In addition to the hospitals listed in the table above, we are building a new hospital in New Braunfels, Texas that is expected to be completed on or around May 2014. As of June 30, 2013, we also owned certain outpatient service locations complementary to our hospitals, including surgery centers, dialysis clinics, physician practices, home health agencies and diagnostic imaging centers, and two surgery centers in Orange County, California. Most of these outpatient facilities are in leased facilities, and certain outpatient facilities are owned and operated by joint ventures. We also own and operate a limited number of medical office buildings in conjunction with our hospitals, which are primarily occupied by physicians practicing at our hospitals.
As of June 30, 2013, we also owned five health plans with approximately 238,500 members. Our health plans include Chicago Health Systems (“CHS”), a contracting entity for outpatient services under multiple contracts and inpatient services for one contract provided by MacNeal Hospital and Weiss Memorial Hospital and participating physicians in the Chicago area; Phoenix Health Plan (“PHP”), a Medicaid managed health plan operating in Arizona; Abrazo Advantage Health Plan (“AAHP”), a Medicare and Medicaid dual eligible managed health plan operating in Arizona; ProCare Health Plan (“ProCare”), a Medicaid managed health plan operating in Michigan; and Valley Baptist Insurance Company (“VBIC”), which offers health maintenance organization, preferred provider organization, and self-funded products to its members in the form of large group, small group, and individual product offerings in south Texas.
During the year ended June 30, 2013, our revenues were impacted by ongoing challenges including less demand for elective services, some of which related to a weak general economy, and a shift from services provided to patients with managed care coverage to uninsured patients. Effective October 1, 2011, AHCCCS, Arizona's State Medicaid program, implemented capitation rate decreases for all state Medicaid plans and changed eligibility qualification for certain categories of members. The full year impact of these changes by AHCCCS caused a decrease in health plan revenues at PHP during the year ended June 30, 2013 compared to the prior year. We have been successful in reducing certain costs to mitigate the impact of these revenue pressures.
Under the Merger Agreement, consummation of the Merger remains subject to the satisfaction or waiver of certain customary closing conditions, including, among others, the absence of any order, preliminary or permanent injunction or other judgment, order or decree issued by a court or other legal restraint or prohibition that prohibits or makes illegal the consummation of the Merger; subject to certain materiality exceptions, the accuracy of the parties' respective representations and warranties and compliance with the parties' respective covenants; and the receipt of certain consents, waivers and approvals of governmental entities required to be obtained in connection with the Merger Agreement. We filed a definitive information statement with the SEC in connection with the Merger on July 26, 2013 that was first mailed to our stockholders beginning on or about August 1, 2013. The FTC granted early termination of the mandatory waiting period under the HSR Act with respect to the Merger on July 29, 2013. The Merger is expected to close early in our second quarter of fiscal 2014.
We believe that the operating environment for hospital operators continues to evolve, which presents both challenges and opportunities for us. These factors will require focus on the expansion of ambulatory and population health services, the quality of care we provide, and reducing our costs in response to governmental regulation and changes in our payer mix as further described below.
Budget Control Act. On August 2, 2011, Congress enacted the Budget Control Act of 2011. This law, among other things, established a two-step process to reduce federal spending and the deficit. In the first phase, the law imposed caps that reduced discretionary (non-entitlement) spending by more than $900 billion over ten years, beginning in FFY 2012. Under the second phase, if spending and deficit amounts reach certain thresholds, an enforcement mechanism called “sequestration” is triggered under which a total of $1.2 trillion in automatic, across-the-board spending reductions must be implemented over ten years beginning in 2013. The spending reductions are to be split evenly between defense and non-defense spending, although certain programs (including Medicaid and the CHIP program) are exempt from these automatic spending reductions, and Medicare expenditures cannot be reduced by more than two percent. For FFY 2013, the triggers were reached, and after being temporarily delayed by Congress, sequestration went into effect on April 1, 2013. Consequently, Medicare payments to hospitals and for other services were reduced two percent. Each year for the next nine years that the deficit thresholds are
Medicare and Medicaid EHR Incentive Payments. The American Recovery and Reinvestment Act of 2009 provides for Medicare and Medicaid electronic health record ("EHR") incentive payments that began in calendar 2011 for eligible hospitals and professionals that adopt and meaningfully use certified EHR technology. Our pre-tax income was positively impacted by combined Medicare and Medicaid EHR incentives of $10.1 million, $28.2 million and $38.0 million for the years ended June 30, 2011, 2012 and 2013. We believe that the operational benefits of EHR technology, including improved clinical outcomes and increased operating efficiencies, will contribute to our long-term ability to grow our business. We incur both capital expenditures and operating expenses in connection with the implementation of our various EHR initiatives. The amount and timing of these expenditures do not directly correlate with the timing of our cash receipts or recognition of the EHR incentives as other income.
During the year ended June 30, 2013 compared to the year ended June 30, 2012, discharges decreased 0.8% while adjusted discharges increased 0.7%. On a same store basis, discharges and adjusted discharges decreased 2.6% and 1.2%, respectively. The following table provides details of consolidated discharges by payer for each of the years ended June 30, 2011, 2012 and 2013.
Health care 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 national product. 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 health care providers or limiting benefits to enrollees. The current weakness in the United States economy magnifies these pressures.
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 afford private insurance coverage. These payers may respond to these challenges by reducing or limiting increases to health care provider reimbursement rates or reducing benefits to enrollees.
Includes uninsured patient accounts and those pending Medicaid eligibility verification only.
Our combined allowances for doubtful accounts, uninsured discounts and charity care covered 103.6% and 102.9% of combined uninsured and self-pay after primary accounts receivable as of June 30, 2012 and 2013, respectively.
The volume of uninsured and self-pay after primary accounts receivable remains sensitive to a combination of factors, including price increases, acuity of services, higher levels of patient deductibles and co-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 health care costs. We have implemented policies and procedures designed to expedite upfront cash collections and promote repayment plans for 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.
Premium revenues are recognized net of amounts recorded for minimum loss ratio ("MLR") rebates payable, as prescribed under the Health Reform Law. MLR rebates are calculated in accordance with regulations issued by HHS. Most of our health plans are managed Medicaid or managed Medicare health plans, which are currently not subject to these MLR rebate requirements. Our premium revenues were reduced by approximately $2.0 million and $0.6 million for MLR rebates during the year ended June 30, 2012 and 2013, respectively. Our MLR rebate liability was approximately $3.9 million and $0.6 million as of June 30, 2012 and 2013, respectively.
Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. In preparing these financial statements, 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 of which form the basis of the estimates and assumptions. We consider the following accounting policies to be critical because they involve highly subjective and complex assumptions and assessments, are subject to a great degree of fluctuation period over period and are the most critical to our operating performance:
Medicare regulations and many of our managed care contracts are often complex and may include multiple reimbursement mechanisms for different types of services provided in our health care facilities. To obtain reimbursement for certain services under the Medicare program, we must submit annual cost reports and record estimates of amounts owed to or receivable from Medicare. These cost reports include complex calculations and estimates related to indirect medical education, disproportionate share payments, reimbursable Medicare bad debts and other items that are often subject to interpretation that could result in payments that differ from recorded estimates. We estimate amounts owed to or receivable from the Medicare program using the best information available and our interpretation of the applicable Medicare regulations. We include differences between original estimates and subsequent revisions to those estimates (including final cost report settlements) in our consolidated statements of operations in the period in which the revisions are made. Net adjustments for final third party settlements increased patient service revenues and income from continuing operations before income taxes by $7.3 million, $6.7 million and $2.5 million during the years ended June 30, 2011, 2012 and 2013, respectively. Additionally, updated regulations and contract negotiations with payers occur frequently, which necessitates continual review of revenue estimation processes by management. We believe that future adjustments to our current third party settlement estimates will not materially impact our results of operations, cash flows or financial position.
We do not pursue collection of amounts due from uninsured patients that qualify for charity care under our guidelines (currently those uninsured patients whose incomes are equal to or less than 200% of the current federal poverty guidelines set forth by the HHS). We deduct charity care accounts from revenues when we determine that the account meets our charity care guidelines. We also generally provide 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 year ended June 30, 2011, a significant percentage of our charity care deductions represented services provided to undocumented aliens under the Section 1011 border funding reimbursement program. Border funding qualification ended in Texas during the year ended June 30, 2009, ended in Illinois during the year ended June 30, 2010, and ended in Arizona during the year ended June 30, 2013.
We record revenues related to the Provider Tax Assessment programs, such as those in Illinois, Michigan and Phoenix, Arizona, when the receipt of payment from the state or city governmental entity is assured. For the Texas UPL program, we recognize revenues that offset the expenses associated with the provision of charity care when the services are provided. We recognize federal match revenues under the Texas UPL program when payments are assured.
Our ability to collect the self-pay portions of our receivables is critical to our operating performance and cash flows. Our allowance for doubtful accounts was approximately 34.3% and 39.1% of accounts receivable, net of contractual discounts, as of June 30, 2012 and 2013, respectively. The primary collection risk relates to uninsured patient accounts and patient accounts for which primary insurance has paid but patient deductibles or co-insurance portions remain outstanding.
reserve policy as necessary given changes in trends from these analyses or pricing changes. If our uninsured accounts receivable as of June 30, 2012 and 2013 was 1% higher, our provision for doubtful accounts would have increased by $2.6 million and $2.5 million, respectively. Significant changes in payer mix, business office operations, general economic conditions and health care 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.
The Recovery Audit Program relies on private RACs to examine Medicaid and Medicare claims filed by health care providers to detect overpayments not identified through existing claims review mechanisms. RACs utilize a post-payment targeted review process employing data analysis techniques in order to identify those claims most likely to contain overpayments, such as incorrectly coded services, incorrect payment amounts, non-covered services and duplicate payments. CMS has given RACs the authority to look back at claims up to three years from the date the claim was paid. Claims identified as overpayments are subject to an appeals process. RACs are paid a contingency fee based on the overpayments they identify and collect.
We maintain a reserve for estimates of potential claims repayments from RAC audits based upon actual claims already audited but for which repayment has not yet occurred and claims for which we have received an audit notice but the audit process is not complete. During the quarter ended September 30, 2012, we reduced our RAC reserve estimate for the Michigan market by $14.5 million ($8.9 million net of taxes or $0.11 per diluted share) as a result of further analysis related to each component of the estimate during the period. The $14.5 million reduction in our RAC reserve estimate increased patient service revenues on the accompanying consolidated statements of operations during the year ended June 30, 2013.
We earned premium revenues of $869.4 million, $757.4 million and $737.1 million during the years ended June 30, 2011, 2012 and 2013, respectively, from our health plans. Our health plans have agreements with government agencies, including AHCCCS and CMS, and various health maintenance organizations or employers to contract to provide medical services to subscribing participants. Under these agreements, our health plans receive monthly payments based on the number and coverage type of members. Our health plans recognize the payments as revenues in the month in which members are entitled to health care services with the exception of AAHP Medicare Part D reinsurance premiums and low income subsidy cost sharing premiums that are recorded as a liability to fund future health care costs or else repaid to CMS.
Due to the nature of our operating environment, we are subject to professional and general liability and workers compensation claims and related lawsuits in the ordinary course of business. We maintain professional and general liability insurance with unrelated commercial insurance carriers to provide for losses up to $65.0 million in excess of our self-insured retention (such self-insured retention maintained at various levels through our captive insurance subsidiary and/or other of our subsidiaries). Effective with the acquisition of DMC on January 1, 2011, we also provide professional and general liability coverage to certain non-employed physicians in Michigan through another of our captive insurance subsidiaries. Similarly, we self-insure our workers compensation claims ranging from $0.6 million to $1.25 million per claim and purchase excess insurance coverage for claims exceeding the self-insured limits.
We use an actuary to assist us in the IBNR estimation process, and the actuary's conclusions serve as the basis for our periodic IBNR assessments. Our actuary applies multiple actuarial methods to our loss data to develop the best estimate of IBNR. These actuarial methods consider a combination of our actual historical losses and projected industry-based losses in differing weights for each policy period, estimates of unreported claims and adverse development for reported claims and the frequency, severity and lag-time to resolve claims. The IBNR analysis also considers actual and projected hospital statistical and census data, the number and risk-based ratings for covered physicians, retention levels for each policy period, tort reform legislation within each state in which we operate and other factors.
The following tables summarize our employee health, professional and general liability and workers compensation reserve balances (including the current portions of such reserves) as of June 30, 2010, 2011, 2012 and 2013 and claims loss and claims payment information during the years ended June 30, 2011, 2012 and 2013 (in millions).
The payment and claims activity is presented on a gross basis and does not reflect the elimination for services provided to our employees by our hospitals and our other health care facilities.
Our best estimate of employee health claims IBNR relies primarily upon payment lag data. If our estimate of the number of unpaid days of employee health claims expense changed by five days, our employee health IBNR estimate would change by approximately $2.5 million.
The decrease in health plan claim reserves primarily relate to decreases in PHP members as a result of AHCCCS eligibility restrictions put in place beginning October 1, 2011. Health plan claims expense is recognized in the period in which services are provided and includes an estimate of costs incurred but not yet paid. Accrued health plans claims and settlements on our consolidated balance sheet includes (1) an estimate of claims incurred but not yet received or adjudicated and claims adjudicated but not yet paid; (2) estimated unallocated loss adjustment expenses representing an estimate of the administrative costs necessary to resolve outstanding claims; and (3) certain amounts receivable from or payable to AHCCCS or CMS for the settlement of actual claims incurred compared to interim payments received related to member groups for which profitability or the risk of loss is limited. Accrued health plan claims and settlements do not include a reserve for adverse deviation. As of June 30, 2012, net settlements payable to AHCCCS or CMS was $2.4 million. As of June 30, 2013, net settlements receivable from AHCCCS or CMS was $11.0 million.
estimation methodology. Any change in the amount of incurred claims related to prior years included in the health plan claims reserve does not directly correspond to a change in our statement of operations due to the reconciliation and settlement provisions included in certain reconciled member groups.
The provisions set forth in accounting for uncertain tax positions allow for the classification of interest on an underpayment of income taxes, when the tax law requires interest to be paid, and penalties, when a tax position does not meet the minimum statutory threshold to avoid payment of penalties, in income taxes, interest expense or another appropriate expense classification based on the accounting policy election of the entity. We elected to continue our historical practice of classifying interest and penalties as a component of income tax expense. As of June 30, 2013, $0.3 million total unrecognized tax benefits would impact the effective tax rate if recognized.
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
assumptions we performed sensitivity analyses and noted that given a reasonable range of key variables, the DCF estimates still exceeded the carrying value for our reporting units. Additionally, for the health plan reporting unit, the revenues we derive from PHP could significantly decrease if the cap placed on PHP's new contract with AHCCCS in Maricopa County is not lifted. If AHCCCS does not lift the cap, then our revenues and profitability would be negatively impacted by the reduction in membership. However, given the expected growth in our other health plans along with our efforts to expand PHP membership, the calculated fair value of the health plan reporting unit exceeded the carrying value by more than 100%.
The following table presents summaries of our operating results for each of the years ended June 30, 2011, 2012 and 2013.
Year ended June 30, 2013 compared to Year ended June 30, 2012
Our percentage of uncompensated care (defined as the sum of uninsured discounts, charity care adjustments and the provision for doubtful accounts) as a percentage of net patient revenues (prior to these uncompensated care deductions) increased to 21.3% during the current year compared to 19.0% during the prior year. This increase primarily resulted from an increase in self-pay discharges as a percentage of total discharges during the current year and price increases implemented since the prior year.
Discharges and adjusted discharges decreased 2.6% and 1.2%, respectively, while emergency room visits increased 0.7% during the current year compared to the prior year. Inpatient and outpatient surgeries decreased 3.5% and 3.4%, respectively, during the current year compared to the prior year. General economic weakness in the markets we serve continues to impact demand for elective surgical procedures.
Salaries and benefits. Salaries and benefits as a percentage of total revenues decreased to 45.7% during the current year compared to 46.2% for the prior year primarily due to our ongoing efforts to increase operational effectiveness and efficiency by monitoring our staffing levels. On a same store basis, salaries and benefits as a percentage of total revenues was 46.0% during the current year compared to 46.4% for the prior year. For the acute care services operating segment, salaries and benefits as a percentage of patient service revenues was 50.9% during the current year compared to 51.6% during the prior year. As of June 30, 2013, we had approximately 39,500 full-time and part-time employees compared to approximately 40,900 as of June 30, 2012. On a same store basis, including corporate and
Acute care services on a consolidated basis. Net patient service revenues increased $1,479.3 million, or 39.8%, during the year ended June 30, 2012 compared to 2011. The significant increase in net patient service revenues is primarily the result of acquisitions, including DMC on January 1, 2011 and Valley Baptist on September 1, 2011, in addition to updates to Medicare reimbursement estimates related to rural floor settlement and SSI ratio updates.
Discharges, adjusted discharges and emergency room visits increased 27.4%, 28.2% and 32.0%, respectively, during the year ended June 30, 2012 compared to 2011. Inpatient and outpatient surgeries increased 35.0% and 28.9%, respectively, during the year ended June 30, 2012 compared to 2011.
Health plan premium revenue. Health plan premium revenues decreased $112.0 million, or 12.9%, during the year ended June 30, 2012 compared to 2011. PHP’s average membership decreased by 2.4% during the year ended June 30, 2012 compared to 2011. Additionally, revenues were lower during the current year as a result of two 5% reimbursement rate reductions implemented by AHCCCS in April 2011 and November 2011 (retroactive to October 1, 2011), and limitations to health plan profitability for member groups not previously subject to settlement.
Costs and expenses. Total costs and expenses from continuing operations, exclusive of income taxes, were $5,870.4 million, or 98.7% of total revenues during the year ended June 30, 2012, compared to $4,575.6 million, or 99.9% of total revenues, during 2011. Many year over year comparisons of individual cost and expense items as a percentage of total revenues, with the exception of health plan related premium revenues and claims expense, were significantly impacted by the acquisitions during the year ended June 30, 2011, as previously discussed. 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.
Other. Depreciation and amortization increased by $64.5 million, or 33.3%, year over year as a result of our capital improvement and expansion initiatives and the DMC and Valley Baptist acquisitions. Net interest increased by $11.6 million, or 6.8%, year over year as a result of the issuance of the additional 7.75% Senior Notes in March 2012 and the full year impact of our note offerings in January 2011 and July 2011. We incurred $14.0 million of acquisition-related expenses during the year ended June 30, 2012 compared to $12.5 million of acquisition-related expenses during 2011. We also incurred $5.1 million of restructuring charges during 2011 related to the elimination of approximately 40 positions for the realignment of certain corporate services. The 2011 results were negatively impacted by $31.3 million in monitoring fees and expenses that include the termination of a transaction and monitoring agreement with our equity sponsors.
Net income (loss) attributable to Vanguard Health Systems, Inc. stockholders. Net income attributable to Vanguard Health Systems, Inc. stockholders was $57.3 million ($0.71 per diluted share) during the year ended June 30, 2012 compared to a net loss of $12.0 million ($0.26 loss per share) during the year ended June 30, 2011. The year over year change was positively impacted by the $22.3 million of updates to SSI and Rural Floor reimbursement estimates recognized during the third quarter of fiscal 2012.
employer contributions of $32.3 million to the DMC defined benefit pension plan during the year ended June 30, 2013, which was $6.9 million higher than these contributions during the prior year;
the receipt of certain settlement receivables from the federal government, net of payments made to third parties utilizing most of these proceeds; and
Cash flows provided by financing activities increased by $355.3 million during the year ended June 30, 2013 compared to the prior year. During the year ended June 30, 2012, we redeemed approximately $450.0 million of the Senior Discount Notes using proceeds from our initial public offering, including the exercise of the underwriters’ over-allotment option. During the year ended June 30, 2012, we recorded debt extinguishment costs of $38.9 million, $25.3 million net of taxes, representing tender premiums and other costs to redeem the Senior Discount Notes and the write-off of net deferred loan costs associated with the redeemed Senior Discount Notes. On March 14, 2013, we amended (the "Amendment") our Credit Agreement, dated January 29, 2010, and borrowed an additional $300.0 million in term loans with a reduced interest rate for the entire term loan facility. Approximately $11.2 million of the $300.0 million in additional proceeds as a result of the Amendment were used to
redeem the remaining 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.
Our senior secured credit agreement contains a number of covenants that, among other things, restrict, subject to certain exceptions, our ability, and the ability of our subsidiaries, to: sell assets; incur additional indebtedness or issue preferred stock; repay other indebtedness (including the 8.0% Notes and the 7.750% Senior Notes); pay certain dividends and distributions or repurchase our capital stock; create liens on assets; make investments, loans or advances; make certain acquisitions; engage in mergers or consolidations; create a health care joint venture; engage in certain transactions with affiliates; amend certain material agreements governing our indebtedness, including the 8.0% Notes and the 7.750% Senior Notes; change the business conducted by our subsidiaries; enter into certain hedging agreements; and make capital expenditures above specified levels. In addition, the senior secured credit agreement includes a minimum consolidated interest coverage ratio and a maximum consolidated leverage ratio. The following table sets forth the interest coverage and leverage covenant tests as of June 30, 2013.
Factors outside our control may make it difficult for us to comply with these covenants during future periods. These factors include, among others, a prolonged economic recession, a higher number of uninsured or underinsured patients and decreased governmental or managed care payer reimbursement, 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 of one or more of the covenants could result in an immediate call of the outstanding principal amount under our senior secured credit agreement or the necessity of lender waivers with more onerous terms, including adverse pricing or repayment provisions or more restrictive covenants. A default under our senior secured credit agreement would also result in a default under the indenture governing our 8.0% Notes and the indenture governing the 7.750% Senior Notes.
As part of the Valley Baptist acquisition, we issued a redeemable non-controlling interest to the seller that enables the seller to require us to redeem all or a portion of its 49% equity interest in the partnership on the third or fifth anniversary of the acquisition date at a stated redemption value. If the seller exercises this put option, we may purchase the non-controlling interest with cash or by issuing stock. It is our intent to settle in cash, if the put option is exercised.
These potential cash outflows could limit our ability to fund our other operating needs, including acquisitions or other growth opportunities. We had $624.0 million of cash and cash equivalents as of June 30, 2013. We rely on available cash, cash flows generated by operations and available borrowing capacity under our revolving credit facility to fund our operations and capital expenditures. We believe that 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 cash balances. However, the significant majority of our cash and cash equivalents, deposits and investments are not federally-insured and could be at risk in the event of a collapse of those financial institutions.
This obligation represents our estimated minimum required funding for the DMC Pension Plan trust in our 2014 and 2015 fiscal years. Because the future cash outflows are uncertain and subject to change, the timing and amounts of payments to the trust beyond 12 months are not included as of June 30, 2013. For additional information about the DMC Pension Plan and expected future benefit payments from the trust, see Note 8 to our Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
Includes the current and long-term portions of our professional and general liability, workers compensation and employee health reserves.
Represents our estimate of amounts we are committed to fund in future periods pursuant to executed agreements to complete projects included as property, plant and equipment on our consolidated balance sheets. The construction and capital improvements obligations include the following capital commitments under the executed DMC purchase
Includes amounts outstanding as of July 2013 primarily for letters of credit with the third party administrator of our self-insured workers compensation program.
Represents the redeemable non-controlling interests for Valley Baptist as reflected on our consolidated balance sheet.
In connection with the closing of the DMC transaction, we placed into escrow for the benefit of DMC a contingent unsecured subordinated promissory note payable to the legacy DMC entity in the original principal amount of $500.0 million to collateralize our $500.0 million specified project capital commitment. The principal amount of the promissory note is reduced automatically as we expend capital or escrow cash related to this capital commitment. Through June 30, 2013, the principal amount of this promissory note had been reduced by $191.5 million.
Various federal, state and local laws have been enacted that, in certain cases, limit our ability to increase prices. Revenues for acute hospital services rendered to Medicare patients are established under the federal government’s prospective payment system. We believe that hospital industry operating margins have been, and may continue to be, under significant pressure because of changes in payer mix and growth in operating expenses in excess of the increase in prospective payments under the Medicare program. In addition, as a result of increasing regulatory and competitive pressures, our ability to maintain operating margins through price increases to non-Medicare patients is limited. These factors combined with normal inflation related to wages, costs of supplies and other operating expenses may result in decreased margins in future periods.
Consolidated Statements of Operations for the years ended June 30, 2011, 2012 and 2013
Consolidated Statements of Equity for the years ended June 30, 2011, 2012 and 2013
We have audited the accompanying consolidated balance sheets of Vanguard Health Systems, Inc. as of June 30, 2013 and 2012, and the related consolidated statements of operations, comprehensive income (loss), equity, and cash flows for each of the three years in the period ended June 30, 2013. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Vanguard Health Systems, Inc. at June 30, 2013 and 2012, and the consolidated results of its operations and its cash flows for each of the three years in the period ended June 30, 2013, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Vanguard Health Systems, Inc.'s internal control over financial reporting as of June 30, 2013, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 framework) and our report dated August 19, 2013 expressed an unqualified opinion thereon.
In preparing the Company’s financial statements in conformity with accounting principles generally accepted in the United States, management makes estimates and assumptions that affect the amounts recorded or classification of items in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
The Company recognizes patient service revenues associated with services provided to patients who have third-party payer coverage on the basis of contractual rates for the services rendered. For uninsured patients that do not qualify for charity care, the Company recognizes revenues on the basis of its standard rates for services provided (or on the basis of discounted rates, if negotiated or provided by policy).
receivable from the Medicare program using the best information available and its interpretation of the applicable Medicare regulations. The Company includes differences between original estimates and subsequent revisions to those estimates (including final cost report settlements) in the consolidated statements of operations in the period in which the revisions are made.
Net adjustments for final third party settlements increased patient service revenues and income from continuing operations by $7.3 million ($4.5 million net of taxes or $0.10 per diluted share), $6.7 million ($4.1 million net of taxes or $0.05 per diluted share) and $2.5 million ($1.5 million net of taxes or $0.02 per diluted share) during the years ended June 30, 2011, 2012 and 2013, respectively. Additionally, updated regulations and contract negotiations occur frequently, which necessitates continual review of estimation processes by management. Management believes that future adjustments to its current third party settlement estimates will not significantly impact the Company’s results of operations or financial position. Estimates for reserves related to cost report settlements were approximately $79.2 million and $63.4 million as of June 30, 2012 and 2013, respectively, and are included in other liabilities on the accompanying consolidated balance sheets. Estimates for amounts due from third party payers were $63.0 million and $62.2 million as of June 30, 2012 and 2013, respectively, and are included in prepaid expenses and other current assets in the accompanying consolidated balance sheets. Substantially all Medicare and Medicaid cost reports are final settled through 2007.
The Balanced Budget Act of 1997 ("BBA") established a rural floor provision, by which an urban hospital's wage index within a particular state could not be lower than the statewide rural wage index. The wage index reflects the relative hospital wage level compared to the applicable average hospital wage level. BBA also made this provision budget neutral, meaning that total wage index payments nationwide before and after the implementation of this provision must remain the same. To accomplish this, the Centers for Medicare & Medicaid Services ("CMS") was required to increase the wage index for all affected urban hospitals, and to then calculate a rural floor budget neutrality adjustment ("RFBNA") to reduce other wage indexes in order to maintain the same level of payments. Litigation had been pending for several years contending that CMS had miscalculated the RFBNA since 1999.
During March 2012, the Centers for Medicare and Medicaid Services ("CMS") issued new Supplemental Security Income ("SSI") ratios used for calculating Medicare Disproportionate Share Hospital ("DSH") reimbursement for federal fiscal years ("FFYs") ending September 30, 2006 through September 30, 2009. As a result of these new SSI ratios, U.S. hospitals must recalculate their Medicare DSH reimbursement for the affected years and record adjustments for any differences in estimated reimbursement as a part of their annual cost report settlement process. Historically, CMS issued each hospital its SSI ratio annually, several months after the end of each fiscal year. However, CMS delayed issuing final SSI ratios for years after FFY 2005 likely due to a court case challenging the government's computation of SSI ratios. This challenge, which began in 2006, was resolved in the U.S. Circuit Court of Appeals during 2012.
alleviate expenses for the governmental entity. The governmental entity is then able to utilize its tax revenue to fund the Medicaid program for private hospitals. The Company recognizes revenues from the UPL program when the Company becomes entitled to the expected reimbursements, including a federal match portion, and such reimbursements are assured.
The Company had premium revenues from its health plans of $869.4 million, $757.4 million and $737.1 million during the years ended 2011, 2012 and 2013, respectively. The Company’s health plans, Phoenix Health Plan (“PHP”), Abrazo Advantage Health Plan (“AAHP”), Chicago Health Systems (“CHS”), ProCare Health Plan ("ProCare") and Valley Baptist Insurance Company ("VBIC"), have agreements with governmental agencies, including the Arizona Health Care Cost Containment System (“AHCCCS”) and CMS, and various health maintenance organizations (“HMOs”) and employers, to contract to provide medical services to subscribing participants. Under these agreements, CHS and VBIC receive monthly payments based on the number of participants in their health plan and PHP, AAHP and ProCare receive monthly payments based on the number and coverage type of their members. The Company’s health plans recognize the payments as revenues in the month in which members are entitled to health care services with the exception of AAHP Medicare Part D reinsurance premiums and low income subsidy cost sharing premiums that are recorded as a liability to fund future health care costs or else repaid to CMS. Premium revenues are recognized net of amounts recorded for minimum loss ratio ("MLR") rebates payable, as prescribed under the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010 (collectively, the “Health Reform Law”). MLR rebates are calculated in accordance with regulations issued by the U.S. Department of Health and Human Services ("HHS"). Most of the Company's health plans are managed Medicaid or managed Medicare health plans, which are currently not subject to these MLR rebate requirements. The Company's premium revenues were reduced by approximately $2.0 million and $0.6 million for MLR rebates during the years ended June 30, 2012 and 2013, respectively, and the Company's MLR rebate liability was approximately $3.9 million and $0.6 million as of June 30, 2012 and 2013, respectively.
The Company’s primary concentration of credit risk is patient accounts receivable, which consists of amounts owed by various governmental agencies, insurance companies and private patients. Any material change in the current demographic, economic, competitive or regulatory conditions in any of the Company's operating regions could adversely affect the overall business results because of the significance of its operations in each of these regions to the overall operating performance. Moreover, due to the concentration of its revenues in only five states, the Company's business is less diversified and, accordingly, is subject to greater regional risk than that of some of the Company's more diversified competitors.
The Company estimates the allowance for doubtful accounts using a standard policy that reserves 100% of all accounts aged greater than 365 days subsequent to discharge date plus a percentage of uninsured accounts less than 365 days old plus a percentage of self-pay after insurance accounts less than 365 days old. The Company has periodically adjusted its policy to
increase the percentages applied to uninsured accounts and self-pay after insurance accounts to account for pricing changes and for the impact of its uninsured discount policy, as previously described in Note 2 under Patient Service Revenues Before Provision for Doubtful Accounts. The Company tests its 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. The Company also supplements its analysis by comparing cash collections to net patient revenues and monitoring self-pay utilization. Significant changes in payer mix, business office operations, general economic conditions and health care coverage provided by federal or state governments or private insurers may have a significant impact on the Company’s estimates and significantly affect its results of operations and cash flows.
The Company classifies accounts pending Medicaid approval as uninsured accounts in its accounts receivable aging report and applies an uninsured discount until such time that qualification is determined. The net account balance is further subject to the allowance for doubtful accounts policy. Should the account qualify for Medicaid coverage, the previously recorded uninsured discount is reversed and the account is reclassified to Medicaid accounts receivable with the appropriate contractual discount applied. Should the account not qualify for Medicaid coverage but qualify as charity care under the Company’s charity policy, the previously recorded uninsured discount is reversed and the entire account balance is recorded as a charity deduction.
Purchases of property, plant and equipment are stated at cost. Routine maintenance and repairs are charged to expense as incurred. Expenditures that increase values, change capacities or extend useful lives are capitalized. For capital additions other
than leasehold improvements, depreciation is computed using the straight-line method over the estimated useful lives of the assets, which approximate 3 to 40 years. Leasehold improvements are depreciated over the lesser of the estimated useful life or term of the lease. Amortization of assets acquired under capital leases is included with depreciation expense. Depreciation and amortization expense was approximately $193.8 million, $258.3 million and $257.1 million for the years ended June 30, 2011, 2012 and 2013, respectively. The Company tests its property, plant and equipment and other long-lived assets for impairment as management becomes aware of impairment indicators.
During the years ended June 30, 2011, 2012 and 2013, the Company capitalized $5.6 million, $3.4 million and $10.5 million of interest, respectively, associated with certain of its hospital construction and expansion projects. The Company estimates that it is contractually obligated to expend approximately $162.2 million related to projects classified as construction in progress as of June 30, 2013. The Company also capitalizes costs associated with developing computer software for internal use. The Company capitalizes both internal and external direct costs, excluding training, during the application development stage primarily for the purpose of customizing vendor software to integrate with the Company’s hospital information systems. The estimated net book value of capitalized internal use software included in net property, plant and equipment was approximately $62.2 million and $74.7 million as of June 30, 2012 and 2013, respectively. Amortization of internal use software included in depreciation expense was approximately $14.7 million, $29.3 million and $28.6 million for the years ended June 30, 2011, 2012 and 2013, respectively.
In 2013, the Company elected not to perform a qualitative impairment assessment for goodwill but instead to complete the quantitative analysis. The first step of the quantitative 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, the Company determines the fair value of a reporting unit using a discounted cash flow (“DCF”) analysis. 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 the Company's own assumptions. The cash flows employed in the DCF analysis are based on the Company's most recent budgets and business plans and, when applicable, various growth rates are assumed for years beyond the current business
Investments in securities include debt and equity securities and are classified as available-for-sale, held-to-maturity or as part of a trading portfolio. As of June 30, 2012 and 2013, the Company held no significant investments in securities classified as either held-to-maturity or trading. Investments in securities classified as available-for-sale are reported at fair value. Unrealized gains and losses, net of taxes, are reported as accumulated other comprehensive income (loss) unless the unrealized loss is determined to be other-than-temporary, at which point the Company would record a loss in the consolidated statement of operations. The Company calculates the realized gain or loss on sales of investments using the amortized cost basis, as determined by specific identification. See Note 4 for more information regarding the Company's investments in securities.
In connection with the Company's acquisition of DMC, certain capital commitments were agreed upon to be satisfied at particular dates. If these commitments are not met by these required dates, the Company is required to escrow cash for the purpose of funding certain capital projects. These funds represent restricted cash that are to be used to acquire long-term assets. Since the funds deposited into escrow for DMC asset purchases represent a contractual obligation to fund long-term capital assets, the Company presents the funds as a noncurrent asset on its consolidated balance sheet until the obligation has been satisfied.
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 health claims incurred by members in PHP. The Company estimates PHP’s reserve for health claims using historical claims experience (including cost per member and payment lag time) and other actuarial data, including the number of members and certain member demographic information. Accrued health plan claims and settlements, including both reported claims and estimates for incurred but not reported claims and net amounts payable to AHCCCS and CMS for certain programs for which profitability is limited, for all the Company's health plans combined was approximately $74.8 million and $72.6 million as of June 30, 2012 and 2013, respectively. 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. Due to changes in historical claims trends during the years ended June 30, 2011, 2012 and 2013, the Company decreased its health plan claims and settlements reserve related to prior year health claims by $12.7 million ($7.8 million net of taxes or $0.17 per diluted share), $14.5 million ($8.8
The Company covers substantially all of its employees under self-insured medical plans. Claims are accrued under the self-insured medical plans as the incidents that give rise to them occur. Unpaid claims accruals are based on the estimated ultimate cost of settlement, including claim settlement expenses, in accordance with an average lag time and historical experience. The reserve for self-insured medical plans was approximately $28.9 million and $22.6 million as of June 30, 2012 and 2013, respectively, and is included in accrued salaries and benefits in the accompanying consolidated balance sheets. During the years ended June 30, 2011, 2012 and 2013, approximately $58.7 million, $75.8 million and $82.8 million, respectively, of medical claims expense was eliminated in consolidation related to self-insured medical claims expense incurred and revenues earned due to employee utilization of the Company’s health care facilities.
The Company’s total reserves for professional and general liability as of June 30, 2012 and 2013 were $340.2 million and$337.7 million, respectively. As of June 30, 2012 and 2013, the reserves for workers compensation were $34.3 million and $30.3 million, respectively. The current portion of the total professional and general liability and workers compensation reserves as of June 30, 2012 and 2013 was $69.7 million and $75.0 million, respectively, and is included in other accrued expenses and current liabilities on the accompanying consolidated balance sheets. The Company utilizes actuarial information to estimate its reserves for professional and general liability and workers compensation claims. Each reserve is comprised of estimated indemnity and expense payments related to: (1) reported events (“case reserves”) and (2) incurred but not reported events (“IBNR”) as of the end of the period. Management uses information from its risk managers and its best judgment to estimate case reserves. Actuarial IBNR estimates are dependent on multiple variables including the Company’s risk exposures, its self-insurance limits, geographic locations in which it operates, the severity of its historical losses compared to industry averages and the reporting pattern of its historical losses compared to industry averages, among others. Most of these variables require judgment, and changes in these variables could result in significant period over period fluctuations in the Company’s estimates. The Company discounts its workers compensation reserve using a 3% factor, an actuarial estimate of projected cash payments in future periods. The Company does not discount the reserve for estimated professional and general liability claims.
The Company adjusts these reserves from time to time as it receives updated information. Due to changes in historical loss trends, during the year ended June 30, 2011, the Company decreased its professional and general liability reserve related to prior years by $5.4 million ($3.3 million net of taxes or $0.07 per diluted share). During the year ended June 30, 2012, the Company increased its professional liability and general reserve related to prior years by $0.5 million ($0.3 million net of taxes or $0.01 per diluted share). During the year ended June 30, 2013, the Company decreased its professional liability and general reserve related to prior years by $12.8 million ($7.8 million net of taxes or $0.10 per diluted share).
Upon completing the acquisition of DMC on January 1, 2011, the Company assumed a frozen defined benefit retirement plan (“DMC Pension Plan”) covering substantially all of the employees of DMC and its subsidiaries hired prior to June 1, 2003. The benefits paid under the DMC Pension Plan are primarily based on years of service and final average earnings. See Note 3 for further discussion of adjustments made to the Company's estimate of the acquisition date projected benefit obligation of the DMC Pension Plan during the year ended June 30, 2013.
The DMC Pension Plan is measured using actuarial techniques that reflect management’s assumptions for discount rates relative to the projected benefit obligation and the interest cost component of net periodic pension cost, expected long-term investment returns on plan assets, expected participant retirement dates and mortality. Management utilizes an independent actuary in determining these estimates.
The accounting guidance related to employers’ accounting for defined benefit pension plans requires recognition in the balance sheet of the funded status of defined benefit pension plans, and the recognition in other comprehensive income (loss) of unrecognized gains or losses and prior service costs or credits. Additionally, the guidance requires the measurement date for plan assets and liabilities to coincide with the plan sponsor’s fiscal year end. As of June 30, 2013, the Company had an accumulated comprehensive loss of $18.9 million ($11.5 million, net of tax) related to the DMC Pension Plan.
evidence can be objectively verified, the Company determines whether it is more likely than not that all or a portion of the deferred tax assets will be realized. The factors used in this determination include the following:
The Company's restructuring charges during the year ended June 30, 2011 resulted from the elimination of approximately 40 positions for the realignment of certain corporate services within the acute care services segment. As of June 30, 2011, the Company had accrued salaries and benefits of approximately $3.0 million for severance and related expenses, all of which were subsequently funded.
During the year ended June 30, 2013, the Company recorded approximately $5.2 million ($3.2 million net of taxes or $0.04 per diluted share) of restructuring charges primarily related to employee severance and similar costs incurred during the Company's fourth quarter ended June 30, 2013. The charges, related to the acute care services segment, were recorded in impairment and restructuring charges on the accompanying consolidated statement of operations.
For stock-based awards included in the Black-Scholes-Merton valuation model, the Company used historical stock price information of certain peer group companies for a period of time equal to the expected award life period to determine estimated volatility. The Company determined the expected life of the stock awards by averaging the contractual life of the awards and the vesting period of the awards. The estimated fair value of awards are amortized to expense on a straight-line basis over the awards’ vesting period.
Effective September 1, 2011, the Company acquired substantially all of the assets of Valley Baptist Medical Center, a 586-bed acute care hospital in Harlingen, Texas, and Valley Baptist Medical Center-Brownsville, a 280-bed acute care hospital in Brownsville, Texas, as well as the assets of certain other incidental health care businesses, partnerships, physician practices and medical office buildings operated as part of such hospital businesses (collectively “Valley Baptist”). The Company paid approximately $200.5 million in cash at closing to acquire the net assets of Valley Baptist. In addition to the cash investment, the Company also assumed certain of the seller’s debt and issued a 49% redeemable non-controlling interest in the partnership to the seller, as more fully discussed in Note 2. The Company funded the cash investment with cash on hand. The Valley Baptist partnership is consolidated by the Company. In connection with this acquisition, the Company entered into a management agreement, pursuant to which the Company is responsible for the management of Valley Baptist’s operations.
The following table provides certain pro forma financial information for the Company as if the DMC and Valley Baptist acquisitions had occurred at the beginning of the year ended June 30, 2011 (in millions).
Investments in corporate bonds, valued at approximately $13.8 million at June 30, 2013, consist of corporate bonds and other fixed income investments. The average expected maturities of the investments in corporate bonds at June 30, 2013 was 6.4 years, compared to the average scheduled maturity of 11.0 years. Expected and scheduled maturities may differ because the issuers of certain securities have the right to call, prepay or otherwise redeem such obligations prior to the scheduled maturity
date. The Company calculates the realized gain or loss on sales of investments using the amortized cost basis, as determined by specific identification. The amortized cost basis of these investments was approximately $53.7 million as of June 30, 2013.
The carrying amounts of the Company's short-term financial instruments, including cash, cash equivalents, restricted cash, accounts receivable and accounts payable, approximate fair value due to the short-term maturity of these items. The fair value of the Company's long-term debt, excluding term loans, capital leases and other long-term debt, was approximately $2,014.9 million, based upon stated market prices (Level 1) at June 30, 2013. The fair values of the Company's term loan facility, capital leases and other long-term debt, was approximately $1,110.0 million, based upon quoted market prices and interest rates (Level 2) at June 30, 2013.
The following table provides information regarding the intangible assets, including deferred loan costs, included on the accompanying consolidated balance sheets as of June 30, 2012 and 2013 (in millions).
Amortization expense for contract-based intangibles and other intangible assets during the years ended June 30, 2011, 2012 and 2013 was approximately $4.0 million, $4.1 million and $4.2 million, respectively. Estimated amortization expense for these intangible assets during the next five years and thereafter is as follows: 2014 - $4.3 million; 2015 - $1.9 million; 2016 - $1.1 million; 2017 - $0.4 million; 2018 - $0.3 million; and $2.0 million thereafter.
Amortization of physician income and other guarantees of $4.8 million, $5.1 million and $4.8 million during the years ended June 30, 2011, 2012 and 2013, respectively, is included in purchased services or other operating expenses.
The weighted-average amortization period for the intangible assets subject to amortization is approximately three years for each class of asset and in total. There is no expected residual values related to these assets.
As of June 30, 2013, the Company had $789.9 million of goodwill, which is tested for impairment at least annually but also as impairment indicators become known. The Company's annual impairment analysis did not result in any impairments of its goodwill for the year ended June 30, 2013. The fair value of each of the Company's reporting units exceeded carrying value by approximately 40%, except for the Arizona hospitals reporting unit (which had $100.7 million of goodwill at June 30, 2013),
In order for the estimated fair values to decrease below the carrying values for all of the reporting units, the Company 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 the Company believes 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 the Company's key assumptions include, among others, a continuation of current challenging economic conditions, uncertainty within the Health Reform Law and PHP's contract with AHCCCS. These changes could create additional pricing, volume and reimbursement pressures that are not within the Company's control.
During the year ended June 30, 2013, the Company paid $4.0 million and $0.6 million of the outstanding accrued monitoring fees and expenses to The Blackstone Group L.P. ("Blackstone") and Metalmark SA, respectively. As of June 30, 2012, approximately $9.0 million and $1.3 million remained payable to Blackstone and Metalmark SA, respectively, and is included in other accrued expenses and current liabilities on the accompanying consolidated balance sheet. As of June 30, 2013, approximately $5.0 million and $0.8 million remained payable to Blackstone and Metalmark SA, respectively, and is included in other accrued expenses and current liabilities on the accompanying consolidated balance sheet. The quarterly payments were due beginning July 1, 2011 and ending July 1, 2014 unless Blackstone and Metalmark SA elect at any time to accelerate the aforementioned quarterly payments to a lump sum payable due immediately. It is expected that the remaining outstanding balance will be paid upon closing of the Tenet transaction.
month. As of June 30, 2013, the Company has approximately 9,600 employees enrolled in these health and welfare benefit plans.
A summary of the Company’s long-term debt as of June 30, 2012 and 2013 follows (in millions).
On May 7, 2010, the Issuers exchanged substantially all of their outstanding 8.0% 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 (the "Securities Act"). Terms and conditions of the exchange offer were set forth in the registration statement on Form S-4 filed with the Securities and Exchange Commission ("SEC") on March 3, 2010, that became effective on April 1, 2010.
On January 26, 2011, the Issuers issued an aggregate principal amount of $350.0 million of 7.750% senior notes due 2019 (the “Senior Notes”), in a private placement. The obligations under the Senior Notes were fully and unconditionally guaranteed on a senior basis by the Company and certain of its subsidiaries.
On June 14, 2011, substantially all of the outstanding Senior Notes were exchanged for new 7.750% senior notes with identical terms and conditions, except that the exchange notes were registered under the Securities Act. 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.
On March 30, 2012, the Company issued an additional $375.0 million ($372.2 million cash proceeds net of original issue discount) aggregate principal amount of Senior Notes (the “New Notes”) in a private placement pursuant to the indenture, dated as of January 26, 2011, governing the Senior Notes. The New Notes generally have the same terms and features as the Senior Notes. The New Notes mature on February 1, 2019. The New Notes were issued at an offering price of 99.25% plus accrued interest from February 1, 2012. The discount of $2.8 million will be accreted to par over the remaining term of the New Notes.
The New Notes are treated as a single series with the existing Senior Notes, except that the New Notes are subject to a separate registration rights agreement. On March 13, 2013, the Company completed the exchange of substantially all of the outstanding New Notes for new 7.750% senior notes with identical terms and conditions, except that the exchange notes are registered under the Securities Act. Terms and conditions of the exchange offer were set forth in the registration statement on Form S-4 filed with the SEC on December 14, 2012, that became effective on January 25, 2013.
On March 14, 2013, certain of the Company's subsidiaries amended (the "amendment") its Credit Agreement, dated January 29, 2010 (the “Credit Agreement”). Pursuant to the amendment, the Company borrowed an additional $300.0 million in term loans and refinanced its outstanding term loans. Initially, the Credit Agreement provided that the Company's term loan facility (the “term loan facility”) bore interest at a rate equal to, at the Company's option, LIBOR (subject to a 1.50% floor) plus 3.50% per annum or an alternate base rate (subject to a 2.50% floor) plus 2.50% per annum. The amendment provided that the term loan facility bear interest at a rate equal to, at the Company's option, LIBOR (subject to a 1.00% floor) plus 2.75% per annum or an alternate base rate (subject to a 2.00% floor) plus 1.75% per annum. The term loan facility matures on January 29, 2016. The interest rate applicable to the term loan facility was 3.75% as of June 30, 2013. A portion of the $300.0 million in additional borrowings was used to redeem the outstanding principal and interest related to the Company's previously
During the year ended June 30, 2012 the Company recorded debt extinguishment costs related to the redemption of the Senior Discount Notes of approximately $38.9 million ($25.3 million net of taxes or $0.32 per diluted share), representing tender premiums and other costs to redeem the Senior Discount Notes and the write-off of net deferred loan costs associated with the redeemed Senior Discount Notes.
During the year ended June 30, 2013, in connection with the redemption of the remaining Senior Discount Notes and the $300.0 million amendment to the Company's Credit Agreement in March 2013, the Company recorded debt extinguishment costs of $2.1 million ($1.3 million net of taxes or $0.02 per diluted share). The debt extinguishment costs include $0.5 million of tender premiums to redeem the Senior Discount Notes; $0.3 million of previously capitalized net deferred loan costs related to the Senior Discount Notes; $0.9 million of loan costs incurred related to the term loan facility that the Company expensed in accordance with accounting guidance related to modifications or exchanges of debt instruments for which carryover lenders' cash flows changed by more than 10%; and $0.4 million of third party costs related to the refinancing of the term loan facility.
The following table summarizes the funded status of the DMC Pension Plan based upon actuarial valuations prepared as of the most recent valuation dates as of June 30, 2012 and 2013, respectively (in millions).
The following table reflects the amounts included in the Company’s accompanying consolidated balance sheets related to the DMC Pension Plan as of the years ended June 30, 2012 and 2013, respectively (in millions):
The Company recognizes actuarial gain or losses, expected return on plan assets and actual return on plan assets related to the DMC Pension Plan as a direct increase or decrease to stockholders’ equity through accumulated other comprehensive income (loss). As of June 30, 2013, the Company recognized an increase in equity through accumulated other comprehensive income of $61.7 million ($37.7 million, net of taxes) based upon the net impact of these factors. The accumulated other comprehensive loss related to the DMC Pension Plan was $18.9 million ($11.5 million net of taxes) as of June 30, 2013.
The increase in the valuation allowance during 2011 result from state net operating loss ("NOL") carryforwards that may not ultimately be utilized because of the uncertainty regarding the Company’s ability to generate taxable income in certain states. The decrease in the valuation allowances during 2012 and 2013 resulted primarily from the expiration of certain state NOL carryforwards.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax assets and liabilities as of June 30, 2012 and 2013 were as follows (in millions):
As of June 30, 2013, the Company had generated NOL carryforwards for federal income tax and state income tax purposes of approximately $3.8 million and $525.0 million, respectively. The federal and state NOL carryforwards expire from 2020 to 2029 and 2014 to 2032, respectively. Approximately $48.0 million of state NOL carryforwards expired as of June 30, 2013 resulting in a deferred tax and valuation allowance impact of $2.5 million. Approximately $1.7 million of these NOLs are subject to annual limitations for federal purposes. These limitations are not expected to significantly affect the Company’s ability to ultimately recognize the benefit of these NOLs in future years.
As of June 30, 2013, $0.3 million total unrecognized tax benefits would impact the effective tax rate if recognized.
The provisions of the guidance for uncertain tax positions allow for the classification of interest on an underpayment of income taxes, when the tax law required interest to be paid, and penalties, when a tax position does not meet the minimum statutory threshold to avoid payment of penalties, in income taxes, interest expense or another appropriate expense classification based on the accounting policy election of the company. The Company has elected to classify interest and penalties related to the unrecognized tax benefits as a component of income tax expense. During the years ended June 30, 2012 and 2013, the Company recognized approximately $5,000 and $2,000, respectively, of such interest and penalties. The Company did not recognize any interest and penalties relative to uncertain tax positions during the year ended June 30, 2011.
The Company computes basic earnings (loss) per share using the weighted average number of common shares outstanding. The Company computes diluted earnings (loss) per share using the weighted average number of common shares outstanding, plus the dilutive effect of outstanding stock options, restricted shares, restricted stock units and performance-based restricted stock, computed using the treasury stock method. Performance-based restricted stock units are included as dilutive shares when the applicable performance measures are achieved.
The Company has the authority to issue 500,000,000 shares of common stock, par value $.01 per share. In 2011, the Company completed an initial public offering of 28,750,000 shares, inclusive of the exercise of the over-allotment option exercised in July 2011, of its common stock at $18.00 per share, prior to underwriting discounts, commissions and other related offering expenses of approximately $33.8 million.
In connection with the Blackstone merger in 2004, Blackstone, Morgan Stanley Capital Partners and its affiliates, members of management and other investors acquired the membership units of VHS Holdings, LLC ("Holdings"). Holdings then acquired the common stock of the Company, in addition Blackstone invested $125.0 million directly in the common stock of the Company. In February 2005, other investors purchased additional membership units of Holdings, which Holdings then invested in the common stock of the Company.
Immediately prior to the Company’s initial public offering, Holdings was merged with and into the Company so that the Company survived the merger (the “Holdings Merger”). As a result of the Holdings Merger, the holders of the outstanding units of Holdings received the same financial values of ownership interests from the equity issued by the Company as that surrendered in Holdings calculated based on the deemed equity value of the Company from the initial public offering. The net impact from the Holdings Merger resulted in the Company issuing to the former unit holders in Holdings an additional 1,720,379 shares of common stock, an additional 1,684,733 shares of restricted stock but with full voting rights and an additional 1,245,086 options to purchase common stock. The restricted stock issued in the Holdings Merger vested in September 2012.
As previously discussed, the Company uses the Black-Scholes-Merton model to record stock-based compensation expense for options granted. During the years ended June 30, 2011, 2012 and 2013, the Company incurred stock-based compensation expense of $4.8 million, $9.2 million and $6.4 million, respectively, under its stock incentive plans. Compensation cost related to stock-based awards will be adjusted for future changes in estimated forfeitures and actual results of performance measures.
All common share and per common share amounts in these consolidated financial statements and notes to the consolidated financial statements reflect the 59.584218-to-1 split that occurred in 2011.
As of June 30, 2013, there was approximately $4.3 million of estimated unrecognized compensation cost related to outstanding stock options. These costs are expected to be recognized over a weighted average period of approximately 1.8 years.
The following table sets forth the summary of performance-based restricted stock activity under the 2011 Plan, based upon shares actually achieved for years ended June 30, 2012 and 2013:
As of June 30, 2013, the performance-based restricted stock awards had an aggregate intrinsic value of approximately $10.3 million. As of June 30, 2013, there was approximately $2.7 million of estimated unrecognized compensation cost related to performance awards. These costs are expected to be recognized over a weighted average remaining period of approximately 1.6 years.
The 401(k) Plan allows eligible employees to make contributions of $25, or 2% to 100% of their annual compensation. Employer matching contributions, which vary by employer, vest 100% after three years of service. For purposes of determining vesting percentages in the 401(k) Plan, many employees received credit for years of service with their respective predecessor companies. The Company’s matching accrual, included in accrued salaries and benefits on the accompanying consolidated balance sheets, was $3.2 million and $4.4 million as of June 30, 2012 and 2013, respectively. The Company’s matching expense, including matching expense for discontinued operations, for the years ended June 30, 2011, 2012 and 2013 was approximately $21.7 million, $26.7 million and $23.4 million, respectively.
During the years ended June 30, 2011, 2012 and 2013, rent and lease expense was $54.1 million, $75.0 million and $76.2 million, respectively.
As of June 30, 2013, the Company had spent approximately $31.5 million related to the $80.0 million calendar year 2013 specific projects commitment. As of June 30, 2013, the Company estimated its remaining commitments, excluding those for DMC, to complete all capital projects in process to be approximately $70.4 million.
The Company is presently, and from time to time, subject to various claims and lawsuits arising in the normal course of business. 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, except the matters discussed below under “Governmental Regulation” and "Antitrust Lawsuits" could have a material adverse effect, individually or in the aggregate, on the Company's financial position or results of operations.
Published sources report that earlier in 2010 the DOJ served subpoenas on a number of hospitals and health systems for this same ICD Medicare billing issue, but that the DOJ appears later in 2010 to have changed its approach, in that hospitals and health systems have since September 2010 received letters regarding ICDs substantially in the form of the letter that the Company received, rather than subpoenas. DMC received its letter from the DOJ in respect of ICDs in December 2010. The Company understands that the DOJ is investigating hundreds of other hospitals, in addition to its hospitals, for ICD billings, as part of a national enforcement initiative.
The Company has entered into tolling agreements with the DOJ. In addition, the DOJ has advised us that the investigation covers implantations after October 1, 2003, has identified the cases that are the subject of the DOJ’s investigation, and has requested that the Company review the identified cases. The Company understands that the DOJ has made similar requests for self-reviews of the other health systems and hospitals under investigation. The DOJ has issued a set of auditing instructions to all of the hospitals being investigated along with a request that the hospitals self-audit the cases previously identified in accordance with those instructions. The Company's outside medical experts have completed their audit of the cases in accordance with the criteria established by the DOJ and, based on the results of that audit, the Company expects to settle the matter as soon as possible. Pending settlement discussions with the DOJ, Baptist Health System has agreed to extend the current tolling agreement until December 31, 2013.
The Company intends to cooperate fully with the investigation of this matter. To date, the DOJ has not asserted any specific claim of damages against the Company or its hospitals. Because the Company still is in the early stages of this investigation, the Company is unable to predict its timing or outcome at this time. However, as the Company understands that this investigation is being conducted under the federal False Claims Act (“FCA”), the Company is at risk for significant damages under the FCA’s treble damages and civil monetary penalty provisions if the DOJ concludes a large percentage of claims for the identified patients are false claims and, as a result, such damages could materially affect the Company's business, financial condition or results of operations.
United States of America ex rel. Shanna Woyak v. Vanguard Health Systems, Inc.; Abrazo Health Care
The Office of the Inspector General of the Department of Health and Human Services has previously informed the Company that its investigation into provider-based matters relating to AHH and PBH has been closed.
The Company believes that all of the allegations described above are without merit and intends to vigorously defend itself in these actions, if pursued. Management does not believe that the final outcome of this matter will materially impact the Company's financial position, operating results or cash flows.
The Company is aware of two lawsuits relating to the Merger Agreement filed by purported stockholders of the Company against the Company, Orange Merger Sub, Inc. ("Merger Sub"), a Delaware corporation and wholly owned subsidiary of Tenet, and Tenet. On June 25, 2013, a purported stockholder filed a putative class action lawsuit in the Chancery Court for Davidson County, Tennessee, captioned James A. Kaurich v. Vanguard Health Systems, Inc., et al., Case No. 13-905-IV. On June 27, 2013, a second purported stockholder filed a substantively identical putative class action lawsuit in the Chancery Court for Davidson County, Tennessee, captioned Marion Edinburgh TTEE FBO Marion Edinburgh Trust U/T/D/ 7/8/1991 v. Vanguard Health Systems, Inc., et al., Case No. 13-921-IV. Both complaints name as defendants the Company, Tenet, Merger Sub, and the members of the Company's Board of Directors (the "Director Defendants") and allege that the Director Defendants breached their fiduciary duties by approving the Merger through an unfair process and at an unfair price, and allege that the Company, Merger Sub, and Tenet aided and abetted the Director Defendants' breach of their fiduciary duties. On July 26, 2013, the complaints were consolidated and an amended complaint was filed. This amended complaint replaced the two putative class actions and seeks to enjoin the Merger and to create a constructive trust for the purportedly improper benefits received by the Director Defendants. The Company and its directors believe the allegations contained in the complaint are without merit and intend to contest the allegations vigorously.
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 2006 through April 2008, the Company and the plaintiffs worked on producing documents to each other relating to, and supplying legal briefs to the court in respect of, solely the issue of whether the court will certify a class in this suit, the court having bifurcated the class and merit issues. In April 2008, the case was stayed by the judge pending his ruling on plaintiffs' motion for class certification. On July 8, 2013, the plaintiffs filed a motion to lift the stay and reopen discovery. The Company continues to believe that the allegations contained within this putative class action suit are without merit, and the Company has vigorously worked to defeat class certification. If a class is certified, the Company will continue to defend vigorously against the litigation.
On the same date in 2006 that this suit was filed against the Company in federal district court in San Antonio, the same attorneys filed three other substantially similar putative class action lawsuits in federal district courts in Chicago, Illinois, Albany, New York and Memphis, Tennessee against some of the hospitals or hospital systems in those cities (none of such hospitals or hospital systems being owned by the Company). The attorneys representing the plaintiffs in all four of these cases 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 eight hospitals or hospital systems in the Detroit, Michigan metropolitan area, including DMC. Since representatives of the Service Employees International Union (“SEIU”) joined plaintiffs' attorneys in announcing the filing of all four complaints on June 20, 2006, and as has been reported in the media, the Company believes that SEIU's involvement in these actions appears to be part of a corporate campaign to attempt to organize nurses in these cities, including San Antonio and Detroit. The registered nurses in the Company's hospitals in San Antonio and Detroit are currently not members of any union. In the suit in Detroit against DMC, the court did not bifurcate class and merits issues. On March 22,
Effective June 1, 1998, the Company executed employment agreements with three of its current executive officers. The Company executed an employment agreement with a fourth current executive officer on September 1, 1999. The employment agreements were amended on September 23, 2004 to extend the term of each employment agreement another five years and to provide that the Blackstone merger did not constitute a change of control, as defined in the agreements. From November 15, 2007 to December 31, 2008, the Company entered into written employment agreements with four other executive officers for terms expiring five years from the agreement date. The employment agreements will renew automatically for additional one-year periods, unless terminated by the Company or the executive officer. The employment agreements provide, among other things, for minimum salary levels, for participation in bonus plans, and for amounts to be paid as liquidated damages in the event of a change in control or termination by the Company without cause.
In the normal course of its business, the Company enters into physician relocation agreements under which it guarantees minimum monthly income, revenues or collections or guarantees reimbursement of expenses up to maximum limits to physicians during a specified period of time (typically, 12 months to 24 months). In return for the guarantee payments, the physicians are required to practice in the community for a stated period of time (typically, three to four years) or else return the guarantee payments to the Company. The Company records a liability and offsetting intangible asset at estimated fair value for all guarantees by calculating an estimate of expected payments to be made over the guarantee period. The Company reduces the liability as it makes guarantee payments and amortizes the intangible asset over the term of the physicians’ relocation agreements. The Company 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 June 30, 2013, the Company had a net intangible asset of $6.4 million and a remaining liability of $3.6 million related to these physician income and service guarantees. The maximum amount of the Company’s unpaid physician income and service guarantees as of June 30, 2013 was approximately $4.4 million.
As part of its contract with the AHCCCS, one of the Company’s health plans, PHP, is required to maintain a performance guarantee, the amount of which is based upon PHP’s membership and capitation premiums received. As of June 30, 2013, the Company maintained this performance guarantee in the form of $40.0 million of surety bonds with independent third party insurers. The Company also has a surety bond for its Michigan Pioneer ACO in the amount of $4.0 million as part of the requirements set forth by CMS has other miscellaneous surety bonds for various corporate needs.
The Company’s acute care hospitals and related health care businesses are similar in their activities and the economic environments in which they operate (i.e., urban and suburban areas). Accordingly, the Company’s reportable operating segments consist of 1) acute care hospitals and related health care businesses, collectively, and 2) health plans, including Chicago Health Systems, a contracting entity for outpatient services under multiple contracts and inpatient services for one contract provided by MacNeal Hospital and Weiss Memorial Hospital and participating physicians in the Chicago area; Phoenix Health Plan, a Medicaid managed health plan operating in Arizona; Abrazo Advantage Health Plan, a Medicare and Medicaid dual eligible managed health plan operating in Arizona; ProCare Health Plan, a Medicaid managed health plan operating in Michigan; and Valley Baptist Insurance Company, which offers health maintenance organization, preferred provider organization, and self-funded products to its members in the form of large group, small group, and individual product offerings in south Texas.
The following tables provide unaudited condensed financial information by operating segment for the years ended June 30, 2011, 2012 and 2013, including a reconciliation of Segment EBITDA to income (loss) from continuing operations before income taxes (in millions).
These amounts include the positive impact of recognizing revenues related to the rural floor provision for approximately $40.6 million and directly related expenses of approximately $7.8 million. The net impact on the quarter ended March 31, 2012 was an increase to net income for approximately $32.8 million ($21.7 million net of taxes or $0.28 per diluted share).