact of compliance with these provisions at this time.

               *Federal and State Regulation andInvestigations*.  The health care industry is subjectto extensive Federal, state and local laws and regulations relatingto licensing, conduct of operations, ownership of facilities,addition of facilities and services, confidentiality and securityissues associated with medical records, billing for services andprices for services.  These laws and regulations are extremelycomplex.  In many instances, the industry does not have thebenefit of significant regulatory or judicial interpretation ofthese laws and regulations.  As a result of these laws andregulations, some of our activities could become the subject ofgovernmental investigations or inquiries.  Both Federal andstate government agencies have heightened and coordinated civil andcriminal enforcement efforts as part of numerous ongoinginvestigations of hospital companies.  In the event of adetermination that we are in violation of any of these laws, rulesor regulations, or if further changes in the regulatory frameworkoccur, our results of operations could be significantlyharmed.

               *Malpractice and General LiabilityClaims*.  Plaintiffs frequently bring actions againsthospitals and other health care providers alleging malpractice orother liabilities.  Many of these claims involve large claimsand significant defense costs.  We maintain professional andgeneral liability insurance in amounts we believe are sufficient tocover claims arising out of the operations of our facilities. Some of the claims, however, could exceed the scope of the coveragein effect or coverage of particular claims or damages could bedenied.  Furthermore, our coverage may not continue to beavailable at a reasonable cost.  We are, from time to time,also subject to claims arising in the ordinary course of business,including employment related claims, damages related to personalinjuries and other general claims.  Although management is notaware of any specific proceeding that would have a material adverseeffect on our business, financial position or results ofoperations, the outcome of these cases are subject to numerousfactors, and potential judgments could exceed our current insurancecoverage.

               *Acquisitions*.  We have acquired and plan tocontinue acquiring businesses with prior operating histories. Acquired companies may have unknown or contingent liabilities,including liabilities for failure to comply with health care lawsand regulations, such as billing and reimbursement, fraud and abuseand similar anti-referral laws. 

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Although we attempt tostructure our acquisitions as asset acquisitions in which we do notassume liability for seller’s wrongful actions and institutepolicies and procedures designed to conform practices to ourstandards following completion of acquisitions, we may becomeliable for such past actions of acquired entities deemed improperby private plaintiffs or government agencies.  We generallyobtain indemnification from prospective sellers covering suchmatters; however, such indemnification may not cover such actionsor may not be adequate to cover potential losses andfines.

               *Unfiled Medicare Cost Reports*.  Hospitals participatingin the Medicare program, whether paid on a reasonable cost basis orby the prospective payment system (“PPS”), are requiredto meet certain financial reporting requirements, includingsubmission of annual cost reports identifying medical costs andexpenses associated with hospital services to Medicarerecipients.  Since implementation of outpatient PPS in August2000, the due dates of all Medicare cost reports have been extendeddue to delays in receiving necessary reports from the Medicarefiscal intermediaries.  We currently have 10 unfiled Medicarecost reports relating to Medicare fiscal year-ends 2000 and 2001and anticipate filing these 10 cost reports and up to 4 additionalcost reports relating to Medicare fiscal year-end 2002 duringfiscal 2003 that could result in significant changes to ourestimates of amounts payable to or receivable fromMedicare.

**Item7A.         Quantitativeand Qualitative Disclosures About Market Risk.**

               We are exposed to market risk related to changes in interestrates.  We utilize interest rate swap derivatives from time totime to manage this risk.  We do not hold or issue derivativeinstruments for trading purposes and are not a party to anyinstruments with leverage features.  As of June 30, 2002, wemaintained an interest swap agreement on a notional amount of $100million of our outstanding $300 million of 9.75% SeniorSubordinated Notes due 2011 (the “9.75 Notes”). The swap agreement effectively converted the 9.75% fixed rate ofthe notional amount to a variable rate, calculated as the 6-monthLIBOR rate in effect on each semi-annual settlement date plus afixed margin of 3.63%.  As of June 30, 2002, the variable ratewas 5.69%.  Effective August 13, 2002, we terminated theinterest rate swap agreement resulting in a net cash payment to usfrom the counter-party of $5.5 million.  Upon the terminationof the interest rate swap agreement, all $300 million of such notesbore interest at the 9.75% fixed rate.  Management may enterinto additional derivative instruments to manage its interest raterisk in the future.

               The fair value of our $300 million of 9.75% Notes was approximately$311 million as of June 30, 2002, based upon quoted marketprices.  Since all of our long-term debt is subject to fixedinterest rates given the termination in August 2002 of our interestrate swap agreement, we did not estimate changes to our interestexpense or fair value of long-term debt based upon hypotheticalincreases or decreases in interest rates.  As of the date ofthis report, other than outstanding letters of credit of $9million, there are no term loans or revolving loans outstandingunder our 2001 credit facility.  Should we borrow amountsunder the 2001 credit facility or enter into other creditagreements in the future that include variable rate debt, we mayseek to mitigate our exposure to such interest raterisk.

**Item 8.    Financial Statementsand Supplementary Data.**

               Information with respect to this Item is contained in ourconsolidated financial statements indicated in the Index on PageF-1 of this Annual Report on Form 10-K.

**Item 9.    Changes in andDisagreements With Accountants on Accounting and FinancialDisclosure.**

               None.

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**PARTIII**

**Item10.         Directors andExecutive Officers of the Registrant.**

                       The table below presents information with respect to our directorsand executive officers as of September 1, 2002.

| Name                      |  | Age |   |                                                                            |
|---------------------------|--|-----|--------|----------------------------------------------------------------------------|
| Charles N. Martin,Jr.     |  | 59  |   | Chairman of the Board& Chief Executive Officer; Director               |
| William L.Hough           |  | 50  |   | President & ChiefOperating Officer; Director                           |
| Joseph D. Moore           |  | 55  |   | Executive Vice President,Chief Financial Officer & Treasurer; Director |
| Ronald P.Soltman          |  | 56  |   | Executive Vice President,General Counsel & Secretary; Director         |
| Reginald M. BallantyneIII |  | 58  |   | Senior VicePresident-Market Strategy & Government Affairs              |
| Bruce F. Chafin           |  | 46  |   | Senior VicePresident-Compliance & Ethics                               |
| Robert E.Galloway         |  | 57  |   | Senior VicePresident-Development                                           |
| Linda W.Hischke           |  | 59  |   | Senior VicePresident-Operations                                            |
| James Johnston            |  | 58  |   | Senior VicePresident-Human Resources                                       |
| Phillip W. Roe            |  | 41  |   | Senior Vice President,Controller & Chief Accounting Officer            |
| Dale S. St.Arnold         |  | 48  |   | Senior VicePresident-Operations                                            |
| James H.Spalding          |  | 43  |   | Senior Vice President,Assistant General Counsel & Assistant Secretary  |
| Alan G. Thomas            |  | 48  |   | Senior VicePresident-Operations Finance                                    |
| Thomas M. Ways            |  | 52  |   | Senior VicePresident-Managed Care & Physician Integration              |
| Keith B. Pitts            |  | 45  |   | Vice Chairman;Director                                                     |
| Karen H.Bechtel           |  | 53  |   | Director                                                                   |
| Eric T. Fry               |  | 35  |   | Director                                                                   |
| Howard I.Hoffen           |  | 38  |   | Director                                                                   |

                       *Charles N. Martin, Jr.* has served as Chairman of the Boardof Directors and Chief Executive Officer of Vanguard since July1997. Until May 31, 2001, he was also Vanguard’s President.From January 1992 until January 1997, Mr. Martin was Chairman,President and Chief Executive Officer of OrNda HealthCorp(“OrNda”), a hospital management company. Prior theretoMr. Martin was President and Chief Operating Officer ofHealthTrust, Inc., a hospital management company, from September1987 until October 1991. Mr. Martin is also a director ofHealthStream, Inc., Kinetic Concepts, Inc. and several privatelyheld companies.

                       *William L. Hough* has served as Chief Operating Officer and adirector of Vanguard since July 1997. Mr. Hough was electedVanguard’s President on May 31, 2001, and prior thereto hehad been an Executive Vice President. From August 1995 untilJanuary 1997, he was Executive Vice President and Chief OperatingOfficer of OrNda. From September 1987 to April 1995, Mr. Houghserved in various executive positions with HealthTrust, Inc.,including Group Vice President from May 1994 to April 1995, andRegional Vice President from April 1990 to April 1994.

                       *Joseph D. Moore* has served as Executive Vice President,Treasurer, Chief Financial Officer and a director of Vanguard sinceJuly 1997. From February 1994 to April 1997, he was Senior VicePresident-Development of Columbia/HCA Healthcare Corporation(“Columbia”), a hospital management company. Mr. Moorefirst joined Hospital Corporation of America (a predecessor ofColumbia) in April 1970, rising to Senior Vice President-Financeand Development in January 1993.

                       *Ronald P. Soltman* has been Executive Vice President, GeneralCounsel, Secretary and a director of Vanguard since July 1997. FromApril 1994 until January 1997, he was Senior Vice President,General Counsel and Secretary of OrNda. From February 1994 untilMarch 1994, he was Vice President and Assistant General Counsel ofColumbia. From 1984 until February 1994, he was Vice President andAssistant General Counsel of Hospital Corporation ofAmerica.

                       *Reginald M. Ballantyne III,* joined Vanguard in May 2001 andhas served as Senior Vice President-Market Strategy &Government Affairs of Vanguard since January 2002.  From 1984to 2001, he served as

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President of PMH HealthResources, Inc. (“PMH”), an Arizona based multi-unithealthcare system.  In February 2001, PMH filed a Chapter 11proceeding in order to implement the sale of the business andassets of PMH to Vanguard.  Prior to 1984, Mr. Ballantyneserved as President of Phoenix Memorial Hospital in Phoenix,Arizona.  Mr. Ballantyne served as Chairman of the AmericanHospital Association (“AHA”) in 1997 and as Speaker ofthe AHA House of Delegates in 1998.  He is a Fellow of theAmerican College of Healthcare Executives (“ACHE”) anda recipient of the ACHE Gold Medal Award for ManagementExcellence.  Mr. Ballantyne also served as a member of thenational Board of Commissioners for the Joint Commission onAccreditation of Healthcare Organizations and as Chairman of theAHA Committee of Commissioners from 1992 until 1995.  Mr.Ballantyne is also a director of Superior Consultant HoldingsCorporation and several privately held companies.

                       *Bruce F. Chafin* has served as Senior VicePresident-Compliance & Ethics of Vanguard since July 1997.Prior thereto, from April 1995 to January 1997, he served as VicePresident–Compliance & Ethics of OrNda.

                       *Robert E. Galloway* has served as Senior VicePresident-Development of Vanguard since October 1997. Prior theretofrom August 1993 to September 1997, he was VicePresident–Development of Columbia and its predecessor,Columbia Hospital Corporation.

                       *Linda W. Hischke* joined Vanguard in September 2001 and hasserved as Senior Vice President-Operations of Vanguard sinceJanuary 2002.  Prior thereto, Ms. Hischke served as DivisionPresident of IASIS Healthcare, a hospital management company, fromOctober 1999 to September 2001.  From 1997 until 1999, she wasPresident of WYN Associates Healthcare Consulting in Park City,Utah.  Ms. Hischke was President of the Mountain Division ofColumbia from 1995 until 1997.  From 1990 until 1995, sheserved in various executive positions with HealthTrust, Inc.,including Regional Vice President.

                       *James Johnston* has served as Senior Vice President-HumanResources of Vanguard since July 1997. Prior thereto from November1995 to January 1997, he served as Senior VicePresident–Human Resources of OrNda.

                       *Phillip W. Roe* has been Senior Vice President, Controller& Chief Accounting Officer of Vanguard since July 1997. Priorthereto he was Senior Vice President, Controller and ChiefAccounting Officer of OrNda from September 1996 until January 1997.Prior thereto, from October 1994 until September 1996, Mr. Roe wasVice President, Controller and Chief Accounting Officer ofOrNda.

                       *Dale S. St. Arnold* has been a Senior VicePresident-Operations of Vanguard since June 2002.  Priorthereto from 1998 until June 2002, he was President and ChiefExecutive Officer of Catholic Health System of Buffalo, New York, anon-profit, integrated health care system which included fourhospitals, fourteen nursing homes and three home carecompanies.  Prior thereto, he had various positions from 1991to 1998 with Mount Carmel Health System of Columbus, Ohio and itspredecessor organization, Mount Carmel Health, a non-profit,integrated health care system which included three hospitals, ahome care company and a Medicare HMO.  He served as Presidentand Chief Executive Officer of Mount Carmel Health and Mount CarmelHealth System from 1992 to 1998.

                       *James H. Spalding* has served as Senior Vice President,Assistant General Counsel and Assistant Secretary of Vanguard sinceNovember 1998. Prior thereto he was Vice President, AssistantGeneral Counsel and Assistant Secretary of Vanguard from July 1997until November 1998. Prior thereto from April 1994 until January1997, he served as Vice President, Assistant General Counsel andAssistant Secretary of OrNda.

                       *Alan G. Thomas* has been Senior Vice President-OperationsFinance of Vanguard since July 1997. Prior thereto, Mr. Thomas wasSenior Vice President–Hospital Financial Operations of OrNdafrom April 1995 until January 1997. Prior thereto he was VicePresident–Reimbursement and Revenue Enhancement of OrNda fromJune 1994 until April 1995.

                       *Thomas M. Ways* has served as Senior Vice President-ManagedCare & Physician Integration of Vanguard since February 1998.Prior thereto from February 1997 to January 1998, he was ChiefExecutive Officer of MSO/Physician Practice Development for theSouthern California Region of Tenet Health Care Corporation,a

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hospital managementcompany. Prior thereto from August 1994 to January 1997, he wasVice President–Physician Integration of OrNda.

                       *Keith B. Pitts* has been Vanguard’s Vice Chairman sinceMay 2001, a director of Vanguard since August 1999, and was anExecutive Vice President of Vanguard from August 1999 until May2001. Prior thereto, from November 1997 until June 1999, he was theChairman and Chief Executive Officer of Mariner Post-Acute Network,Inc. and its predecessor, Paragon Health Network, Inc., which is anursing home management company. In January 2000, MarinerPost-Acute Network, Inc. filed a voluntary petition for reliefunder Chapter 11 of the United States Bankruptcy Code.   InMay 2002, Mariner-Post Acute Network, Inc. emerged from suchChapter 11 proceedings pursuant to a confirmed plan ofreorganization and changed its name to Mariner Health Care,Inc.  Prior thereto from August 1992 until January 1997, Mr.Pitts served as Executive Vice President and Chief FinancialOfficer of OrNda.

                       *Karen H. Bechtel* has served as a Director of Vanguard sinceMarch 2000. Ms. Bechtel has been a Managing Director of MorganStanley Private Equity since 1998 and a Managing Director of MorganStanley & Co. Incorporated since 1986. She is also a directorof Cross Country, Inc. and several privately heldcompanies.

                       *Eric T. Fry* has served as a Director of Vanguard since May1998. He joined MS & Co. in 1989 and has been a ManagingDirector of both Morgan Stanley & Co. Incorporated and MorganStanley Private Equity since December 2001. He is also a directorof ACG Holdings, Inc., American Color Graphics, Inc. and severalprivately held companies.

                       *Howard I. Hoffen* has served as a Director of Vanguard sinceJanuary 2001. Mr. Hoffen is currently the Chairman and ChiefExecutive Officer of Morgan Stanley Private Equity, and has been aManaging Director of Morgan Stanley & Co. Incorporated since1997.  He joined Morgan Stanley & Co. Incorporated in 1985and Morgan Stanley Private Equity in 1986.  Mr. Hoffen is alsoa director of Allegiance Telecom, Inc., Catalytica Energy Systems,Inc., Choice One Communications Inc. and several privately heldcompanies.

                       ***Board of Directors***

                       The board of directors of Vanguard manages its business. Under ourcertificate of incorporation and bylaws, the Vanguard board ofdirectors must consist of not less than three nor more than twentymembers, with the exact number of members being fixed from time totime by our board of directors. Currently, eight members compriseour board of directors.

                       Pursuant to our shareholders agreement, our board of directors isto be made up of eight members, five of which are to be nominatedby the management shareholders and three of which are to benominated by the Morgan Stanley Capital Partners Funds (the“MSCP Funds”).  In conformity with the foregoing,at the current time Ms. Bechtel and Messrs. Fry and Hoffen aredirectors nominated by the MSCP Funds and Messrs. Hough, Martin,Moore, Pitts and Soltman are directors nominated by the managementshareholders. Despite the foregoing, at all times the MSCP Fundshave the right to nominate four members to our board, in whichevent one of the management directors will resign. Also, at anytime after January 1, 2005, the MSCP Funds have the right tonominate a majority of our board if the MSCP Funds exercise theiradditional rights under the shareholders agreement to require allother shareholders to transfer their shares to the same prospectivepurchaser to whom and at the same price at which the MSCP Fundshave agreed to sell all their shares of our common stock. Pursuant to our shareholders agreement each shareholder has agreedto vote his shares of common stock to elect directors nominated inthe manner described above.

                       Our directors are elected by the affirmative vote of a plurality ofthe votes cast by our shareholders at Vanguard’s annualmeeting of shareholders. Once elected, each director serves untilthe next annual meeting of shareholders and until his or hersuccessor is duly elected and qualified, or until his or herearlier death, resignation or removal.

                       We currently have no standing committees of our board of directors.Pursuant to our shareholders agreement, the MSCP Funds have theright to appoint one member to each committee of our board ofdirectors.

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**Item11.         ExecutiveCompensation.**

                       The following table sets forth, for the fiscal years ended June 30,2002 and June 30, 2001, the compensation earned by our ChiefExecutive Officer and our four other most highly compensatedexecutive officers.  We refer to these persons as our namedexecutive officers.

**SummaryCompensation Table**

| ** **                                                                                                              |   | **AnnualCompensation** |   | **Long-Term Compensation** |
|-------------------------------------------------------------------------------------------------------------------------|--------|------------------------|--------|----------------------------|
| ** **                                                                                                              |   | ****                   |   | ****                       |
| **Name andPrincipal Position**                                                                                          |   | **Fiscal Year**        |   | **Salary ($)**             |   | **Bonus ($)** |   | **OtherAnnual Compensation ($) (a)** |   | **Securities Underlying Options (#)** |   | **AllOther Compensation ($) (b)** |
|                                                                                                                         |        |                        |   |                            |
| **Charles N. Martin,Jr.**    Chairman of the Board & Chief ExecutiveOfficer                          |   | 2002                   |   | 900,000                    |   | 0 |   | 0 |   | 975 |   | 7,422 |   |
|                                                                                                                    |   | 2001                   |   | 700,008                    |   | 0 |   | 0 |   | 0 |   | 7,422 |   |
|                                                                                                                    |   |                   |   |                       |   |   |   |   |   |   |   |   |
| **William L.Hough**    President & Chief OperatingOfficer                                            |   | 2002                   |   | 550,000                    |   | 0 |   | 0 |   | 293 |   | 5,100 |   |
|                                                                                                                    |   | 2001                   |   | 428,016                    |   | 0 |   | 0 |   | 0 |   | 5,100 |   |
|                                                                                                                    |   |                   |   |                       |   |   |   |   |   |   |   |   |
| **Joseph D.Moore**    Executive Vice President, Chief FinancialOfficer    & Treasurer |   | 2002                   |   | 500,000                    |   | 0 |   | 0 |   | 293 |   | 0 |   |
|                                                                                                                    |   | 2001                   |   | 369,504                    |   | 0 |   | 0 |   | 0 |   | 0 |   |
|                                                                                                                    |   |                   |   |                       |   |   |   |   |   |   |   |   |
| **Keith B.Pitts**    Vice Chairman                                                                       |   | 2002                   |   | 550,000                    |   | 0 |   | 0 |   | 293 |   | 5,640 |   |
|                                                                                                                    |   | 2001                   |   | 428,016                    |   | 0 |   | 0 |   | 8,409 |   | 380,005 |   |
|                                                                                                                    |   |                   |   |                       |   |   |   |   |   |   |   |   |
| **Ronald P.Soltman**    Executive Vice President, General Counsel    & Secretary      |   | 2002                   |   | 450,000                    |   | 0 |   | 0 |   | 251 |   | 0 |   |
| ** **                                                                                                              |   | 2001                   |   | 272,016                    |   | 0 |   | 0 |   | 0 |   | 0 |   |

| ____________________ |
|----------------------|
| (a)                  |  | An “0” in thiscolumn means that no such compensation was paid other thanperquisites and other personal benefits which have not beenincluded because their aggregate value provided to any of the namedexecutive officers was below the reporting threshold established bythe Securities and Exchange Commission. |
|                      |  |  |
| (b)                  |  | The amounts disclosedunder All Other Compensation in the Summary Compensation Tablerepresent for the named executive officers in fiscal 2002 (i) thefollowing amounts of our matching contributions made under our401(k) Plan:  Mr. Martin: $5,100; Mr. Hough: $5,100; Mr.Moore: $0; Mr. Pitts: $5,100; and Mr. Soltman: $0; and (ii) thefollowing amounts of insurance premiums paid by Vanguard withrespect to group term life insurance:  Mr. Martin: $2,322; Mr.Hough: $0; Mr. Moore: $0; Mr. Pitts: $540; and Mr. Soltman:$0.  The amounts disclosed under All Other Compensation in theSummary Compensation Table represent for the named executiveofficers in fiscal 2001 (i) the following amounts of our matchingcontributions made under our 401(k) Plan:  Mr. Martin: $5,100;Mr. Hough: $5,100; Mr. Moore: $0; Mr. Pitts: $5,100; and Mr.Soltman: $0; $374,365 for Mr. Pitts to reimburse him for certainrelocation expenses in his move to Nashville to commence employmentwith Vanguard; and (iii) the following amounts of insurancepremiums paid by Vanguard with respect to group term lifeinsurance:  Mr. Martin: $2,322; Mr. Hough: $0; Mr. Moore: $0;Mr. Pitts: $540; and Mr. Soltman: $0. |

**Stock Option GrantsDuring Fiscal 2002**

                       In the fiscal year ended June 30, 2002, the grants of stock optionsunder our stock-based employee benefit plans to the named executiveofficers were as follows:

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|                  |   | **Numberof Securities Underlying Options Granted (#)** | ** ** | **Percentof Total Options Granted to Employees in Fiscal Year** |   | **Exercise Price ($/Sh)** |   | **MarketPrice on Date of Grant ($/Sh)** |   | **Expiration Date** | ** ** | **Potential Realizable Values at Assumed Annual Rates of Stock Price Appreciation for Option Term ($)(a)** |
|-----------------------|--------|--------------------------------------------------------|------------|-----------------------------------------------------------------|--------|---------------------------|--------|-----------------------------------------|--------|---------------------|------------|------------------------------------------------------------------------------------------------------------|
|                       |        | ****                                                   |
|                  |   |                                                   |       |                                                            |   |                           |   |                                    |   |                |       | **0%**                                                                                                     | ** ** | **5%** | ** ** | **10%** |
| Charles N. Martin,Jr. |   | 975(b)                                                 |       | 23.8                                                  |   | 170.12                    |   | 1,701.18                                |   | 06/01/08            |       | 1,492,784                                                                                                  |   | 2,118,452 |   | 2,933,628 |
| William L.Hough       |   | 293(b)                                                 |       | 7.1                                                             |   | 170.12                    |   | 1,701.18                                |   | 06/01/08            |       | 448,601                                                                                                    |   | 636,622 |   | 881,593 |
| Joseph D. Moore       |   | 293(b)                                                 |       | 7.1                                                             |   | 170.12                    |   | 1,701.18                                |   | 06/01/08            |       | 448,601                                                                                                    |   | 636,622 |   | 881,593 |
| Keith B. Pitts        |   | 293(b)                                                 |       | 7.1                                                             |   | 170.12                    |   | 1,701.18                                |   | 06/01/08            |       | 448,601                                                                                                    |   | 636,622 |   | 881,593 |
| Ronald P.Soltman      |   | 251(b)                                                 |       | 6.1                                                             |   | 170.12                    |   | 1,701.18                                |   | 06/01/08            |       | 384,296                                                                                                    |   | 545,366 |   | 755,221 |

| ____________________ |
|----------------------|
| (a)                  |  | In accordance with therules of the Securities and Exchange Commission (the“SEC”), shown are the gains or “optionspreads” that would exist for the respective optionsgranted.  These gains are based on the assumed rates of annualcompound stock price appreciation of 5% and 10% from the date theoption was granted over the full option term.  These assumedannual compound rates of stock price appreciation are mandated bythe rules of the Securities and Exchange Commission and do notrepresent our estimate or projection of our future common stockprices. |
|                 |   |   |
| (b)                  |  | One-seventh of the stockoptions will vest on each anniversary of the November 8, 2001 grantdate prior to expiration of these options or upon the occurrence ofa Liquidity Event (as defined in Item 13 under the caption“Shareholders Agreement”).  Vested options becomeexercisable upon the occurrence of a Liquidity Event. |

**Stock Option Exercises,Holdings and Fiscal Year-End Values**

                       The following table sets forth information with respect to thenamed executive officers concerning their exercise of stock optionsduring the fiscal year ended June 30, 2002 and in respect of thenumber and value of unexercised options held by each of them as ofJune 30, 2002.

| **Name**              |   | **SharesAcquired on Exercise (#)** |   | **ValueRealized ($)** |   | **Numberof Securities Underlying Unexercised Options At Fiscal Year-End(#)** |         | **Value ofUnexercised In-the-Money Options At Fiscal Year-End($)(a)** |
|-----------------------|--------|------------------------------------|--------|-----------------------|--------|------------------------------------------------------------------------------|--------------|-----------------------------------------------------------------------|
| ****                  |   |                               | ****   |                  | ****   |                                                                         | ****         |
| ** **            |   |                               |   |                  |   | **Exercisable**                                                              |    | **Unexercisable (b)**                                                 |   | **Exercisable** |   | **Unexercisable** |
| ** **            |   |                               |   |                  |   | ****                                                                         |         | ****                                                                  |
| Charles N. Martin,Jr. |        | 0                                  |   | 0                     |   | 587                                                                          |         |                                                                  | 11,423 |     |   | 898,732 |   | 17,489,298 |
| William L.Hough       |        | 0                                  |   | 0                     |   | 359                                                                          |         |                                                                  | 3,427 |     |   | 549,650 |   | 5,246,943 |
| Joseph D. Moore       |        | 0                                  |   | 0                     |   | 310                                                                          |         |                                                                  | 3,427 |     |   | 474,629 |   | 5,246,943 |
| Keith B. Pitts        |        | 0                                  |   | 0                     |   | 0                                                                            |         |                                                                  | 8,702 |     |   | 0 |   | 13,323,284 |
| Ronald P.Soltman      |        | 0                                  |   | 0                     |   | 228                                                                          |         |                                                                  | 2,938 |     |   | 349,082 |   | 4,498,254 |

| ____________________ |
|----------------------|
| (a)                  |  | There was no public marketfor our common stock at June 30, 2002.  The dollar values ofunexercised in-the-money options represent the difference betweenthe assumed fair market value of $1,701.18 per share at June 30,2002 and the exercise prices of the options. |
|                      |  |  |
| (b)                  |  | All of the options setforth in this chart (except for 5,275 of the options granted to Mr.Pitts) were options granted under our Carry Option Plan, asdescribed in Item 13 under the caption “Our OptionPlans.” |

**DirectorCompensation**

                       Directors do not receive any compensation for their services. Wedo, however, reimburse them for travel expenses and otherout-of-pocket costs incurred in connection with attendance atmeetings of our board of directors, and they are eligible toreceive options pursuant to certain of our option plans, asdescribed in Item 13 under the caption “Our OptionPlans.” To date, however, no non-employee directors have beengranted options.

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**Our EmploymentAgreements**

                       On June 1, 1998, we entered into written employment agreements withour Chief Executive Officer, Chief Operating Officer, ChiefFinancial Officer and General Counsel (Messrs. Martin, Hough, Mooreand Soltman, respectively) for terms expiring on June 1, 2003, withprovisions for renewal. On September 1, 1999, we entered into awritten employment agreement with Keith B. Pitts to be ourExecutive Vice President for a term expiring on September 1, 2004,with provisions for renewal. Effective May 31, 2001, Mr. Pitts waspromoted to the position of Vice Chairman of our board. The basesalaries of Messrs. Martin, Hough, Moore, Pitts and Soltman undersuch written employment agreements are, as of September 1, 2002,$900,000, $550,000, $500,000, $550,000 and $450,000,respectively.  Pursuant to these agreements these officers areto have an annual bonus plan giving each of them an opportunity toearn an annual bonus in such amount as our Board of Directorsshould determine, as well as pension, medical and other customaryemployee benefits.  The terms of these agreements state thatif the employee terminates his employment for Good Reason or if webreach the terms of the agreement and terminate the employee, hewill receive within a specified time after the termination apayment of up to three times his annual salary plus the average ofthe bonuses given to him in the two years immediately preceding histermination.

**Our SeveranceProtection Agreements**

                       We provide our executives at the Vice President level and above(other than Messrs. Martin, Hough, Moore, Soltman and Pitts) withseverance protection agreements granting them severance payments inamounts of 200% to 250% of annual salary and bonus. Generally,severance payments are due under these agreements if a change incontrol (as defined) should occur and employment of the officer isterminated during the term of the agreement by us (or oursuccessor) or by the employee for Good Reason. In addition, theseagreements state that in the event of a Potential Change in Control(defined as the time at which an agreement which would result in achange in control is signed, an acquisition attempt relating to usis publicly announced or there is an increase in the number ofshares owned by one of our ten-percent shareholders by five percentor more), the employees have an obligation to remain in our employuntil the earliest of (i) six months after the Potential Change inControl; (ii) a change in control; (iii) a termination ofemployment by us; or (iv) a termination of employment by theemployee for Good Reason (treating Potential Change in Control as achange in control for the purposes of determining whether theemployee had a Good Reason) or due to death, disability orretirement.

**Compensation CommitteeInterlocks and Insider Participation**

                       During fiscal 2002, we had no compensation committee of our boardof directors.  Messrs. Martin, Hough, Moore, Pitts andSoltman, all of the named executive officers, during fiscal 2002participated in deliberations of our board of directors concerningexecutive officer compensation.

                       During fiscal 2002, three of our executive officers, Charles N.Martin, Jr., Keith B. Pitts, and James H. Spalding, served asexecutive officers and members of the board of directors ofNetContent, Inc. and during fiscal 2002 NetContent had nocompensation committee of its board of directors.  Two of suchexecutive officers, Messrs. Martin and Pitts, served on our boardof directors during fiscal 2002.  Messrs. Martin, Pitts andSpalding receive no compensation for serving as executive officersand directors of NetContent.

**Item12.         SecurityOwnership of Certain Beneficial Owners andManagement.**

                       The following table presents information regarding beneficialownership of shares of our common stock and preferred stock, as ofSeptember 15, 2002, by:

| • |    | each person we know to bethe beneficial owner of 5% or more of our common stock or ourpreferred stock; |
|--------|--------------|--------------------------------------------------------------------------------------------------------|
|   |         |                                                                                                   |
| • |         | each of our executiveofficers listed in the summary compensation table;                                |
|   |         |                                                                                                   |
| • |         | the members of our boardof directors; and                                                              |
|   |         |                                                                                                   |
| • |         | all our current directorsand executive officers as a group.                                            |

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                       When reviewing the following table, you should be awarethat:

| • |     | The amounts and percentageof common stock and preferred stock beneficially owned are reportedon the basis of regulations of the SEC governing the determinationof beneficial ownership of securities. Under the rules of the SEC,a person is deemed to be a “beneficial owner” of asecurity if that person has or shares “voting power,”which includes the power to vote or to direct the voting of suchsecurity, or “investment power,” which includes thepower to dispose of or to direct the disposition of such security.A person is also deemed to be a beneficial owner of any securitiesof which that person has a right to acquire beneficial ownershipwithin 60 days. Under these rules, more than one person may bedeemed a beneficial owner of securities as to which he has noeconomic interest. |
|--------|--------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| • |     | Except as otherwiseindicated in the footnotes to the table, each stockholderidentified in the table possesses sole voting and investment powerover all shares of stock shown as beneficially owned by suchstockholder.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| • |     | We have one seriesoutstanding of preferred stock, our Payable-In-Kind CumulativeRedeemable Convertible Preferred Stock.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   |          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| • |     | Unless otherwise indicatedbelow, the address of each individual or entity listed in the tableis 20 Burton Hills Boulevard, Suite 100, Nashville, Tennessee37215.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |

| ** **                                                  | ** ** | **CommonStock of Vanguard** |            | **Preferred Stock of Vanguard** |
|-------------------------------------------------------------|------------|-----------------------------|------------|---------------------------------|
| ** **                                                  | ** ** | ****                        |            | ****                            |
| ** **                                                  | ** ** | **Numberof Shares**         | ** ** | **Percentof Class**             | ** ** | **Numberof Shares** | ** ** | **Percentof Class** |
| ** **                                                  | ** ** | ****                        |            | ****                            |
| **BeneficialOwners:**                                       |       |                        |            |                            |   |   |  |   |   |   |  |     |   |   |  |     |
| MSCP Funds(1)                                               |       |                        | 163,189    |                            |   |   | 78.9 |  % |   |   | — |   |   |   | — |     |
| The MacNeal MemorialHospital Association(2)                 |       |                        | —    |                            |   |   | — |   |   |   | 23,328 |   |   |   | 100.0 | % |
| Charles N. Martin,Jr.(3)                                    |       |                        | 43,513     |                            |   |   | 21.1 |   |   |   |  |   |   |   | — |      |
| William L.Hough(4)                                          |       |                        | 5,487      |                            |   |   | 2.7 |   |   |   | — |   |   |   | — |      |
| Joseph D.Moore(5)                                           |       |                        | 5,144      |                            |   |   | 2.5 |   |   |   | — |   |   |   | — |      |
| Keith B. Pitts                                              |       |                        | 118        |                            |   |   | * |   |   |   | — |   |   |   | — |      |
| Ronald P.Soltman(6)                                         |       |                        | 3,952      |                            |   |   | 1.9 |   |   |   | — |   |   |   | — |      |
| Karen H.Bechtel(7)                                          |       |                        | —    |                            |   |   | — |   |   |   | — |   |   |   | — |      |
| Eric T. Fry(7)                                              |       |                        | —    |                            |   |   | — |   |   |   | — |   |   |   | — |      |
| Howard I.Hoffen(7)                                          |       |                        | —    |                            |   |   | — |   |   |   | — |   |   |   | — |      |
| All directors andexecutive officers as a group (18 persons) |       |                        | 43,513     |                            |   |   | 21.1 |   |   |   | — |   |   |   | — |      |

| ____________________ |
|----------------------|
| *                    |  | Signifies less than1%. |
|                      |  |  |
| (1)                  |  | The MSCP Funds consist ofMorgan Stanley Capital Partners III, L.P., MSCP III 892 Investors,L.P., Morgan Stanley Capital Investors III, L.P., Morgan StanleyDean Witter Capital Partners IV, L.P., MSDW IV 892 Investors, L.P.,and Morgan Stanley Dean Witter Capital Investors IV, L.P.  Theaddress of each such entity is 1585 Broadway, New York, New York10036. |
|                      |  |  |
| (2)                  |  | Michael P. Kenahan,President of MacNeal Memorial Hospital Association, possesses solevoting and investment power over these shares, subject to specificdirection at any time by the Board of Directors of MacNeal MemorialHospital Association.  The address of The MacNeal MemorialHospital Association and of Mr. Kenahan is 3249 South Oak ParkAvenue, Berwyn, Illinois 60402. |
|                      |  |  |
| (3)                  |  | Includes 3,396 shareswhich Mr. Martin has the right to acquire upon the exercise ofstock options. Includes 24,536 shares beneficially owned by Mr.Martin solely as a result of his rights to vote these 24,536 sharesunder the Voting Proxy Agreement discussed below. Mr. Martin has noeconomic interest in these 24,536 shares. Mr. Martin beneficiallyowns 18,977 shares in which he has an economic interest and whichrepresent 9.2% of the class. |

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| (4) |  | Includes 359 shares whichMr. Hough has the right to acquire upon the exercise of stockoptions.                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|-----|--|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|     |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| (5) |  | Includes 310 shares whichMr. Moore has the right to acquire upon the exercise of stockoptions.                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|     |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| (6) |  | Includes 228 shares whichMr. Soltman has the right to acquire upon the exercise of stockoptions.                                                                                                                                                                                                                                                                                                                                                                                                                                |
|     |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| (7) |  | Mr. Hoffen is the Chairmanand Chief Executive Officer of Morgan Stanley Private Equity. Ms. Bechtel and Mr. Fry are Managing Directors of Morgan StanleyPrivate Equity.  Messrs. Fry and Hoffen and Ms. Bechtel eachdisclaim beneficial ownership of the shares of common stockbeneficially owned by the MSCP Funds which are managed by MorganStanley Private Equity, except to the extent of any directpecuniary interest therein.  The address of each such personis 1585 Broadway, New York, New York 10036. |

**EQUITYCOMPENSATION PLAN INFORMATION**

                       The following table gives information about our common stock thatmay be issued upon the exercise of options, warrants and rightsunder all of our existing equity compensation plans as of June 30,2002.

| ** **                                                                   | ** **       | **EquityCompensation Plan Information**                                                                                                     |
|------------------------------------------------------------------------------|------------------|---------------------------------------------------------------------------------------------------------------------------------------------|
| ** **                                                                   | ** **       | ****                                                                                                                                        |
| **PlanCategory**                                                             | ** **       | **Numberof securities to be issued upon exercise of outstanding options, warrants and rights**                                              | ** ** | **Weighted-average exercise price of outstanding options, warrants and rights** | ** ** | **Numberof securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))** |
| ****                                                                         | ** **       | ****                                                                                                                                        |
|                                                                         | ** **       | **(a)**                                                                                                                                     |   | **(b)** | **(c)** |
| Equity compensation plans approved by    security holders     | **  ** |               51,121                                                  |   | $   569 |              705 (1)(2) |
| Equity compensation plans not approved    by security holders | **  ** |                        0 |   |         0 |                           0 |
| Total                                                                        | ** **       |               51,121                                                  |   | $   569 |                       705 |

| ____________________ |
|----------------------|
| (1)                  |  | Represents 13 sharesremaining available for future issuances of options under our 1998Stock Option Plan and 692 shares remaining available for futureissuances of options under our 2000 Stock Option Plan. |
|                      |  |  |
| (2)                  |  | Up to 2,977 more shareswould become available for future issuance of options under our1998 Stock Option Plan if a Liquidity Event should occur and acertain financial test is met relating to shareholder returns ontheir investment in our shares.  Up to 33,837 more shareswould become available for the issuance of options under the 2000Stock Option Plan if the MSCP Funds and/or Charles N. Martin, Jr.were to purchase additional shares of our common stock pursuant tothe subscription agreement dated June 1, 2000, and if so, shareswould be added to the 2000 Stock Option Plan at the rate of 17.647%of the shares so purchased by the MSCP Funds and 10% of the sharesso purchased by Mr. Martin. |

**Item13.         CertainRelationships and Related Transactions.**

**                       *Founders***

                       Vanguard was founded in July 1997 by four of its directors andexecutive officers mentioned above, Messrs. Martin, Hough, Mooreand Soltman, and by an affiliate of the MSCP Funds. Initially, the individual founders funded the start-up operationsof Vanguard with short-term loans.  In August 1997 the fourindividual founders and certain other current members of managementpurchased for cash shares of our common stock and the short-termloans were repaid with the proceeds of the share purchases. In addition, in August 1997 the affiliate of the MSCP Fundspurchased for cash shares of our preferred stock.  We redeemedthose preferred shares for cash in June 1998.

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**                       *Shareholders Agreement***

                       As noted above, the MSCP Funds currently own collectivelyapproximately 80% of our outstanding shares of common stock. TheMSCP Funds and all the other shareholders in Vanguard have enteredinto a shareholders agreement governing their ownership of ourcommon stock. The following is a summary of the material termsincluded in the shareholders agreement.

| • |   | The shareholders agreementprovides that our board of directors is to be made up of eightmembers, five of which are to be nominated by managementshareholders and three of which are to be nominated by the MSCPFunds. Despite the foregoing, at all times the MSCP Funds have theright to nominate a fourth member to our board, in which event oneof the management directors will resign. Currently, Ms. Bechtel andMessrs. Fry and Hoffen are directors nominated by the MSCP Funds.Also, at any time after January 1, 2005, the MSCP Funds have theright to nominate a majority of our board if the MSCP Fundsexercise their additional right under the shareholders agreement torequire all other shareholders to transfer their shares to the sameprospective purchaser to whom and at the same price at which theMSCP Funds have agreed to sell their shares of our common stock.The MSCP Funds also have the right to designate one member of eachcommittee of our board. |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| • |   | The shareholders haveagreed not to transfer any of their shares other than to permittedtransferees, and that their shares will be subject to certain“tag along” and “first offer” rights uponshare transfer.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| • |   | After June 1, 2003, if theMSCP Funds decide to sell all of their shares to a third party,they can require that the other shareholders who are parties to theshareholders agreement sell all of their shares to a third-partypurchaser chosen by the MSCP Funds, at the price negotiated by theMSCP Funds and the third-party purchaser but, if the sale is priorto January 1, 2005, the other shareholders have the right topurchase all of the shares held by the MSCP Funds in lieu ofselling their shares to the third-party purchaser.                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| • |   | Each of the ManagementInvestors has agreed to sell to us all the shares that he or sheowns at cost if, prior to June 1, 2003, his or her employment isterminated either by him or her without Good Reason or by us forcause and he or she then engages in an activity competitive withour business.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| • |   | Mr. Martin is generallyprohibited from disposing of shares unless, at the time of thedisposition, the proportion of his shareholdings that he hasdisposed of does not exceed the proportion of shareholdingsdisposed of by the MSCP Funds.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| • |   | The MSCP Funds and theother shareholders, under specified circumstances and subject tocertain conditions, have the right to require us to register theirshares under the Securities Act and to participate in specifiedregistrations of shares by us.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| • |   | We have agreed to payreasonable fees and expenses of the MSCP Funds incurred inreviewing the health care facilities which we propose to purchasefrom time to time.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| • |   | If the MSCP Funds receiveaggregate net proceeds upon a Liquidity Event that are less thanwhat they have invested in Vanguard, they may require us torepurchase from our Management Investors an aggregate of 24,187shares at the lower of cost or market value at the time of suchnotice. Morgan Stanley Dean Witter Capital Partners IV, L.P.(“MSCP IV”) can require that we, or we can elect undercertain circumstances to, pay the purchase price by delivery of a3-year note, bearing interest at 1% over the 3-year U.S. Treasurybond rate, in lieu of cash. If our credit agreements do not permitsuch a purchase, then the MSCP Funds are permitted to purchase theshares directly from the Management Investors for cash.                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| • |   | So long as the MSCP Fundsown at least 15% of our outstanding common stock, we have agreednot to take certain important actions without the prior approval ofMSCP IV including, but not                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |

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                                   limited to, the following:

                               •   issuances of equity or equity-type securities orpayments of dividends on our capital stock;

                               •   approval of our annual business plan and budgetand of any long-term strategic plan;

                               •   the appointment or removal of our ChiefExecutive Officer or any change in the compensation                                   of our executive management;

                               •   incurrence, refinancing or discharge ofindebtedness in excess of 10% of our consolidated                                   assets;

                               •   purchases or sales of assets having a value inexcess of 10% of our consolidated assets, other                                   than in the ordinary course of our business;

                               •   a merger, consolidation, reclassification,reorganization, liquidation, dissolution, voluntary                                   bankruptcy or similar significant corporate events;

                               •   changes in our auditors, financial accountingpolicies or tax policies;

                               •   transactions with our affiliates or affiliatesof our management;

                               •   capital expenditures exceeding 5% of ourconsolidated assets for any given project or in any                                   fiscal year;

                               •   employment of investment bankers; and

                               •   any other material transaction.

                       The above-mentioned provisions of the shareholders agreement willterminate in the event of an initial public offering of our commonstock, the sale of our company or the sale by the MSCP Funds oftheir shares of our common stock (each a “LiquidityEvent”). Upon the occurrence of a Liquidity Event, a separateshareholders agreement will become effective which will govern theownership of our common stock among our current shareholders. Thefollowing is a summary of the material terms included in thisseparate shareholders agreement.

| • |   | Shares received upon theexercise of options granted under the Carry Option Plan describedbelow may not be transferred for a period of one year after ourinitial public offering.                                                                                                                                                                                                                                                                                                                               |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| • |   | Mr. Martin is generallyprohibited from disposing of shares unless, at the time of thedisposition, the proportion of his shareholdings that he hasdisposed of does not exceed the proportion of shareholdingsdisposed of by the MSCP Funds.                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| • |   | The MSCP Funds and theother shareholders, under specified circumstances and subject tocertain conditions, have the right to require us to register theirshares under the Securities Act and to participate in specifiedregistrations of shares by us.                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| • |   | We have the right torepurchase at cost all shares, including those received upon theexercise of options granted under the Carry Option Plan if, priorto June 1, 2003, his or her employment is terminated either by himor her without Good Reason or by us for cause and he or she thenengages in an activity competitive with our business. This rightcan be assigned to the other Management Investors, and the MSCPFunds have the right to effect any such repurchase directly fromthe Management Investor. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| • |   | As long as the MSCP Fundsown at least 5% of our outstanding shares, they will have the rightto designate two board members and one member of each committee ofour board.                                                                                                                                                                                                                                                                                                                                       |

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                       As a result of their stock ownership, their positions with Vanguardand the shareholders and related agreements described herein, ourexecutive management and the MSCP Funds control us and have thepower to elect all of our directors. As a result of their holdingapproximately 80% of our outstanding shares of common stock andtheir rights under the shareholders agreement, the MSCP Funds havesignificant influence over our management and policies and over anyaction requiring the approval of the holders of our common stock,including amendments to our certificate of incorporation,acquisitions or sales of all or substantially all of our assets.Circumstances may occur in which the interests of the MSCP Fundscould be in conflict with the interests of our other shareholdersor the holders of our 9.75% Notes.  In addition, the MSCPFunds may have an interest in pursuing transactions that, in theirjudgment, enhance the value of their equity investment in ourcompany, even though those transactions may involve risks to ourshareholders or the holders of the 9.75% Notes.

**                       *Subscription Agreement***

                       Under a subscription agreement dated June 1, 2000, between us andcertain investors, including the MSCP Funds and our executiveofficers, to fund the purchase of hospitals, hospital systems,hospital management companies and related assets, we authorized theissuance and sale of 235,521 shares of common stock at a price of$1,701.18 per share. As of September 15, 2002, we have sold 46,051shares pursuant to this subscription agreement. According to itsterms, the obligation of the MSCP Funds to purchase shares issubject to the approval of the Investment Committee of MorganStanley Capital Partners. The subscription agreement also entitlesthe MSCP Funds and their affiliates an exclusive right of firstoffer to provide equity and equity-linked financing to us (exceptfor equity issued by us or our subsidiaries in connection withhospital or hospital system acquisitions).

**                       *Letter Agreement***

                       On June 1, 1998, we signed a letter agreement with our existingshareholders at that date under which we agreed that if, inconnection with a Management Investor’s ownership of sharesof our common stock acquired prior to June 1, 1998 (“InitialShares”), we become entitled to any tax deduction in respectof the Initial Shares, we will pay to such Management Investor theamount of the benefit, when we actually receive the economicbenefit of the deduction.  As of this time, we have notreceived any benefits which we would be obligated to pay to theManagement Investors under this agreement.

**                       *Our Option Plans***

                       In June 1998, we established a stock option plan (the “1998Stock Option Plan”) which is available for stock optionawards from time to time to our officers, key employees, directorsand consultants, including key employees of acquired hospitals.Except as described below, the terms of this option plan state thatthe options will vest ratably over a term of four years and thatall options will accelerate immediately upon a change in control(as defined in the plan). In addition, all optionees must consentin their option agreements to be bound by the terms of theshareholders agreements referred to above. A certain percentage ofthe options granted pursuant to the 1998 Stock Option Plan (atleast 75% percent of those issued) must be forfeited to us if theinvestment gains received by the MSCP Funds upon a Liquidity Eventare less than a predetermined amount and, accordingly, theseoptions may not be exercised prior to a Liquidity Event. Themaximum number of shares of our common stock reserved for the grantof options under this plan is 13,306, subject to a readjustmentupon the occurrence of a Liquidity Event. As of September 15, 2002,options to purchase 10,316 shares have been granted and remainoutstanding under this plan and 14 shares of common stock have beenissued upon the exercise of options under this plan. Of theremaining 2,977 authorized options, none of these options areavailable for our grant, and all remain outstanding unless aLiquidity Event shall occur and a certain financial test set forthin the plan relating to shareholder returns on their investment inour shares is met.

                       In June 2000, we established another stock option plan (the“2000 Stock Option Plan”) which is available for stockoption awards from time to time to our officers, key employees,directors and consultants, including key employees of acquiredhospitals. The terms of this option plan are substantially similarto those of the 1998 Stock Option Plan, including the forfeitureprovisions described above. The maximum number of shares of commonstock reserved for the grant of options under this plan is 41,931shares or a lesser number based upon a formula relating to recentissuances of our common stock to our shareholders. As of September15, 2002, options to

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purchase 8,094 shares areauthorized for grant under this plan and options to purchase 7,812shares have been granted and remain outstanding under thisplan.

                       In June 1998, we established a Carry Option Plan under whichoptions to purchase our shares may be granted to certain keyemployees. The options granted under this plan vest ratably overseven years and become fully vested upon a Liquidity Event. Theseoptions are exercisable only upon a Liquidity Event and only to anextent determined pursuant to a schedule based on the returnsearned by the MSCP Funds on their aggregate investment in ourcommon stock. Pursuant to our shareholders agreement, the MSCPFunds and certain other shareholders may be obligated to forfeit upto 25% of the shares of our common stock which they own, dependingupon the extent of the investment gains of the MSCP Funds upon aLiquidity Event, to fund options granted under this plan toemployees. Options to purchase 29,822 shares were authorized forgrant under this plan at a price per option equal to 10% of thefair market value of the related underlying share, and, as ofSeptember 15, 2002, options to purchase all 29,822 shares have beengranted under this plan to key employees, including Messrs. Martin,Hough, Moore, Pitts and Soltman.

                       Effective June 1998, we established a Nonqualified Initial OptionPlan under which we granted options to purchase an aggregate of3,595 shares to certain of our employees on June 1, 1998. Most ofthe options granted under this plan were made to our employees whoworked for us during 1997 and 1998 either with no cash salaries orwith salaries below fair market value. These options were grantedwith an exercise price equal to 10% of the purchase price that wecharged purchasers of our shares of common stock on June 1,1998.

                       All of the options which we have granted under the 1998 StockOption Plan, the 2000 Stock Option Plan, the Nonqualified InitialOption Plan and the Carry Option Plan have been granted to ourofficers and other employees. We believe that the past and futuregrants of options to purchase our common stock under these planshave assisted and will assist us in retaining and recruitingemployees of outstanding ability. Stock option grants provide anincentive that focuses the employee’s attention on managingor working for the business of our company from the perspective ofan owner with an equity stake in the business and helps ensure thatoperating decisions are based on long-term results that benefit thebusiness and ultimately our shareholders. Usually, each stockoption granted under these plans becomes vested and exercisableonly over a period of time or upon a Liquidity Event. Generally,the exercise prices of options granted under the 1998 Stock OptionPlan and the 2000 Stock Option Plan have been equal to the fairmarket value of our shares at the time of grant, subject todownward adjustment in the event of superior investment gains bythe MSCP Funds upon a Liquidity Event, while options granted underthe Carry Option Plan and the Initial Option Plan are granted atexercise prices equal to 10% of such fair market value. The numberof shares covered by each grant is intended to reflect thegrantee’s level of responsibility and past and anticipatedcontributions.

                       Each of our option plans provides that, in the event of anyrecapitalization, reclassification, merger, consolidation, stocksplit, or combination or exchange of shares, or other similartransaction, the number of shares of our common stock available forawards, the number of such shares covered by outstanding awards,the option price and any other relevant provisions of the plan willbe equitably adjusted by our board or compensation committee toreflect such event and preserve the value of suchoptions.

***                       Our Voting Proxy Agreement***

                       Each of our shareholders (other than the MSCP Funds) has enteredinto a voting proxy agreement in which the shareholder has grantedMr. Martin (or, if Mr. Martin is no longer employed by us or is nolonger one of our directors, Mr. Moore) an irrevocable proxy tovote that shareholder’s shares of common stock in such manneras Mr. Martin, in his sole discretion, deems proper. Furthermore,Mr. Martin has been authorized under the voting proxy agreement toissue any consent or waiver on behalf of the shareholder under ourshareholders agreement and related agreements. The voting proxyagreement terminates upon the earlier of (i) the consummation of aLiquidity Event and (ii) June 1, 2008.

                       Mr. Martin has used his rights under the voting proxy agreement tonominate himself and Messrs. Hough, Moore, Pitts and Soltman as thedirectors to be nominated by the management shareholders pursuantto our shareholders agreement.

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**                       *Our Related Party Transactions***

                       Charles N. Martin, Jr., our Chairman and Chief Executive Officer,beneficially owns in excess of 97% of the membership interests inThe Healthcare Airplane Group, LLC, a Tennessee limited liabilitycompany, and is its Chief Executive Officer.  We own anapproximately 0.4% membership interest in The Healthcare AirplaneGroup.  The Healthcare Airplane Group’s principal assetis a Falcon model 20F-731 10-passenger jet airplane.  We paidThe Healthcare Airplane Group approximately $434,000 during thefiscal year ended June 30, 2002 to charter the plane from time totime, to fly our employees to and from the sites of our proposedacquisitions and for other corporate purposes.  These charterpayments were made in the ordinary course of our business, and webelieve that the prices paid to The Healthcare Airplane Group forthese charter services were more favorable to us than those charterrates which we could have obtained for comparable plane servicesfrom an independent airplane charter company.

                       During fiscal 2002, we paid $142,000 of the out-of-pocket expensesof the MSCP Funds related to their review of our proposedtransactions and travel and related expenses. During fiscal 2002,we also paid Morgan Stanley & Co. Incorporated or MorganStanley Senior Funding, Inc. underwriting fees of $3,163,000 in respect of our 9.75% Notes, loan origination fees of $743,000 inrespect of our 2001 credit facility and reimbursed them for $60,000of their out-of-pocket travel, clerical and word processing fees inconnection with such matters. As of September 15, 2002, the MSCPFunds owned 78.9% of our common stock. In addition, three of ourdirectors, Karen H. Bechtel, Eric T. Fry and Howard I. Hoffen, aremanaging directors of Morgan Stanley & Co. Incorporated and twoof them, Karen H. Bechtel and Eric T. Fry, are managing directorsof Morgan Stanley Private Equity while Howard I. Hoffen is Chairmanand Chief Executive Officer of Morgan Stanley Private Equity.Morgan Stanley & Co. Incorporated, Morgan Stanley PrivateEquity and Morgan Stanley Senior Funding, Inc. are affiliates ofthe MSCP Funds.

                       During fiscal 2002, certain of our facilities paid approximately$440,000 to Coactive Systems Corporation for nurse triage,physician referral and class registration services and CoactiveSystems reimbursed us approximately $50,000 for our full rentalcost in connection with its month-to-month occupancy of certainoffice space in our headquarters not currently needed by us. In addition, in fiscal 2002 Coactive Systems paid us approximately$21,000 to reimburse us for our costs of its phone use whileoccupying such office space in our headquarters and for anallocation in respect of our cost of certain office services. The above aggregate amount paid by our facilities to CoactiveSystems resulted from several contracts separately negotiated withCoactive Systems by local management of each facility on anarms-length basis and in our opinion such amount paid by ourfacilities does not exceed the fair market value for suchservices.  We currently expect to make a similar or greateramount of such payments to Coactive Systems in fiscal 2003 and forCoactive Systems to make a similar amount of such payments to us infiscal 2003. Our Chairman & Chief Executive Officer, Charles N.Martin, Jr., owns approximately 41.5% of the common stock ofCoactive Systems and is the non-executive chairman of its board ofdirectors.  Certain of our other executive officers (Robert E.Galloway, W. Lawrence Hough, Joseph D. Moore, Keith B. Pitts,Phillip W. Roe, Ronald P. Soltman and Alan G. Thomas) own, in theaggregate, approximately 5.5% of the common stock of CoactiveSystems.  In addition, our Vice Chairman, Keith B. Pitts, ison its board of directors; our Senior Vice President, AssistantGeneral Counsel and Assistant Secretary, James H. Spalding, is itsassistant secretary and our Executive Vice President, GeneralCounsel and Secretary, Ronald P. Soltman, is itssecretary.

                       During fiscal 2002, Phyve Corporation reimbursed us approximately$169,000 for our full rental cost in connection with itsmonth-to-month occupancy of certain office space in ourheadquarters  not currently needed by us. In addition, infiscal 2002 Phyve paid us approximately $39,000 to reimburse us forour costs of its phone use while occupying such office space in ourheadquarters and for an allocation in respect of our cost ofcertain office services.  Also, during fiscal 2002, we paidPhyve approximately $3,000 for computer consulting services. We currently expect to make a similar or greater amount of suchpayments to Phyve in fiscal 2003 and for Phyve  to make asimilar amount of such payments to us in fiscal 2003.  OurChairman & Chief Executive Officer, Charles N. Martin, Jr.,owns approximately 16.9% of the outstanding common stock and 11.6%of the outstanding preferred stock of Phyve and is thenon-executive chairman of its board of directors.  Certain ofour other executive officers (Bruce F. Chafin, Robert E. Galloway,W. Lawrence Hough, James Johnston, Joseph D. Moore, Keith B. Pitts,Phillip W. Roe, Ronald P. Soltman, James H. Spalding, and Alan G.Thomas) own, in the aggregate, approximately 12.8% of its commonstock and Messrs. Galloway, Johnston and Moore  own, in theaggregate, approximately 0.5%

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of its outstandingpreferred stock.  In addition, Mr. Spalding is its secretaryand Mr. Soltman is its assistant secretary.

                       During fiscal 2002, NetContent, Inc. reimbursed us approximately$87,000 for our full rental cost in connection with itsmonth-to-month occupancy of certain office space in ourheadquarters  not currently needed by us.  In addition,in fiscal 2002 NetContent paid us approximately $31,000 toreimburse us for our costs of its phone use while occupying suchoffice space in our headquarters and for an allocation in respectof our cost of certain office services.  Additionally, duringfiscal 2002, we paid NetContent approximately $4,000 for healthcare information services.  We currently expect to make asimilar or greater amount of such payments to NetContent  infiscal 2003 and for NetContent  to make a similar amount ofsuch payments to us in fiscal 2003.   Our Chairman &Chief Executive Officer, Charles N. Martin, Jr., owns 51% of theoutstanding common stock of NetContent and is its President and amember of its board of directors.  Two of our other executiveofficers, Keith B. Pitts and James H. Spalding, own 30% and 19%,respectively, of the outstanding common stock of NetContent. Additionally, Mr. Pitts is the Vice President & Treasurer ofNetContent and a member of its board of directors; and Mr. Spaldingis the Vice President & Secretary of NetContent and a member ofits board of directors.  NetContent’s revenues in itsmost recent fiscal year were approximately $186,000.

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**PARTIV**

**Item14.         Exhibits,Financial Statement Schedules, and Reports on Form8-K.**

|   | (a)    |   | Documents filed as part ofthis report: |
|--------|--------|--------|----------------------------------------|
|   |   |   |                                   |
|   |   |   | (1)                                    |   | FinancialStatements.  The accompanying index to financial statements onpage F-1 of this Annual Report on Form 10-K is provided in response to thisitem. |
|   |   |   |                                   |   |   |
|   |   |   | (2)                                    |   | List of FinancialStatement Schedules.  All schedules are omitted because therequired information is either not present, not present in material amountsor presented within the consolidated financial statements. |
|   |   |   |                                   |   |   |
|   |   |   | (3)                                    |   | List ofExhibits. |

                       The following exhibits are filed with this report.
| **ExhibitNo.**                  | ** **         | **Document**                                                                                                                                                                                                                                                                           |
|---------------------------------|--------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                            |
| 1                               |     | Registration RightsAgreement dated as of July 30, 2001 between Vanguard HealthSystems, Inc. and Morgan Stanley & Co. Incorporated, Banc ofAmerica Securities LLC, Credit Suisse First Boston Corporation, UBSWarburg LLC and First Union Securities, Inc., as InitialPurchasers(1) |
|                  |     |                                                                                                                                                                                                                                                                         |
| 2.1                             |               | Purchase and SaleAgreement, dated as of April 23, 2002, among The University ofChicago Hospitals, Louis A. Weiss Memorial Hospital, VanguardHealth Financial Company, Inc., VHS Acquisition Subsidiary Number3, Inc. and Vanguard Health Systems, Inc.(2)                              |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 2.2                             |               | First Amendment toPurchase and Sale Agreement dated as of May 31, 2002, among TheUniversity of Chicago Hospitals, Louis A. Weiss Memorial Hospital,Vanguard Health Financial Company, Inc., VHS Acquisition SubsidiaryNumber 3, Inc. and Vanguard Health Systems, Inc.(2)              |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 2.3                             |               | Subscription andContribution Agreement dated as of June 1, 2002, among TheUniversity of Chicago Hospitals, Vanguard Health Financial Company,Inc. and VHS Acquisition Subsidiary Number 3, Inc.(2)                                                                                     |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 3.1                             |               | Certificate ofIncorporation(1)                                                                                                                                                                                                                                                         |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 3.2                             |               | By-Laws(1)                                                                                                                                                                                                                                                                             |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 4.1                             |               | Indenture, dated as ofJuly 30, 2001 between Vanguard Health Systems, Inc., otherGuarantors and the Trustee(1)                                                                                                                                                                          |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 4.2                             |               | First SupplementalIndenture, dated as of September 21, 2001 between Vanguard HealthSystems, Inc., other Guarantors and the Trustee(1)                                                                                                                                                  |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 4.3                             |               | Second SupplementalIndenture, dated as of October 2, 2001 between Vanguard HealthSystems, Inc., other Guarantors and the Trustee(1)                                                                                                                                                    |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 4.4                             |               | Amended and RestatedSubscription Agreement dated June 1, 2000 between Vanguard HealthSystems, Inc., funds controlled by Morgan Stanley Capital Partnersand certain investors(1)                                                                                                        |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 4.5                             |               | Voting Proxy Agreementdated as of June 1, 1998, among certain holders and Vanguard HealthSystems, Inc.(1)                                                                                                                                                                              |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 4.6                             |               | Amended and RestatedShareholders Agreement, dated as of June 1, 2000 among VanguardHealth Systems, Inc., funds controlled by Morgan Stanley CapitalPartners and certain holders(1)                                                                                                     |
|                            |               |                                                                                                                                                                                                                                                                                   |
|                            |               |                                                                                                                                                                                                                                                                                   |
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| 4.7                             |               | Surviving ShareholdersAgreement dated as of June 1, 1998 among Vanguard Health Systems,Inc., funds controlled by Morgan Stanley Capital Partners andcertain holders(1)                                                                                                                 |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 4.8                             |               | Letter Agreement dated asof June 1, 1998 among Vanguard Health Systems, Inc., fundscontrolled by Morgan Stanley Capital Partners and certaininvestors(1)                                                                                                                               |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 10.1                            |               | Security Agreement, datedas of July 30, 2001 between Vanguard Health Systems, Inc. and theCollateral Agent(1)                                                                                                                                                                          |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 10.2                            |               | Pledge Agreement, dated asof July 30, 2001 between Vanguard Health Systems, Inc. and theCollateral Trustee(1)                                                                                                                                                                          |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 10.3                            |               | Credit Agreement, dated asof July 30, 2001 between Vanguard Health Systems, Inc. and variouslenders(1)                                                                                                                                                                                 |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 10.4                            |               | 1998 Stock Option Plan(1)(3)                                                                                                                                                                                                                                                           |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 10.5                            |               | 2000 Stock Option Plan(1)(3)                                                                                                                                                                                                                                                           |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 10.6                            |               | Nonqualified InitialOption Plan(1) (3)                                                                                                                                                                                                                                                 |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 10.7                            |               | Carry Option Plan(1)(3)                                                                                                                                                                                                                                                                |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 10.8                            |               | Employment Agreementbetween Vanguard Health Systems, Inc. and Charles N. Martin, Jr.dated as of June 1, 1998 and amendment dated as of May 31, 2001(1)(3)                                                                                                                              |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 10.9                            |               | Employment Agreementbetween Vanguard Health Systems, Inc. and William L. Hough dated asof June 1, 1998 and amendment dated as of May 31, 2001(1)(3)                                                                                                                                    |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 10.10                           |               | Employment Agreementbetween Vanguard Health Systems, Inc. and Joseph D. Moore dated asof June 1, 1998 and amendment dated as of July 31, 2001(1)(3)                                                                                                                                    |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 10.11                           |               | Employment Agreementbetween Vanguard Health Systems, Inc. and Ronald P. Soltman datedas of June 1, 1998 and amendment dated as of July 31, 2001(1)(3)                                                                                                                                  |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 10.12                           |               | Employment Agreementbetween Vanguard Health Systems, Inc. and Keith B. Pitts dated asof June 1, 1998 and amendment dated as of May 31, 2001(1)(3)                                                                                                                                      |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 10.13                           |               | Agreement for Purchase andSale of Assets between Vanguard Health Systems and variousaffiliates and Baptist Health Systems in Phoenix, Arizona and itsvarious affiliates, dated as of March 31, 2000(1)                                                                                 |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 10.14                           |               | Amendment dated as of June1, 2000 to Agreement for Purchase and Sale of Assets betweenVanguard Health Systems and various affiliates and Baptist HealthSystems and its various affiliates(1)                                                                                           |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 10.15                           |               | Asset Purchase Agreementby and among MacNeal Health Services Corporation and variousaffiliates and VHS of Illinois, Inc. and Vanguard Health Systems,Inc., dated as of October 4, 1999(1)                                                                                              |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 10.16                           |               | Amendment, dated as ofFebruary 1, 2000 to Asset Purchase Agreement by and among MacNealHealth Services Corporation and various affiliates and VHS ofIllinois, Inc. and Vanguard Health Systems, Inc.(1)                                                                                |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 10.17                           |               | Arizona Health Care CostContainment System Administration contract with VHS Phoenix HealthPlan, dated as of October 1, 2001 and amendment dated as of October1, 2001(1)                                                                                                                |
|                            |               |                                                                                                                                                                                                                                                                                   |
|                            |               |                                                                                                                                                                                                                                                                                   |
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| 10.18                           |               | Vanguard Health Systems,Inc. 2001 Annual Incentive Plan(1)                                                                                                                                                                                                                             |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 10.19                           |               | Amendments 21, 22, and 23dated November 1, 2001, December 17, 2001, and March 1, 2002,respectively, to the Arizona Health Care Cost Containment SystemAdministration contract with VHS Phoenix Health Plan.                                                                            |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 21                              |               | Subsidiaries of VanguardHealth Systems, Inc.                                                                                                                                                                                                                                           |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 99.1                            |               | Certification of ChiefExecutive Officer pursuant to 18 U.S.C. Section 1350, as adoptedpursuant to Section 906 of the Sarbanes-Oxley Act of2002                                                                                                                                         |
|                            |               |                                                                                                                                                                                                                                                                                   |
| 99.2                            |               | Certification of ChiefFinancial Officer pursuant to 18 U.S.C. Section 1350, as adoptedpursuant to Section 906 of the Sarbanes-Oxley Act of2002.                                                                                                                                        |
| ____________________ |
|----------------------|
| (1)                  |  | Incorporated by referencefrom exhibits to the Company’s Registration Statement on FormS-1 (Registration No. 333-71934). |
| (2)                  |  | Incorporated by referencefrom exhibits to the Company’s Current Report on Form 8-Kdated June 7, 2002, File No. 333-71934. |
| (3)                  |  | Management compensatoryplan or arrangement. |

| (b)    |   | Reports on Form 8-K. On June 7, 2002, we filed a Current Report on Form 8-K reportingunder Item 2 the acquisition of substantially all of the assets constituting Louis A. WeissMemorial Hospital in Chicago, Illinois. On August 13, 2002, we amended this report by filing Amendment No.1 on Form 8-K/A for the purpose of including the required financial statements and proforma financial information with regard to the acquisition. |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| (c)    |   | Exhibits. See Item 14(a)(3) of this report.                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| (d)    |   | Financial StatementSchedules. See Item 14(a)(2) of this report.                                                                                                                                                                                                                                                                                                                                                                             |

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**SIGNATURES**

                       Pursuant to the requirements of Section 13 or 15(d) of theSecurities Exchange Act of 1934, the registrant has duly causedthis report to be signed on its behalf by the undersigned,thereunto duly authorized.

| VANGUARD HEALTH SYSTEMS,INC.                                                                                                                                                                               |                                                                      | Date              |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------|-------------------|
|                                                                                                                                                                                                       |                                                                      |              |
| By: /s/ Charles N.Martin,Jr.                              |                                                                      | September 19,2002 |
|                                                                                                                                                                                   | Charles N. Martin,Jr. Chairman of the Board & Chief Executive Officer |              |   |

                       Pursuant to the requirements of the Securities Exchange Act of1934, this report has been signed below by the following persons onbehalf of the registrant and in the capacities and on the datesindicated.
| **Signature**                                                                                                                                            |   | **Title**                                                                                                |   | **Date**          |
|----------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------|--------|-------------------|
|                                                                                                                                                     |   |                                                                                                     |   |              |
| /s/ Charles N. Martin,Jr.                                                                                                            |   | Chairman of the Board& Chief Executive Officer; Director (Principal Executive Officer)               |   | September 19,2002 |
| Charles N. Martin,Jr.                                                                                                                                    |
|                                                                                                                                                     |   |                                                                                                     |   |              |
|                                                                                                                                                     |   |                                                                                                     |   |              |
| /s/ William L.Hough                                                                                    |   | President & ChiefOperating Officer; Director                                                         |   | September 19,2002 |
| William L.Hough                                                                                                                                          |   |                                                                                                     |   |              |
|                                                                                                                                                     |   |                                                                                                     |   |              |
|                                                                                                                                                     |   |                                                                                                     |   |              |
| /s/ Joseph D.Moore                                                                                |   | Executive Vice President,Chief Financial Officer & Treasurer; Director (Principal Financial Officer) |   | September 19,2002 |
| Joseph D. Moore                                                                                                                                          |
|                                                                                                                                                     |   |                                                                                                     |   |              |
|                                                                                                                                                     |   |                                                                                                     |   |              |
| /s/ Ronald P.Soltman                                                                                        |   | Executive Vice President,General Counsel & Secretary; Director                                       |   | September 19,2002 |
| Ronald P.Soltman                                                                                                                                         |
|                                                                                                                                                     |   |                                                                                                     |   |              |
|                                                                                                                                                     |   |                                                                                                     |   |              |
| /s/ Phillip W.Roe                                                        |   | Senior Vice President,Controller & Chief Accounting Officer (Principal Accounting Officer)           |   | September 19,2002 |
| Phillip W. Roe                                                                                                                                           |
|                                                                                                                                                     |
|                                                                                                                                                     |   |                                                                                                     |   |              |
|                                                                                                                                                     |   |                                                                                                     |   |              |
| /s/ Keith B.Pitts                                              |   | Vice Chairman;Director                                                                                   |   | September 19,2002 |
| Keith B. Pitts                                                                                                                                           |
|                                                                                                                                                     |   |                                                                                                     |   |              |
|                                                                                                                                                     |   |                                                                                                     |   |              |
| /s/ Karen H.Bechtel                                                                               |   | Director                                                                                                 |   | September 19,2002 |
| Karen H.Bechtel                                                                                                                                          |
|                                                                                                                                                     |   |                                                                                                     |   |              |
|                                                                                                                                                     |   |                                                                                                     |   |              |
| /s/ Eric T.Fry                        |   | Director                                                                                                 |   | September 19,2002 |
| Eric T. Fry                                                                                                                                              |
|                                                                                                                                                     |   |                                                                                                     |   |              |
|                                                                                                                                                     |   |                                                                                                     |   |              |
| /s/ Howard I.Hoffen                                                                               |   | Director                                                                                                 |   | September 19,2002 |
| Howard I.Hoffen                                                                                                                                          |

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**CERTIFICATIONS**

               I, Charles N. Martin, Jr., Chairman & Chief Executive Officerof  Vanguard Health Systems, Inc., certify that:

| 1.     |     | I have reviewed thisannual report on Form 10-K of Vanguard Health Systems,Inc.;                                                                                                                                                                                                                                         |
|--------|--------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |               |                                                                                                                                                                                                                                                                                                                    |
| 2.     |     | Based on my knowledge,this annual report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to makethe statements made, in light of the circumstances under which suchstatements were made, not misleading with respect to the periodcovered by this annual report; and |
|   |               |                                                                                                                                                                                                                                                                                                                    |
| 3.     |     | Based on my knowledge, thefinancial statements, and other financial information included inthis annual report, fairly present in all material respects thefinancial condition,  results of operations and cash flows ofthe registrant as of, and for, the periods presented in this annualreport.                  |

Date:   September 19,2002

                                                                                               /s/ Charles N. Martin,Jr.                                                                                                                   Charles N. Martin, Jr.                                                                                               Chairman & Chief Executive Officer

               I, Joseph D. Moore, Executive Vice President, Chief FinancialOfficer & Treasurer of Vanguard Health Systems, Inc., certifythat:

| 1.     |    | I have reviewed thisannual report on Form 10-K of Vanguard Health Systems,Inc.;                                                                                                                                                                                                                                         |
|--------|--------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |    |                                                                                                                                                                                                                                                                                                                    |
| 2.     |    | Based on my knowledge,this annual report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to makethe statements made, in light of the circumstances under which suchstatements were made, not misleading with respect to the periodcovered by this annual report; and |
|   |         |                                                                                                                                                                                                                                                                                                                    |
| 3.     |    | Based on my knowledge, thefinancial statements, and other financial information included inthis annual report, fairly present in all material respects thefinancial condition,  results of operations and cash flows ofthe registrant as of, and for, the periods presented in this annualreport.                  |

Date:   September 19,2002

                                                                                               /s/ Joseph D.Moore                                                                                                                          Joseph D. Moore                                                                                               Executive Vice President, Chief Financial                                                                                               Officer & Treasurer

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**SupplementalInformation to be Furnished with Reports Filed Pursuant to Section15(d) of the Act by Registrants Which Have Not RegisteredSecurities Pursuant to Section 12 of the Act**

                       No annual report or proxy material has been sent to securityholders.

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**INDEX TOFINANCIAL STATEMENTS**

****

**VanguardHealth Systems, Inc.Consolidated Financial Statements**

|                                                      | ** ** | **Page** |
|------------------------------------------------------|------------|----------|
|                                                      |       |          |
| Report of IndependentAuditors                        |            | F-2      |
| Consolidated BalanceSheets                           |            | F-3      |
| Consolidated Statements ofOperations                 |            | F-4      |
| Consolidated Statements ofStockholders’ Equity |            | F-5      |
| Consolidated Statements ofCash Flows                 |            | F-6      |
| Notes to ConsolidatedFinancial Statements            |            | F-8      |

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**Reportof Independent Auditors**

Board ofDirectors

Vanguard Health Systems,Inc.

We have audited theaccompanying consolidated balance sheets of Vanguard HealthSystems, Inc. (the “Company”) as of June 30, 2002and 2001, and the related consolidated statements of operations,stockholders’ equity, and cash flows for each of the threeyears in the period ended June 30, 2002. These financial statementsare the responsibility of the Company’s management.  Ourresponsibility is to express an opinion on these financialstatements based on our audits.

We conducted our audits inaccordance with auditing standards generally accepted in the UnitedStates. Those standards require that we plan and perform the auditsto obtain reasonable assurance about whether the financialstatements are free of material misstatement.   An auditincludes examining, on a test basis, evidence supporting theamounts and disclosures in the financial statements.  An auditalso includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating theoverall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

In our opinion, theconsolidated financial statements referred to above present fairly,in all material respects, the consolidated financial position ofVanguard Health Systems, Inc. at June 30, 2001 and 2002, and theconsolidated results of its operations and its cash flows for eachof the three years in the period ended June 30, 2002, in conformitywith accounting principles generally accepted in the UnitedStates.

As discussed in Note 1 tothe consolidated financial statements, effective July 1, 2001, theCompany changed its method of accounting for goodwill and otherintangible assets to conform with the provisions of Statement ofFinancial Accounting Standards No. 142, “Goodwill and OtherIntangible Assets.”

As discussed in Note 1 tothe consolidated financial statements, the Company adoptedStatement of Financial Accounting Standards No. 145,“Rescission of FASB Statements No. 4, 44, and 64, Amendmentof FASB Statement No. 13, and Technical Corrections,”effective April 1, 2002 resulting in a reclassification of debtextinguishment costs from an extraordinary loss to a component ofincome from continuing operations.

As discussed in Note 1 tothe consolidated financial statements, effective July 1, 2000, theCompany changed its method of accounting for derivative instrumentsto conform to the provisions of Statement of Financial AccountingStandards No. 133, “Accounting for Derivative Instruments andHedging Activities.”

                                                                                                               ERNST & YOUNG LLP

Nashville, TennesseeAugust 16, 2002

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**Table of Contents**

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**VANGUARDHEALTH SYSTEMS, INC.CONSOLIDATED BALANCE SHEETS**

|                                                                                                                                                                                                                                                                                                                                                      |  | **June30, 2001**                     |    |   |   | **June30, 2002** |         |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--|--------------------------------------|---------|--------|--------|------------------|---------|--------|
|                                                                                                                                                                                                                                                                                                                                                      |  |                                      |    |   |
| **ASSETS**                                                                                                                                                                                                                                                                                                                                                |  | *(Inthousands except share amounts)* |    |   |
|                                                                                                                                                                                                                                                                                                                                                           |  | **                                   |         |   |
| Current assets:                                                                                                                                                                                                                                                                                                                                           |  |                                      |         |        |        |                  |         |        |
|    Cash andcash equivalents                                                                                                                                                                                                                                                                                                                |  | $                                    | 12,079  |        |        | $                | 55,408  |   |
|    Accountsreceivable, net of allowance for uncollectible accounts of       approximately $30,704 and$23,173 at June 30, 2001 and       June 30, 2002,respectively                                                                                                             |  |                                      | 128,901 |        |        |                  | 169,363 |        |
|    Supplies                                                                                                                                                                                                                                                                                                                                |  |                                      | 11,363  |        |        |                  | 15,481  |        |
|    Incometax receivable                                                                                                                                                                                                                                                                                                                    |  |                                      | — |        |        |                  | 895     |        |
|    Prepaidexpenses and other current assets                                                                                                                                                                                                                                                                                                |  |                                      | 14,080  |        |        |                  | 27,607  |        |
|    Deferredincome taxes                                                                                                                                                                                                                                                                                                                    |  |                                      | 2,438   |        |        |                  | 1,890   |        |
|                                                                                                                                                                                                                                                                                                                                                      |  |                                      |         |        |        |                  |         |        |
|         Totalcurrent assets                                                                                                                                                                                                                                                                                       |  |                                      | 168,861 |        |        |                  | 270,644 |        |
| Property, plant andequipment, net of accumulated depreciation                                                                                                                                                                                                                                                                                             |  |                                      | 362,964 |        |        |                  | 454,837 |        |
| Goodwill                                                                                                                                                                                                                                                                                                                                                  |  |                                      | 74,233  |        |        |                  | 79,078  |        |
| Intangible assets, net ofaccumulated amortization                                                                                                                                                                                                                                                                                                         |  |                                      | 28,381  |        |        |                  | 38,304  |        |
| Other assets                                                                                                                                                                                                                                                                                                                                              |  |                                      | 5,959   |        |        |                  | 9,081   |        |
|                                                                                                                                                                                                                                                                                                                                                      |  |                                      |         |        |        |                  |         |        |
|         Totalassets                                                                                                                                                                                                                                                                                               |  | $                                    | 640,398 |        |        | $                | 851,944 |        |
|                                                                                                                                                                                                                                                                                                                                                      |  |                                      |         |        |        |                  |         |        |
| **LIABILITIES AND STOCKHOLDERS’EQUITY**                                                                                                                                                                                                                                                                                                             |  |                                      |         |        |        |                  |         |        |
| Currentliabilities:                                                                                                                                                                                                                                                                                                                                       |  |                                      |         |        |        |                  |         |        |
|    Accountspayable                                                                                                                                                                                                                                                                                                                         |  | $                                    | 41,703  |        |        | $                | 49,676  |        |
|    Accruedinterest                                                                                                                                                                                                                                                                                                                         |  |                                      | 5,480   |        |        |                  | 14,365  |        |
|    Incometax payable                                                                                                                                                                                                                                                                                                                       |  |                                      | 788     |        |        |                  | — |        |
|    Otheraccrued expenses and current liabilities                                                                                                                                                                                                                                                                                           |  |                                      | 95,235  |        |        |                  | 114,940 |        |
|    Currentmaturities of long-term debt                                                                                                                                                                                                                                                                                                     |  |                                      | 10,332  |        |        |                  | 3,762   |        |
|                                                                                                                                                                                                                                                                                                                                                      |  |                                      |         |        |        |                  |         |        |
|         Totalcurrent liabilities                                                                                                                                                                                                                                                                                  |  |                                      | 153,538 |        |        |                  | 182,743 |        |
| Otherliabilities                                                                                                                                                                                                                                                                                                                                          |  |                                      | 6,481   |        |        |                  | 22,461  |   |
| Long-term debt, lesscurrent maturities                                                                                                                                                                                                                                                                                                                    |  |                                      | 153,112 |        |        |                  | 311,018 |   |
| Payable-In-Kind PreferredStock; $.01 par value, 150,000 combined shares of     Preferred Stock and Payable-In-Kind PreferredStock authorized, 21,600 and 23,328     shares of Payable-In-Kind Preferred Stockissued and outstanding at     June 30, 2001 and June 30, 2002, respectively,at redemption value |  |                                      | 22,320  |        |        |                  | 24,106  |        |
| Stockholders’Equity:                                                                                                                                                                                                                                                                                                                                |  |                                      |         |        |        |                  |         |        |
| Preferred Stock; $1,000par value, 150,000 combined shares of Preferred Stock     and Payable-In-Kind Preferred Stock authorized,no shares of Preferred     Stock issued and outstanding                                                                                                                                     |  |                                      | — |        |        |                  | — |        |
| Common Stock; $.01 parvalue, 600,000 shares authorized, 203,294 and     203,308 shares issued and outstanding at June30, 2001 and     June 30, 2002, respectively                                                                                                                                                           |  |                                      | 2       |        |        |                  | 2       |        |
| Additional paid-incapital                                                                                                                                                                                                                                                                                                                                 |  |                                      | 307,131 |        |        |                  | 305,369 |        |
| Accumulated othercomprehensive loss                                                                                                                                                                                                                                                                                                                       |  |                                      | (1,654  | )      |        |                  | — |        |
| Retained (deficit)earnings                                                                                                                                                                                                                                                                                                                                |  |                                      | (532    | )      |        |                  | 6,245   |        |
|                                                                                                                                                                                                                                                                                                                                                      |  |                                      |         |        |        |                  |         |        |
|         Totalliabilities and stockholders’ equity                                                                                                                                                                                                                                                           |  | $                                    | 640,398 |        |        | $                | 851,944 |        |
|                                                                                                                                                                                                                                                                                                                                                      |  |                                      |         |        |        |                  |         |        |

Seeaccompanying notes.

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**Table of Contents**

**VANGUARDHEALTH SYSTEMS, INC.CONSOLIDATED STATEMENTS OF OPERATIONS**

|   |                                                      |            | **For theyear ended June 30,** |            |
|--------|------------------------------------------------------|------------|--------------------------------|-----------------|
|        |                                                      |            |                           |
|        |                                                      | ** ** | **2000**                       | ** **      | **2001** | ** ** | **2002** |   |
|   |                                                      |            |                                |
|   |                                                      |            |                                | *(Inthousands)* |  |
|   | Patient servicerevenues                              |       | $                              | 288,886         |  |   | $ | 612,700 |  |   | $ | 725,769 |  |
|   | Premiumrevenues                                      |       |                                | 15,808          |  |  |  | 55,063 |  |  |  | 184,801 |  |
|   |                                                      |       |                                |                 |  |  |  |  |  |  |  |  |  |
|   |       Totalrevenues    |       |                                | 304,694         |  |  |  | 667,763 |  |  |  | 910,570 |  |
|   |                                                 |       |                                |                 |  |  |  |  |  |  |  |  |  |
|   | Costs andexpenses:                                   |       |                                |                 |  |  |  |  |  |  |  |  |  |
|   |    Salariesand benefits               |       |                                | 146,467         |  |  |  | 323,617 |  |  |  | 384,436 |  |
|   |    Supplies                           |       |                                | 40,498          |  |  |  | 92,952 |  |  |  | 116,125 |  |
|   |    Medicalclaims expense              |       |                                | 7,356           |  |  |  | 30,784 |  |  |  | 132,005 |  |
|   |    Purchased services                 |       |                                | 27,655          |  |  |  | 48,577 |  |  |  | 66,374 |  |
|   |    Provision for doubtfulaccounts     |       |                                | 33,138          |  |  |  | 56,846 |  |  |  | 53,253 |  |
|   |    Insurance                          |            |                                | 5,781           |  |  |  | 8,197 |  |  |  | 19,692 |  |
|   |    Otheroperating expenses            |       |                                | 16,446          |  |  |  | 43,160 |  |  |  | 53,080 |  |
|   |    Rentsand leases                    |       |                                | 6,836           |  |  |  | 12,233 |  |  |  | 14,397 |  |
|   |    Depreciation andamortization       |       |                                | 11,793          |  |  |  | 23,799 |  |  |  | 29,509 |  |
|   |    Interest, net                      |       |                                | 8,831           |  |  |  | 16,558 |  |  |  | 26,686 |  |
|   |    Debtextinguishment costs           |            |                                | 1,149           |  |  |  | — |  |  |  | 6,627 |  |
|   |    Other                              |       |                                | 74              |  |  |  | 369 |  |  |  | (1,268 | ) |
|   |                                                 |       |                                |                 |  |  |  |  |  |  |  |  |  |
|   | Income (loss) beforeincome taxes                     |       |                                | (1,330          | ) |  |  | 10,671 |  |  |  | 9,654 |  |
|   | Income taxexpense                                    |       |                                | 119             |  |  |  | 511 |  |  |  | 2,877 |  |
|   |                                                 |       |                                |                 |  |  |  |  |  |  |  |  |  |
|   | Net income(loss)                                     |       |                                | (1,449          | ) |  |  | 10,160 |  |  |  | 6,777 |  |
|   | Preferred stockdividends                             |       |                                | (663            | ) |  |  | (1,657 | ) |  |  | (1,786 | ) |
|   |                                                 |       |                                |                 |  |  |  |  |  |  |  |  |  |
|   | Net income (loss)attributable to common stockholders |       | $                              | (2,112          | ) |  | $ | 8,503 |  |  | $ | 4,991 |  |
|   |                                                 |       |                                |                 |  |  |  |  |  |  |  |  |  |

Seeaccompanying notes.

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**Table of Contents**

**VANGUARDHEALTH SYSTEMS, INC.CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**

|                                                                                                                                                                                                                                                                         |       | **Preferred Stock** | ** ** | **CommonStock** | ** ** | **Additional Paid-in Capital** | ** ** | **Retained Earnings (Deficit)** | ** ** | **Accumulated Other Comprehensive Loss** | ** ** | **Total Stockholders’ Equity** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|-----------------|------------|--------------------------------|------------|---------------------------------|------------|------------------------------------------|------------|--------------------------------------|
|                                                                                                                                                                                                                                                                              |            |
| **Shares**                                                                                                                                                                                                                                                                   | ** ** | **Amount**          | **Shares** | ** **      | **Amount** |
|                                                                                                                                                                                                                                                                         |       | ****                | ** ** | ****            |
| Balance at June 30,1999                                                                                                                                                                                                                                                      |       |                | ―    |            |       | $                              | ―    |                            |       |                                     | 44,800     |                                 |   | $ | ― |   |   | $ | 39,826 |   |   | $ | (9,243 | ) |   | $ | ― |   |   | $ | 30,583 |   |   |
|       Issuance of commonstock                                                                                                                                                                                                                       |       |                | ―    |            |       |                           | ―    |                            |       |                                     | 139,154    |                                 |   |   | 2 |   |   |   | 236,724 |   |   |   | ― |   |   |   | ― |   |   |   | 236,726 |   |   |
|       Payable-In-KindPreferred          Stockdividends                                                                                                                                                      |       |                | ―    |            |       |                           | ―    |                            |       |                                     | ―    |                                 |   |   | ― |   |   |   | (663 | ) |   |   | ― |   |   |   | ― |   |   |   | (663 | ) |   |
|       Netloss                                                                                                                                                                                                                                       |       |                | ―    |            |       |                           | ―    |                            |       |                                     | ―    |                                 |   |   | ― |   |   |   | ― |   |   |   | (1,449 | ) |   |   | ― |   |   |   | (1,449 | ) |   |
|                                                                                                                                                                                                                                                                         |       |                |            |            |       |                           |            |                            |       |                                     |            |                                 |   |   |  |   |   |   |  |   |   |   |  |   |   |   |  |   |   |   |  |   |   |
| Balance at June 30,2000                                                                                                                                                                                                                                                      |       |                | ―    |            |       |                           | ―    |                            |       |                                     | 183,954    |                                 |   |   | 2 |   |   |   | 275,887 |   |   |   | (10,692 | ) |   |   | ― |   |   |   | 265,197 |   |   |
|       Issuance of commonstock                                                                                                                                                                                                                       |       |                | ―    |            |       |                           | ―    |                            |       |                                     | 19,340     |                                 |   |   | ― |   |   |   | 32,901 |   |   |   | ― |   |   |   | ― |   |   |   | 32,901 |   |   |
|       Payable-In-KindPreferred          Stockdividends                                                                                                                                                      |       |                | ―    |            |       |                           | ―    |                            |       |                                     | ―    |                                 |   |   | ― |   |   |   | (1,657 | ) |   |   | ― |   |   |   | ― |   |   |   | (1,657 | ) |   |
|       Comprehensiveincome:                                                                                                                                                                                                                          |       |                |       |            |       |                           |       |                            |       |                                     |       |                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|         Cumulative effect of change in            accounting principle - fair value of            interest rate collar |       |                | ―    |            |       |                           | ―    |                            |       |                                     | ―    |                                 |   |   | ― |   |   |   | ― |   |   |   | ― |   |   |   | (164 | ) |   |   | (164 | ) |   |
|         Net change in fair value of interest            rate collar                                                                                                           |       |                | ―    |            |       |                           | ―    |                            |       |                                     | ―    |                                 |   |   | ― |   |   |   | ― |   |   |   | ― |   |   |   | (1,590 | ) |   |   | (1,590 | ) |   |
|         Amortization of transition adjustment                                                                                                                                                                                        |       |                | ―    |            |       |                           | ―    |                            |       |                                     | ―    |                                 |   |   | ― |   |   |   | ― |   |   |   | ― |   |   |   | 100 |   |   |   | 100 |   |   |
|         Net income                                                                                                                                                                                                                   |       |                | ―    |            |       |                           | ―    |                            |       |                                     | ―    |                                 |   |   | ― |   |   |   | ― |   |   |   | 10,160 |   |   |   | ― |   |   |   | 10,160 |   |   |
|                                                                                                                                                                                                                                                                         |       |                |            |            |       |                           |            |                            |       |                                     |            |                                 |   |   |  |   |   |   |  |   |   |   |  |   |   |   |  |   |   |   |  |   |   |
|       Comprehensiveincome                                                                                                                                                                                                                           |       |                | ―    |            |       |                           | ―    |                            |       |                                     | ―    |                                 |   |   | ― |   |   |   | ― |   |   |   | 10,160 |   |   |   | (1,654 | ) |   |   | 8,506 |   |   |
|                                                                                                                                                                                                                                                                         |       |                |            |            |       |                           |            |                            |       |                                     |            |                                 |   |   |  |   |   |   |  |   |   |   |  |   |   |   |  |   |   |   |  |   |   |
| Balance at June 30,2001                                                                                                                                                                                                                                                      |       |                | ―    |            |       |                           | ―    |                            |       |                                     | 203,294    |                                 |   |   | 2 |   |   |   | 307,131 |   |   |   | (532 | ) |   |   | (1,654 | ) |   |   | 304,947 |   |   |
|       Issuance of commonstock                                                                                                                                                                                                                       |       |                | ―    |            |       |                           | ―    |                            |       |                                     | 14         |                                 |   |   | ― |   |   |   | 24 |   |   |   | ― |   |   |   | ― |   |   |   | 24 |   |   |
|       Payable-In-KindPreferred          Stockdividends                                                                                                                                                      |       |                | ―    |            |       |                           | ―    |                            |       |                                     | ―    |                                 |   |   | ― |   |   |   | (1,786 | ) |   |   | ― |   |   |   | ― |   |   |   | (1,786 | ) |   |
|       Comprehensiveincome:                                                                                                                                                                                                                          |       |                |       |            |       |                           |       |                            |       |                                     |       |                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|         Termination of interest rate collar                                                                                                                                                                                          |       |                | ―    |            |       |                           | ―    |                            |       |                                     | ―    |                                 |   |   | ― |   |   |   | ― |   |   |   | ― |   |   |   | 1,654 |   |   |   | 1,654 |   |   |
|         Net Income                                                                                                                                                                                                                   |       |                | ―    |            |       |                           | ―    |                            |       |                                     | ―    |                                 |   |   | ― |   |   |   | ― |   |   |   | 6,777 |   |   |   | ― |   |   |   | 6,777 |   |   |
|                                                                                                                                                                                                                                                                         |       |                |            |            |       |                           |            |                            |       |                                     |            |                                 |   |   |  |   |   |   |  |   |   |   |  |   |   |   |  |   |   |   |  |   |   |
|       Comprehensiveincome                                                                                                                                                                                                                           |       |                | ―    |            |       |                           | ―    |                            |       |                                     | ―    |                                 |   |   | ― |   |   |   | ― |   |   |   | 6,777 |   |   |   | 1,654 |   |   |   | 8,431 |   |   |
|                                                                                                                                                                                                                                                                         |       |                |            |            |       |                           |            |                            |       |                                     |            |                                 |   |   |  |   |   |   |  |   |   |   |  |   |   |   |  |   |   |   |  |   |   |
| Balance at June 30,2002                                                                                                                                                                                                                                                      |       |                | ―    |            |       | $                              | ―    |                            |       |                                     | 203,308    |                                      |  | $ | 2 |  |  | $ | 305,369 |  |  | $ | 6,245 |  |  | $ | ― |  |  | $ | 311,616 |  |   |
|                                                                                                                                                                                                                                                                              |            |                     |            |                 |            |                                |            |                                 |            |                                          |            |                                      |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |   |

****

Seeaccompanying notes.

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**Table of Contents**

**VANGUARDHEALTH SYSTEMS, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS**

|        |                                                                                                                                                                                         | **For theyear ended June 30,** |     |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------------------------|----------|
|        |                                                                                                                                                                                         |                                |     |
|        |                                                                                                                                                                                         | ** **                     | **2000** | ** ** | **2001** | ** ** | **2002** |   |
|   |                                                                                                                                                                                         |                                |          |
|   | **Operatingactivities:**                                                                                                                                                                |                                |          | *(Inthousands)* |  |
|   | Net income(loss)                                                                                                                                                                        |                           | $        | (1,449 | ) |   | $ | 10,160 |  |   | $ | 6,777 |  |
|   | Adjustments to reconcilenet income (loss) to net    cash provided by operating activities                                                                                |                           |          |  |  |  |  |  |  |  |  |  |  |
|   |       Depreciationand amortization                                                                                                                        |                           |          | 11,793 |  |  |  | 23,799 |  |  |  | 29,509 |  |
|   |       Provision fordoubtful accounts                                                                                                                      |                           |          | 33,138 |  |  |  | 56,846 |  |  |  | 53,253 |  |
|   |       Amortizationof loan costs                                                                                                                           |                           |          | 444 |  |  |  | 863 |  |  |  | 1,350 |  |
|   |       Debtextinguishment costs                                                                                                                            |                           |          | 1,149 |  |  |  | — |  |  |  | 6,627 |  |
|   |       Loss (gain)on disposal of assets                                                                                                                    |                           |          | — |  |  |  | 584 |  |  |  | (815 | ) |
|   |       Deferredincome taxes                                                                                                                                |                           |          | (1,009 | ) |  |  | (909 | ) |  |  | 2,846 |  |
|   |       Interest oninterest rate collar agreement                                                                                                           |                           |          | — |  |  |  | 114 |  |  |  | — |  |
|   |       Changes inoperating assets and liabilities,                                                                                                         |                           |          |  |  |  |  |  |  |  |  |  |  |
|   |          netof effects of acquisitions:                                                                                                    |                           |          |  |  |  |  |  |  |  |  |  |  |
|   |          Accountsreceivable                                                                                                                |                           |          | (51,946 | ) |  |  | (68,555 | ) |  |  | (64,890 | ) |
|   |          Establishmentof accounts receivable of             recentacquisitions |                           |          | (3,653 | ) |  |  | (7,236 | ) |  |  | (1,522 | ) |
|   |          Supplies                                                                                                                          |                                |          | (86 | ) |  |  | (474 | ) |  |  | (692 | ) |
|   |          Prepaidexpenses and other current assets                                                                                          |                                |          | (3,917 | ) |  |  | 1,259 |  |  |  | (9,797 | ) |
|   |          Incometax receivable                                                                                                              |                                |          | 570 |  |  |  | — |  |  |  | (857 | ) |
|   |          Accountspayable                                                                                                                   |                                |          | 15,990 |  |  |  | 8,528 |  |  |  | (2,499 | ) |
|   |          Incometax payable                                                                                                                 |                                |          | 498 |  |  |  | 290 |  |  |  | (788 | ) |
|   |          Accruedexpenses and other long-term liabilities                                                                                   |                           |          | 22,997 |  |  |  | (18,607 | ) |  |  | 26,184 |  |
|   |                                                                                                                                                                                         |                           |          |  |  |  |  |  |  |  |  |  |  |
|   | Net cash provided byoperating activities                                                                                                                                                |                           |          | 24,519 |  |  |  | 6,662 |  |  |  | 44,686 |  |
|   |                                                                                                                                                                                         |                                |          |  |  |  |  |  |  |  |  |  |  |
|   | **Investingactivities:**                                                                                                                                                                |                           |          |  |  |  |  |  |  |  |  |  |  |
|   | Acquisitions                                                                                                                                                                            |                           |          | (325,484 | ) |  |  | (10,640 | ) |  |  | (100,281 | ) |
|   | Capitalexpenditures                                                                                                                                                                     |                           |          | (14,289 | ) |  |  | (26,566 | ) |  |  | (35,072 | ) |
|   | Proceeds from assetsales                                                                                                                                                                |                                |          | — |  |  |  | — |  |  |  | 1,206 |  |
|   | Other                                                                                                                                                                                   |                           |          | 3,867 |  |  |  | (872 | ) |  |  | (1,245 | ) |
|   |                                                                                                                                                                                         |                           |          |  |  |  |  |  |  |  |  |  |  |
|   | Net cash used in investingactivities                                                                                                                                                    |                                |          | (335,906 | ) |  |  | (38,078 | ) |  |  | (135,392 | ) |
|   |                                                                                                                                                                                         |                                |          |  |  |  |  |  |  |  |  |  |  |
|   | **Financingactivities:**                                                                                                                                                                |                                |          |  |  |  |  |  |  |  |  |  |  |
|   | Proceeds from issuance ofcommon stock                                                                                                                                                   |                                |          | 236,726 |  |  |  | 32,901 |  |  |  | — |  |
|   | Equity contribution fromjoint venture partner                                                                                                                                           |                                |          | — |  |  |  | — |  |  |  | 2,488 |  |
|   | Proceeds from long-termdebt                                                                                                                                                             |                                |          | 165,500 |  |  |  | — |  |  |  | 300,000 |  |
|   | Payments of long-termdebt                                                                                                                                                               |                                |          | (69,835 | ) |  |  | (5,859 | ) |  |  | (153,836 | ) |
|   | Payment of loancosts                                                                                                                                                                    |                                |          | (4,546 | ) |  |  | (359 | ) |  |  | (14,641 | ) |
|   | Proceeds from the exerciseof stock options                                                                                                                                              |                                |          | — |  |  |  | — |  |  |  | 24 |  |
|   |                                                                                                                                                                                         |                                |          |  |  |  |  |  |  |  |  |  |  |
|   | Net cash provided byfinancing activities                                                                                                                                                |                                |          | 327,845 |  |  |  | 26,683 |  |  |  | 134,035 |  |
|   |                                                                                                                                                                                         |                                |          |  |  |  |  |  |  |  |  |  |  |
|   | Increase (decrease) incash and cash equivalents                                                                                                                                         |                                |          | 16,458 |  |  |  | (4,733 | ) |  |  | 43,329 |  |
|   | Cash and cash equivalentsat beginning of year                                                                                                                                           |                           |          | 354 |  |  |  | 16,812 |  |  |  | 12,079 |  |
|   |                                                                                                                                                                                         |                                |          |  |  |  |  |  |  |  |  |  |  |
|   | Cash and cash equivalentsat end of year                                                                                                                                                 |                                | $        | 16,812 |  |  | $ | 12,079 |  |  | $ | 55,408 |  |
|   |                                                                                                                                                                                         |                                |          |  |  |  |  |  |  |  |  |  |  |

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**Table of Contents**

**VANGUARDHEALTH SYSTEMS, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(CONTINUED)**

|                                                                                                                                                        |  |   | **For theyear ended June 30,** |  |
|--------------------------------------------------------------------------------------------------------------------------------------------------------|--|---|--------------------------------|--|
|                                                                                                                                                        |  |   |                                |  |
|                                                                                                                                                        |  |   | **2000**                       |  |  |  | **2001** |  |  |  | **2002** |  |
|                                                                                                                                                        |  |   |                                |  |
|                                                                                                                                                        |  |   | *(Inthousands)*                |  |
| **Supplemental cash flowinformation:**                                                                                                                 |  |   |                                |  |  |  |  |  |  |  |  |  |
|      Net interestpaid                                                                                                         |  | $ | 7,414                          |  |  | $ | 13,681 |  |  | $ | 17,801 |  |
|                                                                                                                                                        |  |   |                                |  |  |  |  |  |  |  |  |  |
|      Net income taxespaid                                                                                                     |  | $ | 60                             |  |  | $ | 212 |  |  | $ | 43 |  |
|                                                                                                                                                        |  |   |                                |  |  |  |  |  |  |  |  |  |
| **Supplemental noncashactivities:**                                                                                                                    |  |   |                                |  |  |  |  |  |  |  |  |  |
|      Payable-In-KindPreferred Stock dividends                                                                                 |  | $ | 663                            |  |  | $ | 1,657 |  |  | $ | 1,786 |  |
|                                                                                                                                                        |  |   |                                |  |  |  |  |  |  |  |  |  |
| **Acquisitions:**                                                                                                                                      |  |   |                                |  |  |  |  |  |  |  |  |  |
|      Cash paid, net ofcash received                                                                                           |  | $ | 325,484                        |  |  | $ | 10,640 |  |  | $ | 100,281 |  |
|      Payable-In-KindPreferred Stock issued                                                                                    |  |   | 20,000                         |  |  |  | — |  |  |  | — |  |
|                                                                                                                                                        |  |   |                                |  |  |  |  |  |  |  |  |  |
|           Totalconsideration                                                                         |  |   | 345,484                        |  |  |  | 10,640 |  |  |  | 100,281 |  |
|                                                                                                                                                        |  |   |                                |  |  |  |  |  |  |  |  |  |
|      Fair value ofassets acquired                                                                                             |  |   | 363,497                        |  |  |  | 38,465 |  |  |  | 115,415 |  |
|      Liabilitiesassumed                                                                                                       |  |   | 61,364                         |  |  |  | 59,018 |  |  |  | 23,253 |  |
|                                                                                                                                                        |  |   |                                |  |  |  |  |  |  |  |  |  |
|      Net assetsacquired                                                                                                       |  |   | 302,133                        |  |  |  | (20,553 | ) |  |  | 92,162 |  |
|                                                                                                                                                        |  |   |                                |  |  |  |  |  |  |  |  |  |
|      Goodwill andintangible assets acquired                                                                                   |  | $ | 43,351                         |  |  | $ | 31,193 |  |  | $ | 8,119 |  |
|                                                                                                                                                        |  |   |                                |  |  |  |  |  |  |  |  |  |
|                                                                                                                                                        |  |   |                                |  |  |  |  |  |  |  |  |  |
| Liabilities assumed aspart of the fiscal 2000, 2001 and 2002 acquisitions include capitallease obligations of $1,434, $13,657 and $2,049,respectively. |

Seeaccompanying notes.

F-7

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**Table of Contents**

**VANGUARDHEALTH SYSTEMS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**June 30,2002**

**1.            Basis of Presentation and Summary of Significant AccountingPolicies**

****

***Organization***

******

               Vanguard Health Systems, Inc. (“the Company”), aDelaware corporation, was incorporated on July 1, 1997.  As ofJune 30, 2002, the Company owned and managed ten acute carehospitals with 2,207 licensed beds and related outpatient servicelocations complementary to the hospitals providing health careservices to the metropolitan Los Angeles/Orange County, California;Chicago, Illinois; and Phoenix, Arizona markets.  The Companyalso owns managed health plans in Chicago, Illinois and Phoenix,Arizona.

***Basis ofPresentation***

******

               The accompanying consolidated financial statements include theaccounts of the Company and its wholly-owned and majority-ownedsubsidiaries.  All material intercompany accounts andtransactions have been eliminated.  As none of theCompany’s common shares are publicly held, no earnings pershare information is presented in the accompanying consolidatedfinancial statements.

***Adoption ofAccounting Pronouncements***

******

               During the 4th quarter of the fiscal year ended June 30,2002, the Company adopted the provisions of Statement of FinancialAccounting Standards No. 145, *Rescission of FASB Statements No.4, 44, and 64, Amendment of FASB Statement No. 13, and TechnicalCorrections* (“SFAS 145”).  The FASB issuedSFAS 145 during April 2002.   SFAS 145 prohibits theclassification of gains or losses from debt extinguishments asextraordinary items unless the criteria outlined in APB Opinion No.30, *Reporting the Results of Operations – Reporting theEffects of Disposal of a Segment of a Business, and Extraordinary,Unusual and Infrequently Occurring Events and Transactions*, aremet.  SFAS 145 also eliminates an inconsistency between therequired accounting for sale-leaseback transactions and therequired accounting for certain lease modifications that haveeconomic effects that are similar to sale-leasebacktransactions.  The Company’s audited consolidatedfinancial statements for the fiscal year ended June 30, 2000 havebeen reclassified to reflect debt extinguishment costs as acomponent of income before income taxes.  The effects of thereclassification is as follows:

|                                                             |   | **Priorto Adoption** |   | **Subsequent to Adoption** |
|------------------------------------------------------------------|--------|----------------------|--------|----------------------------|
|                                                             |   |                      |
|                                                             |   | (inthousands)        |
| For the year ended June30, 2000:                                 |   |                 |   |                            |   |   |   |   |
| Consolidated Statement ofOperations                              |   |                 |   |                       |   |   |   |   |
|    Lossbefore income taxes and extraordinary item |   | $                    | (181   | )                          |   | $ | (1,330 | ) |
|    Lossbefore extraordinary item                  |   | $                    | (300   | )                          |   | $ | (1,449 | ) |
|    Extraordinary loss onextinguishment of debt    |   | $                    | (1,149 | )                          |   | $ | — |   |

***Recently IssuedAccounting Pronouncements***

******

               In July 2002, the Financial Accounting Standards Board(“FASB”) issued SFAS No. 146, *Accounting for CostsAssociated with Exit or Disposal Activities*, which supersedesthe provisions of EITF No. 94-3, *Liability Recognition forCertain Employee Termination Benefits and Other Costs to Exit anActivity*.  SFAS 146 requires companies to establishliabilities for costs to exit an activity when the costs areincurred as opposed to the date when the companies commit to theexit plan.  Exit costs covered by SFAS 146 include but are notlimited to certain employee severance and relocation costs, leasetermination costs and other costs related to restructuring ordiscontinuing operations.  SFAS 146 is effective for exitactivities initiated after December 31, 2002.  The Companydoes not expect SFAS 146 to have a significant impact on its futureresults of operations or cash flows.

F-8

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**Table of Contents**

               In August 2001, the FASB issued SFAS No. 144, *Accounting for theImpairment or Disposal of Long-Lived Assets*, which supersedesSFAS No. 121, *Accounting for the Impairment of Long-Lived Assetsand for Long-Lived Assets to Be Disposed Of*, and the accountingand reporting provisions of APB Opinion No. 30, *Reporting theEffects of Disposal of a Segment of a Business, and Extraordinary,Unusual and Infrequently Occurring Events andTransactions*.  SFAS 144 removes goodwill from its scopeand clarifies other implementation issues related to SFAS121.  SFAS 144 also provides a single framework for evaluatinglong-lived assets to be disposed of by sale.  The Company willadopt the provisions of SFAS 144 effective July 1, 2002. Under the current provisions of SFAS 121, when events,circumstances, and operating results indicate that the carryingvalues of certain long-lived assets might be impaired, the Companywould assess whether the carrying value of the assets will berecovered through undiscounted future cash flows expected to begenerated from the use of the assets and their eventualdisposition.  If the assessment indicated that the recordedcosts would not be recoverable, such cost amounts would be reducedto estimated fair value.  As of June 30, 2002, in the opinionof management, there was no such impairment.

               In July 2001, the FASB issued SFAS No. 141, *BusinessCombinations*, and No. 142, *Goodwill and Other IntangibleAssets*.  SFAS 141 is effective for transactions completedsubsequent to June 30, 2001 and SFAS 142 is effective for yearsbeginning after December 15, 2001.  SFAS 141 requires that allbusiness combinations be accounted for under the purchase method ofaccounting.  Under the provisions of SFAS 142, goodwill is nolonger amortized but is subject to annual impairment tests. Other intangible assets are amortized over their usefullives.  The Company elected to adopt the provisions of SFAS141 and 142 effective July 1, 2001.

***Critical AccountingPolicies***

******

               The consolidated financial statements have been prepared inaccordance with accounting principles generally accepted in theUnited States.  In preparing the consolidated financialstatements, the Company makes estimates and assumptions that affectthe reported amounts of assets, liabilities, revenues and expensesincluded in the financial statements.  Management bases itsestimates on historical experience and other available information,the results of which form the basis of the estimates andassumptions.  The Company considers the following accountingpolicies to be most critical to its operating performance andinvolve the most subjective and complex assumptions andassessments.

*Allowance for DoubtfulAccounts*

**

               The Company’s ability to collect outstanding receivables fromthird party payers is critical to its operating performance andcash flows.  The allowance for doubtful accounts wasapproximately 12.0% of accounts receivable, net of contractualdiscounts, as of June 30, 2002.  The primary collection risklies with uninsured patient accounts or patient accounts for whichprimary insurance has paid but patient deductibles or co-insuranceportions remain outstanding.  The Company estimates theallowance for doubtful accounts primarily based upon the age of theaccounts since patient discharge date.  The Companycontinually monitors its accounts receivable balances and utilizescash collections data to support the basis for its estimates of theprovision for doubtful accounts.  Significant changes in payermix or business office operations may have a significant impact onthe Company’s results of operations and cashflows.

               A summary of activity in the Company’s allowance for doubtfulaccounts follows (in thousands).

|                                       |   | **Balanceat beginning of period**                                  |   | **Additions charged to costs and expenses**                        |   | **Additions (1) charged to other accounts**                                                             |   | **Accounts, written off, net of recoveries** |   | **Balanceat end of period**                      |
|--------------------------------------------|--------|--------------------------------------------------------------------|--------|--------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------|--------|----------------------------------------------|--------|--------------------------------------------------|
| Allowance for doubtfulaccounts:            |        |                                                                    |
|    Yearended June 30, 2000  |   | $          8,567 |   | $        33,138            |   | $      37,505                                                             |   | $    33,992              |   | $      45,218           |
|    Yearended June 30, 2001  |   |           45,218 |   |           56,846 |   |                 ― |   |       71,360   |   |        30,704 |
|    Yearended June 30, 2002  |   |           30,704 |   |           53,253 |   |         17,411                                                  |   |       78,195   |   |        23,173 |
|                                       |   |                                                               |   |                                                               |   |                                                                                                    |   |                                         |   |                                             |
| (1) Allowances as a resultof acquisitions. |   |                                                               |   |                                                               |   |                                                                                                    |   |                                         |   |                                             |

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**Table of Contents**

*               Allowance for Contractual Discounts*

**

               The Company typically receives payments from third party payers,including Medicare and managed care payers, that are less thanbilled charges requiring the estimation of contractual discountallowances.  The Medicare regulations and various managed carecontracts are often complex and may include multiple reimbursementmechanisms for different types of services provided in theCompany’s health care facilities and cost settlementprovisions requiring complex calculations and assumptions subjectto interpretation.  The Company estimates the allowance forcontractual discounts on a payer-specific basis given itsinterpretation of the applicable regulations or contractterms.  The Company has made significant investments in humanresources and information systems to improve the estimationprocess.  However, the services authorized and provided andrelated reimbursement are often subject to interpretation that mayresult in payments that differ from the Company’sestimates.  Additionally, updated regulations and contractrenegotiations occur frequently necessitating management’scontinual review and assessment of the estimationprocess.

*               Insurance Reserves*

**

               Given the nature of the Company’s operating environment, theCompany may become subject to medical malpractice or workerscompensation claims or lawsuits.  Through May 31, 2002, theCompany maintained third-party insurance coverage for individualmalpractice claims exceeding $1.0 million and workers compensationclaims exceeding $250,000 to mitigate a portion of this risk. Effective June 1, 2002, the Company established a wholly ownedcaptive subsidiary to insure its professional and general liabilityrisks at a $10.0 million retention level.  The Companymaintains excess coverage for claims exceeding $10.0 million peroccurrence up to $100.0 million in the aggregate.  The Companyestimates its reserve for self-insured professional and generalliability and workers compensation risks using historical claimsdata, demographic factors, severity factors, current incident logsand other actuarial data.  As of June 30, 2001 and 2002, theCompany’s professional and general liability accrual forasserted and unasserted claims was approximately $4.8 million and$16.3 million, respectively, and is included within accruedexpenses and other current liabilities and other liabilities on theaccompanying consolidated balance sheets.  For the year endedJune 30, 2002, the Company’s total premiums and self-insuredretention cost for professional and general liability insurance wasapproximately $18.3 million, including a $5.7 million adjustmentfor the change in coverage to the captive subsidiary with a $10.0million per claim retention level.  The estimated accrual formalpractice and workers compensation claims could be significantlyaffected should current and future occurrences differ fromhistorical claims trends.  The estimation process is alsocomplicated by the relatively short period of time in which theCompany has owned its health care facilities as occurrence dataunder previous ownership may not necessarily reflect occurrencedata under the Company’s ownership.  While managementmonitors current claims closely and considers outcomes whenestimating its reserve, the complexity of the claims and wide rangeof potential outcomes often hampers timely adjustments to theassumptions used in the estimates.

               *Medical Claims Reserves*

               For the year ended June 30, 2002, medical claims expense wasapproximately $132.0 million, primarily representing medical claimson behalf of enrollees in the Company’s Medicaid managedhealth plan in Phoenix, Arizona.  The Company estimates itsreserve for medical claims incurred but not reported usinghistorical claims experience (including severity and payment lagtime) and other actuarial data including number of enrollees, ageof enrollees and certain enrollee health indicators.  Thereserve for medical claims incurred but not reported for theCompany’s health plans was approximately $25.4 million and$24.4 million as of June 30, 2001 and 2002, respectively, and isincluded in accrued expenses and other current liabilities in theaccompanying consolidated balance sheets.  While managementbelieves that its estimation methodology effectively capturestrends in medical claims costs, actual payments could differsignificantly from its estimates given changes in the health carecost structure or adverse experience.  For the year ended June30, 2002, approximately $26.2 million of health care plan paymentsto hospitals and other health care facilities owned by the Companyfor services provided to enrollees were eliminated inconsolidation.  The Company’s operating results and cashflows could be materially affected by increased or decreasedutilization of its owned health care facilities by enrollees of itshealth plans.

***Cash andEquivalents***

******

               The Company considers all highly liquid investments with maturityof 90 days or less when purchased to be cash equivalents.  TheCompany maintains its cash and cash equivalents balances primarilywith high credit quality financial institutions.  The Companymanages its credit exposure by placing its investments in highquality securities and by

F-10

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**Table of Contents**

periodically evaluatingthe relative credit standing of the financial institution. Approximately $2.1 million of the Company’s cash balance atJune 30, 2002, is restricted for use by the Company’s whollyowned insurance captive subsidiary.

***AccountsReceivable***

******

               The Company’s primary concentration of credit risk is patientaccounts receivable, which consists of amounts owed by variousgovernmental agencies, insurance companies and privatepatients.  The Company manages the receivables by regularlyreviewing its accounts and contracts and by providing appropriateallowances for contractual discounts and uncollectibleamounts.  Medicare programs comprised approximately 14% and16% of net patient receivables for the years ended June 30, 2001and 2002, respectively.  Medicaid programs comprisedapproximately 11% and 13% of net patient receivables for the yearsended June 30, 2001 and 2002, respectively.  Remainingreceivables relate primarily to various HMO and PPO programs,commercial insurers and private patients.  Concentration ofcredit risk for these payers is limited by the number of patientsand payers.

***Supplies***

******

               Supply inventory is stated at the lower of cost (first-in,first-out) or market.

***Property, Plant andEquipment***

******

               Property, plant and equipment are stated at cost.  Routinemaintenance and repairs are charged to expense as incurred. Expenditures that increase values, change capacities or extenduseful lives are capitalized.  Depreciation is computed usingthe straight-line method over the estimate useful lives of theassets, which approximate 3 to 40 years.  Depreciation expensewas approximately $8.8 million, $18.5 million and $26.0 million forthe years ended June 30, 2000, 2001 and 2002, respectively. During 2002, the Company capitalized $0.1 million of interestassociated with its construction of a new hospital in Goodyear,Arizona.  The estimated cost to complete projects classifiedas construction in progress is $58.3 million and is expected to beexpended during the next two fiscal years.  The followingtable provides the gross asset balances for each major class ofdepreciable assets and total accumulated depreciation as of June30, 2001 and 2002 (in thousands).

|                                                    |  |   | **As ofJune 30,** |   |
|----------------------------------------------------|--|---|-------------------|---|
|                                                    |  |   | ****              |   |
|                                                    |  |   | **2001**          |   |  |  | **2002** |  |
|                                                    |  |   |                   |   |
| Class of depreciableasset:                         |  |   |                   |   |  |  |  |  |
|    Land andimprovements             |  | $ | 51,086            |   |  | $ | 65,075 |  |
|    Buildings andimprovements        |  |   | 227,697           |   |  |  | 283,335 |  |
|    Equipment                        |  |   | 103,776           |   |  |  | 149,867 |  |
|    Construction inprogress          |  |   | 8,612             |   |  |  | 10,854 |  |
|                                                    |  |   |                   |   |  |  |  |  |
|                                                    |  |   | 391,171           |   |  |  | 509,131 |  |
| Less:  accumulateddepreciation                |  |   | (28,207           | ) |  |  | (54,294 | ) |
|                                                    |  |   |                   |   |  |  |  |  |
|    Netproperty, plant and equipment |  | $ | 362,964           |   |  | $ | 454,837 |  |
|                                                    |  |   |                   |   |  |  |  |  |

***Goodwill and OtherIntangible Assets***

               The Company adopted SFAS 141 and SFAS 142 effective July 1, 2001resulting in adjustments to the allocation of the excess purchaseprice for acquired entities between goodwill and intangible assetsbased upon appraisal data and assumptions.  Amounts allocatedto intangible assets are amortized over their useful lives, whichrange from 3 years to 40 years, except for those indefinite-livedintangible assets for which no amortization is recorded. Goodwill is no longer amortized but is subject to annual impairmentreviews.  Deferred loan costs and syndication costs areamortized over the life of the applicable credit facility orsubordinated notes.  See Note 4 for a summary of goodwill andother intangible assets and the effects of adopting SFAS 141 and142.

F-11

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**Table of Contents**

***Employee HealthInsurance***

******

               The Company maintains self-insured medical and dental plans foremployees.  Claims are accrued under these plans as theincidents that give rise to them occur.  Unpaid claimsaccruals are based on the estimated ultimate cost of settlement,including claim settlement expenses, in accordance with an averagelag time and historical experience.  The reserve forself-insured medical and dental plans was approximately $2.9million and $4.2 million as of June 30, 2001 and 2002,respectively, and is included in accrued expenses and other currentliabilities on the accompanying consolidated balancesheets.

*Revenues*

               *Patient Service Revenues*

               The Company has agreements with third-party payers that provide forpayments to the Company at amounts different from its establishedrates.  A summary of the payment arrangements with majorthird-party payers follows:

| • |     | *Medicare* – Inpatientacute care services rendered to Medicare program beneficiaries arepaid at prospectively determined rates per diagnosis.  Theserates vary according to a patient classification system that isbased on clinical, diagnostic and other factors.  Inpatientnon-acute services, certain other services and medical educationcosts related to Medicare beneficiaries are paid based on a costreimbursement methodology subject to various cost limits.  TheCompany is reimbursed for cost reimbursable items at a tentativerate with final settlement determined after submission of annualcost reports by the Company and audits thereof by the Medicarefiscal intermediary.  Outpatient and home health servicesrelated to Medicare beneficiaries provided after August 1, 2000 andOctober 1, 2000, respectively, are reimbursed based onprospectively determined rates.  The Company’sclassification of patients under the Medicare program and theappropriateness of their admissions are subject to an independentreview.  Estimates recorded for amounts due to or fromMedicare for cost reimbursed services may change upon review by thefiscal intermediary.  The Company derived approximately 22%,20% and 25% of gross patient service revenues from servicesprovided under the Medicare program for the years ended June 30,2000, 2001 and 2002, respectively.
 

 

 

•

   

*Medicaid* – Inpatientservices rendered to beneficiaries under the Medi-Cal program(California’s Medicaid program) are reimbursed either undercontracted rates or a cost reimbursement methodology at a tentativerate with final settlement determined after submission of annualcost reports by the Company and audits thereof by Medi-Cal. The Company owns three hospitals in California.  Inpatient andoutpatient services rendered to Medicaid program beneficiaries inthe other states in which the Company owns hospitals are reimbursedunder contracted rates that generally do not have retroactive costreport settlement procedures.  The Company derivedapproximately 6%, 9% and 7% of gross patient service revenues fromservices provided under the Medicaid program for the years endedJune 30, 2000, 2001 and 2002, respectively.
 

 

 

•

   

*Other* – The Companyhas also entered into payment agreements with certain commercialinsurance carriers, health maintenance organizations and preferredprovider organizations.  The basis for payment to the Companyunder these agreements includes prospectively determined rates perdischarge, discounts from established charges, prospectivelydetermined daily rates and fixed monthly premiums based uponnegotiated per member rates (generally referred to as capitationarrangements).  Capitation premiums received by theCompany’s hospitals are recognized as revenues in the monththat members are entitled to health care services regardless ofservices actually provided.  The Company’s hospitalsreceived capitation premiums of $7.7 million, $30.6 million, and$17.6 million for the years ended June 30, 2000, 2001 and 2002,respectively, which are included in patient service revenues on theaccompanying consolidated statements of operations.  Otherthan Medicare and Medicaid, the Company has no payers thatrepresent more than 10% of aggregate gross or net patient servicerevenues.
               Patient service revenues are recorded at estimated amounts due frompatients and third party payers for the health care servicesprovided in the period the services are provided.  Theseestimates are based on calculations made according to the terms ofthe agreements noted above under which the Company is paid based ona percentage of established charges, the cost of providingservices, predetermined rates per diagnosis, fixed per diem ratesor discounts from established charges.

F-12
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**Table of Contents**

               Final determinations of amounts earned under the Medicare andMedi-Cal programs often occur in subsequent years because of auditsby the program, rights of appeal and the application of numeroustechnical provisions.  Differences between original estimatesand subsequent revisions (including final settlements) are includedin the consolidated statement of operations in the period in whichthe revisions are made.   Management believes that adequateprovision has been made for adjustments that may result from finaldetermination of amounts earned under the Medicare and Medi-Calprograms.  Net adjustments to estimated settlements resultedin an increase to patient service revenues of $6.2 million for theyear ended June 30, 2002.  As part of the acquisitions, theCompany did not assume any settlements under these programsestimated by the sellers through the dates of purchase.  Sinceimplementation of outpatient PPS in August 2000, the due dates ofall Medicare cost reports have been extended due to delays inreceiving necessary reports from Medicare fiscalintermediaries.  The Company currently has 10 unfiled Medicarecost reports relating to Medicare fiscal year-ends 2000 and 2001and anticipates filing these 10 cost reports and up to 4 additionalcost reports relating to Medicare fiscal year-end 2002 duringfiscal 2003 that could result in significant changes to our thirdparty settlement estimates.

               Patient service revenues include certain revenues incidental to thedelivery of health care services including medical office buildingrent revenues, cafeteria sales and other miscellaneousrevenues.  For the year ended June 30, 2002, patient servicesrevenues include $2.6 million of proceeds from a net profitsdistribution of an entity for which the Company acquired aninterest in connection with the acquisition of MacNeal HealthServices.  Patient service revenues are net of contractualadjustments and policy discounts of approximately $556.3 million,$1.2 billion and $1.4 billion for the years ended June 30, 2000,2001 and 2002, respectively.

               *Premium Revenues*

**

               The Company’s health plans have agreements with the ArizonaHealth Care Cost Containment System (“AHCCCS”) andvarious health maintenance organizations (“HMOs”) tocontract to provide medical services to subscribingparticipants.  Under these agreements, the Company’shealth plans receive monthly payments based on the number of eachHMO’s participants and, in the case of the contract withAHCCCS, the number of enrollees in its Medicaid health planaffiliate, Phoenix Health Plan.  The Company’s healthplans receive these monthly payments and recognize them as revenuein the month in which members are entitled to health careservices.

***MarketRisks***

               The Company operates in three geographic markets.  Shouldeconomic or other factors limit our ability to provide health careservices in one or more of these markets, our cash flows andresults of operations could be significantly impacted.

***Stock-BasedCompensation***

******

               The Company has elected to record stock options in accordance withAccounting Principles Board Opinion No. 25, *Accounting for StockIssued to Employees,* and related interpretations thereof and,accordingly, recognizes no compensation expense for options grantedwhen the exercise price equals, or is greater than, the marketprice of the underlying stock on the date of grant.

***IncomeTaxes***

******

               Income taxes are computed based on the liability method ofaccounting whereby deferred tax assets and liabilities aredetermined based on differences between financial reporting and taxbases of assets and liabilities and are measured using the enactedtax rates and laws that will be in effect when the differences areexpected to reverse.

***Fair Value ofFinancial Instruments***

******

*               Cash and cash equivalents*

**

               The carrying amounts reported for cash and cash equivalentsapproximate fair value because of the short-term maturity of theseinstruments.

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**Table of Contents**

               *Accounts Receivable and Accounts Payable*

**

               The carrying amounts reported for accounts receivable and accountspayable approximate fair value because of the short-term maturityof these instruments.

               *Long-term Debt*

**

               The fair value of the $300 million Senior Subordinated Notes due2011 as of June 30, 2002, is approximately $310.9 million basedupon stated market prices.  The fair value is subject tochange as market conditions change.

               *Interest Rate Swap*

               In order to manage its exposure to interest rate risk, managementutilizes derivative instruments from time to time.  TheCompany currently utilizes an interest rate swap agreement on anotional $100 million of its $300 million Senior Subordinated Notesoutstanding as of June 30, 2002.  Under the interest rate swapagreement, interest on the notional amount is calculated in arrearsbased upon the 6-month LIBOR rate in effect on the last day of thesettlement period (February 1 and August 1 of each year) plus afixed margin of 3.63%.  The Company utilizes mark-to-marketaccounting for the interest rate swap agreement under theprovisions of SFAS 133, *Accounting for Derivative Instrumentsand Hedging Activities*, and has determined that its interestrate swap instrument qualifies for the shortcut method ofaccounting for highly effective hedges.

***Reclassifications***

               Certain reclassifications have been made to the prior yearfinancial statements to conform to current yearpresentation.

**2.            Acquisitions**

***Fiscal 2002Acquisitions***

               On June 3, 2002, but effective June 1, 2002, the Company, through amajority-owned acquisition subsidiary, acquired substantially allof the assets of Louis A. Weiss Memorial Hospital(“Weiss”), a 369-bed acute care hospital located inChicago, Illinois.  The acquisition subsidiary is a jointventure corporation owned 80.1% by the Company and 19.9% by anaffiliate of the former owner of Weiss.  The purchase pricewas $59.9 million comprised of cash paid of $41.2 million andliabilities assumed of $18.7 million.  The Company received$2.5 million for the minority joint venture partner’s 19.9%interest in the acquisition subsidiary.  The Company fundedthe acquisition with a portion of the proceeds remaining from itsissuance of $300 million Senior Subordinated Notes due 2011 on July30, 2001.  The Weiss acquisition was accounted for using thepurchase method of accounting, and the operating results of Weisshave been included in the accompanying consolidated financialstatements from the date of acquisition.  The Company expectsto complete the working capital settlement with the former owner ofWeiss during fiscal 2003 that, along with other potentialadjustments, will affect the final purchase priceallocation.

               On November 1, 2001, the Company completed the acquisition of theassets of Paradise Valley Hospital (“Paradise Valley”),a 162-bed acute care hospital located in Phoenix, Arizona, for atotal purchase price of approximately $59.8 million, comprised ofcash of $55.3 million and the assumption of liabilities of $4.5million.  The excess of the purchase price over net assetsacquired was $4.4 million and has been allocated to net intangibleassets and goodwill on the accompanying consolidated balancesheets.  The Company funded the acquisition with a portion ofits cash proceeds from its July 30, 2001 issuance of $300 millionSenior Subordinated Notes due 2011.  The Paradise Valleyacquisition was accounted for using the purchase method ofaccounting, and the operating results of the acquired entity havebeen included in the accompanying consolidated financial statementsfrom the date of acquisition.

               The purchase price for the 2002 acquisitions was allocated asfollows (in thousands):

F-14
****
**Table of Contents**

 

 

**Weiss**

 

**Paradise Valley**

 

**Total**

 

 

Fair value of assetsacquired:

 

 

 

 

 

 

 

 

 

 

 

   Cash

 

$

—

 

 

$

2

 

 

$

2

   Accountsreceivable, net

 

 

17,630

 

 

 

9,675

 

 

 

27,305

   Othercurrent assets

 

 

4,012

 

 

 

1,884

 

 

 

5,896

   Property, plant andequipment

 

 

38,293

 

 

 

43,896

 

 

 

82,189

   Goodwilland intangible assets

 

 

—

 

 

 

4,376

 

 

 

4,376

 

 

 

 

 

 

 

 

 

 

 

 

59,935

 

 

 

59,833

 

 

 

119,768

Liabilitiesassumed

 

 

18,723

 

 

 

4,530

 

 

 

23,253

 

 

 

 

 

 

 

 

 

Cash paid

 

$

41,212

 

 

$

55,303

 

 

$

96,515

 

 

 

 

 

 

 

 

 

***Fiscal 2001Acquisitions***

****

               During the fiscal year ended June 30, 2001, the Company completedthe following acquisitions:

**Date**

   

**Entity**

**   **

**Location**

   

   

July 2000

   

Trinity MedCare,Inc.

   

Nashville, TN

September 2000

   

Pleasant Properties,Inc.

   

Phoenix, AZ

May 2001

   

PMH Health Resources,Inc.

   

Phoenix, AZ

June 2001

   

Touchstone Imaging ofArizona, LLC

   

Phoenix, AZ

               The Company acquired certain net assets of the aforementionedentities, which include a hospital, health plan and imaging centersfor a total purchase price of approximately $90.6 million,comprised of cash of $31.6 million and the assumption of certainliabilities of $59.0 million.  The excess of the purchaseprice over net assets acquired was $35.0 million and is included aspart of net goodwill and net intangible assets on the accompanyingconsolidated balance sheets.  The acquisitions were financedwith the proceeds from equity issuances to various affiliates ofMorgan Stanley Capital Partners (“MSCP”) and certainmembers of management and internally generated cash.  The 2001acquisitions were accounted for using the purchase method ofaccounting, and the operating results of the acquired entities havebeen included in the accompanying consolidated statements ofoperations from the respective dates of acquisition.

               The following table summarizes the allocation of the aggregatepurchase price of the 2001 acquisitions (in thousands):

**PMHHealth Resources**

** **

**Touchstone Imaging**

** **

**Other**

** **

**Total**

 
****
 

 

Fair value of assetsacquired:

 

   Cash

 

$

16,650

 

$

—

$

543

$

17,193

 

   Othercurrent assets

3,129

141

162

3,432

 

   Property, plant andequipment

 

 

18,806

10,210

4,242

33,258

 

   Otherassets

 

 

1,800

—

1

1,801

 

   Goodwilland intangible assets

 

 

19,873

14,458

605

34,936

 

 

 

 

60,258

24,809

5,553

90,620

 

Liabilitiesassumed

 

 

45,559

10,166

3,293

59,018

 

 

Cash paid

 

$

14,699

$

14,643

$

2,260

$

31,602

 

F-15
****
**Table of Contents**

***Fiscal 2000Acquisitions***

******

               During fiscal 2000, the Company completed the followingacquisitions:

**Date**

   

**Entity**

**   **

**Location**

   

   

September 1999

   

West Anaheim MedicalCenter

   

Anaheim, CA

September 1999

   

Huntington Beach MedicalCenter

   

Huntington Beach,CA

February 2000

   

MacNeal HealthServices

   

Berwyn, IL

April 2000

   

LaPalma IntercommunityHospital

   

La Palma, CA

June 2000

   

Arrowhead CommunityHospital and Medical Center

   

Glendale, AZ

June 2000

   

Phoenix Baptist Hospitaland Medical Center

   

Phoenix, AZ

               The Company acquired certain net assets of the aforementionedentities for a total purchase price of approximately $406.8million, comprised of cash of approximately $325.5 million, 20,000shares of the Company’s Payable-In-Kind Preferred Stock valueat $20.0 million and assumed liabilities of $61.3 million. The acquisitions were financed with the proceeds from the 2000credit facility and proceeds from equity issuances to variousaffiliates of MSCP and certain members of management.

               The following table summarizes the allocation of the aggregatepurchase price of the 2000 acquisitions (in thousands):

 

 

**WestAnaheim and Huntington Beach**
** **
**MacNeal**

** **

**LaPalma**

** **

**Phoenix Baptist and Arrowhead**

** **

**Total**

 

Fair value of assetsacquired:

 

   Accountsreceivable, net

 

$

14,529

 

 

$

31,022

 

 

$

 ―

 

 

$

24,771

 

 $

 

70,322

 

   Othercurrent assets

 

 

1,896

 

 

 

6,579

 

 

 

743

 

 

 

5,620

 

 

 

14,838

 

   Property, plant andequipment

 

 

36,892

 

 

 

153,300

 

 

 

8,201

 

 

 

73,290

 

 

 

271,683

 

   Otherassets

 

 

―

 

 

 

6,654

 

 

 

―

 

 

 

―

 

 

 

6,654

 

   Goodwilland intangible assets

 

 

―

 

 

 

43,351

 

 

 

―

 

 

 

―

 

 

 

43,351

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

53,317

 

 

 

240,906

 

 

 

8,944

 

 

 

103,681

 

 

 

406,848

 

Liabilitiesassumed

 

 

7,774

 

 

 

35,577

 

 

 

1,552

 

 

 

16,461

 

 

 

61,364

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net assetsacquired

 

 

45,543

 

 

 

205,329

 

 

 

7,392

 

 

 

87,220

 

 

 

345,484

 

Payable-In-Kind PreferredStock issued

 

 

―

 

 

 

20,000

 

 

 

―

 

 

 

―

 

 

 

20,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash paid

 

$

45,543

 

 

$

185,329

 

 

$

7,392

 

 

$

87,220

 

 

$

325,484

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

***OtherInformation***

               *Pro Forma Results*

               The following table shows the unaudited pro forma results ofconsolidated operations as if the 2000, 2001 and 2002 acquisitionshad occurred at the beginning of the immediate preceding period,after giving effect to certain adjustments, including thedepreciation and amortization of the assets acquired based upontheir fair values, changes in net interest expense resulting fromchanges in consolidated debt and changes in allocated overheadexpenses (in thousands):

 

 

 

**2000**

 

 

 

**2001**

 

 

 

**2002**

 

 

 

 

Revenues

 

$

815,805

 

 

$

975,451

 

 

$

1,032,869

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss before incometaxes

 

 

(48,214

)

 

 

(8,367

)

 

 

(2,575

)

F-16
****
**Table of Contents**

               The pro forma information presented above does not purport to beindicative of what the Company’s results of operations wouldhave been if the acquisitions had in fact occurred at the beginningof the periods presented, and is not intended to be a projection ofthe impact on future results or trends.

**3.            Prepaid Expenses and Other Current Assets**

               Prepaid expenses and other current assets in the accompanyingconsolidated balance sheets consist of the following at June 30 (inthousands).

 

 

 

**2001**

 

 

 

**2002**

 

 

Otherreceivables

 

$

8,888

 

 

$

12,893

Prepaidexpenses

 

 

4,571

 

 

 

10,924

Other

 

 

621

 

 

 

3,790

 

 

 

 

 

 

 

 

$

14,080

 

 

$

27,607

 

 

 

 

 

 

**4.            Goodwill and Intangible Assets**

               Effective July 1, 2001, the Company adopted the provisions of SFASNo. 141 and SFAS No. 142.  In accordance with theseprovisions, the Company reclassified its previous allocations ofexcess purchase price over net assets acquired between goodwill andintangible assets and re-assessed the amortization lives assignedto intangible assets.  The following table providesinformation regarding the intangible assets, including deferredloan costs, included on the accompanying condensed consolidatedbalance sheets as of June 30, 2001 and June 30, 2002 (inthousands).

 

 

** **

**GrossCarrying Amount**

** **

**Accumulated Amortization**

 

  

** **
****
 

 

**June30, 2001**

** **

**June30, 2002**

** **

**June30, 2001**

** **

**June30, 2002**

 

 

**Class of IntangibleAsset**
****
 

Amortized intangibleassets:

 

   Deferred loan costs

$

4,461

$

15,000

$

1,116

$

1,186

 

   Certificate of need

19,351

—

758

—

 

   Assembled workforce

3,580

—

1,874

—

 

    Medicalrecords

6,150

—

2,792

—

 

   Contracts

—

7,910

—

1,302

 

   Customer lists

—

2,250

—

1,480

 

   Other

2,340

3,549

961

954

 

 

 

       Subtotal

35,882

28,709

7,501

4,922

 

 

 

Indefinite-livedintangible assets:

 

    Licenseand accreditation

—

8,013

—

—

 

   Other

—

6,504

—

—

 

 

 

       Subtotal

—

14,517

—

—

 

 

 

Total

$

35,882

$

43,226

$

7,501

$

4,922

 

 

 

               Amortization expense for the year ended June 30, 2002 wasapproximately $3.4 million.  The Company estimatesamortization expense for these intangible assets, excludingdeferred loan costs which are amortized to interest expense, toapproximate $2.4 million, $1.3 million, $1.2 million, $1.2 millionand $1.1 million for the fiscal years ending June 30,2003,

F-17
****
**Table of Contents**

2004, 2005, 2006 and 2007,respectively.  The lives over which intangible assets areamortized range from two years to forty years.

               The following table presents the changes in the carrying amount ofgoodwill from the date of transition to June 30, 2002 (inthousands).

**Acute Care Services**

**Health Plans**

**Total**

Balance as of July 1,2001

$

65,586

$

8,647

 

$

74,233

Working capital settlementadjustment

—

 

2,752

 

2,752

Acquisitions

2,093

 

—

 

2,093

 

 

 

Balance as of June 30,2002

$

67,679

$

11,399

 

$

79,078

 

 

 

               The Company completed its transition and annual impairment tests ofgoodwill and indefinite-lived intangible assets during 2002 notingno impairment.  Amortization of goodwill and indefinite-livedintangible assets has been suspended in the accompanyingconsolidated statement of operations for year ended June 30,2002.  The following table presents the net income for theyears ended June 30, 2001 and 2002 assuming SFAS 141 and 142 hadbeen adopted on July 1, 2000, and given the effects of the adoptionof SFAS 141 and 142 on July 1, 2001 (in thousands).

 

 

 

**Yearended June 30,**

 

 

 

**2000**

 

 

 

**2001**

 

 

 

**2002**

 

Reported net income(loss)

 

$

(1,449

)

$

10,160

 

$

6,777

 

Add back: Goodwillamortization

 

 

2,637

 

 

 

3,971

 

 

 

―

 

Adjust: Amortization ofintangible assets previously classified as    goodwill (net of taxes of $0)

 

 

(826

)

 

 

(1,139

)

 

 

―

 

 

 

 

 

 

 

 

 

 

 

      Adjusted netincome

 

$

362

 

 

$

12,992

 

 

$

6,777

 

 

 

 

 

 

 

 

 

 

 

****

**5.            Other Accrued Expenses and Current Liabilities**

****

               Accrued expenses and other current liabilities in the accompanyingconsolidated balance sheets consist of the following at June 30 (inthousands):

 

 

 

**2001**

 

 

 

**2002**

 

 

 

Salaries andbenefits

 

$

21,554

 

 

$

27,940

Due to third-partypayers

 

 

22,806

 

 

 

24,997

Property taxes

 

 

7,461

 

 

 

8,137

Self-insured employeehealth claims

 

 

2,948

 

 

 

4,244

Medical claimspayable

 

 

25,394

 

 

 

24,367

Current portion ofself-insured insurance risks

 

 

2,704

 

 

 

5,553

Insurancepremiums

 

 

―

 

 

 

6,947

Other

 

 

12,368

 

 

 

12,755

 

 

 

 

 

 

 

 

$

95,235

 

 

$

114,940

 

 

 

 

 

 

**6.            Long-Term Debt**

               A summary of the Company’s long-term debt at June 30 follows(in thousands):

F-18
****
**Table of Contents**

**2001**

**2002**

Senior SubordinatedNotes

$

—

 

$

300,000

FAS 133 valuationadjustment

 

—

 

3,343

Term loanspayable

 

145,011

 

2,137

Term loans payable torelated party

4,359

—

Capital leases

14,074

9,300

 

 

163,444

314,780

Less: currentmaturities

(10,332

)

(3,762

)

 

 

$

153,112

$

311,018

 

 

 

***Senior SubordinatedNotes***

               On July 30, 2001, the Company received $300,000,000 through theissuance of 9.75% Senior Subordinated Notes (the “9.75%Notes”) which mature in August 2011.  Interest on the9.75% Notes is payable semi-annually on February 1 and August1.  The Company may redeem the 9.75% Notes, in whole or inpart, at any time from August 1, 2006 to July 31, 2009 atredemption prices ranging from 104.875% to 101.625%, plus accruedand unpaid interest.  The Company may redeem the 9.75% Noteson or after August 1, 2009 at a 100.00% redemption price plusaccrued and unpaid interest.  Additionally, at any time priorto August 1, 2004, the Company may redeem up to 35% of theprincipal amount of the 9.75% Notes with the net cash proceeds ofone or more sales of its capital stock at a redemption price of109.75% plus accrued and unpaid interest to the redemption date;provided that at least 65% of the aggregate principal amount of the9.75% Notes originally issued on July 30, 2001 remains outstandingafter each such redemption and notice of any such redemption ismailed within 90 days of each such sale of capitalstock.

               Payment of the principal and interest of the 9.75% Notes issubordinate to amounts owed for existing and future seniorindebtedness of the Company and is guaranteed, jointly andseverally, on an unsecured senior subordinated basis by most of theCompany’s subsidiaries.  The Company is subject tocertain restrictive covenants under the Indenture governing the9.75% Notes.  The Company used a portion of the proceeds fromthe offering to repay all amounts outstanding under its thenexisting credit facility (“2000 credit facility”) ofapproximately $147.0 million.

***2001 CreditFacility***

               Concurrent with the issuance of the 9.75% Notes, the Companyentered into a new senior secured credit facility (the “2001credit facility”) with a syndicate of lenders with Bank ofAmerica Securities LLC and Morgan Stanley Senior Funding, Inc.serving as joint lead arrangers and book managers and Bank ofAmerica, N.A. as administrative agent.  The 2001 creditfacility initially provides for up to $125 million of outstandingloans and letters of credit on a revolving basis and contemplates,but the lenders have not committed to provide, additional termloans of up to $250 million.  The Company would be required toobtain commitments from its existing or new lenders to obtain theterm loans.  As of June 30, 2002, the only amounts drawnagainst the 2001 credit facility were letters of credit totalingapproximately $5.6 million.  The applicable interest rateunder the revolving credit facility is based upon either:  1)LIBOR plus a margin ranging from 2.25% to 3.25% depending on theCompany’s net debt to EBITDA ratio for the most recent fourquarters or 2) a base rate plus a margin ranging from 1.25% to2.25% depending on the Company’s net debt to EBITDA ratio forthe four most recent quarters.  The Company is subject tocertain restrictive and financial covenants under the 2001 creditfacility.  The Company is in compliance with such covenants asof June 30, 2002.  Obligations under the 2001 credit facilityare guaranteed by most of the Company’s current wholly owneddomestic subsidiaries and are secured by liens on substantially allof the assets of the Company and its subsidiaries and the stock ofthe Company’s subsidiaries.

               The Company incurred offering costs and loan costs of approximately$11.5 million and $3.5 million in issuing the 9.75% Notes andentering into the 2001 credit facility, respectively.  TheCompany capitalized the costs associated with the 2001 creditfacility and the offering of the 9.75% Notes and is amortizing suchcosts to interest expense over the 5-year life of the 2001 creditfacility and the 10-year life of the 9.75% Notes.

F-19
****
**Table of Contents**

***2000 CreditFacility***

               On * * February 1, 2000, the Company entered into acredit agreement (the “2000 credit facility”) withvarious lenders and Morgan Stanley Senior Funding, Inc., asadministrative agent, to fund an acquisition and to repay amountsoutstanding under its 1998 credit facility.  The Companyinitially borrowed $133.0 million under two term loans pursuant tothe 2000 credit facility and had up to $35.0 million available asrevolving loans, less any amounts available under letters ofcredit.  As of June 30, 2000 and 2001, no amounts wereoutstanding under the revolving facility and approximately $0.8million and $2.4 million were outstanding in letters of credit,respectively.  Pursuant to an amendment to the 2000 creditfacility dated June 1, 2000, the Company borrowed an additional$20.0 million in term loans under the 2000 credit facility to funda portion of the purchase price of acquisitions.

               Interest for each of the two term loans and revolving loansaccrued, at the Company’s option, at either the applicablebase rate or Eurodollar rate, as defined in the 2000 creditfacility, plus the applicable margin (a range of 1.75% to 4.25%dependant upon the type of the loan and the current consolidatedleverage ratio).  Interest was payable quarterly in arrearsfor base rate loans or at the end of the applicable interest periodbut not to exceed three months for Eurodollar loans.  Theinterest rate on the outstanding principal balances of the termloans approximated 10.8% and 8.5% as of June 30, 2000 and 2001,respectively.  The Company was subject to commitment fees onthe unused portion of the revolving loan equal to .5% perannum.  The Company incurred deferred loan costs ofapproximately $4.5 million related to the 2000 creditfacility.

***Derivatives***

**

*               Fair Value Hedge*

**

               On February 15, 2002, the Company entered into an interest rateswap agreement with Bank of America, N.A., to swap its 9.75% fixedinterest rate on a notional amount of $100.0 million of the 9.75%Notes for a floating rate designated at the 6-month LIBOR rate (thebenchmark interest rate) plus a fixed percentage of 3.63%. The swap agreement will terminate upon the maturity or redemptionof the 9.75% Notes.  The floating interest rate is determinedfor the six-month period in arrears on semi-annual settlement datesof February 1 and August 1.  The swap qualifies as a fairvalue hedge under SFAS 133, and the Company elected the shortcutmethod of accounting due to the highly effective nature of theswap.  As of June 30, 2002, the Company recorded the swap atfair market value resulting in a hedge asset of approximately $3.3million with an offsetting increase to the fair value of the 9.75%Notes.

               *Cash Flow Hedge*

               On May 3, 2000, the Company entered into a three-year interest ratecollar having a notional principal amount of $67.0 million with alarge financial institution as a result of a provision of the 2000credit facility requiring the Company to maintain a form ofinterest rate protection.  The Company adopted the provisionsof SFAS 133 effective July 1, 2000 for the collar agreement. The instrument qualified as a cash flow hedge under SFAS 133 andinitially expired on May 3, 2003.  The collar agreementincluded a 90-day settlement period at which time the Company madepayments to the hedging financial institution for instances inwhich the 90-day LIBOR dropped below the designated rate floor of6.865% or received payments from the hedging financial institutionfor instances in which the 90-day LIBOR exceeded the designatedrate ceiling of 8.0%.  The Company terminated the collaragreement in July 2001, concurrent with the issuance of the 9.75%Notes and repayment of the amounts outstanding under the 2000credit facility.

**

***Debt ExtinguishmentCosts***

               Concurrent with the issuance of the 9.75% Notes and repayment ofthe amounts outstanding under the 2000 credit facility in July2001, the Company expensed the remaining deferred loan costsassociated with the 2000 credit facility of approximately $3.2million and incurred penalties for the early termination of certaincapital leases of $0.2 million.  Additionally, the Companypaid approximately $3.7 million in July 2001 representing accruedinterest on the interest rate collar and a $3.2 million fee toterminate the collar agreement that was required under the 2000credit facility.  The termination fee represents the fairmarket value of the collar agreement as of the terminationdate.  Collectively, these transactions resulted in $6.6million of debt extinguishment costs for the fiscal year ended June30, 2002.

F-20
****
**Table of Contents**

               Upon the execution of the 2000 credit facility in February 2000,the Company expensed approximately $1.1 million of remaining netdeferred loan costs under the 1998 credit facility and relatedamendments.  The loss is classified as debt extinguishmentcosts on the accompanying consolidated statements ofoperations.

***FutureMaturities***

               Future maturities of long-term debt, excluding capital leaseobligations, as of June 30, 2002 are as follows (inthousands):

**Year**

**Amount**

2003

$

115

2004

125

2005

137

2006

149

2007

163

Thereafter

304,791

$

305,480

******

***OtherInformation***

               The Company conducts substantially all of its business through itssubsidiaries.  Most of the Company’s subsidiariesjointly and severally guarantee the Company’s 9.75% Notes onan unconditional basis.  Certain other consolidated entitiesthat are not wholly owned by the Company have not guaranteed (andare not required to guaranty) such notes under the indenturegoverning the 9.75% Notes.  The condensed consolidatingfinancial information for the parent company, the subsidiaryguarantors, the non-guarantor subsidiaries, certain eliminationsand the consolidated Company as of June 30, 2001 and 2002, and forthe years ended June 30, 2000, 2001 and 2002, follows.

F-21
****
**Table of Contents**

**VANGUARDHEALTH SYSTEMS, INC.CONDENSED CONSOLIDATING BALANCE SHEETSJune 30, 2001**

 

 

**Parent**
** **
**Wholly-Owned Guarantor Subsidiaries**

** **

**Combined Non-Guarantors**

** **

**Eliminations**

** **

**Total Consolidated**

 

 

 
**
 

 

 

*(Inthousands)*

 

**ASSETS**

 

Current assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cashequivalents

 

$

―

 

 

$

11,734

 

 

$

345

 

 

$

―

 

$

 

12,079

 

Accounts receivable,net

 

 

―

 

 

 

127,684

 

 

 

1,217

 

 

 

―

 

 

 

128,901

 

Supplies

 

 

―

 

 

 

11,256

 

 

 

107

 

 

 

―

 

 

 

11,363

 

Prepaid expenses and othercurrent assets

 

 

1,259

 

 

 

15,047

 

 

 

212

 

 

 

―

 

 

 

16,518

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Totalcurrent assets

 

 

1,259

 

 

 

165,721

 

 

 

1,881

 

 

 

―

 

 

 

168,861

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property, plant andequipment, net

 

 

―

 

 

 

358,083

 

 

 

4,881

 

 

 

―

 

 

 

362,964

 

Cost in excess of netassets acquired

 

 

―

 

 

 

74,233

 

 

 

―

 

 

 

―

 

 

 

74,233

 

Intangible assets,net

 

 

―

 

 

 

28,077

 

 

 

304

 

 

 

―

 

 

 

28,381

 

Investments insubsidiaries

 

 

323,855

 

 

 

―

 

 

 

―

 

 

 

(323,855

)

 

 

―

 

Other assets

 

 

―

 

 

 

5,924

 

 

 

35

 

 

 

―

 

 

 

5,959

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Totalassets

 

$

325,114

 

 

$

632,038

 

 

$

7,101

 

 

$

(323,855

)

 

$

640,398

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**LIABILITIES ANDSTOCKHOLDERS’ EQUITY**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Currentliabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accountspayable

 

$

―

 

 

$

41,337

 

 

$

366

 

 

$

―

 

 

$

41,703

 

Accrued expenses and othercurrent liabilities

 

 

743

 

 

 

100,378

 

 

 

382

 

 

 

―

 

 

 

101,503

 

Current maturities oflong-term debt

 

 

―

 

 

 

10,097

 

 

 

235

 

 

 

―

 

 

 

10,332

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Totalcurrent liabilities

 

 

743

 

 

 

151,812

 

 

 

983

 

 

 

―

 

 

 

153,538

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Otherliabilities

 

 

―

 

 

 

6,481

 

 

 

―

 

 

 

―

 

 

 

6,481

 

Long-term debt, lesscurrent maturities

 

 

―

 

 

 

150,239

 

 

 

2,873

 

 

 

―

 

 

 

153,112

 

Intercompany

 

 

(3,473

)

 

 

5,053

 

 

 

(1,580

)

 

 

―

 

 

 

―

 

Payable-In-Kind PreferredStock

 

 

22,320

 

 

 

―

 

 

 

―

 

 

 

―

 

 

 

22,320

 

Stockholders’equity

 

 

305,524

 

 

 

318,453

 

 

 

4,825

 

 

 

(323,855

)

 

 

304,947

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Totalliabilities and stockholders’ equity

 

$

325,114

 

 

$

632,038

 

 

$

7,101

 

 

$

(323,855

)

 

$

640,398

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

F-22
****
**Table of Contents**

**VANGUARDHEALTH SYSTEMS, INC.CONDENSED CONSOLIDATING BALANCE SHEETSJune 30, 2002**

 

** **

**Parent**
** **
**Wholly-Owned Guarantor Subsidiaries**

** **

**Combined Non-Guarantors**

** **

**Eliminations**

** **

**Total Consolidated**

 

 

** **

 

 

** **

*(Inthousands)*

 

**ASSETS**

** **

 

Current assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cashequivalents

 

$

―

 

 

$

55,040

 

 

$

368

 

 

$

―

 

 

$

55,408

 

Accounts receivable,net

 

 

―

 

 

 

168,429

 

 

 

934

 

 

 

―

 

 

 

169,363

 

Supplies

 

 

―

 

 

 

15,313

 

 

 

168

 

 

 

―

 

 

 

15,481

 

Prepaid expenses and othercurrent assets

 

 

2,785

 

 

 

27,349

 

 

 

258

 

 

 

―

 

 

 

30,392

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Totalcurrent assets

 

 

2,785

 

 

 

266,131

 

 

 

1,728

 

 

 

―

 

 

 

270,644

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property, plant andequipment, net

 

 

―

 

 

 

450,137

 

 

 

4,700

 

 

 

―

 

 

 

454,837

 

Goodwill, net

 

 

―

 

 

 

78,819

 

 

 

259

 

 

 

―

 

 

 

79,078

 

Intangible assets,net

 

 

―

 

 

 

38,304

 

 

 

―

 

 

 

―

 

 

 

38,304

 

Investments insubsidiaries

 

 

323,855

 

 

 

―

 

 

 

―

 

 

 

(323,855

)

 

 

―

 

Other assets

 

 

―

 

 

 

9,058

 

 

 

23

 

 

 

―

 

 

 

9,081

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Totalassets

 

$

326,640

 

 

$

842,449

 

 

$

6,710

 

 

$

(323,855

)

 

$

851,944

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**LIABILITIES ANDSTOCKHOLDERS’ EQUITY**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Currentliabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accountspayable

 

$

―

 

 

$

49,460

 

 

$

216

 

 

$

―

 

 

$

49,676

 

Accrued expenses and othercurrent liabilities

 

 

5

 

 

 

128,819

 

 

 

481

 

 

 

―

 

 

 

129,305

 

Current maturities oflong-term debt

 

 

―

 

 

 

3,599

 

 

 

163

 

 

 

―

 

 

 

3,762

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Totalcurrent liabilities

 

 

5

 

 

 

181,878

 

 

 

860

 

 

 

―

 

 

 

182,743

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Otherliabilities

 

 

5,136

 

 

 

17,325

 

 

 

―

 

 

 

―

 

 

 

22,461

 

Long-term debt, lesscurrent maturities

 

 

―

 

 

 

308,335

 

 

 

2,683

 

 

 

―

 

 

 

311,018

 

Intercompany

 

 

(4,573

)

 

 

5,832

 

 

 

(1,259

)

 

 

―

 

 

 

―

 

Payable-In-Kind PreferredStock

 

 

24,106

 

 

 

―

 

 

 

―

 

 

 

―

 

 

 

24,106

 

Stockholders’equity

 

 

301,966

 

 

 

329,079

 

 

 

4,426

 

 

 

(323,855

)

 

 

311,616

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Totalliabilities and stockholders’ equity

 

$

326,640

 

 

$

842,449

 

 

$

6,710

 

 

$

(323,855

)

 

$

851,944

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

F-23
****
**Table of Contents**

**VANGUARDHEALTH SYSTEMS, INC.CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONSFor the year ended June 30, 2000**

 

 

**Parent**
** **
**Wholly-Owned Guarantor Subsidiaries**

** **

**Combined Non-Guarantors**

** **

**Eliminations**

** **

**Total Consolidated**

 

 

 

 

 

 

*(Inthousands)*

 

 

 

 

Patient servicerevenues

 

$

―

 

 

$

284,270

 

 

$

4,616

 

 

$

―

 

 

$

288,886

 

Premiumrevenues

 

 

―

 

 

 

15,808

 

 

 

―

 

 

 

―

 

 

 

15,808

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Totalrevenues

 

 

―

 

 

 

300,078

 

 

 

4,616

 

 

 

―

 

 

 

304,694

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Salaries andbenefits

 

 

―

 

 

 

145,174

 

 

 

1,293

 

 

 

―

 

 

 

146,467

 

Medical claimsexpense

 

 

―

 

 

 

7,356

 

 

 

―

 

 

 

―

 

 

 

7,356

 

Supplies

 

 

―

 

 

 

39,681

 

 

 

817

 

 

 

―

 

 

 

40,498

 

Purchasedservices

 

 

―

 

 

 

27,498

 

 

 

157

 

 

 

―

 

 

 

27,655

 

Other operatingexpenses

 

 

7

 

 

 

21,700

 

 

 

520

 

 

 

―

 

 

 

22,227

 

Provision for doubtfulaccounts

 

 

―

 

 

 

33,115

 

 

 

23

 

 

 

―

 

 

 

33,138

 

Rents andleases

 

 

―

 

 

 

6,404

 

 

 

432

 

 

 

―

 

 

 

6,836

 

Depreciation andamortization

 

 

―

 

 

 

11,541

 

 

 

252

 

 

 

―

 

 

 

11,793

 

Interest, net

 

 

―

 

 

 

8,412

 

 

 

419

 

 

 

―

 

 

 

8,831

 

Management fees

 

 

―

 

 

 

(35

)

 

 

35

 

 

 

―

 

 

 

―

 

Debt extinguishmentcosts

 

 

―

 

 

 

1,149

 

 

 

―

 

 

 

―

 

 

 

1,149

 

Other

 

 

―

 

 

 

74

 

 

 

―

 

 

 

―

 

 

 

74

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

7

 

 

 

302,069

 

 

 

3,948

 

 

 

―

 

 

 

306,024

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) beforeincome taxes

 

 

(7

)

 

 

(1,991

)

 

 

668

 

 

 

―

 

 

 

(1,330

)

Income taxexpense

 

 

119

 

 

 

―

 

 

 

―

 

 

 

―

 

 

 

119

 

Equity in earnings ofsubsidiaries

 

 

(1,323

)

 

 

―

 

 

 

―

 

 

 

1,323

 

 

 

―

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income(loss)

 

$

(1,449

)

 

$

(1,991

)

 

$

668

 

 

$

1,323

 

 

$

(1,449

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

F-24
****
**Table of Contents**

**VANGUARDHEALTH SYSTEMS, INC.CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONSFor the year ended June 30, 2001**

 

** **

**Parent**
** **
**Wholly-Owned Guarantor Subsidiaries**

** **

**Combined Non-Guarantors**

** **

**Eliminations**

** **

**Total Consolidated**

 

 

** **

 

 

** **

*(Inthousands)*

 

** **

** **

 

Patient servicerevenues

 

$

―

 

 

$

604,679

 

 

$

8,021

 

 

$

―

 

 

$

612,700

 

Premiumrevenues

 

 

―

 

 

 

55,063

 

 

 

―

 

 

 

―

 

 

 

55,063

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Totalrevenues

 

 

―

 

 

 

659,742

 

 

 

8,021

 

 

 

―

 

 

 

667,763

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Salaries andbenefits

 

 

―

 

 

 

321,826

 

 

 

1,791

 

 

 

―

 

 

 

323,617

 

Medical claimsexpense

 

 

―

 

 

 

30,784

 

 

 

―

 

 

 

―

 

 

 

30,784

 

Supplies

 

 

―

 

 

 

91,741

 

 

 

1,211

 

 

 

―

 

 

 

92,952

 

Purchasedservices

 

 

―

 

 

 

48,299

 

 

 

278

 

 

 

―

 

 

 

48,577

 

Other operatingexpenses

 

 

6

 

 

 

50,601

 

 

 

750

 

 

 

―

 

 

 

51,357

 

Provision for doubtfulaccounts

 

 

―

 

 

 

56,745

 

 

 

101

 

 

 

―

 

 

 

56,846

 

Rents andleases

 

 

―

 

 

 

11,701

 

 

 

532

 

 

 

―

 

 

 

12,233

 

Depreciation andamortization

 

 

―

 

 

 

23,380

 

 

 

419

 

 

 

―

 

 

 

23,799

 

Interest, net

 

 

(13

)

 

 

16,682

 

 

 

(111

)

 

 

―

 

 

 

16,558

 

Management fees

 

 

―

 

 

 

(359

)

 

 

359

 

 

 

―

 

 

 

―

 

Other

 

 

―

 

 

 

369

 

 

 

―

 

 

 

―

 

 

 

369

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(7

)

 

 

651,769

 

 

 

5,330

 

 

 

―

 

 

 

657,092

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income before incometaxes

 

 

7

 

 

 

7,973

 

 

 

2,691

 

 

 

―

 

 

 

10,671

 

Income taxexpense

 

 

451

 

 

 

60

 

 

 

―

 

 

 

―

 

 

 

511

 

Equity in earnings ofsubsidiaries

 

 

10,604

 

 

 

―

 

 

 

―

 

 

 

(10,604

)

 

 

―

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

10,160

 

 

$

7,913

 

 

$

2,691

 

 

$

(10,604

)

 

$

10,160

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

F-25
****
**Table of Contents**

**VANGUARDHEALTH SYSTEMS, INC.CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONSFor the year ended June 30, 2002**

**Parent**

**Wholly-Owned Guarantor Subsidiaries**

**Combined Non-Guarantors**

**Eliminations**

**Total Consolidated**

 

 

*(Inthousands)*

 

** **

 

Patient servicerevenues

$

―

$

717,328

$

8,441

$

―

$

725,769

Premiumrevenues

―

184,801

―

―

184,801

    Totalrevenues

―

902,129

8,441

―

910,570

Salaries andbenefits

―

382,782

1,654

―

384,436

Medical claimsexpense

―

132,005

―

―

132,005

Supplies

―

114,701

1,424

―

116,125

Purchasedservices

―

66,144

230

―

66,374

Other operatingexpenses

4

71,448

1,320

―

72,772

Provision for doubtfulaccounts

―

53,200

53

―

53,253

Rents andleases

―

13,864

533

―

14,397

Depreciation andamortization

―

29,176

333

―

29,509

Interest, net

―

26,597

89

―

26,686

Management fees

―

(186

)

186

―

―

Debt extinguishmentcosts

―

6,627

―

―

6,627

Other

―

(1,268

)

―

―

(1,268

)

4

895,090

5,822

―

900,916

Net income (loss) beforeincome taxes

(4

)

7,039

2,619

―

9,654

Income taxexpense

2,855

22

―

―

2,877

Equity in earnings ofsubsidiaries

9,636

―

―

(9,636

)

―

Net income

$

6,777

$

7,017

$

2,619

$

(9,636

)

$

6,777

F-26
****
**Table of Contents**

**VANGUARDHEALTH SYSTEMS, INC.CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWSFor the year ended June 30, 2000**

**Parent**

**Wholly-Owned Guarantor Subsidiaries**

**Combined Non-Guarantors**

**Eliminations**

**Total Consolidated**

 

 

*(Inthousands)*

 

** **

 

Operatingactivities:

Net income(loss)

$

(1,449

)

$

(1,991

)

$

668

$

1,323

$

(1,449

)

Adjustments to reconcilenet income to net cash     provided by operating activities:

   Depreciation and amortization

―

11,541

252

―

11,793

   Provision for doubtful accounts

―

33,115

23

―

33,138

   Amortization of loan costs

―

444

―

―

444

    Loss onsale of assets

―

―

―

―

―

    Debtextinguishment costs

―

1,149

―

―

1,149

   Deferred income taxes

―

(1,009

)

―

―

(1,009

)

Changes in operatingassets and liabilities, net of     effects of acquisitions:

    Equityin earnings of subsidiaries

1,323

―

―

(1,323

)

―

   Accounts receivable

―

(51,675

)

(271

)

―

(51,946

)

   Establishment of accounts receivable of recent         acquisitions

―

(3,653

)

―

―

(3,653

)

   Supplies

―

(108

)

22

―

(86

)

    Prepaidexpenses and other current assets

―

(4,465

)

1,118

―

(3,347

)

   Accounts payable

―

15,954

36

―

15,990

    Accruedexpenses and other liabilities

584

23,002

(91

)

―

23,495

Net cash provided byoperating activities

458

22,304

1,757

―

24,519

Investingactivities:

Acquisitions, includingworking capital settlement     payments

(257,232

)

(68,252

)

―

―

(325,484

)

Capitalexpenditures

―

(14,216

)

(73

)

―

(14,289

)

Other

506

3,351

10

―

3,867

Net cash used in investingactivities

(256,726

)

(79,117

)

(63

)

―

(335,906

)

Financingactivities:

Proceeds from issuance ofcommon stock

256,726

(20,590

)

590

―

236,726

Proceeds from long-termdebt

―

165,500

―

―

165,500

Payments of long-term debtand capital leases

―

(69,174

)

(661

)

―

(69,835

)

Payments of loancosts

―

(4,546

)

―

―

(4,546

)

Cash provided by (used in)intercompany activity

(458)

2,353

(1,895

)

―

―

Exercise of stockoptions

―

―

―

―

―

Net cash provided by (usedin) financing activities

256,268

73,543

(1,966

)

―

327,845

Net increase (decrease) incash and cash equivalents

―

16,730

(272

)

―

16,458

Cash and cash equivalents,beginning of period

―

(110

)

464

―

354

Cash and cash equivalents,end of period

$

―

$

16,620

$

192

$

―

$

16,812

F-27
****
**Table of Contents**

**VANGUARDHEALTH SYSTEMS, INC.CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWSFor the year ended June 30, 2001**

**Parent**

**Wholly-Owned Guarantor Subsidiaries**

**Combined Non-Guarantors**

**Eliminations**

**Total Consolidated**

 

 

*(Inthousands)*

 

** **

 

Operatingactivities:

Net income

$

10,160

$

7,913

$

2,691

$

(10,604

)

$

10,160

Adjustments to reconcilenet income to net cash     provided by operating activities:

   Depreciation and amortization

―

23,380

419

―

23,799

   Provision for doubtful accounts

―

56,745

101

―

56,846

   Amortization of loan costs

―

863

―

―

863

    Loss onsale of assets

―

584

―

―

584

   Interest income from interest collar agreement

―

114

―

―

114

   Deferred income taxes

(80

)

(829

)

―

―

(909

)

Changes in operatingassets and liabilities, net of     effects of acquisitions:

    Equityin earnings (losses) of subsidiaries

(10,604

)

―

―

10,604

―

   Accounts receivable

―

(68,063

)

(492

)

―

(68,555

)

   Establishment of accounts receivable of recent         acquisitions

―

(7,236

)

―

―

(7,236

)

   Supplies

―

(461

)

(13

)

―

(474

)

    Prepaidexpenses and other current assets

―

2,535

(1,276

)

―

1,259

   Accounts payable

―

8,405

123

―

8,528

    Accruedexpenses and other liabilities

1,133

(19,525

)

75

―

(18,317

)

Net cash provided byoperating activities

609

4,425

1,628

―

6,662

Investingactivities:

Acquisitions, includingworking capital settlement     payments

―

(10,640

)

―

―

(10,640

)

Capitalexpenditures

―

(26,246

)

(320

)

―

(26,566

)

Other

―

(872

)

―

―

(872

)

Net cash used in investingactivities

―

(37,758

)

(320

)

―

(38,078

)

Financingactivities:

Proceeds from issuance ofcommon stock

―

32,901

―

―

32,901

Proceeds from long-termdebt

―

―

―

―

―

Payments of long-term debtand capital leases

―

(5,787

)

(72

)

―

(5,859

)

Payments of loancosts

―

(359

)

―

―

(359

)

Cash provided by (used in)intercompany activity

(609)

1,694

(1,085

)

―

―

Exercise of stockoptions

―

―

―

―

―

Net cash provided by (usedin) financing activities

(609

)

28,449

(1,157

)

―

26,683

Net (decrease) increase incash and cash equivalents

―

(4,884

)

151

―

(4,733

)

Cash and cash equivalents,beginning of period

―

16,618

194

―

16,812

Cash and cash equivalents,end of period

$

―

$

11,734

$

345

$

―

$

12,079

F-28
****
**Table of Contents**

**VANGUARDHEALTH SYSTEMS, INC.CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWSFor the year ended June 30, 2002**

**Parent**

**Wholly-Owned Guarantor Subsidiaries**

**Combined Non-Guarantors**

**Eliminations**

**Total Consolidated**

 

 

*(Inthousands)*

 

** **

 

Operatingactivities:

Net income

$

6,777

$

7,017

$

2,619

$

(9,636

)

$

6,777

Adjustments to reconcilenet income to net cash     (used in) provided by operatingactivities:

   Depreciation and amortization

―

29,176

333

―

29,509

   Provision for doubtful accounts

―

53,200

53

―

53,253

   Amortization of loan costs

―

1,350

―

―

1,350

    Debtextinguishment costs

―

6,627

―

―

6,627

    Loss(gain) on disposal of assets

―

(815

)

―

―

(815

)

   Deferred income taxes

2,846

―

―

―

2,846

Changes in operatingassets and liabilities, net of     effects of acquisitions:

    Equityin earnings of subsidiaries

(9,636

)

―

―

9,636

―

   Accounts receivable

―

(65,120

)

230

―

(64,890

)

   Establishment of accounts receivable of recent         acquisitions

―

(1,522

)

―

―

(1,522

)

   Supplies

―

(631

)

(61

)

―

(692

)

    Prepaidexpenses and other current assets

(284

)

(10,324

)

(46

)

―

(10,654

)

   Accounts payable

―

(2,349

)

(150

)

―

(2,499

)

    Accruedexpenses and other liabilities

(375

)

25,649

122

―

25,396

Net cash (used in)provided by operating activities

(672

)

42,258

3,100

―

44,686

Investingactivities:

Acquisitions, includingworking capital settlement     payments

―

(100,281

)

―

―

(100,281

)

Capitalexpenditures

―

(34,959

)

(113

)

―

(35,072

)

Proceeds from assetsales

―

1,206

―

―

1,206

Other

―

(1,257

)

12

―

(1,245

)

Net cash used in investingactivities

―

(135,291

)

(101

)

―

(135,392

)

Financingactivities:

Equity contribution fromjoint venture partner

―

2,488

―

―

2,488

Proceeds from long-termdebt

―

300,000

―

―

300,000

Payments of long-term debtand capital leases

―

(153,573

)

(263

)

―

(153,836

)

Payments of loancosts

―

(14,641

)

―

―

(14,641

)

Cash provided by (used in)intercompany activity

648

2,065

(2,713

)

―

―

Exercise of stockoptions

24

―

―

―

24

Net cash provided by (usedin) financing activities

672

136,339

(2,976

)

―

134,035

Net increase (decrease) incash and cash equivalents

―

43,306

23

―

43,329

Cash and cash equivalents,beginning of period

―

11,734

345

―

12,079

Cash and cash equivalents,end of period

$

―

$

55,040

$

368

$

―

$

55,408

F-29
****
**Table of Contents**

**7.            Income Taxes**

               Significant components of the provision for income taxesattributable to continuing operations are as follows (inthousands):

 

 

 

**2000**

 

 

 

**2001**

 

 

**2002**

 

 

 

 

 

Current:

 

 

 

 

 

 

 

 

 

 

 

   Federal

 

$

1,003

 

 

$

1,200

 

$

(140

)

   State

 

 

125

 

 

 

220

 

 

171

 

 

 

 

 

 

 

 

 

 

Total current

 

 

1,128

 

 

 

1,420

 

 

31

 

 

 

 

 

 

 

 

 

 

 

 

 

Deferred:

 

 

 

 

 

 

 

 

 

 

 

   Federal

 

 

(1,003

)

 

 

(915

)

 

2,501

 

   State

 

 

(6

)

 

 

6

 

 

345

 

 

 

 

 

 

 

 

 

 

Total deferred

 

 

(1,009

)

 

 

(909

)

 

2,846

 

 

 

 

 

 

 

 

 

 

 

 

$

119

 

 

$

511

 

$

2,877

 

 

 

 

 

 

 

 

 

 

               The effective income tax rate differed from the Federal statutoryrate for the years ended June 30, 2000, 2001 and 2002 asfollows:

 

 

**2000**

 

 

**2001**

 

 

**2002**

 

 

 

 

Income tax expense(benefit) at Federal statutory rate

 

(35.0

) %

 

35.0

 %

 

35.0

 %

Income tax expense atstate statutory rate

 

8.9

 

 

7.3

 

 

5.2

 

Nondeductible expenses andother

 

5.5

 

 

1.3

 

 

4.4

 

Increase (decrease) invaluation allowance

 

29.5

 

 

(38.8

)

 

(14.8

)

 

 

 

 

 

 

 

Effective income taxrate

 

8.9

 %

 

4.8

 %

 

29.8

 %

 

 

 

 

 

 

 

               Deferred income taxes reflect the net tax effects of temporarydifferences between the carrying amounts of assets and liabilitiesfor financial reporting purposes and the amounts used for incometax purposes.  Significant components of the Company’sdeferred tax assets and liabilities as of June 30, 2001 and 2002,were approximately as follows (in thousands):

F-30
****
**Table of Contents**

**2001**

**2002**

Deferred taxassets:

   Netoperating loss carryover

$

3,512

$

9,613

   Excesstax basis over book basis of accounts receivable

3,237

423

   Deferredcompensation and other costs

2,056

2,182

   Accruedexpenses

1,210

955

   Interestrate collar liability

1,179

—

   Professional liabilitiesreserves

1,915

5,946

   Minimumtax credit

1,544

—

   Self-insurancereserves

1,861

1,387

   Unearnedrevenue

—

1,036

   Equitymethod of accounting for partnerships

280

427

Total deferred taxassets

16,794

21,969

   Valuation allowance

1,433

—

Total deferred tax assets,net of valuation allowance

$

15,361

$

21,969

Deferred taxliabilities:

   Depreciation, amortization andfixed assets basis differences

$

11,697

$

21,476

   Excessbook basis over tax basis of prepaid assets

1,226

3,740

Total deferred taxliabilities

12,923

25,216

Net deferred tax assetsand liabilities

$

2,438

$

(3,247

)

               Net non-current deferred tax liabilities of $5.1 million as of June30, 2002 are included in the accompanying consolidated balancesheet in other liabilities.

               As of June 30, 2002, the Company generated net operating loss(“NOL”) carryforwards for Federal income tax purposesof approximately $25.3 million and for state purposes ofapproximately $16.1 million that expire from 2012 to 2022. Approximately $5.2 million of these NOLs are subject to annuallimitation for Federal purposes.  These limitations are notexpected to significantly affect the Company’s ability toultimately recognize the benefit of these NOLs in futureyears.

               The Company must make estimates in recording its provision forincome taxes, including the determination of deferred tax assetsand liabilities and any valuation allowance that may be requiredagainst the deferred tax assets.  The Company has not recordedany valuation allowance as of June 30, 2002, because managementbelieves that future taxable income will, more likely than not, besufficient to realize the benefits of those assets as the temporarydifferences reverse in the future.

**8.            Stockholder’s Equity**

               The Company has the authority to issue 750,000 shares of capitalstock, classified as (i) 150,000 shares of preferred stock, parvalue $.01 per share, and (ii) 600,000 shares of common stock, parvalue $.01 per share (the “Common Stock”).

***Common StockIssuances***

               In August 1997, the Company issued 25,000 shares of Common Stock(“Initial Shares”) to certain officers(“Management Investors”) of the Company at $100 pershare. An additional 695 shares were issued to an officer of theCompany in October 1997 at  $100 per share.

F-31
****
**Table of Contents**

               On June 1, 1998 (the “Effective Date”), theCompany’s board of directors (the “Board”)approved the (i) Subscription Agreement, providing for the issuanceand sale of the Company’s Common Stock, (ii) ShareholdersAgreement, providing for, among other things, registration rightsfor stockholders and restrictions on the sale, transfer,encumbrance or other disposition of shares of the Common Stock andto provide for certain rights and obligations relating to thecapital stock of the Company and certain matters relating to theconduct of the business and the affairs of the Company, and (iii)Surviving Shareholders Agreement, providing for, upon an initialpublic offering, among other things, registration rights forstockholders and restrictions on the sale, transfer or thedisposition of shares of the Common Stock. The Company wasauthorized to issue 135,535 shares of Common Stock pursuant to theSubscription Agreement.

               Under the Amended and Restated Subscription Agreement dated June 1,2000, the Company authorized the issuance of 235,521 shares ofcommon stock in addition to the 135,535 shares originallyauthorized pursuant to the original Subscription Agreement datedJune 1, 1998. During fiscal 2000, the Company issued, in accordancewith the original Subscription Agreement and the Amended andRestated Subscription Agreement, 139,154 shares of Common Stock fora price of $1,701.18 per share to fund a portion of the 2000acquisitions.

               On May 1, 2001, the Company issued, in accordance with the originalSubscription Agreement and the Amended and Restated SubscriptionAgreement, 19,340 shares of Common Stock at a price of $1,701.18per share to fund a portion of the 2001 acquisitions.

               Subject to certain terms and conditions of the Amended and RestatedSubscription Agreement, the Company has agreed to issue and sell,and certain investors have agreed to purchase on one or more futuredates, additional shares of Common Stock aggregating 193,457 sharesat a per share price of $1,701.18. The proceeds from any subsequentissuance of Common Stock shall fund the purchase from time to timeby the Company of hospitals, hospital systems, hospital managementcompanies and assets related thereto.

***Forfeiture of CommonShares by Certain Investors***

               Each of certain investors in the Company has also agreed totransfer to the Company upon the occurrence of a Liquidity Event,as defined below, in exchange for no consideration, its allocatedportion of an aggregate number of shares of Common Stock equal tothe Aggregate Carry Amount (as defined in the Carry Option Plan).The determination of the Aggregate Carry Amount is contingent upon,among other things, whether the timing of the Liquidity Eventoccurs prior to or following June 1, 2002 and the computed amountof the Net MSCP Exit Multiple or Net MSCP Internal Rate of Return(“IRR”), as applicable and as defined in the CarryOption Plan, immediately after giving effect to such LiquidityEvent. Any such transfer to the Company shall be made as soon aspracticable following the date on which options granted pursuant tocertain provisions of the Carry Option Plan become vested andexercisable.

               A Liquidity Event means the first to occur of (i) the consummationof an initial public offering, (ii) the sale by MSCP of all orsubstantially all of its aggregate equity interests in the Company,(iii) the sale of all or substantially all of the assets of theCompany, or (iv) the liquidation or dissolution of theCompany.

**

***Repurchase of CommonShares Held by Management Investors***

               If a Management Investor is terminated or resigns, and suchManagement Investor engages in any competitive activity prior toJune 1, 2003, the Company shall have the right to purchase fromsuch Management Investor any and all shares of capital stock orother equity security of the Company then owned by such ManagementInvestor for a purchase price equal to the cost thereof.

               Upon any Liquidity Event in connection with which MSCP receivesaggregate net proceeds in an amount that is less than the aggregateamount of capital invested by MSCP in the Company, MSCP may requirethe Company to purchase from each Management Investor any and allInitial Shares then owned by such Management Investor for apurchase price per share equal to the lesser of the cost or fairmarket value thereof.

F-32
****
**Table of Contents**

***Payable-In-KindPreferred Stock***

**

               On February 1, 2000, as a portion of the payment for theacquisition of MacNeal Health Services, the Company issued 20,000shares of payable-in-kind convertible redeemable preferred stock(“PIK Preferred Shares”) with a par value of $0.01 pershare.  The stock was valued by an independent appraiser at$1,000 per share for purposes of the acquisition.

*               Liquidation Preferences and Conversion Features*

**

               Upon liquidation, dissolution, or winding up of the Company, orupon the Company’s option to redeem such shares, the holdersof the PIK Preferred Shares are entitled to be paid in cash equalto $1,000 per each outstanding share plus accrued dividends. To the extent the Company shall have funds legally available forpayment, the Company is required to redeem all outstanding PIKPreferred Shares at $1,000 per share plus accrued dividends uponthe earlier of (i) a change in control of the Company; (ii) thesale of MacNeal Health Services; or (iii) January 31, 2015.Otherwise, there are no mandatory redemption or put featuresassociated with the PIK Preferred Shares.  The PIK PreferredShares are, with respect to dividend rights and rights onliquidation, dissolution and winding up, senior to all commonshares and may only be junior to other preferred shares designatedas such and such designation requires the majority vote of theholders of the PIK Preferred Shares voting as a separateclass.  The PIK Preferred Shares automatically convert tocommon shares upon consummation of an initial public offering withproceeds to the Company of at least $50 million at a conversionprice equal to the initial public offering price.

**

*               Dividends*

**

               Dividends for the PIK Preferred Shares accrue at an annual rate of$80 per share.  The dividends are payable when, as and ifdeclared by the Board of Directors, in cash or, at theCompany’s option, during any period prior to January 31, 2008(“Pay-In-Kind Period”) in additional PIK PreferredShares at the rate of 0.08 shares for each $80 of such dividend notpaid in cash. The Pay-In-Kind Period shall terminate upon theCompany’s payment of a cash dividend upon any share of itscapital stock. However, the provisions of the 2001 credit facilitylimit the payment of such dividends to the issuance of additionalPIK Preferred Shares.

**

*               Voting Rights*

**

               The holders of the PIK Preferred Shares are not entitled to anyvoting rights except to the extent voting rights vest under one ofthe following occurrences:  (i) when dividends become payable,whether in the form of cash or PIK Preferred Shares, shall be inarrears and unpaid on an amount equal to two full annual dividendsor (ii) the Company’s failure to discharge its mandatoryredemption obligation.   In the event the voting rights vestunder one of these occurrences, the Board of Directors of theCompany will automatically increase by two members, and the holdersof the PIK Preferred Shares shall have the exclusive right, votingas a separate class, to elect the two additional directors. The voting rights are terminated once the accrued dividends havebeen paid or the mandatory redemption obligation has beenfulfilled.

***Put and CallFeatures of Acquisition Subsidiary Stock***

**

               For a period of 30 days commencing June 1, 2007 and each June 1thereafter, University of Chicago Hospitals (“UCH”) hasthe right to require the Company to purchase its shares in thesubsidiary that acquired Louis A. Weiss Memorial Hospital for apurchase price equal to four times the acquisitionsubsidiary’s Adjusted EBITDA (as defined in the shareholdersagreement between the parties) for the most recent 12 months ofoperations less all indebtedness of the acquisition subsidiary(including capital leases) at such time, times UCH’spercentage interest in the acquisition subsidiary on the date ofpurchase.  Similarly, during the same 30-day periods, theCompany has the right to require UCH to sell to us UCH’sshares in the acquisition subsidiary for a purchase price equal tothe greater of (i) six times the acquisition subsidiary’sAdjusted EBITDA (as defined in the shareholders agreement among theparties) for the most recent 12 months of operations less allindebtedness of the acquisition subsidiary (including capitalleases) at such time, times UCH’s percentage interest in theacquisition subsidiary on the date of purchase, and (ii) the pricepaid by UCH for its interest in the acquisition subsidiary minusdividends or other distributions to UCH in respect of thatinterest.

F-33
****
**Table of Contents**

**9.            Employee Benefit Plans**

***Carry OptionPlan***

               On June 1, 1998, (the “Effective Date”) the Boardapproved the grant of 23,883 options, each exercisable for oneshare of Common Stock, at an exercise price of $170.12 under theVanguard Health Systems, Inc. Carry Option Plan (the “CarryOption Plan”). In August 2000, the Board approved a grant of3,134 options to an officer of the Company under the Carry OptionPlan.  In November 2001, the Board approved the grant of 2,805options under the Carry Option Plan, bringing the total number ofoutstanding options to 29,822, the maximum allowed pursuant to theAmended and Restated Shareholders Agreement and Carry Option Plandated June 1, 2000.  Additional options may only be grantedupon the cancellation of previously issued options.  Upon andafter the occurrence of a Liquidity Event, no options shall beavailable for grant under the Carry Option Plan.

               Subject to the terms and conditions of the Carry Option Plan, theoptions granted under the Carry Option Plan shall vest upon theearlier of a Liquidity Event or ratably over seven years. None of the options shall be exercisable prior to a LiquidityEvent. Upon a Liquidity Event, a number of options equal to theExercisable Options, as defined in the Carry Option Plan, shallbecome exercisable. The determination of Exercisable Options, iscontingent upon, among other things, whether the timing of theLiquidity Event occurs prior to or following June 1, 2002 and thecomputed amount of the Net MSCP Exit Multiple or Net MSCP IRRimmediately after giving effect to such Liquidity Event. Suchnumber of options may only be exercised commencing at such time andending on the tenth anniversary of the Effective Date, at whichtime such options shall expire. All options held by a grantee inexcess of the Exercisable Options shall, upon the occurrence of aLiquidity Event, be irrevocably and unconditionally forfeited andcanceled without any consideration payable to the grantee, and thegrantee shall have no further right or considerationtherein.

               Upon the occurrence of a Liquidity Event, the Company will incur animmediate compensation expense on all Excercisable Optionsoutstanding at that time based on the excess of the fair marketvalue of each Common Share over the exercise price.

***Initial OptionPlan***

               The purpose of the Vanguard Health Systems, Inc. NonqualifiedInitial Option Plan (“Initial Option Plan”) wasprimarily to grant option awards to those employees who agreed towork for the Company for no cash salaries or cash salaries belowfair market value during the eleven months ended May 31,1998.

               On June 1, 1998, (the “Effective Date”) the Boardapproved the grant of 3,595 options, each exercisable for one shareof Common Stock, at an exercise price of $170.12 per share. Themaximum number of shares of Common Stock reserved for grant ofawards under the Initial Option Plan was 3,595.  Each of the3,595 granted options vested on June 1, 1999 (one-year vestingperiod).  3,396 of the options became exercisable on June 1,1999, and the other 199 options are exercisable upon a LiquidityEvent.  These options expire ten years subsequent to the dateof the grant of the option.

               Since the exercise price of the options granted was below the fairvalue of the Company’s Common Stock on the date of grant, theCompany recorded approximately $5.0 million of non-cash stockcompensation for the year ended June 30, 1999, with an offsettingincrease to additional paid in capital.

***1998 Stock OptionPlan***

               The purpose of the Vanguard Health Systems, Inc. 1998 Stock OptionPlan, as amended effective June 1, 2000 (the “1998 StockOption Plan”), is to afford an incentive to executiveofficers, other key employees, directors and consultants of theCompany to acquire a proprietary interest in the Company, tocontinue as employees, directors, or consultants, to increase theirefforts on behalf of the Company and to promote the success of theCompany’s business. The 1998 Option Plan is administered bythe Board.

               The maximum number of shares of Common Stock reserved for the grantof options under the 1998 Stock Option Plan (the “MaximumShare Number”) shall be recomputed as of a Liquidity Eventand under such calculations the options available for grant may beincreased up to an additional 2,977 options.  In no eventshall the number of shares of Common

F-34
****
**Table of Contents**

Stock with respect towhich options are granted hereunder exceed 50% of the number ofshares of Common Stock authorized as of the effective date of the1998 Stock Option Plan.  As of June 30, 2002, the MaximumShare Number was 10,315.

               Options granted under the 1998 Stock Option Plan may be designatedas (i) incentive stock options or non-qualified stock options and(ii) a Liquidity Event Option or a Non-Liquidity Event Option;although, certain restrictions exist as to the number of optionswhich can be granted, outstanding, and exercisable under eachdesignation. The Liquidity Event Options and Non-Liquidity EventOptions vest over a four-year period from the date of grant but arenot exercisable until the occurrence of a Liquidity Event. The Liquidity Event Options are subject to forfeiture if a minimumNet MSCP Exit Multiple or Net MSCP IRR is not met at the date ofthe Liquidity Event.  The Non-Liquidity Event Options are notsubject to this forfeiture provision.  All options under the1998 Stock Option plan have a ten-year exercise period.

               As of June 30, 2002, 10,302 options were outstanding with 75% ofeach grant designated as Liquidity Event Options and 25% designatedas Non-Liquidity Event Options.  Of the 10,302 outstandingoptions, 5,027 options were granted at fair market value butprovide that the exercise price will be reduced to $425.32 if theNet MSCP Exit Multiple or Net MSCP IRR at the date of the LiquidityEvent meets or exceeds certain target amounts.  Should theapplicable target amount be met or should additional options begranted with exercise prices less than fair market value on grantdate, the Company will incur an immediate compensation expense onall affected options equal to the excess of fair market value of ashare of Common Stock over the exercise price of each of theaffected options.

               5,275 options under the 1998 Stock Option Plan were granted to aCompany executive in August 2000 at an exercise price of $425.32and were attached to a bonus equal to $351.63 per optionexercised.  The 5,275 options and related bonus are accountedfor as a combined fixed award and may not be exercised until theoccurrence of a Liquidity Event.  On the date of the LiquidityEvent, the Company will incur an immediate compensation expense onthe exercisable options equal to the excess of fair market value ofa share of Common Stock over the exercise price of theseoptions.

               If, while any options remain outstanding under the 1998 StockOption Plan, an event occurs which constitutes a change in controlof the Company, as defined in the 1998 Stock Option Plan, theoptions shall be exercisable or otherwise non-forfeitable in full,whether or not otherwise exercisable or forfeitable; provided that,if a Liquidity Event occurs which results in a Net MSCP IRR that isless than or equal to 12.5%, then all Liquidity Event Options shallbe forfeited and canceled.

***2000 Stock OptionPlan***

               Effective June 1, 2000, the Vanguard Health Systems 2000 StockOption Plan (the “2000 Stock Option Plan”) was approvedby the Board for the same purpose as the 1998 Stock OptionPlan.  The 2000 Option Plan is administered by theBoard.

               The maximum number of shares of Common Stock reserved for the grantof options under the 2000 Stock Option Plan (the “MaximumShare Number”) shall as of any date be the lesser of (i) thesum of (x) 17.647% of the total number of the 235,131 common sharesset forth on Division I of Schedule 2.01(c) to, and issued by theCompany and purchased by investors pursuant to, the Amended andRestated Subscription Agreement prior to such date and (y) 10.00%of the total number of the 4,377 common shares set forth onDivision II of Schedule 2.01(c) to, and issued by the Company andpurchased by investors pursuant to, the Amended and RestatedSubscription Agreement prior to such date and (ii) 41,931 shares ofCommon Stock.

               Options granted under the 2000 Stock Option Plan may be designatedas (i) incentive stock options or non-qualified stock options and(ii) a Liquidity Event Option or a Non-Liquidity Event Option;although, certain restrictions exist as to the number of optionswhich can be granted, outstanding, and excercisable under eachdesignation.

               The Liquidity Event Options and Non-Liquidity Event Options vestover a four-year period from the date of grant but are notexercisable until the occurrence of a Liquidity Event. Liquidity Event Options are subject to forfeiture if a minimum NetMSCP Exit Multiple or Net MSCP IRR is not met at the date of theLiquidity Event.  The Non-Liquidity Event Options are notsubject to this forfeiture provision.  All options under the2000 Stock Option Plan have a ten-year exercise period.

F-35
****
**Table of Contents**

               As of June 30, 2002, 7,402 options were outstanding under the 2000Stock Option Plan with 75% of each grant designated as LiquidityEvent Options and 25% designated as Non-Liquidity EventOptions.  Should the fair market value of a share of CommonStock exceed the exercise price of each affected option at the dateof the Liquidity Event, the Company will incur an immediatecompensation expense equal to such excess.

               If, while any options remain outstanding under the 2000 StockOption Plan, an event occurs that constitutes a change in controlof the Company, as defined in the 2000 Stock Option Plan, theoptions shall be exercisable or otherwise non-forfeitable in full,whether or not otherwise exercisable or forfeitable; provided that,if a Liquidity Event occurs which results in a Net MSCP IRR that isless than or equal to 12.5%, then all Liquidity Event Options shallbe forfeited and canceled.

******

***Summary of OptionTransactions***

               The following is a summary of options transactions during the yearsended June 30, 2000, 2001 and 2002:

 

 

**CarryOption Plan**

** **

**InitialOption Plan**

** **

**1998Stock Option Plan**

** **

**2000Stock Option Plan**

 

 
****
** **
****
 

 

**# ofoptions**

** **

**Weighted average exercise price**

**# ofoptions**

** **

**Weighted average exercise price**

** **

**# ofoptions**

** **

**Weighted average exercise price**

** **

**# ofoptions**

** **

**Weighted average exercise price**

 

 
****
** **
****
Options outstanding atJune 30, 1999

 

 

23,883

 

 

$

170.12

 

 

 

3,595

 

 

$

170.12

 

 

 

1,902

 

 

$

1,701.18

 

 

 

―

 

 

$

―

 

 

      Optionsgranted

 

 

―

 

 

 

―

 

 

 

―

 

 

 

―

 

 

 

1,010

 

 

 

1,701.18

 

 

 

―

 

 

 

―

 

 

      Optionsexercised

 

 

―

 

 

 

―

 

 

 

―

 

 

 

―

 

 

 

―

 

 

 

―

 

 

 

―

 

 

 

―

 

 

      Optionscanceled

 

 

―

 

 

 

―

 

 

 

―

 

 

 

―

 

 

 

60

 

 

 

1,701.18

 

 

 

―

 

 

 

―

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Options outstanding atJune 30, 2000

23,883

170.12

3,595

170.12

2,852

1,701.18

―

―

 

      Optionsgranted

3,134

170.12

―

―

7,477

801.06

7,557

1,701.18

 

      Optionsexercised

―

―

―

―

―

―

―

―

 

      Optionscanceled

―

―

―

―

391

1,701.18

85

1,701.18

 

 

Options outstanding atJune 30, 2001

27,017

170.12

3,595

170.12

9,938

1,023.97

7,472

1,701.18

 

      Optionsgranted

2,805

170.12

―

―

509

1,701.18

791

1,701.18

 

      Optionsexercised

―

―

―

―

14

1,701.18

―

―

 

      Optionscanceled

―

―

―

―

131

1,701.18

861

1,701.18

 

 

Options outstanding atJune 30, 2002

29,822

170.12

3,595

170.12

10,302

1,049.38

7,402

1,701.18

 

 

Options available forgrant at June 30, 2002

―

―

―

―

13

1,701.18

692

1,701.18

 

 

Options exercisable atJune 30, 2002

―

$

―

3,396

$

170.12

―

$

―

14

$

1,701.18

 

 

**OptionsOutstanding**

** **

**OptionsExercisable**

 
****
** **
****
 

**Rangeof Exercisable Prices**

** **

**NumberOutstanding June 30, 2002**

** **

**WeightedAverage Remaining Contractual Life**

** **

**WeightedAverage Exercise Price**

** **

**NumberExercisable June 30, 2002**

** **

**WeightedAverage Exercise Price**

 
****
** **
****
 

$

 

170.12

 

 

 

33,417

 

 

 

6.4years

 

 

$

170.12

 

 

 

3,396

 

 

$

170.12

$

 

425.32

 

 

 

5,275

 

 

 

8.1years

 

 

$

425.32

 

 

 

―

 

 

 

―

$

 

1,701.18

 

 

 

12,429

 

 

 

8.3years

 

 

$

1,701.18

 

 

 

14

 

 

 

1,701.18

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

 

170.12 -$1,701.18

 

 

 

51,121

*

 

 

 

 

 

 

 

 

 

 

3,410

 

 

$

176.41

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

                                          *Includes options granted under all plans

F-36
****
**Table of Contents**

               Statement of Financial Accounting Standards No. 123 (“SFAS123”), *Accounting for Stock-Based Compensation,*requires those entities electing to account for stock options underAPB 25 to provide certain net income pro forma information in thefootnotes to the financial statements.  The fair value of theCompany’s stock options was estimated at the date of grantusing a Minimum Value option pricing model with the followingweighted-average assumptions for 2000, 2001 and 2002: risk-free interest rate of approximately 6.0%, dividend yield of0.0% and a weighted-average expected option life of 10years.

               For purposes of pro forma disclosures, the estimated fair value ofoptions is amortized to expense over the options’ vestingperiod.  The Company’s pro forma information follows (inthousands).

 

 

 

**2000**

 

 

 

**2001**

 

 

**2002**

 

 

 

 

 

Net income(loss)

 

$

(1,449

)

 

$

10,160

 

$

6,777

 

Pro forma compensationexpense from stock options, net of taxes

 

 

(3,676

)

 

 

(6,131

)

 

(6,302

)

 

 

 

 

 

 

 

 

 

Pro forma net income(loss)

 

$

(5,125

)

 

$

4,029

 

$

475

 

 

 

 

 

 

 

 

 

 

               The effect of applying SFAS 123 for providing pro forma disclosuresare not likely to be representative of the effects on reported netincome for future years.

***401(k)Plan***

               Effective June 1, 1998, the Company adopted the Vanguard HealthSystems, Inc. 401(k) Retirement Savings Plan (the “401(k)Plan”).  The 401(k) Plan is a multiple employer definedcontribution plan whereby employees who have completed one year ofservice in which they have worked a minimum of 1,000 hours and areage 21 or older are eligible to participate.

               The participation requirements of the 401(k) Plan do not apply toall employees as certain employees who had balances under plans ofpredecessor companies are eligible to participate in the 401(k)Plan upon employment with the Company.  The 401(k) Plan wasrestated January 1, 2000 to incorporate the adoption agreements ofa number of employers whereby the respective employer tailored theterms of the 401(k) Plan, including:  contribution limits,vesting schedule and employer match.  The 401(k) Plan wasadopted by the Company’s Subsidiary holding its home officeand other certain employees as of July 1, 1998 and by each acquiredentity upon the respective acquisition date.

               For purposes of determining eligibility to participate and vestingpercentages in the 401(k) Plan, employees received credit for yearsof service with their respective predecessor companies.  The401(k) Plan allows eligible employees to make contributions of 2%to 20% of their annual compensation.  Employer matchingcontributions, which vary by employer, vest 20% after three yearsof service and continue vesting at 20% per year until fullyvested.  The Company’s matching expense for the yearsended June 30, 2000, 2001 and 2002 was approximately $1.8 million,$3.7 million and $4.3 million, respectively.

**10.         Leases**

               The Company leases real estate properties and equipment underoperating and capital leases with various expiration dates. Future minimum operating lease payments at June 30, 2002 areapproximately as follows (in thousands).

F-37
****
**Table of Contents**

 

 

 

**Operating Leases**

 

 

 

**Capital Leases**

 

 

**Total**

 

 

 

2003

 

$

12,214

 

 

$

4,338

 

$

16,552

2004

 

 

8,843

 

 

 

3,325

 

 

12,168

2005

 

 

6,479

 

 

 

1,963

 

 

8,442

2006

 

 

5,390

 

 

 

871

 

 

6,261

2007

 

 

4,001

 

 

 

104

 

 

4,105

Thereafter

 

 

25,545

 

 

 

―

 

 

25,545

 

 

 

 

 

 

 

 

Total minimumpayments

 

$

62,472

 

 

 

10,601

 

$

73,073

 

 

 

 

 

 

 

 

 

Less amounts representinginterest

 

 

 

 

 

 

(1,301

)

 

 

 

 

 

 

 

 

 

 

 

 

Present value of futureminimum lease payments

 

 

 

 

 

$

9,300

 

 

 

 

 

 

 

 

 

 

 

 

 

***Assets Under CapitalLeases***

               The carrying value of assets under capital leases, which areincluded with owned assets in the accompanying consolidated balancesheets, are approximately as follows (in thousands).

 

 

 

**June30, 2001**

 

 

 

**June30, 2002**

 

 

 

 

 

Equipment

 

$

15,363

 

 

$

16,921

 

Less:  accumulateddepreciation

 

 

705

 

 

 

4,148

 

 

 

 

 

 

 

 

Net equipment undercapital leases

 

$

14,658

 

 

$

12,773

 

 

 

 

 

 

 

 

               Amortization of the capitalized amounts is included in depreciationand amortization expense in the accompanying consolidatedstatements of operations.  Other operating expenses for thefiscal years ended June 30, 2000, 2001 and 2002 include rentexpense on operating leases of approximately $6.8 million, $12.2million and $14.4 million, respectively, net of rental paymentsmade by affiliates under informal sublease agreements ofapproximately $0.4 million, $1.6 million and $2.3 million,respectively.

**11.         Contingencies and Health Care Regulation**

***Contingencies***

               The Company is presently, and from time to time, subject to variousclaims and lawsuits arising in the normal course of business. In the opinion of management, the ultimate resolution of thesematters will not have a material adverse effect on theCompany’s financial position or results ofoperations.

***Current Operations***

               Final determination of amounts earned under prospective payment andcost-reimbursement activities is subject to review by appropriategovernmental authorities or their agents.  In the opinion ofthe Company’s management, adequate provision has been madefor any adjustments that may result from such reviews.

               Laws and regulations governing the Medicare and Medicaid and otherFederal health care programs are complex and subject tointerpretation.  The Company’s management believes thatthe Company is in compliance with all applicable laws andregulations in all material respects and is not aware of anypending or threatened investigations involving allegations ofpotential wrongdoing. While no such regulatory inquiries have beenmade, compliance with such laws and

F-38
****
**Table of Contents**

regulationscan be subject to future government review and interpretation aswell as significant regulatory action including fines, penalties,and exclusion from the Medicare, Medicaid and other Federal healthcare programs.

               The Company has acquired and will continue to acquire businesseswith prior operating histories. Acquired companies may have unknownor contingent liabilities, including liabilities for failure tocomply with health care laws and regulations, such as billing andreimbursement, fraud and abuse and similar anti-referral laws.Although the Company institutes policies designed to conformpractices to its standards following completion of acquisitions,there can be no assurance that the Company will not become liablefor past activities that may later be asserted to be improper byprivate plaintiffs or government agencies. Although the Companygenerally seeks to obtain indemnification from prospective sellerscovering such matters, there can be no assurance that any suchmatter will be covered by indemnification, or if covered, that suchindemnification will be adequate to cover potential losses andfines.

***Employment-Related Agreements***

               Effective June 1, 1998, the Company executed employment agreementswith four of the Company’s senior executive officers. The Company executed an employment agreement with a fifth seniorexecutive officer on September 1, 1999.  The employmentagreements have a term of five years and contain provisions forterm extensions. The employment agreements provide, among otherthings, for minimum salary levels, for participation in bonusplans, and for amounts to be paid as liquidated damages in theevent of a change in control as defined in the employmentagreements.

               The Company has executed severance protection agreements(“severance agreements”) between the Company and eachof its senior vice presidents and vice presidents.  Theseverance agreements are automatically extended for successive oneyear terms at the discretion of the Company unless an event of achange in control occurs, as defined in the severance agreement, atwhich time the severance agreement shall continue****in effectfor a period of not less than three years beyond the date of suchevent. The Company is obligated to pay severance payments as setforth in the severance agreements in the event of a change incontrol.

               In conjunction with the Company’s issuance of 695 stockoptions to an officer under the Initial Option Plan, the Companyagreed to grant a cash bonus to reimburse the officer for the taxpayable upon the exercise of the options. The bonus is to be paidupon the exercise of the options and is to be calculated using taxrates in effect and the fair market value of the underlying stockat the time of exercise of the options.

               In August 2000, the Company issued 8,409 stock options to anofficer of the Company with 5,275 options granted under the 1998Option Plan, and 3,134 options granted under the Carry OptionPlan.  In conjunction with the grant of the options under the1998 Option Plan, the Company agreed to grant a cash bonus to theofficer upon the exercise of the options that is limited toapproximately $1.9 million.

***Capital ExpendituresCommitments***

               In accordance with the terms of the acquisition agreement, theCompany has agreed to expend, commit to expend or cause or permitthird parties to expend, in the aggregate, not less than $15.0million for capital expenditures at or for the benefit of MaryvaleHospital Medical Center during the first five years subsequent tothe date of acquisition of June 1, 1998.  If the Company failsto expend at least $15.0 million, the Company is required to pay tothe seller the difference between $15.0 million and the amountactually expended by the Company.  The Company has fulfilledapproximately $14.0 million of this requirement, including theadditional investment in an emergency diagnostic clinic as of June30, 2002.  The Company will expend the remaining $1.0 millioncommitment during 2003.

****

               Additionally, in accordance with the terms of the acquisitionagreement, the Company will expend, commit to expend or cause orpermit third parties to expend, in the aggregate, not less than$50.0 million for capital expenditures at or for the benefit ofArrowhead Community Hospital and Medical Center and Phoenix BaptistHospital and Medical Center during the first seven years subsequentto the date of acquisition of June 1, 2000, with an average annualexpenditure as of the end of each of the first seven anniversariesof the closing date of not less than $6.0 million.  If theCompany fails to expend at least $50.0 million, the Company shallpay to the seller the difference between $50.0 million and theamount actually expended by the Company.  The Company hasfulfilled approximately $16.0 million of this requirement as ofJune 30, 2002 and intends to fulfill an additional $10.4 millionduring 2003.

F-39
****
**Table of Contents**

               California has a statute and regulations that require hospitals tomeet seismic performance standards.   Hospitals that do notmeet the standards may be required to retrofit theirfacilities.  California law required that these hospitalsevaluate their facilities and develop a plan and schedule forcomplying with the standards.  Compliance plans, if necessary,were required to be filed with the State of California by January2002.  The Company filed its required Compliance plans on atimely basis.  Any facilities not currently in compliance withthe seismic regulations and standards must be brought intocompliance by 2008, or 2013 if the facility obtains anextension.  The Company expects to expend approximately $10.1million to comply with the seismic standards.

**12.         Related Party Transactions**

****

               Charles N. Martin, Jr., the Company’s Chairman and ChiefExecutive Officer, beneficially owns in excess of 97% of themembership interests in The Healthcare Airplane Group, LLC. The Company purchases charter airplane servicesfrom The Healthcare Airplane Group. Total costs for such servicesincurred during the years ended June 30, 2000, 2001 and 2002and reported in the accompanying consolidated statements ofoperations approximated $332,000, $300,000 and $434,000,respectively.

****

               Prepaid expenses and other current assets in the accompanyingconsolidated balance sheets include receivables from variousunrelated entities that are affiliated with certain of theCompany’s officers of approximately $0.1 million as of June30, 2001 and 2002, respectively. Such balances represent amountsdue for rent and certain shared office services allocable to theaffiliates.

****

               During fiscal 2002, the Company paid  $142,000 of theout-of-pocket expenses of the MSCP Funds related to their review ofour proposed transactions and travel and related expenses. Duringfiscal 2002, the Company also paid Morgan Stanley & Co.Incorporated or Morgan Stanley Senior Funding, Inc. underwritingfees of $3,163,000 in respect of the 9.75% Notes,  loanorigination fees of $743,000 in respect of the 2001 credit facilityand reimbursed them for $60,000 of their out-of-pocket travel,clerical and word processing fees in connection with such matters.The MSCP Funds currently owns 78.9% of the Company’s commonstock.  In addition, three of the Company’s directors,Karen H. Bechtel, Eric T. Fry and Howard I. Hoffen, are managingdirectors of Morgan Stanley & Co. Incorporated and two of them,Karen H. Bechtel and Eric T. Fry,  are managing directorsof  Morgan Stanley Private Equity while Howard I. Hoffen isChairman and Chief Executive Officer of Morgan Stanley PrivateEquity.  Morgan Stanley & Co. Incorporated, Morgan StanleyPrivate Equity and Morgan Stanley Senior Funding, Inc. areaffiliates of the MSCP Funds.  During fiscal 2001 and 2000,the Company paid Morgan Stanley Senior Funding, Inc. $275,000 and$4,377,000, respectively, representing their review of our proposedtransactions and travel and related expenses, loan origination andamendment fees and reimbursed out-of-pocket travel costs in respectof the 2000 credit facility.  During fiscal 2001 and 2000, theCompany paid $671,000 and $6,000, respectively, of theout-of-pocket expenses of the MSCP Funds related to their review ofour proposed acquisitions and travel and relatedexpenses.

               During fiscal 2002, certain of our facilities paid approximately$440,000 to Coactive Systems Corporation for nurse triage,physician referral and class registration services and CoactiveSystems reimbursed us approximately $50,000 for our full rentalcost in connection with its month-to-month occupancy of certainoffice space in our headquarters not currently needed by us. In addition, in fiscal 2002 Coactive Systems paid us approximately$21,000 to reimburse us for our costs of its phone use whileoccupying such office space in our headquarters and for anallocation in respect of our cost of certain office services. The above aggregate amount paid by our facilities to CoactiveSystems resulted from several contracts separately negotiated withCoactive Systems by local management of each facility on anarms-length basis and in our opinion such amount paid by ourfacilities does not exceed the fair market value for suchservices.  We currently expect to make a similar or greateramount of such payments to Coactive Systems in fiscal 2003 and forCoactive Systems to make a similar amount of such payments to us infiscal 2003. Our Chairman & Chief Executive Officer, Charles N.Martin, Jr., owns approximately 41.5% of the common stock ofCoactive Systems and is the non-executive chairman of its board ofdirectors.  Certain of our other executive officers (Robert E.Galloway, W. Lawrence Hough, Joseph D. Moore, Keith B. Pitts,Phillip W. Roe, Ronald P. Soltman and Alan G. Thomas) own, in theaggregate, approximately 5.5% of the common stock of CoactiveSystems.  In addition, our Vice Chairman, Keith B. Pitts, ison its board of directors; our Senior Vice President, AssistantGeneral Counsel and Assistant Secretary, James H. Spalding, is itsassistant secretary and our Executive Vice President, GeneralCounsel and Secretary, Ronald P. Soltman, is itssecretary.

               During fiscal 2002, Phyve Corporation reimbursed us approximately$169,000 for our full rental cost in connection with itsmonth-to-month occupancy of certain office space in ourheadquarters  not currently needed by us. In addition, infiscal 2002 Phyve paid us approximately $39,000 to reimburse us forour costs of its phone use while occupying such office

F-40
****
**Table of Contents**

space in our headquartersand for an allocation in respect of our cost of certain officeservices.  We currently expect to make a similar or greateramount of such payments to Phyve in fiscal 2003 and for Phyve to make a similar amount of such payments to us in fiscal2003.  Our Chairman & Chief Executive Officer, Charles N.Martin, Jr., owns approximately 16.9% of the outstanding commonstock and 11.6% of the outstanding preferred stock of Phyve and isthe non-executive chairman of its board of directors.  Certainof our other executive officers (Bruce F. Chafin, Robert E.Galloway, W. Lawrence Hough, James Johnston, Joseph D. Moore, KeithB. Pitts, Phillip W. Roe, Ronald P. Soltman, James H. Spalding, andAlan G. Thomas) own, in the aggregate, approximately 12.8% of itscommon stock and Messrs. Galloway, Johnston and Moore  own, inthe aggregate, approximately 0.5% of its outstanding preferredstock.  In addition, Mr. Spalding is its secretary and Mr.Soltman is its assistant secretary.

               During fiscal 2002, NetContent, Inc. reimbursed us approximately$87,000 for our full rental cost in connection with itsmonth-to-month occupancy of certain office space in ourheadquarters  not currently needed by us.  In addition,in fiscal 2002 NetContent paid us approximately $31,000 toreimburse us for our costs of its phone use while occupying suchoffice space in our headquarters and for an allocation in respectof our cost of certain office services.  We currently expectto make a similar or greater amount of such payments toNetContent  in fiscal 2003 and for NetContent  to make asimilar amount of such payments to us in fiscal 2003.  Our Chairman & Chief Executive Officer, Charles N. Martin, Jr.,owns 51% of the outstanding common stock of NetContent and is itsPresident and a member of its board of directors.  Two of ourother executive officers, Keith B. Pitts and James H. Spalding, own30% and 19%, respectively, of the outstanding common stock ofNetContent.  Additionally, Mr. Pitts is the Vice President& Treasurer of NetContent and a member of its board ofdirectors; and Mr. Spalding is the Vice President & Secretaryof NetContent and a member of its board of directors.

               On July 1, 2000, the Company purchased 100% of the outstandingstock of Trinity MedCare, Inc. from its nine shareholders. The shareholders of Trinity MedCare, Inc. included certain membersof management and directors of the Company.  These certainmembers of management and directors received approximately $457,000for their interests.

**13.         Segment Information**

               The Company’s acute care hospitals and related health carebusinesses are similar in their activities and economicenvironments in which they operate (i.e. urban markets). Accordingly, the Company’s reportable operating segmentsconsist of 1) acute care hospitals and related health carebusinesses, collectively, and 2) health plans consisting of MacNealHealth Providers, a contracting entity for MacNeal Hospital, andPhoenix Health Plan, a Medicaid managed health plan inArizona.  Prior to the acquisitions of these entities, theCompany determined that it did not have separately reportablesegments as defined under Statement of Financial AccountingStandards No. 131, *Disclosures about Segments of an Enterpriseand Related Information*.  The following table providesfinancial information by business segment for the years ended June30, 2000, 2001 and 2002.

F-41
****
**Table of Contents**

 

 

**For theyear ended June 30, 2000**

 

 

 

 

**HealthPlans**
** **
**AcuteCare Services**

** **

**Eliminations**

** **

**Consolidated**

 

 

 

 

*(Inthousands)*

 

 

Patient servicerevenues

 

$

―

 

 

$

285,355

 

 

$

3,531

 

 

$

288,886

 

Capitationpremiums

 

 

15,808

 

 

 

―

 

 

 

 

 

 

 

15,808

 

Inter-segmentrevenues

 

 

―

 

 

 

3,531

 

 

 

(3,531

)

 

 

―

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Totalrevenues

 

 

15,808

 

 

 

288,886

 

 

 

―

 

 

 

304,694

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Salaries andbenefits

 

 

1,157

 

 

 

145,310

 

 

 

―

 

 

 

146,467

 

Supplies

 

 

51

 

 

 

40,447

 

 

 

―

 

 

 

40,498

 

Medical claimsexpense

 

 

3,825

 

 

 

―

 

 

 

3,531

 

 

 

7,356

 

Provision for doubtfulaccounts

 

 

―

 

 

 

33,138

 

 

 

―

 

 

 

33,138

 

Other operating expenses -external

 

 

6,587

 

 

 

50,082

 

 

 

―

 

 

 

56,669

 

Operating expenses -inter-segment

 

 

3,531

 

 

 

―

 

 

 

(3,531

)

 

 

―

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Totaloperating expenses

 

15,151

 

 

268,977

 

 

 

―

 

 

284,128

 

** **

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    EBITDA(1)

 

 

657

 

 

 

19,909

 

 

 

―

 

 

 

20,566

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Depreciation andamortization

 

235

 

 

 

11,558

 

 

 

―

 

 

 

11,793

 

Interest, net

 

 

(59

)

 

 

8,890

 

 

 

―

 

 

 

8,831

 

Other (2)

 

 

―

 

 

 

1,272

 

 

 

―

 

 

 

1,272

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Income(loss) before income taxes

 

$

481

 

 

$

(1,811

)

 

$

―

 

 

$

(1,330

)

 

 

 

 

 

 

 

 

 

 

 

 

 

Segment assets

 

$

11,396

 

 

$

538,510

 

 

$

―

 

 

$

549,906

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Capitalexpenditures

 

$

1,407

 

$

12,882

 

 

$

―

 

 

$ 

14,289

 

 

 

 

 

 

 

 

 

 

 

 

 

 

____________________

(1)

EBITDA isdefined as income before interest expense (net of interest income),income taxes, depreciation, amortization, gain (loss) on sale ofassets, equity method income (loss), minority interests and debtextinguishment costs.

(2)

Otherexpenses include gain (loss) on sale of assets, equity methodincome (loss), minority interests and debt extinguishmentcosts.

F-42
****
**Table of Contents**

 

 

**For theyear ended June 30, 2001**

 

 

 

 

**HealthPlans**
** **
**AcuteCare Services**

** **

**Eliminations**

** **

**Consolidated**

 

 
**
 

 

*(Inthousands)*

 

 

Patient servicerevenues

 

$

―

 

 

$

596,047

 

 

$

16,653

 

 

$

612,700

 

Capitationpremiums

 

 

55,063

 

 

 

―

 

 

 

―

 

 

 

55,063

 

Inter-segmentrevenues

 

 

―

 

 

 

16,653

 

 

 

(16,653

)

 

 

―

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Totalrevenues

 

 

55,063

 

 

 

612,700

 

 

―

 

 

 

667,763

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Salaries andbenefits

 

 

3,794

 

 

 

319,823

 

 

 

―

 

 

 

323,617

 

Supplies

 

 

88

 

 

 

92,864

 

 

 

―

 

 

 

92,952

 

Medical claimsexpense

 

 

14,131

 

 

 

―

 

 

 

16,653

 

 

 

30,784

 

Provision for doubtfulaccounts

 

 

―

 

 

 

56,846

 

 

 

―

 

 

 

56,846

 

Other operating expenses -external

 

 

18,039

 

 

 

93,286

 

 

 

―

 

 

 

111,325

 

Operating expenses -inter-segment

 

 

16,653

 

 

 

―

 

 

 

(16,653

)

 

 

―

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Totaloperating expenses

 

 

52,705

 

 

 

562,819

 

 

 

―

 

 

 

615,524

 

** **

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    EBITDA(1)

 

 

2,358

 

 

 

49,881

 

 

 

―

 

 

 

52,239

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Depreciation andamortization

 

 

483

 

 

 

23,316

 

 

 

―

 

 

 

23,799

 

Interest, net

 

 

(370

)

 

 

16,928

 

 

 

―

 

 

 

16,558

 

Other (2)

 

 

―

 

 

 

1,211

 

 

 

―

 

 

 

1,211

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Incomebefore income taxes

 

$

2,245

 

 

$

8,426

 

 

$

―

 

 

$

10,671

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Segment assets

 

$

44,177

 

 

$

596,221

 

 

$

―

 

 

$

640,398

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Capitalexpenditures

 

$

―

 

$

26,566

 

 

$

―

 

 

$ 

26,566

 

 

 

 

 

 

 

 

 

 

 

 

 

 

____________________

(1)

EBITDA isdefined as income before interest expense (net of interest income),income taxes, depreciation, amortization, gain (loss) on sale ofassets, equity method income (loss), minority interests and debtextinguishment costs.

(2)

Otherexpenses include gain (loss) on sale of assets, equity methodincome (loss), minority interests and debt extinguishmentcosts.

F-43
****
**Table of Contents**

**For theyear ended June 30, 2002**

 

 

**HealthPlans**

**AcuteCare Services**

**Eliminations**

**Consolidated**

 

 
**
*(Inthousands)*

Patient servicerevenues

 

$

―

 

 

$

725,769

 

 

$

―

 

 

$

725,769

 

Capitationpremiums

 

184,801

―

―

184,801

 

Inter-segmentrevenues

 

 

―

26,242

(26,242

)

―

 

 

 

 

 

 

 

 

 

 

 

 

    Totalrevenues

 

 

184,801

752,011

(26,242

)

910,570

 

 

 

 

Salaries andbenefits

 

 

9,300

375,136

―

384,436

 

Supplies

 

 

169

115,956

―

116,125

 

Medical claimsexpense

 

 

132,005

―

―

132,005

 

Provision for doubtfulaccounts

 

 

―

53,253

―

53,253

Other operating expenses -external

 

 

4,137

148,594

―

152,731

 

Operating expenses -inter-segment

26,242

―

(26,242

)

―

 

 

 

 

 

 

 

 

 

 

    Totaloperating expenses

 

171,853

692,939

(26,242

)

838,550

    EBITDA(1)

 

 

12,948

59,072

―

72,020

 

Depreciation andamortization

 

1,548

27,961

―

29,509

 

Interest, net

 

 

1,171

25,515

―

26,686

 

Other (2)

 

 

―

6,171

―

6,171

 

 

 

 

 

 

 

 

 

 

 

    Income(loss) before income taxes

 

$

10,229

 

 

$

(575

)

 

$

―

 

 

$

9,654

 

 

 

 

 

 

 

 

 

 

Segment assets

 

$

49,165

 

 

$

802,779

 

$

―

 

 

$

851,944

 

 

 

 

 

 

 

 

 

 

 

Capitalexpenditures

 

$

1,690

 

$

33,382

 

$

―

 

$ 

35,072

 

 

 

 

 

 

 

 

 

 

 

____________________

(1)

EBITDA isdefined as income before interest expense (net of interest income),income taxes, depreciation, amortization, gain (loss) on sale ofassets, equity method income (loss), minority interests and debtextinguishment costs.

(2)

Otherexpenses include gain (loss) on sale of assets, equity methodincome (loss), minority interests and debt extinguishmentcosts.

F-44
****
**Table of Contents**

**14.         Comprehensive Income**

****

               The components of comprehensive income, net of related taxes (inthousands) follows.

 

 

 

**Yearended June 30**

 

 

 

**2001**

 

 

 

**2002**

 

 

 

Net income

 

$

10,160

 

 

$

6,777 

 

 

 

 

 

 

 

 

Cumulative effect ofchange in accounting principle - fair value of interest ratecollar

 

 

(164

)

 

 

164 

Net change in fair valueof interest rate collar

 

 

(1,590

)

 

 

1,590 

Amortization of transitionadjustment

 

 

100

 

 

 

(100)

 

 

 

 

 

 

Other comprehensiveloss

 

 

(1,654

)

 

 

1,654 

 

 

 

 

 

 

Comprehensiveincome

 

$

8,506

 

 

$

8,431 

 

 

 

 

 

 

               Accumulated other comprehensive loss, net of related taxes, at June30, 2001 is comprised of the adjusted fair value of the interestrate collar of approximately $1.7 million.

**15.         Subsequent Events**

               On August 13, 2002, the Company terminated its interest rate swapagreement resulting in a cash payment to the Company from Bank ofAmerica, N.A. of $5.5 million.  Approximately $5.3 million ofthe cash received represents the fair value of the swap as of thetermination date, net of interest accrued since the previoussettlement date.  The $5.3 million will be recorded as adeferred gain during fiscal 2003 and amortized as an offset tointerest expense using the effective interest method over theremaining life of the 9.75% Notes.

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****
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