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VANGUARD HEALTH SYSTEMS 10-K 2013
VHS-2013.6.30-10K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K
(Mark One)
þ
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2013
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number: 001-35204
 
VANGUARD HEALTH SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
 
Delaware
62-1698183
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
20 Burton Hills Boulevard, Suite 100
Nashville, TN 37215
(Address and zip code of principal executive offices)

(615) 665-6000
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Name of exchange on which registered
Common Stock, $.01 par value
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. o Yes þ No
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. o Yes þ No
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed under Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ Yes o No
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. þ
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
Accelerated filer þ
Non-accelerated filer o
Smaller reporting company o
 
 
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). o Yes þ No
As of December 31, 2012, the aggregate market value of the shares of Common Stock of the Registrant held by non-affiliates was approximately $383.5 million, based on the closing price of the Registrant’s Common Stock reported on the New York Stock Exchange on such date of $12.25 per share.
As of July 31, 2013, there were 77,932,086 shares of the Registrant’s Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE

Information required by certain portions of Part III (Items 11 and 12) is incorporated by reference to either a definitive proxy statement or an amendment to this Form 10-K to be filed with the Securities and Exchange Commission within 120 days after the end of the Registrant's fiscal year ended June 30, 2013.




VANGUARD HEALTH SYSTEMS, INC.
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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PART I

Item 1.    Business    
Company Overview
We operate regionally-focused integrated health care delivery networks with a significant presence in several large urban and suburban markets. At the core of our networks are our 28 acute care and specialty hospitals with 7,081 beds which, together with our strategically-aligned outpatient facilities and related businesses, allow us to provide a comprehensive range of inpatient and outpatient services in the communities we serve.
We strive to maintain an established reputation in our communities for high quality care by demonstrating our commitment to delivering a patient-centered experience in a reliable environment of care. Drawing on our extensive experience in acquiring and integrating hospitals, we have executed a number of acquisitions that position us well in new markets and enhance our position in current markets and that we believe will result in attractive growth opportunities for us. During the year ended June 30, 2013, we generated total revenues and Adjusted EBITDA of $5,999.4 million and $555.5 million, respectively. See “Item 6. Selected Financial Data” for a reconciliation of net income attributable to Vanguard Health Systems, Inc. stockholders to Adjusted EBITDA for this period. The financial information for our reportable operating segments is presented in Note 17 in the Notes to our Consolidated Financial Statements included under "Item 8. Financial Statements and Supplementary Data" of this Annual Report on Form 10-K.
We were incorporated in Delaware in 1997. In 2004, pursuant to an agreement and plan of merger among us, VHS Holdings LLC and Health Systems Acquisition Corp., a newly formed Delaware corporation, The Blackstone Group, together with its affiliates ("Blackstone"), acquired securities representing a majority of our common equity. In 2011, we completed the initial public offering of 28,750,000 shares of common stock. Our common stock is traded on the New York Stock Exchange under the symbol “VHS”.

Merger with Tenet Healthcare Corporation
On June 24, 2013, we entered into an Agreement and Plan of Merger (the “Merger Agreement”), by and among us, Tenet Healthcare Corporation (“Tenet”) and Orange Merger Sub, Inc., a wholly-owned subsidiary of Tenet (“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, par value $0.01 per share (the “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 New York Stock Exchange, 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 (the “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 Officer, 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.
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

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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 U.S. Securities and Exchange Commission (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 Federal Trade Commission (the "FTC") granted early termination of the mandatory waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (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.  
Acute Care Services
Our general acute care and specialty hospitals offer a variety of medical and surgical services, including emergency services, general surgery, internal medicine, cardiology, obstetrics, orthopedics and neurology, as well as tertiary services such as open-heart surgery, advanced neurosurgery, children’s specialty, level II and III neonatal intensive care and level 1 trauma at certain facilities. In addition, certain of our facilities provide on-campus and off-campus outpatient and ancillary services, including outpatient surgery, physical therapy, rehabilitation, radiation therapy, home health, diagnostic imaging and laboratory services. We also provide outpatient services at our imaging centers and ambulatory surgery centers.
Health Plan Operations
In certain of our markets, we also operate health plans that we believe complement and enhance our market position and provide us with expertise that we believe will be increasingly important as the health care market evolves. Our health plans include 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; 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; ProCare Health Plan (“ProCare”), a Medicaid managed health plan operating in Michigan which we acquired during the year ended June 30, 2013; 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.
 
 
 
 
Membership
Health Plans
 
Location
 
2012
 
2013
PHP - managed Medicaid
 
Arizona
 
188,200

 
186,800

AAHP - managed Medicare and Dual Eligible
 
Arizona
 
3,400

 
6,300

CHS - capitated outpatient and physician services
 
Illinois
 
32,600

 
30,700

VBIC - health maintenance organization
 
Texas
 
10,300

 
12,300

ProCare - managed Medicaid
 
Michigan
 
n/a

 
2,400

 
 
 
 
234,500

 
238,500

Seasonality
We typically experience higher patient volumes and net revenues in the second and third fiscal quarters of each fiscal year because, generally, more people become ill during the winter months. This increases the number of patients that we treat during those months.
Available Information
We file certain reports with the SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K. Our website address is www.vanguardhealth.com. We make available free of charge, through our website, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports filed or furnished pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (the "Exchange Act"), as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. The information provided on our website is not part of this Annual Report on Form 10-K, and is therefore not incorporated by reference unless such information is specifically referenced elsewhere in this Annual Report on Form 10-K.
Our Business Strategies
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

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integrated care. We expect to change the way health care is delivered in our communities through our corporate and regional business strategies. The key elements of our strategy to achieve our mission and generate sustainable growth are outlined below.

Pursue growth opportunities in established markets
We continuously work to identify services that are in demand in the communities we serve that we do not provide or provide only on a limited basis. When such opportunities are identified, we employ a number of strategies to respond, including facility development, outpatient service expansion and physician recruiting. Where appropriate, we will also make selective acquisitions.
Capitalize on acquisitions
We have completed several acquisitions that enhance our capabilities in existing markets or position us well in new markets. For example, we acquired The Detroit Medical Center ("DMC") during the year ended June 30, 2011, which we believe provides us a growth opportunity in a new market, where we can leverage the established market presence of DMC and our expertise and strong financial position to expand services and pursue other initiatives that we believe will result in attractive growth. Additionally, the DMC acquisition added our first children’s hospital, first women’s hospital and first freestanding rehabilitation hospital, and we believe the experience we obtain in managing these specialty hospitals will enable us to introduce such services across the company. The acquisition of Valley Baptist Health System ("Valley Baptist") in the Rio Grande Valley during the year ended June 30, 2012 expanded our presence in Texas into a new geographic market while offering us an opportunity to realize sizable clinical and administrative synergies with our Baptist Health System in San Antonio, and to use the two health systems as a platform for growth throughout south Texas.
Continue to strengthen our market presence and reputation
We intend to position ourselves to thrive in a changing health care environment by continuing to build and operate high-performance, patient-centered care networks, fully engaging in health and wellness, and enhancing our reputation in our markets. We expect each of our facilities to create a highly reliable environment of care, and we have focused particularly on our company-wide patient safety model, our comprehensive patient satisfaction program, opening lines of communication between our nurses and physicians and implementing clinical quality best practices across our hospitals to provide timely, coordinated and compassionate care to our patients. In addition, we intend to lead efforts to measure and directly improve the health of our communities. We believe these efforts, together with our local presence and trust, national scale and access to capital, will enable us to advance our reputation and generate sustainable growth.
Focus on high-quality, patient-centered care
We are focused on providing high-performance, patient-centered care in our communities. Central to this mission is a significant focus on clinical quality, where we have implemented several initiatives to maintain and enhance our delivery of quality care, including investment in clinical best practices, patient safety initiatives, investment in information technology and tools and close involvement of senior leadership. Likewise, we have made significant investments in providing a patient-centered experience and improving patient satisfaction, including hourly rounding by administration and nursing staff, post-discharge follow-up and satisfaction surveys, and a robust commitment to patient advocacy.
Drive physician collaboration and alignment
We believe that we must work collaboratively with physicians to provide clinically superior health care services. The first step in this process is to ensure that physician resources are available to provide the necessary services to our patients. During the past five years, we have recruited a significant number of physicians through both relocation and employment agreements, including more than 200 employed physicians through our acquisitions of DMC, the Arizona Heart Institute and Valley Baptist. As of June 30, 2013, we had approximately 700 employed physicians and approximately 1,400 residents. In addition, we have implemented multiple initiatives, including physician leadership councils, training programs and information technology upgrades, to ease the flow of on-site and off-site communication between physicians, nurses and patients in order to attempt to effectively align the interests of all patient caregivers. In addition, we are aligning with our physicians to participate in various forms of risk contracting, including pay for performance programs, bundled payments and, eventually, global risk.
Expand ambulatory services and further our population health strategies

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.  We have pursued, or are pursuing, joint ventures in physician practice

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management and population health risk services with experienced companies or individuals that already operate in these disciplines.  We also continue to pursue the expansion of certain strategic health risk products, through either acquisition or partnership opportunities, to leverage the skill sets acquired through our physician practice and population health management efforts. Further, in our existing markets, we are pursuing the acquisition or development of ambulatory care facilities, such as ambulatory surgery centers, home health agencies, cancer centers and imaging centers, in an attempt to create a more comprehensive network of health care services. We believe that the added focus on ambulatory care, together with the addition of new ambulatory competencies, will enable us to take advantage of future opportunities in the ambulatory care sector, especially in an era of health reform.

We operate health plans in Arizona, Illinois, Michigan and Texas that we believe provide us with differentiated capabilities in these markets and enable us to develop experience and competencies that we expect to become increasingly important as the health care system evolves. Specifically, PHP, our Arizona-based Medicaid managed health plan, provides us with insights into state initiatives to manage this population ahead of the anticipated expansion of health coverage to currently uninsured patients pursuant to the Patient Protection and Affordable Care Act (Pub. L. No. 111-148, as amended by the Health Care and Education Reconciliation Act of 2010 (Pub. L. No. 111-152), the TRICARE Affirmation Act of 2010 (Pub. L. No. 111-159 and 111-173), the Medicare and Medicaid Extenders Act of 2010 (Pub. L. No. 111-309) and the Middle Class Tax Relief and Job Creation Act of 2012 (Pub. L. No. 112-96) (collectively, the "Health Reform Law"). Additionally, through CHS, our Chicago-based preferred provider network, we manage capitated contracts covering outpatient and physician services. CHS added coverage of inpatient services through one of its contracts effective January 1, 2013. We believe our ownership of CHS allows us to gain experience with risk-bearing contracts and delivery of care in low-cost settings, including our network of health centers. Further, our ownership of VBIC allows us to offer products and services to self-insured employers in Texas prior to the creation of health insurance exchanges ("Exchanges") as required under the Health Reform Law, and will allow us to participate in the Exchanges as well as apply to offer Medicaid managed care and Medicare Advantage plans. We believe that our experience operating these health plans along with our Pioneer Accountable Care Organization in Michigan and other Accountable Care Organizations ("ACOs") in Illinois, Texas, Arizona and Massachusetts give us a solid framework upon which to build and expand our population health strategies.
Pursue selective acquisitions
We believe that our foundation—built on patient-centered health care and clinical quality and efficiency in our existing markets—gives us a competitive advantage in expanding our services in our markets, as well as other markets through acquisitions or partnerships. We have executed three letters of intent to acquire hospitals and their related facilities and businesses in Connecticut, including Waterbury Hospital, Bristol Hospital, Manchester Memorial Hospital and Rockville General Hospital. We continue to monitor opportunities to acquire hospitals or systems that strategically fit our vision and long-term strategies.
Employees and Medical Staff
As of June 30, 2013, we had approximately 39,500 employees, including approximately 5,800 part-time employees. Approximately 3,600 of our full-time employees, substantially all of which are employed at our Detroit and Massachusetts hospitals, are unionized. Overall, we consider our employee relations to be good. While some of our non-unionized hospitals experience union organizing activity from time to time, we do not currently expect these efforts to materially affect our future operations. Our hospitals, like most hospitals, have experienced labor costs rising faster than the general inflation rate. In addition, since the announcement of the Merger, we have seen increased efforts by unions to organize certain of our employees, particularly in our San Antonio hospitals.
Certain portions of the markets we serve have limited available nursing resources. Nursing shortages often result in our using more contract labor resources during times when we see increased demand for our services, especially during the peak winter months. We expect our nurse leadership and recruiting strategies to mitigate the impact of nursing shortages. These strategies include ongoing involvement with nursing schools, participation in job fairs, recruiting nurses from abroad, implementing preceptor programs, providing flexible work hours, improving performance leadership training, creating awareness of our quality of care and patient safety initiatives and providing competitive pay and benefits. We anticipate that demand for nurses will continue to exceed supply especially as the baby boomer population reaches the ages where inpatient stays become more frequent. We strive to implement best practices to reduce turnover and to stabilize our nursing workforce over time.
Our hospitals grant staff privileges to licensed physicians who may serve on the medical staffs of multiple hospitals, including hospitals not owned by us. A physician who is not an employee can terminate his or her affiliation with our hospital at any time subject to contractual requirements. Although we employ a growing number of physicians, a physician does not have to be our employee to be a member of the medical staff of one of our hospitals. Any licensed physician may apply to be

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admitted to the medical staff of any of our hospitals, but admission to the staff must be approved by each hospital’s medical staff and board of trustees in accordance with established credentialing criteria. Under state laws and other licensing standards, hospital medical staffs are generally self-governing organizations subject to ultimate oversight by the hospital’s local governing board. We expect that our previously described physician recruiting and alignment initiatives will make our hospitals more desirable environments in which more physicians will choose to practice.
Compliance Program
Since 1997, we have voluntarily maintained a company-wide compliance program designed to ensure that we maintain high standards of ethics and conduct in the operation of our business and implement policies and procedures so that all of our employees act in compliance with all applicable laws, regulations and company policies. The organizational structure of our compliance program includes oversight by our Board of Directors and a high-level corporate management compliance committee. Our Board of Directors and compliance committee are responsible for ensuring that the compliance program meets its stated goals and remains up-to-date to address the current regulatory environment and other issues affecting the health care industry. Our Senior Vice President—Compliance and Ethics reports jointly to our Chairman, President and Chief Executive Officer and to our Board of Directors, serves as our Chief Compliance Officer and is charged with direct responsibility for the day-to-day management of our compliance program. Other features of our compliance program include Regional Compliance Officers who report to our Chief Compliance Officer in all six of our operating regions, initial and periodic ethics and compliance training and effectiveness reviews, a toll-free hotline for employees to report, without fear of retaliation, any suspected legal or ethical violations, annual “fraud and abuse” audits to examine all of our payments to physicians and other referral sources and annual coding audits to make sure our hospitals bill the proper service codes for reimbursement from the Medicare program.
Our compliance program also oversees the implementation and monitoring of the standards set forth by the Health Insurance Portability and Accountability Act of 1996 and the Health Information Technology for Economic and Clinical Health Act (collectively, "HIPAA") for privacy and security. To facilitate reporting of potential HIPAA compliance concerns by patients, family or employees, we established a second toll-free hotline dedicated to HIPAA and other privacy matters. Corporate HIPAA compliance staff monitors all reports to the privacy hotline and each phone call is responded to appropriately. Ongoing HIPAA compliance also includes self-monitoring of HIPAA policy and procedure implementation by each of our health care facilities and corporate compliance oversight.
The Health Reform Law now requires providers to implement core elements of compliance program criteria to be established by the U.S. Department of Health and Human Services ("HHS"), on a timeline to be established by HHS, as a condition of enrollment in the Medicare or Medicaid programs, and, depending on the core elements for compliance programs established by HHS, we may be required to modify our compliance programs to comply with these new criteria.
Our Industry
The U.S. health care industry is large and growing. According to the U.S. Department of Health and Human Services, Centers for Medicare and Medicaid Services (“CMS”), total annual U.S. health care expenditures grew 3.9% in 2011 to $2.7 trillion, representing 17.9% of the U.S. gross domestic product. National health expenditures grew at the same rate in 2011 as 2010. Although CMS projects total spending will grow by 4.2% in 2012 and 3.8% in 2013, health spending is projected to increase by 7.4% in 2014, as Exchanges and Medicaid expansions become operational. Thereafter, CMS projects total U.S. health care spending to grow by an average annual growth rate of 6.2% from 2015 through 2021. By these estimates, U.S. health care expenditures will reach approximately $4.8 trillion, or 19.6% of the total U.S. gross domestic product, by 2021.
Hospital care expenditures represent the largest segment of the health care industry. According to CMS, in 2011 hospital care expenditures grew by 4.3% and totaled $848.9 billion. CMS estimates that hospital care expenditures will increase to approximately $1.5 trillion by 2020.
Acute care hospitals in the U.S. are either public (government owned and operated), non-profit private (religious or secular), or investor-owned. According to the American Hospital Association, in 2011 there were approximately 5,000 community hospitals in the U.S. that were non-profit owned (59%), investor-owned (20%), or state or local government owned (21%). These facilities generally offer a broad range of health care services, including internal medicine, general surgery, cardiology, oncology, orthopedics, OB/GYN and emergency services. In addition, hospitals often offer other ancillary services, including psychiatric, diagnostic, rehabilitation, home health and outpatient surgery services.
We believe efficient and well-capitalized operators of integrated health care delivery networks are favorably positioned to benefit from current industry trends, including:

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Growing need for health care services
According to the U.S. Census Bureau, there were approximately 41.4 million Americans aged 65 or older in the United States in 2011, comprising approximately 13.3% of the total U.S. population. By the year 2030 the number of these elderly persons is expected to climb to 88.5 million, or 19.0% of the total population. Due to the increasing life expectancy of Americans, the number of people aged 85 years and older is also expected to increase from 5.8 million in 2010 to 8.7 million by the year 2030. This increase in life expectancy will increase demand for health care services and, as importantly, the demand for innovative, more sophisticated means of delivering those services. Hospitals, as the largest category of care in the health care market, will be among the main beneficiaries of this increase in demand.
Growing premium on high-performance, patient-centered care networks
The U.S. health care system continues to evolve in a manner that places an increasing emphasis on high-performance, patient-centered care supported by robust information technology and effective care coordination. For example, there are a number of initiatives that we expect to continue to gain importance, including introduction of value-based payment methodologies tied to performance, quality and coordination of care, implementation of integrated electronic health records and information and an increasing ability for patients and consumers to make choices about all aspects of health care. We believe our focus on developing clinically integrated, comprehensive health care delivery networks, our commitment to patient-centered care, our experience with risk-based contracting and our experienced management team position us well to respond to these emerging trends and to manage the changing health care regulatory and reimbursement environment.
Impact of health reform
The Health Reform Law is expected to have a substantial impact on the health care industry. Among other things, the Health Reform Law significantly reduces the growth of Medicare program payments, materially decreases Medicare and Medicaid disproportionate share hospital (“DSH”) payments and establishes programs where reimbursement is tied in part to quality and integration. In addition, taking into account the U.S. Supreme Court decision regarding state participation in Medicaid expansion, the Congressional Budget Office ("CBO") estimates that the Health Reform Law will expand health insurance to approximately 25 million previously uninsured individuals by 2023. We believe the expansion of insurance coverage will, over time, increase our reimbursement for services provided to individuals who were previously uninsured. Conversely, the reductions in the growth in Medicare payments and the decreases in DSH payments will adversely affect our government reimbursement. Because significant uncertainty regarding the ultimate implementation of the Health Reform Law remains, especially considering the deferral to 2015 of certain of the Health Reform Law's major provisions, we are unable to fully predict its net impact on us. However, we believe that we are well positioned to respond effectively to the opportunities and challenges presented by this important legislation as a result of our high-quality, patient-centered care model, well-developed integrated care networks and our alignment with physicians.
Acute Care Hospital Consolidation
During the late 1980s and early 1990s, there was significant industry consolidation involving large, investor-owned hospital companies seeking to achieve economies of scale, and we believe this trend will continue. However, the industry is still dominated by non-profit hospitals. According to the American Hospital Association, the number of community hospitals in the United States has declined from approximately 5,350 in 1991 to approximately 5,000 in 2011, of which approximately 80% are owned by non-profit and government entities, and we believe this trend will continue. While consolidation in the hospital industry is expected to continue, we believe this consolidation will now primarily involve non-profit hospital systems, particularly those that are facing significant operating challenges. Among the challenges facing many non-profit hospitals are:
limited access to the capital necessary to expand and upgrade their hospital facilities and range of services;
poor financial performance resulting, in part, from the challenges associated with changes in reimbursement;
the need and ability to recruit primary care physicians and specialists; and
the need to achieve general economies of scale to reduce operating and purchasing costs.
As a result of these challenges, we believe many non-profit hospitals will increasingly look to be acquired by, or enter into strategic alliances with, investor-owned hospital companies that can provide them with access to capital, operational expertise and large hospital networks.

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Competition
The hospital industry is highly competitive. We currently face competition from established, non-profit health care systems, investor-owned hospital companies, large tertiary care hospitals, specialty hospitals and outpatient service providers. In the future, we expect to encounter increased competition from companies, like ours, that consolidate hospitals and health care companies in specific geographic markets. Continued consolidation in the health care industry will be a leading factor contributing to increased competition in our current markets and markets we may enter in the future. Due to the shift to outpatient care and more stringent payer-imposed pre-authorization requirements during the past few years, most hospitals have significant unused capacity resulting in increased competition for patients. Many of our competitors are larger than us and have more financial resources available than we do. Certain non-profit competitors have endowment and charitable contribution resources available to them and can purchase equipment and other assets on a tax-free basis.
One of the most important factors in the competitive position of a hospital is its location, including its geographic coverage and access to patients. A location convenient to a large population of potential patients or a wide geographic coverage area through hospital networks can make a hospital significantly more competitive. Another important factor is the scope and quality of services a hospital offers, whether at a single facility or a network of facilities, compared to the services offered by its competitors. A hospital or network of hospitals that offers a broad range of services and has a strong local market presence is more likely to obtain favorable managed care contracts. However, pursuant to the Health Reform Law, hospitals will be required to publish annually a list of their standard charges for items and services. We intend to evaluate changing circumstances in the geographic areas in which we operate on an ongoing basis to ensure that we offer the services and have the access to patients necessary to compete in these markets and, as appropriate, to form our own, or join with others to form, local hospital networks.
A hospital’s competitive position also depends in large measure on the quality and specialties of physicians associated with the hospital. Physicians refer patients to a hospital primarily on the basis of the quality and breadth of services provided by the hospital, the quality of the nursing staff and other professionals affiliated with the hospital, the hospital’s location and the availability of modern equipment and facilities. Although physicians may terminate their affiliation with our hospitals, we seek to retain physicians of varied specialties on our medical staffs and to recruit other qualified physicians by maintaining or expanding our level of services and providing quality facilities, equipment and nursing care for our patients.
Another major factor in the competitive position of a hospital is the ability of its management to obtain contracts with health insurers and other managed care organizations, group health plans, and other third party payers. The importance of obtaining managed care contracts has increased in recent years due primarily to consolidations of health plans. Our markets have experienced significant managed care penetration. The revenues and operating results of our hospitals are significantly affected by our hospitals’ ability to negotiate favorable contracts with payers. Health maintenance organizations, preferred provider organizations, third party administrators, and other third party payers use managed care contracts to encourage patients to use certain hospitals in exchange for discounts from the hospitals’ established charges. Other health care providers may impact our ability to enter into managed care contracts or negotiate increases in our reimbursement and other favorable terms and conditions. For example, some of our competitors may negotiate exclusivity provisions with managed care organizations or otherwise restrict the ability of managed care organizations to contract with us. The trend toward consolidation among non-government payers tends to increase their bargaining power over fee structures. In addition, as various provisions of the Health Reform Law are implemented, including the establishment of Exchanges, non-government payers may increasingly demand reduced fees or be unwilling to negotiate reimbursement increases.
The hospital industry and our hospitals continue to have significant unused capacity. Inpatient utilization, average lengths of stay and average occupancy rates have historically been negatively affected by payer-required pre-admission authorization, utilization review and payer pressure to maximize outpatient and alternative health care delivery services for less acutely ill patients. Admissions constraints, payer pressures and increased competition are expected to continue. We expect to meet these challenges first and foremost by our continued focus on our previously discussed quality of care initiatives, which should increase patient, nursing and physician satisfaction. We also intend to expand our outpatient facilities, strengthen our managed care relationships, upgrade facilities and equipment and offer new or expanded programs and services.

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Sources of Revenues
Hospital revenues depend upon inpatient occupancy levels, the medical and ancillary services ordered by physicians and provided to patients, the volume of outpatient procedures and the charges or payment rates for such services. Charges and reimbursement rates for inpatient services vary significantly depending on the type of payer, the type of service (e.g., acute care, intensive care or subacute) and the geographic location of the hospital. Inpatient occupancy levels fluctuate for various reasons, many of which are beyond our control.
We receive payment for patient services from:
the federal government, primarily under the Medicare program;
state Medicaid programs;
health maintenance organizations, preferred provider organizations, managed Medicare providers, managed Medicaid providers and other private insurers; and
individual patients.
The table below presents net patient revenues before the provision for doubtful accounts we received from the following sources for the periods indicated (dollars in millions):
 
June 30, 2011
 
June 30, 2012
 
June 30, 2013
Medicare
$
994.0

 
26.8
 %
 
$
1,411.6

 
27.2
 %
 
$
1,403.4

 
26.7
 %
Medicaid
461.9

 
12.4

 
720.6

 
13.9

 
708.7

 
13.5

Managed Medicare
458.6

 
12.4

 
538.9

 
10.4

 
594.7

 
11.3

Managed Medicaid
366.7

 
9.9

 
492.9

 
9.5

 
542.6

 
10.3

Managed care
1,295.3

 
34.9

 
1,794.4

 
34.6

 
1,753.7

 
33.3

Commercial
35.5

 
1.0

 
68.8

 
1.3

 
83.8

 
1.6

 
3,612.0

 
97.3

 
5,027.2

 
96.8

 
5,086.9

 
96.7

Self pay
271.2

 
7.3

 
505.3

 
9.7

 
605.9

 
11.5

Other
131.4

 
3.5

 
198.5

 
3.8

 
236.8

 
4.5

Patient service revenues before provision for doubtful accounts
4,014.6

 
108.1

 
5,731.0

 
110.4

 
5,929.6

 
112.7

Provision for doubtful accounts
(302.3
)
 
(8.1
)
 
(539.4
)
 
(10.4
)
 
(667.3
)
 
(12.7
)
Patient service revenues, net
$
3,712.3

 
100.0
 %
 
$
5,191.6

 
100.0
 %
 
$
5,262.3

 
100.0
 %
Our hospitals offer discounts from established charges to certain group purchasers of health care services, including private insurance companies, employers, health maintenance organizations, preferred provider organizations and other managed care plans. These discount programs limit our ability to increase net revenues in response to increasing costs. Patients generally are not responsible for any difference between established hospital charges and amounts reimbursed for such services under Medicare, Medicaid and managed care programs, but are generally responsible for exclusions, deductibles and coinsurance features of their coverages. Due to rising health care costs, many payers have increased the number of excluded services and the levels of deductibles and coinsurance resulting in a higher portion of the contracted rate due from the individual patients. Collecting amounts due from individual patients is typically more difficult than collecting from governmental or private managed care plans.
Traditional Medicare
One of the ways Medicare beneficiaries can elect to receive their medical benefits is through the traditional Medicare program, which provides reimbursement under a prospective payment fee-for-service system. A general description of some of the types of payments we receive for services provided to patients enrolled in the traditional Medicare program is provided below.


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Medicare Inpatient Acute Care Reimbursement
Medicare Severity-Adjusted Diagnosis-Related Group Payments. Sections 1886(d) and 1886(g) of the Social Security Act set forth a system of payments for the operating and capital costs of inpatient acute care hospital admissions based on a prospective payment system ("PPS"). Under the inpatient PPS ("IPPS"), Medicare payments for hospital inpatient operating services are made at predetermined rates for each hospital discharge. Discharges are classified according to a system of Medicare severity-adjusted diagnosis-related group ("MS-DRGs"), which categorize patients with similar clinical characteristics that are expected to require similar amounts of hospital resources to treat. CMS assigns to each MS-DRG a relative weight that represents the average resources required to treat cases in that particular MS-DRG, relative to the average resources used to treat cases in all MS-DRGs. The MS-DRG weight is multiplied by a base rate to determine the payment for a MS-DRG.
    
The MS-DRG base rates, relative weights and geographic adjustment factors are updated annually, effective for the federal fiscal year (“FFY”) beginning each October 1st, with consideration given to the increased cost of goods and services purchased by hospitals, the relative costs associated with each MS-DRG, changes in labor data by geographic area and other legislative and policy changes. Although these payments are adjusted for area labor and capital cost differentials, the adjustments do not consider an individual hospital's operating and capital costs. Historically, the average operating and capital costs for our hospitals have exceeded the Medicare rate increases. Further realignments in the MS-DRG system could also reduce the payments we receive for certain specialties, including cardiology and orthopedics. The more widespread development of specialty hospitals in recent years has caused CMS to focus on payment levels for these specialty services. Changes in the payments for specialty services could adversely impact our revenues.

Full annual rate increases are only available for those providers who submit their patient care quality indicators data to CMS. CMS annually reviews and revises the number of quality measures that must be reported each year to receive the full market basket for the following FFY (e.g., quality measures reported for discharges in Calendar Year ("CY") 2013 are used for purposes of determining a hospital's FFY 2015 inpatient payment update). Failure to submit the required quality indicators will result in a reduction to the hospital's annual payment update.
Inpatient Outlier Payments. Outlier payments are additional payments made to hospitals for treating Medicare patients that are costlier to treat than the average patient in the same MS-DRG. To qualify as a cost outlier, a hospital’s billed charges, adjusted to cost, must exceed the payment rate for the MS-DRG by a fixed threshold established annually by CMS. The Medicare fiscal intermediary calculates the cost of a claim by multiplying the billed charges by a cost-to-charge ratio that is typically based upon data in the hospital’s most recently filed cost report. Generally, if the computed cost exceeds the sum of the MS-DRG payment plus the fixed threshold, the hospital receives 80% of the difference as an outlier payment.
Disproportionate Share Hospital Payments. Hospitals that treat a disproportionately large number of low-income patients currently receive additional payments from Medicare in the form of DSH payments. DSH payments are determined annually based upon certain statistical information defined by CMS and are calculated as a percentage add-on to the MS-DRG payments. This percentage varies depending on several factors that include the percentage of low-income patients served. Under the Health Reform Law, beginning in FFY 2014, Medicare DSH payments will be reduced to 25% of the amount they otherwise would have been absent the new law. The remaining 75% of the amount that would otherwise be paid under Medicare DSH will be effectively pooled. This pool will be paid out to each hospital based on the product of the following three factors: (1) 75% of the estimated Medicare DSH payments that would otherwise have been made; (2) one minus the percentage change in the percentage of individuals under age 65 who are uninsured (less 0.1% for FFY 2014 and less 0.2% for each of FFY 2015-2017); and (3) the hospital's amount of uncompensated care relative to the amount of uncompensated care for all DSH hospitals. It is difficult to predict the full impact of the Medicare DSH reductions. The CBO estimates $22 billion in reductions to Medicare DSH payments between 2010 and 2019, while for the same time period, CMS estimates reimbursement reductions totaling $50 billion. During the year ended June 30, 2013, our Medicare DSH revenues were approximately $162.6 million.
Direct Graduate and Indirect Medical Education. The Medicare program provides additional reimbursement to approved teaching hospitals for additional expenses incurred by such institutions. This additional reimbursement, which is subject to certain limits, is made in the form of Direct Graduate Medical Education (“GME”) and Indirect Medical Education (“IME”) payments. The Health Reform Law includes provisions that increase flexibility in GME funding rules to incentivize outpatient training. During the year ended June 30, 2013, 14 of our hospitals were affiliated with academic institutions and received GME or IME payments. Our most recently filed cost reports during the year ended June 30, 2013 indicated estimated reimbursement from GME and IME for combined Medicare and Medicaid programs of approximately $205.5 million. We currently train

11


approximately 1,400 residents on a combined basis in these 14 hospitals, the majority of which qualify for GME and/or IME reimbursement.
Hospital acquired conditions and serious medical errors. Unless certain hospital acquired conditions ("HACs") were not present on admission, Medicare will not assign an inpatient hospital case with a HAC to a higher paying MS-DRG. There are currently 12 categories of conditions on the list of HACs. CMS has also established three National Coverage Determinations that prohibit Medicare reimbursement for erroneous surgical procedures performed on an inpatient or outpatient basis. Effective January 1, 2011, hospitals were also required to report HAC infection rates to Medicare as part of overall quality reporting requirements. Hospitals that fail to do so will see a reduction in Medicare reimbursement. Beginning in FFY 2015, hospitals in the bottom quartile for performance related to HACs will have Medicare IPPS payments reduced by one percent.
Medicare Outpatient Services Reimbursement
CMS reimburses hospital outpatient services and certain Medicare Part B services furnished to hospital inpatients who have no Part A coverage on a PPS basis. CMS utilizes existing fee schedules to pay for physical, occupational and speech therapies, durable medical equipment, clinical diagnostic laboratory services and nonimplantable orthotics and prosthetics. Freestanding surgery centers and independent diagnostic testing facilities also receive reimbursement from Medicare on a fee schedule basis.
Those hospital outpatient services subject to prospective payment reimbursement are classified into groups called ambulatory payment classifications (“APCs”). Services in each APC are similar clinically and in terms of the resources they require. A payment rate is established for each APC. Depending upon the services provided, a hospital may be paid for more than one APC for a patient visit. CMS periodically updates the APCs and annually adjusts the rates paid for each APC. CMS requires hospitals to submit quality data relating to outpatient care in order to receive the full payment increase in the following calendar year. Failure to submit all required measures results in a reduction in the annual payment update by two percentage points.
Physician Services Reimbursement
CMS reimburses physicians and certain other clinicians based on a fee schedule. As with other Medicare payment systems, the physician fee schedule payment base amounts are adjusted for location, intensity of services and various policy factors. Physicians who report certain quality measures are also eligible for an additional payment equal to a portion of their allowed charges during the reporting year. The base fee schedule amounts are updated each year based on a formula known as the sustainable growth rate ("SGR"). Each year since 2002, the SGR has resulted in a negative payment update that has required Congressional action to override in order to prevent reductions in payments to physicians and certain other clinicians. As a result, each year it is uncertain whether the physician fee schedule rate will be updated or will be subject to significant cuts. Due to the budget impact of repealing the SGR, Congress has been unable to do so for CY 2014. If Congress does not act to override the SGR update, CBO estimates that the physician fee schedule rates would be cut by approximately 25% for CY 2014.
In May 2013, the CBO revised its estimate of the ten-year cost of repealing the SGR from $245 billion to $139 billion. This downward adjustment is prompting significant Congressional attention to repealing and replacing the physician payment formula. The House Energy and Commerce Committee gave unanimous approval on July 31, 2013 to an enhanced fee-for-service physician payment plan that would provide a five-year transition period of payment stability with annual payment updates of 0.5%, before an enhanced fee-for-service system would begin in 2019, with adjustments to physician payment based on their quality performance. Physicians could also choose to participate in approved alternative payment programs. However, this legislation, H.R. 2810, did not include an offset. The House Ways and Means Committee and the Senate Finance Committee are expected to consider physician payment legislation this year. Before enactment of any SGR replacement plan, Congress would need to add provisions to pay for the cost of repealing the SGR. These provisions could include reductions in Medicare and other federal health spending.
Rehabilitation Hospitals and Units
CMS reimburses inpatient rehabilitation hospitals and units pursuant to a PPS. Under this PPS, patients are classified into case mix groups based upon impairment, age, comorbidities and functional capability. Inpatient rehabilitation units are paid a predetermined amount per discharge that reflects the patient’s case mix group and is adjusted for area wage levels, low-income patients, rural areas and high-cost outliers. Beginning in FFY 2013, inpatient rehabilitation units were required to participate in annual quality reporting. Failure to submit all required measures will result in a reduction in the annual payment update by two

12


percentage points beginning in FFY 2014. As of June 30, 2013, we operated one rehabilitation hospital and seven inpatient rehabilitation units within our acute care hospitals.
Psychiatric Units
Medicare utilizes a PPS to pay inpatient psychiatric hospitals and units. This system is a per diem PPS with adjustments to account for certain patient and facility characteristics. Additionally, this system includes a stop-loss provision, an “outlier” policy authorizing additional payments for extraordinarily costly cases and an adjustment to the base payment if the facility maintains a full-service emergency department, which all of our units qualified for. Inpatient psychiatric units were required to participate in annual quality reporting beginning in FFY 2013. Failure to submit all required measures will result in a reduction in the annual payment update by two percentage points beginning in FFY 2014. As of June 30, 2013, we operated ten psychiatric units within our acute care hospitals subject to this reimbursement methodology.
Ambulatory Surgical Centers
Medicare pays for ambulatory surgical center (“ASC”) services under a fee schedule. The fee schedule includes the services for which Medicare will pay when performed at an ASC. Some items, services and procedures, such as office-based procedures, device-intensive procedures, certain costs associated with ancillary radiology services, certain drugs and biologicals and brachytherapy sources, are subject to alternative payment methodologies. ASCs were required to participate in annual quality reporting beginning in CY 2012. Failure to submit all required measures will result in a reduction in the annual payment update by two percentage points beginning in CY 2014. As of June 30, 2013, we had an equity interest in five ASCs.
Final 2013 and 2014 Payment Updates and Proposed 2014 Payment Updates
Inpatient Reimbursement. In the FFY 2014 final rule, released on August 2, 2013, CMS established that the overall increase in hospital operating payments for FFY 2014 would be approximately 0.5% compared with an overall 2.3% increase for FFY 2013. FFY 2014 adjustments, including the revised DSH methodology and HAC reductions, along with a 1.6% increase in per-case capital payments, are expected to result in an overall net increase of $1.2 billion to IPPS hospitals in FFY 2014 as compared to FFY 2013.
For FFY 2014, CMS will lower the inpatient outlier threshold to $21,748 from $21,821 in FFY 2013. Changes to the outlier threshold amount can impact the number of cases at a hospital that qualify for the additional payment and the amount of reimbursement a hospital receives for those cases that qualify. The most recently filed cost reports for our hospitals as of June 30, 2011, 2012 and 2013 reflected outlier payments of $3.9 million, $13.1 million and $13.8 million, respectively.
Outpatient Reimbursement. In the CY 2013 Outpatient PPS Final Rule, CMS established that the payment update for 2013 outpatient hospital payments would be 1.9%. On July 8, 2013, CMS issued a proposed rule related to the CY 2014 outpatient hospital PPS ("OPPS"). In this proposed rule, CMS proposed to increase OPPS payments to providers by 1.8%. CMS also proposed to include seven new categories of items and services in the payment for the primary service and reduce the number of hospital outpatient visit codes from five to one.
Physician Fee Schedule. In the CY 2013 Physician Fee Schedule final Rule, CMS established that the payment update for CY2013 would be negative 26.5% due to the SGR. Congress passed legislation on January 1, 2013 that reversed the SGR cut and maintained the physician fee schedule base payment amount at the 2012 level. On July 8, 2013, CMS released a proposed rule related to the CY 2014 Physician Fee Schedule that proposed a 24.4% decrease. Congress is devoting considerable effort in 2013 to repealing the SGR and its repeated formula-driven payment reductions that Congress routinely averts. Legislation is pending that would afford a five-year period of payment stability from 2014-2019 with 0.5% annual physician payment updates followed by an enhanced fee-for-service system beginning in 2019 with adjustments to physician payment based on quality as well as an opportunity to participate in alternative payment programs.
Rehabilitation Hospital and Unit Reimbursement. In the FFY 2014 Inpatient Rehabilitation Facility PPS Final Rule, published on August 6, 2013, CMS estimated that the rule would increase FFY 2014 payments to inpatient rehabilitation facilities by 2.3% in FFY 2014, compared with a 2.1% increase for FFY 2013.
Psychiatric Unit Reimbursement. Effective October 1, 2012, inpatient psychiatric facilities transitioned from payment on a “rate year” cycle, to payment under a FFY cycle. In the FFY 2014 Inpatient Psychiatric Facility PPS Final Rule, published on August 7, 2013, CMS estimated that the rule would increase FFY 2014 payments to inpatient psychiatric facilities by 2.3%, compared with an increase of 0.8% for FFY 2013.

13


Ambulatory Surgical Centers Reimbursement. In the CY 2013 ASC Fee Schedule Final Rule, CMS established that the payment update for ASCs for CY 2013 would be 0.6%. On July 8, 2013, CMS issued a proposed rule related to the CY 2014 ASC Fee Schedule. In this proposed rule, CMS proposed to increase ASC payments for CY 2014 by 0.9%.
Health Reform Adjustments - Annual Market Basket and Productivity Decreases. The payment updates above include adjustments required by the Health Reform Law. The Health Reform Law provides for annual decreases to the market basket portion of the annual payment update for inpatient and outpatient hospitals and rehabilitation and psychiatric units in the following amounts for each of the following FFYs: 0.25% in 2010 and 2011; 0.1% in 2012 and 2013; 0.3% in 2014; 0.2% in 2015 and 2016; and 0.75% in 2017, 2018 and 2019. For FFY 2012 and each subsequent FFY, the Health Reform Law also provides for the annual market basket update to be further reduced by a productivity adjustment. The amount of that reduction will be the projected, nationwide productivity gains over the preceding ten years. To determine the projection, HHS will use the Bureau of Labor Statistics (“BLS”) ten-year moving average of changes in specified economy-wide productivity (the BLS data is typically a few years old). The Health Reform Law does not contain guidelines for use by HHS in projecting the productivity figure. CMS estimates that the combined market basket and productivity adjustments will reduce Medicare payments under the following payment systems by the following amounts for the period 2010-2019: inpatient PPS by $112.6 billion; outpatient PPS by $26.3 billion; inpatient rehabilitation PPS by $5.7 billion; and inpatient psychiatric PPS by $4.3 billion. CMS did not provide an estimate for the reduction in Medicare payments due to the ASC productivity adjustment, but estimated that all of the market basket and productivity adjustments for Medicare Part B services paid on a fee schedule, excluding durable medical equipment and physician services, would result in a reduction of payments equal to $10.4 billion from 2010-2019.
Quality Reporting and Payment Programs. CMS requires reporting of specified quality measures in order to receive the full annual payment updates discussed above. Failure to submit the required measures for a given reporting period results in a payment reduction in a subsequent payment period. Quality reporting began in FFY 2013 (CY 2013 for ASCs) for inpatient rehabilitation units, psychiatric units and ASCs, with reductions in payment for non-reporting beginning in FFY 2014 (CY 2014 for ASCs). The specific measures that must be reported for each provider type are reviewed and revised by CMS each year.
To date, we have submitted required patient care quality indicators for our hospitals to receive the full market basket index increases for both the inpatient and outpatient PPS for FFY 2013. We intend to submit the necessary information to realize the full FFY 2014 inpatient and outpatient increases for all of our hospitals. However, as additional patient quality indicator reporting requirements are added, system limitations or other difficulties could result in CMS deeming our submissions not timely or not complete to qualify for the full market basket index increases.
The Health Reform Law also provides for reduced payments to hospitals based on readmission rates. In FFY 2013, CMS reduced payments for readmissions of acute myocardial infarction, heart failure and pneumonia patients if the hospital from which the patient was discharged has a risk-adjusted ratio of discharges to readmissions that exceeds the national average over the period July 1, 2008 to June 30, 2011. CMS will use the same measures for FFY 2014, with a reporting period of July 1, 2009 to June 30, 2012. For FFY 2015, CMS will add readmissions for acute exacerbated chronic, obstructive pulmonary disease and elective total hip and knee arthroplasty to the list of conditions for which readmission payments are reduced. We expect reduced payment rates at 20 of our hospitals during FFY 2013 ranging from 0.04% to 1.0% related to readmission rates.
Additionally, the Health Reform Law establishes a value-based purchasing program to further link payments to quality and efficiency. CMS reduced the IPPS payment amount for all discharges by the following amounts: 1% for FFY 2013; 1.25% for FFY 2014; 1.5% for FFY 2015; 1.75% for FFY 2016; and 2% for FFY 2017 and subsequent FFYs. For each FFY, the total amount collected from these reductions will be pooled and used to fund payments to reward hospitals that meet certain quality performance standards. Payments for FFY 2013 were based on each hospital’s performance related to 12 clinical processes of care measures and the Hospital Consumer Assessment of Healthcare Providers and Systems ("HCAHPS") survey for the period July 1, 2011 to March 31, 2012. Payments for FFY 2014 will be based on 13 clinical and HCAHPS measures for the period April 1, 2012 to December 31, 2012 and three outcome-based measures for the period July 1, 2011 to June 30, 2012. Performance scores will be used to compare each hospital to other hospitals and to itself (based on improvement) and a hospital’s relative score will determine the total incentive payment to the hospital. Higher performing hospitals will receive higher payments.
Impact of Budget Control Act of 2011 on Medicare Reimbursement
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-

14


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” will be 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 Children's Health Insurance Program ("CHIP")) are exempt from these automatic spending reductions, and Medicare expenditures cannot be reduced by more than 2%. 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 2%. Each year for the next nine years that the deficit thresholds are 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 reductions.
Congress may take additional action in 2013 or 2014 to further reduce federal spending and the deficit to avoid sequestration being triggered in future years. If so, Medicare, Medicaid and CHIP spending could be reduced further, and provider payments under those programs could be cut substantially. Congress also may consider legislation to resolve expected cuts to Medicare physician payments, and that legislation also could substantially revise Medicare and Medicaid spending, including payments to providers.
Recent proposals to change or cut the Medicare program that might be considered by Congress include the following:
raising the age of eligibility from 65 to 67;
cuts in supplemental Medicare payments such as IME/GME, DSH and bad debt reimbursement;
combining Part A and B deductibles into a single annual deductible;
additional means testing of Medicare;
eliminating first-dollar Medigap coverage;
shifting coverage of persons dually eligible for Medicare and Medicaid (dual eligibles) to Medicaid; and
turning Medicare into a voucher program, and limiting overall federal spending, which could cap Medicare expenditures, forcing deep cuts in the program.
These and other changes, if enacted, would diminish reimbursement for our services.
Contractor Reform
In accordance with the Medicare Modernization Act, CMS is implementing contractor reform whereby CMS will competitively bid the Medicare fiscal intermediary and Medicare carrier functions to Medicare Administrative Contractors (“MACs”). CMS originally designated 15 MAC jurisdictions but plans to transition to ten MAC jurisdictions over the next several years. As of July 2013, there were 13 MAC jurisdictions in varying phases of transition. Hospital companies have the option to work with the selected MAC in the jurisdiction where a given hospital is located or to use the MAC in the jurisdiction where our home office is located. For hospital companies, either all hospitals in the system must choose to stay with the MAC chosen for their locality or all hospitals must opt to use the home office MAC. We filed a request for our single home office MAC to serve all of our hospitals, which CMS has granted. Effective in 2020, all of our hospitals will be served by Cahaba GBA. All of these changes could impact claims processing functions and the resulting cash flows; however, we are unable to predict the impact that these changes could have, if any, to our cash flows.
Recovery Audit Program
The Medicare Recovery Audit Program relies on private auditing firms to examine Medicare claims filed by health care providers to detect Medicare overpayments not identified through existing claims review mechanisms. The Recovery Audit Program began as a demonstration project in 2005, but was made permanent by the Tax Relief and Health Care Act of 2006, which required a permanent and nationwide Recovery Audit Program no later than 2010.
In a recent Medicare Fee For Service National Recovery Audit Program Newsletter, CMS reported that there were a total of approximately $4.8 billion in Medicare improper payments from October 2009 through March 2013, with approximately

15


$4.5 billion of that amount attributed to overpayments collected from providers and the remaining $333.6 million attributed to underpayments repaid to providers.
Medicare recovery audit contractors ("RACs") utilize a post-payment targeted review process employing data analysis techniques in order to identify those Medicare claims most likely to contain overpayments, such as incorrectly coded services, incorrect payment amounts, non-covered services and duplicate payments. The Recovery Audit Program is either “automated,” for which a decision can be made without reviewing a medical record, or “complex,” for which the RAC must contact the provider in order to procure and review the medical record to make a decision about the payment. CMS has given RACs the authority to look back at claims up to three years old, provided that the claim was paid on or after October 1, 2007. Claims identified as overpayments will be subject to the Medicare appeals process.
With respect to “automated” reviews where a review of the medical record is not required, RACs make claim determinations using proprietary software designed to detect certain kinds of errors where both of the following conditions must apply. First, there must be certainty that the service is not covered or is coded incorrectly. Second, there must be a written Medicare policy, Medicare article or Medicare-sanctioned coding guideline supporting the determination. For example, an automated review could identify when a provider is billing for more units than allowed on one day. However, the RACs may also use automated review even if such written policies do not exist on certain CMS-approved “clinically unbelievable issues” and when making certain other types of administrative determinations (e.g., duplicate claims, pricing mistakes) when there is certainty that an error exists.
With respect to “complex” reviews where a review of the medical record is required, RACs make claim determinations when there is a high probability (but not certainty) that a service is not covered, or where no Medicare policy, guidance or Medicare-sanctioned coding guideline exists. It is expected that many complex reviews will be medical necessity audits that assess whether care provided was medically necessary and provided in the appropriate setting.
RACs are paid a contingency fee based on the overpayments they identify and collect. Therefore, we expect that the RACs will look very closely at claims submitted by our facilities in an attempt to identify possible overpayments. We believe the claims for reimbursement submitted to the Medicare program by our facilities have been accurate. However, we cannot predict, once our facilities are subject to recovery audit reviews in all subject matters in the future, the results of such reviews. It is reasonably possible that the aggregate payments that our facilities will be required to return to the Medicare program pursuant to these recovery audit reviews may have a material adverse effect on our financial position, results of operations or cash flows.
Further, on November 15, 2011, CMS announced the Recovery Audit Prepayment Review (“RAPR”) demonstration will allow RACs to review claims before they are paid to ensure that the provider complied with all Medicare payment rules.  The RACs will conduct prepayment reviews on certain types of claims that historically result in high rates of improper payments, beginning with those involving short stay inpatient hospital services. These reviews will focus on seven states (Florida, California, Michigan, Texas, New York, Louisiana and Illinois) with high populations of fraud and error-prone providers and four states (Pennsylvania, Ohio, North Carolina, and Missouri) with high claims volumes of short inpatient hospital stays for a total of 11 states. The goal of the RAPR demonstration is to reduce improper payments before they are paid, rather than the traditional “pay and chase” methods of looking for improper payments after they have been made. These prepayment reviews will not replace the MAC prepayment reviews as RACs and MACs are supposed to coordinate to avoid duplicate efforts. The RAPR demonstration began on September 1, 2012.
Accountable Care Organizations
The Health Reform Law requires HHS to establish a Medicare Shared Savings Program (“MSSP”) that promotes accountability and coordination of care through the creation of ACOs. MSSP ACOs receive payment from Medicare on a fee-for-service basis and may receive additional "shared savings" payments or be at-risk for "shared losses" based on an increase or decrease in annual fee-for-service payments to the ACO. ACOs may be formed by “ACO professionals” (physicians and mid-level providers) in group practice arrangements, networks of individual practices of ACO professionals, partnerships and joint venture arrangements between hospitals and ACO professionals, hospitals employing ACO professionals, Critical Access Hospitals billing under Method II, Federally Qualified Health Centers and Rural Health Clinics. Each ACO must have a minimum of 5,000 retroactively-assigned Medicare fee-for-service beneficiaries.
CMS estimates that approximately 50-270 organizations will enter into ACO agreements with an average aggregate start-up cost estimate of $29 million to $157 million. Further, CMS estimates a total aggregate median impact of $1.31 billion in

16


bonus payments to ACOs for CYs 2012-2015. As of March 2013, CMS has entered into ACO participation agreements with 220 entities. We have 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.
In addition to the MSSP ACO model, CMS developed the “Pioneer ACO” model. The Pioneer ACO model generally requires compliance with the MSSP ACO program rules in the final regulations, but differs from the finalized MSSP ACO model in several ways, including, but not limited to:
higher levels of sharing and risk;
opportunity for population-based payments;
requirements for outcomes-based payment contracting with other payers; and
a higher number of assigned beneficiaries.
Our facilities submitted two applications to join this program in August 2011. In December 2011, CMS selected 32 applicants to become Pioneer ACO applications. Our Michigan Pioneer ACO was selected to become a Pioneer ACO effective January 1, 2012. We expect to continue to explore opportunities to develop or enhance ACOs in our markets.
Bundled Payment Pilot Programs
Pursuant to the Health Reform Law, CMS finalized implementation of the Medicare Bundled Payments for Care Improvement Initiative (the "Initiative") in the FFY 2013 Inpatient PPS Final Rule, released August 1, 2012. Under this voluntary initiative, bundled payments are one-time reimbursements for a given condition or episode of care, the goal being to improve care coordination. The final rule offers four bundled payment models with varying reimbursement structures for acute and post-acute care services. In January 2013, CMS announced that there would be 105 participants in the Initiative.
The Health Reform Law also provides for a five-year bundled payment pilot program for Medicaid services. HHS will select up to eight states to participate based on the potential to lower costs under the Medicaid program while improving care. State programs may target particular categories of beneficiaries, selected diagnoses or geographic regions of the state. The selected state programs will provide one payment for both hospital and physician services provided to Medicaid patients for certain episodes of inpatient care. For both pilot programs, HHS will determine the relationship between the programs and restrictions in certain existing laws, including the Civil Monetary Penalty Law, the Anti-Kickback Statute, the Stark Law and HIPAA privacy, security and transaction standard requirements. However, the Health Reform Law does not authorize HHS to waive other laws that may impact the ability of hospitals and other eligible participants to participate in the pilot programs, such as antitrust laws.
Managed Medicare (Medicare Advantage or "MA")
Under the MA program, the federal government contracts with private health insurers and other managed care organizations ("MA Organizations") to provide Medicare benefits and supplemental benefits to Medicare beneficiaries who enroll in such MA plans offered by these MA Organizations. Nationally, approximately 14.4 million (28%) of Medicare beneficiaries have elected MA plans. The Health Reform Law, beginning in 2012, transitions MA plan capitation payments from a statutorily determined payment formula to payment amounts tied to Medicare fee-for-service payment rates for the geographic region. Payment adjustments linked to quality ratings, including quality bonuses and "rebates" with which to offer enhanced benefits or reduce certain beneficiary cost-sharing obligations are also available. Beginning in 2014, the Health Reform Law requires MA Organizations to keep annual administrative costs, including profits, lower than 15% of annual premium revenue. The CBO estimated in March 2010 that the changes to the payment methodology would reduce MA plan payments by approximately $132 billion over ten years, although these reductions have been mitigated with a demonstration project, in place for 2012-2014, that increases quality MA plans. The long-term changes to the MA plan methodology enacted under the Health Reform Law, expiration of the demonstration project at the end of 2014, and other MA program changes may cause MA Organizations to raise premiums or limit benefits, which in turn might cause some Medicare beneficiaries to terminate their MA coverage and enroll in traditional Medicare, and may increase pressure to reduce provider payments.
MA plan payments also are negatively affected by "sequestration." All payments from CMS to MA Organizations under the MA program are subject to the automatic 2% reduction. In certain instances, MA Organizations are reducing provider payments by the same percentage. The effect of sequestration on MA Organization payments may cause MA Organizations to

17


raise premiums or limit benefits which may affect Medicare beneficiary elections to enroll in MA plans, as well as increase pressure on MA Organizations to reduce provider payments or be unwilling to agree to payment increases for the current and future benefit years.
Medicaid
Medicaid programs are funded jointly by the federal government and the states and are administered by states under CMS-approved plans. Most state Medicaid program fee-for-service payments to providers are made under a prospective payment system or, in select instances, are based on negotiated payment levels with individual hospitals. Medicaid payment rates are typically less than Medicare payment rates for the same services and are often less than a hospital’s cost of services. Many states have recently reduced or are currently considering legislation to reduce the state's level of Medicaid funding (including upper payment limits ("UPLs") or program eligibility that could adversely affect future levels of Medicaid reimbursement received by our hospitals). As a result of recent actions or proposed actions in the states in which we operate, management estimates and expects overall Medicaid reimbursement rates to be flat during fiscal 2014 compared to fiscal 2013. As permitted by law, certain states in which we operate have adopted broad-based provider taxes to fund their Medicaid programs. Since states must operate with balanced budgets and since the Medicaid program is often the state’s largest program, states may consider further reductions in their Medicaid expenditures.
Medicaid Disproportionate Share Payments
Certain states in which we operate provide Medicaid DSH payments to hospitals that treat a disproportionately large number of low-income patients as part of their state Medicaid programs, similar to DSH payments received from Medicare. For the year ended June 30, 2013, Medicaid DSH reimbursement was $84.8 million. These amounts do not include our revenues recognized from payments related to various UPL, provider tax assessment and community benefit programs that are separate from Medicaid DSH. 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 the year ended June 30, 2012. The states in which we operate continually assess the level of expenditures for these types of federal matching programs. Changes to the Medicaid DSH and these other programs could have an adverse impact on our reimbursement.
Medicaid Electronic Health Record Incentive Payments
The Medicaid Electronic Health Record ("EHR") Incentive Program provides incentive payments to eligible hospitals and professionals as they adopt, implement, upgrade or demonstrate meaningful use of certified EHR technology in their first year of participation and demonstrate meaningful use for up to five remaining participation years. Medicaid EHR incentive payments to hospitals and professionals are 100% federally funded; however, the Medicaid EHR incentive program is voluntarily offered by individual states. Although CMS established January 3, 2011 as the earliest date states could offer Medicaid EHR incentive payments if they so choose, states must develop and receive CMS approval of state plans prior to offering Medicaid incentive payments. A provider that is eligible for Medicare and Medicaid EHR Incentive Program payments may only receive incentive payments from one program. HHS recently indicated that the Medicaid EHR Incentive Program payments will not be reduced due to the sequester.
During the years ended June 30, 2011, 2012 and 2013, we acquired certified EHR technology for several of our acute care hospitals including those in Michigan, San Antonio, and Illinois. As a result, we recognized $10.1 million, $28.2 million and $38.0 million, respectively, of other income related to estimated combined Medicaid and Medicare EHR incentives.
Impact of Health Reform Law on Medicaid Reimbursement
The Health Reform Law, as passed by Congress, provides federal funding for states to expand Medicaid coverage to all individuals under age 65 with incomes up to 133% of the federal poverty level ("FPL") by 2014, with such limit effectively increasing to 138% with the “5% income disregard” provision. In addition, states are to maintain, at a minimum, Medicaid eligibility standards established prior to the enactment of the law for adults until January 1, 2014 and for children until October 1, 2019. However, states with budget deficits may seek exemptions from this requirement to address eligibility standards that apply to adults making more than 133% of the FPL. As a result of the U.S. Supreme Court's June 28, 2012 decision on the Health Reform Law, HHS may not withhold existing Medicaid funding from states that choose not to expand Medicaid eligibility up to 133% of the FPL. It is currently not known how many states will decide to opt out of Medicaid expansion. The CBO estimates that one-fifth of the population that would be newly eligible to receive Medicaid coverage under the provisions of the Health Reform Law will live in states that opt out of Medicaid expansion, and an additional one-tenth of the newly

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eligible population will live in states that partially expand Medicaid eligibility. It should be noted that CMS has indicated that federal matching funds for Medicaid expansion will not be available to states that do not expand Medicaid to 133% of the FPL. Failure of a state to adopt the Medicaid expansion could adversely impact our revenues.
The Health Reform Law increases federal funding for Medicaid Integrity Contractors (“MIC”), private contractors who perform post-payment audits of Medicaid claims to identify overpayments, for FFYs 2011 and beyond. The Health Reform Law also expanded the scope of RAC programs to include Medicaid, as described herein.
The Health Reform Law also reduces funding for the Medicaid DSH hospital program in FFYs 2014 through 2020 by the following amounts: 2014—$500 million; 2015—$600 million; 2016—$600 million; 2017—$1.8 billion; 2018—$5 billion; 2019—$5.6 billion; and 2020—$4 billion. CMS released a proposed rule in May 2013 addressing the Medicaid DSH Health Reform Methodology to implement the annual reductions for FFYs 2014 and 2015. The proposed methodology would reflect the five factors identified in the Health Reform Law, and CMS also intends to take into account whether a state is expanding its Medicaid program and thus potentially reducing the rate of uninsured and hospitals' need for Medicaid DSH funding. Comments on the proposed rule were due to CMS on July 12, 2013. It is not clear when CMS will finalize the methodology, whether CMS will adopt the methodology as proposed, or how any one state's Medicaid DSH funding will be affected.
The Health Reform Law also required HHS to issue Medicaid regulations effective July 1, 2011 to prohibit federal payments to states for amounts expended for providing medical assistance for HACs. On June 6, 2011, CMS issued final rules designed to implement that provision of the Health Reform Law.
Managed Medicaid Recovery Audit Contractor Program
In addition to the Medicare Recovery Audit Program, CMS finalized provisions relating to implementation of a Medicaid RAC program in the September 16, 2011 Federal Register. States were expected to implement their respective RAC programs by January 1, 2012, although states could request an extension. CMS's website suggests 48 of the 50 states are reporting RAC data to CMS. Medicaid RACs have authority to look back at claims up to three years from the date of the claim, although states may request an exception for a shorter or longer look-back period. States may coordinate with Medicaid RACs regarding recoupment of overpayments and refer suspected fraud and abuse to appropriate law enforcement agencies. Medicaid RACs are paid with amounts recovered. Most Medicaid RACs appear to be paid by states on a contingency fee basis with most contingency fees ranging from 8-12% of recovered payments. It is not clear whether providers have or will face challenges under the Medicaid RAC program that are similar to those in connection with the Medicare RAC, such as denial of claims for billing the wrong site of service. Questions also exist as to how the Medicaid RAC program will coordinate with the MIC Program.
Managed Medicaid
Managed Medicaid programs represent arrangements where states contract with one or more managed care organizations ("Medicaid MCOs") to arrange for the provision of Medicaid benefits to assigned Medicaid-eligible individuals through a contracted network of providers. The contracted Medicaid MCOs are also typically responsible for enrollment, care management and claims adjudication for their enrollees in the state Medicaid programs. The states usually retain responsibility for setting the payment rates to the Medicaid MCOs, establishing enrollee eligibility criteria and setting broad benefit plan design requirements. We generally contract directly with one of the Medicaid MCOs to participate in their provider network although providers are not obligated to contract with a Medicaid MCO and we have the ability to choose not to participate in a Medicaid MCO's provider network. The provisions of these programs are state-specific. Enrollment in managed Medicaid plans has increased in recent years, as state governments seek to control the cost of Medicaid programs. However, general economic conditions in the states in which we operate may require reductions in premium payments to these plans and may reduce reimbursement received from these plans.
Annual Cost Reports
All hospitals participating in the Medicare and Medicaid programs are required to meet specific financial reporting requirements. Federal and, where applicable, state regulations require submission of annual cost reports identifying medical costs and expenses associated with the services provided by each hospital to Medicare beneficiaries and Medicaid recipients. Moreover, annual cost reports required under the Medicare and Medicaid programs are subject to routine audits, which may result in adjustments to the amounts ultimately determined to be due to us under these reimbursement programs. The audit process takes several years to reach the final determination of allowable amounts under the programs. Providers also have the right of appeal, and it is common to contest issues raised in audits of prior years’ reports.

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Many prior year cost reports of our facilities are still open. If any of our facilities are found to have been in violation of federal or state laws relating to preparing and filing of Medicare or Medicaid cost reports, whether prior to or after our ownership of these facilities, we and our facilities could be subject to substantial monetary fines, civil and criminal penalties and exclusion from participation in the Medicare and Medicaid programs. With the exception of the DMC acquisition, if an allegation is lodged against one of our facilities for a violation occurring during the time period before we acquired the facility, we may have indemnification rights against the seller of the facility as we generally negotiate customary indemnification and hold harmless provisions in our acquisition agreements regarding any damages we incur with respect to the time period before we acquired a facility. In the DMC acquisition, to the extent that we incur liability arising out of a violation or alleged violation by DMC prior to the closing of the DMC acquisition of certain stipulated health care laws, if payments exceed $25.0 million, we have the right to offset such excess payments against certain of our capital expenditure commitments.
Managed Care and Other Private Insurers
Managed care providers, including health maintenance organizations, preferred provider organizations, other private insurance companies and employers, are organizations that provide insurance coverage and a network of health care providers to members for a fixed monthly premium. To attract additional volume, most of our hospitals offer discounts from established charges or prospective payment systems to these large group purchasers of health care services. These discount programs often limit our ability to increase charges in response to increasing costs. However, as part of our business strategy, we have been able to renegotiate payment rates on many of our managed care contracts to improve our operating margin. While we generally received annual average payment rate increases of 4% to 5% from non-governmental managed care payers during the year ended June 30, 2013, there can be no assurance that we will continue to receive increases in the future and that patient volumes from these payers will not be adversely affected by rate negotiations. These contracts often contain exclusions, carve-outs, performance criteria and other provisions and guidelines that require our constant focus and attention. Also, it is not clear what impact, if any, the increased obligations on managed care payers and other health plans imposed by the Health Reform Law will have on our ability to negotiate reimbursement increases. Patients who are members of managed care plans are not required to pay us for their health care services except for coinsurance and deductible portions of their plan coverage calculated after managed care discounts have been applied. While more of our admissions and revenues are generated from patients covered by managed care plans than any other type of coverage, the percentage may decrease in the future due to increased Medicare utilization associated with the aging U.S. population. We experienced a slight decrease in managed care discharges as a percentage of total discharges to 22.3% during the year ended June 30, 2013 compared to 22.8% for the year ended June 30, 2012. On a same store basis, managed care discharges also experienced a slight decrease as a percentage of total discharges to 22.8% during the year ended June 30, 2013 compared to 23.1% for the year ended June 30, 2012.
Self-Pay Patients
Self-pay patients are patients who do not qualify for government programs payments, such as Medicare and Medicaid, who do not qualify for charity care under our guidelines and who do not have some form of private insurance. These patients are responsible for their own medical bills. We also include in our self-pay accounts those unpaid coinsurance and deductible amounts for which payment has been received from the primary payer.
Effective for service dates on or after April 1, 2009, as a result of a state mandate, we implemented a new uninsured discount policy for those patients receiving services in our Illinois hospitals who had no insurance coverage and who did not otherwise qualify for charity care under our guidelines. Under this policy, we apply an uninsured discount (calculated as a standard percentage of gross charges) at the time of patient billing and include this discount as a reduction to patient service revenues. We subsequently implemented this policy in our Arizona and Texas facilities. 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.
A significant portion of our self-pay patients are admitted through our hospitals’ emergency departments and often require high-acuity treatment. The Emergency Medical Treatment and Active Labor Act (“EMTALA”) requires any hospital that participates in the Medicare program to conduct an appropriate medical screening examination of every person who presents to the hospital’s emergency room for treatment and, if the individual is suffering from an emergency medical condition, to either stabilize that condition or make an appropriate transfer of the individual to a facility that can handle the condition. The obligation to screen and stabilize emergency medical conditions exists regardless of an individual’s ability to pay for treatment. High-acuity treatment is more costly to provide and, therefore, results in higher billings, which are the least collectible of all accounts. We believe self-pay patient volumes and revenues have been impacted during the last two years due to a combination of broad economic factors, including reductions in state Medicaid budgets, increasing numbers of individuals and employers

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who choose not to purchase insurance and an increased burden of coinsurance and deductibles to be made by patients instead of insurers.
Self-pay accounts pose significant collectability problems. At June 30, 2013, approximately 25.6% of our accounts receivable, prior to the allowance for doubtful accounts, contractual allowances and the charity care allowance, was comprised of self-pay accounts. The majority of our provision for doubtful accounts relates to self-pay patients. As of June 30, 2013, our combined allowances for doubtful accounts, uninsured discounts and charity care covered more than 100% of our combined uninsured and self-pay after insurance receivables. Until the Health Reform Law is implemented, we remain vulnerable to further increased self-pay utilization. We are taking multiple actions in an effort to mitigate the effect on us of the high number of uninsured patients and the related economic impact. These initiatives include conducting detailed reviews of intake procedures in hospitals facing the greatest pressures and applying these intake best practices to all of our hospitals. We developed hospital specific reports detailing collection rates by type of patient to help the hospital management teams better identify areas of vulnerability and opportunities for improvement. Also, we completely redesigned our self-pay collection workflows, enhanced technology and improved staff training in an effort to increase collections.
The Health Reform Law requires health plans to reimburse hospitals for emergency services provided to enrollees without prior authorization and without regard to whether a participating provider contract is in place. Further, the Health Reform Law contains provisions that seek to decrease the number of uninsured individuals, including requirements for individuals to obtain, and employers to provide, insurance coverage. These mandates may reduce the financial impact of screening for and stabilizing emergency medical conditions. However, many factors are unknown regarding the impact of the Health Reform Law, including when certain provisions will be implemented, how many uninsured individuals will obtain coverage as a result of the new law or the change, if any, in the volume of inpatient and outpatient hospital services that are sought by and provided to uninsured individuals. In addition, it is difficult to predict the full impact of the Health Reform Law due to the law’s complexity, limited implementing regulations or interpretive guidance, gradual implementation and possible amendment.
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 HHS). We exclude charity care accounts from revenues when we determine that the account meets our charity care guidelines. We provide expanded 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 FPL. During the years ended June 30, 2011, 2012 and 2013, we deducted $121.5 million, $233.4 million and $230.5 million of charity care from gross charges, respectively.

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Government Regulation and Other Factors
Overview
All participants in the health care industry are required to comply with extensive government regulation at the federal, state and local levels. In addition, these laws, rules and regulations are extremely complex and the health care industry has not had the benefit of regulatory or judicial interpretation of many of them. Although we believe we are in compliance in all material respects with such laws, rules and regulations, if a determination is made that we were in material violation of such laws, rules or regulations, our business, financial condition or results of operations could be materially adversely affected. If we fail to comply with applicable laws and regulations, we can be subject to criminal penalties and civil sanctions. In addition, our hospitals and other health care facilities can lose their licenses and their ability to participate in the Medicare and Medicaid programs.
Licensing, Certification and Accreditation
The construction and operation of health care facilities is subject to federal, state and local regulations relating to the adequacy of medical care, equipment, personnel, operating policies and procedures, fire prevention, rate-setting and compliance with building codes and environmental protection laws. Our facilities also are subject to periodic inspection by governmental and other authorities to assure continued compliance with the various standards necessary for licensing and accreditation. We believe that all of our operating health care facilities are properly licensed under appropriate state health care laws.
All of our operating hospitals are certified under the Medicare program and all except two of our hospitals, which are accredited by the health care Facilities Accreditation Program, are accredited by The Joint Commission (formerly known as The Joint Commission on Accreditation of Health Care Organizations), the effect of which is to permit the facilities to participate in the Medicare and Medicaid programs. If any facility loses its accreditation by The Joint Commission, or otherwise loses its certification under the Medicare program, then the facility will be unable to receive reimbursement from the Medicare and Medicaid programs. We intend to conduct our operations in compliance with current applicable federal, state, local and independent review body regulations and standards. The requirements for licensure, certification and accreditation are subject to change and, in order to remain qualified, we may need to make changes in our facilities, equipment, personnel and services.
Certificates of Need
In some states, the construction of new facilities, acquisition of existing facilities or addition of new beds or services may be subject to review by state regulatory agencies and require governmental certifications or determinations of need ("Certificates of Need"). Illinois, Michigan and Massachusetts are the only states in which we currently operate that require approval under a Certificate of Need program. These laws generally require appropriate state agency determination of public need and approval prior to the addition of beds or services or other capital expenditures. Failure to obtain necessary state approval can result in the inability to expand facilities, add services, acquire a facility or change ownership. Further, violation of such laws may result in the imposition of civil sanctions or the revocation of a facility’s license.
Utilization Review
Federal law contains numerous provisions designed to ensure that services rendered by hospitals to Medicare and Medicaid patients meet professionally recognized standards and are medically necessary and that claims for reimbursement are properly filed. These provisions include a requirement that a sampling of admissions of Medicare and Medicaid patients be reviewed by quality improvement organizations that analyze the appropriateness of Medicare and Medicaid patient admissions and discharges, quality of care provided, validity of diagnosis related group classifications and appropriateness of cases of extraordinary length of stay or cost. Quality improvement organizations may deny payment for services provided, assess fines and recommend to HHS that a provider not in substantial compliance with the standards of the quality improvement organization be excluded from participation in the Medicare and Medicaid programs. Most non-governmental managed care organizations also require utilization review.
There has been recent increased scrutiny of a hospital’s “Medicare Observation Rate” from outside auditors, government enforcement agencies and industry observers. The term “Medicare Observation Rate” is defined as total unique observation claims divided by the sum of total unique observation claims and total inpatient short-stay acute care hospital claims. A low rate may raise suspicions that a hospital is inappropriately admitting patients that could be cared for in an observation setting. In our affiliated hospitals, we use the independent, evidence-based clinical criteria developed by McKesson Corporation,

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commonly known as InterQual Criteria, to determine whether a patient qualifies for inpatient admission. The industry anticipates increased scrutiny and litigation risk, including government investigations and qui tam suits, related to inpatient admission decisions and the Medicare Observation Rate.
Federal Health Care Program Statutes and Regulations
Participation in any federal health care program, such as the Medicare and Medicaid programs, is regulated heavily by statute and regulation. If a hospital provider fails to substantially comply with the numerous conditions of participation in the Medicare or Medicaid program or performs specific prohibited acts, the hospital’s participation in the Medicare and Medicaid programs may be terminated or civil or criminal penalties may be imposed upon it under provisions of the Social Security Act and other statutes.

Executive Order 13563
Executive Order (“EO”) 13563 requires federal agencies to develop plans to periodically review existing significant regulations to identify outmoded, ineffective, insufficient or excessively burdensome regulations and to modify, streamline, expand, or repeal the regulations as appropriate. This EO may result in revisions to health care regulations, the nature and impact of which cannot be predicted. In January 2013, HHS released an updated list of existing and proposed regulations for review. The CMS regulations designated for future review and revision and that are relevant to our operations include rules related to:
MA and prescription drug plan burden reduction, including changes to reporting frequency, removal of unnecessary requirements and modifications of technical specifications;
Medicaid home and community-based services waivers; and
clarifying Clinical Laboratory Improvement Act (“CLIA”) regulations and promoting patient access to laboratory tests.
The HHS plan also includes a HIPAA-related provision that would reduce the administrative reporting burdens.
Since the implementation of the EO 13563 review process, CMS has finalized or proposed rules that include, among other changes, elimination or revision to unnecessary, obsolete or burdensome hospital conditions of participation, ASC patient notice requirements, MA and prescription drug plan marketing rules and comment processes, quality and performance measure reporting processes and the administrative reporting burdens of HIPAA.
Anti-Kickback Statute
A section of the Social Security Act known as the federal Anti-Kickback Statute prohibits providers and others from soliciting, receiving, offering or paying, directly or indirectly, any remuneration with the intent of generating referrals or orders for services or items covered by a federal health care program. Courts have interpreted this statute broadly and held that there is a violation of the Anti-Kickback Statute if just one purpose of the remuneration is to generate referrals, even if there are other lawful purposes. Furthermore, the Health Reform Law provides that knowledge of the Anti-Kickback Statute or the intent to violate the law is not required. Violation of this statute is a felony, including criminal penalties of imprisonment or criminal fines up to $25,000 for each violation, but it also includes civil money penalties of up to $50,000 per violation, damages up to three times the total amount of the improper payment to the referral source and exclusion from participation in Medicare, Medicaid or other federal health care programs. The Health Reform Law provides that submission of a claim for services or items generated in violation of the Anti-Kickback Statute constitutes a false or fraudulent claim and may be subject to additional penalties under the federal False Claims Act ("FCA").
The HHS Office of Inspector General ("OIG") has published final safe harbor regulations that outline categories of activities that are deemed protected from prosecution under the Anti-Kickback Statute. Currently there are safe harbors for various activities, including the following: investment interests; space rental; equipment rental; practitioner recruitment; personal services and management contracts; sale of practice; referral services; warranties; discounts; employees; group purchasing organizations; waiver of beneficiary coinsurance and deductible amounts; managed care arrangements; obstetrical malpractice insurance subsidies; investments in group practices; ambulatory surgery centers; and referral agreements for specialty services.

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The fact that conduct or a business arrangement does not fall within a safe harbor does not automatically render the conduct or business arrangement illegal under the Anti-Kickback Statute. The conduct or business arrangement, however, does increase the risk of scrutiny by government enforcement authorities. We may be less willing than some of our competitors to take actions or enter into business arrangements that do not clearly satisfy the safe harbors. As a result, this unwillingness may put us at a competitive disadvantage.
The OIG, among other regulatory agencies, is responsible for identifying and eliminating fraud, abuse and waste. The OIG carries out this mission through a nationwide program of audits, investigations and inspections. In order to provide guidance to health care providers, the OIG has from time to time issued “fraud alerts” that, although they do not have the force of law, identify features of a transaction that may indicate that the transaction could violate the Anti-Kickback Statute or other federal health care laws. The OIG has identified several incentive arrangements as potential violations, including:
payment of any incentive by the hospital when a physician refers a patient to the hospital;
use of free or significantly discounted office space or equipment for physicians in facilities usually located close to the hospital;
provision of free or significantly discounted billing, nursing or other staff services;
free training for a physician’s office staff, including management and laboratory techniques;
guarantees that provide that, if the physician’s income fails to reach a predetermined level, the hospital will pay any portion of the remainder;
low-interest or interest-free loans, or loans which may be forgiven, if a physician refers patients to the hospital;
payment of the costs of a physician’s travel and expenses for conferences or a physician’s continuing education courses;
coverage on the hospital’s group health insurance plans at an inappropriately low cost to the physician;
rental of space in physician offices, at other than fair market value terms, by persons or entities to which physicians refer;
payment of services which require few, if any, substantive duties by the physician, or payment for services in excess of the fair market value of the services rendered; or
“gain sharing,” the practice of giving physicians a share of any reduction in a hospital’s costs for patient care attributable in part to the physician’s efforts.
The OIG has encouraged persons having information about hospitals who offer the types of incentives listed above to physicians to report such information to the OIG. The OIG also issues “Special Advisory Bulletins” as a means of providing guidance to health care providers. These bulletins, along with other “fraud alerts,” have focused on certain arrangements between physicians and providers that could be subject to heightened scrutiny by government enforcement authorities, including “suspect” joint ventures where physicians may become investors with the provider in a newly formed joint venture entity where the investors refer their patients to this new entity, and are paid by the entity in the form of “profit distributions.”
In a Special Advisory Bulletin issued in April 2003, the OIG focused on “questionable” contractual arrangements where a health care provider in one line of business (the “Owner”) expands into a related health care business by contracting with an existing provider of a related item or service (the “Manager/Supplier”) to provide the new item or service to the Owner’s existing patient population, including federal health care program patients (so called “suspect Contractual Joint Ventures”). The Manager/Supplier not only manages the new line of business, but may also supply it with inventory, employees, space, billing, and other services. In other words, the Owner contracts out substantially the entire operation of the related line of business to the Manager/Supplier - otherwise a potential competitor - receiving in return the profits of the business as remuneration for its referrals. Through an Advisory Opinion, the OIG extended this suspect contractual joint venture analysis to arrangements between anesthesiologists and physician owners of ASCs.
    

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In March 2013, the OIG issued a Special Fraud Alert addressing physician-owned entities known as physician-owned distributorships (“PODs”). PODs are physician-owned manufacturers or distributors of devices ordered by the physician members. The OIG focused on implantable devices, but indicated that its analysis applies to other physician-owned entities. In the Special Fraud Alert, the OIG stated that while some PODs may be lawful, the OIG believes that they are inherently suspect under the Anti-Kickback Statute. Questionable features identified by the OIG include, but are not limited to: (1) selecting investors because of their potential to generate business for the POD; (2) requiring investors who cease practicing in the service area to divest ownership interests in the POD; and (3) extraordinary return on investment compared to the level of risk involved. The OIG expressed concern that PODs could incentivize the physician-owners to perform more procedures using devices sold through PODs, when such procedures are not medically necessary or could be performed using other more clinically appropriate devices. Finally, the OIG expressly noted that hospitals and ASCs that enter into arrangements with PODs may also be at risk under the Anti-Kickback Statute.
In addition to issuing fraud alerts and Special Advisory Bulletins, the OIG from time to time issues compliance program guidance for certain types of health care providers. In January 2005, the OIG published a Supplemental Compliance Guidance for Hospitals, supplementing its 1998 guidance for the hospital industry. In the supplemental guidance, the OIG identified a number of risk areas under federal fraud and abuse statutes and regulations. These areas of risk include compensation arrangements with physicians, recruitment arrangements with physicians and joint venture relationships with physicians. In addition, the Health Reform Law includes provisions that revised the scienter requirements such that a person need not have actual knowledge of the Anti-Kickback Statute or intent to violate the Anti-Kickback Statute to be found guilty of a violation.
We have a variety of financial relationships with physicians who refer patients to our hospitals. As of June 30, 2013, physicians owned interests in our two freestanding surgery centers in California, our freestanding surgery center in Harlingen, Texas, seven of our diagnostic imaging centers in San Antonio, Texas and our Pioneer ACO in Detroit, Michigan. We may sell ownership interests in certain of our other facilities to physicians and other qualified investors in the future. We also have contracts with physicians providing for a variety of financial arrangements, including employment contracts, leases and professional service agreements. We have provided financial incentives to recruit physicians to relocate to communities served by our hospitals, including income and collection guarantees and reimbursement of relocation costs, and will continue to provide recruitment packages in the future. Although we have established policies and procedures to ensure that our arrangements with physicians comply with current laws and applicable regulations, we cannot assure you that regulatory authorities that enforce these laws will not determine that some of these arrangements violate the Anti-Kickback Statute or other applicable laws. An adverse determination could subject us to liabilities under the Social Security Act, including criminal penalties, civil monetary penalties and exclusion from participation in Medicare, Medicaid or other federal health care programs, any of which could have a material adverse effect on our business, financial condition or results of operations.
Other Fraud and Abuse Provisions
The Social Security Act also imposes criminal and civil penalties for submitting false claims to Medicare and Medicaid. False claims include, but are not limited to, billing for services not rendered, misrepresenting actual services rendered in order to obtain higher reimbursement and cost report fraud. Like the Anti-Kickback Statute, these provisions are very broad. Further, the Social Security Act contains civil penalties for conduct including improper coding and billing for unnecessary goods and services. Under the Health Reform Law, civil penalties may be imposed for the failure to report and return an overpayment within 60 days of identifying the overpayment or by the date a corresponding cost report is due, whichever is later. To avoid liability, providers must, among other things, carefully and accurately code claims for reimbursement, promptly return overpayments and accurately prepare cost reports.
Some of these provisions, including the federal Civil Monetary Penalty Law, require a lower burden of proof than other fraud and abuse laws, including the Anti-Kickback Statute. Civil monetary penalties that may be imposed under the federal Civil Monetary Penalty Law range from $10,000 to $50,000 per act, and in some cases may result in penalties of up to three times the remuneration offered, paid, solicited or received. In addition, a violator may be subject to exclusion from federal and state health care programs. Federal and state governments increasingly use the federal Civil Monetary Penalty Law, especially where they believe they cannot meet the higher burden of proof requirements under the Anti-Kickback Statute. Other fraud and abuse programs include the Medicaid Integrity Program and an incentive program under which individuals can receive monetary rewards for providing information on Medicare fraud and abuse that leads to the recovery of Medicare funds. In addition, federal enforcement officials may exclude from Medicare and Medicaid any investors, officers and managing employees associated with business entities that have committed health care fraud.

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The Stark Law
The Social Security Act also includes a provision commonly known as the “Stark Law.” This law prohibits physicians from referring Medicare and (to an extent) Medicaid patients to entities with which they or any of their immediate family members have a financial relationship for the provision of certain designated health services that are reimbursable by Medicare or Medicaid, including inpatient and outpatient hospital services. The law also prohibits the entity from billing the Medicare program for any items or services that stem from a prohibited referral. Sanctions for violating the Stark Law include denial of payment, refunding amounts received for services provided pursuant to prohibited referrals, civil money penalties up to $15,000 per item or service improperly billed and exclusion from the federal health care programs. The statute also provides for a penalty of up to $100,000 for a circumvention scheme. There are a number of exceptions to the self-referral prohibition for many of the customary financial arrangements between physicians and providers, including employment contracts, leases, professional services agreements, non-cash gifts having an annual value of no more than $380 in CY 2012 and recruitment agreements. Unlike safe harbors under the Anti-Kickback Statute with which compliance is voluntary, an arrangement must comply with every requirement of a Stark Law exception or the arrangement is in violation of the Stark Law.
Although there is an exception for a physician’s ownership interest in an entire hospital, the Health Reform Law prohibits newly created physician-owned hospitals from billing for Medicare patients referred by their physician owners. As a result, the new law effectively prevents the formation of physician-owned hospitals after December 31, 2010. While the new law grandfathers existing physician-owned hospitals, it does not allow these hospitals to increase the percentage of physician ownership and significantly restricts their ability to expand services. There have been unsuccessful attempts through litigation and legislation to revise the provision. It is possible that Congress could revisit and make additional changes to the hospital-physician ownership provisions in future legislation. Over the last decade, we have faced significant competition from hospitals that have physician ownership and it is uncertain how these changes may affect such competition.
CMS has issued three phases of final regulations implementing the Stark Law. Phases I and II became effective in January 2002 and July 2004, respectively, and Phase III became effective in December 2007. While these regulations help clarify the requirements of the exceptions to the Stark Law, it is unclear how the government will interpret many of these exceptions for enforcement purposes. On July 31, 2008, CMS issued a final rule which effectively prohibits, as of a delayed effective date of October 1, 2009, many “under arrangements” ventures between a hospital and any referring physician or entity owned, in whole or in part, by a referring physician. The rule also effectively prohibits unit-of-service-based or “per click” compensation and percentage-based compensation in office space and equipment leases between a hospital and any referring physician or entity owned, in whole or in part, by a referring physician.
Because the Stark Law and its implementing regulations continue to evolve, we do not always have the benefit of significant regulatory or judicial interpretation of this law and its regulations. We attempt to structure our relationships to meet an exception to the Stark Law, but the regulations implementing the exceptions are detailed and complex, and we cannot be certain that every relationship complies fully with the Stark Law. In addition, in the July 2008 final Stark rule, CMS indicated that it will continue to enact further regulations tightening aspects of the Stark Law that it perceives allow for Medicare program abuse, especially those regulations that still permit physicians to profit from their referrals of ancillary services. There can be no assurance that the arrangements entered into by us and our facilities with physicians will be found to be in compliance with the Stark Law, as it ultimately may be implemented or interpreted.
Similar State Laws, etc.
Many of the states in which we operate also have adopted laws that prohibit payments to physicians in exchange for referrals similar to the federal Anti-Kickback Statute or that otherwise prohibit fraud and abuse activities. Many states also have passed self-referral legislation, similar to the Stark Law, prohibiting the referral of patients to entities with which the physician has a financial relationship. Often these state laws are broad in scope and they may apply regardless of the source of payment for care. These statutes typically provide criminal and civil penalties, as well as loss of licensure. Little precedent exists for the interpretation or enforcement of many of these state laws.
Certain Implications of these Fraud and Abuse Laws or New Laws
Our operations could be adversely affected by the failure of our arrangements to comply with the Anti-Kickback Statute, the Stark Law, billing laws and regulations, current state laws or other legislation or regulations in these areas adopted in the future. We are unable to predict whether other legislation or regulations at the federal or state level in any of these areas will be adopted, what form such legislation or regulations may take or how they may impact our operations. We are continuing to enter

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into new financial arrangements with physicians and other providers in a manner structured to comply in all material respects with these laws. We cannot assure you, however, that governmental officials responsible for enforcing these laws will not assert that we are in violation of them or that such statutes or regulations ultimately will be interpreted by the courts in a manner consistent with our interpretation.
The Federal False Claims Act and Similar Laws
Another trend affecting the health care industry today is the increased use of the federal FCA, and, in particular, actions being brought by individuals on the government’s behalf under the FCA’s “qui tam” or whistleblower provisions. These provisions allow private individuals to bring actions on behalf of the government alleging that the defendant has defrauded the federal government. If the government intervenes in the action and prevails, the party filing the initial complaint may share in any settlement or judgment. If the government does not intervene in the action, the whistleblower plaintiff may pursue the action independently, and may receive a larger share of any settlement or judgment. When a private party brings a qui tam action under the FCA, the defendant generally will not be made aware of the lawsuit until the government makes a determination whether it will intervene.
The Health Reform Law significantly increased the rights of whistleblowers to bring FCA actions by materially narrowing the so-called “public disclosure” bar to their FCA actions. Until the Health Reform Law was enacted, a whistleblower was not entitled to pursue publicly disclosed claims unless he or she was a direct and independent source of the information on which his or her allegations of misconduct were based. Under new Health Reform Law provisions:
It will now be enough that the whistleblower has independent knowledge that materially adds to publicly disclosed allegations.
Furthermore, the Health Reform Law limits the type of activity that counts as a “public disclosure” to disclosures made in a federal setting; disclosure in state reports or state proceedings will no longer qualify.
Even if all requirements are met to bar a whistleblower’s suit, the Health Reform Law permits the U.S. Department of Justice ("DOJ") to oppose a defendant’s motion to dismiss on public disclosure bar grounds, at its discretion, so that the whistleblower can proceed with his or her complaint.
When a defendant is determined by a court of law to be liable under the FCA, the defendant must pay three times the actual damages sustained by the government, plus mandatory civil penalties of between $5,500 to $11,000 for each separate false claim. Settlements entered into prior to litigation usually involve a less severe calculation of damages. There are many potential bases for liability under the FCA. Typically, each fraudulent bill submitted by a provider is considered a separate false claim, and thus the penalties under the FCA may be substantial. Liability arises when an entity knowingly submits a false claim for reimbursement to the federal government or, since May 2009, when an entity knowingly or improperly retains an overpayment that it has an obligation to refund. The FCA defines the term “knowingly” broadly. Thus, simple negligence will not give rise to liability under the FCA, but submitting a claim with reckless disregard as to its truth or falsity can constitute “knowingly” submitting a false claim and result in liability. The Fraud Enforcement and Recovery Act of 2009 expanded the scope of the FCA by, among other things, creating liability for knowingly and improperly avoiding repayment of an overpayment received from the government and broadening protections for whistleblowers.
Under the Health Reform Law, the FCA is implicated by the knowing failure to report and return an overpayment within 60 days of identifying the overpayment or by the date a corresponding cost report is due, whichever is later. In February 2012, CMS proposed regulations that would find that a provider has “identified” an overpayment if the provider has “actual knowledge of the existence of the overpayment” or “acts in reckless disregard or deliberate ignorance of the overpayment.” CMS also proposed suspending the 60-day period for returning an overpayment for overpayments that are the subject of a Medicare Self-Referral Disclosure Protocol already received by CMS or OIG Self-Disclosure Protocol already received by the OIG. Under the proposed rules, a provider would have an obligation to report and return an overpayment if that overpayment is discovered within 10 years of the date the overpayment was received. Further, the Health Reform Law expands the scope of the FCA to cover payments in connection with the new Exchanges to be created by the Health Reform Law, if those payments include any federal funds.
In some cases, whistleblowers or the federal government have taken the position that providers who allegedly have violated other statutes and have submitted claims to a governmental payer during the time period they allegedly violated these other statutes, have thereby submitted false claims under the FCA. Such other statutes include the Anti-Kickback Statute and the Stark Law. Courts have held that violations of these statutes can properly form the basis of a FCA case. The Health Reform

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Law clarifies this issue with respect to the Anti-Kickback Statute by providing that a claim including services or items resulting from a violation of the Anti-Kickback Statute constitutes a false or fraudulent claim under the FCA. In addition, in the February 2012 proposed regulations, CMS suggested that there may be situations where a provider is unaware of a kickback arrangement between third parties that causes the provider to submit claims that are the subject of the kickback. For example, a hospital submitting a claim for a medical device may not be aware that a medical device manufacturer paid kickbacks to a referring physician. CMS has proposed that a provider who is not a party to a kickback arrangement may still have a duty to report a kickback scheme if it has sufficient knowledge of the arrangement to identify an overpayment. Under this proposed rule, such a failure to report could create potential false claims liability.
A number of states, including states in which we operate, have adopted their own false claims provisions as well as their own whistleblower provisions whereby a private party may file a civil lawsuit in state court. From time to time, companies in the health care industry, including ours, may be subject to actions under the FCA or similar state laws.
Provisions in the Deficit Reduction Act of 2005 (the “DRA”) that went into effect on January 1, 2007 give states significant financial incentives to enact false claims laws modeled on the federal FCA. Additionally, the DRA requires every entity that receives annual payments of at least $5 million from a state Medicaid plan to establish written policies for its employees that provide detailed information about federal and state false claims statutes and the whistleblower protections that exist under those laws. Both provisions of the DRA are expected to result in increased false claims litigation against health care providers. We have complied with the written policy requirements.
Corporate Practice of Medicine and Fee Splitting
The states in which we operate have laws that prohibit unlicensed persons or business entities, including corporations, from employing physicians or laws that prohibit certain direct or indirect payments or fee-splitting arrangements between physicians and unlicensed persons or business entities. Possible sanctions for violations of these restrictions include loss of a physician’s license, civil and criminal penalties and rescission of business arrangements that violate these restrictions. These statutes vary from state to state, are often vague and seldom have been interpreted by the courts or regulatory agencies. Although we exercise care to structure our arrangements with health care providers to comply with the relevant state law, and believe these arrangements comply with applicable laws in all material respects, we cannot assure you that governmental officials responsible for enforcing these laws will not assert that we, or transactions in which we are involved, are in violation of such laws, or that such laws ultimately will be interpreted by the courts in a manner consistent with our interpretations.
The Health Insurance Portability and Accountability Act of 1996
The Administrative Simplification Provisions of HIPAA require the use of uniform electronic data transmission standards for health care claims and payment transactions submitted or received electronically. These provisions are intended to encourage and standardize electronic commerce in the health care industry. HHS has issued regulations implementing the HIPAA Administrative Simplification Provisions and compliance with these regulations is mandatory for our health care providers and health plans that are HIPAA covered entities. In January 2009, CMS published a final rule regarding updated standard code sets for certain diagnoses and procedures known as ICD-10 code sets and related changes to the formats used for certain electronic transactions. While use of the ICD-10 code sets is not mandatory until October 1, 2014, we will be modifying our payment systems and processes to prepare for the implementation. The ICD-10 code sets will require significant administrative changes, but we believe that the cost of compliance with these regulations has not had, and is not expected to have, a material adverse effect on our cash flows, financial position or results of operations.
The Health Reform Law requires HHS to adopt standards for additional electronic transactions and to establish operating rules to promote uniformity in the implementation of each standardized electronic transaction. HHS has adopted operating rules for the eligibility for a health plan, health care claim status, health care electronic fund transfers and remittance advice transactions. The operating rules will require significant technical and administrative changes, but we believe that the cost of compliance with the operating rules has not had, and is not expected to have, a material adverse effect on our cash flows, financial position or results of operations.
The privacy and security regulations promulgated pursuant to HIPAA extensively regulate the use and disclosure of protected health information and require covered entities, including our hospitals and health plans, to implement administrative, physical and technical safeguards to protect the security of such information. The Health Information Technology for Economic and Clinical Health Act (the "HITECH Act")—one part of the American Recovery and Reinvestment Act of 2009 ("ARRA")—broadened the scope of the HIPAA privacy and security regulations. In addition, the HITECH Act extends the application of

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certain provisions of the security and privacy regulations to business associates (entities that handle protected health information on behalf of covered entities) and subjected business associates to civil and criminal penalties for violation of the regulations beginning February 17, 2010. On January 25, 2013, HHS issued an omnibus Final Rule (HITECH Final Rule) containing modifications to the HIPAA privacy standards, security standards, breach notification standards and enforcement standards to implement certain HITECH Act provisions or otherwise deemed appropriate by HHS. The HITECH Final Rule will require significant technical, physical and administrative changes, but we believe that the cost of implementation and compliance with the HITECH Final Rule has not had, and is not expected to have, a material adverse effect on our cash flows, financial position or results of operations.
In addition, on May 27, 2011, HHS issued a proposed amendment to the existing accounting for disclosures standard of the HIPAA privacy regulations. The proposed amendment would implement a HITECH Act provision that requires covered entities to account for disclosures of electronic protected health information ("EPHI") for treatment, payment and health care operations purposes if the disclosure is made through an electronic health record. The proposed amendment goes beyond the HITECH Act provision and would require covered entities, including our hospitals and health plans, to provide a report identifying each instance that a natural person or organization accessed EPHI in any of our electronic treatment and billing record systems during the three-year period ending on the date the report is requested. The report must track access even if the access did not involve a disclosure outside of the covered entity. Modifying our electronic record systems to prepare such access reports would require a significant commitment, action and cost by us.
Violations of the HIPAA privacy, security and breach notification regulations may result in civil and criminal penalties. The HITECH Act and the HITECH Final Rule have strengthened the enforcement provisions of HIPAA and the Office for Civil Rights has increased its HIPAA enforcement activity relative to prior years. For violations occurring on or after February 18, 2009, entities are subject to tiered ranges for civil money penalty amounts based upon the increasing levels of culpability associated with violations. Under the HITECH Act and the HITECH Final Rule, the range of minimum penalty amounts for each offense increases from up to $100 to up to $50,000 (for violations due to willful neglect and not corrected during the 30-day period beginning on the first date the entity knew or, by exercising reasonable diligence, would have known that the violation occurred). Similarly, the penalty amount available in a CY for identical violations is substantially increased from $25,000 to $1,500,000. In one recent enforcement action, HHS imposed a $4,300,000 civil monetary penalty against a covered entity for violations of the privacy rule related to patient access to health records. In another action, the covered entity that was the subject of an investigation by HHS paid a settlement of $1,500,000 and agreed to be bound by a resolution agreement and corrective action plan. In addition, the ARRA authorizes state attorney generals to bring civil actions seeking either an injunction or damages in response to violations of HIPAA privacy and security regulations that threaten the privacy of state residents. Additionally, ARRA broadens the applicability of the criminal penalty provisions to employees of covered entities and requires HHS to impose penalties for violations resulting from willful neglect.
Further, under ARRA, HHS is now required to conduct periodic HIPAA compliance audits of covered entities and their business associates. HHS completed a pilot compliance audit program in 2012 and is designing a permanent HIPAA audit program.
The HITECH Act established a framework for security breach notification requirements to individuals affected by a breach of unsecured protected health information and, in some cases, to HHS or to prominent media outlets. On August 24, 2009, HHS issued interim final breach notification standards to implement the HITECH Act's breach notification provisions and subsequently amended the interim final standards as part of the HITECH Final Rule. Specifically, the HITECH Act and the standards require covered entities to report breaches of unsecured protected health information to affected individuals without unreasonable delay, but not to exceed 60 days of discovery of the breach by a covered entity or its agents. Notification must also be made to HHS and, in certain situations involving large breaches, to the media. HHS is required to publish on its website a list of all covered entities that report a breach involving more than 500 individuals. This reporting obligation applies broadly to breaches involving unsecured protected health information and became effective September 23, 2009. The HITECH Final Rule included various amendments to the breach notification standards, including a revised definition of a breach that is intended to require covered entities to report more unauthorized disclosure to individuals affected by a breach and place the burden on the covered entity to establish that an unauthorized disclosure of protected health information is not a breach.
In addition, we remain subject to any state laws that relate to privacy or the reporting of security breaches that are more restrictive than HIPAA, the HITECH Act and the regulations thereunder. For example, various state laws and regulations may require us to notify affected individuals in the event of a data breach involving certain personal information such as individually identifiable health or financial information. In addition, FTC issued regulations that initially required health providers and health plans to implement by December 31, 2010 written identity theft prevention programs to detect, prevent, and mitigate

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identity theft in connection with certain accounts. However, on December 18, 2010, President Obama signed the Red Flag Program Clarification Act of 2010 (“Clarification Act”) that clarified the categories of individuals and entities that are “creditors” subject to the FTC’s Red Flags Rule. Pursuant to the Clarification Act, creditors subject to the Red Flags Rule include entities or individuals that regularly and in the ordinary course of business: (1) obtain or use consumer reports, directly or indirectly, in connection with a credit transaction; (2) furnish information to consumer reporting agencies in connection with a credit transaction; or (3) advance funds to or on behalf of a person based on an obligation of the person to repay the funds. We are in compliance with these Red Flags Rules as they apply to our hospitals and health plans.
Compliance with these standards has and will continue to require significant commitment and action by us and significant costs. We have appointed members of our management team to direct our compliance with these standards. Implementation has and will continue to require us to engage in extensive preparation and make significant expenditures. At this time we have appointed a corporate privacy officer and a privacy officer at each of our facilities, prepared privacy policies, trained our workforce on these policies and entered into business associate agreements with the appropriate vendors. We are amending our policies to reflect the requirements of the HITECH Final Rule. However, failure by us or third parties on which we rely, including payers, to resolve HIPAA-related implementation or operational issues could have a material adverse effect on our results of operations and our ability to provide health care services. Consequently, we can give you no assurance that issues related to the full implementation of, or our operations under, HIPAA and the HITECH Act will not have a material adverse effect on our financial condition, results of operations or cash flows.
Conversion Legislation
Many states have enacted laws affecting the conversion or sale of non-profit hospitals. These laws generally include provisions relating to attorney general approval, advance notification and community involvement. In addition, attorneys general in states without specific conversion legislation may exercise authority over these transactions based upon existing laws. In many states, there has been an increased interest in the oversight of non-profit conversions. The adoption of conversion legislation and the increased review of non-profit hospital conversions may increase the cost and difficulty of, or prevent or delay the completion of, transactions with, or acquisitions of, non-profit organizations in various states.
The Emergency Medical Treatment and Active Labor Act
EMTALA was adopted by the U.S. Congress in response to reports of a widespread hospital emergency room practice of “patient dumping.” The law imposes requirements upon physicians, hospitals and other facilities that provide emergency medical services. Such requirements pertain to what care must be provided to anyone who comes to such facilities seeking care before they may be transferred to another facility or otherwise denied care. The government broadly interprets the law to cover situations in which patients do not actually present to a hospital’s emergency department, but present to a hospital-based clinic that treats emergency medical conditions on an urgent basis or are transported in a hospital-owned ambulance, subject to certain exceptions. EMTALA does not generally apply to patients admitted for inpatient services. Sanctions for violations of this statute include termination of a hospital’s Medicare provider agreement, exclusion of a physician from participation in Medicare and Medicaid programs and civil monetary penalties. In addition, the law creates private civil remedies that enable an individual who suffers personal harm as a direct result of a violation of the law, and a medical facility that suffers a financial loss as a direct result of another participating hospital’s violation of the law, to sue the offending hospital for damages and equitable relief. Although we believe that our practices are in substantial compliance with the law, we cannot assure you that governmental officials responsible for enforcing the law will not assert from time to time that our facilities are in violation of this statute.
Federal Sunshine Law
The Federal Sunshine Law requires annual public reporting by certain drug and device manufacturers of payments made by them to physicians and teaching hospitals and of physician ownership interests in such manufacturers. The law also requires group purchasing organizations ("GPOs") to make annual public reports of physician ownership interests in such organizations.
On February 1, 2013, CMS released a final rule implementing the Sunshine Law. The final rule provides guidance about which manufacturers and GPOs must report information, the scope of information that must be reported and how the manufacturers must track and report the information. In the final rule, CMS established that beginning August 1, 2013, manufacturers subject to reporting must begin collecting data on reportable payments and transfers of value and manufacturers and GPOs subject to reporting must begin collecting data on the reportable ownership and investment interests held by physicians and their immediate family members. Reporting to CMS will be required by March 31, 2014 and by the 90th

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calendar day of each subsequent year. CMS will make reported information available via a public website by September 30, 2014.
Antitrust Laws
The federal government and most states have enacted antitrust laws that prohibit certain types of anti-competitive conduct. These laws prohibit certain types of price fixing, agreements to fix wages, concerted refusal to deal, price discrimination and tying arrangements, as well as monopolization and acquisitions of competitors that have, or may have, a substantial adverse effect on competition. Violations of federal or state antitrust laws can result in various sanctions, including criminal and civil penalties.
Antitrust enforcement in the health care industry is currently a priority of the FTC. In 2011, the FTC filed three administrative complaints challenging hospital transactions in Ohio, Georgia and Illinois. Subsequently, in November 2012, the FTC filed another complaint challenging a hospital transaction in Pennsylvania and in June 2013, announced its intent to file an administrative complaint challenging a hospital transaction in Arkansas (the parties abandoned the transaction). In April 2013, in Congressional testimony, FTC Chairwoman Edith Ramirez stated that the FTC has “redoubled its efforts to prevent hospital mergers that may leave insufficient local options for inpatient services.” In addition to hospital merger enforcement, the Chairwoman also noted that the FTC is “increasingly concerned about the effect of combinations involving other health care providers,” including physician practices. The FTC has also entered into numerous consent decrees the past several years settling allegations of price-fixing among providers.
We believe we are in compliance with such federal and state antitrust laws, but there can be no assurance that a review of our practices by courts or regulatory authorities will not result in a determination that could adversely affect our operations.
Health Care Reform
The Health Reform Law is changing how health care services are covered, delivered and reimbursed through expanded coverage of uninsured and under-insured individuals, changes to Medicare and Medicaid program reimbursement, and the establishment of programs where reimbursement is tied to quality and integration. In addition, the Health Reform Law contains provisions intended to strengthen fraud and abuse enforcement.
On June 28, 2012, the U.S. Supreme Court issued a decision in a major challenge to the Health Reform Law brought by a majority of states and private individuals and groups representing stakeholders, such as small business advocates. The Court concluded that provisions requiring individuals to possess health insurance or pay a penalty (or tax) are constitutional and therefore valid. However, the U. S. Supreme Court invalidated a provision empowering the HHS Secretary to withhold all federal Medicaid funds from states that chose not to expand Medicaid as prescribed under the law. This aspect of the ruling has caused some states to refuse to expand Medicaid eligibility thereby limiting the number of individuals with access to health insurance. As of July1, 2013, 23 states and the District of Columbia have agreed to expand Medicaid to all individuals up to 133% of the FPL, as envisioned by the Health Reform Law; 21 states have decided against the expansion and six are debating whether to expand. In states where Medicaid is not expanded, the uninsured population could continue to be large, and reimbursement for our services will be negatively affected.
States are moving at different rates to implement portions of the Health Reform Law left to their discretion, including Exchanges that will be necessary to enroll millions of uninsured Americans in insurance plans. In states that have been slow to establish Exchanges, whether and when residents of those states will become insured pursuant to the expectations of the Health Reform Law is unclear.
On July 2, 2013, the U.S. Treasury announced plans to delay for one year a mandate requiring certain employers to offer health insurance, as required under the Health Reform Law. This mandate was originally scheduled to be effective January 1, 2014. To the extent fewer employers offer employees health insurance as a result of this change, more individuals may be left without insurance or without adequate insurance, and reimbursement for our services could be negatively affected.
Congress also is considering a number of changes that could further alter the scope or implementation of the Health Reform Law. In 2013, the U.S. House of Representatives approved legislation that would repeal the entire law, as well as portions of the original measure. While Congress under its current composition is not expected to repeal the Health Reform Law, a future Congress might do so.

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Expanded Coverage
Following the U.S. Supreme Court decision, the CBO estimates that the Health Reform Law will expand health insurance coverage to approximately 25 million additional individuals by 2023. This is a reduction from the CBO's projection prior to the U.S. Supreme Court decision that 30 to 33 million individuals would obtain coverage due to the Health Reform Law. The decision also affected the type of coverage obtained by individuals who will be newly insured as a result of the Health Reform Law. As a result of the decision, the CBO projects that more individuals are expected to receive coverage through the Exchanges and fewer are expected to receive coverage through the Medicaid expansion. Any anticipated increased coverage will likely occur through a combination of public program expansion and private sector health insurance and other reforms.
Medicaid Expansion. States are currently required to provide coverage for only limited categories of low-income adults under 65 years old (e.g., women who are pregnant, and the blind or disabled). In addition, the income level required for individuals and families to qualify for Medicaid varies widely from state to state.
The Health Reform Law materially changes Medicaid eligibility requirements and expands the categories of individuals eligible for Medicaid coverage. Commencing January 1, 2014, all state Medicaid programs will have the option to provide, and the federal government will subsidize, Medicaid coverage to virtually all adults under 65 years old with incomes at or under 133% of the FPL. Further, the Health Reform Law requires states to apply a “5% income disregard” to the Medicaid eligibility standard, so that Medicaid eligibility will effectively be extended to those with incomes up to 138% of the FPL. Following the U.S. Supreme Court decision, the CBO estimates that Medicaid and CHIP coverage will expand by approximately 13 million people by 2023. A disproportionately large percentage of the new Medicaid coverage may be in states that currently have relatively low income eligibility requirements. The CBO estimates that one-fifth of the population that would be newly eligible to receive Medicaid coverage under the provisions of the Health Reform Law will live in states that opt out of Medicaid expansion, and an additional one-tenth of the newly eligible population will live in states that partially expand Medicaid eligibility.
As Medicaid is a joint federal and state program, the federal government provides states with “matching funds” in a defined percentage, known as the federal medical assistance percentage (“FMAP”). Beginning in 2014, states that opt to expand their Medicaid programs will receive an enhanced FMAP for the individuals enrolled in Medicaid pursuant to the Health Reform Law. The FMAP percentage for the expansion population is as follows: 100% for calendar years 2014 through 2016; 95% for 2017; 94% in 2018; 93% in 2019; and 90% in 2020 and thereafter. CMS has indicated that federal matching funds for Medicaid expansion will not be available to states that do not expand Medicaid to 133% of the FPL.
The Health Reform Law also provides that the federal government will subsidize states that create non-Medicaid plans called Basic Health Programs for residents whose incomes are greater than 133% of the FPL but do not exceed 200% of the FPL. Approved state plans will be eligible to receive federal funding. The amount of that funding per individual will be equal to 95% of subsidies that would have been provided for that individual had he or she enrolled in a health plan offered through one of the Exchanges, as discussed below. CMS announced in February 2013 that the Basic Health Program would not be operational until 2015.
Historically, states often have attempted to reduce Medicaid spending by limiting benefits, tightening Medicaid eligibility requirements, and reducing provider payments. Effective March 23, 2010, the Health Reform Law requires states to at least maintain Medicaid eligibility standards established prior to the enactment of the law for adults until January 1, 2014 and for children until October 1, 2019. States with budget deficits may, however, seek exemptions from this requirement, but only to address eligibility standards that apply to adults making more than 133% of the FPL. Maine brought a legal challenge that was dismissed arguing that the maintenance of effort requirements are not applicable as a result of the U. S. Supreme Court ruling. There do not appear to be any current legal challenges to the maintenance of effort requirements although it is possible states could bring future legal challenges.
Private Sector Expansion. The expansion of health coverage through the private sector as a result of the Health Reform Law will occur through new requirements on health insurers, employers and individuals. A number of market reforms were effective September 23, 2010, including the provision prohibiting health insurers and group health plans from denying coverage to children under 19 years old based on a pre-existing condition and the provision establishing that, if health insurance coverage or a group health plan provides dependent coverage, dependent coverage must be available for qualifying individuals up to 26 years old. The medical loss ratio provisions, which became effective January 1, 2011, require each health insurer to keep its annual administrative costs, including profit, lower than 15% of premium revenue in the large group market and lower than 20% in the small group and individual markets, or rebate its enrollees the amount attributable to administrative costs in excess

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of the percentage. A number of market reforms commence January 1, 2014, including the provisions prohibiting health insurers and group health plans from imposing annual coverage limits or excluding persons based upon pre-existing conditions. In addition, health insurance issuers are prohibited from denying coverage for any individual or employer who is willing to pay premiums for such coverage and in most instances must give enrollees the option to renew existing coverage. Under the Health Reform Law, health insurance premiums for coverage offered in the individual or small group markets will be subject to state or federal review if proposed premium increases are greater than 10% or the state-specific review threshold, as applicable. Despite these required restrictions on how health insurers operate, CMS has indicated a willingness to grant waivers of the provisions in certain circumstances. For example, 17 states, plus Guam, have requested waivers of the medical loss ratio requirements, and, as of August 12, 2013, CMS had granted eight of these requests. As of August 12, 2013, CMS had granted 1,231 waivers to health insurance issuers and group health plans of the annual coverage limit restrictions, most through 2013. CMS stopped accepting applications for new annual coverage limit waivers on September 22, 2011, consistent with the 2014 prohibition on all such limits.
Large employers will be subject to new requirements and incentives to provide health insurance benefits to their full time employees. Currently, it is estimated that over 95% of large employers offer health coverage to their employees. Under the Health Reform Law, employers with 50 or more full-time employees that do not offer health insurance will be subject to a penalty if an employee obtains coverage through an Exchange and such coverage is subsidized by the government. The employer penalties will range from $2,000 to $3,000 per employee, subject to certain thresholds and conditions. These large employer coverage provisions were scheduled to go into effect on January 1, 2014, but, on July 9, 2013, the U.S. Treasury Department released a notice delaying the reporting requirements associated with the large employer coverage mandate until January 1, 2015. As a result, U.S. Treasury will not impose penalties on large employers for failing to provide coverage to its employees until January 1, 2015 when the reporting requirements become effective. The CBO projects this agency action will cause one million fewer individuals to receive coverage from large employers in 2014 than previously projected, although half of these individuals are expected to receive coverage through the Exchanges, Medicaid or CHIP. As a result, there is expected to be 500,00 fewer insured individuals in 2014 as a result of the delay. It also is possible that the delay in implementing the large employer coverage mandate is an indication that other Health Reform Law requirements may also be delayed, but it is not clear at this time what requirements, if any, would be delayed and for how long.
As enacted, the Health Reform Law uses various means to induce individuals who do not have health insurance to obtain coverage. By January 1, 2014, most individuals will be required to maintain health insurance for a minimum defined set of benefits or pay a tax penalty. The penalty will be the greater of a flat amount of $95 in 2014, $325 in 2015, $695 in 2016, and indexed to a cost of living adjustment in subsequent years, or a defined percentage of the individual's taxable income. The Internal Revenue Service (“IRS”), in consultation with HHS, is responsible for enforcing the tax penalty, although the Health Reform Law limits the availability of certain IRS enforcement mechanisms. In addition, for individuals and families with income between 100% and 400% of the FPL who do not otherwise qualify for minimum essential coverage (e.g., through Medicaid, their employer, or another government program), the cost of obtaining health insurance through Exchanges will be subsidized by the federal government through advance premium tax credits paid directly to an individual's health insurer. Those with lower incomes will be eligible to receive greater subsidies. It is anticipated that those at the lowest income levels will have the majority of their premiums subsidized by the federal government, in some cases in excess of 95% of the premium amount. HHS has indicated that individuals and families with income between 100% and 250% of the FPL will also have access to cost-sharing reductions in order to reduce the out-of-pocket expenses associated with the utilization of covered health care services. Beginning in 2014, the Health Reform Law also establishes a limit on the total out-of-pocket spending that can be required of an individual or family enrolled in health insurance coverage; in 2014 this amount has been set at $6,350 for self-only coverage and $12,700 for family coverage. After an individual or family's cost-sharing and deductible payments equal these amounts, the health insurer must cover 100% of the individual or family's covered medical expenses.
To facilitate the purchase of health insurance by individuals and small employers, marketplaces for health insurance purchasers, referred to as Exchanges, will be established in each state that will begin enrolling individuals on October 1, 2013 for coverage than can be effective beginning on January 1, 2014. Based on CBO estimates, following the U.S. Supreme Court decision, 24 million individuals will obtain their health insurance coverage through an Exchange by 2023. The Health Reform Law requires that the Exchanges be designed to make the process of evaluating, comparing and acquiring coverage available through Exchanges - called qualified health plans ("QHPs) - simple for consumers. For example, each Exchange must maintain a website that includes standardized information about and ratings of QHPs, information on premium tax credits or cost-sharing reductions for individuals, and information about the small business tax credit for small employers. The Exchange must also operate a toll-free telephone line to provide consumer assistance. A number of states have chosen not to establish an Exchange, which means the federal government will be responsible for establishing and administering the Exchange in these states. There

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is a risk that some or all of the Exchanges, whether state-run or federally-run, will face operational hurdles and challenges in the initial period of their operation, and this could reduce the number of individuals that obtain coverage through the Exchanges.
QHPs must provide coverage for a set of minimum "essential" benefits as defined by reference to a state's EHB-Benchmark Plan, but may offer more comprehensive benefits. Coverage of such essential benefits is also required for individual and small group health insurance coverage offered off of an Exchange. Moreover, health insurers participating in an Exchange may offer up to five levels of coverage on the Exchange. The levels of coverage are referred to as metal levels and vary by the percentage of projected medical expenses that are covered by the health insurer as opposed to the enrollee. These metal levels of coverage are referred to as platinum, gold, silver, bronze and catastrophic plans (catastrophic coverage is available to those up to age 30 or individuals older than 30 years old that obtain a waiver). The Health Reform Law requires health insurance issuers offering coverage on an Exchange to offer, at a minimum, gold and silver metal level plans, although states operating their own Exchange could require health insurance issuers to offer additional levels of coverage.
Public Program Spending
The Health Reform Law provides for Medicare, Medicaid and other federal health care program spending reductions between 2010 and 2019. The CBO estimates that these reductions will include $156 billion in Medicare fee-for-service market basket and productivity reimbursement reductions for all providers, the majority of which will come from hospitals. CMS sets this estimate at $233 billion. The CBO estimates also include an additional $36 billion in reductions of Medicare and Medicaid DSH funding ($22 billion for Medicare and $14 billion for Medicaid). CMS estimates include an additional $64 billion in reductions of Medicare and Medicaid DSH funding, with $50 billion of the reductions coming from Medicare.
Program Integrity and Fraud and Abuse
The Health Reform Law makes several significant changes to health care fraud and abuse laws, provides additional enforcement tools to the government, increases cooperation between governmental agencies by establishing mechanisms for the sharing of information and enhances criminal and administrative penalties for non-compliance. For example, in addition to those provisions discussed above, the Health Reform Law: (1) provides increased federal funding to fight health care fraud, waste and abuse; (2) expands the scope of the RAC program to include MA plans; (3) authorizes HHS, in consultation with the OIG, to suspend Medicare and Medicaid payments to a provider of services or a supplier “pending an investigation of a credible allegation of fraud;” and (4) provides Medicare contractors with additional flexibility to conduct random prepayment reviews.
Impact of Health Reform Laws on Us
The expansion of health insurance coverage under the Health Reform Law may result in a material increase in the number of patients using our facilities who have either private or public program coverage. Further, the Health Reform Law provides for a value-based purchasing program, the establishment of ACOs and bundled payment pilot programs, which will create possible sources of additional revenue.
It is difficult to predict the size of the potential revenue implications for us because of uncertainty surrounding a number of material factors, including the following:
how many states will implement the Medicaid expansion provisions and under what terms;
how many currently uninsured individuals will obtain coverage (either private health insurance or Medicaid) as a result of the Health Reform Law;
what percentage of the newly insured patients will be covered under the Medicaid program and what percentage will be covered by private health insurers;
the extent to which states will enroll new Medicaid participants in managed care programs;
the pace at which insurance coverage expands, including the pace of different types of coverage expansion;
the change, if any, in the volume of inpatient and outpatient hospital services that are sought by and provided to previously uninsured individuals;
the rate paid to hospitals by private payers for newly covered individuals, including those covered through the newly created Exchanges and those who might be covered under the Medicaid program under contracts with the state;

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the rate paid by state governments under the Medicaid program for newly covered individuals;
the percentage of individuals in the Exchanges who select the high deductible plans, since health insurers offering those kinds of products have traditionally sought to pay lower rates to hospitals;
the extent to which the net effect of the Health Reform Law, including the prohibition on excluding individuals based on pre-existing conditions, the requirement to keep medical costs lower than a specified percentage of premium revenue, other health insurance reforms and the annual fee applied to all health insurers, will put pressure on the profitability of health insurers, which in turn might cause them to seek to reduce payments to hospitals with respect to both newly insured individuals and their existing business; and
the possibility that the Health Reform Law or components of it will be delayed, revised, or eliminated as a result of court challenges or actions by Congress.
On the other hand, the Health Reform Law provides for significant reductions in the growth of Medicare spending, reductions in Medicare and Medicaid DSH payments and the establishment of programs where reimbursement is tied to quality and integration. Since approximately 62% of our net patient revenues during the year ended June 30, 2013 were from Medicare and Medicaid (including managed Medicare and Medicaid plans), reductions to these programs may significantly impact us and could offset any positive effects of the Health Reform Law. It is difficult to predict the size of the revenue reductions to Medicare and Medicaid spending, because of uncertainty regarding a number of material factors, including the following:
the amount of overall revenues we will generate from Medicare and Medicaid business when the reductions are implemented;
whether future reductions required by the Health Reform Law will be changed by statute prior to becoming effective;
the size of the Health Reform Law’s annual productivity adjustment to the market basket;
the amount of the Medicare DSH reductions that will be made, commencing in FFY 2014;
the allocation to our hospitals of the Medicaid DSH reductions, commencing in FFY 2014;
what the losses in revenues will be, if any, from the Health Reform Law’s quality initiatives;
how successful ACOs, in which we participate, will be at coordinating care and reducing costs or whether they will decrease reimbursement;
the scope and nature of potential changes to Medicare reimbursement methods, such as an emphasis on bundling payments or coordination of care programs;
whether our revenues from UPL programs, or other Medicaid supplemental programs developed through a federally approved waiver program, will be adversely affected, because there may be reductions in available state and local government funding for the programs, or because there may be fewer indigent, non-Medicaid patients for whom we provide services pursuant to UPL programs in which we participate; and
reductions to Medicare payments CMS may impose for “excessive readmissions.”
Because of the many variables involved, we are unable to predict the net effect on us of the expected decreases in uninsured individuals using our facilities, the reductions in Medicare spending and reductions in Medicare and Medicaid DSH funding and numerous other provisions in the Health Reform Law that may affect us.

Recent Massachusetts Legislation

On August 6, 2012, the Governor of Massachusetts signed comprehensive health care payment reform legislation, "An Act Improving The Quality Of Health Care And Reducing Costs Through Increased Transparency, Efficiency And Innovation." This legislation is estimated to reduce health care costs in Massachusetts by as much as $200 billion over the next 15 years through many provider-specific and systemic changes. Among these changes are provisions setting targets for statewide health care spending growth, requiring adoption of new payment methodologies by state-funded health care programs, public

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reporting of health care provider cost and quality measures, monitoring of price variation among health care providers and enforcement of health care cost growth benchmarks. We are unable to predict the effect of this legislation on our revenue and operations.
Health Care Industry Investigations
Significant media and public attention has focused in recent years on the hospital industry. In recent years, increased attention has been paid to hospitals with high Medicare outlier payments and to recruitment arrangements with physicians. Further, there are numerous ongoing federal and state investigations regarding multiple issues. These investigations have targeted hospital companies as well as their executives and managers. Like other hospital companies, we have substantial Medicare, Medicaid and other governmental billings and we engage in various arrangements with physicians, which could result in scrutiny of our operations. We continue to monitor these and all other aspects of our business and have developed a compliance program to assist us in gaining comfort that our business practices are consistent with both legal principles and current industry standards. However, because the laws in this area are complex and constantly evolving, we cannot assure you that government investigations will not result in interpretations that are inconsistent with industry practices, including ours. Government investigations may be based on novel legal theories that challenge common industry practices not previously thought to be noncompliant, theories for which there was previously limited official guidance or theories that are inconsistent with prior guidance from other government agencies. In some instances, government investigations that have in the past been conducted under the civil provisions of federal law may now be conducted as criminal investigations.
Many current health care investigations are national initiatives in which federal agencies target an entire segment of the health care industry. The Health Reform Law includes additional federal funding to fight health care fraud, waste and abuse. In addition, governmental agencies and their agents, such as the MACs, fiscal intermediaries and carriers, may conduct audits of our health care operations. Also, we are aware that prior to our acquisition of them, several of our hospitals were contacted in relation to certain government investigations relating to their operations. Although we take the position that, under the terms of the acquisition agreements, with the exception of the DMC acquisition, the prior owners of these hospitals retained any liability resulting from these government investigations, we cannot assure you that the prior owners’ resolution of these matters or failure to resolve these matters, in the event that any resolution was deemed necessary, will not have a material adverse effect on our operations. Further, under the federal FCA, private parties have the right to bring “qui tam” whistleblower lawsuits against companies that submit false claims for payments to the government. Some states have adopted similar state whistleblower and false claims provisions.
In addition to national enforcement initiatives, federal and state investigations commonly relate to a wide variety of routine health care operations such as: cost reporting and billing practices; financial arrangements with referral sources; physician recruitment activities; physician joint ventures; and hospital charges and collection practices for self-pay patients. We engage in many of these routine health care operations and other activities that could be the subject of governmental investigations or inquiries from time to time. For example, we have significant Medicare and Medicaid billings, we have numerous financial arrangements with physicians who are referral sources to our hospitals and we have joint venture arrangements involving physician investors.
Similar to the investigation by the DOJ of claims for payment for the implantation of implantable cardioverter defibrillators (as described in Item 3 - Legal Proceedings), it is possible that governmental entities may conduct future investigations of our facilities and that such investigations could result in significant penalties to us, as well as adverse publicity. It is also possible that our executives and managers, many of whom have worked at other health care companies that are or may become the subject of federal and state investigations and private litigation, could be included in governmental investigations or named as defendants in private litigation. The positions taken by authorities in any future investigations of us, our executives or managers or other health care providers and the liabilities or penalties that may be imposed could have a material adverse effect on our business, financial condition and results of operations.
Health Plan Regulatory Matters
Our health plans are subject to state and federal laws and regulations. CMS has the right to audit our health plans to determine the plans’ compliance with such standards. In addition, the Arizona Health Care Cost Containment System ("AHCCCS") has the right to audit PHP to determine PHP’s compliance with such standards. Also, PHP is required to file periodic reports with AHCCCS, meet certain financial viability standards, provide its members with certain mandated benefits and meet certain quality assurance and improvement requirements. Our health plans also have to comply with the standardized formats for electronic transmissions and privacy and security standards set forth in the Administrative Simplifications

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Provisions of HIPAA. Our health plans have implemented the necessary policies and procedures to comply with the final federal regulations on these matters and were in compliance with them by their deadlines.
The Anti-Kickback Statute has been interpreted to prohibit the payment, solicitation, offering or receipt of any form of remuneration in return for the referral of federal health program patients or any item or service that is reimbursed, in whole or in part, by any federal health care program. Similar statutes have been adopted in Illinois and Arizona that apply regardless of the source of reimbursement. HHS has adopted safe harbor regulations specifying certain relationships and activities that are deemed not to violate the Anti-Kickback Statute which specifically relate to managed care including:
waivers by health maintenance organizations of Medicare and Medicaid beneficiaries’ obligations to pay cost-sharing amounts or to provide other incentives in order to attract Medicare and Medicaid enrollees;
certain discounts offered to prepaid health plans by contracting providers;
certain price reductions offered to eligible managed care organizations; and
certain price reductions offered by contractors with substantial financial risk to managed care providers.
We believe that the incentives offered by our health plans to their members and the discounts they receive contracting with health care providers satisfy the requirements of the safe harbor regulations. However, the failure to satisfy each criterion of the applicable safe harbor does not mean that the arrangement constitutes a violation of the law; rather, the safe harbor regulations provide that an arrangement which does not fit within a safe harbor must be analyzed on the basis of its specific facts and circumstances. We believe that our health plans’ arrangements comply in all material respects with the federal Anti-Kickback Statute and similar state statutes.
Environmental Matters
We are subject to various federal, state and local laws and regulations, including those relating to the protection of human health and the environment. The principal environmental requirements and concerns applicable to our operations relate to:
the proper handling and disposal of hazardous waste as well as low level radioactive and other medical waste;
ownership, operation or historical use of underground and above-ground storage tanks;
management of impacts from leaks of hydraulic fluid or oil associated with elevators, chiller units or incinerators;
appropriate management of asbestos-containing materials present or likely to be present at some locations; and
the potential acquisition of, or maintenance of air emission permits for, boilers or other equipment.
We do not expect our compliance with environmental laws and regulations to have a material adverse effect on us. We are not now but may become subject to material requirements to investigate and remediate hazardous substances and other regulated materials that have been released into the environment at or from properties now or formerly owned or operated by us or our predecessors or at properties where such substances and materials were sent for off-site treatment or disposal. Liability for costs of investigation and remediation of contaminated sites may be imposed without regard to fault, and under certain circumstances on a joint and several basis, and can be substantial.
General Economic and Demographic Factors
The United States economy continues to be weak. Depressed consumer spending and higher unemployment rates continue to pressure many industries. During economic downturns, governmental entities often experience budget deficits as a result of increased costs and lower than expected tax collections. These budget deficits have forced federal, state and local government entities to decrease spending for health and human service programs, including Medicare, Medicaid and similar programs, which represent significant payer sources for our hospitals. Other risks we face from general economic weakness include potential declines in the population covered under managed care agreements, patient decisions to postpone or cancel elective and non-emergency health care procedures, potential increases in the uninsured and underinsured populations and further difficulties in our collecting patient co-payment and deductible receivables. The Health Reform Law seeks to decrease over time the number of uninsured individuals by, among other things, requiring employers to offer, and individuals to carry, health

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insurance or be subject to penalties. However, it is difficult to predict the full impact of the Health Reform Law due to the law’s complexity, lack of implementing regulations or interpretive guidance, gradual implementation and possible amendment.
The health care industry is impacted by the overall United States financial pressures. The federal deficit, the growing magnitude of Medicare expenditures and the aging of the United States population will continue to place pressure on federal and state health care programs.

Iran Sanctions Related Disclosure
Under the Iran Threat Reduction and Syria Human Rights Act of 2012 (“ITRSHRA”), which added Section 13(r) of the Exchange Act, we are required to include certain disclosures in our periodic reports if we or any of our “affiliates” knowingly engaged in specified activities, transactions or dealings relating to Iran or with certain designated parties during the period covered by the report. We are not presently aware that we or our consolidated subsidiaries have knowingly engaged in any transaction or dealing reportable under Section 13(r) of the Exchange Act during the quarter ended June 30, 2013. Because the SEC defines the term “affiliate” broadly, it includes any entity controlled by us as well as any person or entity that controls us or is under common control with us (“control” is also construed broadly by the SEC). Accordingly, we note that one of our equity sponsors, Blackstone, has included information in its Quarterly Report on Form 10-Q for the three months ended June 30, 2013, as required by Section 219 of the ITRSHRA and Section 13(r) of the Exchange Act, regarding the activities of certain of its portfolio companies. Blackstone included within Exhibit 99.1 to its Form 10-Q statements regarding certain activities of two companies that may be considered its affiliates: Hilton Worldwide Inc. (“Hilton”) and Travelport Limited (“Travelport”). These disclosures are reproduced below.
Hilton Disclosure
“As previously disclosed, during the reporting period, certain individual employees at two Hilton-branded hotels in the United Arab Emirates received routine wage payments as direct deposits to their personal accounts at Bank Melli, an entity identified on the Specially Designated Nationals and Blocked Persons List (“SDN List”) maintained by the Office of Foreign Assets Control in the U.S. Department of the Treasury. Both of these hotels are owned by a third party, staffed by employees of the third-party owner and operated pursuant to a management agreement between the owner and a Hilton affiliate. In each case, these payments originated from the third-party owner's account to the personal accounts of the employees at their chosen bank. During the reporting period, both hotels discontinued making direct deposits to accounts at Bank Melli. No revenues or net profits are associated with these transactions.
Also as previously disclosed, during the reporting period, several individuals stayed at the DoubleTree Kuala Lumpur, Malaysia, pursuant to a rate agreement between the hotel and Mahan Air, an entity identified on the SDN List. The rate agreement was terminated as of May 2, 2013. This hotel is staffed by employees of the third-party owner and operated pursuant to a management agreement between the owner and a Hilton affiliate. Under the rate agreement, which was entered into in the name of the owner, the hotel reserved a number of rooms for Mahan Air crew members at the DoubleTree Kuala Lumpur several times each week. Revenue and net profit received by Hilton attributable to Mahan Air crew hotel stays during the reporting period was approximately $430.”
Travelport Disclosure
“As part of our global business in the travel industry, we provide certain passenger travel related GDS and airline IT Solutions services to Iran Air. We also provide certain airline IT Solutions services to Iran Air Tours. All of these services are either exempt from applicable sanctions prohibitions pursuant to a statutory exemption in the International Emergency Economic Powers Act permitting transactions ordinarily incident to travel or, to the extent not otherwise exempt, specifically licensed by the U.S. Office of Foreign Assets Control (“OFAC”). Subject to any changes in the exempt/licensed status of such activities, we intend to continue these business activities, which are directly related to and promote the arrangement of travel for individuals.
Prior to and during the reporting period, we also provided airline IT Solutions services to Syrian Arab Airlines. These services were generally understood to be permissible under the same statutory travel exemption. The services were terminated following the May 2013 action by OFAC to designate this airline as a Specially Designated Global Terrorist pursuant to the Global Terrorism Sanctions Regulations.”

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We have no involvement in or control over the activities described above, and we have not independently verified or participated in the preparation of the disclosure described in such filings. To the extent Blackstone makes additional disclosure under Section 13(r), we will provide updates in our subsequent periodic filings.

Item 1A.    Risk Factors.

You should carefully consider the following risks as well as the other information included in this Annual Report on Form 10-K, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and related notes. Any of the following risks could materially and adversely affect our business, financial condition or results of operations. However, the selected risks described below are not the only risks facing us. Additional risks and uncertainties not currently known to us or those we currently view to be immaterial may also materially and adversely affect our business, financial condition or results of operations. While we attempt to mitigate known risks to the extent we believe to be practicable and reasonable, we can provide no assurance, and we make no representation, that our mitigation efforts will be successful.
Risks Relating to our Pending Merger
We may be unable to obtain satisfaction of all conditions to complete the Merger in the anticipated timeframe.
On June 24, 2013, we entered into the Merger Agreement with Tenet and Merger Sub, pursuant to which Tenet has agreed to acquire us.
Completion of the Merger is 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. Although we and Tenet have agreed in the Merger Agreement to use reasonable best efforts to consummate the Merger as promptly as practicable, these and the other conditions to the Merger may fail to be satisfied. In addition, satisfying the conditions to, and completion of, the Merger may take longer than, and could cost more than, we expect. Failure to complete the Merger may adversely affect us.
Failure to complete the Merger could negatively impact our stock price, future business and financial results.
The conditions to the completion of the Merger may not be satisfied as noted above. If the Merger is not completed for any reason, we would still remain liable for significant transaction costs and the focus of our management would have been diverted from seeking other potential strategic opportunities, in each case without realizing any benefits of a completed merger. Depending on the reasons for not completing the Merger, we could also be required to pay Tenet a termination fee of $61 million. For these and other reasons, a failed merger could adversely affect our business, operating results or financial condition. In addition, the trading price of our Common Stock could be adversely affected to the extent that the current price reflects an assumption that the Merger will be completed.
While the Merger is pending, we are subject to business uncertainties and contractual restrictions that could adversely affect our business.
Our employees, patients, customers and suppliers may have uncertainties about the effects of the Merger. Although we have taken actions designed to reduce any adverse effects of these uncertainties, these uncertainties may impair our ability to attract, retain and motivate key employees and could cause customers, suppliers and others that deal with us to try to change our existing business relationships.
The pursuit of the Merger and preparations for integration have placed, and will continue to place, a significant burden on many employees and internal resources. If, despite our efforts, key employees depart because of these uncertainties and burdens, or because they do not wish to remain with the combined company, our business and operating results could be adversely affected.
While the Merger is pending, some of our patients and customers could delay or forgo receiving certain health care services and suppliers could seek additional rights or benefits from us. In addition, the Merger Agreement restricts us from taking certain actions with respect to our business and financial affairs without Tenet's consent, and these restrictions could be

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in place for an extended period of time if the Merger is delayed. For these and other reasons, the pendency of the Merger could adversely affect our business, operating results or financial condition.
The Merger Agreement generally requires us to operate our business in the ordinary course of business pending consummation of the Merger, but includes certain contractual restrictions on the conduct of our business. In addition the pendency of the acquisition by Tenet and the completion of the conditions to closing could divert the time and attention of our management.
In addition, the Merger Agreement prohibits us from, among other things, soliciting, initiating or knowingly encouraging or facilitating the submission of any proposal, or engaging in any discussions or negotiations, with respect to an alternative transaction, subject to exceptions set forth in the Merger Agreement. The Merger Agreement also provides that we are required to pay a termination fee of $61 million if the Merger Agreement is terminated under certain circumstances. These provisions limit our ability to receive or pursue offers from third parties that may otherwise have resulted in greater value to our stockholders than the value resulting from the Merger.
Risks Related to Our Business and Structure
The current challenging economic environment, along with difficult and volatile conditions in the capital and credit markets, could materially adversely affect our financial position, results of operations or cash flows, and we are unsure whether these conditions will improve in the near future.
The U.S. economy and global credit markets remain volatile. Instability in consumer confidence and continued high unemployment have increased concerns of prolonged economic weakness. While certain health care spending is considered non-discretionary and may not be significantly impacted by economic downturns, other types of health care spending may be significantly adversely impacted by such conditions. When patients are experiencing personal financial difficulties or have concerns about general economic conditions, they may choose to defer or forego elective surgeries and other non-emergency procedures, which are generally more profitable lines of business for hospitals. We are unable to determine the specific impact of the current economic conditions on our business at this time, but we believe that further deterioration or a prolonged period of economic weakness will have an adverse impact on our operations. Other risk factors discussed herein describe some significant risks that may be magnified by the current economic conditions such as the following:
our concentration of operations in a small number of regions, and the impact of economic downturns in those communities. To the extent the communities in and around San Antonio, Harlingen and Brownsville, Texas; Phoenix, Arizona; Chicago, Illinois; Detroit, Michigan; or certain communities in Massachusetts experience a greater degree of economic weakness than average, the adverse impact on our operations could be magnified;
our revenues may decline if federal or state programs reduce our Medicare or Medicaid payments or managed care companies (including managed Medicare and managed Medicaid payers) reduce our reimbursement. Current economic conditions have accelerated and increased the budget deficits for most states, including those in which we operate. These budgetary pressures have resulted, and may continue to result, in health care payment reductions under state Medicaid plans or reduced benefits to participants in those plans. Also, governmental, managed Medicare or managed Medicaid payers may defer payments to us to conserve cash. Managed care companies have reduced and may continue to seek to reduce payment rates or limit payment rate increases to hospitals in response to continuing pressure from employers and from reductions in enrolled participants;
our hospitals face a growth in uncompensated care as the result of the inability of uninsured patients to pay for health care services and difficulties in collecting the patient portions of insured accounts. Higher unemployment, Medicaid benefit reductions and employer efforts to reduce employee health care costs may increase our exposure to uncollectible accounts for uninsured patients or those patients with higher co-pay and deductible limits; and
under extreme market conditions, there can be no assurance that funds necessary to run our business will be available to us on favorable terms or at all. Most of our cash and borrowing capacity under the 2010 Credit Facilities (as defined below) are with a limited number of financial institutions, which could increase our liquidity risk if one or more of those institutions become financially strained or are no longer able to operate.

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


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We are unable to predict the impact of the Health Reform Law, which represents significant change to the health care industry.
The Health Reform Law is changing how health care services are covered, delivered, and reimbursed through expanded coverage of uninsured individuals, changes to Medicare and Medicaid program reimbursement, and the establishment of programs where reimbursement is tied to quality and integration. In addition, the Health Reform Law contains provisions intended to strengthen health care fraud and abuse enforcement.
On June 28, 2012, the U.S. Supreme Court issued a decision in a major challenge to the Health Reform Law brought by a majority of states and private individuals and groups representing stakeholders, such as small business advocates. The U.S. Supreme Court concluded that provisions requiring individuals to possess health insurance or pay a penalty (or tax) are constitutional and therefore valid. However, the U.S. Supreme Court invalidated a provision empowering the HHS Secretary to withhold all federal Medicaid funds from states that chose not to expand Medicaid as prescribed under the law. This aspect of the ruling has caused some states to refuse to expand Medicaid eligibility thereby limiting the number of individuals with access to health insurance. As of July 1, 2013, 23 states and the District of Columbia have agreed to expand Medicaid to all individuals up to 133% of the FPL, as envisioned by the Health Reform Law; 21 states have decided against the expansion; and six are debating whether to expand. In states where Medicaid is not expanded, the uninsured population could continue to be large, and reimbursement for our services will be negatively affected.
States are moving at different rates to implement portions of the Health Reform Law left to their discretion, including Exchanges that will be necessary to enroll millions of uninsured Americans in insurance plans. In states that have been slow to establish Exchanges, whether and when residents of those states will become insured pursuant to the expectations of the Health Reform Law is unclear.
On July 2, 2013, the U.S. Treasury announced plans to delay for one year a mandate requiring certain employers to offer health insurance, as required under the Health Reform Law. This mandate was originally scheduled to be effective January 1, 2014. To the extent fewer employers offer employees health insurance as a result of this change, more individuals may be left without insurance or without adequate insurance, and reimbursement for our services could be negatively affected.
Congress also is considering a number of changes that could further alter the scope or implementation of the Health Reform Law. In 2013, the U.S. House of Representatives approved legislation that would repeal the entire law, as well as portions of the original measure. While Congress under its current composition is not expected to repeal the Health Reform Law, a future Congress might do so.
The expansion of health insurance coverage under the Health Reform Law may result in a material increase in the number of patients using our facilities who have either private or public program coverage. Further, the Health Reform Law provides for a value-based purchasing program, the establishment of ACOs and bundled payment pilot programs, which will create possible sources of additional revenue.
It is difficult to predict the size of the potential revenue implications for us because of uncertainty surrounding a number of material factors, including the following:
how many states will implement the Medicaid expansion provisions and under what terms;
how many currently uninsured individuals will obtain coverage (either private health insurance or Medicaid) as a result of the Health Reform Law;
what percentage of the newly insured patients will be covered under the Medicaid program and what percentage will be covered by private health insurers;
the extent to which states will enroll new Medicaid participants in managed care programs;
the pace at which insurance coverage expands, including the pace of different types of coverage expansion;
the change, if any, in the volume of inpatient and outpatient hospital services that are sought by and provided to previously uninsured individuals;
the rate paid to hospitals by private payers for newly covered individuals, including those covered through the newly created Exchanges and those who might be covered under the Medicaid program under contracts with the state;
the rate paid by state governments under the Medicaid program for newly covered individuals;
the percentage of individuals in the Exchanges who select the high deductible plans, since health insurers offering those kinds of products have traditionally sought to pay lower rates to hospitals;

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the extent to which the net effect of the Health Reform Law, including the prohibition on excluding individuals based on pre-existing conditions, the requirement to keep medical costs lower than a specified percentage of premium revenue, other health insurance reforms and the annual fee applied to all health insurers, will put pressure on the profitability of health insurers, which in turn might cause them to seek to reduce payments to hospitals with respect to both newly insured individuals and their existing business; and
the possibility that the Health Reform Law or components of it will be delayed, revised or eliminated as a result of court challenges or actions by Congress.
    
On the other hand, the Health Reform Law provides for significant reductions in the growth of Medicare spending, reductions in Medicare and Medicaid DSH payments and the establishment of programs where reimbursement is tied to quality and integration. Reductions to these programs may significantly impact us and could offset any positive effects of the Health Reform Law. It is difficult to predict the size of the revenue reductions to Medicare and Medicaid spending because of uncertainty regarding a number of material factors including the following:
the amount of overall revenues we will generate from Medicare and Medicaid business when the reductions are implemented;
whether future reductions required by the Health Reform Law will be changed by statute prior to becoming effective;
the size of the Health Reform Law's annual productivity adjustment to the market basket;
the amount of the Medicare DSH reductions that will be made, commencing in FFY 2014;
the allocation to our hospitals of the Medicaid DSH reductions, commencing in FFY 2014;
what the losses in revenues will be, if any, from the Health Reform Law's quality initiatives;
how successful the ACOs in which we participate will be at coordinating care and reducing costs or whether they will decrease reimbursement;
the scope and nature of potential changes to Medicare reimbursement methods, such as an emphasis on bundling payments or coordination of care programs;
whether our revenues from UPL programs, or other Medicaid supplemental programs developed through a federally approved waiver program, will be adversely affected, because there may be reductions in available state and local government funding for the programs, or because there may be fewer indigent, non-Medicaid patients for whom we provide services pursuant to UPL programs in which we participate; and
reductions to Medicare payments CMS may impose for “excessive readmissions.”

Because of the many variables involved, we are unable to predict the net effect on us of the expected decreases in uninsured individuals using our facilities, the reductions in Medicare spending, reductions in Medicare and Medicaid DSH funding and numerous other provisions in the Health Reform Law that may affect us. The negative impacts of the Health Reform Law may exceed the positive impacts and adversely impact our results of operations and cash flows.
If we are unable to enter into favorable contracts with managed care plans, our operating revenues may be reduced.
Our ability to negotiate favorable contracts with health maintenance organizations, insurers offering preferred provider arrangements and other managed care plans significantly affects the revenues and operating results of our hospitals. Revenues derived from health maintenance organizations, insurers offering preferred provider arrangements and other managed care plans, including managed Medicare and managed Medicaid plans, accounted for a significant portion of our patient service revenues for each of the years ended June 30, 2011, 2012 and 2013. Managed care organizations offering prepaid and discounted medical services packages represent a significant portion of our admissions. In addition, private payers are increasingly attempting to control health care costs through direct contracting with hospitals to provide services on a discounted basis, increased utilization reviews and greater enrollment in managed care programs such as health maintenance organizations and preferred provider organizations. The trend towards consolidation among private managed care payers tends to increase their bargaining power over prices and fee structures. As various provisions of the Health Reform Law are implemented, including the establishment of the Exchanges, non-government payers increasingly may demand reduced fees. In most cases, we negotiate our managed care contracts annually as they come up for renewal at various times during the year. Our future success will depend, in part, on our ability to renew existing managed care contracts and enter into new managed care contracts on terms favorable to us. Other health care companies, including some with greater financial resources, greater geographic coverage or a wider range of services, may compete with us for these opportunities. For example, some of our competitors may negotiate exclusivity provisions with managed care plans or otherwise restrict the ability of managed care companies to contract with us. It is not clear what impact, if any, the increased obligations on managed care payers and other payers imposed by the Health Reform Law will have on our ability to negotiate reimbursement increases. If we are unable to contain costs through

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increased operational efficiencies or to obtain higher reimbursements and payments from managed care payers, our results of operations and cash flows will be materially adversely affected.
Our revenues may decline if federal or state programs reduce our Medicare or Medicaid payments.
More than 60% of our patient service revenues for each of the years ended June 30, 2011, 2012 and 2013 came from the Medicare and Medicaid programs, including managed Medicare and Medicaid plans. In recent years federal and state governments have made significant changes to the Medicare and Medicaid programs. Some of those changes adversely affect the reimbursement we receive for certain services. In addition, due to budget deficits in many states, significant decreases in state funding for Medicaid programs have occurred or are being proposed. Changes in government health care programs may reduce the reimbursement we receive and could adversely affect our business and results of operations.
In recent years, legislative and regulatory changes have resulted in limitations on and, in some cases, reductions in levels of payments to health care providers for certain services under the Medicare program. For example, CMS completed a two-year transition to full implementation of the MS-DRG system, which represents a refinement to the existing diagnosis-related group system. Future realignments in the MS-DRG system could impact the margins we receive for certain services. Further, the Health Reform Law provides for material reductions in the growth of Medicare program spending, including reductions in Medicare market basket updates and Medicare DSH funding.
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” will be 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 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 reductions.
Since most states must operate with balanced budgets and since the Medicaid program is often a state's largest category of spending, some states can be expected to enact or consider enacting legislation designed to reduce their Medicaid expenditures. The current weakened economic conditions have increased the budgetary pressures on many states, and these budgetary pressures have resulted, and likely will continue to result, in decreased rates of spending growth for Medicaid programs and the CHIP in many states. Certain states in which we operate are also delaying payments to us, or accelerating payments we owe to them, as a way to deal with their budget shortfalls. Further, many states have also adopted, or are considering, legislation designed to reduce coverage, enroll Medicaid recipients in managed care programs and/or impose additional taxes on hospitals to help finance or expand the states' Medicaid systems.     
On March 15, 2011, the Governor of Arizona announced the state's plan to reform Medicaid by making changes to eligibility, freezing enrollment, and modifying reimbursement rates, among other proposals. Many of the proposed changes required federal approval. In April 2011, the Governor signed Arizona's fiscal year 2012 budget legislation, which included a 5% reduction to provider reimbursement, effective October 1, 2011, and a reduction in Medicaid beneficiaries through enrollment caps, attrition and more stringent eligibility requirements. Following the passage of the legislation, on October 21, 2011, CMS approved a temporary waiver of certain federal requirements (a "Medicaid waiver") to allow Arizona to implement the legislative plans. The Arizona Hospital and Health Care Association ("AHH") challenged the reimbursement cut, but the U.S. District Court for the District of Arizona declined to issue a preliminary injunction preventing the rate decrease and AHH voluntarily dismissed its claims on April 2, 2012.
The Medicaid waiver would allow Arizona to freeze Medicaid enrollment for the Childless Adult Program for five years and provides flexibility for the state to fund the Childless Adult Program based on availability of resources. However, CMS did not approve Arizona's Medicaid waiver proposal to freeze enrollment of parents with incomes between 75-100% of the FPL. In April 2012, CMS approved a modification to Arizona's Medicaid waiver to implement AHCCCS's Safety Net Care Pool ("SNCP"), which provides additional funding to certain safety net hospitals and temporarily expands Medicaid eligibility for low income children. In April 2012, CMS also approved Arizona's State Plan Amendment, which imposed a 25-day limit per

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year on inpatient hospital services for adults 21 years old and older, retroactive to October 1, 2011. Additionally, AHCCCS has indicated that it will develop a Payment Modernization Plan by October 1, 2013 that is expected to move the agency towards greater use of gainsharing and other alternative payment models in its Medicaid managed care administration. On July 30, 2012 and again on January 31, 2013, CMS approved updates to Arizona's Medicaid waiver that revised Arizona's Medicaid DSH payment methodology.
On June 17, 2013, Arizona enacted legislation expanding eligibility for Medicaid beginning January 1, 2014 for individuals and families with income below 133% of the FPL, consistent with the eligibility expansion under the Health Reform Law. This is predicted to increase Medicaid enrollment by up to 300,000 individuals. As of January 1, 2014, this expanded eligibility will make inoperative existing waivers that impose Medicaid enrollment caps or allow Arizona to restrict Medicaid eligibility.
Similar to the Arizona reimbursement cuts, in August 2011, the Texas Health and Human Services Commission ("HHSC")issued a final rule implementing a statewide acute care hospital inpatient Standard Dollar Amount (“SDA”) rate along with an 8% reduction in Medicaid hospital reimbursement. The MS-DRG relative weights were also rebased concurrent with the SDA rate change. In September 2012, HHSC issued a final rule to transition from the use of MS-DRGs to the All Patient Refined Diagnosis Related Groups (APR-DRG). After holding a public hearing on July 23, 2012 and receiving written comments on the proposed regulations, HHSC issued a final regulation, which was effective September 1, 2012. The SDA rate includes certain add-on adjustments for geographic wage-index, indirect medical education and trauma services but does not include add-on adjustments for higher acuity services such as neonatal and other women's services. HHSC also issued a proposed rule in June 2013 to reduce outpatient hospital rates by 4%. The proposed adjustment would become effective on September 1, 2013.
Our Texas hospitals also participate in private supplemental Medicaid reimbursement programs that are structured to expand the community safety net by providing indigent health care services and result in additional revenues for participating hospitals. CMS approved a Medicaid waiver in December 2011 that allows Texas to continue receiving supplemental Medicaid reimbursement while expanding its managed Medicaid program. HHSC issued a final rule, effective July 1, 2012 and amended on June 13, 2013, which implements the provider eligibility requirements and payment methodologies approved by CMS under the waiver. We cannot predict whether the Texas private supplemental Medicaid reimbursement programs will continue or guarantee that revenues recognized from the programs will not decrease. Additional Medicaid spending reductions may be implemented in the future in Texas and in the other states in which we operate.
The Health Reform Law expands Medicaid coverage to all individuals under age 65 with incomes up to 133% of the FPL by 2014, with such limit effectively increasing to 138% with the "5% income disregard" provision. In addition, states are to maintain, at a minimum, Medicaid eligibility standards established prior to the enactment of the law for adults until January 1, 2014 and for children until October 1, 2019. However, states with budget deficits may seek exemptions from this requirement to address eligibility standards that apply to adults making more than 133% of the FPL. As a result, of the U.S. Supreme Court's June 28, 2012 decision on the Health Reform Law, HHS may not withhold existing Medicaid funding from states that choose not to expand Medicaid up to 133% of the FPL. The CBO estimates that one-fifth of the population that would be newly eligible to receive Medicaid coverage under the provisions of the Health Reform Law will live in states that opt out of Medicaid expansion, and an additional one-tenth of the newly eligible population will live in states that partially expand Medicaid eligibility. CMS has indicated that federal matching funds for expansion will not be available to states that do not expand Medicaid to 133% of the FPL. Failure of a state to adopt the Medicaid expansion could adversely impact our revenues. In addition, the Health Reform Law will result in increased state legislative and regulatory changes in order for states to comply with new federal mandates, such as the requirement to establish Exchanges, and to participate in grants and other incentive opportunities. Future legislation or other changes in the administration or interpretation of government health programs could have a material adverse effect on our financial position and results of operations.
In recent years, both the Medicare program and several large managed care companies have changed their reimbursement to us to link some of their payments, especially their annual increases in payments, to performance on certain quality of care measures. We expect this trend to “pay-for-performance” to increase in the future. If we are unable to meet these performance measures, our financial position, results of operations and cash flows will be materially adversely affected.
In some cases, commercial third-party payers rely on all or portions of the MS-DRG system to determine payment rates, which may result in decreased reimbursement from some commercial third-party payers. Other changes to government health care programs may negatively impact payments from commercial third-party payers.
Current or future health care reform efforts, changes in laws or regulations regarding government health care programs, other changes in the administration of government health care programs and changes to commercial third-party payers in

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response to health care reform and other changes to government health care programs could have a material adverse effect on our financial position and results of operations.
We conduct business in a heavily regulated industry, and changes in regulations or violations of regulations may result in increased costs or sanctions that could reduce our revenues and profitability.
The health care industry is subject to extensive federal, state and local laws and regulations relating to licensing, the conduct of operations, the ownership of facilities, the addition of facilities and services, financial arrangements with physicians and other referral sources, confidentiality, maintenance and security issues associated with medical records, billing for services and prices for services. If a determination was made that we were in material violation of such laws or regulations, our operations and financial results could be materially adversely affected.
In many instances, the industry does not have the benefit of significant regulatory or judicial interpretations of these laws and regulations. This is particularly true in the case of the Medicare and Medicaid statute codified under Section 1128B(b) of the Social Security Act and known as the “Anti-Kickback Statute.” This statute prohibits providers and other persons or entities from soliciting, receiving, offering or paying, directly or indirectly, any remuneration with the intent to generate referrals of orders for services or items reimbursable under Medicare, Medicaid and other federal health care programs. Courts have interpreted this statute broadly and held that there is a violation of the Anti-Kickback Statute if just one purpose of the remuneration is to generate referrals, even if there are other lawful purposes. Furthermore, the Health Reform Law provides that knowledge of the law or the intent to violate the law is not required. As authorized by the U.S. Congress, HHS has issued regulations that describe certain conduct and business relationships immune from prosecution under the Anti-Kickback Statute. The fact that a given business arrangement does not fall within one of these “safe harbor” provisions does not render the arrangement illegal, but business arrangements of health care service providers that fail to satisfy the applicable safe harbor criteria risk increased scrutiny by enforcement authorities.
The safe harbor requirements are generally detailed, extensive, narrowly drafted and strictly construed. Many of the financial arrangements that our facilities maintain with physicians do not meet all of the requirements for safe harbor protection. The regulatory authorities that enforce the Anti-Kickback Statute may in the future determine that one or more of these arrangements violate the Anti-Kickback Statute or other federal or state laws. A determination that a facility has violated the Anti-Kickback Statute or other federal laws could subject us to liability under the Social Security Act, including criminal and civil penalties, as well as exclusion of the facility from participation in government programs such as Medicare and Medicaid or other federal health care programs.
In addition, the portion of the Social Security Act commonly known as the “Stark Law” prohibits physicians from referring Medicare and (to an extent) Medicaid patients to providers of certain “designated health services” if the physician or a member of his or her immediate family has an ownership or investment interest in, or compensation arrangement with, that provider. In addition, the provider in such arrangements is prohibited from billing for all of the designated health services referred by the physician, and, if paid for such services, is required to promptly repay such amounts. Most of the services furnished by our facilities are “designated health services” for Stark Law purposes, including inpatient and outpatient hospital services. There are multiple exceptions to the Stark Law, among others, for physicians having a compensation relationship with the facility as a result of employment agreements, leases, physician recruitment and certain other arrangements. However, each of these exceptions applies only if detailed conditions are met. An arrangement subject to the Stark Law must qualify for an exception in order for the services to be lawfully referred by the physician and billed by the provider.
Although there is an exception for a physician's ownership interest in an entire hospital, the Health Reform Law prohibits newly created physician owned hospitals from billing for Medicare patients referred by their physician owners. As a result, the new law effectively prevents the formation of physician-owned hospitals after December 31, 2010. While the new law grandfathers existing physician-owned hospitals, it does not allow these hospitals to increase the percentage of physician ownership and significantly restricts their ability to expand services. There have been unsuccessful attempts through litigation and legislation to revise the provision. It is possible that Congress could revisit and make additional changes to the hospital-physician ownership provisions in future legislation. Over the last decade, we have faced significant competition from hospitals that have physician ownership and it is uncertain how these changes may affect such competition.
CMS has issued three phases of final regulations implementing the Stark Law. Phases I and II became effective in January 2002 and July 2004, respectively, and Phase III became effective in December 2007. While these regulations help clarify the requirements of the exceptions to the Stark Law, it is unclear how the government will interpret many of these exceptions for enforcement purposes. On July 31, 2008, CMS issued a final rule which effectively prohibits, as of a delayed effective date of

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October 1, 2009, both “under arrangements” ventures between a hospital and any referring physician or entity owned, in whole or in part, by a referring physician. The rule also effectively prohibits unit-of-service-based “per click” compensation and percentage-based compensation in office space and equipment leases between a hospital and any referring physician or entity owned, in whole or in part, by a referring physician.
Because the Stark Law and its implementing regulations continue to evolve, we do not always have the benefit of significant regulatory or judicial interpretation of this law and its regulations. We attempt to structure our relationships to meet an exception to the Stark Law, but the regulations implementing the exceptions are detailed and complex, and we cannot assure you that every relationship complies fully with the Stark Law. In addition, in the July 2008 final Stark rule CMS indicated that it will continue to enact further regulations tightening aspects of the Stark Law that it perceives allow for Medicare program abuse, especially those regulations that still permit physicians to profit from their referrals of ancillary services. We cannot be certain that the arrangements entered into by our hospitals with physicians will be found to be in compliance with the Stark Law, as it ultimately may be implemented or interpreted.
Additionally, if we violate the Anti-Kickback Statute or Stark Law, or if we improperly bill for our services, we may be found to violate the FCA, either under a suit brought by the government or by a private person under a qui tam, or “whistleblower,” suit. For a discussion of remedies and penalties under the FCA, see “Providers in the health care industry have been the subject of federal and state investigations, whistleblower lawsuits and class action litigation, and we may become subject to investigations, whistleblower lawsuits or class action litigation in the future” below.
Effective December 31, 2010, in connection with the impending acquisition of DMC, we and DMC entered into a Settlement Agreement with the DOJ and the OIG releasing us from liability under the FCA, the Civil Monetary Penalties Law, and the civil monetary penalties provisions of the Stark Law for certain disclosed conduct (the “Covered Conduct”) by DMC prior to our acquisition that may have violated the Anti-Kickback Statute or the Stark Law or failed to comply with governmental reimbursement rules. (A copy of the Settlement Agreement may be found as Exhibit 2.6 to our Current Report on Form 8-K, dated January 5, 2011, filed with the SEC.) DMC paid $30 million to the government in connection with such settlement based upon the government's analysis of DMC's net worth and ability to pay, but not upon our net worth and ability to pay. The Settlement Agreement is subject to the government's right of rescission in the event of DMC's nondisclosure of assets or any misrepresentation in DMC's financial statements disclosed to the government by DMC. While we are not aware of any such misrepresentation or nondisclosure at this time, such misrepresentation or nondisclosure by DMC would provide the government the right to rescind the Settlement Agreement. Additionally, while the scope of release for the Covered Conduct under the Stark Law is materially similar to or broader than that found in most similar publicly-available settlement agreements, the precise scope of such a release under the Stark Law and the FCA, as amended by the Fraud Enforcement and Recovery Act of 2009 and the Health Reform Law, has not been interpreted by any court, and it is possible that a regulator or a court could interpret these laws such that the release would not extend to all possible liability for the Covered Conduct. If the Settlement Agreement were to be rescinded or so interpreted, this could have a material adverse effect on our business, financial condition, results of operations or prospects, and our business reputation could suffer significantly. In addition, the DOJ continues to investigate the Covered Conduct covered by the Settlement Agreement with respect to potential claims against individuals. It is possible that this investigation might result in adverse publicity or adversely impact our business reputation or otherwise have a material adverse impact on our business.
If we fail to comply with the Anti-Kickback Statute, the Stark Law, the FCA or other applicable laws and regulations, or if we fail to maintain an effective corporate compliance program, we could be subjected to liabilities, including civil penalties (including the loss of our licenses to operate one or more facilities), exclusion of one or more facilities from participation in the Medicare, Medicaid and other federal and state health care programs and, for violations of certain laws and regulations, criminal penalties.
All of the states in which we operate have adopted or have considered adopting similar anti-kickback and physician self-referral legislation, some of which extends beyond the scope of the federal law to prohibit the payment or receipt of remuneration for the referral of patients and physician self-referrals, regardless of the source of payment for the care. Little precedent exists for the interpretation or enforcement of these laws. Both federal and state government agencies have announced heightened and coordinated civil and criminal enforcement efforts.
Government officials responsible for enforcing health care laws could assert that one or more of our facilities, or any of the transactions in which we are involved, are in violation of the Anti-Kickback Statute or the Stark Law and related state laws. It is also possible that the courts could ultimately interpret these laws in a manner that is different from our interpretations. Moreover, other health care companies, alleged to have violated these laws, have paid significant sums to settle such allegations

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and entered into “corporate integrity agreements” because of concern that the government might exercise its authority to exclude those providers from governmental payment programs (e.g., Medicare, Medicaid and TRICARE). Both Arizona Heart Hospital and Arizona Heart Institute had such “corporate integrity agreements” prior to our purchase of certain of their assets and liabilities that the OIG has not sought to impose on us. A determination that one or more of our facilities has violated these laws, or the public announcement that we are being investigated for possible violations of these laws, could have a material adverse effect on our business, financial condition, results of operations or prospects, and our business reputation could suffer significantly.
Federal law permits the OIG to impose civil monetary penalties, assessments and to exclude from participation in federal health care programs individuals and entities who have submitted false, fraudulent or improper claims for payment. Improper claims include those submitted by individuals or entities that have been excluded from participation or an order to prescribe a medical or other item or service during a period a person was excluded from participation, where the person knows or should know that the claim would be made to a federal health care program. These penalties may also be imposed on providers or entities that employ or enter into contracts with excluded individuals to provide services to beneficiaries of federal health care programs. Furthermore, if services are provided by an excluded individual or entity, the penalties may apply even if the payment is made directly to a non-excluded entity. Employers of, or entities that contract with, excluded individuals or entities for the provision of services may be liable for up to $10,000 for each item or service furnished by the excluded individual or entity, an assessment of up to three times the amount claimed and program exclusions. In order for the penalties to apply, the employer or contractor must have known or should have known that the person or entity was excluded from participation. The OIG may seek to apply its exclusion authority to an officer or a managing employee of an excluded or convicted entity. The OIG has used the responsible corporate officer doctrine to apply this authority expansively. Legislation to expand the scope of the exclusion authority has been introduced in the current Congress and was also introduced in each of the past two Congresses. Chances of passage of such legislation are unclear. Claims for services furnished by excluded parties may constitute false claims under the federal FCA. As such, the DOJ may also impose penalties on providers that employ excluded parties. Penalties include three times the actual damages sustained by the government, plus civil penalties of $5,500 to $11,000 for each claim. On October 19, 2009, we voluntarily reported to the OIG that two of our employees had been excluded from participation in Medicare at certain times during their employment. On August 27, 2012 we reached a settlement of this matter with the U.S. Attorney's office for the District of Arizona.
Illinois, Michigan and Massachusetts require Certificates of Need prior to the purchase of major medical equipment or the construction, expansion, closure, sale or change of control of health care facilities. We believe our facilities have obtained appropriate Certificates of Need wherever applicable. However, if a determination were made that we were in material violation of such laws, our operations and financial results could be materially adversely affected. The governmental determinations, embodied in Certificates of Need, can also affect our facilities' ability to add bed capacity or important services as well as our ability to acquire health care facilities. We cannot predict whether we will be able to obtain required Certificates of Need in the future. A failure to obtain any required Certificates of Need may impair our ability to operate the affected facility profitably.
Executive Order 13563

EO 13563 requires federal agencies to develop plans to periodically review existing significant regulations to identify outmoded, ineffective, insufficient or excessively burdensome regulations and to modify, streamline, expand, or repeal the regulations as appropriate. This EO may result in revisions to health care regulations, the nature and impact of which cannot be predicted. In January 2013, HHS released an updated list of existing and proposed regulations for review. The CMS regulations designated for future review and revision and that are relevant to our operations include rules related to:

MA and prescription drug plan burden reduction, including changes to reporting frequency, removal of unnecessary requirements and modification of technical specifications;
Medicaid home and community-based services waivers; and
clarifying CLIA regulations and promoting patient access to laboratory tests.

The HHS plan also includes a HIPAA-related provision that would reduce the administrative reporting burdens.

Since the implementation of the EO 13563 review process, CMS has finalized or proposed rules that include, among other changes, elimination or revision to unnecessary, obsolete or burdensome hospital conditions of participation, ASC patient notice requirements, MA and prescription drug plan marketing rules and comment processes, quality and performance measure reporting processes and the administrative reporting burdens of HIPAA. Although the regulatory review process and

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regulations revised thereunder are intended to result in less regulatory burden, the results of these reviews and revised regulations are uncertain and may result in regulatory changes that could adversely affect our operations.

The laws, rules and regulations described above are complex and subject to interpretation. If we are in violation of any of these laws, rules or regulations, or if further changes in the regulatory framework occur, our results of operations could be significantly harmed.
Some of our hospitals may be required to submit to CMS information on their relationships with physicians and this submission could subject such hospitals and us to liability.
CMS announced in 2007 that it intended to collect information on ownership, investment and compensation arrangements with physicians from several hundred pre-selected hospitals by requiring these hospitals to submit to CMS Disclosure of Financial Relationship Reports (“DFRR”). CMS intended to use this data to determine whether these hospitals were in compliance with the Stark Law and implementing regulations during the reporting period. Hospitals that receive a DFRR request will have 60 days to compile a significant amount of information relating to its financial relationships with physicians. Hospitals that do not respond could face civil monetary penalties of up to $10,000 per day and those that do respond could be subject to investigations or enforcement actions if a government agency determines that any of the information provided indicates a potential violation of law.
In June 2010, CMS decided to delay implementation of the DFRR and instead focus on implementation of the Health Reform Law reporting provisions as to physician-owned hospitals. If CMS decides to re-implement the DFRR initiative, any governmental investigation or enforcement action which results from the DFRR process could materially adversely affect our results of operations.
Providers in the health care industry have been the subject of federal and state investigations, whistleblower lawsuits and class action litigation, and we may become subject to investigations, whistleblower lawsuits or class action litigation in the future.
Both federal and state government agencies have heightened and coordinated civil and criminal enforcement efforts as part of numerous ongoing investigations of hospital companies, as well as their executives and managers. These investigations relate to a wide variety of topics, including:
cost reporting and billing practices;
laboratory and home health care services;
physician ownership of, and joint ventures with, hospitals;
physician recruitment activities; and
other financial arrangements with referral sources.
The Health Reform Law included additional federal funding of $350 million over ten years to fight health care fraud, waste and abuse.
In addition, the federal FCA permits private parties to bring qui tam, or whistleblower, lawsuits against companies. Whistleblower provisions allow private individuals to bring actions on behalf of the government alleging that the defendant has defrauded the federal government. Because qui tam lawsuits are filed under seal, we could be named in one or more such lawsuits of which we are not aware. Defendants determined to be liable under the FCA may be required to pay three times the actual damages sustained by the government, plus mandatory civil penalties of between $5,500 and $11,000 for each separate false claim. Typically, each fraudulent bill submitted by a provider is considered a separate false claim, and thus the penalties under the FCA may be substantial. Liability arises when an entity knowingly submits a false claim for reimbursement to the federal government. The Fraud Enforcement and Recovery Act, which became law on May 20, 2009, changed the scienter requirements for liability under the FCA. An entity may now violate the FCA if it “knowingly and improperly avoids or decreases an obligation” to pay money to the United States. This includes obligations based on an “established duty . . . arising from . . . the retention of any overpayment.” Thus, if a provider is aware that it has retained an overpayment that it has an obligation to refund, this may form the basis of a FCA violation even if the provider did not know the claim was “false” when it was submitted. The Health Reform Law expressly requires health care providers and others to report and return overpayments. The term overpayment is defined as “any funds that a person receives or retains under title XVIII or XIX to which the person, after applicable reconciliation, is not entitled under such title.” The Health Reform Law also defines the period of time in which an overpayment must be reported and returned to the government. The Health Reform Law provides that “[a]n overpayment must be reported and returned” within “60 days after the date on which the overpayment was identified,” or “the date any

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corresponding cost report is due,” whichever is later. In February 2012, CMS proposed regulations that would find that a provider has “identified” an overpayment if the provider has “actual knowledge of the existence of the overpayment” or “acts in reckless disregard or deliberate ignorance of the overpayment.” CMS also proposed suspending the 60-day period for returning an overpayment for overpayments that are the subject of a Medicare Self-Referral Disclosure Protocol already received by CMS or OIG Self-Disclosure Protocol already received by the OIG. Under the proposed rules, a provider would have an obligation to report and return an overpayment if that overpayment is discovered within 10 years of the date the overpayment was received. The Health Reform Law explicitly states that if the overpayment is retained beyond the 60-day period, it becomes an “obligation” sufficient for reverse false claim liability under the FCA, and is therefore subject to treble damages and penalties if there is a “knowing and improper” failure to return the overpayment.
In some cases, courts have held that violations of the Stark Law and Anti-Kickback Statute can properly form the basis of a FCA case, finding that in cases where providers allegedly violated other statutes and have submitted claims to a governmental payer during the time period they allegedly violated these other statutes, the providers thereby submitted false claims under the FCA. Some states have adopted similar whistleblower and false claims provisions. The Health Reform Law now explicitly links violations of the Anti-Kickback Statute to the FCA. In addition, in February 2012, CMS suggested that there may be situations where a provider is unaware of a kickback arrangement between third parties that causes the provider to submit claims that are the subject of the kickback. For example, a hospital submitting a claim for a medical device may not be aware that a medical device manufacturer paid kickbacks to a referring physician. CMS has proposed that a provider who is not a party to a kickback arrangement may still have a duty to report a kickback scheme if it has sufficient knowledge of the arrangement to identify an overpayment. Under this proposed rule, such a failure to report could create potential false claims liability.
The Health Reform Law changes the intent requirement for health care fraud under 18 U.S.C. § 1347, such that “a person need not have actual knowledge or specific intent to commit a violation.” In addition, the Health Reform Law significantly changes the FCA by removing the jurisdictional bar for allegations based on publicly disclosed information and by loosening the requirements for a qui tam relator to qualify as an “original source,” by permitting the DOJ to oppose a defendant's motion to dismiss on “public disclosure bar” grounds and by narrowing the definition of what prior disclosures constitute “public disclosure” for the purpose of the bar. These changes will effectively increase FCA exposure by enabling a greater number of whistleblowers to bring a claim.
Should we be found out of compliance with any of these laws, regulations or programs, depending on the nature of the findings, our business, financial position and results of operations could be negatively impacted.
As required by statute, CMS has implemented the Recovery Audit Program on a nationwide basis. Under the program, CMS contracts with recovery auditors to conduct post-payment reviews to detect and correct improper payments in the fee-for-service Medicare program. The Health Reform Law expands the Recovery Audit Program's scope to include managed Medicare plans and to include Medicaid claims by requiring all states to have established a Recovery Audit Program by December 31, 2010. States were expected to implement their respective RAC programs by January 1, 2012, although states could request an extension. CMS's website suggests 48 of the 50 states are reporting RAC data to CMS. Medicaid RACs have authority to look back at claims up to three years from the date of the claim, although states may request an exception for a shorter or longer look-back period. States may coordinate with Medicaid RACs regarding recoupment of overpayments and refer suspected fraud and abuse to appropriate law enforcement agencies. Medicaid RACs are paid with amounts recovered. Most Medicaid RACs appear to be paid by states on a contingency fee basis with most contingency fees ranging from 8-12% of recovered payments. It is not clear whether providers have or will face program challenges under the Medicaid RAC program that are similar to those in connection with the Medicare RAC program, such as denial of claims for billing the wrong site of service. Questions also exist as to how the Medicaid RAC program will coordinate with the MIC Program. CMS employs MICs to perform post-payment audits of Medicaid claims and identify overpayments. The Health Reform Law increased federal funding for the MIC program beginning in FFY 2011 and the increased funding continues through FFY 2016. In addition to Medicare recovery auditors and MICs, several other contractors, including the state Medicaid agencies, have increased their review activities.
Further, on November 15, 2011, CMS announced the RAPR demonstration will allow RACs to review claims before they are paid to ensure that the provider complied with all Medicare payment rules.  The RACs will conduct prepayment reviews on certain types of claims that have historically resulted in high rates of improper payments, beginning with those involving short stay inpatient hospital services. These reviews will focus on seven states (Florida, California, Michigan, Texas, New York, Louisiana and Illinois) with high populations of fraud and error-prone providers and four states (Pennsylvania, Ohio, North Carolina, and Missouri) with high claims volumes of short inpatient hospital stays for a total of 11 states. The goal of the RAPR demonstration is to reduce improper payments before they are paid, rather than the traditional “pay and chase” methods of

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looking for improper payments after they have been made. These prepayment reviews will not replace the MAC prepayment reviews as RACs and MACs are supposed to coordinate to avoid duplicate efforts. The RAPR demonstration was to start in January 2012, but CMS decided in January 2012 to delay the start of the program. The RAPR demonstration ultimately began on September 1, 2012.
The OIG and the DOJ have, from time to time, including for fiscal year 2012, established national enforcement initiatives that focus on specific billing practices or other suspected areas of abuse. As a result of these initiatives, some of our activities could become the subject of governmental investigations or inquiries. For example, we have significant Medicare and Medicaid billings, we provide some durable medical equipment and home health care services, and we have joint venture arrangements involving physician investors. We also have a variety of other financial arrangements with physicians and other potential referral sources, including recruitment arrangements and leases. In addition, our executives and managers, many of whom have worked at other health care companies that are or may become the subject of federal and state investigations and private litigation, could be included in governmental investigations or named as defendants in private litigation. We are aware that several of our hospitals or their related health care operations were and may still be under investigation in connection with activities conducted prior to our acquisition of them. With the exception of the acquisition of the assets of DMC, under the terms of our various acquisition agreements, the prior owners of our hospitals are responsible for any liabilities arising from pre-closing violations. The prior owners' resolution of these matters or failure to resolve these matters, in the event that any resolution was deemed necessary, may have a material adverse effect on our business, financial condition or results of operations. Any investigations of us, our executives, managers, facilities or operations could result in significant liabilities or penalties to us, as well as adverse publicity.
We maintain a compliance program to address health regulatory and other compliance requirements. This program includes initial and periodic ethics and compliance training, a toll-free hotline for employees to report, without fear of retaliation, any suspected legal or ethical violations, annual “fraud and abuse” audits to look at our financial relationships with physicians and other referral sources and annual “coding audits” to make sure our hospitals bill the proper service codes in obtaining payment from the Medicare and Medicaid programs.
As an element of our corporate compliance program and our internal compliance audits, from time to time we make voluntary disclosures and repayments to the Medicare and Medicaid programs and/or to the federal and/or state regulators for these programs in the ordinary course of business. All of these voluntary actions on our part could lead to an investigation by the regulators to determine whether any of our facilities have violated the Stark Law, the Anti-Kickback Statute, the FCA or similar state law. Either an investigation or initiation of administrative or judicial actions could result in a public announcement of possible violations of the Stark Law, the Anti-Kickback Statute or the FCA or similar state law. Such determination or announcements could have a material adverse effect on our business, financial condition, results of operations or prospects, and our business reputation could suffer significantly.
Additionally, several hospital companies have in recent years been named defendants in class action litigation alleging, among other things, that their charge structures are fraudulent and, under state law, unfair or deceptive practices, insofar as those hospitals charge insurers lower rates than those charged to uninsured patients. We cannot assure you that we will not be named as a defendant in litigation of this type. Furthermore, the outcome of these suits may affect the industry standard for charity care policies and any response we take may have a material adverse effect on our financial results.
In June 2006, we and two other hospital systems operating in San Antonio, Texas had a putative class action lawsuit brought against all of us alleging that we and the other defendants had conspired with one another and with other unidentified San Antonio area hospitals to depress the compensation levels of registered nurses employed at the competing hospitals within the San Antonio area by engaging in certain activities that violated the federal antitrust laws. On the same day that this litigation was brought against us and two other hospital systems in San Antonio, substantially similar class action litigation was brought against multiple hospitals or hospital systems in three other cities (Chicago, Illinois; Albany, New York; and Memphis, Tennessee), with a fifth suit instituted against hospitals or hospital systems in Detroit, Michigan later in 2006, one of which hospital systems was DMC. A negative outcome in the San Antonio and/or the Detroit actions could materially affect our business, financial condition or results of operations.
Competition from other hospitals or health care providers (especially specialty hospitals) may reduce our patient volumes and profitability.
The health care business is highly competitive and competition among hospitals and other health care providers for patients has intensified in recent years. Generally, other hospitals in the local communities served by most of our hospitals provide services similar to those offered by our hospitals. In addition, CMS publicizes on its Medicare website performance

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data related to quality measures and data on patient satisfaction surveys hospitals submit in connection with their Medicare reimbursement. Federal law provides for the future expansion of the number of quality measures that must be reported. Additional quality measures and future trends toward clinical transparency may have an unanticipated impact on our competitive position and patient volumes. Further, the Health Reform Law requires all hospitals to annually establish, update and make public a list of the hospital's standard charges for items and services. If any of our hospitals achieve poor results (or results that are lower than our competitors) on these quality measures or on patient satisfaction surveys or if our standard charges are higher than our competitors, our patient volumes could decline.
In addition, we believe the number of freestanding specialty hospitals and surgery and diagnostic centers in the geographic areas in which we operate has increased significantly in recent years. As a result, most of our hospitals operate in an increasingly competitive environment. Some of the hospitals that compete with our hospitals are owned by governmental agencies or non-profit corporations supported by endowments and charitable contributions and can finance capital expenditures and operations on a tax-exempt basis. Increasingly, we are facing competition from physician-owned specialty hospitals and freestanding surgery centers that compete for market share in high margin services and for quality physicians and personnel. If ambulatory surgery centers are better able to compete in this environment than our hospitals, our hospitals may experience a decline in patient volume, and we may experience a decrease in margin, even if those patients use our ambulatory surgery centers. Further, if our competitors are better able to attract patients, recruit physicians, expand services or obtain favorable managed care contracts at their facilities than our hospitals and ambulatory surgery centers, we may experience an overall decline in patient volume.
PHP also faces competition within the Arizona markets that it serves. As in the case of our hospitals, some of our health plan competitors in these markets are owned by governmental agencies or non-profit corporations that have greater financial resources than we do. 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.
We may be subject to liabilities from claims brought against our facilities.
We operate in a highly regulated and litigious industry. As a result, various lawsuits, claims and legal and regulatory proceedings have been instituted or asserted against us, including those outside of the ordinary course of business such as class actions and those in the ordinary course of business such as malpractice lawsuits. Some of these actions may involve large claims as well as significant defense costs.
We maintain professional and general liability insurance with unrelated commercial insurance carriers to provide for losses in excess of our self-insured retention (such retention is maintained by our captive insurance subsidiary and/or other of our subsidiaries) at amounts ranging from $10.0 million to $17.5 million. As a result, a few successful claims against us that are within our self-insured retention amounts could have an adverse effect on our results of operations, cash flows, financial condition or liquidity. We also maintain umbrella coverage for an additional $65.0 million above our self-insured retention with independent third party carriers. There can be no assurance that one or more claims might not exceed the scope of this third-party coverage.
The relatively high cost of professional liability insurance and, in some cases, the lack of availability of such insurance coverage for physicians with privileges at our hospitals increases our risk of vicarious liability in cases where both our hospital and the uninsured or underinsured physician are named as co-defendants. As a result, we are subject to greater self-insured risk and may be required to fund a higher amount of claims out of our operating cash flows in future periods as our claims mature. We cannot assure you that we will be able to continue to obtain insurance coverage in the future or that such insurance coverage, if it is available, will be available on acceptable terms.
While we cannot predict the likelihood of future claims or inquiries, we expect that new matters may be initiated against us from time to time. Moreover, the results of current claims, lawsuits and investigations cannot be predicted, and it is possible that the ultimate resolution of these matters, individually or in the aggregate, may have a material adverse effect on our business (both in the near and long term), financial position, results of operations or cash flows.
Our hospitals face a growth in uncompensated care as the result of the inability of uninsured patients to pay for health care services and difficulties in collecting patient portions of insured accounts.
Like others in the hospital industry, we have experienced an increase in uncompensated care. Our combined provision for doubtful accounts, uninsured discounts and charity care deductions as a percentage of net patient revenues (prior to these adjustments) was 19.0% and 21.3% for the years ended June 30, 2012 and 2013, respectively. Our self-pay discharges as a percentage of total discharges during the year ended June 30, 2013 increased to 7.5% compared to 6.7% for the year ended June 30, 2012. Our hospitals remain at risk for increases in uncompensated care as a result of price increases, the continuing trend of increases in coinsurance and deductible portions of managed care accounts and increases in uninsured patients as a result of

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potential state Medicaid funding reductions or general economic weakness. We continue to seek ways to improve point of service collection efforts and to implement appropriate payment plans with our patients. However, if we continue to experience growth in self-pay revenues prior to the Health Reform Law being fully implemented, our results of operations and cash flows could be materially adversely affected. Further, our ability to improve collections for self-pay patients may be limited by regulatory and investigatory initiatives, including private lawsuits directed at hospital charges and collection practices for uninsured and underinsured patients.
The Health Reform Law seeks to decrease over time the number of uninsured individuals. The Health Reform Law will expand Medicaid in those states choosing to participate and incentivize employers to offer, and require individuals to carry, health insurance or be subject to penalties. However, it is difficult to predict the full impact of the Health Reform Law due to the law's complexity, limited implementing regulations and interpretive guidance, gradual implementation and possible amendment by Congress, as well as our inability to foresee how individuals and businesses will respond to the choices afforded them by the law. In addition, even after implementation of the Health Reform Law, we may continue to experience bad debts and have to provide uninsured discounts and charity care for undocumented aliens who are not permitted to enroll in an Exchange or government health care program.
Our performance depends on our ability to recruit and retain quality physicians.
Physicians generally direct the majority of hospital admissions. Thus, the success of our hospitals depends in part on the following factors:
the number and quality of the physicians on the medical staffs of our hospitals;
the admitting practices of those physicians; and
the maintenance of good relations with those physicians.
Most physicians at our hospitals also have admitting privileges at other hospitals. Our efforts to attract and retain physicians are affected by our managed care contracting relationships, national shortages in some specialties, such as anesthesiology and radiology, the adequacy of our support personnel, the condition of our facilities and medical equipment, the availability of suitable medical office space and federal and state laws and regulations prohibiting financial relationships that may have the effect of inducing patient referrals. If facilities are not staffed with adequate support personnel or technologically advanced equipment that meets the needs of patients, physicians may be discouraged from referring patients to our facilities, which could adversely affect our financial condition, results of operations and profitability.
In an effort to meet community needs in the markets in which we operate, we have implemented a strategy to employ physicians both in primary care and in certain specialties. As of June 30, 2013, we employed approximately 700 practicing physicians, excluding residents. A physician employment strategy includes increased salary and benefits costs, physician integration risks and difficulties associated with physician practice management. While we believe this strategy is consistent with industry trends, we cannot be assured of the long-term success of such a strategy. In addition, if we raise wages in response to our competitors' wage increases and are unable to pass such increases on to our payers and/or patients, our margins could decline, which could adversely affect our business, financial condition and results of operations.
We may be unable to achieve our acquisition and growth strategies and we may have difficulty acquiring non-profit hospitals due to regulatory scrutiny.
An important element of our business strategy is expansion by acquiring hospitals and ambulatory care facilities in our existing markets and in new urban and suburban markets and by entering into partnerships or affiliations with other health care service providers. The competition to acquire these facilities is significant, including competition from health care companies with greater financial resources than us. As previously discussed, during the year ended June 30, 2011, we acquired two hospitals in Chicago, Illinois, one hospital in Phoenix, Arizona and eight hospitals in metropolitan Detroit, Michigan, and during the year ended June 30, 2012, we acquired two hospitals in Harlingen and Brownsville, Texas. There is no guarantee that we will be able to successfully integrate acquired hospitals and ambulatory care facilities, which limits our ability to complete future acquisitions.
We may not be able to acquire additional hospitals on satisfactory terms and future acquisitions may be on less than favorable terms. We may have difficulty obtaining financing, if necessary, for future acquisitions on satisfactory terms. The DMC acquisition includes, and other future acquisitions may include, significant capital or other funding commitments. Furthermore, we invest capital in our existing facilities to develop new services or expand or renovate our facilities in an effort to generate new, or sustain existing, revenues from our operations. We may not be able to finance these capital commitments or development programs through operating cash flows or additional debt or equity proceeds. We sometimes agree not to sell an acquired hospital for some period of time (currently no longer than ten years) after purchasing it and/or grant the seller a right of first refusal to purchase the hospital if we agree to sell it to a third party.

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Additionally, many states, including some where we have hospitals and others where we may in the future attempt to acquire hospitals, have adopted legislation regarding the sale or other disposition of hospitals operated by non-profit entities. In other states that do not have specific legislation, the attorneys general have demonstrated an interest in these transactions under their general obligations to protect charitable assets from waste. These legislative and administrative efforts focus primarily on the appropriate valuation of the assets divested and the use of the sale proceeds by the non-profit seller. These review and approval processes can add time to the consummation of an acquisition of a non-profit hospital, and future actions on the state level could seriously delay or even prevent future acquisitions of non-profit hospitals. Furthermore, as a condition to approving an acquisition, the attorney general of the state in which the hospital is located may require us to maintain specific services, such as emergency departments, or to continue to provide specific levels of charity care, which may affect our decision to acquire or the terms upon which we acquire these hospitals.
Future acquisitions or joint ventures may use significant resources, may be unsuccessful and could expose us to unforeseen liabilities.
As part of our growth strategy, we may pursue acquisitions or joint ventures of hospitals or other health care facilities and services. These acquisitions or joint ventures may involve significant cash expenditures, debt incurrence, additional operating losses and expenses that could have a material adverse effect on our financial condition, results of operations and cash flows. Acquisitions or joint ventures involve numerous risks, including:
difficulty and expense of integrating acquired personnel into our business;
diversion of management's time from existing operations;
potential loss of key employees or customers of acquired companies; and
assumption of the liabilities and exposure to unforeseen liabilities of acquired companies, including liabilities for failure to comply with health care regulations.
We cannot assure you that we will succeed in obtaining financing for acquisitions or joint ventures at a reasonable cost, or that such financing will not contain restrictive covenants that limit our operating flexibility. We also may be unable to operate acquired facilities profitably or succeed in achieving improvements in their financial performance.
The cost of our malpractice insurance and the malpractice insurance of physicians who practice at our facilities remains volatile. Successful malpractice or tort claims asserted against us, our physicians or our employees could materially adversely affect our financial condition and profitability.
Physicians, hospitals and other health care providers are subject to legal actions alleging malpractice, general liability or related legal theories. Many of these actions involve large monetary claims and significant defense costs. Hospitals and physicians have typically maintained malpractice or professional liability insurance to protect against the costs of these types of legal actions. We created a captive insurance subsidiary on June 1, 2002 to assume a substantial portion of the professional and general liability risks of our facilities. We self-insured our professional and general liability risks, either through our captive subsidiary or through another of our subsidiaries, for losses ranging from $10.0 million to $17.5 million. We have also purchased umbrella excess policies for professional and general liability insurance for all periods through June 30, 2014 with unrelated commercial carriers to provide an additional $65.0 million of coverage in the aggregate above our self-insured retention. While our premium prices have not fluctuated significantly during the past few years, the total cost of professional and general liability insurance remains sensitive to the volume and severity of cases reported. There is no guarantee that excess insurance coverage will continue to be available in the future at a cost allowing us to maintain adequate levels of such insurance. Moreover, due to the increased retention limits insured by us and our captive subsidiary, if actual payments of claims materially exceed our projected estimates of malpractice claims, our financial condition, results of operations and cash flows could be materially adversely affected.
Physicians' professional liability insurance costs in certain markets have dramatically increased to the point where some physicians are either choosing to retire early or leave those markets. If physician professional liability insurance costs continue to escalate in markets in which we operate, some physicians may choose not to practice at our facilities, which could reduce our patient volumes and revenues. Our hospitals may also incur a greater percentage of the amounts paid to claimants if physicians are unable to obtain adequate malpractice coverage since we are often sued in the same malpractice suits brought against physicians on our medical staffs who are not employed by us.
We have employed a significant number of additional physicians from our acquisitions. Also, effective with the DMC acquisition, we now provide malpractice coverage through certain of our insurance captive subsidiaries to approximately 1,000 non-employed attending physicians, which creates additional risks for us. We expect to continue to employ additional physicians in the future. A significant increase in employed physicians could significantly increase our professional and general liability risks and related costs in future periods since for employed physicians there is no insurance coverage from unaffiliated insurance companies.

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Our facilities are concentrated in a small number of regions. If any one of the regions in which we operate experiences a regulatory change, economic downturn or other material change, our overall business results may suffer.
Among our operations as of June 30, 2013, five hospitals and various related health care businesses were located in San Antonio, Texas; six hospitals and related health care businesses were located in metropolitan Phoenix, Arizona; four hospitals and related health care businesses were located in metropolitan Chicago, Illinois; eight hospitals and various related health care businesses were located in metropolitan Detroit, Michigan; three hospitals and related health care businesses were located in Massachusetts; and two hospitals and related health care businesses were located in Harlingen and Brownsville, Texas.
For the years ended June 30, 2011, 2012 and 2013 our total revenues were generated as follows:
 
Year Ended June 30,
2011
 
2012
 
2013
San Antonio
20.7
%
 
16.5
%
 
17.4
%
PHP and AAHP
16.6

 
11.9

 
10.5

Massachusetts
12.5

 
10.4

 
10.9

Metropolitan Phoenix, excluding PHP and AAHP
13.2

 
9.1

 
9.7

Metropolitan Chicago (1)
15.5

 
12.0

 
11.3

Metropolitan Detroit (2)
21.3

 
32.9

 
32.3

Harlingen and Brownsville, Texas (3)

 
7.1

 
7.6

Other
0.2

 
0.1

 
0.3

 
100.0
%
 
100.0
%
 
100.0
%
__________
(1)
Includes CHS
(2)
Includes ProCare
(3)
Includes VBIC
Any material change in the current demographic, economic, competitive or regulatory conditions in any of these regions could adversely affect our overall business results because of the significance of our operations in each of these regions to our overall operating performance. Moreover, due to the concentration of our revenues in only six markets, our business is less diversified and, accordingly, is subject to greater regional risk than that of some of our larger competitors.

In addition, a natural disaster or other catastrophic event could affect us more significantly than other companies with less geographic concentration, and the property insurance we obtain may not be adequate to cover our losses. In particular, hurricanes could have a disruptive effect on the operations of our hospitals in south Texas and the patient populations in the areas they serve.
If we are unable to control our health care costs at PHP or if AHCCCS does not lift the cap on the new PHP contract that begins October 1, 2013, then our profitability may be adversely affected.
For the years ended June 30, 2011, 2012 and 2013, PHP generated approximately 15.9%, 10.7%, 9.6% of our total revenues, respectively. PHP derives substantially all of its revenues through a contract with AHCCCS. AHCCCS pays capitated rates to PHP and PHP subcontracts with physicians, hospitals and other health care providers to provide services to its members. If we fail to effectively manage our health care costs, these costs may exceed the payments we receive. Many factors can cause actual health care costs to exceed the capitated rates paid by AHCCCS, including:
our ability to contract with cost-effective health care providers;
the increased cost of individual health care services;
the type and number of individual health care services delivered; and
the occurrence of catastrophes, epidemics or other unforeseen occurrences.

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

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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. If AHCCCS does not lift the cap on PHP's contract, then our revenues and profitability would be reduced during the contract runout period while members are lost without being replaced.
We are dependent on our senior management team and local management personnel, and the loss of the services of one or more of our senior management team or key local management personnel could have a material adverse effect on our business.
The success of our business is largely dependent upon the services and management experience of our senior management team, which includes Charles N. Martin, Jr., our Chairman, President and Chief Executive Officer; Keith B. Pitts, our Vice Chairman; Phillip W. Roe, our Executive Vice President, Chief Financial Officer and Treasurer; Bradley A. Perkins, M.D., our Executive Vice President and Chief Transformation Officer; Timothy M. Petrikin, our Executive Vice President, Ambulatory Care Services; Joseph D. Moore, our Executive Vice President; James H. Spalding, our Executive Vice President, General Counsel and Secretary; Mark R. Montoney, M.D., our Executive Vice President and Chief Medical Officer; and Alan G. Thomas, our Executive Vice President-Operations Finance. In addition, we depend on our ability to attract and retain local managers at our hospitals and related facilities, on the ability of our senior officers and key employees to manage growth successfully and on our ability to attract and retain skilled employees. We do not maintain key man life insurance policies on any of our officers. If we were to lose any of our senior management team or members of our local management teams, or if we are unable to attract other necessary personnel in the future, it could have a material adverse effect on our business, financial condition and results of operations. If we were to lose the services of one or more members of our senior management team or a significant portion of our hospital management staff at one or more of our hospitals, we would likely experience a significant disruption in our operations and failure of the affected hospitals to adhere to their respective business plans.
Controls designed to reduce inpatient services may subject us to increased regulatory scrutiny and reduce our revenues.
Controls imposed by Medicare and commercial third-party payers designed to reduce admissions and lengths of stay, commonly referred to as “utilization reviews,” have affected and are expected to continue to affect our facilities. Utilization review entails the review of the admission and course of treatment of a patient by payers. Inpatient utilization, average lengths of stay and occupancy rates continue to be negatively affected by payer-required preadmission authorization and utilization review and by payer pressures to maximize outpatient and alternative health care delivery services for less acutely ill patients. Efforts to impose more stringent cost controls are expected to continue. For example, the Health Reform Law potentially expands the use of prepayment review by Medicare contractors by eliminating statutory restrictions on their use. Although we are unable to predict the effect these changes will have on our operations, significant limits on the scope of services reimbursed and on reimbursement rates and fees could have a material adverse effect on our business, financial position and results of operations.
There has been recent increased scrutiny of a hospital's “Medicare Observation Rate” from outside auditors, government enforcement agencies and industry observers. The term “Medicare Observation Rate” is defined as total unique observation claims divided by the sum of total unique observation claims and total inpatient short-stay acute care hospital claims. A low rate may raise suspicions that a hospital is inappropriately admitting patients that could be cared for in an observation setting. In our affiliated hospitals, we use the independent, evidence-based clinical criteria developed by McKesson Corporation, commonly known as InterQual Criteria, to determine whether a patient qualifies for inpatient admission. The industry may anticipate increased scrutiny and litigation risk, including government investigations and qui tam suits, related to inpatient admission decisions and the Medicare Observation Rate.
The industry trend towards value-based purchasing may negatively impact our revenues.
There is a trend in the health care industry towards value-based purchasing of health care services. These value-based purchasing programs include both public reporting of quality data and preventable adverse events tied to the quality and efficiency of care provided by facilities. Governmental programs, including Medicare and Medicaid, currently require hospitals to report certain quality data to receive full reimbursement updates. In addition, Medicare does not reimburse for care related to certain preventable adverse events (also called “never events”). Many large commercial payers currently require hospitals to report quality data, and several commercial payers do not reimburse hospitals for certain preventable adverse events. The Health Reform Law contains a number of provisions intended to promote value-based purchasing under Medicare and Medicaid.

55


We expect value-based purchasing programs, including programs that condition reimbursement on patient outcome measures, to become more common and to involve a higher percentage of reimbursement amounts. We are unable at this time to predict how this trend will affect our results of operations, but it could negatively impact our revenues.
Our facilities are subject to extensive federal and state laws and regulations relating to the privacy of individually identifiable information.
HIPAA required HHS to adopt standards to protect the privacy and security of individually identifiable health-related information. HHS released final regulations containing privacy standards in December 2000 and published revisions to the final regulations in August 2002. The HITECH Act (one part of the ARRA) significantly broadened the scope of the HIPAA privacy and security regulations. In addition, the HITECH Act extends the application of certain provisions of the security and privacy regulations to business associates (entities that handle protected health information on behalf of covered entities) and subjected business associates to civil and criminal penalties for violation of the regulations beginning February 17, 2010. On January 25, 2013, HHS issued the HITECH Final Rule containing modifications to the HIPAA privacy standards, security standards, breach notification standards and enforcement standards to implement certain HITECH Act provisions or otherwise deemed appropriate by HHS. The HITECH Final Rule will require significant technical, physical and administrative changes, but we believe that the cost of implementation and compliance with the HITECH Final Rule has not had, and is not expected to have, a material adverse effect on our cash flows, financial position or results of operations. In addition, on May 27, 2011, HHS issued a proposed amendment to the existing accounting for disclosures standard of the HIPAA privacy regulations. The proposed amendment would implement a HITECH Act provision that requires covered entities to account for disclosures of EPHI for treatment, payment and health care operations purposes if the disclosure is made through an electronic health record. The proposed amendment goes beyond the HITECH Act provision and would require covered entities, including our hospitals and health plans, to provide a report identifying each instance that a natural person or organization accessed EPHI in any of our electronic treatment and billing record systems during the three-year period ending on the date the report is requested. The report must track access even if the access did not involve a disclosure outside of the covered entity. Modifying our electronic record systems to prepare such access reports would require a significant commitment, action and cost by us.
Violations of the HIPAA privacy, security and breach notification regulations may result in civil and criminal penalties. The HITECH Act and the HITECH Final Rule have strengthened the enforcement provisions of HIPAA and the Office for Civil Rights has increased its HIPAA enforcement activity relative to prior years. For violations occurring on or after February 18, 2009, entities are subject to tiered ranges for civil money penalty amounts based upon the increasing levels of culpability associated with violations. Under the HITECH Act and the HITECH Final Rule, the range of minimum penalty amounts for each offense increases from up to $100 to up to $50,000 (for violations due to willful neglect and not corrected during the 30-day period beginning on the first date the entity knew or, by exercising reasonable diligence, would have known that the violation occurred). Similarly, the penalty amount available in a CY for identical violations is substantially increased from $25,000 to $1,500,000. In one recent enforcement action, HHS imposed a $4,300,000 civil monetary penalty against a covered entity for violations of the privacy rule related to patient access to health records. In another action, the covered entity that was the subject of an investigation by HHS paid a settlement of $1,500,000 and agreed to be bound by a resolution agreement and corrective action plan. In addition, the ARRA authorizes state attorney generals to bring civil actions seeking either injunction or damages in response to violations of HIPAA privacy and security regulations that threaten the privacy of state residents. Additionally, ARRA broadens the applicability of the criminal penalty provisions to employees of covered entities and requires HHS to impose penalties for violations resulting from willful neglect.
As a result of increased reviews of claims to Medicare and Medicaid for our services, we may incur additional costs and may be required to repay amounts already paid to us.
We are subject to regular post-payment inquiries, investigations and audits of the claims we submit to Medicare for payment for our services. These post-payment reviews are increasing as a result of government cost-containment initiatives, including enhanced medical necessity reviews for Medicare patients admitted as inpatients to general acute care hospitals for certain procedures (e.g., cardiovascular procedures) and to long-term care hospitals, and audits of Medicare claims under the Recovery Audit Program. The Recovery Audit Program began as a demonstration project in 2005, but the program was made permanent by the Tax Relief and Health Care Act of 2006. CMS commenced the permanent national Recovery Audit Program in 2010.
Medicare RACs utilize a post-payment targeted review process employing data analysis techniques in order to identify those Medicare claims most likely to contain overpayments, such as incorrectly coded services, incorrect payment amounts, non-covered services and duplicate payments. The Recovery Audit Program review is either “automated”, for which a decision can be made without reviewing a medical record, or “complex”, for which the RAC must contact the provider in order to procure and review the medical record to make a decision about the payment. CMS has given RACs the authority to look back at claims up to three years old, provided that the claim was paid on or after October 1, 2007. Claims identified as overpayments

56


will be subject to the Medicare appeals process. Under the Health Reform Law, CMS also has general authority to enter into contracts with RACs to identify, reconcile and recoup overpayments for Medicare Advantage plans and Medicare Part D.
In addition to the Medicare Recovery Audit Program, in the September 16, 2011 Federal Register, CMS finalized provisions relating to implementation of a Medicaid RAC program. States were expected to implement their respective RAC programs by January 1, 2012, although states could request an extension. CMS's website suggests 48 of the 50 states are reporting RAC data to CMS. Medicaid RACs have authority to look back at claims up to three years from the date of the claim, although states may request and exception for a shorter or longer look-back period. States may coordinate with Medicaid RACs regarding recoupment of overpayments and refer suspected fraud and abuse to appropriate law enforcement agencies. Medicaid RACs are paid with amounts recovered. Most Medicaid RACs appear to be paid by states on a contingency fee basis with most contingency fees ranging from 8-12% of recovered payments. It is not clear whether providers have or will face challenges under the Medicaid RAC program that are similar to those in connection with the Medicare RAC program, such as denial of claims for billing the wrong site of service. Questions also exist as to how the Medicaid RAC program will coordinate with the MIC Program. CMS employs MICs to perform post-payment audits of Medicaid claims and identify overpayments. The Health Reform Law increased federal funding for the MIC program beginning in FFY 2011 and the increased funding continues through FFY 2016. In addition to Medicare recovery auditors and MICs, several other contractors, including the state Medicaid agencies, have increased their review activities.
Further, on November 15, 2011, CMS announced the RAPR demonstration will allow RACs to review claims before they are paid to ensure that the provider complied with all Medicare payment rules.  The RACs will conduct prepayment reviews on certain types of claims that historically result in high rates of improper payments, beginning with those involving short stay inpatient hospital services. These reviews will focus on seven states (Florida, California, Michigan, Texas, New York, Louisiana and Illinois) with high populations of fraud and error-prone providers and four states (Pennsylvania, Ohio, North Carolina, and Missouri) with high claims volumes of short inpatient hospital stays for a total of 11 states. The goal of the RAPR demonstration is to reduce improper payments before they are paid, rather than the traditional “pay and chase” methods of looking for improper payments after they have been made. These prepayment reviews will not replace the MAC prepayment reviews as RACs and MACs are supposed to coordinate to avoid duplicate efforts. The RAPR demonstration was to start in January 2012, but CMS decided in January 2012 to delay the start of the program. The RAPR demonstration began on September 1, 2012.
These additional post-payment reviews may require us to incur additional costs to respond to requests for records and to pursue the reversal of payment denials, and ultimately may require us to refund amounts paid to us by Medicare or Medicaid that are determined to have been overpaid.
If we fail to continually enhance our hospitals with the most recent technological advances in diagnostic and surgical equipment, our ability to maintain and expand our markets will be adversely affected.
Technological advances with respect to computed axial tomography, magnetic resonance imaging and positron emission tomography equipment, as well as other equipment used in our facilities, are continually evolving. In an effort to compete with other health care providers, we must constantly evaluate our equipment needs and upgrade equipment as a result of technological improvements. Such equipment costs typically range from $1.0 million to $3.0 million, exclusive of construction or build-out costs. If we fail to remain current with the technological advancements of the medical community, our patient volumes and revenue may be negatively impacted.
Our hospitals face competition for staffing especially as a result of the shortage of nurses and the increased imposition on us of nurse-staffing ratios, which has in the past and may in the future increase our labor costs and materially reduce our profitability.
We compete with other health care providers in recruiting and retaining qualified management and staff personnel responsible for the day-to-day operations of each of our hospitals, including most significantly nurses and other non-physician health care professionals. While the national nursing shortage has abated somewhat as a result of the weakened U.S. economy, certain portions of our markets have limited available nursing resources. In the health care industry generally, including in our markets, the shortage of nurses and other medical support personnel has become a significant operating issue. This shortage has caused us in the past and may require us in the future to increase wages and benefits to recruit and retain nurses and other medical support personnel or to hire more expensive temporary personnel. On several occasions in the past, we voluntarily raised, and expect to raise in the future, wages for our nurses and other medical support personnel.
In addition, union-mandated or state-mandated nurse-staffing ratios significantly affect not only labor costs, but may also cause us to limit patient admissions with a corresponding adverse effect on revenues if we are unable to hire the appropriate number of nurses to meet the required ratios. While we do not currently operate in any states with mandated nurse-staffing

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ratios, the states in which we operate could adopt mandatory nurse-staffing ratios at any time. In those instances where our nurses are unionized, it is our experience that new union contracts often impose significant new additional staffing ratios by contract on our hospitals. This was the case with the increased staffing ratios imposed on us in our union contract with our nurses at Saint Vincent Hospital in Worcester, Massachusetts negotiated in 2007.
The U.S. Congress has considered a bill called the Employee Free Choice Act of 2009 (“EFCA”), which organized labor has called its number one legislative objective. EFCA would amend the National Labor Relations Act to establish a procedure whereby the National Labor Relations Board (“NLRB”) would certify a union as the bargaining representative of employees, without a NLRB-supervised secret ballot election, if a majority of unit employees sign valid union authorization cards (the “card-check provision”). Additionally, under EFCA, parties that are unable to reach a first contract within 90 days of collective bargaining could refer the dispute to mediation by the Federal Mediation and Conciliation Service (the “Service”). If the Service is unable to bring the parties to agreement within 30 days, the dispute then would be referred to binding arbitration. Also, the bill would provide for increased penalties for labor law violations by employers. In July 2009, due to intense opposition from the business community, alternative draft legislation became public, dropping the card-check provision, but putting in its place new provisions making it easier for employees to organize including provisions to require shorter unionization campaigns, faster elections and limitations on employer-sponsored anti-unionization meetings, which employees are required to attend. We believe it is unlikely this legislation will be considered in the current Congress, since the House of Representatives is controlled by the Republican party. However, this legislation, if passed by this or a subsequent Congress, would make it easier for our nurses or other hospital employees to unionize, which could materially increase our labor costs. On December 21, 2011, the NLRB issued a final rule, effective April 30, 2012, which reduced the time it takes to conduct elections largely by limiting litigation issues and procedures by employers prior to the conduct of the election and deferring questions of individual voter eligibility until after the election has been held. This change in NLRB procedures is not as far-reaching as was considered in the EFCA, but it may make it easier for our employees to unionize, which could materially increase our labor costs.
If our labor costs continue to increase, we may not be able to raise our payer reimbursement levels to offset these increased costs. Because substantially all of our net patient revenues consist of payments based on fixed or negotiated rates, our ability to pass along increased labor costs is materially constrained. Our failure to recruit and retain qualified management, nurses and other medical support personnel, or to control our labor costs, could have a material adverse effect on our profitability.
Our pension plan obligations under one of DMC's pension plans are currently underfunded, and we may have to make significant cash payments to this plan, which would reduce the cash available for our businesses.
Effective January 1, 2011, we acquired substantially all of DMC's assets (other than donor-restricted assets and certain other assets) and assumed substantially all of its liabilities (other than its outstanding bonds and similar debt and certain other liabilities). The assumed liabilities include a pension liability under a “frozen” defined benefit pension plan of DMC. As of June 30, 2013, the unfunded pension liability reflected on our consolidated balance sheet was approximately $187.7 million. This pension liability is dependent upon many factors, including returns on invested assets, the level of certain market interest rates and the discount rate used to recognize pension obligations. Unfavorable returns on the plan assets or unfavorable changes in applicable laws or regulations could materially change the timing and amount of required plan funding, which would reduce the cash available for our businesses. In addition, a decrease in the discount rate used to determine this pension obligation could result in an increase in the valuation of this pension obligation, which could affect the reported funded status of this pension plan and necessary future contributions, as well as the periodic pension cost in respect of this plan in subsequent fiscal years.
Under the Employee Retirement Income Security Act of 1974, as amended, the Pension Benefit Guaranty Corporation (“PBGC”) has the authority to terminate an underfunded tax-qualified pension plan under limited circumstances. In the event that the tax-qualified pension plan referred to above is terminated by the PBGC, we could be liable to the PBGC for the entire amount of the underfunding.
Compliance with Section 404 of the Sarbanes-Oxley Act may negatively impact our results of operations and failure to comply may subject us to regulatory scrutiny and a loss of investors' confidence in our internal control over financial reporting.
Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”) requires us to perform an evaluation of our internal control over financial reporting and file management's attestation with our Annual Report on Form 10-K each year. Section 404 also requires our independent auditors to opine on our internal control over financial reporting. We have evaluated, tested and implemented internal controls over financial reporting to enable management to report on such internal controls under Section 404. However, we cannot assure you that the conclusions we and our independent auditor reached as of June 30, 2013 will represent conclusions we or our independent auditors reach in future periods. Failure on our part to comply with Section 404

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may subject us to regulatory scrutiny and a loss of public confidence in the reliability of our financial statements. In addition, we may be required to incur costs in improving our internal control over financial reporting and hiring additional personnel. Any such actions could negatively affect our financial condition and results of operations.
A failure of our information systems would adversely affect our ability to properly manage our operations.
We rely on our information systems and our ability to successfully use these systems in our operations. These systems are essential to the following areas of our business operations, among others:

patient accounting, including billing and collection of patient service revenues;
financial, accounting, reporting and payroll;
coding and compliance;
laboratory, radiology and pharmacy systems;
remote physician access to patient data;
negotiating, pricing and administering managed care contracts; and
monitoring quality of care.
If we are unable to use these systems effectively, we may experience delays in collection of patient service revenues and may not be able to properly manage our operations or oversee compliance with laws or regulations.
If we fail to effectively and timely implement electronic health record systems and transition to the ICD-10 coding system, our operations could be adversely affected.
As required by ARRA, HHS has adopted an incentive payment program for eligible hospitals and health care professionals that implement certified EHR technology and use it consistently with “meaningful use” requirements. If our hospitals and employed or contracted professionals do not meet the Medicare or Medicaid EHR incentive program requirements, we will not receive Medicare or Medicaid incentive payments to offset some of the costs of implementing the EHR systems. Further, beginning in FFY 2015, eligible hospitals and physicians that fail to demonstrate meaningful use of certified EHR technology will be subject to reduced payments from Medicare. Failure to implement EHR systems effectively and in a timely manner could have a material adverse effect on our financial position and results of operations.
Health plans and providers, including our hospitals, are required to transition to the new ICD-10 coding system, which greatly expands the number and detail of billing codes used for inpatient claims. Use of the ICD-10 system is required beginning October 1, 2014 as a result of an extension granted by CMS. Transition to the new ICD-10 system requires significant investment in coding technology and software as well as the training of staff involved in the coding and billing process. In addition to these upfront costs of transition to ICD-10, it is possible that our hospitals could experience disruption or delays in payment due to technical or coding errors or other implementation issues involving our systems or the systems and implementation efforts of health plans and their business partners. Further, the transition to the more detailed ICD-10 coding system could result in decreased reimbursement if the use of ICD-10 codes result in conditions being reclassified to MS-DRGs or commercial payer or payment groupings with lower levels of reimbursement than assigned under the previous system.
Difficulties with current construction projects or new construction projects such as additional hospitals or major expansion projects may involve significant capital expenditures that could have an adverse impact on our liquidity.
We have begun construction on a new acute care hospital in New Braunfels, Texas, which is north of San Antonio, and may decide to construct additional hospitals and expand existing facilities in the future in order to achieve our growth objectives. Additionally, the DMC purchase agreement includes a commitment by us to fund $500 million of specified construction projects and $350 million of routine capital expenditures at the DMC facilities during the five years subsequent to the closing of the acquisition. As of June 30, 2013, we had spent approximately $191.5 million related to the specified construction projects commitment and $129.5 million related to the routine capital expenditures commitment. The DMC capital commitments include the following remaining annual aggregate spending amounts as of June 30, 2013: $204 million committed within one year; $275 million committed within two to three years; and $50 million committed in the fourth year and beyond. Our ability to complete construction of new hospitals or new expansion projects on budget and on schedule would depend on a number of factors, including, but not limited to:

our ability to control construction costs;
the ability of general contractors or subcontractors to perform under their contracts;
weather conditions;
availability of labor or materials;
our ability to obtain necessary licensing and other required governmental authorizations; and
our ability to avoid other unforeseen problems and delays.

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As a result of these and other factors, we cannot assure you that we will not experience increased construction costs on our construction projects or that we will be able to construct our current or any future construction projects as originally planned. In addition, our current and any future major construction projects would involve a significant commitment of capital with no revenues associated with the projects during construction, which also could have a future adverse impact on our liquidity.
If the costs for construction materials and labor continue to rise, such increased costs could have an adverse impact on the return on investment relating to our expansion projects.
The cost of construction materials and labor has significantly increased over the past years as a result of global and domestic events. Increases in oil and gas prices have increased costs for oil-based products and for transporting materials to job sites. As we continue to invest in modern technologies, emergency rooms and operating room expansions, we expend significant sums of cash. We evaluate the financial viability of such projects based on whether the projected cash flow return on investment exceeds our cost of capital. Such returns may not be achieved if the cost of construction continues to rise significantly or anticipated volumes do not materialize.
State efforts to regulate the construction or expansion of hospitals could impair our ability to operate and expand our operations.
Some states require health care providers to obtain prior approval, known as Certificates of Need, for:

the purchase, construction or expansion of health care facilities;
capital expenditures exceeding a prescribed amount; or
changes in services or bed capacity.
In giving approval, these states consider the need for additional or expanded health care facilities or services. Illinois, Michigan and Massachusetts are the only states in which we currently own hospitals that have Certificate of Need laws. The failure to obtain any required Certificate of Need could impair our ability to operate or expand operations in these states.
If the fair value of our reporting units declines, a material non-cash charge to earnings from impairment of our goodwill could result.
The Blackstone Group L.P., together with its affiliates (collectively, “Blackstone”), acquired our predecessor company during fiscal 2005. We recorded a significant portion of the purchase price as goodwill. At June 30, 2013, we had $789.9 million of goodwill recorded on our financial statements. There is no guarantee that we will be able to recover the carrying value of this goodwill through our future cash flows. On an ongoing basis, we evaluate, based on the fair value of our reporting units, whether the carrying value of our goodwill is impaired.
Our hospitals are subject to potential responsibilities and costs under environmental laws that could lead to material expenditures or liability.
We are subject to various federal, state and local environmental laws and regulations, including those relating to the protection of human health and the environment. We could incur substantial costs to maintain compliance with these laws and regulations. To our knowledge, we have not been and are not currently the subject of any material investigations relating to noncompliance with environmental laws and regulations. We could become the subject of future investigations, which could lead to fines or criminal penalties if we are found to be in violation of these laws and regulations. The principal environmental requirements and concerns applicable to our operations relate to proper management of regulated materials, including hazardous waste, low-level radioactive and other medical waste, above-ground and underground storage tanks, operation of boilers, chillers and other equipment, and management of building conditions, such as the presence of mold, lead-based paint or asbestos. Our hospitals engage independent contractors for the transportation, handling and disposal of hazardous waste, and we require that our hospitals be named as additional insureds on the liability insurance policies maintained by these contractors.
We also may be subject to requirements related to the remediation of hazardous substances and other regulated materials that have been released into the environment at properties now or formerly owned or operated by us or our predecessors, or at properties where such substances and materials were sent for off-site treatment or disposal. Liability for costs of investigation and remediation may be imposed without regard to fault, and under certain circumstances on a joint and several basis and can be substantial.
Our Sponsors and certain members of our management continue to have significant influence over us and they may have conflicts of interest with us in the future.
We are controlled by private equity funds associated with Blackstone and Metalmark Capital, together with their affiliates (the “Sponsors”), and certain members of our management who are party to a stockholders agreement between such

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shareholders and us. As of July 31, 2013, our Sponsors owned approximately 46.5% of our Common Stock through various investment funds affiliated with our Sponsors. Also, as of July 31, 2013, certain members of our management who are party to the stockholders agreement beneficially owned approximately 11.6% of our Common Stock. Our Sponsors have the ability to nominate a majority of our directors provided certain ownership thresholds are maintained, and thereby control our policies and operations, including the appointment of management, future issuances of our Common Stock or other securities, the payment of dividends, if any, on our Common Stock, the incurrence of debt by us, amendments to our certificate of incorporation and bylaws and the entering into of extraordinary transactions, and their interests may not in all cases be aligned with the interest of our public stockholders. In addition, under the stockholders agreement, Blackstone has consent rights over certain extraordinary transactions by us, including mergers and sales of all or substantially all of our assets, provided a certain ownership threshold is maintained. In addition, the Sponsors may have an interest in pursuing acquisitions, divestitures and other transactions that, in their judgment, could enhance their equity investment, even though such transactions might involve risks to us and our public stockholders. For example, the Sponsors could cause us to make acquisitions that increase our indebtedness or to sell revenue-generating assets. As a result, the Sponsors have control over our decisions to enter into any corporate transaction regardless of whether others believe that the transaction is in our best interests. So long as the Sponsors and certain members of our management who are party to the stockholders agreement continue to beneficially own a majority of our outstanding Common Stock, they will have the ability to control the vote in any election of directors.
Our Sponsors are also in the business of making investments in companies and may from time to time acquire and hold interests in businesses that compete directly or indirectly with us. Our Sponsors may also pursue acquisition opportunities that are complementary to our business and, as a result, those acquisition opportunities may not be available to us. So long as the Sponsors and certain members of our management who are party to the stockholders agreement continue to beneficially own a significant amount of our outstanding Common Stock, even if such amount is less than 50%, the Sponsors will continue to be able to strongly influence or effectively control our decisions and the Sponsors will have the right to nominate a certain number of our directors.
Risks Related to Our Indebtedness
Our high level of debt and significant leverage may adversely affect our operations and our ability to grow and otherwise execute our business strategy.
We have a substantial amount of indebtedness. As of June 30, 2013, we had approximately $2,996.2 million of total indebtedness outstanding, $1,092.9 million of which was secured indebtedness (consisting of outstanding debt under our senior secured term loan facility maturing in January 2016 (the “2010 Term Loan Facility”) and capital leases). In addition, as of June 30, 2013, we had an additional $327.2 million of secured indebtedness available for borrowing under our senior secured revolving credit facility (the "2010 Revolving Facility" and together with the 2010 Term Loan Facility, the "2010 Credit Facilities"), after taking into account $37.8 million of outstanding letters of credit. In addition, we may request an incremental term loan facility be added to our 2010 Term Loan Facility to issue additional term loans in such amounts as we determine subject to the receipt of lender commitments and certain other conditions. We may seek to further increase the borrowing capacity under the 2010 Revolving Facility to an amount larger than $365.0 million, subject to the receipt of lender commitments and certain other conditions. The amount of our outstanding indebtedness is substantial compared to the net book value of our assets.
Our substantial indebtedness could have important consequences, including the following:
it could become difficult for us to satisfy our obligations with respect to the $1,175.0 million 8% senior notes due in 2018 issued in January 2010 and July 2010 (the "8.0% Notes") and the $725.0 million 7.75% senior notes due 2019 issued in January 2011 and March 2012 (the "7.75% Senior Notes");
limit our ability to obtain additional financing to fund future capital expenditures, working capital, acquisitions or other needs;
increase our vulnerability to general adverse economic, market and industry conditions and limit our flexibility in planning for, or reacting to, these conditions;
make us vulnerable to increases in interest rates since all of our borrowings under our 2010 Credit Facilities are, and additional borrowings may be, at variable interest rates;
limit our flexibility to adjust to changing market conditions and ability to withstand competitive pressures, and we may be more vulnerable to a downturn in general economic or industry conditions or be unable to carry out capital spending that is necessary or important to our growth strategy and our efforts to improve operating margins;
limit our ability to use operating cash in other areas of our business because we must use a substantial portion of these funds to make principal and interest payments; and
limit our ability to compete with others who are not as highly leveraged.

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Our ability to make scheduled payments of principal and interest or to satisfy our debt obligations, to refinance our indebtedness or to fund capital expenditures will depend on our future operating performance. Prevailing economic conditions (including interest rates) and financial, business and other factors, many of which are beyond our control, will also affect our ability to meet these needs. We may not be able to generate sufficient cash flows from operations or realize anticipated revenue growth or operating improvements, or obtain future borrowings in an amount sufficient to enable us to pay our debt, or to fund our other liquidity needs. We may need to refinance all or a portion of our debt on or before maturity. We may not be able to refinance any of our debt when needed on commercially reasonable terms or at all.
A breach of any of the restrictions or covenants in our debt agreements could cause a cross-default under other debt agreements. A significant portion of our indebtedness then may become immediately due and payable. We are not certain whether we would have, or be able to obtain, sufficient funds to make these accelerated payments. If any senior debt is accelerated, our assets may not be sufficient to repay in full such indebtedness and our other indebtedness.
Despite our current leverage, we may still be able to incur substantially more debt. This could further exacerbate the risks that we and our subsidiaries face.
We and our subsidiaries may be able to incur substantial additional indebtedness in the future. The terms of the indentures governing the 8.0% Notes and the 7.75% Senior Notes and the 2010 Credit Facilities do not fully prohibit us or our subsidiaries from doing so. Our 2010 Revolving Facility provides commitments of up to $365.0 million (not giving effect to any outstanding letters of credit or outstanding borrowings, which would reduce the amount available under our 2010 Revolving Facility). In addition, we may seek to further increase the borrowing availability under the 2010 Revolving Facility and to increase the amount of our 2010 Term Loan Facility as previously described. All of those borrowings would be senior and secured, and, as a result, would be effectively senior to the 8.0% Notes, the 7.75% Senior Notes, and the guarantees of the 8.0% Notes and the guarantees of the 7.75% Senior Notes by our guarantor subsidiaries. If we incur any additional indebtedness that ranks equally with the 8.0% Notes, the 7.75% Senior Notes, and the holders of that debt will be entitled to share ratably with the holders of the 8.0% Notes and the 7.75% Senior Notes in any proceeds distributed in connection with any insolvency, liquidation, reorganization, dissolution or other winding up of us. If new debt is added to our current debt levels, the related risks that we and our subsidiaries now face could intensify.
An increase in interest rates would increase the cost of servicing our debt and could reduce our profitability.
All of the borrowings under the 2010 Credit Facilities bear interest at variable rates. As a result, an increase in interest rates, whether because of an increase in market interest rates or an increase in our own cost of borrowing, would increase the cost of servicing our debt and could materially reduce our profitability. A 1.0% increase in the expected rate of interest under the 2010 Term Loan Facility would increase our annual interest expense by approximately $10.9 million. The impact of such an increase would be more significant to us than it would be for some other companies because of our substantial debt. We have from time to time managed our exposure to changes in interest rates through the use of interest rate swap agreements on certain portions of our previously outstanding debt and may elect to enter into similar instruments in the future for the 2010 Credit Facilities. If we enter into such derivative instruments, our ultimate interest payments may be greater than those that would be required under existing variable interest rates.
Operating and financial restrictions in our debt agreements limit our operational and financial flexibility.
The 2010 Credit Facilities and the indentures under which the 8.0% Notes, and the 7.75% Senior Notes were issued contain a number of significant covenants that, among other things, restrict our ability to:
incur additional indebtedness or issue preferred stock;
pay dividends on or make other distributions or repurchase our capital stock or make other restricted payments;
make investments;
enter into certain transactions with affiliates;
limit dividends or other payments by restricted subsidiaries to the issuers of the notes or other restricted subsidiaries;
create liens without securing the notes;
designate our subsidiaries as unrestricted subsidiaries; and
sell certain assets or merge with or into other companies or otherwise dispose of all or substantially all of our assets.


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In addition, under the 2010 Credit Facilities, we are required to satisfy and maintain specified financial ratios and tests. Events beyond our control may affect our ability to comply with those provisions, and we may not be able to meet those ratios and tests. The breach of any of these covenants would result in a default under the 2010 Credit Facilities. In the event of default, the lenders could elect to declare all amounts borrowed under the 2010 Credit Facilities, together with accrued interest, to be due and payable and could proceed against the collateral securing that indebtedness. Borrowings under the 2010 Credit Facilities are effectively senior in right of payment to the 8.0% Notes and the 7.75% Senior Notes. If any of our indebtedness were to be accelerated, our assets may not be sufficient to repay in full our indebtedness.
Our capital expenditure and acquisition strategies require substantial capital resources. The building of new hospitals and the operations of our existing hospitals and acquired hospitals require ongoing capital expenditures for construction, renovation, expansion and the addition of medical equipment and technology. More specifically, we are contractually obligated to make significant capital expenditures relating to the acquired DMC facilities. Also, construction costs to build new hospitals are substantial and continue to increase. Our debt agreements may restrict our ability to incur additional indebtedness to fund these expenditures.
A breach of any of the restrictions or covenants in our debt agreements could cause a cross-default under other debt agreements. A significant portion of our indebtedness then may become immediately due and payable. We are not certain whether we would have, or be able to obtain, sufficient funds to make these accelerated payments. If any debt is accelerated, our assets may not be sufficient to repay in full such indebtedness and our other indebtedness.
We may not be able to generate sufficient cash to service all of our indebtedness and may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.
Our ability to make scheduled payments or to refinance our debt obligations depends on our financial and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. We may not be able to maintain a level of cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness. In addition, the agreements governing our indebtedness allow us to make significant dividend payments, investments and other restricted payments. The making of these payments could decrease available cash and adversely affect our ability to make principal and interest payments on our indebtedness.
If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, seek additional capital or seek to restructure or refinance our indebtedness. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. In the absence of such operating results and resources, we could face substantial liquidity problems and might be required to sell material assets or operations in an attempt to meet our debt service and other obligations. The 2010 Credit Facilities and the indentures governing the 8.0% Notes and the 7.75% Senior Notes restrict our ability to use the proceeds from asset sales. We may not be able to consummate those asset sales to raise capital or sell assets at prices that we believe are fair and proceeds that we do receive may not be adequate to meet any debt service obligations then due.
We must rely on payments from our subsidiaries to fund payments on our indebtedness. Such funds may not be available in certain circumstances.
We are a holding company and all of our operations are conducted through our subsidiaries. Therefore, we depend on the cash flows of our subsidiaries to meet our obligations, including our indebtedness. The ability of these subsidiaries to distribute money to us by way of dividends, distributions, interest, return on investments, or other payments (including loans) is subject to various restrictions, including restrictions imposed by the 2010 Credit Facilities and the indentures relating to our existing senior notes; and future debt may also limit such payments.
If we default on our obligations to pay our other indebtedness, we may not be able to make payments on our existing notes.
Any default under the agreements governing our indebtedness, including a default under our 2010 Credit Facilities that is not waived by the required lenders, and the remedies sought by the holders of such indebtedness, could make us unable to pay principal, premium, if any, and interest on our existing notes and substantially decrease the market value of our existing notes. If we are unable to generate sufficient cash flows and are otherwise unable to obtain funds necessary to meet required payments of principal, premium, if any, and interest on our indebtedness, or if we otherwise fail to comply with the various covenants, including financial and operating covenants, in the instruments governing our indebtedness (including our 2010 Credit Facilities), we could be in default under the terms of the agreements governing such indebtedness. In the event of such default,

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the holders of such indebtedness could elect to declare all the funds borrowed thereunder to be due and payable, together with accrued and unpaid interest, the lenders under our 2010 Revolving Facility could elect to terminate their commitments, cease making further loans and institute foreclosure proceedings against our assets, and we could be forced into bankruptcy or liquidation.
If our operating performance declines, we may in the future need to seek a waiver from the required lenders under our 2010 Credit Facilities to avoid being in default. If we breach our covenants under our 2010 Credit Facilities and seek a waiver, we may not be able to obtain a waiver from the required lenders. If this occurs, we would be in default under our 2010 Credit Facilities, the lenders could exercise their rights as described above, and we could be forced into bankruptcy or liquidation.
Item 1B.    Unresolved Staff Comments.
Not applicable.

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Item 2.     Properties.
We owned and operated 28 hospitals as of June 30, 2013. The following table contains information concerning our hospitals:
Hospital (1)
 
City
 
Licensed Beds
 
Date Acquired
Arizona
 
 
 
 
 
 
Maryvale Hospital
 
Phoenix
 
232

 
June 1, 1998
Phoenix Baptist Hospital
 
Phoenix
 
221

 
June 1, 2000
Arrowhead Hospital
 
Glendale
 
217

 
June 1, 2000
West Valley Hospital (2)
 
Goodyear
 
164

 
September 4, 2003
Paradise Valley Hospital
 
Phoenix
 
136

 
November 1, 2001
Arizona Heart Hospital (3)
 
Phoenix
 
59

 
October 1, 2010
Illinois
 
 
 
 
 
 
MacNeal Hospital
 
Berwyn
 
427

 
February 1, 2000
Louis A. Weiss Memorial Hospital
 
Chicago
 
236

 
June 1, 2002
West Suburban Medical Center
 
Oak Park
 
233

 
August 1, 2010
Westlake Hospital
 
Melrose Park
 
242

 
August 1, 2010
Massachusetts
 
 
 
 

 
 
Saint Vincent Hospital at Worcester Medical Center
 
Worcester
 
321

 
December 31, 2004
MetroWest Medical Center — Framingham Union Hospital
 
Framingham
 
178

 
December 31, 2004
MetroWest Medical Center — Leonard Morse Hospital
 
Natick
 
141

 
December 31, 2004
Michigan
 
 
 
 
 
 
DMC Harper University Hospital
 
Detroit
 
567

 
January 1, 2011
DMC Sinai—Grace Hospital
 
Detroit
 
383

 
January 1, 2011
DMC Detroit Receiving Hospital
 
Detroit
 
273

 
January 1, 2011
DMC Children’s Hospital of Michigan
 
Detroit
 
228

 
January 1, 2011
DMC Huron Valley—Sinai Hospital
 
Commerce
 
153

 
January 1, 2011
DMC Rehabilitation Institute of Michigan (3)
 
Detroit
 
94

 
January 1, 2011
DMC Surgery Hospital (3)
 
Madison Heights
 
36

 
January 1, 2011
DMC Hutzel Women’s Hospital (4)
 
Detroit
 
N/A

 
January 1, 2011
Texas
 
 
 
 

 
 
Baptist Medical Center
 
San Antonio
 
623

 
January 1, 2003
Valley Baptist Medical Center (5)
 
Harlingen
 
586

 
September 1, 2011
Northeast Baptist Hospital
 
San Antonio
 
379

 
January 1, 2003
St. Luke’s Baptist Hospital
 
San Antonio
 
282

 
January 1, 2003
North Central Baptist Hospital
 
San Antonio
 
280

 
January 1, 2003
Valley Baptist Medical Center—Brownsville (5)
 
Brownsville
 
280

 
September 1, 2011
Mission Trail Baptist Hospital (2)
 
San Antonio
 
110

 
June 27, 2011
       Total Licensed Beds
 
 
 
7,081

 
 
_____________________
(1)
All of our hospitals are acute care hospitals, except as indicated below.
 
 
(2)
These hospitals were constructed, not acquired. Mission Trail Baptist Hospital was a replacement facility for Southeast Baptist Hospital.
 
 
(3)
This is a specialty hospital.
 
 
(4)
Licensed beds for DMC Hutzel Women’s Hospital are presented on a combined basis with DMC Harper University Hospital.
 
 
(5)
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.

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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 leased approximately 53,200 square feet of office space at 20 Burton Hills Boulevard, Nashville, Tennessee, for our corporate headquarters.
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.

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Item 3.     Legal Proceedings.
We operate in a highly regulated and litigious industry. As a result, various lawsuits, claims and legal and regulatory proceedings have been instituted or asserted against us. While we cannot predict the likelihood of future claims or inquiries, we expect that new matters may be initiated against us from time to time. The results of claims, lawsuits and investigations cannot be predicted, and it is possible that the ultimate resolution of these matters, individually or in the aggregate, may have a material adverse effect on our business (both in the near and long term), financial position, results of operations or cash flows. We recognize that, where appropriate, our interests may be best served by resolving certain matters without litigation. If non-litigated resolution is not possible or appropriate with respect to a particular matter, we will continue to defend ourselves vigorously.
Currently pending legal proceedings and investigations that are not in the ordinary course of business are set forth below. Where specific amounts are sought in any pending legal proceeding, those amounts are disclosed. For all other matters, where the possible loss or range of loss is reasonably estimable, an estimate is provided. Where no estimate is provided, the possible amount of loss is not reasonably estimable at this time. We record reserves for claims and lawsuits when they are probable and reasonably estimable. For matters where the likelihood or extent of a loss is not probable or cannot be reasonably estimated, we have not recognized in our consolidated financial statements potential liabilities that may result.
We are also subject to claims and lawsuits arising in the ordinary course of business, including potential claims related to care and treatment provided at our hospitals and outpatient services facilities. Although the results of these claims and lawsuits cannot be predicted with certainty, we believe that the ultimate resolution of these ordinary course claims and lawsuits will not have a material adverse effect on our business, financial condition or results of operations.
Sherman Act Antitrust Class Action Litigation — Maderazo, et al v. VHS San Antonio Partners, L.P. d/b/a Baptist Health Systems, et. al., Case No. 5:06cv00535 (United States District Court, Western District of Texas, San Antonio Division, filed June 20, 2006 and amended August 29, 2006) and Cason-Merenda, et al. v. VHS of Michigan, Inc. d/b/a Detroit Medical Center, et al., Case No. 2:06-cv-15601-GER-DAS (United States District Court, Eastern District of Michigan, Southern Division, filed December 15, 2006
On June 20, 2006, a federal antitrust class action suit was filed in San Antonio, Texas against our Baptist Health System subsidiary in San Antonio, 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 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, we 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. We continue to believe that the allegations contained within this putative class action suit are without merit, and we have vigorously worked to defeat class certification. If a class is certified, we will continue to defend vigorously against the litigation.
On the same date in 2006 that this suit was filed against us 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 us). 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, we believe 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

67


Detroit. The registered nurses in our 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, 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 DMC will be the only non-settling defendant, and we understand 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 plaintiff's 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 our 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 our financial position or results of operations.
DOJ Enforcement Initiative: Medicare Billing for Implantable Cardioverter Defibrillators (“ICDs”)
In September 2010, we received a letter, which was signed jointly by an Assistant United States Attorney in the Southern District of Florida and an attorney from the DOJ Civil Division, stating that, among other things, (1) the DOJ is conducting an investigation to determine whether or not certain hospitals have submitted claims for payment for the implantation of ICDs that were not medically indicated and/or otherwise violated Medicare payment policy, (2) the investigation covers the time period commencing with Medicare’s expansion of coverage of ICDs in 2003 through the present, (3) the relevant CMS National Coverage Determination (“NCD”) excludes Medicare coverage for ICDs implanted in patients who have had an acute myocardial infarction within the past 40 days or an angioplasty or bypass surgery within the past three months, (4) DOJ’s initial analysis of claims submitted to Medicare indicates that many of our hospitals may have submitted claims for ICDs and related services that were excluded from coverage, (5) the DOJ’s review is preliminary, but continuing, and it may include medical review of patient charts and other documents, along with statements under oath, and (6) we and our hospitals should ensure the retention and preservation of all information, electronic or otherwise, pertaining or related to ICDs. Upon receipt of this letter, we immediately took steps to retain and preserve all of our information and that of our hospitals related to ICDs.
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 we received, rather than subpoenas. DMC received its letter from DOJ in respect of ICDs in December 2010. We understand that the DOJ is investigating hundreds of other hospitals, in addition to ours, for ICD billings, as part of a national enforcement initiative.
We have 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 we review the identified cases. We understand 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.
We intend to cooperate fully with the investigation of this matter. To date, the DOJ has not asserted any specific claim of damages against us or our hospitals. Because we are in the early stages of this investigation, we are unable to predict its timing or outcome at this time. However, as we understand that this investigation is being conducted under the FCA, we are 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 our business, financial condition or results of operations.

68


United States of America ex rel. Shanna Woyak v. Vanguard Health Systems, Inc.; Abrazo Health Care

On April 8, 2013, we were made aware of a civil action against us that was originally filed under seal on June 25, 2012 in the U.S. District Court for the District of Arizona.  This action was brought by Shanna Woyak as a private party “qui tam relator” on behalf of the federal government.
The action brought by Ms. Woyak alleges civil violations of the federal FCA.  Ms. Woyak's claims are primarily premised on allegations that our Arizona Heart Hospital (“Arizona Heart") 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 we allegedly fraudulently increased our 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.
The OIG has previously informed us that its investigation into provider-based matters relating to Arizona Heart and PBH has been closed.
We believe that all of the allegations described above are without merit and intend to vigorously defend ourself in these actions, if pursued. Management does not believe that the final outcome of this matter will materially impact our financial position, operating results or cash flows.
Litigation Related to the Merger

We are aware of two lawsuits relating to the Merger Agreement filed by purported stockholders against us, Tenet and Merger Sub. 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 us, Tenet, Merger Sub, and the members of our 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 we, 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. We and our directors believe the allegations contained in the complaint are without merit and intend to contest the allegations vigorously.

Item 4.     Mine Safety Disclosures.

Not applicable.

69


PART II

Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Price Range of Common Stock
Our Common Stock began trading on June 22, 2011, on the New York Stock Exchange (“NYSE”) under the symbol “VHS.” Prior to that date, there was no public market for our common stock. As of July 31, 2013, there were 55 holders of record of our Common Stock. This does not include persons who hold our common stock in nominee or “street name” accounts through brokers or banks.
The following table sets forth the high and low sales prices per share of our Common Stock as reported on the NYSE for the years ended June 30, 2013 and 2012:
 
High
 
Low
Year ended June 30, 2013:
 
 
 
First quarter
$
12.52

 
$
8.01

Second quarter
$
12.79

 
$
7.84

Third quarter
$
17.74

 
$
12.06

Fourth quarter
$
20.97

 
$
11.80

 
 
 
 
Year ended June 30, 2012:
 
 
 
First quarter
$
18.00

 
$
9.85

Second quarter
$
11.30

 
$
8.60

Third quarter
$
11.90

 
$
8.84

Fourth quarter
$
9.98

 
$
6.92


70


Stock Performance Graph
The following graph reflects the cumulative total return for our Common Stock compared to two indices. The Standard & Poor's 500 Stock Index includes 500 companies representing all major industries. The Standard & Poor's Health Care Composite Index is a group of 54 companies involved in a variety of health care related businesses. Stock price performance shown in the graph is not necessarily indicative of future stock price performance.
 
 
6/22/2011
 
6/11
 
9/11
 
12/11
 
3/12
 
6/12
 
9/12
 
12/12
 
3/13
 
6/13
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Vanguard Health Systems
 
100.00

 
95.12

 
56.29

 
56.62

 
54.63

 
49.25

 
68.53

 
67.87

 
82.38

 
114.90

S&P 500
 
100.00

 
98.33

 
84.70

 
94.70

 
106.62

 
103.69

 
110.28

 
109.86

 
121.51

 
125.05

S&P Health Care
 
100.00

 
98.88

 
88.97

 
97.84

 
106.70

 
108.57

 
115.25

 
115.34

 
133.58

 
138.70

Dividend Policy
We have no current plans to pay any cash dividends on our Common Stock for the foreseeable future and instead plan to retain earnings, if any, for future operations, expansions and debt repayments. Any decision to declare and pay dividends in the future will be made at the discretion of our Board of Directors and will depend on, among other things, our results of operations, cash requirements, financial condition, contractual restrictions and other factors that our Board of Directors may deem relevant. In addition, our ability to pay dividends is limited by covenants in our 2010 Credit Facilities and in the indentures governing the 8.0% Notes and 7.750% Notes, and any financing arrangements that we may enter into in the future.

71


Item 6.    Selected Financial Data.
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 “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations.” This table should be read in conjunction with the consolidated financial statements and notes thereto.
 
Year ended June 30,
 
2009
 
2010
 
2011
 
2012
 
2013
Statement of Operations Data (millions):
 
 
 
 
 
 
 
 
 
Total revenues
$
2,975.1

 
$
3,224.4

 
$
4,581.7

 
$
5,949.0

 
$
5,999.4

Costs and expenses:
 
 
 
 
 
 
 
 
 
Salaries and benefits (includes stock compensation of $4.4, $4.2 $4.8, $9.2 and $6.4 respectively)
1,233.8

 
1,296.2

 
2,020.4

 
2,746.9

 
2,740.6

Health plan claims expense
525.6

 
665.8

 
686.3

 
578.9

 
577.4

Supplies
455.5

 
456.1

 
669.9

 
911.6

 
917.0

Other operating expenses
461.9

 
483.9

 
798.8

 
1,173.3

 
1,253.3

Medicare and Medicaid EHR incentives

 

 
(10.1
)
 
(28.2
)
 
(38.0
)
Depreciation and amortization
128.9

 
139.6

 
193.8

 
258.3

 
257.1

Interest, net
111.6

 
115.5

 
171.2

 
182.8

 
197.0

Monitoring fees and expenses
5.2

 
5.1

 
31.3

 

 

Acquisition related expenses

 
3.1

 
12.5

 
14.0

 
8.1

Impairment and restructuring charges
6.2

 
43.1

 
6.0

 
(0.1
)
 
5.2

Debt extinguishment costs

 
73.5

 

 
38.9

 
2.1

Loss (gain) on disposal of assets
(2.3
)
 
1.8

 
(0.2
)
 
0.6

 
(13.3
)
Other
(0.2
)
 
(0.9
)
 
(4.3
)
 
(6.6
)
 
(16.9
)
Subtotal
2,926.2

 
3,282.8

 
4,575.6

 
5,870.4

 
5,889.6

Income (loss) from continuing operations before income taxes
48.9

 
(58.4
)
 
6.1

 
78.6

 
109.8

Income tax benefit (expense)
(16.8
)
 
13.8

 
(8.6
)
 
(22.2
)
 
(40.8
)
Income (loss) from continuing operations
32.1

 
(44.6
)
 
(2.5
)
 
56.4

 
69.0

Income (loss) from discontinued operations, net of taxes
(0.3
)
 
(1.7
)
 
(5.9
)
 
(0.5
)
 
0.1

Net income (loss)
31.8

 
(46.3
)
 
(8.4
)
 
55.9

 
69.1

Net loss (income) attributable to non-controlling interests
(3.2
)
 
(2.9
)
 
(3.6
)
 
1.4

 
(7.2
)
Net income (loss) attributable to Vanguard Health Systems, Inc. stockholders
$
28.6

 
$
(49.2
)
 
$
(12.0
)
 
$
57.3

 
$
61.9

 
 
 
 
 
 
 
 
 
 
Per Share Data:
 
 
 
 
 
 
 
 
 
Basic earnings (loss) per share
$
0.64

 
$
(1.10
)
 
$
(0.26
)
 
$
0.75

 
$
0.78

Diluted earnings (loss) per share
0.63

 
(1.10
)
 
(0.26
)
 
0.71

 
0.75

Cash dividends paid per share

 

 
9.81

 

 

 
 
 
 
 
 
 
 
 
 
Balance Sheet Data (millions):
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
308.2

 
$
257.6

 
$
936.6

 
$
455.5

 
$
624.0

Assets
2,731.1

 
2,729.6

 
4,596.9

 
4,788.1

 
5,042.6

Long-term debt, including current portion
1,551.6

 
1,752.0

 
2,787.6

 
2,706.6

 
2,996.2

Working capital
251.6

 
105.0

 
333.1

 
594.3

 
644.2


72


 
Year ended June 30,
 
2009
 
2010
 
2011
 
2012
 
2013
Other Financial Data (millions):
 
 
 
 
 
 
 
 
 
Adjusted EBITDA (a)
$
302.7

 
$
326.6

 
$
423.0

 
$
575.7

 
$
555.5

Capital expenditures
132.0

 
155.9

 
206.5

 
293.3

 
420.5

Cash provided by operating activities
313.1

 
315.2

 
276.6

 
113.6

 
300.8

Cash used in investing activities
(133.6
)
 
(156.5
)
 
(544.9
)
 
(513.2