**UNITED STATESSECURITIES AND EXCHANGE COMMISSION****WASHINGTON, D.C. 20549**

_______________**FORM 10-Q**_______________

| **(Mark One)** |       |                                                            |
|----------------|------------|-----------------------------------------------------------------|
| ** **     | ** ** | ** **                                                      |
| **x**          |       | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF**         |
|           | ** ** | **THE SECURITIES EXCHANGE ACT OF 1934**                         |
|           |       |                                                            |
|           | ** ** | **For the quarterly period ended December 31, 2009**            |
|           |       |                                                            |
|           |       | **OR**                                                          |
| ** **     | ** ** | ** **                                                      |
| o              | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF**        |
|           | ** ** | **THE SECURITIES EXCHANGE ACT OF 1934**                         |
|           |       |                                                            |
|           | ** ** | **For the transition period from ____________ to ____________** |

**Commission File Number: 333-71934**_______________
**VANGUARD HEALTH SYSTEMS, INC.******(Exact name of registrant as specified in its charter)

**Delaware**

**62-1698183**

*(State or other jurisdiction of incorporation or organization)*

* *

*(I.R.S. Employer Identification No.)*

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

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

          Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of the Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.)   Yeso   Noo 

          Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See thedefinitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filero

 

Accelerated Filero

Non-accelerated filerx

 

Smaller reporting companyo

          Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yeso   Nox          There were 749,104 shares of common stock outstanding as of February 2, 2010 (all of which are privately owned and not traded on a public market).

****
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**VANGUARD HEALTH SYSTEMS, INC.QUARTERLY REPORT ON FORM 10-QTABLE OF CONTENTS**

** **

** **

** **

**Page**

**PART I.**

 

**FINANCIAL INFORMATION**

 

 Item 1.

 

Financial Statements (unaudited):

 

 

 

Condensed Consolidated Balance Sheets as of June 30, 2009 and December 31, 2009

 

4

Condensed Consolidated Statements of Operations for the three and six months ended December 31, 2008 (as adjusted) and 2009

 

5

Condensed Consolidated Statement of Equity for the six months ended December 31, 2009

6

Condensed Consolidated Statements of Cash Flows for the six months ended December 31, 2008 (as adjusted) and 2009

 

7

 

 

Notes to Condensed Consolidated Financial Statements

 

8

 Item 2.

 

Management's Discussion and Analysis of Financial Condition and Results of Operations

32

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

52

Item 4.

 

Controls and Procedures

53

**PART II. **

 

**OTHER INFORMATION**

 

 Item 1

Legal Proceedings

54

Item 1A

Risk Factors

55

Item 4.

 

Submission of Matters to a Vote of Security Holders

 

73

Item 6.

 

Exhibits

 

73

 

 

Signature

 

74

 

Index to Exhibits

75

3
****
**PART IFINANCIAL INFORMATION**

**Item 1.    Financial Statements.**

**VANGUARD HEALTH SYSTEMS, INC.CONDENSED CONSOLIDATED BALANCE SHEETS(Unaudited)**

 

 

**June 30, 2009**

 

 

 

**December 31, 2009**

 

 

 

 

 

 

**ASSETS**

 

*(In millions, except share and per share amounts)*

 

 

Current assets:

 

 

 

 

 

 

 

 

   Cash and cash equivalents

$

308.2

 

$

358.0

 

   Restricted cash

1.9

21.9

   Accounts receivable, net of allowance for doubtful accounts of approximately       $121.5 and $69.9 at June 30, 2009 andDecember 31, 2009, respectively

275.3

 

288.6

 

   Inventories

48.3

 

50.1

 

   Deferred tax assets

29.6

 

13.2

   Prepaid expenses and other current assets

68.4

 

61.4

 

 

 

 

        Total current assets

731.7

 

793.2

 

Property, plant and equipment, net of accumulated depreciation

1,174.1

 

1,164.3

 

Goodwill

692.1

 

649.1

 

Intangible assets, net of accumulated amortization

54.6

 

50.6

 

Deferred tax assets, noncurrent

38.0

60.7

Investments in auction rate securities

21.6

21.6

Other assets

19.0

 

20.1

 

 

 

 

        Total assets

$

2,731.1

 

$

2,759.6

 

 

 

**LIABILITIES AND  EQUITY**

 

 

Current liabilities:

 

 

   Accounts payable

$

127.9

 

$

148.5

 

   Accrued salaries and benefits

133.9

121.5

   Accrued health plan claims

117.6

 

136.0

 

   Accrued interest

13.2

 

19.2

 

   Other accrued expenses and current liabilities

79.5

 

79.1

 

   Current maturities of long-term debt

8.0

 

8.0

 

 

 

 

        Total current liabilities

480.1

 

512.3

 

Professional and general liability and workers compensation reserves

76.7

83.0

Other liabilities

34.9

 

36.6

 

Long-term debt, less current maturities

1,543.6

 

1,545.6

 

Commitments and contingencies

Equity:

   Vanguard Health Systems, Inc. stockholders’ equity:

     Common Stock; $.01 par value, 1,000,000 shares authorized, 749,550 shares         issued and outstanding at June 30, 2009 andDecember 31, 2009

–

–

     Additional paid-in capital

651.3

654.2

     Accumulated other comprehensive loss

(6.8

)

(4.1

)

     Retained deficit

(56.7

)

(75.9

)

 

        Total Vanguard Health Systems, Inc. stockholders’ equity

587.8

574.2

   Non-controlling interests

8.0

7.9

 

        Total equity

595.8

582.1

        Total liabilities and equity

$

2,731.1

$

2,759.6

 

 

See accompanying notes.

4

**VANGUARD HEALTH SYSTEMS, INC.CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS(Unaudited)**

**Three months ended December 31,**

** **

**Six months ended December 31,**

 

**2008 (as adjusted, See Note 2)**

** **

**2009**

** **

**2008 (as adjusted, See Note 2)**

** **

**2009**
******
*(In millions)*

 

Patient service revenues

 

$

614.4

 

$

631.3

 

$

1,212.7

 

$

1,250.4

Premium revenues

 

 

178.2

212.3

298.9

416.6

 

 

      Total revenues

 

 

792.6

843.6

1,511.6

1,667.0

 

 

 

Costs and Expenses:

 

 

   Salaries and benefits (includes stock compensation       of $0.8, $1.0, $2.2 and $2.9, respectively)

 

 

302.7

324.5

595.3

638.9

   Health plan claims expense

 

 

140.7

170.8

227.7

331.8

   Supplies

 

 

112.8

114.8

224.6

225.8

   Provision for doubtful accounts

 

 

48.3

35.0

102.9

72.2

   Purchased services

 

 

40.3

44.7

81.7

92.3

   Non-income taxes

10.9

10.7

19.0

24.9

   Rents and leases

 

 

10.3

11.2

21.5

22.3

   Other operating expenses

 

 

48.9

49.1

99.4

109.2

   Depreciation and amortization

 

 

32.1

34.3

64.4

68.3

   Interest, net

 

 

28.6

27.5

57.3

54.7

   Impairment loss

–

43.1

–

43.1

   Other

 

 

1.0

1.5

0.8

2.6

 

 

 

Income (loss) from continuing operations before income taxes

 

 

16.0

(23.6

)

17.0

(19.1

)

Income tax benefit (expense)

 

 

(5.1

)

3.6

(5.3

)

1.7

 

 

 

Income (loss) from continuing operations

 

 

10.9

(20.0

)

11.7

(17.4

)

Income (loss) from discontinued operations, net of taxes

 

 

(0.1

)

0.1

0.9

(0.1

)

 

 

 

Net income (loss)

 

10.8

(19.9

)

12.6

(17.5

)

Less: Net income attributable to non-controlling interests

(0.7

)

(0.8

)

(1.6

)

(1.7

)

Net income (loss) attributable to Vanguard Health Systems,    Inc. stockholders

$

10.1

$

(20.7

)

$

11.0

$

(19.2

)

 

 

 

Amounts attributable to Vanguard Health Systems, Inc.    stockholders:

      Income (loss) from continuing operations, net of taxes

$

10.2

$

(20.8

)

$

10.1

$

(19.1

)

      Income (loss) from discontinued operations, net of taxes

(0.1

)

0.1

0.9

(0.1

)

Net income (loss) attributable to Vanguard Health    Systems, Inc. stockholders

$

10.1

$

(20.7

)

$

11.0

$

(19.2

)

 

 

 

 

See accompanying notes.

5

**VANGUARD HEALTH SYSTEMS, INC.CONDENSED CONSOLIDATED STATEMENT OF EQUITYSix months ended December 31, 2009(Unaudited)**

**Vanguard Health Systems, Inc. Stockholders**

 

 

 

**Common Stock**

 

 

 

**Additional Paid-In Capital**

 

 

 

**Accumulated Other Comprehensive Loss**

 

 

 

**Retained Deficit**

 

 

 

**Non- Controlling Interests**

 

 

 

**Total Equity**

**Shares**

 

 

 

**Amount**

*(In millions, except share amounts)*

Balance at June 30, 2009

749,550

$

–

$

651.3

$

(6.8

)

$

(56.7

)

$

8.0

$

595.8 

   Stock compensation (non-cash)

–

–

2.9

–

–

–

2.9 

   Distributions paid to non-controlling       interests

–

–

–

–

–

(1.8

)

(1.8)

   Comprehensive income (loss):

      Change in fair value of interest rate          swap (net of tax effect)

–

–

–

2.7

–

–

2.7 

     Net income (loss)

–

–

–

–

(19.2

)

1.7

(17.5)

 

 

 

     Total comprehensive income (loss)

2.7

(19.2

)

1.7

(14.8)

Balance atDecember 31, 2009

749,550

$

–

$

654.2

$

(4.1

)

$

(75.9

)

$

7.9

$

582.1

 

 

 

See accompanying notes

6

.

**VANGUARD HEALTH SYSTEMS, INC.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited)**

 

 

 

**Six months ended December 31, 2008 (as adjusted, See Note 2)**

** **

**               **

 

**Six months ended December 31, 2009**

 

 

 

 

 

 

 

 

 

 

 

*(In millions)*

**Operating activities:**

 

 

 

 

 

 

 

 

Net income (loss)

 

$

12.6

 

$

(17.5

)

Adjustments to reconcile net income (loss) to net cash provided by    operating activities:

 

 

 

 

 

 

   Loss (income) from discontinued operations, net of taxes

(0.9

)

0.1

   Depreciation and amortization

 

 

64.4

 

 

 

68.3

   Provision for doubtful accounts

 

 

102.9

 

 

 

72.2

   Deferred income taxes

 

1.6

 

(7.7

)

   Amortization of loan costs

 

 

2.6

 

 

 

2.9

   Accretion of principal on senior discount notes

 

10.6

 

 

5.8

   Loss (gain) on sale of assets

 

 

(2.1

)

 

 

0.4

   Stock compensation

 

 

2.2

 

 

 

2.9

   Non-cash realized holding loss on investments

0.6

–

   Impairment loss

–

43.1

   Changes in operating assets and liabilities:

 

 

 

 

 

 

      Accounts receivable

 

 

(103.6

)

 

 

(85.5

)

      Inventories

 

 

(1.3

)

 

 

(1.8

)

      Prepaid expenses and other current assets

 

 

2.1

 

 

5.2

      Accounts payable

 

 

4.4

 

 

20.6

      Accrued expenses and other liabilities

 

 

57.2

 

 

40.7

 

 

 

 

 

 

 

Net cash provided by operating activities – continuing operations

153.3

149.7

Net cash provided by (used in) operating activities – discontinued operations

0.9

(0.1

)

 

 

 

 

 

 

 

Net cash provided by operating activities

154.2

149.6

 

 

 

 

 

 

 

 

 

**Investing activities:**

 

 

 

 

 

 

 

 

Capital expenditures

 

 

(54.7

)

 

 

(68.4

)

Acquisitions

(3.6

)

(1.5

)

Proceeds from asset dispositions

 

 

4.0

 

 

 

1.4

Increase in restricted cash

–

(20.0

)

Other

 

 

(0.3

)

 

 

(0.3

)

 

 

 

 

 

 

 

Net cash used in investing activities

(54.6

)

(88.8

)

 

 

 

 

 

 

 

 

 

**Financing activities:**

 

 

 

 

 

 

 

 

Payments of long-term debt

 

 

(3.9

)

 

 

(3.8

)

Payments related to derivative instrument with financing element

–

(5.4

)

Distributions paid to non-controlling interests

(2.7

)

(1.8

)

 

 

 

 

 

 

 

Net cash used in financing activities

 

 

(6.6

)

 

 

(11.0

)

 

 

 

 

 

 

 

Net increase in cash and cash equivalents

 

 

93.0

 

 

49.8

Cash and cash equivalents, beginning of period

 

 

141.6

 

 

308.2

 

 

 

 

 

 

 

Cash and cash equivalents, end of period

 

$

234.6

 

 

$

358.0

 

 

 

 

 

 

 

Net cash paid for interest

 

$

45.1

 

$

41.9

 

 

 

 

 

 

 

Net cash paid (received) for income taxes

 

$

1.0

 

$

(13.2

)

 

 

 

 

 

 

 

 

See accompanying notes.

7

**VANGUARD HEALTH SYSTEMS, INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTSDecember 31, 2009(Unaudited)**

**1.     BUSINESS AND BASIS OF PRESENTATION**

**Business**

        Vanguard Health Systems, Inc. (“Vanguard”) is an investor-owned healthcare company whose affiliates own and operate hospitals and related healthcare businesses in urbanand suburban areas.  As of December 31, 2009, Vanguard’s affiliates owned and managed 15 acute care hospitals with 4,135 licensed beds and related outpatient service locations complementary to the hospitals providing healthcare services in San Antonio,Texas; metropolitan Phoenix, Arizona; metropolitan Chicago, Illinois; and Massachusetts. Vanguard also owns managed health plans in Chicago, Illinois and Phoenix, Arizona and two surgery centers in Orange County, California.

**Basis of Presentation**

        The accompanying unaudited condensed consolidated financial statements include the accounts of subsidiaries and affiliates controlled by Vanguard. Vanguard generally defines controlas the ownership of the majority of an entity’s voting interests. Vanguard also consolidates any entities for which it receives the majority of the entity’s expected returns or is at risk for the majority of the entity’s expected losses based uponits investment or financial interest in the entity. All material intercompany accounts and transactions have been eliminated. Since none of Vanguard’s common shares are publicly held, no earnings per share information is presented in the accompanying unauditedcondensed consolidated financial statements.  Certain prior year amounts from the accompanying condensed consolidated financial statements have been reclassified to conform to current year presentation. The majority of Vanguard’s expenses are “costof revenue” items. Costs that could be classified as general and administrative include certain Vanguard corporate office costs, which approximated $11.6 million, $17.1 million, $23.5 million and $33.9 million for the three and six months ended December 31,2008 and 2009, respectively.

        During the first quarter of fiscal 2010, Vanguard implemented its new uninsured discount policy in its Phoenix and San Antonio hospitals. The new policy applies to patients receivingservices in these hospitals who had no insurance coverage and who did not otherwise qualify for charity care under Vanguard’s guidelines. Under this policy, Vanguard applies an uninsured discount (calculated as a standard percentage of gross charges) at thetime of patient billing and includes this discount as a reduction to patient service revenues. These discounts were approximately $51.9 million and $112.9 million for the three months and six months ended December 31, 2009.

        The unaudited condensed consolidated financial statements as of December 31, 2009 and for the three and six months ended December 31, 2008, as adjusted (see Note 2), and 2009 havebeen prepared in conformity with accounting principles generally accepted in the United States for interim reporting and in accordance with Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of the information and notes required by accountingprinciples generally accepted in the United States for complete financial statements.  In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) necessary for afair presentation of the financial position and the results of operations for the periods presented.  The results of operations for the periods presented are not necessarily indicative of the expected results for the fiscal year ending June 30, 2010. The interimunaudited condensed consolidated financial statements should be read in connection with the audited consolidated financial statements as of and for the year ended June 30, 2009 included in Vanguard’s Current Report on Form 8-K filed with the Securities andExchange Commission on January 19, 2010.

        *Use of Estimates*

        In preparing Vanguard’s financial statements in conformity with accounting principles generally accepted in the United States, management makes estimates and assumptions thataffect the amounts recorded or classification of items in the unaudited condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

8

**2.     ADOPTION OF NEW ACCOUNTING STANDARDS**

        In June 2009, the Financial Accounting Standards Board (“FASB”) issued its Accounting Standards Codification (“ASC”) and modified the Generally AcceptedAccounting Principles (“GAAP”) hierarchy by establishing only two levels of GAAP, authoritative and nonauthoritative accounting literature. Effective July 2009, ASC is considered the single source of authoritative U.S. accounting and reporting standards,except for additional authoritative rules and interpretive releases issued by the SEC. Nonauthoritative guidance and literature would include, among other things, FASB Concepts Statements, American Institute of Certified Public Accountants Issue Papers and TechnicalPractice Aids and accounting textbooks. ASC was developed to organize GAAP pronouncements by topic so that users can more easily access authoritative accounting guidance. It is organized by topic, subtopic, section, and paragraph, each of which is identified by anumerical designation. This guidance became effective for Vanguard beginning in the first quarter for fiscal year ending June 30, 2010.

        Effective July 1, 2009, Vanguard adopted the transition guidance of accounting for non-controlling interests in consolidated financial statements.  The guidance establishes asingle method of accounting for non-controlling interests in subsidiaries and requires non-controlling interests in a subsidiary to be reported as a component of equity in the consolidated balance sheet subject to the guidance for distinguishing liabilities fromequity. The transition guidance also requires consolidated net income (loss) to include both the parent and non-controlling interest’s portion of the operating results of the subsidiary with separate disclosure on the income statement of the amountsattributable to the parent versus the non-controlling interest. The following describes the impact to Vanguard’s financial statements as of June 30, 2009 and December 31, 2009 and for the three and six months ended December 31, 2008 and 2009 related to theadoption of this guidance (Note, the presentation and disclosure requirements of the guidance discussed above were retrospectively applied in Vanguard’s Current Report on Form 8-K filed with the Securities and Exchange Commission on January 19,2010).

               •

 

Vanguard reclassified its minority interests in equity of consolidated entities from the liabilities section of its balance sheets to equity. This reclassification was $8.0 million as of June 30, 2009. Vanguard has onenon-controlling interest whose classification was included in mezzanine equity due to the existence of redemption features that are outside the control of Vanguard. However, the fair value of this non-controlling interest was zero (the maximum redemption value) as ofJune 30, 2009 and December 31, 2009.

 

 

 

               •

Net income attributable to non-controlling interests is no longer deducted to arrive at net income (loss). Instead, net income (loss) is attributed to the controlling and non-controlling interests in the condensed consolidatedstatements of operations. Accordingly, net income increased by $0.7 million and $1.6 million for the three and six months ended December 31, 2008 compared to net income previously reported for those periods.

 

 

 

               •

The payment of cash distributions to the entities holding the non-controlling interests are now reported as financing activities on the condensed consolidated statements of cash flows for the six months ended December 31, 2008and 2009 instead of being included in operating activities. These cash distributions were $2.7 million and $1.8 million for the six months ended December 31, 2008 and 2009, respectively.

9

**3.     RESTRICTED CASH**

**        The $21.9 million of restricted cash at December 31, 2009 is primarily comprised of $20.0 million in cash that Vanguard was required to deposit into an escrow account inVanguard’s name as security for a litigation-related agreement. Vanguard made this deposit to stay the execution of the judgment pending appeal for a professional and general liability case. Under the terms of the escrow agreement, Vanguard is restricted fromusing the cash for any other purpose until this case is resolved.
**4****.     FAIR VALUE MEASUREMENTS**

        Fair value is determined using assumptions that market participants would use to determine the price of the asset or liability as opposed to measurements determined based uponinformation specific to the entity holding those assets and liabilities. To determine those market participant assumptions, Vanguard considered the guidance for fair value measurements and disclosures, the hierarchy of inputs that the entity must consider includingboth independent market data inputs and the entity’s own assumptions about the market participant assumptions. This hierarchy is summarized as follows.

*Level 1*

               

Unadjusted quoted prices in active markets for identical assets and liabilities.

               

 

 

*Level 2*

 

Directly or indirectly observable inputs, other than quoted prices included in Level 1. Level 2 inputs may include, among others, interest rates and yield curves observable at commonly quoted intervals, volatilities, lossseverities, credit risks and other inputs that are derived principally from or corroborated by observable market data by correlation or other means.

 

 

 

*Level 3*

 

Unobservable inputs used when there is little, if any, market activity for the asset or liability at the measurement date. These inputs represent the entity’s own assumptions about the assumptions that marketparticipants would use to price the asset or liability developed using the best information available. 

        Vanguard’s policy is to recognize transfers between levels as of the actual date of the event, or change in circumstances, that caused the transfer.

        The following table summarizes Vanguard’s assets measured at fair value on a recurring basis as of December 31, 2009, aggregated by the fair value hierarchy level within whichthose measurements were made (in millions).

   

 

**Fair Value**

   

 

**Level 1 Inputs**

   

 

**Level 2 Inputs**

   

 

**Level 3 Inputs**

 

Assets:

 

 

Investments in auction rate securities

 

$

21.6

 

$

–

 

$

–

 

$

21.6

 

Liabilities:

Interest rate swap liability

 

$

2.6

 

$

–

 

$

2.6

 

$

–

 

 

 

 

 

 

 

 

 

 

        There was no significant change in the fair value measurements using significant Level 3 unobservable inputs from June 30, 2009 to December 31, 2009.

        *Auction Rate Securities*

        At December 31, 2009, Vanguard held $21.6 million in total available for sale investments in auction rate securities (“ARS”) backed by student loans, which are included ininvestments in auction rate securities on the accompanying condensed consolidated balance sheets. These ARS are accounted for as long-term available for sale securities. The par value of the ARS was $26.3 million at December 31, 2009. The ARS have maturity datesranging from 2039 to 2043 and are guaranteed by the U.S. government at approximately 96%-98% of the principal and accrued interest under the Federal Family Education Loan Program or other similar programs. Due to the lack of market liquidity and other observablemarket inputs for these ARS, Vanguard utilized Level 3 inputs to estimate the $21.6 million fair value of these ARS. Valuations from forced liquidations or distressed sales are inconsistent with the definition of fair value set forth in the pertinent accountingguidance, which assumes an orderly market. For its valuation estimate, management utilized a discounted cash flow analysis that included estimates of the timing of liquidation of these ARS and the impact of market risks on exit value. Vanguard does

10

not currently intend to sell and does not believe it is more likely than not it will be required to sell these ARS prior to liquidity returning to the market and their fair value recovering to par value.

        In September 2008, Vanguard received a tender offer for $10.0 million par value of ARS at 94% of par value. As a result of Vanguard’s acceptance of the tender offer and theother-than-temporary decline in fair value, Vanguard recorded a $0.6 million realized holding loss on these marketable securities during the quarter ended September 30, 2008, which is included in other expenses on the accompanying condensed consolidated statement ofoperations for the six months ended December 31, 2008. However, the tender offer contained certain conditions that were not met as of the December 2008 deadline, and the tender failed. As a result of the failed tender, all $21.6 million of ARS are presented aslong-term assets on the accompanying condensed consolidated balance sheets. In addition, Vanguard recorded temporary impairments of $4.1 million ($2.5 million, net of taxes) related to the ARS during the fiscal year ended June 30, 2009, which are included inaccumulated other comprehensive loss (“AOCL”) on the condensed consolidated balance sheets.

        *Interest Rate Swap Agreement*

        Vanguard enters into derivative instruments from time to time to manage the cash flows risk associated with the variable interest component of its outstanding term debt or to managethe fair value risk of its other debt instruments with fixed interest rates. Vanguard does not hold or issue derivative instruments for trading purposes and is not a party to any instrument with leverage features.

        During April 2008, Vanguard entered into an interest rate swap agreement with Bank of America, N.A. (the “counterparty”) that went into effect on June 30, 2008 for anotional $450.0 million of its outstanding term debt. Under this agreement and through March 31, 2009, Vanguard made or received net interest payments based upon the difference between the 90-day LIBOR rate and the swap fixed interest rate of 2.785%. Vanguardaccounted for this swap as a highly effective cash flow hedge with critical terms that substantially match the underlying term debt and measured any ineffectiveness using the hypothetical derivative method.

        In March 2009, Vanguard and the counterparty executed an amended swap agreement with the same terms and provisions as the original agreement except that after March 31, 2009, Vanguardwill make or receive net interest payments based upon the difference between the 30-day LIBOR rate and the swap fixed interest rate of 2.5775%. As a result of this amended swap agreement, Vanguard de-designated its existing cash flow hedge and re-designated theamended swap agreement as a hedge of the remaining interest payments associated with $450.0 million of Vanguard’s outstanding term debt. As the forecasted transactions (i.e. the future interest payments under Vanguard’s outstanding term debt) are stillprobable of occurring, Vanguard did not immediately recognize the AOCL balance related to the de-designated swap in earnings. Based on its assessment, Vanguard determined that this re-designated swap will be highly effective in offsetting the changes in cash flowsrelated to the hedged risk. Upon the execution of the amended swap agreement, Vanguard measured hedge ineffectiveness by comparing the fair value of the original swap agreement to a new hypothetical derivative using the amended terms to determine if the underlyingterm debt has been overhedged. Vanguard determined that the hedge ineffectiveness was not significant as of December 31, 2009. The valuation of the amended interest rate swap is based upon a discounted cash flows analysis that reflects the term of the agreement andan observable market-based input, the 30-day LIBOR interest rate curve, which is observable at commonly quoted intervals for the full term of the swap. Vanguard also considered potential credit adjustment risks related to its own performance and thecounterparty’s performance under the swap agreement. Management deemed the credit adjustment risks as Level 3 inputs. However, management determined that any potential credit adjustment risks were not significant and thus classified the entire interest rateswap valuation in Level 2 of the fair value hierarchy. Vanguard classified its $5.4 million of payments under the re-designated swap during the six months ended December 31, 2009 as financing activities in its condensed consolidated statement of cash flows due to thesignificant financing element present at the inception of the re-designated swap.

11

        The following tables provide information regarding the valuation and presentation of assets, liabilities and expenses related to this interest rate swap for the respective periods (inmillions).

 

 

 

**June 30, 2009**

 

        

**December 31, 2009**

 

 

 

 

 

**Interest rate swap contract:**

 

 

**Balance Sheet Location**

 

 

**Fair Value**

 

 

**Balance Sheet Location**

 

 

**Fair Value**

 

 

 

Gross valuation

 

Other accrued

 

 

 

 

Other accrued

 

 

 

 

 

 

expenses and

 

 

 

expenses and

 

 

current liabilities

$

(6.9

)

 

current liabilities

$

(2.6)

 

 

 

 

 

 

 

 

 

 

 

Tax effect

 

 

Deferred tax

Deferred tax

 

 

 

assets

2.6

assets

1.0  

 

 

 

 

 

 

 

 

Net liability balance offset to AOCL

 

 

 

 

$

(4.3

)

 

 

 

$

(1.6)

 

 

 

 

**Six months ended December 31, 2008**

** **

** **

**Six months ended December 31, 2009**

 

 
********
 

 

**Amount of gain (loss) recognized in AOCL on derivative**

** **

**Location of gain (loss) recognized on derivative- reclassified from AOCL**

** **

**Amount of gain (loss) recognized on derivative - reclassified from AOCL**

** **

** **

**Amount of gain (loss) recognized in AOCL on derivative**

**Location of gain (loss) recognized on derivative- reclassified from AOCL**

**Amount of gain (loss) recognized on derivative - reclassified from AOCL**

 

 
********
Interest rate swap contract, net of taxes

$

(8.1)

Interest, net

**$**

1.1

**$**

2.7

Interest, net

**$**

(5.4)

        The $1.6 million balance included in AOCL, net of taxes, is expected to be reclassified to net interest during the next fiscal quarter since the interest rate swap expires on March31, 2010. See Note 15 for subsequent developments related to the interest rate swap agreement.

*        Cash and Cash Equivalents and Restricted Cash*

        The carrying amounts reported for cash and cash equivalents and restricted cash approximate fair value because of the short-term maturity of these instruments.

       *Accounts Receivable and Accounts Payable*

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

        *Long-Term Debt*

        The fair values of Vanguard’s 9.0% Notes, and 11.25% Notes and term loans payable under Vanguard’s credit facility as of December 31, 2009 were approximately $597.3million, $227.9 million and $747.3 million, respectively, based upon stated market prices. The fair values are subject to change as market conditions change.

**5.     STOCK-BASED COMPENSATION**

        Vanguard has one stock-based compensation plan, the 2004 Stock Incentive Plan (“the 2004 Option Plan”). As of December 31, 2009, the 2004 Option Plan, as amended, allowsfor the issuance of up to 145,611 options to purchase common stock of Vanguard to its employees. The stock options may be granted as Liquidity Event Options, Time Options or Performance Options at the discretion of the Board. The Liquidity Event Options vest 100% atthe eighth anniversary of the date of grant and have an exercise price per share as determined by the Board or a committee thereof.  The Time Options vest 20% at each of the first five anniversaries of the date of grant and have an exercise price per share asdetermined by the Board or a committee thereof.  The Performance Options vest 20% at each of the first five anniversaries of the date of grant and have an exercise price equal to $3,000 per share or as determined by the Board or a committee thereof. The TimeOptions

12

and Performance Options immediately vest upon a change of control, while the Liquidity Event Options immediately vest only upon a qualifying Liquidity Event, as defined in the 2004 Option Plan. As of December 31, 2009, 116,167options were outstanding under the 2004 Option Plan. Vanguard recognized compensation expense related to the 2004 Option Plan of $0.8 million, $1.0 million, $2.2 million and $2.9 million during the three and six months ended December 31, 2008 and 2009,respectively.

**6****.     INTANGIBLE ASSETS**

        The following table provides information regarding the intangible assets, including deferred loan costs, included on the accompanying condensed consolidated balance sheets as of June30, 2009 and December 31, 2009 (in millions).

 

 

 

**Gross Carrying Amount**

 

        

**Accumulated Amortization**

 

 

 

 

 

**Class of Intangible Asset **

 

 

**June 30, 2009**

 

 

**December 31 2009**

 

 

**June 30, 2009**

 

 

**December 31, 2009**

 

 

 

 

 

 

 

Amortized intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

   Deferred loan costs

 

$

43.8

 

$

43.8

$

21.5

 

$

24.4

   Contracts

 

 

31.4

 

 

31.4

 

14.9

 

 

16.5

   Physician income and other guarantees

27.2

28.5

 

18.3

21.9

   Other

 

 

4.7

 

 

8.7

 

1.0

 

 

2.2

 

 

 

 

 

 

 

 

   Subtotal

107.1

112.4

 

55.7

65.0

Indefinite-lived intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

   License and accreditation

 

 

3.2

 

 

3.2

 

–

 

 

–

 

 

 

 

 

 

 

 

Total

$

110.3

$

115.6

$

55.7

$

65.0

 

 

        Amortization expense for contract-based intangibles and other intangible assets during the six months ended December 31, 2008 and 2009 was approximately $1.8 million and $2.8 million,respectively.

        Amortization of deferred loan costs of $2.6 million and $2.9 million during the six months ended December 31, 2008 and 2009, respectively, is included in net interest. Amortization of physician income and other guarantees of $2.9 million and $3.6 million during the six months ended December 31, 2008 and 2009, respectively, is included in purchased services or other operating expenses.

**7.     IMPAIRMENT OF GOODWILL AND LONG-LIVED ASSETS**

       Vanguard’s two Chicago hospitals have experienced deteriorating economic factors that have negatively impacted their results of operationsand cash flows. While various initiatives mitigated the impact of these economic factors in previous quarters, the operating results of the Chicago hospitals have not improved to the level anticipated. After having the opportunity to evaluate the operating results ofthe Chicago hospitals for the first six months of fiscal year 2010 and reassess the market trends and economic factors, Vanguard concluded that it was unlikely that previously projected cash flows for these hospitals would be achieved. Vanguard performed an interimgoodwill impairment test and, based upon revised projected cash flows, market participant data and appraisal information, Vanguard determined that the $43.1 million remaining goodwill related to this reporting unit of Vanguard’s acute care services segment wasimpaired. Vanguard recorded a $43.1 million ($31.8 million, net of taxes) non-cash impairment loss in the condensed consolidated statement of operations for the quarter ended December 31, 2009.

13

**8.     FINANCING ARRANGEMENTS**

        A summary of Vanguard’s long-term debt at June 30, 2009 and December 31, 2009 follows (in millions).

 

 

**June 30, 2009**

** **

 

** **

**December 31, 2009**

** **

 

 

 

 

 

 

9.0% Senior Subordinated Notes

$

575.0

$

575.0

11.25% Senior Discount Notes

210.2

216.0

Term loans payable under credit facility

766.4

762.6

 

 

1,551.6

1,553.6

Less: current maturities

(8.0

)

(8.0

)

 

$

1,543.6

$

1,545.6

**9.0% Notes**

        In connection with the acquisition of Vanguard by merger on September 23, 2004 by certain investment funds affiliated with The Blackstone Group L.P. (collectively“Blackstone”), two of Vanguard’s wholly owned subsidiaries, Vanguard Health Holding Company II, LLC and Vanguard Holding Company II, Inc. (collectively, the “Issuers”), completed a private placement of $575.0 million 9% SeniorSubordinated Notes due 2014 (“9.0% Notes”). Interest on the 9.0% Notes is payable semi-annually on October 1 and April 1 of each year. The 9.0% Notes are general unsecured senior subordinated obligations and rank junior in right of payment to all existingand future senior indebtedness of the Issuers. All payments on the 9.0% Notes are guaranteed jointly and severally on a senior subordinated basis by Vanguard and its domestic subsidiaries, other than those subsidiaries that do not guarantee the obligations of theborrowers under the senior credit facilities.

        On or after October 1, 2009, the Issuers may redeem all or part of the 9.0% Notes at various redemption prices given the date of redemption as set forth in the indenture governing the9.0% Notes.  The initial redemption price for the 9.0% Notes beginning on October 1, 2009 and ending September 30, 2010 is equal to 104.50% of their principal amount, plus accrued and unpaid interest.  The redemption price declines each year after 2009 onOctober 1 of each such year.  The redemption price will be 100% of the principal amount, plus accrued and unpaid interest, beginning on October 1, 2012. See Note 15 for subsequent developments related to the 9.0% Notes.

**11.25% Notes**

        In connection with the Blackstone merger on September 23, 2004, two of Vanguard’s wholly owned subsidiaries, Vanguard Health Holding Company I, LLC and Vanguard Holding CompanyI, Inc. (collectively, the “Discount Issuers”), completed a private placement of $216.0 million aggregate principal amount at maturity ($124.7 million in gross proceeds) of 11.25% Senior Discount Notes due 2015 (“11.25% Notes”). The 11.25%Notes accrete at the stated rate compounded semi-annually on April 1 and October 1 of each year to, but not including, October 1, 2009. From and after October 1, 2009, cash interest on the 11.25% Notes will accrue at 11.25% per annum, and will be payable on April 1and October 1 of each year, commencing on April 1, 2010 until maturity. The 11.25% Notes are general senior unsecured obligations and rank junior in right of payment to all existing and future senior indebtedness of the Discount Issuers but senior to any of theDiscount Issuers’ future senior subordinated indebtedness. All payments on the 11.25% Notes are guaranteed by Vanguard as a holding company guarantee.

        On or after October 1, 2009, the Discount Issuers may redeem all or a part of the 11.25% Notes at various redemption prices given the date of redemption as set forth in the indenturegoverning the 11.25% Notes. The initial redemption price for the 11.25% Notes beginning on October 1, 2009 and ending September 30, 2010 is equal to 105.625% of their principal amount, plus accrued and unpaid interest. The redemption price declines each year after2009 on October 1 of each such year. The redemption price will be 100% of the principal amount, plus accrued and unpaid interest, beginning on October 1, 2012. See Note 15 for subsequent developments related to the 11.25% Notes.

14

**Credit Facility Debt**

        In connection with the Blackstone merger on September 23, 2004, two of Vanguard’s wholly owned subsidiaries, Vanguard Health Holding Company II, LLC and Vanguard Holding CompanyII, Inc. (collectively, the “Co-borrowers”), entered into new senior secured credit facilities (the “merger credit facilities”) with various lenders and Bank of America, N.A. as administrative agent and Citicorp North America, Inc. assyndication agent, and repaid all amounts outstanding under its previous credit facility. The merger credit facilities include a seven-year term loan facility in the aggregate principal amount of $800.0 million and a six-year $250.0 million revolving creditfacility.

        On September 26, 2005, the Co-borrowers refinanced and repriced all $795.7 million of the then outstanding term loans under the merger credit facilities by borrowing $795.7 million ofreplacement term loans that also mature on September 23, 2011 (the “2005 term loan facility”). In addition, upon the occurrence of certain events, the Co-borrowers may request an incremental term loan facility to be added to the 2005 term loan facility inan amount not to exceed $300.0 million in the aggregate, subject to receipt of commitments by existing lenders or other financing institutions and to the satisfaction of certain other conditions. The revolving credit facility under the merger credit facilities didnot change in connection with the term loan refinancing. As of December 31, 2009, $762.6 million of indebtedness was outstanding under the 2005 term loan facility. Vanguard’s remaining borrowing capacity under the revolving credit facility, net of letters ofcredit outstanding, was $219.8 million as of December 31, 2009.

        The 2005 term loan facility borrowings bear interest at a rate equal to, at Vanguard’s option, LIBOR plus 2.25% per annum or a base rate plus 1.25% per annum. As discussed inNote 4, $450.0 million of the term loan facility borrowings are subject to a fixed interest rate of 4.8275% per annum under the terms of an interest rate swap agreement that expires on March 31, 2010. The interest rate applicable to the unhedged portion ofVanguard’s term loan facility borrowings was approximately 2.5% as of December 31, 2009. Borrowings under the revolving credit facility currently bear interest at a rate equal to, at Vanguard’s option, LIBOR plus 2.0% per annum or a base rate plus 1.0%per annum, subject to an increase of up to 0.50% per annum should Vanguard’s leverage ratio increase over certain designated levels. Vanguard also pays a commitment fee to the lenders under the revolving credit facility in respect of unutilized commitmentsthereunder at a rate equal to 0.50% per annum. Vanguard also pays customary letter of credit fees under this facility. Vanguard makes quarterly principal payments equal to one-fourth of one percent of the outstanding principal balance of the 2005 term loan facilityand will continue to make such payments until maturity of the term debt.

        Obligations under the credit agreement are unconditionally guaranteed by Vanguard and Vanguard Health Holding Company I, LLC (“VHS Holdco I”) and, subject to certainexceptions, each of VHS Holdco I’s wholly-owned domestic subsidiaries (the “U.S. Guarantors”). Obligations under the credit agreement are also secured by substantially all of the assets of Vanguard Health Holding Company II, LLC (“VHS HoldcoII”) and the U.S. Guarantors including a pledge of 100% of the membership interests of VHS Holdco II, 100% of the capital stock of substantially all U.S. Guarantors (other than VHS Holdco I) and 65% of the capital stock of each of VHS Holdco II’s non-U.S.subsidiaries that are directly owned by VHS Holdco II or one of the U.S. Guarantors and a security interest in substantially all tangible and intangible assets of VHS Holdco II and each U.S. Guarantor. See Note 15 for subsequent developments related to the 2005 termloan facility and the $250.0 million revolving credit facility.

**Interest Rate Swap Agreement**

        In March 2009, Vanguard and Bank of America N.A. (“the counterparty”) executed an amended swap agreement with the same terms and provisions as the original agreementexcept that after March 31, 2009, Vanguard will make or receive net interest payments based upon the difference between the 30-day LIBOR rate and the swap fixed interest rate of 2.5775% (see Note 4). Given the turbulence in the credit markets and the attractive swaprates then available, Vanguard amended the swap agreement to hedge its cash flows related to a portion of the 2005 term loan facility against potential market fluctuations to the variable 30-day LIBOR interest rate. Vanguard will continue to make its normal quarterlyinterest payments under the 2005 term loan facility as described above. Vanguard deems the counterparty to be creditworthy.  As of June 30, 2009 and December 31, 2009, the estimated fair value of the interest rate swap was a liability for Vanguard ofapproximately $6.9 million ($4.3 million net of taxes of $2.6 million) and $2.6 million ($1.6 million net of taxes of $1.0 million), respectively. The swap liabilities are included in other accrued expenses and current liabilities and accumulated other comprehensiveloss on the accompanying condensed consolidated balance sheets. The swap matures on March 31, 2010. See Note 15 for subsequent developments related to the interest rate swap agreement.

15

**9.     INCOME TAXES**

        Significant components of the provision for income taxes from continuing operations are as follows (in millions).

 

 

 

**Six months ended**

 

 

 

 

 

**December 31, 2008**

 

 

 

**December 31, 2009**

 

Current: 

 

 
****
 

 

 

 

   Federal

 

$

2.5

$

5.1

   State

 

 

1.2

 

0.9

 

 

Total current

 

 

3.7

 

 

 

6.0

 

 

 

 

 

 

 

Deferred:

 

 

 

 

 

 

   Federal

 

 

3.8

 

(8.0

)

   State

 

 

(7.5

)

 

(1.6

)

 

Total deferred

 

 

(3.7

)

 

(9.6

)

Change in valuation allowance

 

 

5.3

 

 

 

1.9

 

 

 

 

   Total income tax expense (benefit)

 

$

5.3

 

$

(1.7

)

 

 

 

 

 

 

 

        The effective income tax rate differed from the federal statutory rate for the periods presented as follows:

 

 

**Six months ended**

 

 

 

 

**December 31, 2008**

 

 

**December 31, 2009**

 

 

 

 

 

Income tax at federal statutory rate

 

35.0

%

 

35.0

%

Income tax at state statutory rate

(7.9

)

 

5.4

Nondeductible expenses and other

 

6.4

 

(2.8

)

Book income of consolidated partnerships attributable to    noncontrolling interests

(3.2

)

3.1

Nondeductible impairment loss

–

(21.9

)

Change in valuation allowance

0.9

(9.9

)

 

 

 

 

 

Effective income tax rate

 

31.2

%

 

8.9

%

 

 

 

 

 

        As of December 31, 2009, Vanguard had generated net operating loss (“NOL”) carryforwards for federal income tax and state income tax purposes of approximately $12.0million and $558.0 million, respectively. The remaining federal and state NOL carryforwards expire from 2030 to 2031 and 2010 to 2031, respectively.

        Vanguard’s U.S. federal income tax returns for tax years 2005 and subsequent years remain subject to examination by the Internal Revenue Service.

16

**10.  COMPREHENSIVE INCOME (LOSS)**

        Comprehensive income (loss) consists of two components: net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) refers to revenues, expenses, gainsand losses that under the guidance related to accounting for comprehensive income are recorded as elements of equity but are excluded from net income (loss). The following table presents the components of comprehensive income (loss), net of taxes, for the three andsix month periods ended December 31, 2008 and 2009 (in millions).

 

 

 

**Three months ended December 31, 2008**

 

 

**Three months ended December 31, 2009**

 

 

**Six months ended December 31, 2008**

 

 

**Six months ended December 31, 2009**

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

10.8

$

(19.9)

 

$

12.6 

$

(17.5)

Change in fair value of interest rate swap

 

 

(11.9

)

 

2.6 

 

 

(13.1)

 

4.3 

Change in unrealized holding losses on auction rate securities

 

 

(0.2

)

 

– 

 

 

(0.9)

 

– 

Change in income tax (expense) benefit

4.5

(1.0)

5.0 

(1.6)

 

 

 

 

 

 

 

 

 

      Comprehensive income (loss)

 

$

3.2

$

(18.3)

 

$

3.6

$

(14.8)

 

 

 

 

 

 

 

 

 

        The components of accumulated other comprehensive loss, net of taxes, as of June 30, 2009 and December 31, 2009 are as follows (in millions).

 

 

 

**June 30, 2009**

 

               

**December 31, 2009**

 

 

 

 

 

 

 

Fair value of interest rate swap

 

$

(6.9

)

$

(2.6

)

Unrealized holding loss on investments in auction rate securities

 

 

(4.1              

)

 

(4.1

)

Income tax benefit

4.2

2.6

 

 

   Accumulated other comprehensive loss

 

$

(6.8

)

$

(4.1

)

 

 

 

 

 

 

**11.  RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS**

        In January 2010, the FASB issued guidance requiring additional information to be disclosed principally in respect of Level 3 fair value measurements and transfers to and from Level 1and Level 2 measurements. In addition, enhanced disclosures are required concerning inputs and valuation techniques used to determine Level 2 and Level 3 fair value measurements.  The new disclosures and clarifications of existing disclosures are effective forthe quarter ending March 31, 2010, with the effective date for additional Level 3 related disclosures effective for periods beginning after December 15, 2010. Vanguard does not expect the adoption to significantly impact its financial position, results of operations,or cash flows.

        In September 2009, the FASB issued additional guidance concerning the manner in which fair value of liabilities should be determined. Previous guidance defined the fair value of aliability as the price that would be paid to transfer the liability in an orderly transaction between market participants at the measurement date. The new guidance amends these criteria by specifically addressing valuation techniques, liabilities traded as assets,and quoted prices in an active market. The new guidance was effective for Vanguard’s quarter ended December 31, 2009. Vanguard does not expect the adoption to significantly impact its financial position, results of operations or cash flows.

17

**12.  SEGMENT INFORMATION**

        Vanguard’s acute care hospitals and related healthcare businesses are similar in their activities and the economic environments in which they operate (i.e. urban markets). Accordingly, Vanguard’s reportable operating segments consist of 1) acute care hospitals and related healthcare businesses, collectively, and 2) health plans consisting of MacNeal Health Providers, a contracting entity for outpatient services provided byMacNeal Hospital and Weiss Memorial Hospital and participating physicians in the Chicago area, Phoenix Health Plan, a Medicaid managed health plan operating in Arizona, and Abrazo Advantage Health Plan, a Medicare and Medicaid dual eligible managed health planoperating in Arizona.

        The following tables provide unaudited condensed financial information by business segment for the three and six month periods ended December 31, 2008 and 2009, including areconciliation of Segment EBITDA to income (loss) from continuing operations before income taxes (in millions).

 

 

**Three months ended December 31, 2008**

** **

**Three months ended December 31, 2009**

 

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

 

**Acute Care Services**

** **

**Health Plans**

** **

**Eliminations**

** **

**Consolidated**

** **

**Acute Care Services**

** **

**Health Plans**

** **

**Eliminations**

** **

**Consolidated**

 

 
********
Patient service revenues (1)

$

614.4

$

–

$

–

$

614.4

$

631.3

$

–

$

–

$

631.3

Premium revenues

–

178.2

–

178.2

–

212.3

–

212.3

Inter-segment revenues

7.8

–

(7.8

)

–

10.4

–

(10.4

)

–

 

      Total revenues

622.2

178.2

(7.8

)

792.6

641.7

212.3

(10.4

)

843.6

 

Salaries and benefits       (excludes stock compensation)

294.6

7.3

–

301.9

315.2

8.3

–

323.5

 

Health plan claims expense (1)

–

140.7

–

140.7

–

170.8

–

170.8

 

Supplies

112.7

0.1

–

112.8

114.7

0.1

–

114.8

 

Provision for doubtful accounts

48.3

–

–

48.3

35.0

–

–

35.0

 

Other operating expenses - external

101.0

9.4

–

110.4

107.7

8.0

–

115.7

Operating Expenses – inter-segment

–

7.8

(7.8

)

–

–

10.4

(10.4

)

–

 

      Total operating expenses

556.6

165.3

(7.8

)

714.1

572.6

197.6

(10.4

)

759.8

 

      Segment EBITDA (2)

65.6

12.9

–

78.5

69.1

14.7

–

83.8

 

Less:

  Interest, net

28.9

(0.3

)

–

28.6

27.6

(0.1

)

–

27.5

  Depreciation and amortization

31.1

1.0

–

32.1

33.1

1.2

–

34.3

  Equity method income

(0.3

)

–

–

(0.3

)

(0.3

)

–

–

(0.3

)

  Stock compensation

0.8

–

–

0.8

1.0

–

–

1.0

  Impairment loss

–

–

–

–

43.1

–

–

43.1

  Loss disposal of assets

–

–

–

–

0.4

–

–

0.4

  Monitoring fees and expenses

1.3

–

–

1.3

1.4

–

–

1.4

 

      Income (loss) from continuing          operations before income taxes

$

3.8

$

12.2

$

–

$

16.0

$

(37.2

)

$

13.6

$

–

$

(23.6

)

 

      Capital expenditures

$

36.5

$

0.6

$

–

$

37.1

$

34.2

$

0.4

$

–

$

34.6

 

18

 

 

**Six months ended December 31, 2008**

** **

**Six months ended December 31, 2009**

 

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

 

**Acute Care Services**

** **

**Health Plans**

** **

**Eliminations**

** **

**Consolidated**

** **

**Acute Care Services**

** **

**Health Plans**

** **

**Eliminations**

** **

**Consolidated**

 

 
********
Patient service revenues (1)

$

1,212.7

$

–

$

–

$

1,212.7

$

1,250.4

$

–

$

–

$

1,250.4

Premium revenues

–

298.9

–

298.9

–

416.6

–

416.6

Inter-segment revenues

17.3

–

(17.3

)

–

21.0

–

(21.0

)

–

 

      Total revenues

1,230.0

298.9

(17.3

)

1,511.6

1,271.4

416.6

(21.0

)

1,667.0

 

Salaries and benefits       (excludes stock compensation)

578.6

14.5

–

593.1

619.2

16.8

–

636.0

 

Health plan claims expense (1)

–

227.7

–

227.7

–

331.8

–

331.8

 

Supplies

224.4

0.2

–

224.6

225.7

0.1

–

225.8

 

Provision for doubtful accounts

102.9

–

–

102.9

72.2

–

–

72.2

 

Other operating expenses - external

204.3

17.3

–

221.6

230.9

17.8

–

248.7

Operating Expenses – inter-segment

–

17.3

(17.3

)

–

–

21.0

(21.0

)

–

 

      Total operating expenses

1,110.2

277.0

(17.3

)

1,369.9

1,148.0

387.5

(21.0

)

1,514.5

 

      Segment EBITDA (2)

119.8

21.9

–

141.7

123.4

29.1

–

152.5

 

Less:

  Interest, net

58.4

(1.1

)

–

57.3

55.0

(0.3

)

–

54.7

  Depreciation and amortization

62.4

2.0

–

64.4

66.1

2.2

–

68.3

  Equity method income

(0.3

)

–

–

(0.3

)

(0.5

)

–

–

(0.5

)

  Stock compensation

2.2

–

–

2.2

2.9

–

–

2.9

  Impairment loss

–

–

–

–

43.1

–

–

43.1

  Loss (gain) on disposal of assets

(2.1

)

–

–

(2.1

)

0.4

–

–

0.4

  Realized holding loss on investments

0.6

–

–

0.6

–

–

–

–

  Monitoring fees and expenses

2.6

–

–

2.6

2.7

–

–

2.7

 

      Income (loss) from continuing          operations before income taxes

$

(4.0

)

$

21.0

$

–

$

17.0

$

(46.3

)

$

27.2

$

–

$

(19.1

)

 

Capital expenditures

$

53.8

$

0.9

$

–

$

54.7

$

68.0

$

0.4

$

–

$

68.4

Segment assets

$

2,492.8

$

165.3

$

–

$

2,658.1

$

2,559.9

$

199.7

$

–

$

2,759.6

____________________

(1)

 

Vanguard eliminates in consolidation those patient service revenues earned by its hospitals and related healthcare facilities attributable to services provided to enrollees in its owned health plans and also eliminates thecorresponding medical claims expenses incurred by the health plans for those services.

 

 

 

(2)

 

Segment EBITDA is defined as income (loss) from continuing operations before income taxes less interest expense (net of interest income), depreciation and amortization, equity method income, stock compensation, gain or loss ondisposal of assets, realized holding losses on investments, monitoring fees and expenses, debt extinguishment costs and impairment losses. Management uses Segment EBITDA to measure performance for Vanguard’s segments and to develop strategic objectives andoperating plans for those segments. Segment EBITDA eliminates the uneven effect of non-cash depreciation of tangible assets and amortization of intangible assets, much of which results from acquisitions accounted for under the purchase method of accounting. SegmentEBITDA also eliminates the effects of changes in interest rates which management believes relate to general trends in global capital markets, but are not necessarily indicative of the operating performance of Vanguard’s segments. Management believes thatSegment EBITDA provides useful information about the financial performance of Vanguard’s segments to investors, lenders, financial analysts and rating agencies. Additionally, management believes that investors and lenders view Segment EBITDA as an importantfactor in making investment decisions and assessing the value of Vanguard. Segment EBITDA is not a substitute for net income, operating cash flows or other cash flow statement data determined in accordance with accounting principles generally accepted in the UnitedStates.  Segment EBITDA, as presented, may not be comparable to similarly titled measures of other companies.

**13.  COMMITMENTS AND CONTINGENCIES**

        Management evaluates contingencies based upon the best available information and believes that adequate provision for potential losses associated with contingencies has been made. Inmanagement’s opinion, based on current available

19

information, these commitments described below will not have a material effect on Vanguard’s results of operations or financial position, but the capital commitments could have an effect on the timing of Vanguard’scash flows, including its need to borrow available amounts under its revolving credit facility.

**Capital Expenditure Commitments**

        Vanguard currently has multiple capital projects underway including significant advanced clinical system upgrades.  As of December 31, 2009, Vanguard estimated its remainingcommitments to complete capital projects in process to be approximately $21.5 million.

**Insurance Risks**

        Given the nature of its operating environment, Vanguard is subject to professional and general liability claims and related lawsuits in the ordinary course of business. Forprofessional and general liability claims incurred from June 1, 2002 to May 31, 2006, Vanguard’s wholly owned captive subsidiary insured its risks at a $10.0 million retention level. For claims incurred subsequent to May 31, 2006, Vanguard self-insures thefirst $9.0 million per claim, and the captive subsidiary insures the next $1.0 million per claim. Vanguard’s captive subsidiary maintains excess coverage from independent third party insurers on a claims-made basis for individual claims exceeding $10.0 millionup to $75.0 million, but limited to total annual payments of $65.0 million in the aggregate. Vanguard self-insures its workers compensation claims up to $1.0 million per claim and purchases excess insurance coverage for claims exceeding $1.0 million. During the sixmonths ended December 31, 2009, Vanguard increased its professional and general liability reserve by $8.0 million ($5.0 million, net of taxes) and reduced its workers compensation reserve by $3.5 ($2.2 million, net of taxes) million for changes in claims developmentrelated to prior years.

**Patient Service Revenues**

        Settlements under reimbursement agreements with third party payers are estimated during the period the related services are provided, but final settlements are typically not knownuntil future periods. There is at least a reasonable possibility that recorded estimates will change by a material amount when final settlements are known. Differences between original estimates and subsequent revisions (including final settlements) are included inthe condensed consolidated income statements in the period in which the revisions are made.  Management believes that adequate provision has been made for adjustments that may result from final determination of amounts earned under the Medicare and Medicaidprograms and other managed care plans with settlement provisions. Net adjustments for final third party settlements positively impacted Vanguard’s income (loss) from continuing operations before income taxes by $0.3 million and $4.5 million for the three monthsended December 31, 2008 and 2009 and by $3.9 million and $4.5 million for the six months ended December 31, 2008 and 2009, respectively. Vanguard recorded $22.9 million and $20.7 million of charity care deductions during the three months ended December 31, 2008 and2009, respectively. Vanguard recorded $48.4 million and $43.2 million of charity care deductions during the six months ended December 31, 2008 and 2009, respectively.

**Governmental Regulation**

        Laws and regulations governing the Medicare, Medicaid and other federal healthcare programs are complex and subject to interpretation.  Vanguard’s management believes thatit is in compliance with all applicable laws and regulations in all material respects. However, compliance with such laws and regulations can be subject to future government review and interpretation as well as significant regulatory action including fines,penalties, and exclusion from the Medicare, Medicaid and other federal healthcare programs. Vanguard is not aware of any material regulatory proceeding or investigation underway or threatened involving allegations of potential wrongdoing.

**Acquisitions**

        Vanguard has acquired and will continue to acquire businesses with prior operating histories.  Acquired companies may have unknown or contingent liabilities, includingliabilities for failure to comply with healthcare laws and regulations, such as billing and reimbursement, anti-kickback and physician self-referral laws. Although Vanguard institutes policies designed to conform practices to its standards following completion ofacquisitions and attempts to structure its acquisitions as asset acquisitions in which Vanguard does not assume liability for seller wrongful actions, there can be no assurance that Vanguard will not become liable for past activities that may later be alleged to beimproper by private plaintiffs or government

20

agencies.  Although Vanguard obtains general indemnifications from sellers covering such matters, there can be no assurance that any specific matter will be covered by such indemnifications, or if covered, that suchindemnifications will be adequate to cover potential losses and fines.

**Guarantees**

*        Physician Guarantees*

**

        In the normal course of its business, Vanguard enters into physician relocation agreements under which it guarantees minimum monthly income, revenues or collections or guaranteesreimbursement of expenses up to maximum limits to physicians during a specified period of time (typically, 12 months to 36 months). In return for the guarantee payments, the physicians are required to practice in the community for a stated period of time (typically,3 to 4 years) or else return the guarantee payments to Vanguard. Accounting for minimum revenue guarantees requires that a liability be recorded at fair value for all guarantees entered into on or after January 1, 2006. Vanguard determines this liability and anoffsetting intangible asset by calculating an estimate of expected payments to be made over the guarantee period. Vanguard reduces the liability as it makes guarantee payments and amortizes the intangible asset over the term of the physicians’ relocationagreements. Vanguard also estimates the fair value of liabilities and offsetting intangible assets related to payment guarantees for physician service agreements for which no repayment provisions exist. As of December 31, 2009, Vanguard had a net intangible asset of$6.6 million and a remaining liability of $1.7 million related to these physician income and service guarantees. The maximum amount of Vanguard’s unpaid physician income and service guarantees as of December 31, 2009 was approximately $3.6 million.

        *Other Guarantees*

        As part of its contract with the Arizona Health Care Cost Containment System, one of Vanguard’s health plans, Phoenix Health Plan, is required to maintain a performanceguarantee, the amount of which is based upon Plan membership and capitation premiums received.  As of December 31, 2009, Vanguard maintained this performance guarantee in the form of $50.0 million of surety bonds with independent third party insurerscollateralized by letters of credit of approximately $5.0 million.

**14.  FINANCIAL INFORMATION FOR SUBSIDIARY GUARANTORS AND        NON-GUARANTOR SUBSIDIARIES**

        Vanguard conducts substantially all of its business through its subsidiaries. Most of Vanguard’s subsidiaries jointly and severally guarantee the 9.0% Notes on an unsecuredsenior subordinated basis. Certain of Vanguard’s other consolidated wholly-owned and non wholly-owned entities do not guarantee the 9.0% Notes in conformity with the provisions of the indenture governing the 9.0% Notes and do not guarantee Vanguard’ssenior secured credit facilities in conformity with the provisions thereof. The condensed consolidating financial information for the parent company, the issuers of the 9.0% Notes, the issuers of the 11.25% Notes, the subsidiary guarantors, the non-guarantorsubsidiaries, certain eliminations and consolidated Vanguard as of June 30, 2009 and December 31, 2009 and for the three and six months ended December 31, 2008 and 2009 follows.

21

**VANGUARD HEALTH SYSTEMS, INC.CONDENSED CONSOLIDATING BALANCE SHEETSJune 30, 2009(Unaudited)**

 

 

**Parent**

 

**Issuers of 9.0% Notes**

 

**Issuers of 11.25% Notes**

 

**Guarantor Subsidiaries**

 

**Combined Non-Guarantors**

 

**Eliminations**

 

**Total Consolidated**

 

 

**ASSETS**

 

*(In millions)*

Current assets:

 

 

               

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

–

 

 

$

–

 

 

$

–

 

 

$

168.3

 

 

$

139.9

 

 

$

–

 

 

$

308.2

 

Restricted cash

 

 

–

 

 

 

–

 

 

 

–

 

 

 

0.2

 

 

 

1.7

 

 

 

–

 

 

 

1.9

 

Accounts receivable, net

 

 

–

 

 

 

–

 

 

 

–

 

 

 

257.0

 

 

 

18.3

 

 

 

–

 

 

 

275.3

 

Inventories

 

 

–

 

 

 

–

 

 

 

–

 

 

 

44.5

 

 

 

3.8

 

 

 

–

 

 

 

48.3

 

Prepaid expenses and other current assets

 

 

2.5

 

 

 

–

 

 

 

–

 

 

 

94.9

 

 

 

34.6

 

 

 

(34.0

)

 

 

98.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

        Total current assets

 

 

2.5

 

 

 

–

 

 

 

–

 

 

 

564.9

 

 

 

198.3

 

 

 

(34.0

)

 

 

731.7

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property, plant and equipment, net

 

 

–

 

 

 

–

 

 

 

–

 

 

 

1,114.7

 

 

 

59.4

 

 

 

–

 

 

 

1,174.1

 

Goodwill

 

 

–

 

 

 

–

 

 

 

–

 

 

 

608.5

 

 

 

83.6

 

 

 

–

 

 

 

692.1

 

Intangible assets, net

 

 

–

 

 

 

19.4

 

 

 

2.9

 

 

 

13.5

 

 

 

18.8

 

 

 

–

 

 

 

54.6

 

Investments in consolidated subsidiaries

 

 

608.8

 

 

 

–

 

 

 

–

 

 

 

–

 

 

 

24.5

 

 

 

(633.3

)

 

 

–

 

Investments in auction rate securities

–

–

–

–

21.6

21.6

Other assets

 

 

–

 

 

 

–

 

 

 

–

 

 

 

56.8

 

 

 

0.2

 

 

 

–

 

 

 

57.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

        Total assets

 

$

611.3

 

 

$

19.4

 

 

$

2.9

 

 

$

2,358.4

 

 

$

406.4

 

 

$

(667.3

)

 

$

2,731.1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**LIABILITIES AND EQUITY**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

–

 

 

$

–

 

 

$

–

 

 

$

112.7

 

 

$

15.2

 

 

$

–

 

 

$

127.9

 

Accrued expenses and other current    liabilities

 

 

–

 

 

 

20.0

 

 

 

–

 

 

 

201.9

 

 

 

122.3

 

 

 

–

 

 

344.2

 

Current maturities of long-term debt

 

 

–

 

 

 

8.0

 

 

 

–

 

 

 

(0.2

)

 

 

0.2

 

 

 

–

 

 

 

8.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

        Total current liabilities

 

 

–

 

 

 

28.0

 

 

 

–

 

 

 

314.4

 

 

 

137.7

 

 

 

–

 

 

480.1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other liabilities

 

 

–

 

 

 

–

 

 

 

–

 

 

 

71.9

 

 

 

73.7

 

 

 

(34.0

)

 

 

111.6

 

Long-term debt, less current maturities

 

 

–

 

 

 

1,333.4

 

 

 

210.2

 

 

 

–

 

 

 

–

 

 

 

–

 

 

 

1,543.6

 

Intercompany

 

 

15.5

 

 

 

(810.4

)

 

 

(120.9

)

 

 

1,314.8

 

 

 

(60.1

)

 

 

(338.9

)

 

 

–

 

Equity

 

 

595.8

 

 

 

(531.6

)

 

 

(86.4

)

 

 

657.3

 

 

 

255.1

 

 

 

(294.4

)

 

 

595.8

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

        Total liabilities and equity

 

$

611.3

 

 

$

19.4

 

 

$

2.9

 

 

$

2,358.4

 

 

$

406.4

 

 

$

(667.3

)

 

$

2,731.1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

22
****
**VANGUARD HEALTH SYSTEMS, INC.CONDENSED CONSOLIDATING BALANCE SHEETSDecember 31, 2009(Unaudited)**

 

 

**Parent**

 

**Issuers of 9.0% Notes**

 

**Issuers of 11.25% Notes**

 

**Guarantor Subsidiaries**

 

**Combined Non-Guarantors**

 

**Eliminations**

 

**Total Consolidated**

 

 

**ASSETS**

 

*(In millions)*

Current assets:

 

 

               

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

–

 

 

$

–

 

 

$

–

 

 

$

257.0

 

 

$

101.0

 

 

$

–

 

$

358.0

 

Restricted cash

 

 

–

 

 

 

–

 

 

 

–

 

 

 

20.2

 

 

 

1.7

 

 

 

–

 

 

21.9

 

Accounts receivable, net

 

 

–

 

 

 

–

 

 

 

–

 

 

 

268.5

 

 

 

20.1

 

 

 

–

 

 

288.6

 

Inventories

 

 

–

 

 

 

–

 

 

 

–

 

 

 

46.0

 

 

 

4.1

 

 

 

–

 

 

50.1

 

Prepaid expenses and other current assets

 

 

0.9

 

 

 

–

 

 

 

–

 

 

 

65.4

 

 

 

25.2

 

 

 

(16.9

)

 

 

74.6

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

        Total current assets

 

 

0.9

 

 

 

–

 

 

 

–

 

 

 

657.1

 

 

 

152.1

 

 

 

(16.9

)

 

 

793.2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property, plant and equipment, net

 

 

–

 

 

 

–

 

 

 

–

 

 

 

1,106.3

 

 

 

58.0

 

 

 

–

 

 

1,164.3

 

Goodwill

 

 

–

 

 

 

–

 

 

 

–

 

 

 

565.5

 

 

 

83.6

 

 

 

–

 

 

649.1

 

Intangible assets, net

 

 

–

 

 

 

16.7

 

 

 

2.8

 

 

 

14.1

 

 

 

17.0

 

 

 

–

 

 

50.6

 

Investments in consolidated subsidiaries

 

 

608.8

 

 

 

–

 

 

 

–

 

 

 

–

 

 

 

24.5

 

 

 

(633.3

)

 

 

–

 

Investments in auction rate securities

–

–

–

–

21.6

–

21.6

Other assets

 

 

–

 

 

 

–

 

 

 

–

 

 

 

80.6

 

 

 

0.2

 

 

 

–

 

 

80.8

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

        Total assets

 

$

 609.7

 

 

$

16.7

 

 

$

2.8

 

 

$

2,423.6

 

 

$

357.0

 

 

$

(650.2

)

 

$

2,759.6

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**LIABILITIES AND EQUITY**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

–

 

 

$

–

 

 

$

–

 

 

$

126.2

 

$

22.3

 

$

–

 

 

$

148.5

 

Accrued expenses and other current    liabilities

 

 

–

 

 

 

15.7

 

 

 

6.1

 

 

 

192.0

 

 

142.0

 

 

 

–

 

 

355.8

 

Current maturities of long-term debt

 

 

–

 

 

 

8.0

 

 

 

–

 

 

 

(0.2

)

 

 

0.2

 

 

 

–

 

 

 

8.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

        Total current liabilities

 

 

–

 

 

 

23.7

 

 

 

6.1

 

 

318.0

 

 

 

164.5

 

 

–

 

 

512.3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other liabilities

 

 

–

 

 

 

–

 

 

–

 

 

74.8

 

 

 

61.7

 

 

(16.9

)

 

 

119.6

 

Long-term debt, less current maturities

 

 

–

 

 

 

1,329.6

 

 

216.0

 

 

–

 

 

 

–

 

 

–

 

 

1,545.6

 

Intercompany

 

 

27.6

 

 

 

(760.4

)

 

 

(120.8

)

 

 

1,362.6

 

 

 

(138.5

)

 

 

(370.5

)

 

 

–

 

Equity

 

 

582.1

 

 

 

(576.2

)

 

 

(98.5

)

 

 

668.2

 

 

269.3

 

 

(262.8

)

 

 

582.1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

        Total liabilities and equity

 

$

609.7

 

 

$

16.7

 

 

$

2.8

 

 

$

2,423.6

 

 

$

357.0

 

 

$

(650.2

)

 

$

2,759.6

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

23

**VANGUARD HEALTH SYSTEMS, INC.CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONSFor the three months ended December 31, 2008(Unaudited)**

 

 

**Parent**

 

**Issuers of 9.0% Notes**

 

**Issuers of 11.25% Notes**

 

**Guarantor Subsidiaries**

 

**Combined Non-Guarantors**

 

**Eliminations**

 

**Total Consolidated**

 

 

 

 

*(In millions)*

 

 

 

               

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Patient service revenues

 

$

–

 

 

$

–

 

 

$

–

 

 

$

579.6

 

 

$

39.8

 

 

$

(5.0

)

 

$

614.4

 

Premium revenues

 

 

–

 

 

 

–

 

 

 

–

 

 

 

14.9

 

 

 

163.3

 

 

 

–

 

 

 

178.2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

        Total revenues

 

 

–

 

 

 

–

 

 

 

–

 

 

 

594.5

 

 

 

203.1

 

 

 

(5.0

)

 

 

792.6

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Salaries and benefits

 

 

0.8

 

 

 

–

 

 

 

–

 

 

 

280.8

 

 

 

21.1

 

 

 

–

 

 

 

302.7

 

Health plan claims expense

 

 

–

 

 

 

–

 

 

 

–

 

 

 

8.7

 

 

 

137.0

 

 

 

(5.0

)

 

 

140.7

 

Supplies

 

 

–

 

 

 

–

 

 

 

–

 

 

 

104.4

 

 

 

8.4

 

 

 

–

 

 

 

112.8

 

Provision for doubtful accounts

 

 

–

 

 

 

–

 

 

 

–

 

 

 

45.7

 

 

 

2.6

 

 

 

–

 

 

 

48.3

 

Purchased services

 

 

–

 

 

 

–

 

 

 

–

 

 

 

36.8

 

 

 

3.5

 

 

 

–

 

 

 

40.3

 

Other operating expenses

 

 

–

 

 

 

–

 

 

 

–

 

 

 

50.4

 

 

 

9.4

 

 

 

–

 

 

 

59.8

 

Rents and leases

 

 

–

 

 

 

–

 

 

 

–

 

 

 

9.0

 

 

 

1.3

 

 

 

–

 

 

 

10.3

 

Depreciation and amortization

 

 

–

 

 

 

–

 

 

 

–

 

 

 

28.5

 

 

 

3.6

 

 

 

–

 

 

 

32.1

 

Interest, net

 

 

–

 

 

 

24.5

 

 

 

5.5

 

 

 

(1.8

)

 

 

0.4

 

 

 

–

 

 

 

28.6

 

Management fees

 

 

–

 

 

 

–

 

 

 

–

 

 

 

(3.5

)

 

 

3.5

 

 

 

–

 

 

 

–

 

Other

 

 

–

 

 

 

–

 

 

 

–

 

 

 

1.0

 

 

 

–

 

 

 

–

 

 

 

1.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

        Total costs and expenses

 

 

0.8

 

 

 

24.5

 

 

 

5.5

 

 

 

560.0

 

 

 

190.8

 

 

 

(5.0

)

 

 

776.6

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations    before income taxes

 

 

(0.8

)

 

 

(24.5

)

 

 

(5.5

)

 

 

34.5

 

 

 

12.3

 

 

 

–

 

 

 

16.0

Income tax benefit (expense)

 

(5.1

)

 

 

–

 

 

 

–

 

 

 

–

 

 

 

(2.5

)

 

 

2.5

 

 

(5.1

)

Equity in earnings of subsidiaries

 

 

16.0

 

 

 

–

 

 

 

–

 

 

 

–

 

 

 

–

 

 

 

(16.0

)

 

 

–

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

 

 

10.1

 

 

 

(24.5

)

 

 

(5.5

)

 

 

34.5

 

 

 

9.8

 

 

 

(13.5

)

 

 

10.9

Income (loss) from discontinued    operations, net of taxes

 

 

–

 

 

 

–

 

 

 

–

 

 

 

(0.4

)

 

 

0.3

 

 

–

 

 

 

(0.1

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

10.1

 

 

(24.5

)

 

(5.5

)

 

34.1

 

 

10.1

 

 

(13.5

)

 

10.8

 

Less: Net income attributable to non-    controlling interests

–

–

–

(0.7

)

–

–

(0.7

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) attributable to Vanguard    Health Systems, Inc. stockholders

$

10.1

$

(24.5

)

$

(5.5

)

$

33.4

$

10.1

$

(13.5

)

$

10.1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

24

**VANGUARD HEALTH SYSTEMS, INC.CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONSFor the three months ended December 31, 2009(Unaudited)**

 

 

**Parent**

 

**Issuers of 9.0% Notes**

 

**Issuers of 11.25% Notes**

 

**Guarantor Subsidiaries**

 

**Combined Non-Guarantors**

 

**Eliminations**

 

**Total Consolidated**

 

 

 

 

*(In millions)*

 

 

 

               

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Patient service revenues

 

$

–

 

 

$

–

 

$

–

 

 

$

592.8

 

 

$

45.4

 

 

$

(6.9

)

 

$

631.3

 

Premium revenues

 

 

–

 

 

 

–

 

 

 

–

 

 

 

15.2

 

 

 

204.9

 

 

 

(7.8

)

 

 

212.3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

        Total revenues

 

 

–

 

 

 

–

 

 

 

–

 

 

 

608.0

 

 

250.3

 

 

 

(14.7

)

 

 

843.6

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Salaries and benefits

 

 

1.0

 

 

 

–

 

 

 

–

 

 

 

299.3

 

 

24.2

 

 

 

–

 

 

324.5

 

Health plan claims expense

 

 

–

 

 

 

–

 

 

 

–

 

 

 

8.2

 

 

169.5

 

 

 

(6.9

)

 

 

170.8

 

Supplies

 

 

–

 

 

–

 

 

 

–

 

 

 

106.1

 

 

8.7

 

 

 

–

 

 

114.8

 

Provision for doubtful accounts

 

 

–

 

 

 

–

 

 

 

–

 

 

 

33.3

 

 

1.7

 

 

 

–

 

 

35.0

 

Purchased services

 

 

–

 

 

 

–

 

 

 

–

 

 

 

39.0

 

 

5.7

 

 

 

–

 

 

44.7

 

Other operating expenses

 

 

0.1

 

 

 

–

 

 

 

–

 

 

 

52.5

 

 

15.0

 

 

 

(7.8

)

 

 

59.8

 

Rents and leases

 

 

–

 

 

 

–

 

 

 

–

 

 

 

9.4

 

 

1.8

 

 

 

–

 

 

11.2

 

Depreciation and amortization

 

 

–

 

 

 

–

 

 

 

–

 

 

 

31.3

 

 

3.0

 

 

 

–

 

 

34.3

 

Interest, net

 

 

–

 

 

 

22.3

 

 

 

6.3

 

 

 

(2.0

)

 

 

0.9

 

 

 

–

 

 

27.5

 

Management fees

 

 

–

 

 

 

–

 

 

 

–

 

 

 

(4.2

)

 

 

4.2

 

 

 

–

 

 

–

 

Impairment loss

–

–

–

43.1

–

–

43.1

Other

 

 

–

 

 

 

–

 

 

 

–

 

 

 

1.5

 

 

–

 

 

 

–

 

 

1.5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

        Total costs and expenses

 

 

1.1

 

 

 

22.3

 

 

 

6.3

 

 

 

617.5

 

 

 

234.7

 

 

 

(14.7

)

 

 

867.2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations    before income taxes

 

 

(1.1

)

 

 

(22.3

)

 

 

(6.3

)

 

 

(9.5

)

 

 

15.6

 

 

 

–

 

 

(23.6

)

Income tax benefit (expense)

 

3.6

 

 

–

 

 

 

–

 

 

 

–

 

 

 

(6.1

)

 

 

6.1

 

 

3.6

Equity in earnings of subsidiaries

 

 

(23.2

)

 

 

–

 

 

 

–

 

 

 

–

 

 

 

–

 

 

 

23.2

 

 

–

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

 

 

(20.7

)

 

 

(22.3

)

 

 

(6.3

)

 

 

(9.5

)

 

 

9.5

 

 

 

29.3

 

 

(20.0

)

Income (loss) from discontinued    operations, net of taxes

 

 

–

 

 

 

–

 

 

 

–

 

 

0.1

 

 

–

 

 

–

 

 

 

0.1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

(20.7

)

 

(22.3

)

 

(6.3

)

 

(9.4

)

 

9.5

 

 

29.3

 

(19.9

)

Less:  Net income attributable to non-    controlling interests

–

–

–

(0.8

)

–

–

(0.8

)

Net income (loss) attributable to Vanguard    Health Systems, Inc. stockholders

$

(20.7

)

$

(22.3

)

$

(6.3

)

$

(10.2

)

$

9.5

$

29.3

$

(20.7

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

****

25
****
**VANGUARD HEALTH SYSTEMS, INC.CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONSFor the six months ended December 31, 2008(Unaudited)**

 

 

**Parent**

 

**Issuers of 9.0% Notes**

 

**Issuers of 11.25% Notes**

 

**Guarantor Subsidiaries**

 

**Combined Non-Guarantors**

 

**Eliminations**

 

**Total Consolidated**

 

 

 

 

*(In millions)*

 

 

 

               

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Patient service revenues

 

$

–

 

 

$

–

 

 

$

–

 

 

$

1,143.4

 

 

$

81.0

 

 

$

(11.7

)

 

$

1,212.7

 

Premium revenues

 

 

–

 

 

 

–

 

 

 

–

 

 

 

30.2

 

 

 

268.8

 

 

 

(0.1

)

 

 

298.9

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

        Total revenues

 

 

–

 

 

 

–

 

 

 

–

 

 

 

1,173.6

 

 

 

349.8

 

 

 

(11.8

)

 

 

1,511.6

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Salaries and benefits

 

 

2.2

 

 

 

–

 

 

 

–

 

 

 

549.1

 

 

 

44.0

 

 

 

–

 

 

 

595.3

 

Health plan claims expense

 

 

–

 

 

 

–

 

 

 

–

 

 

 

17.3

 

 

 

222.1

 

 

 

(11.7

)

 

 

227.7

 

Supplies

 

 

–

 

 

 

–

 

 

 

–

 

 

 

208.8

 

 

 

15.8

 

 

 

–

 

 

 

224.6

 

Provision for doubtful accounts

 

 

–

 

 

 

–

 

 

 

–

 

 

 

97.9

 

 

 

5.0

 

 

 

–

 

 

 

102.9

 

Purchased services

 

 

–

 

 

 

–

 

 

 

–

 

 

 

74.6

 

 

 

7.1

 

 

 

–

 

 

 

81.7

 

Other operating expenses

 

 

0.1

 

 

 

–

 

 

 

–

 

 

 

100.3

 

 

 

18.1

 

 

 

(0.1

)

 

 

118.4

 

Rents and leases

 

 

–

 

 

 

–

 

 

 

–

 

 

 

18.2

 

 

 

3.3

 

 

 

–

 

 

 

21.5

 

Depreciation and amortization

 

 

–

 

 

 

–

 

 

 

–

 

 

 

57.2

 

 

 

7.2

 

 

 

–

 

 

 

64.4

 

Interest, net

 

 

–

 

 

 

49.1

 

 

 

10.7

 

 

 

(2.9

)

 

 

0.4

 

 

 

–

 

 

 

57.3

 

Management fees

 

 

–

 

 

 

–

 

 

 

–

 

 

 

(7.0

)

 

 

7.0

 

 

 

–

 

 

 

–

 

Other

 

 

–

 

 

 

–

 

 

 

–

 

 

 

0.2

 

 

 

0.6

 

 

 

–

 

 

 

0.8

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

        Total costs and expenses

 

 

2.3

 

 

 

49.1

 

 

 

10.7

 

 

 

1,113.7

 

 

 

330.6

 

 

 

(11.8

)

 

 

1,494.6

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations    before income taxes

 

 

(2.3

)

 

 

(49.1

)

 

 

(10.7

)

 

 

59.9

 

 

 

19.2

 

 

 

–

 

 

 

17.0

Income tax benefit (expense)

 

(5.3

)

 

 

–

 

 

 

–

 

 

 

–

 

 

 

(6.7

)

 

 

6.7

 

 

(5.3

)

Equity in earnings of subsidiaries

 

 

18.6

 

 

–

 

 

 

–

 

 

 

–

 

 

 

–

 

 

 

(18.6

)

 

 

–

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

 

 

11.0

 

 

(49.1

)

 

 

(10.7

)

 

 

59.9

 

 

 

12.5

 

 

 

(11.9

)

 

 

11.7

Income from discontinued operations,    net of taxes

 

 

–

 

 

 

–

 

 

 

–

 

 

 

0.5

 

 

0.4

 

 

–

 

 

 

0.9

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

11.0

 

(49.1

)

 

(10.7

)

 

60.4

 

 

12.9

 

 

(11.9

)

 

12.6

Less: Net income attributable to non-    controlling interests

–

–

–

(1.6

)

–

–

(1.6

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) attributable to Vanguard    Health Systems, Inc. stockholders

$

11.0

$

(49.1

)

$

(10.7

)

$

58.8

$

12.9

$

(11.9

)

$

11.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

26
****
**VANGUARD HEALTH SYSTEMS, INC.CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONSFor the six months ended December 31, 2009(Unaudited)**

 

 

**Parent**

 

**Issuers of 9.0% Notes**

 

**Issuers of 11.25% Notes**

 

**Guarantor Subsidiaries**

 

**Combined Non-Guarantors**

 

**Eliminations**

 

**Total Consolidated**

 

 

 

 

*(In millions)*

 

 

 

               

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Patient service revenues

 

$

–

 

 

$

–

 

 

$

–

 

 

$

1,173.2

 

 

$

90.6

 

 

$

(13.4

)

 

$

1,250.4

 

Premium revenues

 

 

–

 

 

 

–

 

 

 

–

 

 

 

30.6

 

 

 

401.5

 

 

 

(15.5

)

 

 

416.6

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

        Total revenues

 

 

–

 

 

 

–

 

 

 

–

 

 

 

1,203.8

 

 

492.1

 

 

 

(28.9

)

 

 

1,667.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Salaries and benefits

 

 

2.9

 

 

 

–

 

 

 

–

 

 

 

587.7

 

 

48.3

 

 

 

–

 

 

638.9

 

Health plan claims expense

 

 

–

 

 

 

–

 

 

 

–

 

 

 

16.3

 

 

328.9

 

 

 

(13.4

)

 

 

331.8

 

Supplies

 

 

–

 

 

 

–

 

 

 

–

 

 

 

208.6

 

 

17.2

 

 

 

–

 

 

225.8

 

Provision for doubtful accounts

 

 

–

 

 

 

–

 

 

 

–

 

 

 

68.1

 

 

4.1

 

 

 

–

 

 

72.2

 

Purchased services

 

 

–

 

 

 

–

 

 

 

–

 

 

 

81.3

 

 

11.0

 

 

 

–

 

 

92.3

 

Other operating expenses

 

 

0.1

 

 

 

–

 

 

 

–

 

 

 

117.0

 

 

32.5

 

 

 

(15.5

)

 

 

134.1

 

Rents and leases

 

 

–

 

 

 

–

 

 

 

–

 

 

 

18.6

 

 

3.7

 

 

 

–

 

 

22.3

 

Depreciation and amortization

 

 

–

 

 

 

–

 

 

 

–

 

 

 

61.6

 

 

6.7

 

 

 

–

 

 

68.3

 

Interest, net

 

 

–

 

 

 

44.6

 

 

 

12.1

 

 

 

(3.6

)

 

 

1.6

 

 

 

–

 

 

54.7

 

Management fees

 

 

–

 

 

 

–

 

 

 

–

 

 

 

(8.5

)

 

 

8.5

 

 

 

–

 

 

–

 

Impairment loss

–

–

–

43.1

–

–

43.1

Other

 

 

–

 

 

 

–

 

 

 

–

 

 

 

2.6

 

 

–

 

 

 

–

 

 

2.6

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

        Total costs and expenses

 

 

3.0

 

 

 

44.6

 

 

 

12.1

 

 

 

1,192.8

 

 

 

462.5

 

 

 

(28.9

)

 

 

1,686.1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations    before income taxes

 

 

(3.0

)

 

 

(44.6

)

 

 

(12.1

)

 

 

11.0

 

 

 

29.6

 

 

 

–

 

 

(19.1

)

Income tax benefit (expense)

 

1.7

 

 

–

 

 

 

–

 

 

 

–

 

 

 

(10.4

)

 

 

10.4

 

 

1.7

Equity in earnings of subsidiaries

 

 

(17.9

)

 

 

–

 

 

 

–

 

 

 

–

 

 

 

–

 

 

 

17.9

 

 

–

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

 

 

(19.2

)

 

 

(44.6

)

 

 

(12.1

)

 

 

11.0

 

 

 

19.2

 

 

 

28.3

 

 

(17.4

)

Loss from discontinued operations,    net of taxes

 

 

–

 

 

 

–

 

 

 

–

 

 

(0.1

)

 

 

–

 

 

–

 

 

 

(0.1

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

(19.2

)

 

(44.6

)

 

(12.1

)

 

10.9

 

 

19.2

 

 

28.3

 

(17.5

)

Less:  Net income attributable to non-    controlling interests

–

–

–

(1.7

)

–

–

(1.7

)

Net income (loss) attributable to Vanguard    Health Systems, Inc. stockholders

$

(19.2

)

$

(44.6

)

$

(12.1

)

$

9.2

$

19.2

$

28.3

$

(19.2

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

27
****
**VANGUARD HEALTH SYSTEMS, INC.CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWSFor the six months ended December 31, 2008(Unaudited)**

 

 

**Parent**

 

**Issuers of 9.0% Notes**

 

**Issuers of 11.25% Notes**

 

**Guarantor Subsidiaries**

 

**Combined Non-Guarantors**

 

**Eliminations**

 

**Total Consolidated**

 

 

 

 

*(In millions)*

 

 

               

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**Operating activities:**

 

Net income (loss)

 

$

11.0

 

$

(49.1

)

 

$

(10.7

)

 

$

60.4

 

 

$

12.9

 

 

$

(11.9

)

 

$

12.6

Adjustments to reconcile net income    (loss) to net cash provided by (used in)    operating activities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from discontinued

   operations, net of taxes

–

–

–

(0.5

)

(0.4

)

–

(0.9

)

Depreciation and amortization

 

 

–

 

 

 

–

 

 

 

–

 

 

 

57.2

 

 

 

7.2

 

 

 

–

 

 

 

64.4

 

Provision for doubtful accounts

 

 

–

 

 

 

–

 

 

 

–

 

 

 

97.9

 

 

 

5.0

 

 

 

–

 

 

 

102.9

 

Deferred income taxes

 

 

1.6

 

 

–

 

 

 

–

 

 

 

–

 

 

 

–

 

 

 

–

 

 

1.6

Amortization of loan costs

 

 

–

 

 

 

2.5

 

 

 

0.1

 

 

 

–

 

 

 

–

 

 

 

–

 

 

2.6

 

Accretion of principal on senior discount

   notes

 

 

–

 

 

 

–

 

 

 

10.6

 

 

 

–

 

 

 

–

 

 

 

–

 

 

 

10.6

 

Gain on disposal of assets

 

 

–

 

 

 

–

 

 

 

–

 

 

 

(2.1

)

 

 

–

 

 

–

 

 

(2.1

)

Stock compensation

 

 

2.2

 

 

 

–

 

 

 

–

 

 

 

–

 

 

 

–

 

 

 

–

 

 

 

2.2

 

Realized loss on investments

–

–

–

–

0.6

–

0.6

Changes in operating assets and liabilities,    net of effects of acquisitions:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Equity in earnings of subsidiaries

 

 

(18.6

)

 

 

–

 

 

 

–

 

 

 

–

 

 

–

 

 

18.6

 

 

–

 

    Accounts receivable

 

 

–

 

 

 

–

 

 

 

–

 

 

 

(97.3

)

 

 

(6.3

)

 

 

–

 

 

 

(103.6

)

    Inventories

–

–

–

(1.1

)

(0.2

)

–

(1.3

)

    Prepaid expenses and other current        assets

 

 

–

 

 

 

–

 

 

 

–

 

 

 

(1.7

)

 

 

3.8

 

 

 

–

 

 

 

2.1

    Accounts payable

 

–

 

 

–

 

 

–

 

 

0.7

 

3.7

 

 

–

 

4.4

    Accrued expenses and other liabilities

 

 

3.8

 

 

 

8.5

 

 

 

–

 

 

 

30.8

 

 

 

24.3

 

 

(10.2

)

 

 

57.2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by (used in) operating    activities - continuing operations

 

 

–

 

 

(38.1

)

 

 

–

 

 

 

144.3

 

 

 

50.6

 

 

 

(3.5

)

 

 

153.3

Net cash provided by operating activities -    discontinued operations

–

–

–

0.5

0.4

–

0.9

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by (used in)    operating activities

–

(38.1

)

–

144.8

51.0

(3.5

)

154.2

 

**Investing activities:**

 

 

Capital expenditures

 

 

–

–

–

(51.2

)

(3.5

)

–

(54.7

)

Acquisitions

 

 

–

–

–

(3.6

)

–

–

(3.6

)

Proceeds from asset dispositions

 

 

–

–

–

4.0

–

–

4.0

Other

 

–

–

–

–

(0.3

)

–

(0.3

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash used in investing activities

–

–

–

(50.8

)

(3.8

)

–

(54.6

)

28

**VANGUARD HEALTH SYSTEMS, INC.CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWSFor the six months ended December 31, 2008(Unaudited)(continued)**

 

 

**Parent**

 

**Issuers of 9.0% Notes**

 

**Issuers of 11.25% Notes**

 

**Guarantor Subsidiaries**

 

**Combined Non-Guarantors**

 

**Eliminations**

 

**Total Consolidated**

 

 

 

 

*(In millions)*

 

 

               

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**Financing activities:**

Payments of long-term debt

$

–

$

(3.9

)

$

–

$

–

$

–

$

–

$

(3.9

)

Distributions paid to non-controlling    interests

–

–

–

–

(6.2

)

3.5

(2.7

)

Cash provided by (used in) intercompany    activity

–

42.0

–

11.0

(53.0

)

–

–

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by (used in) financing     activities

–

38.1

–

11.0

(59.2

)

3.5

(6.6

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net increase (decrease) in cash and cash    equivalents

–

–

–

105.0

(12.0

)

–

93.0

Cash and cash equivalents, beginning of    period

–

–

–

82.0

59.6

–

141.6

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents, end of period

$

–

$

–

$

–

$

187.0

$

47.6

$

–

$

234.6

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

29

**VANGUARD HEALTH SYSTEMS, INC.CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWSFor the six months ended December 31, 2009(Unaudited)**

 

 

**Parent**

 

**Issuers of 9.0% Notes**

 

**Issuers of 11.25% Notes**

 

**Guarantor Subsidiaries**

 

**Combined Non-Guarantors**

 

**Eliminations**

 

**Total Consolidated**

 

 

 

 

*(In millions)*

 

 

               

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**Operating activities:**

 

Net income (loss)

 

$

(19.2

)

 

$

(44.6

)

 

$

(12.1

)

 

$

10.9

 

$

19.2

 

$

28.3

 

$

(17.5

)

Adjustments to reconcile net income    (loss) to net cash provided by (used in)    operating activities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loss from discontinued operations,    net of taxes

–

–

–

0.1

–

–

0.1

Depreciation and amortization

 

 

–

 

 

–

 

 

 

–

 

 

61.6

 

 

6.7

 

 

–

 

 

68.3

Provision for doubtful accounts

 

 

–

 

 

–

 

 

 

–

 

 

68.1

 

 

4.1

 

 

–

 

 

72.2

Deferred income taxes

 

 

(7.7

)

 

 

–

 

 

 

–

 

 

–

 

 

–

 

 

–

 

 

(7.7

)

Amortization of loan costs

 

 

–

 

 

2.7

 

 

 

0.2

 

 

–

 

 

–

 

 

–

 

 

2.9

Accretion of principal on senior discount    notes

 

 

–

 

 

–

 

 

 

5.8

 

 

–

 

 

–

 

 

–

 

 

5.8

Loss (gain) on disposal of assets

–

–

–

0.4

–

–

0.4

Stock compensation

 

 

2.9

 

 

–

 

 

 

–

 

 

–

 

 

–

 

 

–

 

 

2.9

Impairment loss

–

–

–

43.1

–

–

43.1

Changes in operating assets and liabilities:

 

 

    Equity in earnings of subsidiaries

 

 

17.9

 

 

–

 

 

 

–

 

 

–

 

 

–

 

 

(17.9

)

 

 

–

    Accounts receivable

 

 

–

 

 

–

 

 

 

–

 

 

(79.6

)

 

 

(5.9

)

 

 

–

 

 

(85.5

)

    Inventories

–

–

–

(1.6

)

(0.2

)

–

(1.8

)

    Prepaid expenses and other current        assets

 

 

–

 

 

–

 

 

 

–

 

 

(3.9

)

 

 

9.1

 

 

 

 

5.2

    Accounts payable

 

–

 

–

 

 

–

 

13.5

 

7.1

 

–

 

20.6

    Accrued expenses and other liabilities

 

 

6.1

 

 

(4.3

)

 

 

6.1

 

 

35.3

 

 

7.8

 

 

(10.3

)

 

 

40.7

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by (used in) operating    activities - continuing operations

 

 

–

 

 

(46.2

)

 

 

–

 

 

 

147.9

 

 

 

47.9

 

 

 

0.1

 

 

149.7

Net cash used in operating activities -    discontinued operations

–

–

–

(0.1

)

–

–

(0.1

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by (used in)    operating activities

–

(46.2

)

–

147.8

47.9

0.1

149.6

 

**Investing activities:**

 

 

Capital expenditures

 

 

–

–

–

(64.8

)

(3.6

)

–

(68.4

)

Acquisitions

–

–

–

(1.5

)

–

–

(1.5

)

Proceeds from asset dispositions

–

–

–

1.4

–

–

1.4

Increase in restricted cash

–

–

–

(20.0

)

–

–

(20.0

)

Other

 

–

–

–

(0.3

)

–

–

(0.3

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash used in investing activities

–

–

–

(85.2

)

(3.6

)

–

(88.8

)

30

**VANGUARD HEALTH SYSTEMS, INC.CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWSFor the six months ended December 31, 2009(Unaudited)(continued)**

 

 

**Parent**

 

**Issuers of 9.0% Notes**

 

**Issuers of 11.25% Notes**

 

**Guarantor Subsidiaries**

 

**Combined Non-Guarantors**

 

**Eliminations**

 

**Total Consolidated**

 

 

 

 

*(In millions)*

 

 

               

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**Financing activities:**

Payments of long-term debt

$

–

$

(3.8

)

$

–

$

–

$

–

$

–

$

(3.8

)

Payments related to derivative instrument    with financing element

(5.4

)

–

–

–

–

–

(5.4

)

Distributions paid to non-controlling    interests

–

–

–

–

(4.6

)

2.8

(1.8

)

Cash provided by (used in)    intercompany activity

5.4

50.0

–

26.1

(78.6

)

(2.9

)

–

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by (used in) financing    activities

–

46.2

–

26.1

(83.2

)

(0.1

)

(11.0

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net increase (decrease) in cash and cash    equivalents

–

–

–

88.7

(38.9

)

–

49.8

Cash and cash equivalents, beginning of    period

–

–

–

168.3

139.9

–

308.2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents, end of period

$

–

$

–

$

–

$

257.0

$

101.0

$

–

$

358.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

31

**15.  SUBSEQUENT EVENTS**

        Vanguard has evaluated subsequent events for the three and six months ended December 31, 2009 through February 9, 2010, the date these financial statements were issued. In January2010, Vanguard completed a comprehensive refinancing plan (the “Refinancing”). Under the Refinancing, certain of Vanguard’s subsidiaries entered into an $815.0 million senior secured term loan (the “2010 term loan facility”) and a $260.0million revolving credit facility (the “2010 revolving facility” and together with the 2010 term loan facility, the “2010 credit facilities”). The 2010 term loan facility matures in January 2016 and will bear interest at a per annum rate equalto, at Vanguard’s option, LIBOR (subject to a floor of 1.50%) plus 3.50% or a base rate plus 2.50%.  Upon the occurrence of certain events, Vanguard’s subsidiaries may request an incremental term loan facility to be added to the 2010 term loanfacility to issue additional term loans in such amounts as Vanguard determines, subject to the receipt of commitments by existing lenders or other financing institutions for such amount of term loans and the satisfaction of certain other conditions. The 2010revolving facility matures in January 2015, and Vanguard’s subsidiaries may seek to increase the borrowing availability under the 2010 revolving facility to an amount larger than $260.0 million, subject to the receipt of commitments by existing lenders or otherfinancial institutions for such increased revolving facility and the satisfaction of other conditions. Any future borrowings under the 2010 revolving facility will bear interest at a per annum rate equal to, at Vanguard’s option, LIBOR plus 3.50% or a base rateplus 2.50%, both of which are subject to a 0.25% decrease dependent upon Vanguard’s consolidated leverage ratio. Vanguard may utilize the 2010 revolving facility to issue up to $100.0 million of letters of credit ($30.2 million of which were outstanding as ofthe date of the Refinancing). The 2010 credit facilities contain numerous covenants that restrict Vanguard or its subsidiaries from completing certain transactions and also include limitations on capital expenditures, a minimum interest coverage ratio requirement anda maximum leverage ratio requirement. Vanguard’s first test period to comply with these covenants is June 30, 2010.

        As part of the Refinancing, certain of Vanguard’s subsidiaries issued $950.0 million aggregate amount at maturity ($936.3 million cash proceeds) of 8.0% senior unsecured notesdue February 2018 (the “8.0% Notes”) in a private placement offering. The 8.0% Notes are redeemable, in whole or in part, at any time on or after February 1, 2014 at specified redemption prices. These subsidiaries may redeem up to 35% of the 8.0% Notesbefore February 1, 2013 with the net cash proceeds from certain equity offerings at a price equal to 108% plus accrued interest or some or all of the notes prior to February 1, 2014 at a redemption price equal to 100% plus accrued interest plus a make-wholepremium.

        The proceeds from the 2010 credit facilities, the issuance of the 8.0% Notes and available cash were used to repay the $764.2 million principal and interest outstanding related to the2005 term loan facility; to fund $597.0 million and $232.5 million of cash tender offers and consent solicitations and accrued interest for those holders of the 9.0% Notes and 11.25% Notes, respectively, who accepted the tender offers; to pay fees and expensesrelated to the Refinancing; to pay $2.6 million to terminate the interest rate swap agreement related to the 2005 term loan facility, representing the swap liability at the Refinancing date; to purchase 446 shares held by certain former employees; and to fund a$300.0 million distribution to repurchase a portion of the shares owned by the remaining stockholders. Subsequent to the $300.0 million share repurchase, Vanguard completed a 1.4778 for one split that effectively returned the share ownership for each stockholder thatparticipated in the distribution to the same level as that in effect immediately prior to the distribution. Approximately $20.6 million and $4.1 million of the 9.0% Notes and 11.25% Notes remained outstanding as of the expiration of the initial tender offer andconsent solicitation period and through the portion of the extended tender offer period as of the date of this filing for the holders of the 9.0% Notes and 11.25% Notes. Certain of Vanguard’s subsidiaries will redeem for cash those remaining 9.0% Notes and11.25% Notes that have not been tendered by February 11, 2010 on March 5, 2010. The redemption price for the 9.0% Notes will be 104.500% of the principal amount thereof plus accrued and unpaid interest, and the redemption price for the 11.25% Notes will be 105.625%of the principal amount thereof plus accrued and unpaid interest.

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

**Forward Looking Statements**

        This report on Form 10-Q contains “forward-looking statements” within the meaning of the federal securities laws which are intended to be covered by the safe harborscreated thereby.  Forward-looking statements are those statements that are based upon management’s current plans and expectations as opposed to historical and current facts and are often identified in this report by use of words including but not limitedto  “may,” “believe,” “will,” “project,” “expect,” “estimate,” “anticipate,” and “plan.”  These statements are based upon estimates and assumptions made byVanguard’s management that, although believed to be reasonable, are subject to numerous factors, risks and uncertainties that could cause actual outcomes

32

and results to be materially different from those projected.  These factors, risks and uncertainties include, among others, the following:

          •  Our high degree of leverage and interest rate risk          •  Our ability to incur substantially more debt          •  Operating and financial restrictions in our debt agreements          •  Our ability to generate cash necessary to service our debt          •  Weakened economic conditions and volatile capital markets          •  Potential liability related to disclosures of relationships between physicians and our hospitals          •  Post-payment claims reviews by governmental agencies could result in additional costs to us          •  Our ability to successfully implement our business strategies          •  Our ability to grow our business and successfully integrate future acquisitions          •  Potential acquisitions could be costly, unsuccessful or subject us to unexpected liabilities          •  Conflicts of interest that may arise as a result of our control by a small number of stockholders          •  The highly competitive nature of the healthcare industry          •  Governmental regulation of the industry, including Medicare and Medicaid reimbursement levels          •  Pressures to contain costs by managed care organizations and other insurers and our ability to negotiate acceptable             terms with these third party payers          •  Our ability to attract and retain qualified management and healthcare professionals, including physicians             and nurses          •  Potential federal or state reform of healthcare          •  Future governmental investigations          •  Our failure to adequately enhance our facilities with technologically advanced equipment could adversely affect              our revenues and market position          •  Potential lawsuits or other claims asserted against us          •  Our ability to maintain or increase patient membership and control costs of our managed healthcare plans          •  Our exposure to the increased amounts of and collection risks associated with uninsured accounts and the co-pay             and deductible portions of insured accounts          •  Dependence on our senior management team and local management personnel          •  Volatility of professional and general liability insurance for us and the physicians who practice at our hospitals             and increases in the quantity and severity of professional liability claims          •  Our ability to maintain and increase patient volumes and control the costs of providing services, including             salaries and benefits, supplies and bad debts          •  Increased costs from further government regulation of healthcare and our failure to comply, or allegations of our             failure to comply, with applicable laws and regulations          •  The geographic concentration of our operations          •  Technological and pharmaceutical improvements that increase the cost of providing, or reduce the demand for,              healthcare services and shift demand for inpatient services to outpatient settings          •  Costs and compliance risks associated with Section 404 of the Sarbanes-Oxley Act          •  A failure of our information systems would adversely impact our ability to manage our operations          •  Material non-cash charges to earnings from impairment of goodwill associated with declines in the fair market             values of our reporting units          •  Volatility of materials and labor costs for, or state efforts to regulate, potential construction projects that may be               necessary for future growth

        Our forward-looking statements speak only as of the date made.  Except as required by law, we undertake no obligation to publicly update or revise any forward-looking statementscontained herein, whether as a result of new information, future events or otherwise.  We advise you, however, to consult any additional disclosures we make in our other filings with the Securities and Exchange Commission, including, without limitation, thediscussion of risks and other uncertainties under the caption “Item 1A. Risk Factors” included later in this Report. You are cautioned to not rely on such forward-looking statements when evaluating the information contained in this report.  In lightof the significant uncertainties inherent in the forward-looking statements included in this report, you should not regard the inclusion of such information as a representation by us that our objectives and plans anticipated by the forward-looking statements willoccur or be achieved, or if any of them do, what impact they will have on our results of operations and financial condition.

33

**Executive Overview**

        As of December 31, 2009, we owned and operated 15 hospitals with a total of 4,135 licensed beds, and related outpatient service facilities complementary to the hospitals in SanAntonio, Texas; metropolitan Phoenix, Arizona; metropolitan Chicago, Illinois; and Massachusetts, and two surgery centers in Orange County, California. As of December 31, 2009, we also owned three health plans as set forth in the following table.

**Health Plan**

    

 

**   Location   **

      

**Membership**

 

Phoenix Health Plan (“PHP”) – managed Medicaid

 

Arizona

 

198,400

Abrazo Advantage Health Plan (“AAHP”) – managed Medicare and Dual Eligible

 

Arizona

 

2,700

MacNeal Health Providers (“MHP”) – capitated outpatient and physician services

 

Illinois

 

38,700

 

 

 

 

 

 

 

239,800

 

 

 

 

        Our objective is to help people in the communities we serve achieve health for life by delivering an ideal patient-centered experience in a highly reliable environment of care. Weplan to grow our business by improving quality of care, expanding services and strengthening the financial performance of our existing operations and selectively acquiring other hospitals where we see an opportunity to improve operating performance andprofitability.

**Operating Environment**

        We believe that the operating environment for hospital operators continues to evolve, which presents both challenges and opportunities for us.  In order to remain competitive inthe markets we serve, we must transform our operating strategies to not only accommodate changing environmental factors but to make them operating advantages for us relative to our peers.  These factors will require continued focus on quality of careinitiatives. As consumers become more involved in their healthcare decisions, we believe perceived quality of care will become an even greater factor in determining where physicians choose to practice and where patients choose to receive care. In the followingparagraphs we discuss both current challenges and future challenges that we face and our strategies to proactively address them.

        *Pay for Performance Reimbursement*

        Many payers, including Medicare and several large managed care organizations, currently require hospital providers to report certain quality measures in order to receive the fullamount of payment increases that were awarded automatically in the past.  For federal fiscal year 2010, Medicare expanded the number of quality measures to be reported to 47 compared to 43 during federal fiscal year 2009. Many large managed care organizationshave developed quality measurement criteria that are similar to or even more stringent than these Medicare requirements.  While current Medicare guidelines and contracts with most managed care payers provide for reimbursement based upon the reporting of qualitymeasures, we believe it is only a matter of time until all significant payers utilize the quality measures themselves to determine reimbursement rates for hospital services. In order to meet these requirements, we must deliver an ideal patient-centered experience.This will require us to engage our nurses and partner with physicians to drive our quality of care strategies, to invest in and upgrade our information technology systems to monitor clinical quality indicators and to make all of our processes moreefficient.

        *Physician Alignment*

        Our ability to attract skilled physicians to our hospitals is critical to our success. Coordination of care and alignment of care strategies between hospitals and physicians willbecome more critical as reimbursement becomes more episode-based. We have adopted several significant physician recruitment goals with primary emphasis on recruiting physicians specializing in family practice, internal medicine, obstetrics and gynecology, cardiology,neurology, orthopedics and inpatient hospital care (hospitalists). To provide our patients access to the appropriate physician resources, we actively recruit physicians to the communities served by our hospitals through employment agreements, relocation agreements orphysician practice acquisitions. We have invested heavily in the infrastructure necessary to coordinate our physician alignment strategies and manage our physician operations. Our hospitalist employment strategy is a key element in coordination of patient-centeredcare. The costs associated with recruiting, integrating and managing such a large number of new physicians will have a

34

negative impact on our operating results and cash flows in the short term. However, we expect to realize improved clinical quality and service expansion capabilities from this initiative that will positively impact ouroperating results over the long-term.

        *Cost pressures*

        In order to demonstrate a highly reliable environment of care, we must hire and retain nurses who share our ideals and beliefs and who have access to the training necessary toimplement our clinical quality initiatives. While the national nursing shortage has abated somewhat during the past year, the nursing workforce remains volatile. As a result, we expect continuing pressures on nursing salaries and benefits costs. These pressuresinclude higher than normal base wage increases, demands for flexible working hours and other increased benefits and higher nurse to patient ratios necessary to improve quality of care. Inflationary pressures and technological advancements continue to drive suppliescosts higher. We have implemented multiple supply chain initiatives including consolidation of low-priced vendors, establishment of value analysis teams and coordination of care efforts with physicians to reduce physician preference items.

        *Potential Healthcare Reform*

        A comprehensive healthcare reform bill was widely anticipated to become law sometime in early 2010. The House of Representatives passed its health reform bill on November 7, 2009followed by Senate passage of their version of a health reform bill on December 24, 2009. During January 2010, Congressional leaders and representatives of the Obama administration have been meeting to develop a single bill that incorporates provisions from the billspassed by each of the House of Representatives and the Senate. With the election to the United States Senate of State Senator Scott Brown (R) of Massachusetts, the enactment of such a bill, and the contents of any bill so enacted, have become uncertain. AssumingCongress comes to an agreement and passes final legislation, President Obama is expected to sign the health reform package. We are not able to predict what impact these developments may have on our future operating results or cash flows at this time.

*        Implementation of our Clinical Quality Initiatives*

The integral component of each of the challenge areas previously discussed is quality of care. We have implemented many of our expanded clinical quality initiatives and are in the process of implementing several others. Theseinitiatives include monthly review of the 47 CMS quality indicators in place for federal fiscal year 2010, rapid response teams, mock Joint Commission surveys, hourly nursing rounds, our nurse leadership professional practice model, alignment of hospital managementincentive compensation with quality performance indicators and the formation of Physician Advisory Councils at our hospitals to align the quality goals of our hospitals with those of the physicians who practice in our hospitals.

**Sources of Revenues**

        Hospital revenues depend upon inpatient occupancy levels, the medical and ancillary services ordered by physicians and provided to patients, the volume of outpatient procedures andthe charges or payment rates for such services. Charges and reimbursement rates for inpatient services vary significantly depending on the type of payer, the type of service (e.g., acute care, intensive care or subacute) and the geographic location of the hospital.Inpatient occupancy levels fluctuate for various reasons, many of which are beyond our control.

        We receive payment for patient services from:

        •  the federal government, primarily under the Medicare program;        •  state Medicaid programs;        •  health maintenance organizations, preferred provider organizations, managed Medicare providers,           managed Medicaid providers and other private insurers; and        •  individual patients

35

        The following table sets forth the percentages of net patient revenues by payer for the three months and six months ended December 31, 2008 and 2009.

**Three months ended December 31,**

**Six months ended December 31,**

 

 

 

**2008**

**2009**

**2008**

**2009**

 

 

 

 

 

 

 

Medicare

 

 

25.9%

26.1%

25.8%

25.3%

Medicaid

 

7.1%

6.7%

7.3%

7.2%

Managed Medicare

 

14.2%

15.1%

13.8%

14.8%

Managed Medicaid

8.9%

9.3%

9.2%

9.9%

Managed care

 

 

35.3%

35.0%

34.8%

35.0%

Self pay

 

7.7%

6.7%

8.1%

6.8%

Other

0.9%

1.1%

1.0%

1.0%

 

 

Total

100.0%

100.0%

100.0%

100.0%

 

 

        The Medicare program, the nation’s largest health insurance program, is administered by CMS. Medicare provides certain hospital and medical insurance benefits to persons age 65and over, some disabled persons and persons with end-stage renal disease without regard to beneficiary income or assets. Medicaid is a federal-state program, administered by the states, which provides hospital and medical benefits to qualifying individuals who areunable to afford healthcare. All of our general, acute care hospitals located in the United States are certified as healthcare services providers for persons covered under the Medicare and the various state Medicaid programs. Amounts received under these programs aregenerally significantly less than established hospital gross charges for the services provided.

        In our June 30, 2009 10-K, we described the types of payments we receive for services provided to patients enrolled in the traditional Medicare plan (both for inpatient and outpatientservices), managed Medicare plans, Medicaid plans, managed Medicaid plans and managed care plans. We also discussed the unique reimbursement features of the traditional Medicare plan, including disproportionate share, outlier cases and direct graduate and indirectmedical education. The annual Medicare regulatory updates published by CMS in August 2009 that impact reimbursement rates under the plan for services provided during the federal fiscal year beginning October 1, 2009 were also discussed in our June 30, 200910-K.

        Our hospitals offer discounts from established charges to certain group purchasers of healthcare services, including private insurance companies, employers, health maintenanceorganizations, preferred provider organizations and other managed care plans as well as uninsured discounts for patients with no insurance coverage at most of our hospitals. These discount programs limit our ability to increase patient service revenues in response toincreasing costs. Patients generally are not responsible for any difference between established hospital charges and amounts reimbursed for such services under Medicare, Medicaid and managed care programs, but are generally responsible for exclusions, deductibles andcoinsurance features of their coverages. Due to rising healthcare costs, many payers have increased the number of excluded services and the levels of deductibles and coinsurance resulting in a higher portion of the contracted rate due from the individual patients.Collecting amounts due from individual patients is typically more difficult than collecting from governmental or private managed care plans.

36

*        Volumes by Payer*

        During the six months ended December 31, 2009 compared to the prior year period, discharges were flat and total adjusted discharges increased 2.8%. The following table providesdetails of discharges by payer for the three and six months ended December 31, 2008 and 2009.

**Three months ended December 31,**

**Six months ended, December 31,**

**2008**

**2009**

**2008**

**2009**

Medicare

 

11,375

 

27.3%

  

11,593

27.6%

 

22,631

 

27.0%

  

22,696

27.0%

Medicaid

 

4,313

 

10.4%

 

3,672

 

8.7%

 

8,764

 

10.5%

 

7,264

 

8.7%

Managed Medicare

6,524

15.7%

6,769

16.1%

12,914

15.4%

13,449

16.0%

Managed Medicaid

5,678

13.7%

6,552

15.6%

11,560

13.8%

12,971

15.5%

Managed care

 

12,364

 

29.7%

 

11,286

 

26.8%

 

25,099

 

29.9%

 

22,928

 

27.3%

Self pay

 

1,220

 

2.9%

 

1,999

 

4.8%

 

2,635

 

3.1%

 

4,257

 

5.1%

Other

130

0.3%

 

166

0.4%

282

0.3%

 

355

0.4%

 

 

 

 

 

 

 

 

 

Total

 

41,604

 

100.0%

 

42,037

 

100.0%

 

83,885

 

100.0%

 

83,920

 

100.0%

 

 

 

 

 

 

 

 

 

        *Payer Reimbursement Trends*

        In addition to the volume factors described above, patient mix, acuity factors and pricing trends affect our patient service revenues. Net patient revenue per adjusted discharge was$8,284 and $8,314 for the six months ended December 31, 2008 and 2009, respectively. This small increase relative to prior periods was primarily due to the uninsured discount policy that we implemented in our Chicago hospitals on April 1, 2009 and in our Phoenix andSan Antonio hospitals on July 1, 2009. Under this policy, we apply an uninsured discount (calculated as a standard percentage of gross charges) at the time of patient billing for those patients with no insurance coverage who do not qualify for charity care under ourguidelines. We recorded $112.9 million of uninsured discount revenue deductions during the six months ended December 31, 2009, $74.2 million of which would have otherwise been included in net patient revenues and subjected to our allowance for doubtful accountspolicy had we not implemented our uninsured discount policy at these hospitals.

        *Impact of Current Economic Environment*

        We continue to experience limited volume growth due to stagnant demand for inpatient healthcare services and increased competition for available patients. The current weakenedeconomic environment has negatively impacted many industries. While many healthcare services are considered non-discretionary in nature, certain services including elective procedures and other non-emergent services may be deferred or canceled by patients when theyare suffering personal financial hardship or have a negative outlook on the general economy. Increases in unemployment often result in a higher number of uninsured patients, and employer cost reduction programs may result in a higher level of co-pays and deductiblelimits for patients.  Governmental payers and managed care payers may reduce reimbursement paid to hospitals and other healthcare providers to address budget shortfalls or enrollment declines. We are unable to determine the specific impact of the weakenedeconomic environment to our results of operations or cash flows.  However, we believe these economic conditions have negatively impacted our volumes and payer mix during the current year period to some degree. We expect our volumes to improve more significantlyover the long-term as a result of our quality of care and service expansion initiatives and other market-specific strategies, especially as more individuals in the markets we serve reach ages where hospital services become more prevalent. However, we have no way toestimate when the economy may improve or when we will realize the benefits of our long-term strategies.

37

        *Accounts Receivable Collection Risks Leading to Increased Bad Debts*

        Similar to other companies in the hospital industry, we face continued pressures in collecting outstanding accounts receivable primarily due to volatility in the uninsured andunderinsured populations in the markets we serve. The following table provides a summary of our accounts receivable payer class mix as of each respective period presented.

**December 31, 2008**

** **

**0-90 days**

**91-180 days**

**Over 180 days**

**Total**

Medicare

 

 

15.4%

0.4%

0.3%

16.1%

Medicaid

7.4%

2.0%

1.6%

11.0%

Managed Medicare

9.4%

0.4%

0.4%

10.2%

Managed Medicaid

6.6%

0.6%

0.4%

7.6%

Managed Care

26.0%

2.5%

1.7%

30.2%

Self-Pay(1)

8.4%

8.0%

0.9%

17.3%

Self-Pay after primary(2)

1.6%

2.2%

1.1%

4.9%

Other

1.6%

0.7%

0.4%

2.7%

 

    Total

 

76.4%

16.8%

6.8%

100.0%

 

 

 

 

 

 

 

 

 

 

 

**June 30, 2009**

**0-90 days**

**91-180 days**

**Over 180 days**

**Total**

Medicare

 

 

15.6%

 

 

 

0.3%

 

 

0.3%

 

 

16.2%

Medicaid

6.7%

0.9%

1.0%

8.6%

Managed Medicare

10.0%

0.5%

0.3%

10.8%

Managed Medicaid

7.1%

0.5%

0.5%

8.1%

Managed Care

25.1%

2.3%

1.5%

28.9%

Self-Pay(1)

9.7%

8.1%

0.8%

18.6%

Self-Pay after primary(2)

2.1%

2.9%

0.9%

5.9%

Other

1.8%

0.6%

0.5%

2.9%

 

    Total

 

78.1%

 

16.1%

 

5.8%

 

100.0%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**December 31, 2009**

**0-90 days**

**91-180 days**

**Over 180 days**

**Total**

Medicare

 

 

17.5%

0.5%

0.4%

18.4%

Medicaid

5.0%

0.9%

1.0%

6.9%

Managed Medicare

12.1%

0.7%

0.4%

13.2%

Managed Medicaid

8.0%

0.5%

0.5%

9.0%

Managed Care

27.9%

1.9%

1.4%

31.2%

Self-Pay(1)

9.1%

3.1%

0.6%

12.8%

Self-Pay after primary(2)

1.9%

2.7%

0.7%

5.3%

Other

2.2%

0.6%

0.4%

3.2%

 

    Total

 

83.7%

10.9%

5.4%

100.0%

 

____________________(1)  Includes uninsured patient accounts only.(2)  Includes patient co-insurance and deductible amounts after payment has been received from the primary payer.

        Our combined allowances for doubtful accounts, uninsured discounts and charity care covered 96.5% and 88.6% of combined self-pay and self-pay after primary accounts receivable as ofJune 30, 2009 and December 31, 2009, respectively. 

38

The period over period decrease is due to the implementation of our uninsured discount policy at our Phoenix and San Antonio hospitals effective July 1, 2009.

        The volume of self-pay accounts receivable remains sensitive to a combination of factors including price increases, acuity of services, higher levels of patient deductibles andco-insurance under managed care plans, economic factors and the increased difficulties of uninsured patients who do not qualify for charity care programs to pay for escalating healthcare costs. We have implemented policies and procedures designed to expedite upfrontcash collections and promote repayment plans from our patients. However, we believe bad debts will remain a significant risk for us and the rest of the hospital industry in the near term.

*        Governmental and Managed Care Payer Reimbursement*

        Healthcare spending comprises a significant portion of total spending in the United States and has been growing at annual rates that exceed inflation, wage growth and gross nationalproduct. There is considerable pressure on governmental payers, managed Medicare/Medicaid payers and commercial managed care payers to control costs by either reducing or limiting increases in reimbursement to healthcare providers or limiting benefits to enrollees.The current weakened economic environment has magnified these pressures. Lower than expected tax collections due to higher unemployment and depressed consumer spending have resulted in budget shortfalls for most states, including those in which we operate.Additionally, the demand for Medicaid coverage has increased due to job losses that have left many individuals without health insurance. To balance their budgets, many states, either directly or through their managed Medicaid programs, may enact healthcare spendingcuts or defer cash payments to healthcare providers.  Further, the tightened credit markets have complicated the states’ efforts to issue additional bonds to raise cash. During the six months ended December 31, 2009, combined Medicaid and managed Medicaidprograms accounted for approximately 17% of our net patient revenues. Managed care payers also face economic pressures during periods of economic weakness due to lower enrollment resulting from higher unemployment rates and the inability of individuals to affordprivate insurance coverage. These payers may respond to these challenges by reducing or limiting increases to healthcare provider reimbursement rates or reducing benefits to enrollees. During the six months ended December 31, 2009, we recognized approximately 35% ofour net patient revenues from managed care payers. If we do not receive increased payer reimbursement rates from governmental or managed care payers that cover the increasing cost of providing healthcare services to our patients or if governmental payers deferpayments to our hospitals, our financial position, results of operations and cash flows could be materially adversely impacted.

        *Increased Costs of Compliance in a Heavily Regulated Industry*

        We conduct business in a heavily regulated industry. Accordingly, we maintain a comprehensive, company-wide compliance program to address healthcare regulatory and other compliancerequirements. This compliance program includes, among other things, initial and periodic ethics and compliance training, a toll-free reporting hotline for employees, annual fraud and abuse audits and annual coding audits. The organizational structure of ourcompliance program includes oversight by our board of directors and a high-level corporate management compliance committee. Our Senior Vice President of Compliance and Ethics reports jointly to our Chairman and Chief Executive Officer and to our board of directors,serves as our Chief Compliance Officer and is charged with direct responsibility for the day-to-day management of our compliance program. We also have regional compliance officers in our markets that are 100% dedicated to compliance duties. The financial resourcesnecessary for program oversight, internal enforcement and periodic improvements to our program continue to grow, especially when we add new features to our program or engage external resources to assist with these highly complex matters.

        *Premium Revenues*

        We recognize premium revenues from our three health plans, PHP, AAHP and MHP. PHP’s membership increased to approximately 198,400 at December 31, 2009 compared to approximately160,500 at December 31, 2008 primarily due to weakened economic conditions in Arizona that has resulted in a greater number of individuals eligible for coverage under Arizona Health Care Cost Containment System (“AHCCCS”), and the fact that the currentyear period reflects a full six months under PHP’s new AHCCCS contract (see discussion below). Premium revenues from these three plans increased $117.7 million or 39.4% during the six months ended December 31, 2009 compared to the prior year period.

        In May 2008, PHP was awarded a new contract with AHCCCS effective for the three-year period beginning October 1, 2008 and ending September 30, 2011. AHCCCS has the option to renew thenew contract, in whole or in part, for two

39

additional one-year periods commencing on October 1, 2011 and on October 1, 2012. The new contract covers the three counties covered under the previous contract (Gila, Maricopa and Pinal) plus an additional six Arizonacounties (Apache, Coconino, Mohave, Navajo, Pima and Yavapai). The new contract utilizes a national episodic/diagnostic risk adjustment factor for non-reconciled enrollee risk groups, which AHCCCS applied retroactively to October 1, 2008, that was not part ofPHP’s previous AHCCCS contract. Our financial statements include an estimated reserve for the impact of this risk adjustment factor. In response to the State of Arizona’s  budget crisis and continued concerns about economic indicators during its 2010fiscal year, AHCCCS has made certain changes to its current contract with PHP that negatively impact PHP’s current and future revenues.  AHCCCS could take further actions in the near term that could materially adversely impact our operating results andcash flows including reimbursement rate cuts, enrollment reductions, capitation payment deferrals, covered services reductions or limitations or other steps to reduce program expenditures including cancelling PHP’s contract.

**Critical Accounting Policies**

        Our condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. In preparing these financialstatements, we make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses included in the financial statements. Management bases its estimates on historical experience and other available information, the results ofwhich form the basis of its estimates and assumptions. We consider the following accounting policies to be critical because they involve highly subjective and complex assumptions, are subject to greater fluctuation and are the most critical to our operatingperformance.

               •

 

Revenues and revenue deductions

               •

 

Allowance for doubtful accounts and provision for doubtful accounts

               •

 

Insurance reserves

               •

 

Health plan claims reserves

               •

 

Income taxes

               •

 

Long-lived assets and goodwill

        There have been no changes in the nature or application of our critical accounting policies during the three months ended December 31, 2009 when compared to those described in ourCurrent Report on Form 8-K filed with the SEC on January 19, 2010, except those described below.

        *Revenues and Revenue Deductions*

        Effective for service dates on or after July 1, 2009, we implemented a new uninsured discount policy for those patients receiving services in our Phoenix and San Antonio hospitals whohad no insurance coverage and who did not otherwise qualify for charity care under our guidelines. We implemented this same policy for our Chicago hospitals on April 1, 2009. Under this policy, we apply an uninsured discount (calculated as a standard percentage ofgross charges) at the time of patient billing and include this discount as a reduction to patient service revenues. These discounts were approximately $112.9 million for the six months ended December 31, 2009.

*        Allowance for Doubtful Accounts and Provision for Doubtful Accounts*

        We estimate our allowance for doubtful accounts using a standard policy that reserves all accounts aged greater than 365 days subsequent to discharge date plus percentages ofuninsured accounts and self-pay after primary accounts less than 365 days old. We test our allowance for doubtful accounts policy quarterly using a hindsight calculation that utilizes write-off data for all payer classes during**the previous twelve-month periodto estimate the allowance for doubtful accounts at a point in time. We also supplement our analysis by comparing cash collections to net patient revenues and monitoring self-pay utilization. We adjust the standard percentages in our allowance for doubtful accountsreserve policy as necessary given changes in trends from these analyses. We most recently adjusted this reserve policy when we implemented our uninsured discount policy in our Phoenix and San Antonio hospitals on July 1, 2009 and in our Illinois hospitals on April 1,2009. Significant changes in payer mix, business office operations, general economic conditions and healthcare coverage provided by federal or state governments or private insurers may have a significant impact on our estimates and significantly affect our liquidity,results of operations and cash flows.

**

        Prior to the implementation of our new uninsured discount policy, we classified accounts pending Medicaid approval as Medicaid accounts in our accounts receivable aging report andrecorded a contractual allowance for these accounts based

40

upon the average Medicaid reimbursement rate for that specific state until qualification was confirmed at which time the account was netted in the aging. In the event an account did not successfully qualify for Medicaidcoverage and did not meet our charity guidelines, the previously recorded Medicaid contractual adjustment remained a revenue deduction (similar to a self-pay discount), and the remaining net account balance was reclassified to uninsured status and subjected to ourallowance for doubtful accounts policy. If accounts did not qualify for Medicaid coverage but did qualify as charity care, the contractual adjustments were reversed and the gross account balances was recorded as charity deductions.

        Upon the implementation of our new uninsured discount policy in our Phoenix, San Antonio and Illinois hospitals, all uninsured accounts (including those pending Medicaidqualification) that do not qualify for charity care receive the standard uninsured discount. The balance of these accounts is subject to our allowance for doubtful accounts policy. For those accounts that subsequently qualify for Medicaid coverage, the uninsureddiscount is reversed and the account is reclassified to Medicaid accounts receivable with the appropriate contractual discount applied. Thus, the contractual allowance for Medicaid pending accounts is no longer necessary for those accounts subject to the uninsureddiscount policy.

**

*        Long-Lived Assets and Goodwill*

        Both long-lived assets, including property, plant and equipment and amortizable intangible assets, and goodwill comprise a significant portion of our total assets. We evaluate thecarrying value of long-lived assets when impairment indicators are present or when circumstances indicate that impairment may exist. When management believes impairment indicators may exist, projections of the undiscounted future cash flows associated with the use ofand eventual disposition of long-lived assets held for use are prepared. If the projections indicate that the carrying values of the long-lived assets are not recoverable, we reduce the carrying values to fair value.

        We review goodwill for impairment annually during our fourth fiscal quarter or more frequently if certain impairment indicators arise. We review goodwill at the reporting level unit,which is one level below an operating segment. We compare the carrying value of the net assets of each reporting unit to the net present value of estimated discounted future cash flows of the reporting unit. If the carrying value exceeds the net present value ofestimated discounted future cash flows, an impairment indicator exists and an estimate of the impairment loss is calculated. The fair value calculation includes multiple assumptions and estimates, including the projected cash flows and discount ratesapplied.

        Our two Chicago hospitals have experienced deteriorating economic factors that have negatively impacted their results of operations and cash flows. While various initiatives mitigatedthe impact of these economic factors in previous quarters, the operating results of the Chicago hospitals have not improved to the level anticipated. After having the opportunity to evaluate the operating results of the Chicago hospitals for the first six months offiscal year 2010 and to reassess the market trends and economic factors, we concluded that it was unlikely that previously projected cash flows for these hospitals would be achieved. We performed an interim goodwill impairment test and, based upon revised projectedcash flows, market participant data and appraisal information, we determined that the $43.1 million remaining goodwill related to this reporting unit was impaired. We recorded the $43.1 million ($31.8 million, net of taxes) non-cash impairment loss in our condensedconsolidated statement of operations for the quarter ended December 31, 2009.

41
****
**Selected Operating Statistics**

        The following table sets forth certain operating statistics for each of the periods presented.

**Quarter ended December 31,**

**Six months ended December 31,**

 

 

 

 

**2008**

 

 

**2009**

 

 

 

**2008**

 

 

**2009**

 

Number of hospitals at end of period

 

 

 

15

 

15

 

 

15

 

15

Number of licensed beds at end of period

 

 

 

4,135

 

4,135

 

 

4,135

 

4,135

Discharges (a)

 

 

 

41,604

 

42,037

 

 

83,885

 

83,920

Adjusted discharges - hospitals (a)

 

 

 

67,337

 

69,022

 

 

136,044

 

139,126

Adjusted discharges (a)

70,939

72,990

143,261

147,213

Net revenue per adjusted discharge - hospitals (a)

 

 

$

8,626

$

8,533

 

$

8,449

$

8,384

Net revenue per adjusted discharge (a)

$

8,495

$

8,470

$

8,284

$

8,314

Patient days (a)

 

 

 

175,944

 

176,233

 

 

354,058

 

348,199

Average length of stay (days) (a)

 

 

 

4.23

 

4.19

 

 

4.22

 

4.15

Inpatient surgeries (a)

9,384

 

9,380

18,862

 

18,888

Outpatient surgeries (a)

 

 

 

19,026

 

19,143

 

 

37,926

 

38,460

Emergency room visits (a)

 

 

 

142,671

 

155,818

 

 

289,853

 

310,727

Occupancy rate (a)

46.2

%

46.3

%

46.5

%

45.8

%

Member lives (a)

204,600

239,800

204,600

239,800

Health plan claims expense percentage (a)

79.0

%

80.5

%

76.2

%

79.6

%

____________________(a)   The definitions for the statistics included above are set forth in Part 2, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, “Selected Operating Statistics” in our Report onForm 8-K filed with the SEC on January 19, 2010.

42
****
**R****esults of Operations**

        The following table presents summaries of our operating results for the quarters and six months ended December 31, 2008 and 2009.

 

 

**Quarter ended December 31,**

 

 

 

 

**2008**

 

**2009**

 

 
****
 
****
 

 

**Amount**

 

**%**

** **

** **

**Amount**

** **

** **

**%**

 

 

 
****
 
****
 

 

*(In millions)*

 

 

** **

Patient service revenues

 

$

614.4

 

 

 

77.5

%

 

$

631.3

 

 

 

74.8

%

Premium revenues

 

 

178.2

 

 

 

22.5

%

 

 

212.3

 

 

 

25.2

%

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

792.6

 

 

 

100.0

%

 

843.6

 

 

 

100.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Salaries and benefits (includes stock compensation of $0.8    and $1.0, respectively)

 

 

302.7

 

 

 

38.2

%

 

 

324.5

 

 

 

38.5

%

Health plan claims expense

 

 

140.7

 

 

 

17.8

%

 

 

170.8

 

 

 

20.2

%

Supplies

 

 

112.8

 

 

 

14.2

%

 

 

114.8

 

 

 

13.6

%

Provision for doubtful accounts

 

 

48.3

 

 

 

6.1

%

 

 

35.0

 

 

 

4.1

%

Other operating expenses

 

 

110.4

 

 

 

13.9

%

 

 

115.7

 

 

 

13.7

%

Depreciation and amortization

 

 

32.1

 

 

 

4.1

%

 

 

34.3

 

 

 

4.1

%

Interest, net

 

 

28.6

 

 

 

3.6

%

 

 

27.5

 

 

 

3.3

%

Impairment loss

–

0.0

%

43.1

5.1

%

Other

 

 

1.0

 

 

0.1

%

 

 

1.5

 

 

0.2

%

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations before income taxes

 

 

16.0

 

 

2.0

%

 

 

(23.6

)

 

 

(2.8

)%

Income tax benefit (expense)

 

 

(5.1

)

 

 

(0.6

)%

 

 

3.6

 

 

0.4

%

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

10.9

1.4

%

(20.0

)

(2.4

)%

Income (loss) from discontinued operations, net of taxes

(0.1

)

0.0

%

0.1

0.0

%

Net income (loss)

 

10.8

 

 

1.4

%

 

(19.9

)

 

 

(2.4

)%

Less:  Net income attributable to non-controlling interests

(0.7

)

(0.1

)%

(0.8

)

(0.1

)%

Net income (loss) attributable to Vanguard Health Systems, Inc.    stockholders

$

10.1

1.3

%

$

(20.7

)

(2.5

)%

 

 

 

 

 

 

 

 

 

 

 

 

43

 

 

**Six months ended December 31,**

 

 

 

 

**2008**

 

**2009**

 

 
****
 
****
 

 

**Amount**

 

**%**

** **

** **

**Amount**

** **

** **

**%**

 

 

 
****
 
****
 

 

*(In millions)*

 

 

** **

Patient service revenues

 

$

1,212.7

 

 

 

80.2

%

 

$

1,250.4

 

 

 

75.0

%

Premium revenues

 

 

298.9

 

 

 

19.8

%

 

 

416.6

 

 

 

25.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

1,511.6

 

 

 

100.0

%

 

1,667.0

 

 

 

100.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Salaries and benefits (includes stock compensation of $2.2    and $2.9, respectively)

 

 

595.3

 

 

 

39.4

%

 

 

638.9

 

 

 

38.3

%

Health plan claims expense

 

 

227.7

 

 

 

15.1

%

 

 

331.8

 

 

 

19.9

%

Supplies

 

 

224.6

 

 

 

14.8

%

 

 

225.8

 

 

 

13.5

%

Provision for doubtful accounts

 

 

102.9

 

 

 

6.8

%

 

 

72.2

 

 

 

4.3

%

Other operating expenses

 

 

221.6

 

 

 

14.7

%

 

 

248.7

 

 

 

14.9

%

Depreciation and amortization

 

 

64.4

 

 

 

4.3

%

 

 

68.3

 

 

 

4.1

%

Interest, net

 

 

57.3

 

 

 

3.8

%

 

 

54.7

 

 

 

3.3

%

Impairment loss

–

0.0

%

43.1

2.6

%

Other expenses

 

 

0.8

 

 

0.0

%

 

 

2.6

 

 

0.2

%

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations before income taxes

 

 

17.0

 

 

1.1

%

 

 

(19.1

)

 

 

(1.1

)%

Income tax benefit (expense)

 

 

(5.3

)

 

 

(0.4

)%

 

 

1.7

 

 

0.1

%

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

11.7

0.7

%

(17.4

)

(1.0

)%

Income (loss) from discontinued operations, net of taxes

0.9

0.1

%

(0.1

)

0.0

%

Net income (loss)

 

12.6

 

 

0.8

%

 

(17.5

)

 

 

(1.0

)%

Less:  Net income attributable to non-controlling interests

(1.6

)

(0.1

)%

(1.7

)

(0.1

)%

Net income (loss) attributable to Vanguard Health Systems, Inc.    stockholders

$

11.0

0.7

%

$

(19.2

)

(1.1

)%

 

 

 

 

 

 

 

 

 

 

 

 

44

**Quarter ended December 31, 2009 compared to quarter ended December 31, 2008**

        *Revenues*.  Total revenues increased $51.0 million or 6.4% during the quarter ended December 31, 2009 compared to the prior year quarter primarily due to a significantincrease in health plan premium revenues as a result of increased PHP enrollment. Average enrollment at PHP was 195,365 during the quarter ended December 31, 2009, an increase of 20.5% compared to the prior year quarter. Worsened economic conditions in Arizona sincethe prior year quarter resulted in more individuals becoming eligible for AHCCCS coverage. Enrollment in our other two health plans remained relatively flat quarter over quarter.

        Patient service revenues increased $16.9 million or 2.8% during the quarter ended December 31, 2009 compared to the prior year quarter. Adjusted discharges increased 2.9%, totalsurgeries increased 0.4% and emergency room visits increased 9.2% during the current year quarter compared to the prior year quarter, respectively. Net revenue per adjusted discharge decreased 0.3% during the current year quarter compared to the prior year quarter.This decrease was primarily due to the implementation of our uninsured discount policies in our Illinois hospitals effective April 1, 2009 and in our Phoenix and San Antonio hospitals effective July 1, 2009. During the current year quarter, we recognized $51.9million of uninsured discount revenue deductions, $37.8 million of which would have otherwise been included in revenues and subjected to our allowance for doubtful accounts policy had the uninsured discount policy not been implemented at these hospitals. We continueto face volume and pricing pressures as a result of continuing economic weakness in the communities our hospitals serve, state efforts to reduce Medicaid program expenditures and intense competition for limited physician and nursing resources, among other factors. Weexpect the average population growth in the markets we serve to remain generally high in the long-term. As these populations increase and grow older, we believe that our clinical quality initiatives will improve our competitive position in those markets. However,these growth opportunities may not overcome the current industry and market challenges in the short-term.

        We continue to implement multiple initiatives to transform our company’s operations to prepare for the future changes we expect to occur in the healthcare industry. Thistransformation process is built upon providing ideal experiences for our patients and their families through clinical excellence, aligning nursing and physician interests to provide coordination of care and improving healthcare delivery efficiencies to providequality outcomes without overutilization of resources. The success of these initiatives will determine our ability to increase revenues from our existing operations and to increase revenues through acquisitions of other hospitals.

        *Costs and Expenses*.  Total costs and expenses from continuing operations, exclusive of income taxes, were $867.2 million or 102.8% of total revenues during the currentyear quarter, compared to 98.0% during the prior year quarter. This ratio was negatively impacted by the $43.1 million ($31.8 million, net of taxes) goodwill impairment related to our Chicago hospitals reporting unit during the current year quarter as previouslydiscussed. Salaries and benefits, supplies, health plan claims and provision for doubtful accounts represent the most significant of our normal costs and expenses and those typically subject to the greatest level of fluctuation period over period.

        •

  

**Salaries and benefits. Salaries and benefits as a percentage of total revenues increased to 38.5% during the current year quarter from 38.2% during the prior year quarter. This ratio was positively impacted bythe significant increase in premium revenues, which utilize a much lower percentage of salaries and benefits than acute care services, during the current year quarter compared to the prior year quarter. For the acute care services operating segment, salaries andbenefits as a percentage of patient service revenues was 49.3% during the current year quarter compared to 47.5% during the prior year quarter. This increase was primarily due to the impact to patient service revenues of our uninsured discount policy previouslydiscussed. We continue to employ more physicians to support the communities our hospitals serve and have made significant investments in clinical quality initiatives that will require additional human resources in the short-term. As of December 31, 2009, we hadapproximately 19,600 full-time and part-time employees compared to approximately 19,000 as of December 31, 2008. We have been successful in limiting contract labor utilization as a result of our investments in clinical quality and nurse leadership initiatives.
 

 

** **

         •

**Supplies. Supplies as a percentage of patient service revenues decreased to 18.2% during the current year quarter compared to 18.4% during the prior year quarter primarily due to our continued focus on supplychain efficiencies including reduction in physician commodity variation and improved pharmacy formulary management. Our ability to reduce this ratio in future periods may be limited because our
45

growth strategies include expansion of higher acuity services and due to inflationary pressures on medical supplies and pharmaceuticals.

 

 

** **

        •

**Health plan claims. Health plan claims expense as a percentage of premium revenues increased to 80.5% during the current year quarter compared to 79.0% during the prior year quarter. As enrollment increases, thisratio becomes especially sensitive to the mix of enrollees, including covered groups based upon age and gender and county of residence. AHCCCS also implemented limits on profitability for certain enrollee groups during the current contract year, which negativelyimpacted this ratio. In addition, the increased PHP revenues diluted the impact of the third party administrator revenues at MHP that have no corresponding health plan claims expense. Revenues and expenses between the health plans and our hospitals and relatedoutpatient service providers of approximately $10.4 million, or 5.7% of gross health plan claims expense, were eliminated in consolidation during the current year quarter.
 

 

** **

        •

**Provision for doubtful accounts. The provision for doubtful accounts as a percentage of patient service revenues decreased to 5.5% during the current year quarter from 7.9% during the prior year quarter.Substantially all of this decrease related to the uninsured discount policy and Medicaid pending policy changes previously discussed. The net impact of these policy changes resulted in the recognition of a significant amount of uninsured revenue deductions that wouldhave otherwise been reflected in the provision for doubtful accounts absent these changes. On a combined basis, the provision for doubtful accounts, charity care deductions and uninsured discounts as a percentage of acute care services segment revenues (prior tothese revenue deductions) was 11.0% and 15.1% for the prior year and current year quarters, respectively. The uninsured discount and Medicaid pending policy changes resulted in an approximate 230 basis point increase in this ratio during the current year quarter.
        *Other operating expenses*. Other operating expenses as a percentage of total revenues decreased to 13.7% during the current year quarter compared to 13.9% during the prior yearperiod. Other operating expenses as a percentage of patient service revenues increased slightly to 18.3% during the current year quarter compared to 18.0% during the prior year quarter.

        *Income taxes*.  Our effective tax rate decreased to approximately 15.3% during the current year quarter compared to 31.9% during the prior year quarter. The effective ratewas much lower during the current year quarter due to the fact that a considerable portion of the goodwill impairment loss related to our Chicago hospitals reporting unit was non-deductible for tax purposes.

        *Net income (loss) attributable to Vanguard Health Systems, Inc. stockholders*.  Net income attributable to Vanguard stockholders was $10.1 million during the prior yearquarter compared to net loss attributable to Vanguard Health Systems, Inc. stockholders of $20.7 million during the current year quarter. This change resulted primarily from the goodwill impairment loss recognized during the current year quarter.

**Six months ended December 31, 2009 compared to six months ended December 31, 2008**

        *Revenues*.  Total revenues increased $155.4 million or 10.3% during the six months ended December 31, 2009 compared to the prior year period primarily due to a significantincrease in health plan premium revenues as a result of increased PHP enrollment. Average enrollment at PHP was 190,747 during the six months ended December 31, 2009, an increase of 42.7% compared to the prior year period. The new AHCCCS contract that went intoeffect on October 1, 2008 included six new counties that PHP had not previously served. The new contract was in effect for the entire six-month period ended December 31, 2009 but only in effect for half of the six-month period ended December 31, 2008.

        Patient service revenues increased $37.7 million or 3.1% during the six months ended December 31, 2009 compared to the prior year period. Adjusted discharges increased 2.8%, totalsurgeries increased 1.0% and emergency room visits increased 7.2% during the current year period compared to the prior year period, respectively. Net revenue per adjusted discharge increased 0.4% during the current year period compared to the prior year period. Thissmall increase compared to those increases from previous periods resulted from the implementation of our uninsured discount policies in our Illinois hospitals effective April 1, 2009 and in our Phoenix and San Antonio hospitals effective July 1, 2009. During thecurrent year period, we recognized $112.9 million of uninsured discount revenue deductions, $74.2 million of which would have otherwise been included in revenues and subjected to our allowance for doubtful accounts policy had the uninsured discount policy not beenimplemented at these hospitals.

46

        *Costs and Expenses*.  Total costs and expenses from continuing operations, exclusive of income taxes, were $1,686.1 million or 101.1% of total revenues during the currentyear period, compared to 98.9% during the prior year period. This ratio was adversely impacted by the $43.1 million ($31.8 million, net of taxes) goodwill impairment loss related to our Chicago hospitals reporting unit during the current year period. Salaries andbenefits, supplies, health plan claims and provision for doubtful accounts represent the most significant of our normal costs and expenses and those typically subject to the greatest level of fluctuation period over period.

        •

  

**Salaries and benefits. Salaries and benefits as a percentage of total revenues decreased to 38.3% during the current year period from 39.4% during the prior year period. This ratio was positively impacted by thesignificant increase in premium revenues, which utilize a much lower percentage of salaries and benefits than acute care services, during the current year period compared to the prior year period. For the acute care services operating segment, salaries and benefitsas a percentage of patient service revenues was 48.9% during the current year period compared to 47.2% during the prior year period. This increase was primarily due to the impact to patient service revenues of our uninsured discount policy previously discussed.
 

 

** **

         •

**Supplies. Supplies as a percentage of patient service revenues decreased to 18.1% during the current year period compared to 18.5% during the prior year period primarily due to our continued focus on supply chainefficiencies including reduction in physician commodity variation and improved pharmacy formulary management.
 

 

** **

        •

**Health plan claims. Health plan claims expense as a percentage of premium revenues increased to 79.6% during the current year period compared to 76.2% during the prior year period. The new PHP contract withAHCCCS that went into effect on October 1, 2008 resulted in a significant change in the mix of our enrollees with a significant increase in enrollees in geographic areas not previously served by PHP. As a result of the bid process for these new areas, the rates paidto providers in those six new counties and capitated payment rates received from AHCCCS for those counties were not necessarily the same as those applicable to the three counties served by PHP under its previous contract. The implementation by AHCCCS of the nationalepisodic risk adjustment factor payment methodology for certain enrollees and the dilution of the third party administrator revenues at MHP also adversely impacted this ratio during the current year period. Revenues and expenses between the health plans and ourhospitals and related outpatient service providers of approximately $21.0 million, or 6.0% of gross health plan claims expense, were eliminated in consolidation during the current year period.
 

 

** **

        •

**Provision for doubtful accounts. The provision for doubtful accounts as a percentage of patient service revenues decreased to 5.8% during the current year period from 8.5% during the prior year period.Substantially all of this decrease related to the uninsured discount policy and Medicaid pending policy changes previously discussed. The net impact of these policy changes resulted in the recognition of a significant amount of uninsured revenue deductions that wouldhave otherwise been reflected in the provision for doubtful accounts absent these changes. On a combined basis, the provision for doubtful accounts, charity care deductions and uninsured discounts as a percentage of acute care services segment revenues (prior tothese revenue deductions) was 11.8% and 16.0% for the prior year and current year periods, respectively. The uninsured discount and Medicaid pending policy changes resulted in an approximate 330 basis point increase in this ratio during the current year period.
        *Other operating expenses*. Other operating expenses as a percentage of total revenues increased to 14.9% during the current year period compared to 14.7% during the prior yearperiod. Other operating expenses as a percentage of patient service revenues increased to 19.9% during the current year period compared to 18.3% during the prior year period. This increase was primarily due to the impact to patient service revenues of our uninsureddiscount and Medicaid pending policy changes previously discussed and a $8.0 million increase to insurance expense during the current year period due to adverse professional and general liability claims development related to prior fiscal years.

        *Income taxes*.  Our effective tax rate decreased to approximately 8.9% during the current year period compared to 31.2 % during the prior year period. The effective ratewas much lower during the current year period due to the fact that a considerable portion of the goodwill impairment loss related to our Chicago hospitals reporting unit, as previously discussed, was non-deductible for tax purposes.

47

        *Net income (loss) attributable to Vanguard Health Systems, Inc. stockholders*.  Net income attributable to Vanguard Health Systems, Inc. stockholders was $11.0 millionduring the prior year period compared to net loss attributable to Vanguard Health Systems, Inc. stockholders of $19.2 million during the current year period. This change resulted primarily from the goodwill impairment loss recognized during the current yearperiod.

**Liquidity and Capital Resources**

        *Operating Activities*

**

        At December 31, 2009, we had working capital of $280.9 million, including cash and cash equivalents of $358.0 million.  Working capital at June 30, 2009 was $251.6 million. Cashprovided by operating activities decreased $4.6 million during the six months ended December 31, 2009 compared to the prior year period. Net accounts receivable days was 46 days at December 31, 2009, compared to 45 days at June 30, 2009 and 50 days at December 31,2008.

        *Investing Activities*

        Cash used in investing activities increased from $54.6 million during the prior year period to $88.8 million during the current year period, primarily as a result of a $20.0 millionincrease in restricted cash related to a professional and general liability escrow fund requirement and a $13.7 million increase in capital expenditures during the current year period compared to the prior year period.

        We anticipate spending a total of $180.0 million to $200.0 million in capital expenditures during fiscal 2010, including the $68.4 million already spent through December 31, 2009.This estimated range includes $71.0 million of replacement, regulatory or maintenance capital and $129.0 million of combined information technology upgrades and other discretionary initiatives. We could choose to defer or cancel most of the information technology anddiscretionary capital projects included in our fiscal year 2010 capital expenditures estimate should we need to conserve cash, avoid debt covenant violations or for other reasons. Any decision to defer or cancel such capital projects, while providing some short-termbenefits, could have negative long-term implications to our operating results and cash flows. We believe our current capital expenditure program is sufficient to service, expand and improve our existing facilities to meet our quality objectives and growthstrategies.

        *Financing Activities*

        Cash flows used in financing activities increased $4.4 million during the current year period compared to the prior year period primarily due to interest payments made under ourre-designated interest rate swap agreement being classified as financing activities. As of December 31, 2009, we had outstanding $1,553.6 million in aggregate indebtedness. The “Refinancing” section below provides additional information related to ourliquidity.

*        The Refinancing*

****

**       ** In late January 2010, we completed a comprehensive refinancing plan (the “Refinancing”). As a result of the Refinancing, our liquidity requirements remainsignificant due to debt service requirements. Under the Refinancing, we entered into an $815.0 million senior secured term loan (the “2010 term loan facility”) and a $260.0 million revolving credit facility (the “2010 revolving facility” andtogether with the 2010 term loan facility, the “2010 credit facilities”). The 2010 term loan facility matures in January 2016 and bears interest at a per annum rate equal to, at our option, LIBOR (subject to a floor of 1.50%) plus 3.50% or a base rateplus 2.50%.  Upon the occurrence of certain events, we may request an incremental term loan facility to be added to the 2010 term loan facility to issue additional term loans in such amount as we determine, subject to the receipt of commitments by existinglenders or other financial institutions for such amount of term loans and the satisfaction of certain other conditions. The 2010 revolving facility matures in January 2015, and we may seek to increase the borrowing availability under the 2010 revolving facility to anamount larger than $260.0 million, subject to the receipt of commitments by existing lenders or other financial institutions for such increased revolving facility and the satisfaction of other conditions. Borrowings under the 2010 revolving facility bear interest ata per annum rate equal to, at our option, LIBOR plus 3.50% or a base rate plus 2.50%, both of which are subject to a 0.25% decrease dependent upon our consolidated leverage ratio. We may utilize the 2010 revolving facility to issue up to $100.0 million of letters ofcredit ($30.2 million of which were outstanding as of the date of the Refinancing).

48

        Under the Refinancing, we issued $815.0 million in term loans under the 2010 term loan facility and $950.0 million aggregate amount at maturity ($936.3 million cash proceeds) of 8.0%senior unsecured notes due February 2018 in a private placement offering (the “8.0% Notes”). The 8.0% Notes are redeemable, in whole or in part, at any time on or after February 1, 2014 at specified redemption prices.

        The proceeds from the 2010 credit facilities, the issuance of the 8.0% Notes and available cash were used to repay the $764.2 million principal and interest outstanding related to our2005 term loan facility; to fund $597.0 million and $232.5 million of cash tender offers and consent solicitations and accrued interest for those holders of the 9.0% Notes and 11.25% Notes, respectively, who accepted the tender offers; to pay fees expenses related tothe Refinancing; to pay $2.6 million to terminate our interest rate swap agreement related to our 2005 term loan facility representing the swap liability at the Refinancing date; to purchase 446 shares held by certain former employees; and to fund a $300.0 milliondistribution to repurchase a portion of the shares owned by the remaining stockholders.  Subsequent to the $300.0 million share repurchase, we completed a 1.4778 for one split that effectively returned the share ownership for each stockholder that participatedin the distribution to the same level as that in effect immediately prior to the distribution. Approximately $20.6 million and $4.1 million of the 9.0% Notes and 11.25% Notes remained outstanding as of the expiration of the initial tender offer and consentsolicitation period and through the portion of the extended tender offer period as of the date of this filing for the holders of the 9.0% Notes and the 11.25% Notes. We estimate that the net impact of the Refinancing will result in an approximate $219.0 milliondecrease in our cash and cash equivalents balance.

        *Debt Covenants*

        Our 2010 credit facilities contain a number of covenants that, among other things, restrict, subject to certain exceptions, our ability, and the ability of our subsidiaries, to sellassets, incur additional indebtedness or issue preferred stock, repay other indebtedness (including the 8.0% Notes), pay dividends and distributions or repurchase our capital stock, create liens on assets, make investments, loans or advances, make certainacquisitions, engage in mergers or consolidations, create a healthcare joint venture, engage in certain transactions with affiliates, amend certain material agreements governing our indebtedness, including the 8.0% Notes, change the business conducted by oursubsidiaries, enter into certain hedging agreements and make capital expenditures above specified levels. In addition, the 2010 credit facilities include the following additional financial covenants: a maximum consolidated leverage ratio and a minimum consolidatedinterest coverage ratio. The following table sets forth the leverage and interest coverage covenant requirements for the next 5 test periods.

 

** **

**Consolidated Leverage Ratio**

 

**Consolidated Interest Coverage Ratio**

           

 

 

 

June 30, 2010

6.25x

 

2.00x

 

September 30, 2010

6.25x

 

2.00x

 

December 31, 2010

6.25x

2.00x

March 31, 2011

6.25x

2.00x

June 30, 2011

5.95x

 

2.10x

 

        Factors outside our control may make it difficult for us to comply with these covenants during future periods. These factors include a prolonged economic recession, a higher number ofuninsured or underinsured patients and decreased governmental or managed care payer reimbursement, among others, any or all of which could negatively impact our results of operations and cash flows and cause us to violate one or more of these covenants. Violation ofone or more of the covenants under our 2010 credit facilities could result in an immediate call of the outstanding principal amount of our 2010 term loan or the necessity of lender waivers with more onerous terms including adverse pricing or repayment provisions ormore restrictive covenants. A default under our 2010 credit facilities would also result in a default under the Indenture governing our 8.0% Notes.

        *Credit Ratings*

        The table below summarizes our credit ratings as of the date of this filing.

 

 

**Standard & Poor’s**

           

**Moody’s**

 

 

Corporate credit rating

 

B

 

B2

8.0% Notes

 

CCC+

 

B3

2010 credit facilities

B+

Ba2

49

        Our credit ratings are subject to periodic reviews by the ratings agencies. If our results of operations deteriorate either as a result of the weakness in the current U.S. economy orother factors, any or all of our corporate ratings may be downgraded. A credit rating downgrade could further impede our ability to refinance all or a portion of our outstanding debt.

        *Capital Resources*

        We expect that cash on hand, cash generated from our operations and cash expected to be available to us under our 2010 credit facilities will be sufficient to meet our working capitalneeds, debt service requirements and planned capital expenditure programs during the next twelve months and into the foreseeable future. However, we cannot assure you that our operations will generate sufficient cash or that additional future borrowings under oursenior credit facilities will be available to enable us to meet these requirements, especially given the current volatility in the credit markets and general economic weakness.

        We had $358.0 million of cash and cash equivalents as of December 31, 2009. We rely on available cash, cash flows generated by operations and available borrowing capacity under our2010 revolving facility to fund our operations and capital expenditures. We invest our cash in accounts in high-quality financial institutions. We continually explore various options to increase the return on our invested cash while preserving our principal cashbalances. However, the significant majority of our cash and cash equivalents are not federally-insured and could be at risk in the event of a collapse of those financial institutions.

        At December 31, 2009, we held $21.6 million in total available for sale investments in auction rate securities (“ARS”) backed by student loans, which are included inlong-term investments in auction rate securities on our condensed consolidated balance sheet due to inactivity in the primary ARS market during the past year. The par value of the ARS was $26.3 million as of December 31, 2009.

        We also intend to continue to pursue acquisitions or partnering arrangements, either in existing markets or new markets, which fit our growth strategies. To finance such transactions,we might draw upon cash on hand, amounts available under our revolving credit facility or seek additional funding sources. We continually assess our capital needs and may seek additional financing, including debt or equity, as considered necessary to fund potentialacquisitions, fund capital projects or for other corporate purposes. However, we may be unable to raise additional equity proceeds from Blackstone or other investors should we need to obtain cash for any of these purposes. Our future operating performance, ability toservice our debt and ability to draw upon other sources of capital will be subject to future economic conditions and other business factors, many of which are beyond our control.

50
****
**Obligations and Commitments**

        The following table reflects a summary of obligations and commitments outstanding, including both the principal and interest portions of long-term debt, with payment dates as ofDecember 31, 2009.

 

 

**Payments due by period**

** **

** **

 

 

 
****
** **

** **

 

 

 

**Within 1 year**
** **
**During Years 2-3**

** **

**During Years 4-5**

** **

**After 5 years**

** **

**Total**

 

 

 

 

**Contractual Cash Obligations:**

 

*(In millions)*

 

Long-term debt (1)

 

$

106.4

 

 

$

921.3

 

 

$

727.1

 

 

$

240.3

 

$

 

1,995.1

 

Operating leases (2)

 

 

30.3

 

 

 

47.0

 

30.7

 

 

 

37.5

 

 

 

145.5

 

Purchase obligations (2)

 

 

41.7

 

 

 

–

 

–

 

 

 

–

 

 

 

41.7

 

Health plan claims payable (3)

136.0

–

–

–

136.0

Estimated self-insurance liabilities (4)

 

 

48.2

 

 

 

43.1

 

25.3

 

 

 

14.6

 

 

 

131.2

 

 

 

 

 

 

 

 

 

 

 

    Subtotal

 

$

362.6

 

 

$

1,011.4

 

$

783.1

 

 

$

292.4

 

 

$

2,449.5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**Within 1 year**
** **
**During Years 2-3**

** **

**During Years 4-5**

** **

**After 5 years**

** **

**Total**

 

 

 

 

**Other Commitments:**

 

*(In millions)*

 

Construction and capital improvements (5)

 

$

20.4

 

 

$

1.1

 

 

$

–

 

 

$

–

 

$

 

21.5

 

Guarantees of surety bonds (6)

 

 

50.0

 

 

 

–

 

–

 

 

 

–

 

 

 

50.0

 

Letters of credit (7)

 

 

30.2

 

 

 

–

 

–

 

 

 

–

 

 

 

30.2

 

Physician commitments (8)

3.5

–

–

–

3.5

Estimated net liability for uncertain tax positions (9)

 

 

3.4

 

 

 

–

 

–

 

 

 

–

 

 

 

3.4

 

 

 

 

 

 

 

 

 

 

 

    Subtotal

 

$

107.5

 

 

$

1.1

 

$

–

 

 

$

–

 

 

$

108.6

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Total obligations and commitments

 

$

470.1

 

 

$

1,012.5

$

783.1

$

292.4

$

2,558.1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

____________________

(1)

 

Includes both principal and interest payments. The interest portion of our debt outstanding at December 31, 2009 assumes an average interest rate of 8.0%. The long-term debt obligations, including principal and interest,adjusted to reflect the impact of the Refinancing, would have been the following as of December 31, 2009: $146.0 million due within one year; $300.4 million due within two to three years; $298.0 million due within four to five years and $2,037.0 million due afterfive years. The interest portion of these estimates are calculated using the fixed rate applicable to these notes and using 8.0% as the estimated average variable rate for the 2010 term loan facility.

 

 

 

(2)

These obligations are not reflected in our condensed consolidated balance sheets.

 

 

 

(3)

 

Represents estimated payments to be made in future periods for healthcare costs incurred by enrollees in PHP, AAHP and MHP and is separately stated on our condensed consolidated balance sheets.

 

 

 

(4)

 

Includes the current and long-term portions of our professional and general liability, workers’ compensation and employee health reserves.

 

 

 

(5)

 

Represents our estimate of amounts we are committed to fund in future periods through executed agreements to complete projects included as construction in progress on our condensed consolidated balance sheets.

 

 

 

(6)

 

Represents performance bonds we have purchased related to health claims liabilities of PHP.

 

 

 

(7)

 

Amounts relate primarily to instances in which we have letters of credit outstanding with the third party administrator of our self-insured workers’ compensation program.

 

 

 

(8)

 

Includes physician guarantee liabilities recognized in our condensed consolidated balance sheets under the guidance of accounting for guarantees and liabilities for other fixed expenses under physician relocation agreementsnot yet paid.

 

 

 

(9)

 

Represents expected future tax liabilities determined under the guidance of accounting for income taxes.

51

**Item 3.    Quantitative and Qualitative Disclosures About Market Risk.**

        We are subject to market risk from exposure to changes in interest rates based on our financing, investing and cash management activities. As of December 31, 2009, we had in place$1,012.6 million of senior credit facilities bearing interest at variable rates (prior to consideration of the interest rate swap agreement) at specified margins above either the agent bank’s alternate base rate or its LIBOR rate.

        After the Refinancing and as of the date of this report, our 2010 credit facilities consist of $815.0 million in term loans maturing in January 2016 and a $260.0 million revolvingcredit facility maturing in January 2015 (of which $30.2 million of capacity was utilized by outstanding letters of credit as of Refinancing date). Although changes in the alternate base rate or the LIBOR rate would affect the cost of funds borrowed in the future, webelieve the effect, if any, of reasonably possible near-term changes in interest rates would not be material to our results of operations or cash flows. An estimated 0.25% change in the variable interest rate under our 2010 term loan facility would result in a changein net interest of approximately $2.0 million.

        Our $260.0 million revolving credit facility bears interest at the alternate base rate plus a margin ranging from 2.25%-2.50% per annum or the LIBOR rate plus a margin ranging from3.25%-3.50% per annum, in each case dependent upon our consolidated leverage ratio. Our $815.0 million in outstanding term loans bear interest at the alternate base rate plus a margin of 2.50% per annum or the LIBOR rate (subject to a 1.50% floor) plus a margin of3.50% per annum. We may request an incremental term loan facility to be added our 2010 term loan facility in an unlimited amount, subject to receipt of commitments by existing lenders or other financing institutions and the satisfaction of certain other conditions.We may also seek to increase the borrowing availability under the 2010 revolving facility to an unlimited amount subject to the receipt of commitments by existing lenders or other financial institutions and the satisfaction of other conditions.

        As of December 31, 2009, we were subject to an amended interest rate swap agreement under which we made or received net interest payments based upon the difference between the 30-dayLIBOR rate and the swap fixed interest rate of 2.5775%. We determined that the hedge ineffectiveness of this amended interest rate swap agreement was not significant as of December 31, 2009. The fair value of the amended interest rate swap as of December 31, 2009 wasa liability for us of approximately $2.6 million ($1.6 million, net of taxes). In addition with the Refinancing, we terminated the amended interest rate swap agreement and repaid the $2.6 million liability outstanding. We use derivatives such as interest rate swapsfrom time to time to manage our market risk associated with variable rate debt or similar derivatives for fixed rate debt. We do not hold or issue derivative instruments for trading purposes and are not a party to any instruments with leverage features.

        At December 31, 2009, we held $21.6 million in total available for sale investments in auction rate securities (“ARS”) backed by student loans, which are included inlong-term investments in auction rate securities on our condensed consolidated balance sheets. The par value of the ARS was $26.3 million as of December 31, 2009.   We recorded a realized loss on the ARS of $0.6 million and temporary impairments totaling $4.1million ($2.5 million, net of taxes) related to all $26.3 million par value ARS during our fiscal year ended June 30, 2009. The temporary impairments related to the ARS are included in accumulated other comprehensive loss on our condensed consolidated balance sheetas of December 31, 2009.

        Our ARS were rated “AAA” by one or more major credit rating agencies at December 31, 2009 based on their most recent ratings update. The ratings take into accountinsurance policies guaranteeing both the principal and accrued interest of the investments. The U.S. government guarantees approximately 96%-98% of the principal and accrued interest on each investment in student loans under the Federal Family Education Loan Programor similar programs.

        We will continue to monitor market conditions for this type of ARS to ensure that our classification and fair value estimate remain appropriate. Should market conditions in futureperiods warrant a reclassification or other than temporary impairment of our ARS, we do not believe our financial position, results of operations, cash flows or compliance with debt covenants would be materially impacted. We believe that we currently have adequateworking capital to fund operations during the near future based on access to cash and cash equivalents, expected operating cash flows and availability under our revolving credit facility. We do not expect that our holding of the ARS until market conditions improvewill significantly adversely impact our operating cash flows.

52

**Item 4.   Controls and Procedures.**

**        Evaluation of Disclosure Controls and Procedures**

        As of the end of the period covered by this report, our management conducted an evaluation, with the participation of our chief executive officer and chief financial officer, of theeffectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)).  Based on this evaluation, our chief executive officer and chief financial officerhave concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periodsspecified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regardingrequired disclosure.

**        Changes in Internal Control Over Financial Reporting**

        There were no changes in our internal control over financial reporting during our fiscal quarter ended December 31, 2009, that have materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.

53
****
**PART IIOTHER INFORMATION**

**Item 1.    Legal Proceedings.**

***Sherman Act Antitrust Class Action Litigation — Maderazo, et al v. VHS San Antonio Partners, L.P. d/b/a Baptist Health Systems, et. al., Case No. 5:06cv00535 (UnitedStates District Court, Western District of Texas, San Antonio Division, filed June 20, 2006 and amended August 29, 2006)***

        On June 20, 2006, a federal antitrust class action suit was filed in San Antonio, Texas against our Baptist Health System subsidiary in San Antonio, Texasand two other large hospital systems in San Antonio. In the complaint, plaintiffs allege that the three hospital system defendants conspired with each other and with other unidentified San Antonio area hospitals to depress the compensation levels ofregistered nurses employed at the conspiring hospitals within the San Antonio area by engaging in certain activities that violated the federal antitrust laws. The complaint alleges two separate claims. The first count asserts that the defendant hospitalsviolated Section 1 of the federal Sherman Act, which prohibits agreements that unreasonably restrain competition, by conspiring to depress nurses’ compensation. The second count alleges that the defendant hospital systems also violated Section 1 ofthe Sherman Act by participating in wage, salary and benefits surveys for the purpose, and having the effect, of depressing registered nurses’ compensation or limiting competition for nurses based on their compensation. The class on whose behalf the plaintiffsfiled the complaint is alleged to comprise all registered nurses employed by the defendant hospitals since June 20, 2002. The suit seeks unspecified damages, trebling of this damage amount pursuant to federal law, interest, costs and attorneys fees. From 2006through April 2008 we and the plaintiffs worked on producing documents to each other relating to, and supplying legal briefs to the court in respect of, the issue of whether the court will certify a class in this suit. In April 2008 the case was stayed by the judgepending his ruling on plaintiffs’ motion for class certification. We believe that the allegations contained within this putative class action suit are without merit, and we have vigorously worked to defeat class certification. If a class is certified, we willcontinue to defend vigorously against the litigation.

        On the same date that this suit was filed against us in federal district court in San Antonio, the same attorneys filed three other substantially similar putativeclass action lawsuits in federal district courts in Chicago, Illinois, Albany, New York and Memphis, Tennessee against some of the hospitals in those cities (none of such hospitals being owned by us). The attorneys representing the plaintiffs in all four of thesecases said in June 2006 that they may file similar complaints in other jurisdictions and in December 2006 they brought a substantially similar class action lawsuit against various hospitals in the Detroit, Michigan metropolitan area. Since representatives of theService Employees International Union joined plaintiffs’ attorneys in announcing the filing of all four complaints on June 20, 2006, and as has been reported in the media, we believe that SEIU’s involvement in these actions appears to be part of acorporate campaign to attempt to organize nurses in these cities, including San Antonio. The nurses in our hospitals in San Antonio are currently not members of any union.

        If the plaintiffs (1) are successful in obtaining class certification and (2) are able to prove substantial damages which are then trebled under Section 1of the Sherman Act, such a result could materially affect our business, financial condition or results of operations. However, in the opinion of management, the ultimate resolution of this matter is not expected to have a material adverse effect on our financialposition or results of operations.

***Self-Disclosure of Employment of Excluded Persons***

        Federal law permits the Department of Health and Human Services Office of Inspector General (“OIG”) to impose civil monetary penalties, assessments and/or toexclude from participation in federal healthcare programs, individuals and entities who have submitted false, fraudulent or improper claims for payment. Improper claims include those submitted by individuals or entities who have been excluded from participation.Civil monetary penalties of up to $10,000 for each item or service furnished by the excluded individual or entity, an assessment of up to three times the amount claimed and program exclusions also be imposed on providers or entities who employ or enter into contractswith excluded individuals to provide services to beneficiaries of federal healthcare programs. On October 12, 2009, we voluntarily disclosed to OIG that two past employees had been excluded from participation in Medicare at certain times during their employment.We are diligently investigating the circumstances surrounding the employment of these two excluded individuals, and intend to submit a voluntary disclosure pursuant to the Provider Self-Disclosure Protocol once the necessary information is obtained. If the OIG wereto impose all potentially available sanctions and penalties against us in this matter, such a result could materially affect

54

our business, financial condition or results of operations. However, in the opinion of management, the ultimate resolution of this matter is not expected to have a material adverse effect on our financialposition or results of operations.

**Item 1A.*  * Risk Factors.**

        There have not been any material changes to the risk factors previously disclosed in our Annual Report on Form 10-K for the fiscal year ended June 30, 2009, other thanthe changes set forth in the new or revised risk factors set forth below.

**Risks Related to Our Indebtedness**

***Our high level of debt and significant leverage may adversely affect our operations and our ability to grow and otherwise execute our business strategy.***

        We will continue to have substantial indebtedness after the completion of the Refinancing. As of December 31, 2009, we had $1,545.6 million of outstanding debt,excluding letters of credit and guarantees. As of December 31, 2009, on an as adjusted basis after giving effect to the Refinancing, we would have had approximately $1,765.0 million of total indebtedness outstanding, $815.0 million of which would have beensecured. We also expect to have $229.8 million of secured indebtedness available for borrowing under the 2010 revolving facility, after taking into account $30.2 million of outstanding letters of credit. The amount of our outstanding indebtedness issubstantial compared to the net book value of our assets.

        Our substantial indebtedness could have important consequences, including the following:

        •

  

our high level of indebtedness could make it more difficult for us to satisfy our obligations under the 8.0% Notes, including any repurchase obligations;

 

 

 

        •

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

 

 

 

        •

increase our vulnerability to general adverse economic, market and industry conditions and limit our flexibility in planning for, or reacting to, these conditions;

 

 

 

        •

make us vulnerable to increases in interest rates since all (as of December 31, 2009 after giving effect to the Refinancing) of our borrowings under the 2010 credit facilities are, and additional borrowings maybe, at variable interest rates;

 

 

 

        •

our flexibility to adjust to changing market conditions and ability to withstand competitive pressures could be limited, and we may be more vulnerable to a downturn in general economic or industry conditions orbe unable to carry out capital spending that is necessary or important to our growth strategy and our efforts to improve operating margins;

 

 

 

        •

limit our ability to use operating cash in other areas of our business because we must use a substantial portion of these funds to make principal and interest payments; and

 

 

 

        •

limit our ability to compete with others who are not as highly-leveraged.

        Our ability to make scheduled payments of principal and interest or to satisfy our other debt obligations, to refinance our indebtedness or to fund capital expenditureswill depend on our future operating performance. Prevailing economic conditions (including interest rates) and financial, business and other factors, many of which are beyond our control, will also affect our ability to meet these needs. We may not be able togenerate sufficient cash flows from operations or realize anticipated revenue growth or operating improvements, or obtain future borrowings in an amount sufficient to enable us to pay our debt, or to fund our other liquidity needs. We may need to refinance all or aportion of our debt on or before maturity. We may not be able to refinance any of our debt when needed on commercially reasonable terms or at all.

        A breach of any of the restrictions or covenants in our debt agreements could cause a cross-default under other debt agreements. A significant portion of ourindebtedness then may become immediately due and payable. We are not certain

55

whether we would have, or be able to obtain, sufficient funds to make these accelerated payments. If any senior debt is accelerated, our assets may not be sufficient to repay in full such indebtedness and ourother indebtedness.

***Despite our current leverage, we may still be able to incur substantially more debt. This could further exacerbate the risks that we and our subsidiaries face.***

        We and our subsidiaries may be able to incur substantial additional indebtedness in the future. The terms of the indenture and the 2010 credit facilities do not fullyprohibit us or our subsidiaries from doing so. Our 2010 revolving facility will provide commitments of up to $260.0 million (not giving effect to any outstanding letters of credit, which would reduce the amount available under our 2010 revolving facility), ofwhich $229.8 million would have been available for future borrowings as of December 31, 2009, on an as adjusted basis after giving effect to the Refinancing. In addition, upon the occurrence of certain events and satisfaction of a maximum senior secured leverageratio test, we may request an incremental term loan facility or facilities in an unlimited amount in the aggregate, subject to receipt of commitments by existing lenders or other financing institutions and to the satisfaction of certain other conditions. All of thoseborrowings would be senior and secured, and as a result, would be effectively senior to the notes and the guarantees of the notes by the guarantors. If we incur any additional indebtedness that ranks equally with the notes, the holders of that debt will be entitledto share ratably with the holders of the notes in any proceeds distributed in connection with any insolvency, liquidation, reorganization, dissolution or other winding-up of us. This may have the effect of reducing the amount of proceeds paid to you. If new debt isadded to our current debt levels, the related risks that we and our subsidiaries now face could intensify.

***An increase in interest rates would increase the cost of servicing our debt and could reduce our profitability.***

        All of the borrowings under the 2010 credit facilities bear interest at variable rates. As a result, an increase in interest rates, whether because of an increase inmarket interest rates or an increase in our own cost of borrowing, would increase the cost of servicing our debt and could materially reduce our profitability. A 0.25% increase in the expected rate of interest under the 2010 credit facilities would increase ourannual interest expense by approximately $2.0 million. The impact of such an increase would be more significant than it would be for some other companies because of our substantial debt.

**Risks Related to Our Business and Structure**

***The current challenging economic environment, along with difficult and volatile conditions in the capital and credit markets, could materially adversely affect our financial position, results of operationsor cash flows, and we are unsure whether these conditions will improve in the near future.***

        The U.S. economy and global credit markets remain volatile. Declining consumer confidence and increased unemployment have increased concerns of prolonged economicweakness. While certain healthcare spending is considered non-discretionary and may not be significantly impacted by economic downturns, other types of healthcare spending may be significantly adversely impacted by such conditions. When patients are experiencingpersonal financial difficulties or have concerns about general economic conditions, they may choose to defer or forego elective surgeries and other non-emergent procedures, which are generally more profitable lines of business for hospitals. We are unable todetermine the specific impact of the current economic conditions on our business at this time, but we believe that further deterioration or a prolonged period of recession will have an adverse impact on our operations. Other risk factors discussed in this offeringmemorandum describe some significant risks that may be magnified by the current economic conditions such as the following:

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Our concentration of operations in a small number of regions, and the impact of economic downturns in those communities. To the extent the communities in and around San Antonio, Texas; Phoenix, Arizona;Chicago, Illinois or certain communities in Massachusetts experience a greater degree of economic weakness than average, the adverse impact on our operations could be magnified.

 

 

 

        •

Our revenues may decline if federal or state programs reduce our Medicare or Medicaid payments or managed care companies (including managed Medicare and managed Medicaid payers) reduce our reimbursement. Currenteconomic conditions have accelerated and increased the budget deficits for most states, including those in which we operate. These budgetary pressures may result in healthcare payment reductions under state Medicaid plans or reduced benefits to participants in thoseplans. Also, governmental, managed Medicare or managed Medicaid payers may defer payments to us to conserve

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cash. Managed care companies may also seek to reduce payment rates or limit payment rate increases to hospitals in response to reductions in enrolled participants.

 

 

 

        •

Our hospitals face a growth in uncompensated care as the result of the inability of uninsured patients to pay for healthcare services and difficulties in collecting patient portions of insured accounts. Higherunemployment, Medicaid benefit reductions and employer efforts to reduce employee healthcare costs may increase our exposure to uncollectible accounts for uninsured patients or those patients with higher co-pay and deductible limits.

 

 

 

        •

Under extreme market conditions, there can be no assurance that funds necessary to run our business will be available to us on favorable terms or at all. Most of our cash and borrowing capacity under our NewCredit Facilities will be held with a limited number of financial institutions, which could increase our liquidity risk if one or more of those institutions become financially strained or are no longer able to operate.

        We are unable to predict if the condition of the U.S. economy, the local economies in the communities we serve or global credit conditions will improve in the nearfuture or when such improvements may occur.

***The current U.S. and state health reform legislative initiatives could adversely affect our operations and business condition.***

        A comprehensive healthcare reform bill was widely anticipated to become law sometime in early 2010. The House passed its health reform bill on November 7, 2009followed by Senate passage of their version of a health reform bill on December 24, 2009. During January 2010, leadership from the houses along with representatives in the Obama administration have been meeting to develop a single bill that incorporatesprovisions from both bills. With the election to the United States Senate of Senator Scott Brown (R) of Massachusetts, the enactment of such bill, and the contents of any bill so enacted, have become more uncertain. Assuming Congress comes to an agreement and passesfinal legislation, President Obama is expected to sign the health reform package.

        A common issue addressed in the federal health reform bills is increasing access to health benefits for uninsured or underinsured populations through creation of healthinsurance exchanges. The bills also include reductions in the annual market basket updates and add productivity adjustments for Medicare providers. Some states also have pending health reform legislative initiatives. We will not be able to determine the effect thatany such legislation may have on our operations and business condition until such legislation is enacted, but such legislation may adversely affect our operations and business condition.

***If we are unable to enter into favorable contracts with managed care plans, our operating revenues may be reduced.***

        Our ability to negotiate favorable contracts with health maintenance organizations, insurers offering preferred provider arrangements and other managed care plans significantlyaffects the revenues and operating results of our hospitals. Revenues derived from health maintenance organizations, insurers offering preferred provider arrangements and other managed care plans, including managed Medicare and managed Medicaid plans, accounted forapproximately 58% and 60% of our net patient revenues for the year ended June 30, 2009 and the six months ended December 31, 2009, respectively. Managed care organizations offering prepaid and discounted medical services packages represent an increasing portionof our admissions, a general trend in the industry which has limited hospital revenue growth nationwide and a trend that may continue. In addition, private payers are increasingly attempting to control healthcare costs through direct contracting with hospitals toprovide services on a discounted basis, increased utilization review and greater enrollment in managed care programs such as health maintenance organizations and preferred provider organizations. Additionally, the trend towards consolidation among private managedcare payers tends to increase their bargaining prices over fee structures. In most cases, we negotiate our managed care contracts annually as they come up for renewal at various times during the year. Our future success will depend, in part, on our ability to renewexisting managed care contracts and enter into new managed care contracts on terms favorable to us. Other healthcare companies, including some with greater financial resources, greater geographic coverage or a wider range of services, may compete with us for theseopportunities. If we are unable to contain costs through increased operational efficiencies or to obtain higher reimbursements and payments from managed care payers, our results of operations and cash flows will be materially adversely affected.

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***Our revenues may decline if federal or state programs reduce our Medicare or Medicaid payments or managed care companies reduce our reimbursements.***

        Approximately 56% and 57% of our net patient revenues for the year ended June 30, 2009 and the six months ended December 31, 2009, respectively, came from the Medicare andMedicaid programs, including Medicare and Medicaid managed plans. In recent years, federal and state governments have made significant changes in the Medicare and Medicaid programs. Some of those changes adversely affect the reimbursement we receive for certainservices. In addition, due to budget deficits in many states, significant decreases in state funding for Medicaid programs have occurred or are being proposed.

        On August 22, 2007, CMS issued a final rule for federal fiscal year 2008 for the hospital inpatient prospective payment system. This rule adopted a two-year implementation ofMedicare severity-adjusted diagnosis-related groups (“MS-DRGs”), a severity-adjusted diagnosis-related group (“DRG”) system. This change represented a refinement to the DRG system, and its impact on our revenues has not been significant.Realignments in the DRG system could impact the margins we receive for certain services.

        DRG rates are updated and MS-DRG weights are recalibrated each federal fiscal year. The index used to update the market basket gives consideration to the inflation experienced byhospitals and entities outside the healthcare industry in purchasing goods and services. The Medicare Inpatient Hospital Prospective System Final Rule for federal fiscal year 2010 provides for a 2.1% market basket update for hospitals that submit certain qualitypatient care indicators and a 0.1% update for hospitals that do not submit this data. While we will endeavor to comply with all quality data submission requirements, our submissions may not be deemed timely or sufficient to entitle us to the full market basketadjustment for all our hospitals. Medicare payments to hospitals in federal fiscal year 2009 were reduced by 0.9% to eliminate what CMS estimates will be the effect of coding or classification changes as a result of hospitals implementing the MS-DRG system. Afterearlier proposing an increase in the “documentation and coding adjustment” to 1.9% for federal fiscal year 2010, on July 31, 2009 CMS announced that it had decided not to make any adjustment in federal fiscal year 2010 since it did not know whetherfederal fiscal year 2009 spending from documentation and coding is more or less than earlier projected. However, the U.S. Congress has given CMS the ability to continue to retrospectively determine if the documentation and coding adjustment levels for federalfiscal years 2008 and 2009 were adequate to account for changes in payments not related to changes in case mix. If the levels are found to have been inadequate, CMS could impose an adjustment to payments for federal fiscal years 2011 and 2012. This evaluation ofchanges in case-mix based on actual claims data may yield a higher documentation and coding adjustment thereby potentially reducing our revenues and impacting our results of operations in ways that cannot be quantified at this time. Additionally, Medicare payments tohospitals are subject to a number of other adjustments, and the actual impact on payments to specific hospitals may vary. In some cases, commercial third-party payers and other payers such as some state Medicaid programs rely on all or portions of the Medicare DRGsystem to determine payment rates. The change from traditional Medicare DRGs to MS-DRGs could adversely impact those payment rates if any other payers adopt MS-DRGs.

        The federal government and many states have recently adopted or are currently considering reducing the level of Medicaid funding (including upper payment limits) or programeligibility that could adversely affect future levels of Medicaid reimbursement received by our hospitals. Since states must operate with balanced budgets and since the Medicaid program is often a state’s largest program, a number of states have adopted, or areconsidering adopting, legislation designed to reduce their Medicaid expenditures. The Deficit Reduction Act of 2005 (“DRA”) includes federal Medicaid cuts of approximately $4.8 billion over five years. Additionally, on May 29, 2007, CMSpublished a final rule entitled “Medicaid Program; Cost Limit for Providers Operated by Units of Government and Provisions to Ensure the Integrity of Federal-State Financial Partnership” which is estimated to reduce federal Medicaid funding from$12 billion to $20 billion over five years. The U.S. Congress enacted two moratoria in respect of this rule that delayed six of seven proposed Medicaid regulations in this final CMS rule until July 1, 2009. On June 30, 2009, three more of theMedicaid regulations that had been under a congressional moratorium set to expire July 1, 2009 were officially rescinded, all or in part, by CMS, and CMS also delayed until June 30, 2010 the enforcement of the fourth of the six regulations. As a result ofthese changes in implementing the final rule, the impact on us of the final rule cannot be quantified. States in which we operate have also adopted, or are considering adopting, legislation designed to reduce coverage and program eligibility, enroll Medicaidrecipients in managed care programs and/or impose additional taxes on hospitals to help finance or expand the states’ Medicaid systems. For example, Arizona has frozen hospital inpatient and outpatient reimbursements at the October 1, 2008 rates anddiscontinued a state health benefits program for low-income parents. Additional Medicaid spending cuts may be implemented in the future in the states in which we operate, including reductions in supplemental Medicaid reimbursement programs. Our Texashospitals

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participate in private supplemental Medicaid reimbursement programs that are structured to expand the community safety net by providing indigent healthcare services and result in additional revenues for participatinghospitals. We cannot predict whether the Texas private supplemental Medicaid reimbursement programs will continue or guarantee that revenues recognized from the programs will not decrease. Future legislation or other changes in the administration or interpretation ofgovernment health programs could have a material adverse effect on our financial position and results of operations.

        Our ability to negotiate favorable contracts with managed care plans significantly affects the revenues and operating results of most of our hospitals. Managed care payersincreasingly are demanding discounted fee structures, and the trend toward consolidation among managed care plans tends to increase their bargaining power over fee structures. Reductions in price increases or the amounts received from managed care plans could have amaterial adverse effect on our financial position and results of operations.

        In recent years, both the Medicare program and several large managed care companies have changed our reimbursement to link some of their payments, especially their annual increases inpayments, to performance of quality of care measures. We expect this trend to “pay-for-performance” to increase in the future. If we are unable to meet these performance measures, our results of operations and cash flow will be materially adverselyaffected.

***We conduct business in a heavily regulated industry, and changes in regulations or violations of regulations may result in increased costs or sanctions that could reduce our revenues and profitability.***

        The healthcare industry is subject to extensive federal, state and local laws and regulations relating to licensing, the conduct of operations, the ownership of facilities, theaddition of facilities and services, financial arrangements with physicians and other referral sources, confidentiality, maintenance and security issues associated with medical records, billing for services and prices for services. If a determination were made thatwe were in material violation of such laws or regulations, our operations and financial results could be materially adversely affected.

        In many instances, the industry does not have the benefit of significant regulatory or judicial interpretations of these laws and regulations. This is particularly true in the case ofthe Medicare and Medicaid statute codified under Section 1128B(b) of the Social Security Act and known as the “Anti-Kickback Statute.” This law prohibits providers and other person or entities from soliciting, receiving, offering or paying, directlyor indirectly, any remuneration with the intent to generate referrals of orders for services or items reimbursable under Medicare, Medicaid and other federal healthcare programs. As authorized by the U.S. Congress, the U.S. Department of Health and HumanServices has issued regulations which describe certain conduct and business relationships immune from prosecution under the Anti-Kickback Statute. The fact that a given business arrangement does not fall within one of these “safe harbor” provisions doesnot render the arrangement illegal, but business arrangements of healthcare service providers that fail to satisfy the applicable safe harbor criteria risk increased scrutiny by enforcement authorities.

        The safe harbor requirements are generally detailed, extensive, narrowly drafted and strictly construed. Many of the financial arrangements that our facilities maintain withphysicians do not meet all of the requirements for safe harbor protection. The regulatory authorities that enforce the Anti-Kickback Statute may in the future determine that one or more of these arrangements violate the Anti-Kickback Statute or other federal or statelaws. In addition, the Senate health reform bill includes provisions that would revise the scienter requirements such that a person need not have actual knowledge of the Anti-Kickback Statute or intent to violate the Anti-Kickback Statute to be found guilty of aviolation. A determination that a facility has violated the Anti-Kickback Statute or other federal laws could subject us to liability under the Social Security Act, including criminal and civil penalties, as well as exclusion of the facility from participation ingovernment programs such as Medicare and Medicaid or other federal healthcare programs.

        In addition, the portion of the Social Security Act commonly known as the “Stark Law” prohibits physicians from referring Medicare and (to an extent) Medicaid patients toproviders of certain “designated health services” if the physician or a member of his or her immediate family has an ownership or investment interest in, or compensation arrangement with, that provider. In addition, the provider in such arrangements isprohibited from billing for all of the designated health services referred by the physician, and, if paid for such services, is required to promptly repay such amounts. Most of the services furnished by our facilities are “designated health services” forStark Law purposes, including inpatient and outpatient hospital services. There are multiple exceptions to the Stark Law, among others, for physicians maintaining an ownership interest in an entire hospital or having a compensation relationship with the facility as aresult of employment agreements, leases, physician recruitment and certain other arrangements. However, each of these exceptions applies only if detailed conditions

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are met. An arrangement subject to the Stark Law must qualify for an exception in order for the services to be lawfully referred by the physician and billed by the provider.

        CMS has issued three phases of final regulations implementing the Stark Law. Phases I and II became effective in January 2002 and July 2004, respectively, and Phase IIIbecame effective in December 2007. While these regulations help clarify the requirements of the exceptions to the Stark Law, it is unclear how the government will interpret many of these exceptions for enforcement purposes. In addition, in July 2007 CMS proposedfar-reaching changes to the regulations implementing the Stark Law that would further restrict the types of arrangements that hospitals and physicians may enter, including additional restrictions on certain leases, percentage compensation arrangements, and agreementsunder which a hospital purchases services under arrangements. On July 31, 2008, CMS issued a final rule which, in part, finalized and responded to public comments regarding some of its July 2007 proposed major changes to the Stark Law regulations. The mostfar-reaching of the changes made in this final July 2008 rule effectively prohibit, as of a delayed effective date of October 1, 2009, both “under arrangements” ventures between a hospital and any referring physician or entity owned, in whole or inpart, by a referring physician and unit-of-service-based “per click” compensation and percentage-based compensation in office space and equipment leases between a hospital and any referring physician or entity owned, in whole or inpart, by a referringphysician. We examined all of our “under arrangement” ventures and space and equipment leases with physicians to identify those arrangements which would have failed to conform to these new Stark regulations as of October 1, 2009, and we restructuredor terminated all such non-conforming arrangements so identified prior to October 1, 2009. Because the Stark Law and its implementing regulations are relatively new, we do not always have the benefit of significant regulatory or judicial interpretation of thislaw and its regulations. We attempt to structure our relationships to meet an exception to the Stark Law, but the regulations implementing the exceptions are detailed and complex, and we cannot assure you that every relationship complies fully with the Stark Law. Inaddition, in the July 2008 final Stark rule CMS indicated that it will continue to enact further regulations tightening aspects of the Stark Law that it perceives allow for Medicare program abuse, especially those regulations that still permit physicians toprofit from their referrals of ancillary services. We cannot assure you that the arrangements entered into by our hospitals with physicians will be found to be in compliance with the Stark Law, as it ultimately may be implemented or interpreted.

        Additionally, if we violate the Anti-Kickback Statute or Stark Law, or if we improperly bill for our services, we may be found to violate the False Claims Act, either under a suitbrought by the government or by a private person under a *qui tam*, or “whistleblower,” suit.

        If we fail to comply with the Anti-Kickback Statute, the Stark Law, the False Claims Act or other applicable laws and regulations, or if we fail to maintain an effective corporatecompliance program, we could be subjected to liabilities, including civil penalties (including the loss of our licenses to operate one or more facilities), exclusion of one or more facilities from participation in the Medicare, Medicaid and other federal and statehealthcare programs and, for violations of certain laws and regulations, criminal penalties.

        All of the states in which we operate have adopted or have considered adopting similar anti-kickback and physician self-referral legislation, some of which extends beyond the scope ofthe federal law to prohibit the payment or receipt of remuneration for the referral of patients and physician self-referrals, regardless of the source of payment for the care. Little precedent exists for the interpretation or enforcement of these laws. Both federaland state government agencies have announced heightened and coordinated civil and criminal enforcement efforts.

        Government officials responsible for enforcing healthcare laws could assert that one or more of our facilities, or any of the transactions in which we are involved, are in violationof the Anti-Kickback Statute or the Stark Law and related state law exceptions. It is also possible that the courts could ultimately interpret these laws in a manner that is different from our interpretations. Moreover, other healthcare companies, alleged to haveviolated these laws, have paid significant sums to settle such allegations and entered into “corporate integrity agreements” because of concern that the government might exercise its authority to exclude those providers from governmental payment programs(e.g., Medicare, Medicaid, TRICARE). A determination that one or more of our facilities has violated these laws, or the public announcement that we are being investigated for possible violations of these laws, could have a material adverse effect on our business,financial condition, results of operations or prospects, and our business reputation could suffer significantly.

        Federal law permits the Department of Health and Human Services Office of Inspector General (“OIG”) to impose civil monetary penalties, assessments or to exclude fromparticipation in federal healthcare programs, individuals and entities who have submitted false, fraudulent or improper claims for payment. Improper claims include those submitted by individuals or

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entities who have been excluded from participation. These penalties may also be imposed on providers or entities who employ or enter into contracts with excluded individuals to provide services to beneficiaries of federalhealthcare programs. Furthermore, if services are provided by an excluded individual or entity, the penalties may apply even if the payment is made directly to a non-excluded entity. Employers of or entities that contract with excluded individuals or entities for theprovision of services may be liable for up to $10,000 for each item or service furnished by the excluded individual or entity, an assessment of up to three times the amount claimed and program exclusions. In order for the penalties to apply, the employer orcontractor must have known or should have known that the person or entity was excluded from participation. On October 12, 2009, we voluntarily reported to OIG that two past employees of Vanguard had been excluded from participation in Medicare at certain timesduring their employment. Illinois and Massachusetts require governmental determinations of need (“Certificates of Need”) prior to the purchase of major medical equipment or the construction, expansion, closure, sale or change of control of healthcarefacilities. We believe our facilities have obtained appropriate certificates wherever applicable. However, if a determination were made that we were in material violation of such laws, our operations and financial results could be materially adversely affected. Thegovernmental determinations, embodied in Certificates of Need, can also affect our facilities’ ability to add bed capacity or important services. We cannot predict whether we will be able to obtain required Certificates of Need in the future. A failure toobtain any required Certificates of Need may impair our ability to operate the affected facility profitably.

        The laws, rules and regulations described above are complex and subject to interpretation. If we are in violation of any of these laws, rules or regulations, or if further changes inthe regulatory framework occur, our results of operations could be significantly harmed.

***Some of our hospitals will be required to submit to CMS information on their relationships with physicians and this submission could subject such hospitals and us to liability.***

        CMS announced in 2007 that it intends to collect information on ownership, investment and compensation arrangements with physicians from 500 (pre-selected) hospitals by requiringthese hospitals to submit to CMS Disclosure of Financial Relationship Reports (“DFRR”) from each selected hospital. CMS also indicated that at least 10 of our hospitals will be among these 500 hospitals required to submit a DFRR because these 10 hospitalsdid not respond to CMS’ voluntary survey instrument on this topic purportedly submitted to these hospitals via email by CMS in 2006. CMS intends to use this data to determine whether these hospitals were in compliance with the Stark Law and implementingregulations during the reporting period, and CMS has indicated it may share this information with other government agencies and with congressional committees. Many of these agencies have not previously analyzed this information and have the authority to bringenforcement actions against the hospitals. However, in July 2008 CMS announced that, based on its further review and expected further public comments on this matter, CMS may decide in the future to decrease (but not increase) the number of hospitals to which it willsend the DFRR below the 500 hospitals originally designated.

        Once a hospital receives this request for a DFRR, the hospital will have 60 days to compile a significant amount of information relating to its financial relationships withphysicians. The hospital may be subject to civil monetary penalties of up to $10,000 per day if it is unable to assemble and report this information within the required timeframe or if CMS or any other government agency determines that the submission is inaccurate orincomplete. The hospital may be the subject of investigations or enforcement actions if a government agency determines that any of the information indicates a potential violation of law.

        Also, while in 2007 CMS had announced that it was contemplating proposing a regular financial disclosure process that would apply in the future to all Medicare participatinghospitals, in July 2008 CMS announced that, based upon public comments previously received, it was not adopting a regular reporting or disclosure process at that time, and, thus, CMS said the DFRR will initially be used as a one-time collection effort. However, CMSalso said in July 2008 that, depending on the information received from the initial DFRR process and other factors, it may propose future rulemaking to use the DFRR or some other instrument as a periodic or regular collection instrument. Thus, even if one of ourhospitals does not receive the DFRR survey as part of the initial up to 500 selected hospitals, we expect that all of our hospitals will possibly have to report similar information to CMS in the future.

        The DFRR and its supporting documentation are currently under review by the Office of Management and Budget and have not yet been released. Depending on the final format of the DFRR,responding hospitals may be subject to substantial penalties as a result of enforcement actions brought by government agencies and whistleblowers acting pursuant to the False Claims Act and similar state laws, based on such allegations like failure to respond withinrequired deadlines, that the

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response is inaccurate or contains incomplete information or that the response indicates a potential violation of the Stark Law or other requirements.

        Any governmental investigation or enforcement action which results from the DFRR process could materially adversely affect our results of operations.

***Providers in the healthcare industry have been the subject of federal and state investigations, whistleblower lawsuits and class action litigation, and we may become subject to investigations, whistleblower lawsuits orclass action litigation in the future.***

        Both federal and state government agencies have heightened and coordinated civil and criminal enforcement efforts as part of numerous ongoing investigations of hospital companies, aswell as their executives and managers. These investigations relate to a wide variety of topics, including:

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cost reporting and billing practices;

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laboratory and home healthcare services;

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physician ownership of, and joint ventures with, hospitals;

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physician recruitment activities; and

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other financial arrangements with referral sources.

        In addition, the federal False Claims Act permits private parties to bring *qui tam*, or whistleblower, lawsuits against companies. Whistleblower provisions allow privateindividuals to bring actions on behalf of the government alleging that the defendant has defrauded the federal government. Because *qui tam* lawsuits are filed under seal, we could be named in one or more such lawsuits of which we are not aware. Defendantsdetermined to be liable under the False Claims Act may be required to pay three times the actual damages sustained by the government, plus mandatory civil penalties of between $5,500 and $11,000 for each separate false claim. Typically, each fraudulent bill submittedby a provider is considered a separate false claim, and thus the penalties under the False Claims Act may be substantial. Liability arises when an entity knowingly submits a false claim for reimbursement to the federal government. The Fraud Enforcement and RecoveryAct, which became law on May 20, 2009, changes the scienter requirements for liability under the False Claims Act. An entity may now violate the False Claims Act if it “knowingly and improperly avoids or decreases an obligation” to pay money to theUnited States. This includes obligations based on an “established duty . . . arising from . . . the retention of any overpayment.” Thus, if a provider is aware that it has retained an overpayment that it has an obligation to refund, this may form thebasis of a False Claims Act violation even if the provider did not know the claim was “false” when it was submitted. In some cases, whistleblowers or the federal government have taken the position that providers who allegedly have violated other statutesand have submitted claims to a governmental payer during the time period they allegedly violated these other statutes, have thereby submitted false claims under the False Claims Act. Such other statutes include the Anti-Kickback Statute and the Stark Law. Courts haveheld that violations of these statutes can properly form the basis of a False Claims Act case. Some states have adopted similar whistleblower and false claims provisions.

        The Office of the Inspector General of the U.S. Department of Health and Human Services and the U.S. Department of Justice have, from time to time, established nationalenforcement initiatives that focus on specific billing practices or other suspected areas of abuse. Initiatives include a focus on hospital billing for outpatient charges associated with inpatient services, as well as hospital laboratory, home health and durablemedical equipment billing practices. As a result of these regulations and initiatives, some of our activities could become the subject of governmental investigations or inquiries. For example, we have significant Medicare and Medicaid billings, we provide somedurable medical equipment and home healthcare services, and we have joint venture arrangements involving physician investors. We also have a variety of other financial arrangements with physicians and other potential referral sources including recruitmentarrangements and leases. In addition, our executives and managers, many of whom have worked at other healthcare companies that are or may become the subject of federal and state investigations and private litigation, could be included in governmental investigationsor named as defendants in private litigation. We are aware that several of our hospitals or their related healthcare operations were and may still be under investigation in connection with activities conducted prior to our acquisition of them. Under the terms of ourvarious acquisition agreements, the prior owners of our hospitals are responsible for any liabilities arising from pre-closing violations. The prior owners’ resolution of these matters or failure to resolve these matters, in the event that any resolution wasdeemed necessary, may have a material adverse effect on our business, financial condition or results of operations. Any investigations of us, our executives, managers, facilities or operations could result in significant liabilities or penalties to us, as well asadverse publicity.

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        We maintain a voluntary compliance program to address health regulatory and other compliance requirements. This program includes initial and periodic ethics and compliance training, atoll-free hotline for employees to report, without fear of retaliation, any suspected legal or ethical violations, annual “fraud and abuse” audits to look at our financial relationships with physicians and other referral sources and annual “codingaudits” to make sure our hospitals bill the proper service codes in respect of obtaining payment from the Medicare and Medicaid programs.

        As an element of our corporate compliance program and our internal compliance audits, from time to time we make voluntary disclosures and repayments to the Medicare and Medicaidprograms and/or to the federal and/or state regulators for these programs in the ordinary course of business. At the current time, we know of no active investigations by any of these programs or regulators in respect of our disclosures or repayments. All of thesevoluntary actions on our part could lead to an investigation by the regulators to determine whether any of our facilities have violated the Stark Law, the Anti-Kickback Statute, the False Claims Act or similar state law. Either an investigation or initiation ofadministrative or judicial actions could result in a public announcement of possible violations of the Stark Law, the Anti-Kickback Statute or the False Claims Act or similar state law. Such determination or announcements could have a material adverse effect on ourbusiness, financial condition, results of operations or prospects, and our business reputation could suffer significantly.

        Additionally, several hospital companies have in recent years been named defendants in class action litigation alleging, among other things, that their charge structures arefraudulent and, under state law, unfair or deceptive practices, insofar as those hospitals charge insurers lower rates than those charged to uninsured patients. We cannot assure you that we will not be named as a defendant in litigation of this type. Furthermore, theoutcome of these suits may affect the industry standard for charity care policies and any response we take may have a material adverse effect on our financial results.

        In June 2006, we and two other hospital systems operating in San Antonio, Texas had a putative class action lawsuit brought against all of us alleging that we and the otherdefendants had conspired with one another and with other unidentified San Antonio area hospitals to depress the compensation levels of registered nurses employed at the competing hospitals within the San Antonio area by engaging in certain activities thatviolated the federal antitrust laws. On the same day that this litigation was brought against us and two other hospital systems in San Antonio, substantially similar class action litigation was brought against multiple hospitals in three other cities.

***Competition from other hospitals or healthcare providers (especially specialty hospitals) may reduce our patient volumes and profitability.***

        The healthcare business is highly competitive and competition among hospitals and other healthcare providers for patients has intensified in recent years. Generally, other hospitalsin the local communities served by most of our hospitals provide services similar to those offered by our hospitals. In addition, we believe the number of freestanding specialty hospitals and surgery and diagnostic centers in the geographic areas in which we operatehas increased significantly in recent years. As a result, most of our hospitals operate in an increasingly competitive environment. Some of the hospitals that compete with our hospitals are owned by governmental agencies or not-for-profit corporations supported byendowments and charitable contributions and can finance capital expenditures and operations on a tax-exempt basis. Increasingly, we are facing competition from physician-owned specialty hospitals and freestanding surgery centers that compete for market share in highmargin services and for quality physicians and personnel. If ambulatory surgery centers are better able to compete in this environment than our hospitals, our hospitals may experience a decline in patient volume, and we may experience a decrease in margin, even ifthose patients use our ambulatory surgery centers. Further, if our competitors are better able to attract patients, recruit physicians, expand services or obtain favorable managed care contracts at their facilities than our hospitals and ambulatory surgery centers,we may experience an overall decline in patient volume.

        In 2005, CMS began making public performance data related to 10 quality measures that hospitals submit in connection with their Medicare reimbursement. In February 2006, federallegislation was enacted to expand and provide for the future expansion of the number of quality measures that must be reported. During federal fiscal year 2008, CMS required hospitals to report 30 measures of inpatient quality of care to avoid a 2% point reduction intheir market basket update. During federal fiscal year 2009, CMS required hospitals to report 43 inpatient quality measures to avoid a 2% point reduction in their market basket update. For federal fiscal year 2010, CMS will require hospitals to report 47 inpatientquality measures to avoid a 2% reduction in their market basket update. If any of our hospitals achieve poor results (or results that are lower than our competitors) on these quality measures, patient volumes could decline. Also, the additional quality measures andfuture trends toward clinical transparency may have an unanticipated impact on our competitive position and patient volumes.

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        Our Phoenix Health Plan unit (“PHP”) also faces competition within the Arizona markets that it serves. As in the case of our hospitals, some of our health plan competitorsin these markets are owned by governmental agencies or not-for-profit corporations that have greater financial resources than we do. The revenues we derive from PHP could significantly decrease if new plans operating in the Arizona Health Care Cost Containment System(“AHCCCS”), which is Arizona’s state Medicaid program, enter these markets or other existing AHCCCS plans increase their number of enrollees. Moreover, a failure to attract future enrollees may negatively impact our ability to maintain ourprofitability in these markets.

***We may be subject to liabilities from claims brought against our facilities.***

        We operate in a highly regulated and litigious industry. As a result, various lawsuits, claims and legal and regulatory proceedings have been instituted or asserted against us,including those outside of the ordinary course of business such as class actions and those in the ordinary course of business such as malpractice lawsuits. Some of these actions may involve large claims as well as significant defense costs.

        We maintain professional and general liability insurance with unrelated commercial insurance carriers to provide for losses in excess of our self-insured retention (directly, orindirectly, through an insurance subsidiary) of $10.0 million. As a result, a few successful claims against us that are within our self-insured retention amounts could have an adverse effect on our results of operations, cash flows, financial condition or liquidity.In addition, one or more claims could exceed the scope of the third-party coverage in effect or the coverage of particular claims or damages could be denied.

        Additionally, we experienced unfavorable claims development results during the six months ended December 31, 2009, which are reflected in our professional and general liability costs.The relatively high cost of professional liability insurance and, in some cases, the lack of availability of such insurance coverage, for physicians with privileges at our hospitals increases our risk of vicarious liability in cases where both our hospital and theuninsured or underinsured physician are named as co-defendants. As a result, we are subject to greater self-insured risk and may be required to fund claims out of our operating cash flows to a greater extent than during fiscal year 2009. We cannot assure you that wewill be able to continue to obtain insurance coverage in the future or that such insurance coverage, if it is available, will be available on acceptable terms.

        While we cannot predict the likelihood of future claims or inquiries, we expect that new matters may be initiated against us from time to time. Moreover, the results of currentclaims, lawsuits and investigations cannot be predicted, and it is possible that the ultimate resolution of these matters, individually or in the aggregate, may have a material adverse effect on our business (both in the near and long term), financial position,results of operations or cash flows.

***Our hospitals face a growth in uncompensated care as the result of the inability of uninsured patients to pay for healthcare services and difficulties in collecting patient portions of insuredaccounts.***

        Like others in the hospital industry, we have experienced an increase in uncompensated care. Our combined provision for doubtful accounts, uninsured discounts and charity caredeductions as a percentage of acute care services segment revenues (prior to these adjustments) was 11.8% during both fiscal 2008 and 2009. This ratio increased to 16.0% for the six months ended December 31, 2009. Approximately 330 basis points of this increaserelated to the uninsured discount and Medicaid pending policy changes implemented in our Illinois hospitals effective April 1, 2009 and in our Phoenix and San Antonio hospitals effective July 1, 2009. Our self-pay discharges as a percentage of totaldischarges have not fluctuated significantly during the past three fiscal years. Our hospitals remain at risk for increases in uncompensated care as a result of price increases, the continuing trend of increases in coinsurance and deductible portions of managed careaccounts and increases in uninsured patients as a result of potential state Medicaid funding cuts or general economic weakness. Although we continue to seek ways of improving point of service collection efforts and implementing appropriate payment plans with ourpatients, if we continue to experience growth in self-pay revenues, our results of operations could be materially adversely affected. Further, our ability to improve collections for self-pay patients may be limited by regulatory and investigatory initiatives,including private lawsuits directed at hospital charges and collection practices for uninsured and underinsured patients.

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

Physicians generally direct the majority of hospital admissions. Thus, the success of our hospitals depends in part on the following factors:

        •

  

the number and quality of the physicians on the medical staffs of our hospitals;

        •

the admitting practices of those physicians; and

        •

the maintenance of good relations with those physicians.

        Most physicians at our hospitals also have admitting privileges at other hospitals. Our efforts to attract and retain physicians are affected by our managed care contractingrelationships, national shortages in some specialties, such as anesthesiology and radiology, the adequacy of our support personnel, the condition of our facilities and medical equipment, the availability of suitable medical office space and federal and state laws andregulations prohibiting financial relationships that may have the effect of inducing patient referrals. If facilities are not staffed with adequate support personnel or technologically advanced equipment that meets the needs of patients, physicians may be discouragedfrom referring patients to our facilities, which could adversely affect our profitability.

        In an effort to meet community needs in the markets in which we operate, we have implemented a strategy to employ physicians both in primary care and in certain specialties. As ofDecember 31, 2009, we employed more than 300 practicing physicians, excluding residents. The deployment of a physician employment strategy includes increased salary and benefits costs, physician integration risks and difficulties associated with physician practicemanagement. While we believe this strategy is consistent with industry trends, we cannot be assured of the long-term success of such a strategy. In addition, if we raise wages in response to our competitors’ wage increases and are unable to pass such increaseson to our clients, our margins could decline, which could adversely affect our business, financial condition and results of operations.

***We may be unable to achieve our acquisition and growth strategies and we may have difficulty acquiring not-for-profit hospitals due to regulatory scrutiny.***

        An important element of our business strategy is expansion by acquiring hospitals in our existing and in new urban and suburban markets and by entering into partnerships oraffiliations with other healthcare service providers. The competition to acquire hospitals is significant, including competition from healthcare companies with greater financial resources than ours. We have not acquired a hospital since December 2004 and may neveracquire another hospital, which would seriously impact our ability to grow our business.

        Even if we are able to acquire more hospitals, such acquisitions may be on less than favorable terms. We may have difficulty obtaining financing, if necessary, for such acquisitionson satisfactory terms. We sometimes agree not to sell an acquired hospital for some period of time (currently no longer than 10 years) after purchasing it and/or grant the seller a right of first refusal to purchase the hospital if we agree to sell it to a thirdparty. In addition, we may not be able to effectively integrate any acquired facilities with our operations. Even if we continue to acquire additional facilities and/or enter into partnerships or affiliations with other healthcare service providers, federal and stateregulatory agencies may constrain our ability to grow.

        Additionally, many states, including some where we have hospitals and others where we may in the future attempt to acquire hospitals, have adopted legislation regarding the sale orother disposition of hospitals operated by not-for-profit entities. In other states that do not have specific legislation, the attorneys general have demonstrated an interest in these transactions under their general obligations to protect charitable assets fromwaste. These legislative and administrative efforts focus primarily on the appropriate valuation of the assets divested and the use of the sale proceeds by the not-for-profit seller. These review and approval processes can add time to the consummation of anacquisition of a not-for-profit hospital, and future actions on the state level could seriously delay or even prevent future acquisitions of not-for-profit hospitals. Furthermore, as a condition to approving an acquisition, the attorney general of the state in whichthe hospital is located may require us to maintain specific services, such as emergency departments, or to continue to provide specific levels of charity care, which may affect our decision to acquire or the terms upon which we acquire one of thesehospitals.

65

***Future acquisitions or joint ventures may use significant resources, may be unsuccessful and could expose us to unforeseen liabilities.***

        As part of our growth strategy, we may pursue acquisitions or joint ventures of hospitals or other related healthcare facilities and services. These acquisitions or joint ventures mayinvolve significant cash expenditures, debt incurrence, additional operating losses and expenses that could have a material adverse effect on our financial condition and results of operations. Acquisitions or joint ventures involve numerous risks,including:

        •

  

difficulty and expense of integrating acquired personnel into our business;

 

 

 

        •

diversion of management’s time from existing operations;

 

 

 

        •

potential loss of key employees or customers of acquired companies; and

 

 

 

        •

assumption of the liabilities and exposure to unforeseen liabilities of acquired companies, including liabilities for failure to comply with healthcare regulations.

        We cannot assure you that we will succeed in obtaining financing for acquisitions or joint ventures at a reasonable cost, or that such financing will not contain restrictive covenantsthat limit our operating flexibility. We also may be unable to operate acquired hospitals profitably or succeed in achieving improvements in their financial performance.

***The cost of our malpractice insurance and the malpractice insurance of physicians who practice at our facilities remains volatile. Successful malpractice or tort claims asserted against us, our physicians or ouremployees could materially adversely affect our financial condition and profitability.***

        Physicians, hospitals and other healthcare providers are subject to legal actions alleging malpractice, product liability or related legal theories. Many of these actions involvelarge monetary claims and significant defense costs. Hospitals and physicians have typically maintained a special type of insurance (commonly called malpractice or professional liability insurance) to protect against the costs of these types of legal actions. Wecreated a captive insurance subsidiary on June 1, 2002, to assume a substantial portion of the professional and general liability risks of our facilities. For claims incurred during the period June 1, 2002 to May 31, 2006 and those subsequent toJune 30, 2009, we maintained all of our professional and general liability insurance through this captive insurance subsidiary in respect of losses up to $10.0 million per occurrence. For claims incurred from June 1, 2006 to June 30, 2009, weself-insured the first $9.0 million per occurrence, and our captive subsidiary insured the next $1.0 million per occurrence. We have also purchased an umbrella excess policy for professional and general liability insurance for the period July 1, 2009to June 30, 2010 with unrelated commercial carriers. This policy covers losses in excess of $10.0 million per occurrence up to $75.0 million, but is limited to total annual payments of $65.0 million in the aggregate. While our premium prices havedeclined during the past few years, the total cost of professional and general liability insurance remains sensitive to the volume and severity of cases reported. There is no guarantee that excess insurance coverage will continue to be available in the future at acost allowing us to maintain adequate levels of such insurance. Moreover, due to the increased retention limits insured by us and our captive subsidiary, if actual payments of claims materially exceed our projected estimates of malpractice claims, our financialcondition could be materially adversely affected.

        Physicians’ professional liability insurance costs in certain markets have dramatically increased to the point where some physicians are either choosing to retire early or leavethose markets. If physician professional liability insurance costs continue to escalate in markets in which we operate, some physicians may choose not to practice at our facilities, which could reduce our patient volumes and revenues. Our hospitals may also incur agreater percentage of the amounts paid to claimants if physicians are unable to obtain adequate malpractice coverage since we are often sued in the same malpractice suits brought against physicians on our medical staffs who are not employed by us.

        We anticipate employing over 160 additional physicians during our fiscal year 2010. Such a significant increase in employed physicians could significantly increase our professionaland general liability risks and related costs in future periods since for employed physicians there is no insurance coverage from unaffiliated insurance companies.

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***Our facilities are concentrated in a small number of regions. If any one of the regions in which we operate experiences a regulatory change, economic downturn or other material change, our overall business results maysuffer.***

        Among our operations as of December 31, 2009, five hospitals and various related healthcare businesses were located in San Antonio, Texas; five hospitals and related healthcarebusinesses were located in metropolitan Phoenix, Arizona; two hospitals and related healthcare businesses were located in metropolitan Chicago, Illinois; and three hospitals and related healthcare businesses were located in Massachusetts.

        For the year ended June 30, 2009 and the six months ended December 31, 2009, our total revenues were generated as follows:

    

 

**Year Ended June 30, 2009**

      

**Six Months Ended December 31, 2009**

 

San Antonio

29.6

%

25.8

%

Phoenix Health Plan and Abrazo Advantage Health Plan

 

19.3

23.2

Massachusetts

 

18.3

18.2

Metropolitan Phoenix, excluding Phoenix Health Plan and Abrazo Advantage Health Plan

 

17.9

18.3

Metropolitan Chicago (1)

 

14.6

 

14.1

Other

 

0.3

 

0.4

 

 

 

 

100.0

%

100.0

%

 

____________________(1) Includes MacNeal Health Providers

        Any material change in the current demographic, economic, competitive or regulatory conditions in any of these regions could adversely affect our overall businessresults because of the significance of our operations in each of these regions to our overall operating performance. Moreover, due to the concentration of our revenues in only four regions, our business is less diversified and, accordingly, is subject to greaterregional risk than that of some of our larger competitors.

***If we are unable to control our healthcare costs at Phoenix Health Plan and Abrazo Advantage Health Plan, if the health plans should lose their governmental contracts or if budgetary cuts reduce the scopeof Medicaid or dual-eligibility coverage, our profitability may be adversely affected.***

        For the year ended June 30, 2009 and the six months ended December 31, 2009, PHP generated approximately 18.1% and 22.1% of our total revenues, respectively. PHPderives substantially all of its revenues through a contract with AHCCCS. AHCCCS pays capitated rates to PHP, and PHP subcontracts with physicians, hospitals and other healthcare providers to provide services to its enrollees. If we fail to effectively manage ourhealthcare costs, these costs may exceed the payments we receive. Many factors can cause actual healthcare costs to exceed the capitated rates paid by AHCCCS, including:

        •

  

our ability to contract with cost-effective healthcare providers;

        •

the increased cost of individual healthcare services;

        •

the type and number of individual healthcare services delivered; and

        •

the occurrence of catastrophes, epidemics or other unforeseen occurrences.

        Our current contract with AHCCCS began October 1, 2008 and expires September 30, 2011. This contract is terminable without cause on 90 days’ writtennotice from AHCCCS or for cause upon written notice from AHCCCS if we fail to comply with any term or condition of the contract or fail to take corrective action as required to comply with the terms of the contract. AHCCCS may also terminate the contract with PHP inthe event of unavailability of state or federal funding. If our AHCCCS contract is terminated, our profitability would be adversely affected by the loss of these revenues and cash flows. Also, should the scope of the Medicaid program be reduced as a result of statebudgetary cuts or other political factors, our results of operations could be adversely affected.

        For the year ended June 30, 2009 and the six months ended December 31, 2009, AAHP generated 1.2% and 1.1% of our total revenues,respectively. AAHP began providing healthcare coverage to Medicare and Medicaid dual-eligible enrollees on

67

January 1, 2006. Most of AAHP’s members were formerly enrolled in PHP. AAHP’s contract with CMS went into effect on January 1, 2006, for a term of one year, with a provision for successiveone year renewals, and has currently been renewed through December 31, 2010. If we fail to effectively manage AAHP’s healthcare costs, these costs may exceed the payments we receive.

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

        The success of our business is largely dependent upon the services and management experience of our senior management team, which includes Charles N. Martin, Jr.,our Chairman and Chief Executive Officer; Kent H. Wallace, our President and Chief Operating Officer; Keith B. Pitts, our Vice Chairman, Phillip W. Roe, our Executive Vice President, Chief Financial Officer and Treasurer; and Joseph D. Moore, Executive VicePresident. In addition, we depend on our ability to attract and retain local managers at our hospitals and related facilities, on the ability of our senior officers and key employees to manage growth successfully and on our ability to attract and retain skilledemployees. We do not maintain key man life insurance policies on any of our officers. If we were to lose any of our senior management team or members of our local management teams, or if we are unable to attract other necessary personnel in the future, it could havea material adverse effect on our business, financial condition and results of operations. If we were to lose the services of one or more members of our senior management team or a significant portion of our hospital management staff at one or more of our hospitals,we would likely experience a significant disruption in our operations and failure of the affected hospitals to adhere to their respective business plans.

***Controls designed to reduce inpatient services may reduce our revenues.***

        Controls imposed by Medicare and commercial third-party payers designed to reduce admissions and lengths of stay, commonly referred to as “utilizationreview,” have affected and are expected to continue to affect our facilities. Utilization review entails the review of the admission and course of treatment of a patient by managed care plans. Inpatient utilization, average lengths of stay and occupancy ratescontinue to be negatively affected by payer-required preadmission authorization and utilization review and by payer pressures to maximize outpatient and alternative healthcare delivery services for less acutely ill patients. Efforts to impose more stringent costcontrols are expected to continue. Although we are unable to predict the effect these changes will have on our operations, significant limits on the scope of services reimbursed and on reimbursement rates and fees could have a material, adverse effect on ourbusiness, financial position and results of operations.

***Our facilities are subject to extensive federal and state laws and regulations relating to the privacy of individually identifiable information.***

        The Health Insurance Portability and Accountability Act of 1996 required the U.S. Department of Health and Human Services to adopt standards to protect the privacyand security of individually identifiable health-related information. The department released final regulations containing privacy standards in December 2000 and published revisions to the final regulations in August 2002. The Health Information Technology forEconomic and Clinical Health Act (“HITECH Act”) — one part of the American Recovery and Reinvestment Act of 2009 (“ARRA”) — broadened the scope of the HIPAA privacy and security regulations. On August 24, 2009, HHSissued an Interim Final Rule addressing security breach notification requirements and, on October 30, 2009, issued an Interim Final Rule implementing amendments to the enforcement regulations under HIPAA. The privacy regulations extensively regulate the use anddisclosure of individually identifiable health-related information. The regulations also provide patients with significant rights related to understanding and controlling how their health information is used or disclosed. The security regulations require healthcareproviders to implement administrative, physical and technical practices to protect the security of individually identifiable health information that is maintained or transmitted electronically.

        Violations of the Health Insurance Portability and Accountability Act of 1996 could result in civil or criminal penalties. An investigation or initiation of civil orcriminal actions could have a material adverse effect on our business, financial condition, results of operations or prospects and our business reputation could suffer significantly. In addition, there are numerous federal and state laws and regulations addressingpatient and consumer privacy concerns, including unauthorized access or theft of personal information. State statutes and regulations vary from state to state and could impose additional penalties. We have developed a comprehensive set of policies and procedures inour efforts to comply with the Health

68

Insurance Portability and Accountability Act of 1996 and other privacy laws. Our compliance officers are responsible for implementing and monitoring compliance with our privacy and security policies andprocedures at our facilities. We believe that the cost of our compliance with the Health Insurance Portability and Accountability Act of 1996 and other federal and state privacy laws will not have a material adverse effect on our business, financial condition,results of operations or cash flows.

***As a result of increased post-payment reviews of claims we submit to Medicare for our services, we may incur additional costs and may be required to repay amounts already paid to us.***

        We are subject to regular post-payment inquiries, investigations and audits of the claims we submit to Medicare for payment for our services. These post-payment reviewsare increasing as a result of new government cost-containment initiatives, including enhanced medical necessity reviews for Medicare patients admitted to long-term care hospitals, and audits of Medicare claims under the Recovery Audit Contractor program(“RAC”). The RAC program began as a demonstration project in 2005 in three states (New York, California and Florida) and was expanded into the three additional states of Arizona, Massachusetts and South Carolina in July 2007. The program was madepermanent by the Tax Relief and Health Care Act of 2006 enacted in December 2006. CMS ended the demonstration project in March 2008 and commenced the permanent RAC program in all states beginning in 2009 with plans to have RACs in full operation in all 50 statesby 2010.

        RACs utilize a post-payment targeted review process employing data analysis techniques in order to identify those Medicare claims most likely to contain overpayments,such as incorrectly coded services, incorrect payment amounts, non-covered services and duplicate payments. The RAC review is either “automated”, for which a decision can be made without reviewing a medical record, or “complex”, for which theRAC must contact the provider in order to procure and review the medical record to make a decision about the payment. CMS has given RACs the authority to look back at claims up to three years old, provided that the claim was paid on or after October 1, 2007.Claims identified as overpayments will be subject to the Medicare appeals process.

        These additional post-payment reviews may require us to incur additional costs to respond to requests for records and to pursue the reversal of payment denials, andultimately may require us to refund amounts paid to us by Medicare that are determined to have been overpaid.

***If we fail to continually enhance our hospitals with the most recent technological advances in diagnostic and surgical equipment, our ability to maintain and expand our markets will be adverselyaffected.***

        Technological advances with respect to computed axial tomography (CT), magnetic resonance imaging (MRI) and positron emission tomography (PET) equipment, as well asother equipment used in our facilities, are continually evolving. In an effort to compete with other healthcare providers, we must constantly evaluate our equipment needs and upgrade equipment as a result of technological improvements. Such equipment costs typicallyrange from $1.0 million to $3.0 million, exclusive of construction or build-out costs. If we fail to remain current with the technological advancements of the medical community, our volumes and revenue may be negatively impacted.

***Our hospitals face competition for staffing especially as a result of the national shortage of nurses and the increased imposition on us of nurse-staffing ratios, which has in the past and may in the futureincrease our labor costs and materially reduce our profitability.***

        We compete with other healthcare providers in recruiting and retaining qualified management and staff personnel responsible for the day-to-day operations of each of ourhospitals, including most significantly nurses and other non-physician healthcare professionals. In the healthcare industry generally, including in our markets, the national shortage of nurses and other medical support personnel has become a significant operatingissue. This shortage has caused us in the past and may require us in the future to increase wages and benefits to recruit and retain nurses and other medical support personnel or to hire more expensive temporary personnel. We have voluntarily raised on severaloccasions in the past, and expect to raise in the future, wages for our nurses and other medical support personnel.

        In addition, union-mandated or state-mandated nurse-staffing ratios significantly affect not only labor costs, but may also cause us to limit patient admissions with acorresponding adverse effect on revenues if we are unable to hire the appropriate number of nurses to meet the required ratios. While we do not currently operate in any states with mandated nurse-staffing

69

ratios, the states in which we operate could adopt mandatory nurse-staffing ratios at any time. In those instances where our nurses are unionized, it is our experience that new union contracts often imposesignificant new additional staffing ratios by contract on our hospitals. This was the case with the increased staffing ratios imposed on us in our union contract with our nurses at Saint Vincent Hospital in Worcester, Massachusetts negotiated in 2007.

        The U.S. Congress is currently considering a bill called the Employee Free Choice Act of 2009 (“EFCA”), which organized labor, a major supporter of theObama administration, has called its number one legislative objective. EFCA would amend the National Labor Relations Act to establish a procedure whereby the National Labor Relations Board (“NLRB”) would certify a union as the bargaining representative ofemployees, without a NLRB-supervised secret ballot election, if a majority of unit employees signs valid union authorization cards (the “card-check provision”). Additionally, under EFCA, parties that are unable to reach a first contract within90 days of collective bargaining could refer the dispute to mediation by the Federal Mediation and Conciliation Service (the “Service”). If the Service is unable to bring the parties to agreement within 30 days, the dispute then would bereferred to binding arbitration. Also, the bill would provide for increased penalties for labor law violations by employers. In July 2009, due to intense opposition from the business community, alternative draft legislation became public, dropping the card-checkprovision, but putting in its place new provisions making it easier for employees to organize including provisions to require shorter unionization campaigns, faster elections and limitations on employer-sponsored anti-unionization meetings, which employees arerequired to attend. This legislation, if passed, would make it easier for our nurses or other groups of hospital employees to unionize, which could materially increase our labor costs.

        If our labor costs continue to increase, we may not be able to raise our payer reimbursement levels to offset these increased costs, including the significantlyincreased costs that we will incur for wage increases and nurse-staffing ratios under our new union contract with our nurses at Saint Vincent Hospital. Because substantially all of our net patient revenues consist of payments based on fixed or negotiated rates, ourability to pass along increased labor costs is materially constrained. Our failure to recruit and retain qualified management, nurses and other medical support personnel, or to control our labor costs, could have a material adverse effect on ourprofitability.

***Compliance with Section 404 of the Sarbanes-Oxley Act may negatively impact our results of operations and failure to comply may subject us to regulatory scrutiny and a loss of investors’confidence in our internal control over financial reporting.***

        Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”) requires us to perform an evaluation of our internal control over financial reportingand file management’s attestation with our annual report. Section 404 also requires our independent auditors to opine on our internal control over financial reporting beginning with our fiscal year ending June 30, 2010. We have evaluated, tested andimplemented internal controls over financial reporting to enable management to report on such internal controls under Section 404. However, we cannot assure you that the conclusions we will reach in our June 30, 2010 management report will be the same asthose reached by our independent auditors in their report. Failure on our part to comply with Section 404 may subject us to regulatory scrutiny and a loss of public confidence in the reliability of our financial statements. In addition, we may be required toincur costs in improving our internal control over financial reporting and hiring additional personnel. Any such actions could negatively affect our results of operations.

***A failure of our information systems would adversely affect our ability to properly manage our operations.***

        We rely on our advanced information systems and our ability to successfully use these systems in our operations. These systems are essential to the following areas ofour business operations, among others:

        •

  

patient accounting, including billing and collection of patient service revenues;

        •

financial, accounting, reporting and payroll;

        •

coding and compliance;

        •

laboratory, radiology and pharmacy systems;

        •

remote physician access to patient data;

        •

negotiating, pricing and administering managed care contracts; and

        •

monitoring quality of care.

        If we are unable to use these systems effectively, we may experience delays in collection of patient service revenues and may not be able to properly manage ouroperations or oversee compliance with laws or regulations.

70

***Difficulties with current construction projects or new construction projects such as additional hospitals or major expansion projects may involve significant capital expenditures that could have an adverseimpact on our liquidity.***

        We may decide to construct an additional hospital or hospitals in the future or construct additional major expansion projects to existing hospitals in order to achieveour growth objectives. Our ability to complete construction of new hospitals or new expansion projects on budget and on schedule would depend on a number of factors, including, but not limited to:

        •

our ability to control construction costs;

        •

the failure of general contractors or subcontractors to perform under their contracts;

        •

adverse weather conditions;

        •

shortages of labor or materials;

        •

our ability to obtain necessary licensing and other required governmental authorizations; and

        •

other unforeseen problems and delays.

        As a result of these and other factors, we cannot assure you that we will not experience increased construction costs on our construction projects or that we will beable to construct our current or any future construction projects as originally planned. In addition, our current and any future major construction projects would involve a significant commitment of capital with no revenues associated with the projects duringconstruction, which also could have a future adverse impact on our liquidity.

***If the costs for construction materials and labor continue to rise, such increased costs could have an adverse impact on the return on investment relating to our expansion projects.***

        The cost of construction materials and labor has significantly increased over the past years as a result of global and domestic events. We have experienced significantincreases in the cost of steel due to the demand in China for such materials and an increase in the cost of lumber due to multiple factors. Increases in oil and gas prices have increased costs for oil-based products and for transporting materials to job sites. As wecontinue to invest in modern technologies, emergency rooms and operating room expansions, we expend large sums of cash generated from operating activities. We evaluate the financial viability of such projects based on whether the projected cash flow return oninvestment exceeds our cost of capital. Such returns may not be achieved if the cost of construction continues to rise significantly or anticipated volumes do not materialize.

***State efforts to regulate the construction or expansion of hospitals could impair our ability to operate and expand our operations.***

Some states require healthcare providers to obtain prior approval, known as certificates of need, for:

        •

 

the purchase, construction or expansion of healthcare facilities;

        •

 

capital expenditures exceeding a prescribed amount; or

        •

 

changes in services or bed capacity.

        In giving approval, these states consider the need for additional or expanded healthcare facilities or services. Illinois and Massachusetts are the only states in whichwe currently own hospitals that have certificate-of-need laws. The failure to obtain any required certificate of need could impair our ability to operate or expand operations in these states.

***If the fair value of our reporting units declines, a material non-cash charge to earnings from impairment of our goodwill could result.***

        Blackstone acquired our predecessor company during fiscal 2005. We recorded a significant portion of the purchase price as goodwill. At December 31, 2009, we had approximately $649.1 million of goodwill recorded on our financial statements. There is no guarantee that we will be able to recover the carrying value of this goodwill through our future cash flows. On an ongoing basis, we evaluate, basedon the fair value of our reporting units, whether the carrying value of our goodwill is impaired. During fiscal 2007, we recorded a $123.8 million ($110.5 million, net of tax benefit) impairment charge to goodwill to reduce the carrying values of ourChicago hospitals to their fair values. Our two Chicago hospitals have experienced deteriorating economic factors that have negatively impacted their results of operations and cash flows. While

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various initiatives mitigated the impact of these economic factors in previous quarters, the operating results of the Chicago hospitals have not improved to the level anticipated.

        After having the opportunity to evaluate the operating results of the Chicago hospitals for the first six months of fiscal year 2010 and to reassess the market trendsand economic factors, we concluded that it was unlikely that previously projected cash flows for these hospitals would be achieved. We performed an interim goodwill impairment test and, based upon revised projected cash flows, market participant data and appraisalinformation, we determined that the $43.1 million remaining goodwill related to this reporting unit was impaired. We recorded the $43.1 million ($31.8 million, net of taxes) non-cash impairment loss in our condensed consolidated statement of operations forthe quarter ended December 31, 2009.

***Our hospitals are subject to potential responsibilities and costs under environmental laws that could lead to material expenditures or liability.***

        We are subject to various federal, state and local environmental laws and regulations, including those relating to the protection of human health and the environment. Wecould incur substantial costs to maintain compliance with these laws and regulations. To our knowledge, we have not been and are not currently the subject of any investigations relating to noncompliance with environmental laws and regulations. We could become thesubject of future investigations, which could lead to fines or criminal penalties if we are found to be in violation of these laws and regulations. The principal environmental requirements and concerns applicable to our operations relate to proper management ofhazardous materials, hazardous waste and medical waste, above-ground and underground storage tanks, operation of boilers, chillers and other equipment, and management of building conditions, such as the presence of mold, lead-based paint or asbestos. Our hospitalsengage independent contractors for the transportation and disposal of hazardous waste, and we require that our hospitals be named as additional insureds on the liability insurance policies maintained by these contractors.

        We also may be subject to requirements related to the remediation of substances that have been released into the environment at properties owned or operated by us or ourpredecessors or at properties where substances were sent for off-site treatment or disposal. These remediation requirements may be imposed without regard to fault, and liability for environmental remediation can be substantial.

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

        The following persons were re-elected to our board of directors by the holders of 100% of our outstanding common stock by action taken pursuant to a written consent dated November 3,2009 of such holders in lieu of an annual stockholders’ meeting:

Michael A. Dal BelloM. Fazle HusainCharles N. Martin, Jr.Alan M. Muney, M.D.James A. QuellaNeil P. Simpkins

        Also, on November 3, 2009 (but prior to the election of the directors referred to above), Michael J. Parsons informed us, at a regular meeting of our board of directors, that hedeclined to stand for re-election to the Company’s board of directors. Mr. Parsons cited as the reason the increased demands on his time as a result of him assuming earlier in calendar year 2009 on a full-time basis the position of Chief Executive Officer ofSouthernCare, Inc., a hospice provider based in Birmingham, Alabama, with offices in 25 states.

**Item 6.    Exhibits.**

        The exhibits filed as part of this report are listed in the Index to Exhibits which is located at the end of this report.

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**SIGNATURE**

****

        Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

DATE:     February 9,2010                                                                 VANGUARD HEALTH SYSTEMS, INC.

                                                                                                               BY:          /s/ Gary D.Willis                                                                                                                                                                                *Gary D. Willis                                                                                                                               Senior Vice President, Controller and                                                                                                                               Chief Accounting Officer*                                                                                                                               (Authorized Officer and Chief Accounting Officer)

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**INDEX TO EXHIBITS**

**Exhibit No.     **

  

**Description**

 

 

 

4.1

Indenture, dated as of January 29, 2010, relating to the 8% Senior Notes due 2018, among Vanguard Health Holding Company II, LLC, Vanguard Holding Company II, Inc., Vanguard Health Systems, Inc. and the other guarantorsnamed therein and U.S. Bank National Association, as Trustee, including the form of 8% Senior Notes due 2018. (Incorporated by reference from Exhibit 4.1 to the registrant’s Current Report on Form 8-K dated February 3, 2010, File No. 333-71934.)

 

 

 

4.2

Registration Rights Agreement, dated as of January 29, 2010, relating to the 8% Senior Notes due 2018, among Vanguard Health Holding Company II, LLC, Vanguard Holding Company II, Inc., Vanguard Health Systems, Inc. andthe other guarantors named therein and U.S. Bank National Association, as Trustee. (Incorporated by reference from Exhibit 4.2 to the registrant’s Current Report on Form 8-K dated February 3, 2010, File No. 333-71934.)

 

 

 

4.3

Ninth Supplemental Indenture, dated as of January 28, 2010, relating to the 9% Senior Subordinated Notes due 2014, among Vanguard Health Holding Company II, LLC, Vanguard Holding Company II, Inc., Vanguard Health Systems,Inc., and the other guarantors named therein and U.S. Bank National Association, as Trustee. (Incorporated by reference from Exhibit 4.3 to the registrant’s Current Report on Form 8-K dated February 3, 2010, File No. 333-71934.)

 

 

4.4

First Supplemental Indenture, dated as of January 28, 2010, relating to the 11.25% Senior Discount Notes due 2015, among Vanguard Health Holding Company I, LLC, Vanguard Holding Company I, Inc., Vanguard Health Systems,Inc. and U.S. Bank National Association, as Trustee. (Incorporated by reference from Exhibit 4.4 to the registrant’s Current Report on Form 8-K dated February 3, 2010, File No. 333-71934.)

 

 

 

10.1

Credit Agreement, dated as of January 29, 2010, among Vanguard Health Holding Company II, LLC, Vanguard Health Holding Company I, LLC, the lenders from time to time party thereto, Bank of America, N.A., as AdministrativeAgent, and the other parties thereto. (Incorporated by reference from Exhibit 10.1 to the registrant’s Current Report on Form 8-K dated February 3, 2010, File No. 333-71934.)

 

 

 

10.2

Amendment No. 1, dated as of November 3, 2009, to Stockholders Agreement Concerning Vanguard Health Systems, Inc., dated as of November 4, 2004, by and among Vanguard Health Systems, Inc., VHS Holdings LLC, Blackstone FCHCapital Partners IV L.P. and its affiliates identified on the signature pages thereto and Charles N. Martin, Jr., as proxyholder for certain employees party thereto.

 

 

 

31.1

 

Certification of CEO pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

31.2

 

Certification of CFO pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

32.1

 

Certification of CEO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

32.2

 

Certification of CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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