We owned and operated 28 hospitals as of June 30, 2013. The following table contains information concerning our hospitals:
These hospitals are operated by a consolidated joint venture limited liability company, in which we own 51% of the equity interests and VB Medical Holdings formerly known as Valley Baptist Medical Center - Brownsville, a Texas non-profit corporation, owns 49% of the equity interests.
Our headquarters, hospitals and other facilities are suitable for their respective uses and are, in general, adequate for our present needs. Our obligations under the 2010 Credit Facilities are secured by a pledge of substantially all of our assets, including first priority mortgages on each of our hospitals that are owned by subsidiaries that guarantee our obligations under the 2010 Credit Facilities. Also, our properties are subject to various federal, state and local statutes and ordinances regulating their operation. Management does not believe that maintaining compliance with such statutes and ordinances will materially affect our financial position or results of operations.
The following table sets forth our selected historical financial and operating data for, or as of the end of, each of the five years ended June 30, 2009, 2010, 2011, 2012 and 2013. The selected historical financial data as of and for the years ended June 30, 2009, 2010, 2011, 2012 and 2013 were derived from our consolidated financial statements that have been audited by Ernst & Young LLP, an independent registered public accounting firm. See “Executive Overview” included in “
See “Item 1A - Risk Factors” for further discussion. 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 statements contained 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 (the "SEC"). You are cautioned not to rely on such forward-looking statements when evaluating the information contained in this Annual Report on Form 10-K. In light of significant uncertainties inherent in the forward-looking statements included in this Annual Report on Form 10-K, you should not regard the inclusion of such information as a representation by us that the objectives and plans anticipated by the forward-looking statements will occur or be achieved or, if any of them do, what impact they will have on our financial condition, results of operations or cash flows.
Our mission is to transform the delivery of health services we provide to the communities we serve by implementing innovative population health models and creating a patient-centered experience in a high performance environment of integrated care. We plan to grow our business by continually improving our quality of care, redesigning care delivery to a fee-for-value basis, expanding services to further our continuum of care, and selectively developing or acquiring other health care businesses where we see an opportunity to improve our operating performance and expand our mission.
As of June 30, 2013, we owned and operated 28 hospitals with a total of 7,081 licensed beds and related outpatient service facilities complementary to the hospitals in San Antonio, Harlingen and Brownsville Texas; metropolitan Detroit, Michigan; metropolitan Phoenix, Arizona; metropolitan Chicago, Illinois; and Massachusetts.
On June 24, 2013, we entered into an Agreement and Merger Agreement by and among us, Tenet and Merger Sub. Pursuant to the Merger Agreement and subject to the terms and conditions set forth therein, upon consummation of the merger, Merger Sub will merge with and into us (the “Merger”), with us continuing as the surviving corporation and becoming a wholly-owned subsidiary of Tenet. During the year ended June 30, 2013, we recorded $7.8 million of transaction costs related to the Merger.
Pursuant to the Merger Agreement, at the effective time of the Merger, each issued and outstanding share of our Common Stock will be converted into the right to receive $21.00 in cash, without interest, other than any shares of Common Stock owned by Tenet or us or any wholly-owned subsidiary thereof (which will automatically be canceled with no consideration paid therefor) and those shares of Common Stock with respect to which appraisal rights under Delaware law are properly exercised and not withdrawn. Following the effective time of the Merger, our Common Stock will cease to be traded on the NYSE, and we will no longer be a reporting company under the Exchange Act.
In connection with the execution of the Merger Agreement, Tenet entered into a Voting Agreement with certain funds affiliated with each of Blackstone and Morgan Stanley Capital Partners, as well as Charles N. Martin, Jr., our Chairman, President and Chief Executive Office, Keith B. Pitts, our Vice Chairman, Phillip W. Roe, our Executive Vice President, Chief Financial Officer and Treasurer, and James H. Spalding, our Executive Vice President, General Counsel and Secretary (collectively, the “Majority Stockholders”). Under the Voting Agreement, the Majority Stockholders agreed to execute and deliver a written consent adopting the Merger Agreement and, during the term of the Voting Agreement, but subject to certain limitations set forth therein, to vote certain of their shares of Common Stock against any action or agreement that the Majority Stockholders know or reasonably suspect is in opposition to the Merger. As a result of the execution and delivery of the Written Consent on June 24, 2013 following execution and delivery of the Merger Agreement, the required approval of our stockholders for the Merger has been obtained.
On March 22, 2013, we were notified that PHP was not awarded an acute care program contract with AHCCCS for the three-year period commencing October 1, 2013. However, on April 1, 2013, PHP agreed with AHCCCS on the general terms of a capped contract for Maricopa County for the three-year period commencing October 1, 2013. Approximately 98,000 of PHP's members resided in Maricopa County as of June 30, 2013. Pursuant to the terms of PHP's agreement with AHCCCS, PHP will not file a protest of any of AHCCCS' decisions. In addition, PHP agreed that enrollment will be capped effective October 1, 2013 and the enrollment cap will not be lifted at any time during the total contract period, unless AHCCCS deems additional plan capacity necessary based upon growth in covered lives or other reasons as outlined in a letter provided by AHCCCS that clarifies certain terms of the capped contract. AHCCCS has also indicated that it intends to hold an open enrollment for PHP members in Maricopa County sometime in calendar year 2014.
On March 14, 2013, certain of our subsidiaries amended (the "amendment") the existing Credit Agreement, dated January 29, 2010. Pursuant to the amendment, we borrowed an additional $300.0 million in term loans and refinanced our outstanding term loans. Approximately $11.2 million of the $300.0 million in additional borrowings was used to redeem the outstanding principal and interest related to our previously outstanding 10.375% senior discount notes due 2016 (the "Senior Discount Notes") and to pay the associated fees related to the amendment. The remaining proceeds will be used to finance other general operating and investing activities.
As we attempt to remain flexible and competitive in a dynamic health care environment, we have added focus and resources to our ambulatory care endeavors. As of June 30, 2013, we employed approximately 700 non-resident physicians and will continue to recruit primary care and specialty physicians and physician groups to the communities that we serve as market-specific needs warrant. We have invested heavily in the infrastructure necessary to coordinate our physician alignment strategies and manage our physician operations. During the first quarter of the year ended June 30, 2013, we entered into a joint venture arrangement with a national physician practice management company to manage the administration of these practices to enable us to focus on quality and physician alignment initiatives necessary for the transition to fee-for-value reimbursement. We have also established Physician Leadership Councils, comprised of physicians focused on driving clinical and operational performance, at most of our hospitals to align the quality goals of our hospitals with those of the physicians who practice in our hospitals. We believe our hospitalist employment strategy is a key element of our focus on patient-centered care. These initiatives require significant upfront investment and may take years to fully implement.
Quality of care will have a greater impact on governmental reimbursement in the future. We have implemented many clinical quality initiatives and are in the process of implementing several others. These initiatives include monthly review of reportable CMS quality indicators, rapid response teams, continued focus on work flow efficiency and process improvement, establishing clinical standards of care across key system service lines, improving transition of care to reduce hospital readmissions and aligning hospital management incentive compensation with quality performance indicators.
Health Reform Law. The Health Reform Law provides for, among other things, increased access to health benefits for a significant number of uninsured individuals through the creation of Exchanges and expanded state Medicaid programs; reductions in future Medicare reimbursement, including market basket and disproportionate share payments; development of a payment bundling pilot program and similar programs to promote accountability and coordination of care; continued efforts to tie reimbursement to quality of care, including penalties for excessive readmissions and hospital-acquired conditions; and changes to premiums paid and the establishment of profit restrictions on Medicare managed care plans and Exchange plans. The Health Reform Law is also under considerable scrutiny from Congress, and the states are moving at different speeds to implement portions of the Health Reform Law left to their discretion.
reached, similar across-the-board spending reductions could be implemented, and Medicare payments would be similarly reduced. Some private health insurance plans where payments are linked or related to Medicare payment amounts may seek to implement similar payment solutions.
We were approved to become a Pioneer ACO effective January 1, 2012 in our Michigan market. We have also been awarded MSSP ACOs, effective July 1, 2012, in Illinois and Texas and two additional MSSP ACOs, effective January 1, 2013, in Massachusetts and Arizona. While most of these ACOs are still in their infancies, we did achieve shared savings in our Michigan Pioneer ACO for the 2012 calendar year.
During the year ended June 30, 2013 compared to the prior year, we provided more health care services to patients who were uninsured and provided fewer health care services to patients who had insurance coverage. Much of this shift resulted from general economic weakness in the markets we serve and Medicaid eligibility reductions in Arizona. We are uncertain how long the economic weakness will continue, but believe that conditions will not improve significantly during the remainder of calendar year 2013. During the current year, we have also experienced a shift from services provided to Medicare and Medicaid patients to those with managed Medicare and managed Medicaid coverage. These managed payers typically provide reimbursement at lower rates and with slower payment terms than traditional Medicare and Medicaid programs and often require more of our time to document medical necessity and level of care for billed services.
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 on a same store basis was $7,950, $9,640 and $9,656 for the years ended June 30, 2011, 2012 and 2013, respectively. The 2012 amount was positively impacted by reimbursement updates for the rural floor provision of the Balanced Budget Act of 1997 and revised Supplemental Security Income ratios, which combined resulted in additional revenues of $49.7 million during 2012. Growth in this ratio continues to be limited by the payer mix shifts we have experienced in recent years as previously discussed.
The demand for Medicaid coverage has increased during the past two years due to job losses that have left many individuals without health insurance. Medicaid remains the highest individual program cost for most states, including those in which we operate. To balance their budgets, many states, either directly or through their Medicaid or managed Medicaid programs, have enacted and may enact further health care spending cuts or defer cash payments to health care providers to avoid raising taxes during periods of economic weakness. Medicaid rate cuts in Arizona, Texas, and Illinois during the past two years have negatively impacted our revenues. We receive a significant amount of funding under governmental supplemental reimbursement programs, including various state UPL and provider tax assessment programs. We recognized $385.7 million of revenues and $115.8 million of expenses related to state UPL and provider tax assessment programs during the year ended June 30, 2013 compared to revenues of $323.2 million and expenses of $86.7 million during 2012.
We recognize premium revenues from our five health plans, PHP, AAHP, CHS, ProCare and VBIC. Premium revenues from these plans decreased $20.3 million, or 2.7%, during the year ended June 30, 2013 compared to the year ended June 30, 2012. PHP’s average membership decreased to approximately 187,100 for the year ended June 30, 2013 compared to approximately 198,900 for the year ended June 30, 2012. PHP’s decrease in revenues primarily resulted from enacted rate reductions, changes made by AHCCCS effective October 1, 2011 to limit health plan profitability for the remaining enrollee groups not previously subject to settlement, and more stringent Medicaid eligibility standards.
We recognize patient service revenues during the period the health care services are provided based upon estimated amounts due from payers. We record contractual adjustments to our gross charges to reflect expected reimbursement negotiated with or prescribed by third party payers. We estimate contractual adjustments and allowances based upon payment terms set forth in managed care health plan contracts and by federal and state regulations. For the majority of our patient service revenues, we apply contractual adjustments to patient accounts at the time of billing using specific payer contract terms entered into the accounts receivable systems, but in some cases we record an estimated allowance until payment is received. If our estimated contractual adjustments as a percentage of gross revenues was 1% higher for all insured accounts, our patient service revenues would have been reduced by approximately $163.7 million and $172.9 million for the years ended June 30, 2012 and
2013, respectively. We derive most of our patient service revenues from health care services provided to patients with Medicare (including managed Medicare plans) or managed care insurance coverage.
In the ordinary course of business, we provide services to patients who are financially unable to pay for hospital care. We include charity care as a revenue deduction measured by the value of our services, based on standard charges, to patients who qualify under our charity care policy and do not otherwise qualify for reimbursement under a governmental program. The estimated cost incurred by us to provide these services to patients who are unable to pay was approximately $30.2 million, $59.7 million and $55.6 million for the years ended June 30, 2011, 2012 and 2013, respectively. The estimated cost of charity care services was determined using a ratio of cost to gross charges determined from our most recently filed Medicare cost reports and applying that ratio to the gross charges associated with providing charity care for the period.
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 of uninsured accounts (including those pending Medicaid qualifications) and self-pay after insurance 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 12-month period to 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 percentages in our allowance for doubtful accounts
Many of our hospitals have an uninsured discount policy whereby uninsured accounts (including those pending Medicaid qualification) 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 uninsured discount 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 uninsured discount policy. Medicaid pending accounts receivable was $103.4 million and $108.2 million as of June 30, 2012 and 2013, respectively.
We receive premiums from private payers and state and federal agencies for members that are assigned to, or have selected, us to provide health care services under applicable contracts. The premiums we receive for each member vary according to the specific contract and are generally determined at the beginning of each contract period. The premiums are subject to adjustment throughout the terms of the respective contracts, although such adjustments are typically made at the commencement of each contract renewal period.
Our professional and general liability reserve as of June 30, 2013 was $337.7 million and was comprised of (1) estimated indemnity payments and related loss adjustment expenses related to reported events (“case reserves”); (2) estimated indemnity payments related to incurred but not reported events (“IBNR”); and (3) estimated unallocated loss adjustment expenses representing an estimate of the administrative costs necessary to resolve outstanding claims, all on an undiscounted basis. Our accounting policy is to include estimates of case reserves, IBNR and unallocated loss adjustment expenses in our professional and general liability reserve. The IBNR portion of the reserve includes an estimate of losses expected to be covered by our excess insurance policies of approximately $32.2 million at June 30, 2013. We also had a receivable of approximately $32.2 million at June 30, 2013 for the expected reimbursement of these estimated excess coverage losses from third party insurance companies, reflected in other assets on our consolidated balance sheet. We enter into excess or reinsurance policies with insurance carriers whose financial strength ratings are “A-” or greater, as issued by A. M. Best Company, a credit rating organization that specializes in the insurance industry. We believe any recorded excess receivables from such insurance carriers would be collectible at such time that a reported event reached an excess layer.
Our best estimate of professional and general liability and workers compensation IBNR utilizes statistical confidence levels that are below 75%. Using a higher statistical confidence level, while not permitted under United States GAAP, would increase the estimated reserve. The following table illustrates the sensitivity of the reserve estimates at 75% and 90% confidence levels (in millions).
During the years ended June 30, 2011, 2012 and 2013, health plan claims expense was $686.3 million, $578.9 million and $577.4 million, respectively, primarily representing medical claims of PHP. We estimate PHP’s reserve for medical claims using historical claims experience (including cost per member and payment lag time) and other actuarial data including number of members and certain member demographic information. The following table provides the health plan reserve balances as of June 30, 2011, 2012 and 2013 and health plan claims and payment information during the years ended June 30, 2011, 2012 and 2013 (in millions).
We estimate accrued health claims by analyzing claims payment information from a claims triangle model that compares the incurred date for claims to the payment date for those claims. We then calculate per member per month health plan claims costs based upon claims payments for historical periods divided by the number of members during that period. Completion factors are then applied to this estimate to determine the total accrual estimate. We assess the appropriateness of this methodology by comparing our estimates to those of an independent external actuary and also by reviewing ultimate claims payments for certain prior year periods and analyzing utilization trends to determine if adjustments need to be made to the
While management believes that its estimation methodology effectively captures trends in medical claims costs, actual payments could differ significantly from its estimates given changes in the health care cost structure or adverse experience. During the years ended June 30, 2011, 2012 and 2013, approximately $41.3 million, $42.4 million and $40.1 million, respectively, of accrued and paid claims for services provided to our health plan members by our hospitals and our other health care facilities were eliminated in consolidation. Our operating results and cash flows could be materially affected by increased or decreased utilization of our health care facilities by members in our health plans.
In addition, financial forecasts used in determining the need for, or amount of, federal and state valuation allowances are subject to changes in underlying assumptions and fluctuations in market conditions that could significantly alter our recoverability analysis and thus have a material adverse effect on our consolidated financial condition, results of operations or cash flows. Effective July 1, 2007, we adopted the relevant guidance for accounting for uncertainty in income taxes. The following table provides a detailed rollforward of our net liability for uncertain tax positions for each of the years ended June 30, 2011, 2012 and 2013 (in millions).
Goodwill and indefinite-lived intangible assets are evaluated annually for impairment during our fourth fiscal quarter or earlier upon the occurrence of certain events or substantive changes in circumstances. The first step of the two-step process involves a comparison of the estimated fair value of a reporting unit to its carrying amount, including goodwill. In performing the first step, we determine the fair value of a reporting unit using a discounted cash flow (“DCF”) analysis. The cash flows are projected based on a year-by-year assessment that considers historical results, estimated market conditions, internal projections, and relevant publicly available statistics. The cash flows projected are then used as the basis for projecting cash flows for the remaining years in our model. Determining fair value requires the exercise of significant judgment, including judgments about appropriate discount rates, perpetual growth rates and the amount and timing of expected future cash flows. The significant judgments are typically based upon Level 3 inputs, generally defined as unobservable inputs representing our own assumptions. The cash flows employed in the DCF analysis are based on our most recent budgets and business plans and, when applicable, various growth rates are assumed for years beyond the current business plan period. Discount rate assumptions are based on an assessment of the risk inherent in the future cash flows of the respective reporting units. The discount rate is mainly based on judgment of the specific risk inherent within the reporting unit. The variables within the discount rate, many of which are outside of our control, provide our best estimate of all assumptions applied within the model.
If the carrying amount of a reporting unit exceeds its estimated fair value, then the second step of the goodwill impairment
test must be performed. The second step of the goodwill impairment test compares the implied fair value of the reporting unit's
goodwill with its carrying amount to measure the amount of impairment loss, if any. The implied fair value of goodwill is
unit's goodwill, an impairment loss is recognized in an amount equal to that excess.
In order for the estimated fair values to decrease below the carrying values for all of our reporting units, we would need to experience a significant decrease in future profitability projections coupled with a significant increase in the weighted average cost of capital, both of which we believe is unlikely to occur during the year ended June 30, 2014. However, as noted in Item 1A. Risk Factors, potential events that could negatively affect our key assumptions include, among others, a continuation of current challenging economic conditions, uncertainty with the Health Reform Law and PHP's contract with AHCCCS. These changes could create additional pricing, volume and reimbursement pressures that are not within our control.
The following table sets forth certain operating statistics on a consolidated and same store basis for each of the periods presented. We have excluded two hospitals that were acquired during the year ended June 30, 2012 from the same store statistics for the years ended June 30, 2012 and 2013.
Acute care services on a consolidated basis. Net patient service revenues increased $70.7 million, or 1.4%, during the current year compared to the prior year.
Discharges decreased 0.8%, while adjusted discharges and emergency room visits increased 0.7% and 2.5%, respectively, during the current year compared to the prior year. Inpatient and outpatient surgeries decreased 1.5% and 1.7%, respectively, during the current year compared to the prior year.
Acute care services on a same store basis. Net patient service revenues increased $3.0 million, or 0.1%, during the current year compared to the prior year. We define same store as those facilities that we owned for the entirety of both 12-month comparative periods. We excluded two hospitals and related health care facilities from our same store analysis.
Our percentage of uncompensated care as a percentage of net patient revenues, as previously defined, increased to 20.0% during the current year compared to 18.0% during the prior year. This increase primarily resulted from an increase in same store self-pay discharges as a percentage of total discharges during the current year and price increases implemented since the prior year.
Health plan premium revenue. Health plan premium revenues decreased $20.3 million, or 2.7%, during the current year compared to the prior year. PHP’s average membership decreased by 6.0% during the current year compared to the prior year.
Membership in our health plans as of June 30, 2012 and 2013 was as follows:
Costs and expenses. Total costs and expenses from continuing operations, exclusive of income taxes, were $5,889.6 million, or 98.2% of total revenues, during the current year compared to $5,870.4 million, or 98.7% of total revenues, during the prior year. Salaries and benefits, health plan claims and supplies represent the most significant of our normal costs and expenses and those typically subject to the greatest level of fluctuation year over year.
regional employees, the number of full-time and part-time employees decreased approximately 3.6% compared to the prior year.
Supplies. Supplies as a percentage of acute care services segment revenues was 17.3% during the current year compared to 17.4% during the prior year. This ratio was positively impacted by the continued reduction in same store surgeries between the current and prior years. We expect that our transition to a single group purchasing organization effective January 1, 2013 will reduce supplies costs in future periods. However, supplies costs may be pressured in future periods due to our growth strategies that include expansion of higher acuity services and due to inflationary pressures.
Other. Depreciation and amortization decreased by $1.2 million, or 0.5%, year over year as a result of timing of when certain of our capital improvement and expansion initiatives were placed into service. Net interest increased by $14.2 million, or 7.8%, year over year as a result of the issuance of the additional 7.75% Senior Notes in March 2012 and additional term loan borrowings in March 2013. We incurred $8.1 million of acquisition-related expenses during the current year and $14.0 million of acquisition-related expenses during the prior year. Approximately $7.8 million of the current year costs relate to the Tenet Merger. During the current year, we recognized a net gain of $13.3 million on asset dispositions substantially all of which related to our sale of a portion of our laboratory business in Chicago in June 2013 compared to a net loss on asset dispositions of $0.6 million during the prior year. During the current year, we also incurred $5.2 million in severance costs related to a restructuring in the Michigan market.
Medicare and Medicaid EHR incentives. During the current year, we recognized $38.0 million of Medicare and Medicaid EHR incentives compared to $28.2 million during the prior year.
Income taxes. Our effective tax rate was approximately 37.1% during the current year. Our effective income tax rate was approximately 28.2% during the prior year. The prior year rate was lower due to a combination of changes to state tax laws in Michigan and adjustments to state deferred tax asset valuation allowances on loss carryforwards in other states during the fourth quarter of fiscal 2012 combined with a reduction in the reserve for uncertain tax positions related to success-based transaction costs during the third quarter of fiscal 2012.
Net income attributable to Vanguard Health Systems, Inc. stockholders. Net income attributable to Vanguard Health Systems, Inc. stockholders was $61.9 million ($0.75 per diluted share) during the year ended June 30, 2013 compared to $57.3 million ($0.71 per diluted share) during the year ended June 30, 2012.
Salaries and benefits. Salaries and benefits as a percentage of total revenues was 46.2% during the year ended June 30, 2012 compared to 44.1% for 2011. The increase during the year ended June 30, 2012 was primarily due to the decrease in health plan premium revenues for which salaries and benefits are not as significant as for the acute care services. As of June 30, 2012, we had approximately 40,900 full-time and part-time employees compared to approximately 38,600 as of June 30, 2011.
Supplies. Supplies as a percentage of acute care services segment revenues decreased to 17.4% during the year ended June 30, 2012 compared to 17.8% during 2011.
Other operating expenses. Other operating expenses as a percentage of total revenues increased to 19.7% during the year ended June 30, 2012 compared to 17.4% during 2011 primarily as a result of increased purchased services related to acquisitions during the years ended June 30, 2011 and 2012.
Income taxes. Our effective tax rate was approximately 28.2% during the year ended June 30, 2012 compared to 141.0% during 2011. The effective rate was higher during 2011 due to the non-deductibility of certain components of monitoring fees and expenses and an increase in the valuation allowance associated with state net operating loss carryforwards.
interest and income tax payments of $206.3 million during the year ended June 30, 2013, which was $39.4 million higher than these payments during the prior year;
improved cash collections on our patient accounts receivable as demonstrated by the reduction in net days in accounts receivable from 50 days at June 30, 2012 to 46 days at June 30, 2013;
the timing of payments on accounts payable and certain accrued expenses, including incentive compensation based upon achieving our financial performance goals for the year ended June 30, 2013;
Cash flows used in investing activities decreased from $513.2 million during the year ended June 30, 2012 to $406.1 million during the year ended June 30, 2013, primarily as a result of less cash paid for acquisitions. Capital expenditures increased 43.4% to $420.5 million during the year ended June 30, 2013 compared to the prior year due to increased spending related to the DMC specified project commitments, the construction of a new hospital in New Braunfels, Texas, and other expansion projects.
As of June 30, 2013, our outstanding debt was $2,996.2 million, and we had $327.2 million of remaining borrowing capacity under our revolving credit facility, net of letters of credit outstanding.
As of June 30, 2013, we held $59.1 million in total available-for-sale investments in securities held by our wholly-owned captive insurance subsidiary. We may not be able to utilize these investments to fund our operating or capital expenditure funding needs due to statutory limitations placed on this captive insurance subsidiary.
We expect that cash on hand, the capacity under our revolving credit facility, and cash generated from our operations will be sufficient to fund our operating and capital needs during the next 12 months and into the foreseeable future. However, if our projections are proved wrong, we cannot be certain that cash on hand, cash flows from operations and the capacity under our revolving credit facility will be sufficient to fund our operating and capital needs and debt service requirements during the long-term.
We intend to continue to pursue acquisitions, partnership arrangements and service expansion or de novo development opportunities, either in existing markets or new markets, that fit our growth strategies. These opportunities may require significant additional investment. We also have significant capital commitments remaining under our DMC purchase agreement to be funded during the next few years. To finance these growth opportunities and our capital commitments or for other general corporate needs, we may increase borrowings under our term loan facility, issue additional senior or subordinated notes, use available cash on hand, utilize amounts available under our revolving credit facility or seek additional financing, including debt or equity. As market conditions warrant, we and our major equity holders, including Blackstone and its affiliates, may from time to time repurchase debt securities issued by us, in privately negotiated or open market transactions, by tender offer or otherwise. Our future operating performance, ability to service existing debt or opportunities to obtain additional financing on favorable terms may be limited by economic or other market conditions or business factors, many of which are beyond our control.
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 of June 30, 2013.
Includes both principal and interest payments. The interest portion of our debt outstanding at June 30, 2013 assumes an average interest rate of 8.0%.
Represents health claims incurred by members of PHP, AAHP, CHS, ProCare and VBIC, including both reported claims and estimates for incurred but not reported claims, and net amounts payable for program settlements to AHCCCS and CMS for certain programs for which profitability is limited. Accrued health plan claims and settlements are separately stated on our consolidated balance sheets.
agreement (as previously discussed) as of June 30, 2013: $204.0 million committed within one year; $275.0 million committed within two to three years; and $50.0 million committed in the fourth year and beyond.
We had standby letters of credit outstanding of $37.8 million as of June 30, 2013, which primarily relate to security for the payment of claims as required by various insurance programs.
Consolidated Statements of Comprehensive Income (Loss) for the years ended June 30, 2011, 2012 and 2013
Consolidated Statements of Cash Flows for the years ended June 30, 2011, 2012 and 2013
Vanguard Health Systems, Inc. (the “Company”) is an investor-owned health care company whose subsidiaries and affiliates own and operate hospitals and related health care businesses in urban and suburban areas. The Company's common stock is traded on the New York Stock Exchange (symbol "VHS"). As of June 30, 2013, the Company’s subsidiaries and affiliates owned and operated 28 acute care hospitals with 7,081 licensed beds and related outpatient service locations complementary to the hospitals providing health care services in San Antonio, Harlingen and Brownsville, Texas; metropolitan Detroit, Michigan; metropolitan Phoenix, Arizona; metropolitan Chicago, Illinois; and Massachusetts. The Company also owns managed health plans in Chicago, Illinois; Detroit, Michigan; Harlingen, Texas; and Phoenix, Arizona, and two surgery centers in Orange County, California.
On June 24, 2013, the Company announced that it has entered into a merger agreement with Tenet Healthcare Corporation (“Tenet”). Pursuant to the merger agreement, each of the Company's common shares will be converted into the right to receive $21.00 per common share in cash and Tenet will assume the Company's net debt. The Company will become a wholly-owned subsidiary of Tenet and the Company's shares will cease to be traded on the New York Stock Exchange. The merger is subject to customary regulatory approvals and specific obligations that are required by parties to become effective. During the year ended June 30, 2013, the Company recorded $7.8 million of transaction costs related to the merger that is included in acquisition related expenses on the accompanying consolidated statements of operations. The transaction is expected to close early in the Company's second quarter of fiscal 2014.
The accompanying consolidated financial statements include the accounts of subsidiaries and affiliates controlled by the Company. The Company generally defines control as the ownership of the majority of an entity’s voting interests. The Company 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 upon its investment or financial interest in the entity. All material intercompany accounts and transactions have been eliminated. The share and earnings per share information included in the accompanying consolidated financial statements and included in Note 10 reflect the impact of the stock split that the Company effectuated in connection with the initial public offering of its common stock in June 2011. The majority of the Company’s expenses are “cost of revenue” items. Costs that could be classified as general and administrative include certain corporate office costs of the Company, which approximated $73.1 million, $67.8 million and $62.4 million for the years ended June 30, 2011, 2012 and 2013, respectively.
Certain balances in the accompanying consolidated financial statements and these notes have been adjusted to conform to the June 30, 2013 presentations.
In 2011, the Company adopted Accounting Standards Update No. 2011-07, Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts for Certain Health Care Entities (“ASU 2011-07”). ASU 2011-07 requires health care entities to change the presentation of the statement of operations by reclassifying the provision for doubtful accounts from an operating expense to a deduction from patient service revenues.
The Company's revenues from third-party payers, the uninsured and other sources are summarized in the following table (dollars in millions).
The Company recognizes patient service revenues during the period the health care services are provided based upon estimated amounts due from payers. The Company estimates contractual adjustments and allowances based upon payment terms set forth in managed care health plan contracts and by federal and state regulations. For the majority of its patient service revenues, the Company applies contractual adjustments to patient accounts at the time of billing using specific payer contract terms entered into the accounts receivable systems, but in some cases the Company records an estimated allowance until payment is received. The Company derives most of its patient service revenues from health care services provided to patients with Medicare and related managed Medicare plans or managed care insurance coverage. Medicare, which represented approximately 27% of the Company’s net patient service revenues during each of its years ended June 30, 2011, 2012 and 2013, was the only individual payer for which the Company derived more than 10% of its net patient service revenues during those periods.
Services provided to Medicare and related managed Medicare patients are generally reimbursed at prospectively determined rates per diagnosis (“PPS”), while services provided to managed care patients are generally reimbursed based upon predetermined rates per diagnosis, per diem rates or discounted fee-for-service rates. Medicaid reimbursements vary by state.
The related litigation was settled in April 2012. As a result of the settlement, the Company received additional Medicare payments of approximately $40.6 million in May and June 2012. This amount was recorded as additional revenues during the year ended June 30, 2012. Estimated direct related expenses of approximately $7.8 million were recorded for the year ended June 30, 2012. Net income attributable to Vanguard Health Systems, Inc. stockholders was positively impacted from the rural floor provision by $21.7 million ($0.28 per diluted share) for the year ended June 30, 2012.
During the third quarter of fiscal 2009, the federal government approved federal matching funds for the Illinois Provider Tax Assessment (“PTA”) program. The PTA program enables the State of Illinois to increase funding for its state Medicaid plan. Hospitals providing services to Medicaid enrollees receive funds directly from the state. Hospital providers, with certain exceptions, are then assessed a provider tax, which is payable to the state, and may or may not exceed funds received from the state. The Company participates in a similar program with the State of Michigan through its DMC hospitals and with the city of Phoenix for three of its hospitals in Arizona. The Company recognizes revenues equal to the gross PTA payments to be received when such payments are assured. The Company recognizes expenses for the taxes due back to the states under these PTA programs when the related revenues are recognized.
Effective for service dates on or after April 1, 2009, as a result of a state mandate, the Company implemented an uninsured discount policy for those patients receiving services in its Illinois hospitals who had no insurance coverage and who did not otherwise qualify for charity care under its guidelines. The Company implemented this same policy in its Phoenix and San Antonio hospitals effective for service dates on or after July 1, 2009 and in its Harlingen and Brownsville, Texas hospitals upon acquisition of those facilities. Under this policy, the Company applies an uninsured discount (calculated as a standard percentage of gross charges) at the time of patient billing and includes this discount as a reduction to patient service revenues. These discounts were approximately $277.2 million, $451.4 million and $545.0 million for the years ended June 30, 2011, 2012 and 2013, respectively.
The Company does not pursue collection of amounts due from uninsured patients that qualify for charity care under its guidelines (currently those uninsured patients whose incomes are equal to or less than 200% of the current federal poverty guidelines set forth by HHS). The Company deducts charity care accounts from revenues when it determines that the account meets its charity care guidelines. The Company also generally provides discounts from billed charges and alternative payment structures for uninsured patients who do not qualify for charity care but meet certain other minimum income guidelines, primarily those uninsured patients with incomes between 200% and 500% of the federal poverty guidelines. During the years ended June 30, 2011, 2012 and 2013, the Company deducted $121.5 million, $233.4 million and $230.5 million of charity care from revenues, respectively. The estimated cost incurred by the Company to provide services to patients who qualify for charity care was approximately $30.2 million, $59.7 million and $55.6 million for the years ended 2011, 2012 and 2013, respectively.
These estimates were determined using a ratio of cost to gross charges calculated from the Company’s most recently filed Medicare cost reports and applying that ratio to the gross charges associated with providing charity care for the period.
The American Recovery and Reinvestment Act of 2009 provided for Medicare and Medicaid incentive payments beginning in calendar year 2011 for eligible hospitals and professionals that implement and achieve meaningful use of certified electronic health record ("EHR") technology. The Company utilizes the contingency model to account for Medicare and Medicaid EHR incentive payments. Under the contingency model, EHR incentive payments are recognized when all contingencies relating to the incentive payment have been satisfied. For Medicaid EHR incentive payments, recognition occurs at the time meaningful use criteria are met and formal state acceptance is documented since Medicaid payments for the states in which the Company operates are based upon historical cost reports with no subsequent payment adjustment. For Medicare EHR incentive payments, recognition is deferred until both the Medicare federal fiscal year during which EHR meaningful use was demonstrated ends and the cost report information utilized to determine the final amount of reimbursement is known.
The Company recognized other income of $10.1 million, $28.2 million and $38.0 million related to Medicare and Medicaid EHR incentives during the years ended June 30, 2011, 2012 and 2013, respectively, under the contingency model. The Company incurs both capital expenditures and operating expenses in connection with the implementation of its various EHR initiatives. The amount and timing of these expenditures do not directly correlate with the timing of the Company's cash receipts or recognition of the EHR incentives as other income. As of June 30, 2012 and 2013, the Company had recognized approximately $2.7 million and $5.0 million in Medicaid EHR receivables, respectively, on its consolidated balance sheet. In addition, as of June 30, 2012 and 2013, the Company had recognized $4.3 million and $8.9 million in Medicare EHR deferred revenues, respectively, on its consolidated balance sheet.
As of June 30, 2012 and 2013, approximately $43.2 million and $10.4 million, respectively, of total cash and cash equivalents in the accompanying consolidated balance sheets were identified for the operations of the Company’s captive insurance subsidiaries. As of June 30, 2013, approximately $33.3 million of cash and cash equivalents are included in the Company's investments in securities on the accompanying consolidated balance sheet and are held by the Company's wholly-owned captive insurance subsidiary for the purpose of providing a potential funding source to pay professional liability claims covered by the captive.
The Company manages the receivables by regularly reviewing its accounts and contracts and by providing appropriate allowances for contractual discounts and uncollectible amounts. The Company typically writes off uncollected uninsured accounts receivable 120 days subsequent to discharge date. Medicare program net receivables, including managed Medicare receivables, comprised approximately 27% of net patient receivables as of June 30, 2012 and 2013. Medicare revenues are included in the acute care services operating segment. Receivables from various state Medicaid programs and managed Medicaid programs comprised approximately 23% and 19% of net patient receivables as of June 30, 2012 and 2013, respectively. Remaining receivables relate primarily to various HMO and preferred provider organization payers, commercial insurers and private patients. Concentration of credit risk for these payers is limited by the number of patients and payers.
The allowance for doubtful accounts was $366.5 million and $408.1 million as of June 30, 2012 and June 30, 2013, respectively. These balances as a percentage of accounts receivable net of contractual adjustments were 34.3% and 39.1% as of June 30, 2012 and June 30, 2013, respectively. The percentage increase in allowance for doubtful accounts primarily related to the increase in uninsured patient volumes during the year ended June 30, 2013 compared to the year ended June 30, 2012. General market and economic conditions impacted the Company's payer mix and resulted in more services provided to patients who were uninsured, which increased the Company's allowance for doubtful accounts in the current period. The Company’s combined allowances for doubtful accounts, uninsured discounts and charity care covered more than 100% of combined uninsured and self-pay after insurance accounts receivable as of June 30, 2012 and June 30, 2013. In addition, the Company's total uncompensated care, as a percent of net patient revenues, prior to uncompensated care deductions, increased from 19.0% during the year ended June 30, 2012 to 21.3% during the year ended June 30, 2013 primarily due to the increase in uninsured patient volumes coupled with deterioration within the aging of these payers.
The following table provides the gross asset balances for each major class of asset and total accumulated depreciation as of June 30, 2012 and 2013 (in millions).
During the year ended June 30, 2013, the Company recognized a gain on the sale of equipment, certain current assets and third-party customer relationships associated with certain lab services in Illinois. Related to this sale, the Company received approximately $15.5 million in cash and recognized a gain of approximately $15.2 million ($9.3 million, net of taxes, or $0.12 per diluted share) included in gain on disposal of assets on the accompanying consolidated statement of operations for the year ended June 30, 2013.
Goodwill and indefinite-lived intangible assets are evaluated annually for impairment during the fourth quarter or earlier upon the occurrence of certain events or substantive changes in circumstances. Goodwill is tested for impairment at a level referred to as a reporting unit. In assessing goodwill for impairment, the Company has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the Company determines that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment review process is unnecessary. However, if the Company concludes otherwise or elects not to perform the qualitative assessment, then it is required to perform the first step of the two-step impairment review process.
plan period. Discount rate assumptions are based on an assessment of the risks inherent in the future cash flows of the respective reporting units. If the estimated fair value of a reporting unit exceeds its carrying amount, the goodwill of the reporting unit is not impaired and the second step of the impairment test is not necessary.
If the carrying amount of a reporting unit exceeds its estimated fair value, then the second step of the goodwill impairment test must be performed. The second step of the goodwill impairment test compares the implied fair value of the reporting unit's goodwill with its carrying amount to measure the amount of impairment loss, if any. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination (i.e., the estimated fair value of the reporting unit is allocated to all of the assets and liabilities of that reporting unit, including any unrecognized intangible assets, as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the purchase price paid). If the carrying amount of the reporting unit's goodwill exceeds the implied fair value of the reporting unit's goodwill, an impairment loss is recognized in an amount equal to that excess. See Note 5 for more information regarding the Company's goodwill.
Amounts allocated to contract-based intangible assets, which primarily represent PHP’s contract with AHCCCS and PHP’s various contracts with network providers, are amortized over their useful lives, which equal ten years. These intangible assets will be fully amortized by September 30, 2014. The Company expects to continue to recognize cash flows from its capped contract with AHCCCS during this period. No amortization is recorded for indefinite-lived intangible assets. Deferred loan costs are amortized over the life of the applicable credit facility or notes using the effective interest method. Physician income and service agreement guarantee intangible assets are recorded based upon the estimated future payments under the contracts and are amortized over the applicable contract service periods. The useful lives over which intangible assets are amortized range from two years to ten years.
During the years ended June 30, 2011, 2012 and 2013, approximately $41.3 million, $42.4 million and $40.1 million, respectively, of accrued and paid claims for services provided to the Company’s health plan members by its hospitals and its other health care facilities were eliminated in consolidation. The Company’s operating results and cash flows could be materially affected by increased or decreased utilization of its health care facilities by members in its health plans.
Given the nature of its operating environment, the Company is subject to professional and general liability and workers compensation claims and related lawsuits in the ordinary course of business. The Company maintains professional and general liability insurance with unrelated commercial insurance carriers to provide for losses up to $65.0 million in excess of its self-insured retention (such self-insured retention maintained through the Company’s wholly-owned captive insurance subsidiary and/or another of its wholly-owned subsidiaries) of amounts ranging from $10.0 million to $17.5 million. The Company self-insures its workers compensation claims at levels ranging from $0.6 million to $1.25 million per claim and purchases excess insurance coverage for claims exceeding these self-insured limits.
Similarly, the Company decreased its workers compensation reserve related to prior years by $4.3 million ($2.6 million net of taxes or $0.06 per diluted share), $0.3 million ($0.2 million net of taxes) and $6.3 million ($3.9 million net of taxes or $0.05 per diluted share) during the years ended 2011, 2012 and 2013, respectively. Additional adjustments to prior year estimates may be necessary in future periods as the Company’s reporting history and loss portfolio matures.
In September 2011, the Company obtained a 51% controlling interest in a partnership that held the assets acquired and liabilities assumed in the purchase of Valley Baptist Health System as more fully discussed in Note 3. The remaining 49% non-controlling interest was granted to the former owner of Valley Baptist (the “seller”) as purchase consideration. The partnership operating agreement includes an option by which the seller may put its 49% non-controlling interest back to the Company upon either the third or fifth anniversary of the transaction date. The redemption value is calculated based upon the operating results and the debt of the partnership, but is subject to a floor value. The Company also has the option to call a stated percentage of the seller's non-controlling interest in the event the seller does not exercise its put option on either of the anniversary dates. Noncontrolling interests that are redeemable or may become redeemable at a fixed or determinable price at the option of the holder, or upon the occurrence of an event outside of the control of the Company, are presented in mezzanine equity on the accompanying consolidated balance sheets.
The Company believes that its tax return provisions are accurate and supportable, but certain tax matters require interpretations of tax law that may be subject to future challenge and may not be upheld under tax audit. To reflect the possibility that all of its tax positions may not be sustained, the Company maintains tax reserves that are subject to adjustment as updated information becomes available or as circumstances change. The Company records the impact of tax reserve changes to its income tax provision in the period in which the additional information, including the progress of tax audits, is obtained.
The Company assesses the realization of its deferred tax assets to determine whether an income tax valuation allowance is required. Based on all available evidence, both positive and negative, and the weight of that evidence to the extent such
The Company's restructuring charge represents the elimination of more than 300 positions during the year ended June 30, 2013 in the Michigan market. As of June 30, 2013, accrued salaries and benefits on the accompanying consolidated balance sheet included approximately $2.6 million of severance and related expenses that the Company expects to fund over the next 12 months.
The Company records stock-based employee compensation for options granted subsequent to July 1, 2006 using a Black-Scholes-Merton model. The following table sets forth the range of assumptions the Company has utilized in the Black-Scholes-Merton model.
The Company accounts for business combinations under the acquisition method of accounting, which requires the assets acquired and liabilities assumed to be recorded at their respective fair values as of the acquisition date in the Company’s consolidated financial statements. The determination of estimated fair value may require management to make significant estimates and assumptions. The excess of the purchase price over the fair value of the acquired net assets, where applicable, is recorded as goodwill. The results of operations of an acquired business are included in the Company's consolidated financial statements from the date of acquisition. Costs associated with the acquisition of a business are expensed in the period incurred.
The goodwill recognized for the business combinations described below represents both the value the Company expects to realize from developing synergies by combining operations and for the value attributable to other intangible assets that do not qualify for separate recognition.
Effective January 1, 2011, the Company purchased substantially all of the assets of DMC, a Michigan non-profit corporation, and certain of its affiliates, which assets consisted of eight acute care and specialty hospitals and related health care facilities in the Detroit, Michigan metropolitan area. Under the acquisition method of accounting, the purchase price of DMC was allocated to the identifiable assets acquired and liabilities assumed based upon their estimated fair values as of the acquisition date. During the year ended June 30, 2013, the Company adjusted its estimate of the DMC pension benefit obligation from $228.0 million to $255.2 million as of the acquisition date, based upon currently available information that became available in fiscal year 2013 relating to plan administration issues that are in the process of being analyzed and resolved. The increase in the assumed pension benefit obligation resulted in a $16.9 million increase in goodwill and a $10.3 million increase in non-current deferred tax assets related to the DMC acquisition. The Company believes the adjustment to be immaterial for the restatement of prior period balance sheet amounts. The table below summarizes the fair values of assets acquired and liabilities assumed at the date of acquisition (in millions):
The Company’s financial assets recorded at fair value on a recurring basis primarily relate to investments in available-for-sale securities held by one of its captive insurance subsidiaries. The following table indicates the fair value hierarchy of the valuation techniques the Company utilized to determine such fair values. In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets. The Company considers a security that trades at least weekly to have an active market. Fair values determined by Level 2 inputs utilize data points that are observable, such as quoted prices, interest rates and yield curves. Fair values determined by Level 3 inputs are unobservable data points for the asset, and include situations where there is little, if any, market activity for the asset. The Company’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 presents information about the assets that are measured at fair value on a recurring basis as of June 30, 2012 and 2013 (in millions).
The following table provides a reconciliation of activity for the Company's investments in securities, excluding activity related to ARS as previously disclosed, for the years ended June 30, 2012 and 2013, respectively (in millions).
The Company determines whether an other-than-temporary decline in market value has occurred by considering the duration that, and extent to which, the fair value of the investment is below its amortized cost; the financial condition and near-term prospects of the issuer or underlying collateral of a security; and the Company's intent and ability to retain the security in order to allow for an anticipated recovery in fair value. Other-than-temporary declines in fair value from amortized cost for available-for-sale equity and debt securities that the Company intends to sell or would be more likely than not required to sell before the expected recovery of the amortized cost basis are recognized in the consolidated statement of operations in the period in which the loss occurs. The cumulative gross unrealized gain for the securities was approximately $0.7 million ($0.5 million, net of taxes) and $5.4 million ($3.5 million, net of taxes) at June 30, 2012 and 2013, respectively, which is included in accumulated other comprehensive loss on the accompanying consolidated balance sheets.
Supplemental information regarding the Company's available-for-sale investment securities held as of June 30, 2013 is set forth in the table below (in millions).
As of June 30, 2013, the Company held no investments in securities with unrealized loss positions greater than 12 months.
Amortization of deferred loan costs of $6.3 million, $6.9 million and $9.2 million during the years ended June 30, 2011, 2012 and 2013, respectively, is included in net interest. During the year ended June 30, 2013, net deferred loan costs of $1.2 million were written off as part of the debt extinguishment costs associated with the redemption of the 10.375% Senior Discount Notes, the term loan facility refinancing and revolver increase (see Note 7). During the year ended June 30, 2013, the Company capitalized an additional $2.8 million of deferred loan costs, whereas $5.0 million of the previously unamortized deferred loan costs will continue to be capitalized as intangible assets under the carryover lender provisions.
As of June 30, 2013, the acute care services segment and the health plans segment had approximately $698.2 million and $91.7 million, respectively, of goodwill. During the year ended June 30, 2012, goodwill increased by $7.7 million related to acute care services segment acquisitions and $3.6 million related to a health plan service segment acquisition. During the year ended June 30, 2013, goodwill increased by $17.8 million related to an adjustment to the Company's estimate of the acquired DMC pension benefit obligation (see Note 3) and other acute care services segment acquisitions and $3.8 million related to a health plan service segment acquisition. During the year ended June 30, 2013, goodwill decreased by approximately $0.1 million related to the dispositions of certain businesses within the Company's acute care services segment. As of June 30, 2013, the Company had recognized cumulative goodwill impairments of $166.9 million, all of which relate to the Company’s acute care services segment. As of June 30, 2013, approximately $201.5 million of the Company's goodwill is deductible for tax purposes.
which exceeded its carrying value by approximately 15%. In order to address the uncertainties in the DCF assumptions the Company performed sensitivity analyses and noted that given a reasonable range of key variables, the DCF estimates still exceeded carrying value for the reporting units. Additionally, for the health plan reporting unit, the revenues derived from PHP could significantly decrease if the cap placed on PHP's new contract with AHCCCS in Maricopa County is not lifted (see below for further discussion of the AHCCCS capped contract). If AHCCCS does not lift the cap, then the Company's revenues and profitability would be negatively impacted by the reduction in membership. However, given the expected growth in the Company's other health plans along with the Company's efforts to expand PHP's membership, the calculated fair value of the health plan reporting unit exceeded the carrying value by more than 100%.
Effective July 1, 2008, the Company entered into an Employer Health Program Agreement with Equity Healthcare LLC (“Equity Healthcare”), which is an affiliate of Blackstone. Equity Healthcare negotiates with providers of standard administrative services for health benefit plans as well as other related services for cost discounts and quality of service monitoring capability by Equity Healthcare. Equity Healthcare receives from the Company a fee of $2.50 per employee per
On or after February 1, 2014, the Issuers may redeem all or part of the 8.0% Notes at various redemption prices given the date of redemption as set forth in the indenture governing the 8.0% Notes. The Issuers could have redeemed up to 35% of the 8.0% Notes prior to February 1, 2013 with the net cash proceeds from certain equity offerings at a price equal to 108% of their principal amount, plus accrued and unpaid interest. The Issuers may also redeem some or all of the 8.0% Notes before February 1, 2014 at a redemption price equal to 100% of the principal amount thereof, plus a “make-whole” premium and accrued and unpaid interest.
On July 14, 2010, the Issuers entered into a Second Supplemental Indenture, under which the Issuers co-issued (the “Add-on Notes Offering”) $225.0 million ($216.6 million cash proceeds) aggregate principal amount of 8.0% Senior Unsecured Notes due 2018 (the “Add-on Notes”), which are guaranteed on a senior unsecured basis by the Company and its domestic subsidiaries, other than those subsidiaries that do not guarantee the obligations of the borrowers under the 2010 credit facilities. The Add-on Notes Offering was made under the indenture governing the 8.0% Notes, which was executed on January 29, 2010 as part of the Refinancing. The Add-on Notes were issued at an offering price of 96.25% plus accrued interest from January 29, 2010. The discount of $8.4 million is accreted to par over the remaining term of the Add-on Notes. The proceeds from the Add-on Notes were used to finance, in part, the Company’s acquisition of DMC and to pay fees and expenses incurred in connection with the Add-on Notes offering.
On June 14, 2011, the Issuers exchanged substantially all of their outstanding Add-on Notes for new 8.0% senior unsecured notes with identical terms and conditions, except that the exchange notes were registered under the Securities Act of 1933. Terms and conditions of the exchange offer were set forth in the registration statement on Form S-4 filed with the SEC on April 8, 2011, that became effective on May 4, 2011.
The Senior Notes bear interest at a rate of 7.750% per annum. The Company pays cash interest semi-annually in arrears on February 1 and August 1 of each year. The Senior Notes are unsecured general obligations of the Issuers and rank pari passu in right of payment to all existing and future unsecured indebtedness of the Issuers. The Senior Notes mature on February 1, 2019. The Company used the proceeds from the Senior Notes for general corporate purposes, including acquisitions, and to pay the related transaction fees and expenses of the offering and the offering of the 10.375% Senior Discount Notes.
On January 26, 2011, the Company issued, in a private placement, senior discount notes due 2016 (the “Senior Discount Notes”) with a stated principal amount at maturity of approximately $747.2 million. The sale of the Senior Discount Notes generated approximately $444.7 million of gross proceeds. The Senior Discount Notes were not guaranteed by any of the Company’s subsidiaries.
The Company used the net proceeds from its initial public offering in June 2011 and the exercise of the over-allotment option by the underwriters in July 2011 to redeem approximately $453.6 million accreted value ($724.0 million principal balance) of the Senior Discount Notes and to pay $27.6 million of redemption premiums related thereto. The redemptions resulted in approximately $14.7 million of remaining unredeemed accreted value of Senior Discount Notes outstanding immediately after the redemptions were completed. During the remainder of the year ended June 30, 2012, the Company redeemed an additional $6.0 million ($8.9 million principal balance) of Senior Discount Notes through privately negotiated transactions. On March 19, 2013, the Company redeemed the remaining $10.7 million accreted value ($14.3 million principal balance) of the Senior Discount Notes.
outstanding Senior Discount Notes and to pay the associated fees related to the amendment. The remaining proceeds will be used to finance other general operating and investing activities.
Subsequent to the amendment, the Company's senior secured credit facilities include a term loan facility, which matures in January 2016, in the amount of $1,092.9 million and a revolving credit facility, which matures in January 2015, in the amount of $365.0 million (the “2010 revolving facility”). The Company’s remaining borrowing capacity under the 2010 revolving facility, net of letters of credit outstanding, was $327.2 million as of June 30, 2013. The Company makes quarterly principal payments equal to one-fourth of one percent of the outstanding principal balance of the term loan facility and will continue to make such payments until the maturity of the term loan facility.
Any borrowings under the 2010 revolving facility bear interest at a rate equal to, at the Company's option, LIBOR plus an applicable margin ranging from 3.25% to 3.50% per annum or an alternate base rate plus an applicable margin ranging from 2.25% to 2.50% per annum, in each case subject to the lower end of the range should the Company's leverage ratio decrease below a certain designated level. The Company also pays a commitment fee to the lenders under the 2010 revolving facility in respect of unutilized commitments thereunder, with that commitment fee being subject to a decrease should the Company's leverage ratio decrease below a certain designated level. The Company also pays customary letter of credit fees under the 2010 revolving facility.
The aggregate annual principal payments and scheduled redemptions of long-term debt, including capital leases and other long term debt, for each of the next five years and thereafter are as follows: Year 1 - $14.5 million; Year 2 - $14.8 million; Year 3 - $1,075.3 million; Year 4 - $3.5 million; Year 5 - $1,178.5 million; and $725.0 million thereafter.
The Company conducts substantially all of its business through its subsidiaries. Most of the Company’s subsidiaries jointly and severally guarantee the 8.0% Notes and the Senior Notes. The subsidiary guarantee release provisions under the indentures governing these notes are considered customary and include the sale, merger or transfer of the subsidiary's assets or capital stock under a qualifying transaction as set forth in the indentures; the full release or discharge of the indebtedness including a legal defeasance or a qualifying covenant defeasance; and the designation of the subsidiary as an unrestricted subsidiary as set forth in the indentures.
Certain of the Company’s other consolidated wholly-owned and non-wholly-owned entities do not guarantee the 8.0% Notes and Senior Notes in conformity with the provisions of the indentures governing these notes, and do not guarantee the term loan facility or the 2010 revolving facility in conformity with the provisions thereof. The condensed consolidating financial information for the parent company, the issuers of the senior notes and term debt, the issuers of the Senior Discount Notes, the subsidiary guarantors, the non-guarantor subsidiaries, certain eliminations and consolidated Company as of June 30, 2012 and 2013 and for the years ended June 30, 2011, 2012 and 2013 follows.
During the year ended June 30, 2013, the Company adjusted its estimate for the DMC pension benefit obligation from $228.0 million to $255.2 million as of the DMC acquisition date, based upon currently available information that became available in fiscal year 2013 relating to plan administration issues that are in process of being analyzed and resolved. The $27.2 million increase in the assumed pension benefit obligation resulted in a $16.9 million increase in goodwill and a $10.3 million increase in non-current deferred tax assets related to the DMC acquisition. The Company believes the adjustment to be immaterial for the restatement of prior period balance sheet amounts and has reflected the amount as an other plan administration adjustment to the projected benefit obligation during the year ended June 30, 2013.
To develop the expected long-term rate of return on plan assets assumption, the DMC Pension Plan considers the current level of expected returns on risk-free investments (primarily government bonds), the historical level of risk premium associated with the other asset classes in which the portfolio is invested and the expectations for future returns on each asset class. The expected return for each asset class was then weighted based on the target asset allocation to develop the expected long-term rate of return on assets assumption for the portfolio. The DMC Pension Plan’s weighted-average asset allocations by asset category as of June 30, 2013, were as follows:
The DMC Pension Plan assets are invested in separately managed portfolios using investment management firms. The DMC Pension Plan’s objective for all asset categories is to maximize total return without assuming undue risk exposure. The DMC Pension Plan maintains a well-diversified asset allocation that best meets these objectives. The DMC Pension Plan assets are largely comprised of equity securities, which include companies with various market capitalization sizes in addition to international and convertible securities. Cash and cash equivalents are comprised of money market funds. Debt securities include domestic and foreign government obligations, corporate bonds, and mortgage-backed securities. Under the investment policy of the DMC Pension Plan, investments in derivative securities are not permitted for the sole purpose of speculating on the direction of market interest rates. Included in this prohibition are leveraging, shorting, swaps, futures, options, forwards, and similar strategies.
In each investment account, investment managers are responsible to monitor and react to economic indicators, such as gross domestic product, consumer price index and the Federal Monetary Policy, that may affect the performance of their account. The performance of all managers and the aggregate asset allocation are formally reviewed on a quarterly basis, with a rebalancing of the asset allocation occurring at least once a year. The current asset allocation objective is to maintain a certain percentage with each class allowing for a 10% deviation from the target.
The following tables summarize the plan assets measured at fair value on a recurring basis as of June 30, 2012 and June 30, 2013, aggregated by the level in the fair value hierarchy within which those measurements are determined as disclosed in Note 4 (in millions). Fair value methodologies for Level 1 and Level 2 are consistent with the inputs described in Note 4. Fair value for Level 3 inputs are unobservable data points for the asset, and include situations where there is little, if any, market activity for the asset.
The expected future minimum required funding contribution is $1.1 million for the Company’s year ending June 30, 2014. The estimated required funding contribution related to the 2013 plan year to be made in September 2014 is approximately $5.0 million. There is no expected amortization from the amounts included in other comprehensive income into net pension plan expense (credit) over the next fiscal year. Additionally, no plan assets are expected to be returned to the Company during the year ended June 30, 2014. The estimated pension credits for the year ended June 30, 2014 are $7.9 million based upon the excess of expected return on plan assets of 7.0% over the interest cost on the projected benefit obligation of 4.93%. The expected benefits payments from the DMC Pension Plan, which represent the total benefits expected to be paid from the plan assets held by the plan trust, for the next five fiscal years and the five fiscal years thereafter are as follows (in millions):
The table below summarizes the total changes in unrecognized tax benefits during the years ended June 30, 2011, 2012 and 2013 (in millions).
For the years ended June 30, 2012 and 2013, the Company excluded 4,377,280 and 3,140,261, respectively, of potentially dilutive stock options and other stock-based awards from the calculation of diluted earnings per share because such stock-based awards were anti-dilutive.
The components of accumulated other comprehensive loss, net of taxes, as of June 30, 2012 and 2013 are as follows (in millions).
The Company issues stock-based awards, including stock options and other stock-based awards (restricted stock units and
In June 2011, the Company adopted the 2011 Stock Incentive Plan (the “2011 Plan”), which effectively replaced the 2004 Stock Incentive Plan (the "2004 Plan"), from which stock-based awards were granted prior to the Company's initial public offering. No further equity awards will be made under the 2004 Plan. The 2011 Plan allows for the issuance of 14,000,000 shares of common stock, all of which may be granted as incentive stock awards. As of June 30, 2013, there were 1,496,431 options, 1,209,037 restricted stock units and 498,864 performance-based restricted stock units outstanding under the 2011 Plan. As of June 30, 2013, there were 8,760,003 awards available to be granted under the 2011 Plan. The options issued pursuant to the 2011 Plan vest and become exercisable ratably over three years, while the time-based restricted stock units vest ratably over four years. The performance-based restricted stock units vest ratably over four years.
As of June 30, 2013, the performance-based restricted stock units outstanding included 498,864 awards earned based upon the Company’s fiscal 2012 financial performance. The Company recognized no expense for the year ended June 30, 2013 for the performance-based awards granted during the year based upon the Company not achieving targets related to financial performance metrics for the year ended June 30, 2013.
Pursuant to the terms of the 2004 Plan, the holders of nonvested stock options received $994.05 per share ($16.68 on a post-split basis) reductions to the exercise price of the share-based awards related to the combination of a stock repurchase completed during the year ended June 30, 2010 and a dividend paid during the year ended June 30, 2011 (subject to certain tax related limitations that resulted in deferred distributions for a portion of the declared dividend, which will be paid upon the vesting of the applicable stock options) to the exercise price of the share-based awards as a result of the dividend.
The following tables summarize options activity under both the Company's 2011 Plan and 2004 Plan during the year ended June 30, 2013.
The following table provides information relating to options during each period presented.
The following table sets forth certain information regarding vested options at June 30, 2013, options expected to vest subsequent to June 30, 2013 and total options expected to vest over the life of all options granted.
The following table summarizes information about the Company’s outstanding stock options as of June 30, 2013:
The following table summarizes restricted stock unit activity during the year ended June 30, 2013.
As of June 30, 2013, the restricted stock units had an aggregate intrinsic value of approximately $31.2 million. As of June 30, 2013, there was approximately $13.9 million of estimated unrecognized compensation cost related to restricted stock units. These costs are expected to be recognized over a weighted average period of approximately 2.0 years.
Effective June 1, 1998, the Company adopted its defined contribution employee benefit plan, the 401(k) Retirement Savings Plan (the “401(k) Plan”). The 401(k) Plan is a multiple employer defined contribution plan whereby employees who are age 21 or older are eligible to participate.
The Company leases certain real estate properties and equipment under operating leases having various expiration dates. Future minimum operating lease payments under non-cancelable leases for each fiscal year presented below are approximately as follows (in millions).
As part of its acquisition of DMC, effective January 1, 2011, the Company committed to spend a total of $850.0 million over a five-year period, $500.0 million of which related to a specific list of expansion projects. As of June 30, 2013, the Company had spent approximately $321.0 million related to this commitment, including approximately $191.5 million related to the specific project list. Under the terms of the DMC acquisition agreement, the Company is required to spend at least $80.0 million related to the specific list of expansion projects during each of the five calendar years after the closing of the acquisition.
calendar year, the Company was reimbursed the full $41.8 million from the escrow account resulting from capital expenditures made subsequent to December 2011.
For the calendar year 2012 capital commitment, the $80.0 million specific projects capital commitment was not met; therefore, in February 2013, the Company deposited $27.8 million of cash into the restricted escrow account. Since funding the escrow in February 2013, the Company had received the full $27.8 million from the account for reimbursement of capital expenditures related to the specific project list made through June 30, 2013.
The action brought by Ms. Woyak alleges civil violations of the federal FCA. Ms. Woyak's claims are primarily premised on allegations that the Company's Arizona Heart Hospital (“AHH”) failed to properly qualify for provider-based status under Medicare rules as a campus of the Company's Phoenix Baptist Hospital (“PBH”), though Ms. Woyak also alleges various means by which the Company allegedly fraudulently increased its billings. The action further alleges retaliation in violation of the FCA and common-law wrongful discharge. The action seeks damages provided for in the FCA and under common law.
On June 20, 2006, a federal antitrust class action suit was filed in San Antonio, Texas against the Company's Baptist Health System subsidiary in San Antonio, Texas and 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 of registered 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 hospitals violated 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 of the 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 plaintiffs filed the complaint is alleged to comprise all registered nurses
2012, the judge issued an opinion and order granting in part and denying in part the defendants' motions for summary judgment. The defendants' motions were granted as to the count of the complaint alleging wage fixing by defendants, but were denied as to the count alleging that the defendants' sharing of wage information allegedly resulted in the suppression of nurse wages. The opinion, however, did not address plaintiffs' motion for class certification and did not address defendants' challenge to the opinion of plaintiffs' expert, but specifically reserved ruling on those matters for a later date. At a mandatory mediation in January 2013 before the presiding U.S. District Court judge, counsel for DMC was advised that it appears likely that the DMC will be the only non-settling defendant, and the Company understands that the other defendants have settled the case or are in the process of having their settlements approved by the court. Subsequently, on April 22, 2013, the judge issued an opinion and order denying defendants' motion to exclude the testimony of plaintiffs' expert. Plaintiffs' motion for class certification is still pending before the court.
If the plaintiffs in the San Antonio and/or Detroit suits (1) are successful in obtaining class certification and (2) are able to prove both liability and substantial damages, which are then trebled under Section 1 of the Sherman Act, such a result could materially affect the Company's business, financial condition or results of operations. However, in the opinion of management, the ultimate resolution of these matters is not expected to have a material adverse effect on the Company's financial position or results of operations.
The Company has executed severance protection agreements (“severance agreements”) between the Company and each of its other officers who do not have employment agreements. The severance agreements are automatically extended for successive one year terms at the discretion of the Company unless a change in control occurs, as defined in the severance agreement, at which time the severance agreement continues in effect for a period of not less than three years beyond the date of such event. The Company may be obligated to pay severance payments as set forth in the severance agreements in the event of a change in control and the termination of the executive’s employment of the Company.
Segment EBITDA is defined as income from continuing operations before income taxes less interest expense (net of interest income), depreciation and amortization, equity method income, stock compensation, gain or loss on disposal of assets, realized gains or losses on investments, monitoring fees and expenses, acquisition related expenses, debt extinguishment costs, impairment and restructuring charges, and pension expense (credits). Management uses Segment EBITDA to measure the performance of the Company’s segments and to develop strategic objectives and operating 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. Segment EBITDA 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 the Company’s segments. Management believes that Segment EBITDA provides useful information to investors, lenders, financial analysts and rating agencies about the financial performance of the Company’s segments. Additionally, management believes that investors and lenders view Segment EBITDA as an important factor in making investment decisions and assessing the value of the Company. 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 United States. Segment EBITDA, as presented, may not be comparable to similar measures of other companies.
The following table presents summarized unaudited quarterly results of operations for the years ended June 30, 2012 and 2013. Management believes that all necessary adjustments have been included in the amounts stated below for a fair presentation of the results of operations for the periods presented when read in conjunction with the Company’s consolidated financial statements for the years ended June 30, 2012 and 2013. Results of operations for a particular quarter are not necessarily indicative of results of operations for an annual period and are not predictive of future periods (in millions except per share amounts).
These amounts include a gain on the disposition of equipment, certain current assets and third-party customer relationships associated with certain lab services. Related to this sale, the Company received approximately $15.5 million in cash and recognized a gain on sale for approximately $15.2 million ($9.3 million net of taxes or $0.12 per diluted share) during the quarter ended June 30, 2013.