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VANGUARD HEALTH SYSTEMS 10-Q 2012
VHS-2012.9.30-10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549 
FORM 10-Q 
(Mark One)
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2012
OR
¨
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) 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by 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     ¨  No
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of the Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files.)     Yes  þ     No  ¨
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 Exchange Act). ¨  Yes     þ  No
As of October 30, 2012, there were 77,383,124 shares of the Registrant’s common stock outstanding.




VANGUARD HEALTH SYSTEMS, INC.
QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



PART I
FINANCIAL INFORMATION
Item 1. Financial Statements.
VANGUARD HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
June 30, 2012
 
September 30, 2012
 
(In millions, except share and
per share amounts)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
455.5

 
$
330.2

Restricted cash
2.4

 
3.9

Accounts receivable, net of allowance for doubtful accounts of $366.5 and $363.8, respectively
702.1

 
672.4

Inventories
97.0

 
96.8

Deferred tax assets
89.6

 
89.8

Prepaid expenses and other current assets
236.4

 
214.8

Total current assets
1,583.0

 
1,407.9

Property, plant and equipment, net of accumulated depreciation
2,110.1

 
2,106.7

Goodwill
768.4

 
768.4

Intangible assets, net of accumulated amortization
89.0

 
87.5

Deferred tax assets, noncurrent
71.2

 
67.9

Investments in securities
51.8

 
56.8

Escrowed cash for capital commitments
20.3

 

Other assets
94.3

 
96.2

Total assets
$
4,788.1

 
$
4,591.4

LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
390.6

 
$
343.2

Accrued salaries and benefits
226.0

 
216.4

Accrued health plan claims and settlements
67.8

 
66.4

Accrued interest
73.2

 
35.8

Other accrued expenses and current liabilities
219.9

 
152.3

Current maturities of long-term debt
11.2

 
12.5

Total current liabilities
988.7

 
826.6

Professional and general liability and workers compensation reserves
304.8

 
303.7

Unfunded pension liability
269.9

 
234.1

Other liabilities
174.7

 
161.5

Long-term debt, less current maturities
2,695.4

 
2,692.1

Commitments and contingencies

 

Redeemable non-controlling interests
53.1

 
54.2

Equity:
 
 
 
Vanguard Health Systems, Inc. stockholders’ equity:
 
 
 
Common Stock of $0.01 par value; 500,000,000 shares authorized; 75,474,000 and 77,366,000 shares issued and outstanding, respectively
0.8

 
0.8

Additional paid-in capital
403.3

 
403.9

Accumulated other comprehensive loss
(48.4
)
 
(47.2
)
Retained deficit
(60.6
)
 
(46.7
)
Total Vanguard Health Systems, Inc. stockholders’ equity
295.1

 
310.8

Non-controlling interests
6.4

 
8.4

Total equity
301.5

 
319.2

Total liabilities and equity
$
4,788.1

 
$
4,591.4


See accompanying notes.
1


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

 
Three months ended September 30,
 
2011
 
2012
 
(In millions, except share and per share amounts)
Patient service revenues
$
1,351.5

 
$
1,463.9

Less: Provision for doubtful accounts
(126.2
)
 
(169.6
)
Patient service revenues, net
1,225.3

 
1,294.3

Premium revenues
211.0

 
176.4

Total revenues
1,436.3

 
1,470.7

 
 
 
 
Salaries and benefits (includes stock compensation of $0.7 and $2.2, respectively)
665.0

 
680.2

Health plan claims expense
164.7

 
134.3

Supplies
213.6

 
226.1

Purchased services
127.0

 
147.2

Rents and leases
18.0

 
19.0

Other operating expenses
133.1

 
144.2

Medicare and Medicaid EHR incentives
(3.1
)
 
(11.3
)
Depreciation and amortization
62.6

 
65.6

Interest, net
45.8

 
50.8

Acquisition related expenses
12.2

 

Debt extinguishment costs
38.9

 

Other
(2.4
)
 
(5.1
)
Income (loss) from continuing operations before income taxes
(39.1
)
 
19.7

Income tax benefit (expense)
15.2

 
(4.9
)
Income (loss) from continuing operations
(23.9
)
 
14.8

Income (loss) from discontinued operations, net of taxes
(0.1
)
 
0.1

Net income (loss)
(24.0
)
 
14.9

Net loss (income) attributable to non-controlling interests
2.3

 
(1.0
)
Net income (loss) attributable to Vanguard Health Systems, Inc. stockholders
$
(21.7
)
 
$
13.9

 
 
 
 
Amounts attributable to Vanguard Health Systems, Inc. stockholders:
 
 
 
Income (loss) from continuing operations, net of taxes
$
(21.6
)
 
$
13.8

Income (loss) from discontinued operations, net of taxes
(0.1
)
 
0.1

Net income (loss) attributable to Vanguard Health Systems, Inc. stockholders
$
(21.7
)
 
$
13.9

 
 
 
 
Earnings (loss) per share attributable to Vanguard Health Systems, Inc. stockholders:
 
 
 
Basic earnings (loss) per share
$
(0.29
)
 
$
0.18

Diluted earnings (loss) per share
$
(0.29
)
 
$
0.17

 
 
 
 
Weighted average shares (in thousands):
 
 
 
Basic
74,854

 
75,697

Diluted
74,854

 
78,813


See accompanying notes.
2


VANGUARD HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
 
Three months ended September 30, 2012
 
2011
 
2012
 
(In millions)
Net income (loss)
$
(24.0
)
 
$
14.9

Other comprehensive income (loss):
 
 
 
Change in unrealized holding gains on investments in securities
(3.2
)
 
2.2

Other comprehensive income (loss) before taxes
(3.2
)
 
2.2

Change in income tax (expense) benefit
1.4

 
(1.0
)
Other comprehensive income (loss), net of taxes
(1.8
)
 
1.2

Comprehensive income (loss)
(25.8
)
 
16.1

Net (income) loss attributable to non-controlling interests
2.3

 
(1.0
)
Comprehensive income (loss) attributable to Vanguard Health Systems, Inc. stockholders
$
(23.5
)
 
$
15.1




See accompanying notes.
3


VANGUARD HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENT OF EQUITY
Three months ended September 30, 2012
(Unaudited)
 
Vanguard Health Systems, Inc. Stockholders
 
 
 
 
 
Common Stock
 
Additional Paid-In Capital
 
Accumulated Other Comprehensive Income (Loss)
 
Retained Deficit
 
Non-Controlling Interests
 
Total Equity
 
Shares
 
Amount
 
 
 
 
 
 
(In millions, except share amounts)
Balance at June 30, 2012
75,474,000

 
$
0.8


$
403.3

 
$
(48.4
)
 
$
(60.6
)
 
$
6.4

 
$
301.5

Net income

 

 

 

 
13.9

 
1.0

 
14.9

Stock compensation (non-cash)

 

 
2.2

 

 

 

 
2.2

Dividends to equity holders and related equity payments, net of taxes

 

 
(0.2
)
 

 

 

 
(0.2
)
Common stock issued for stock-based awards exercised
1,892,000

 

 
(0.3
)
 

 

 

 
(0.3
)
Contributions from non-controlling interests and other, net

 

 

 

 

 
1.0

 
1.0

Accretion of redeemable non-controlling interest

 

 
(1.1
)
 

 

 

 
(1.1
)
Other comprehensive income, net of taxes

 

 

 
1.2

 

 

 
1.2

Balance at September 30, 2012
77,366,000

 
$
0.8

 
$
403.9

 
$
(47.2
)
 
$
(46.7
)
 
$
8.4

 
$
319.2



See accompanying notes.
4


VANGUARD HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Three months ended September 30,
 
2011
 
2012
 
(In millions)
Operating activities:
 
 
 
Net income (loss)
$
(24.0
)
 
$
14.9

Adjustments to reconcile net income (loss) to net cash used in operating activities:
 
 
 
Loss (income) from discontinued operations
0.1

 
(0.1
)
Depreciation and amortization
62.6

 
65.6

Amortization of loan costs
1.6

 
2.2

Accretion of principal on notes
4.1

 
1.1

Acquisition related expenses
12.2

 

Stock compensation
0.7

 
2.2

Deferred income taxes
(16.1
)
 
2.9

Debt extinguishment costs
38.9

 

Other
(1.3
)
 
(0.7
)
Changes in operating assets and liabilities
(166.5
)
 
(144.6
)
Net cash used in operating activities — continuing operations
(87.7
)
 
(56.5
)
Net cash provided by (used in) operating activities — discontinued operations
(0.1
)
 
0.1

Net cash used in operating activities
(87.8
)
 
(56.4
)
 
 
 
 
Investing activities:
 
 
 
Acquisitions and related expenses, net of cash acquired
(210.1
)
 
(0.5
)
Capital expenditures
(63.4
)
 
(82.7
)
Proceeds from sale of investments in securities
22.7

 
27.1

Purchases of investments in securities
(21.0
)
 
(30.1
)
Net reimbursements from restricted cash and escrow fund

 
18.8

Other investing activities
2.2

 
1.6

Net cash used in investing activities
(269.6
)
 
(65.8
)
 
 
 
 
Financing activities:
 
 
 
Payments of long-term debt and capital lease obligations
(456.5
)
 
(3.1
)
Payments of debt issuance costs

 
(0.2
)
Proceeds from issuance of common stock
67.5

 

Payments of IPO related costs
(6.9
)
 

Payment of tender premiums on note redemption
(27.6
)
 

Other financing activities
(1.0
)
 
0.2

Net cash used in financing activities
(424.5
)
 
(3.1
)
Net decrease in cash and cash equivalents
(781.9
)
 
(125.3
)
Cash and cash equivalents, beginning of period
936.6

 
455.5

Cash and cash equivalents, end of period
$
154.7

 
$
330.2

Supplemental cash flow information:
 
 
 
Net cash paid for interest
$
70.8

 
$
85.0

Net cash paid for income taxes
$
0.3

 
$
4.0


See accompanying notes.
5

VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)


1. BUSINESS AND BASIS OF PRESENTATION
The Company is an investor-owned health care company whose subsidiaries and affiliates own and operate hospitals and related health care businesses in urban and suburban areas. As of September 30, 2012, the Company’s subsidiaries and affiliates owned and operated 28 acute care hospitals with 7,064 licensed beds and related outpatient service locations complementary to the hospitals providing health care services in San Antonio, Harlingen and Brownsville, Texas; metropolitan Detroit, Michigan; metropolitan Phoenix, Arizona; metropolitan Chicago, Illinois; and Massachusetts. The Company also owns managed health plans in Chicago, Illinois, Harlingen, Texas, and Phoenix, Arizona, and two surgery centers in Orange County, California.
Basis of Presentation
The accompanying condensed consolidated financial statements include the accounts of subsidiaries and affiliates controlled by the Company. The Company generally defines control as the ownership of the majority of an entity’s voting interests. The Company also consolidates any entities for which it receives the majority of the entity’s expected returns or is at risk for the majority of the entity’s expected losses based upon its investment or financial interest in the entity. All material intercompany accounts and transactions have been eliminated. The majority of the Company’s expenses are “cost of revenue” items. Costs that could be classified as general and administrative include certain Company corporate office costs, which approximated $13.9 million and $14.8 million for the three months ended September 30, 2011 and 2012, respectively.

The unaudited condensed consolidated financial statements as of September 30, 2012 and for the three months ended September 30, 2011 and 2012 have been prepared in conformity with accounting principles generally accepted in the United States for interim reporting and in accordance with Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the Company’s financial position and results of operations for the periods presented. The results of operations for the periods presented are not necessarily indicative of the expected results for the fiscal year ending June 30, 2013. The interim unaudited condensed consolidated financial statements should be read in connection with the audited consolidated financial statements as of and for the year ended June 30, 2012 included in the Company’s Annual Report on Form 10-K (the “10-K”) filed with the Securities and Exchange Commission on August 24, 2012. The accompanying condensed consolidated balance sheet at June 30, 2012 has been derived from the audited consolidated financial statements included in the 10-K.

Certain balances in the accompanying condensed consolidated financial statements and these notes have been adjusted to reflect the retroactive application of the contingency model for recognizing Medicare and Medicaid electronic health record ("EHR") incentives as further described in Note 3.
Use of Estimates
In preparing the Company’s financial statements in conformity with accounting principles generally accepted in the United States, management makes estimates and assumptions that affect the amounts recorded or classification of items in the condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

2. REVEVUES AND REVENUE DEDUCTIONS
Allowance for Doubtful Accounts
The Company estimates the allowance for doubtful accounts using a standard policy that reserves all accounts aged greater than 365 days subsequent to the discharge date plus percentages of uninsured accounts and self-pay after insurance accounts less than 365 days old. The Company analyzes the allowance for doubtful accounts quarterly using a hindsight calculation that utilizes write-off data for all payer classes during the previous twelve-month period to estimate the allowance for doubtful accounts at a point in time. The Company also supplements the analysis by comparing cash collections to net patient revenues and monitoring self-pay utilization. The standard percentages used to estimate the allowance for doubtful accounts reserve are adjusted as necessary given changes in trends from these analyses or policy changes. Significant changes in payer mix, business office operations, general economic conditions and health care coverage provided by federal or state governments or private insurers may have a significant impact on the Company’s estimates and significantly affect its liquidity, results of operations and cash flows. The Company’s estimate of the allowance for doubtful accounts and recoveries of accounts previously written off determine its provision for doubtful accounts recorded during a period. The Company records the


6

VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)

provision for doubtful accounts at the time the services are provided for uninsured patients, since historical experience shows that the significant majority of uninsured balances will not be collected.
The allowance for doubtful accounts was approximately $366.5 million and $363.8 million as of June 30, 2012 and September 30, 2012, respectively. These balances as a percent of accounts receivable net of contractual adjustments were approximately 34.3% and 35.1% as of June 30, 2012 and September 30, 2012, respectively. On a same hospital basis, the Company’s combined allowance for doubtful accounts, uninsured discounts and charity care covered approximately 98.4% and 97.0% of combined uninsured and self-pay after insurance accounts receivable as of June 30, 2012 and September 30, 2012, respectively.
Charity Care
The Company does not pursue collection of amounts due from uninsured patients that qualify for charity care under its guidelines (currently those uninsured patients whose incomes are equal to or less than 200% of the current federal poverty guidelines set forth by the Department of Health and Human Services). The Company deducts charity care accounts from revenues when it determines that the account meets its charity care guidelines. The Company also generally provides discounts from billed charges and alternative payment structures for uninsured patients who do not qualify for charity care but meet certain other minimum income guidelines, primarily those uninsured patients with incomes between 200% and 500% of the federal poverty guidelines. During the three months ended September 30, 2011 and 2012, the Company deducted $50.4 million and $55.5 million of charity care from revenues, respectively. The estimated cost incurred by the Company to provide services to patients who qualify for charity care was approximately $13.2 million and $15.7 million for the three months ended September 30, 2011 and 2012, respectively. These estimates were determined using a ratio of cost to gross charges calculated from the Company’s most recently filed Medicare cost reports and applying that ratio to the gross charges associated with providing charity care for the period.
Settlements
Settlements under reimbursement agreements with third party payers are initially estimated during the period the related services are provided, with final estimates made at the time the applicable payer cost reports are filed. Final settlements are typically not known until future periods. There is at least a reasonable possibility that recorded estimates will change by a material amount when final settlements are known. Differences between estimates made at the cost report filing date and subsequent revisions (including final settlements) are included in the condensed consolidated statements of operations in the period in which the revisions are made. Management believes that adequate provision has been made for adjustments that may result from final determination of amounts earned under the Medicare and Medicaid programs and other managed care plans with settlement provisions.
Net adjustments for final third party settlements positively impacted the Company’s loss from continuing operations before income taxes by $0.4 million ($0.2 million net of taxes or $0.01 per diluted share) for the three months ended September 30, 2011, and negatively impacted the Company’s income from continuing operations before income taxes by $1.3 million ($0.8 million net of taxes or $0.01 per diluted share) for the three months ended September 30, 2012, respectively.
Recovery Audit Program
The Recovery Audit Program relies on private recovery audit contractors, or RACs, to examine Medicaid and Medicare claims filed by health care providers to detect overpayments not identified through existing claims review mechanisms. RACs utilize a post-payment targeted review process employing data analysis techniques in order to identify those claims most likely to contain overpayments, such as incorrectly coded services, incorrect payment amounts, non-covered services and duplicate payments.  Centers for Medicare and Medicaid Services ("CMS") has given RACs the authority to look back at claims up to three years from the date the claim was paid.  Claims identified as overpayments will be subject to the appeals process.  RACs are paid a contingency fee based on the overpayments they identify and collect.
The Company maintains a reserve for its estimate of potential claims repayments from RAC audits based upon actual claims already audited but for which repayment has not yet occurred; claims for which it has received an audit notice but the audit process is not complete; and potential future exposure related to a portion of paid claims for which an audit notice has not yet been received, which is based upon certain historical experience of audit recoveries and appeals and other available information. During the three months ended September 30, 2012, the Company reduced its RAC reserve estimate in its Michigan market by $14.5 million ($8.9 million net of taxes or $0.11 per diluted share) as a result of further analysis related to each of these components of the estimate during the period. The $14.5 million reduction in the Company's RAC reserve estimate increased patient service revenues on the accompanying condensed consolidated statement of operations during the


7

VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)

three months ended September 30, 2012.  As of June 30, 2012 and September 30, 2012, the Company's current portion of RAC reserves was approximately $1.9 million and $1.6 million, respectively, and is included in other accrued expenses and current liabilities on the accompanying condensed consolidated balance sheets.  As of June 30, 2012 and September 30, 2012, the Company's non-current portion of RAC reserves was approximately $23.8 million and $9.2 million, respectively, and is included in other liabilities on the accompanying condensed consolidated balance sheets.

3. MEDICARE AND MEDICAID EHR INCENTIVES
The American Recovery and Reinvestment Act of 2009 provides for Medicare and Medicaid incentive payments beginning in calendar year 2011 for eligible hospitals and professionals that implement and achieve meaningful use of certified EHR technology. For Medicare and Medicaid EHR incentive payments prior to the quarter ended December 31, 2011, the Company originally utilized a grant accounting model to recognize these revenues. Under this accounting policy, EHR incentive payments were recognized as revenues when attestation that the EHR meaningful use criteria for the required period of time was demonstrated and were recognized ratably over the relevant cost report period to determine the amount of reimbursement.
During the quarter ended December 31, 2011, the Company concluded that it should have applied the contingency model to account for Medicare and Medicaid EHR incentive payments beginning in its year ended June 30, 2011. Under the contingency model, EHR incentive payments are recognized when all contingencies relating to the incentive payment have been satisfied. For Medicaid EHR incentive payments, recognition occurs at the time meaningful use criteria are met and formal state acceptance is documented since Medicaid payments for the states in which the Company operates are based upon historical cost reports with no subsequent payment adjustment. For Medicare EHR incentive payments, recognition is deferred until both the Medicare federal fiscal year during which EHR meaningful use was demonstrated ends and the cost report information utilized to determine the final amount of reimbursement is known. As a result of the retrospective application of the contingency model, $3.1 million of Medicaid EHR incentives was reclassified from revenues to other income and previously reported net income attributable to the Company's stockholders was reduced by $2.5 million for the quarter ended September 30, 2011.
The Company recognized approximately $11.3 million of other income related to Medicare and Medicaid EHR incentives during the three months ended September 30, 2012 under the contingency model. The Company incurs both capital expenditures and operating expenses in connection with the implementation of its various EHR initiatives. The amount and timing of these expenditures do not directly correlate with the timing of the Company's cash receipts or recognition of the EHR incentives as other income. As of June 30, 2012 and September 30, 2012, the Company had recognized approximately $2.7 million and $2.6 million in Medicaid EHR receivables, respectively, on its condensed consolidated balance sheets. In addition, as of June 30, 2012 and September 30, 2012, the Company had recognized $4.3 million and $4.1 million in Medicare EHR deferred revenues, respectively, on its condensed consolidated balance sheets.
4. FAIR VALUE MEASUREMENTS
The Company’s financial assets recorded at fair value on a recurring basis primarily relate to investments in available-for-sale securities held by one of its captive insurance subsidiaries. The following table indicates the fair value hierarchy of the valuation techniques the Company utilized to determine such fair values. In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets. The Company considers a security that trades at least weekly to have an active market. Fair values determined by Level 2 inputs utilize data points that are observable, such as quoted prices, interest rates and yield curves. Fair values determined by Level 3 inputs are unobservable data points for the asset, and include situations where there is little, if any, market activity for the asset. The Company’s policy is to recognize transfers between levels as of the actual date of the event or change in circumstances that caused the transfer. The following table presents information about the assets that are measured at fair value on a recurring basis as of September 30, 2012 (in millions).


8

VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)

 
September 30, 2012
 
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
United States short-term treasury bills
$
20.9

 
$

 
$
20.9

 
$

Cash and cash equivalents
3.3

 
3.3

 

 

Corporate bonds
13.3

 

 
13.3

 

Common stock — domestic
10.7

 
0.1

 
10.6

 

Common stock — international
8.4

 
8.1

 
0.3

 

Preferred stock — international
0.2

 
0.2

 

 

Investments in securities
$
56.8

 
$
11.7

 
$
45.1

 
$

Investments in securities
As of September 30, 2012, the Company held $56.8 million in total available-for-sale investments in debt and equity securities, which are included in investments in securities on the condensed consolidated balance sheets. Investments in corporate bonds, valued at approximately $13.3 million at September 30, 2012, consist of corporate bonds and other fixed income investments. The average expected maturity of the investments in corporate bonds at September 30, 2012 was 6.4 years, compared to the average scheduled maturity of 10.7 years. Expected and scheduled maturities may differ because the issuers of certain securities have the right to call, prepay or otherwise redeem such obligations prior to the scheduled maturity date. The Company calculates the realized gain or loss on sales of investments using the amortized cost basis, as determined by specific identification. The amortized cost basis of these investments was approximately $53.9 million as of September 30, 2012.
The investments are classified as “available-for-sale” and recorded at fair value. The investment securities are held for the purpose of providing a funding source to pay professional liability claims covered by one of the Company's captive insurance subsidiaries.
The following table provides a reconciliation of activity for the Company's investments in securities for the three months ended September 30, 2012 (in millions).
 
Fair value at June 30, 2012
 
Proceeds from sales
 
Purchases of securities
 
Realized loss on sales, pre tax
 
Change in fair value, pre tax
 
Fair value at September 30, 2012
Investment in securities
$
51.8

 
$
(27.1
)
 
$
30.1

 
$
(0.2
)
 
$
2.2

 
$
56.8

The Company determines whether an other-than-temporary decline in market value has occurred by considering the duration that, and extent to which, the fair value of the investment is below its amortized cost; the financial condition and near-term prospects of the issuer or underlying collateral of a security; and the Company's intent and ability to retain the security in order to allow for an anticipated recovery in fair value. Other-than-temporary declines in fair value from amortized cost for available-for-sale equity and debt securities that the Company intends to sell or would be more likely than not required to sell before the expected recovery of the amortized cost basis are recognized in the statement of operations in the period in which the loss occurs. The gross unrealized gain for the securities was approximately $2.9 million ($1.8 million, net of taxes) which is included in accumulated other comprehensive loss on the condensed consolidated balance sheet at September 30, 2012.


9

VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)

Supplemental information regarding the Company's available-for-sale investment securities held as of September 30, 2012 is set forth in the table below (in millions).
 
Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
United States short-term treasury bills
$
20.9

 
$

 
$

 
$
20.9

Cash and cash equivalents
3.3

 

 

 
3.3

Corporate bonds
11.3

 
2.0

 

 
13.3

Common stock - domestic
9.2

 
1.5

 

 
10.7

Common stock - international
8.9

 
0.6

 
(1.1
)
 
8.4

Preferred stock - international
0.3

 

 
(0.1
)
 
0.2

 
$
53.9

 
$
4.1

 
$
(1.2
)
 
$
56.8

As of September 30, 2012, the Company's investments in securities with unrealized loss positions greater than twelve months aggregated approximately $1.1 million. The Company does not intend to sell and it is not more likely than not that the Company will be required to sell its investments in securities in unrealized loss positions before recovery of their amortized cost bases. The Company will continue to monitor and evaluate the recoverability of the Company's investments in these securities. As of September 30, 2012, the Company concluded that other-than-temporary impairment charges were not necessary.
Financial Instruments
The carrying amounts of the Company's short-term financial instruments, including cash, cash equivalents, restricted cash, accounts receivable and accounts payable ,approximate fair value due to the short-term maturity of these items. The fair value of the Company's long-term debt, excluding capital leases and other long-term debt, was approximately $2,044.4 million, based upon stated market prices (Level 1) at September 30, 2012. The fair values of the Company's term loan facility, capital leases and other long-term debt was approximately $818.1 million, based upon quoted market prices and interest rates (Level 2) at September 30, 2012.

5. GOODWILL
The Company has a significant amount of goodwill, which is tested for impairment at least annually but also as impairment indicators become known. The Company's fiscal 2012 annual impairment analysis did not result in any impairments of its goodwill. However, the Company's Arizona hospitals experienced market challenges that negatively impacted their results of operations and cash flows during the fiscal year ended June 30, 2012 continuing through the three months ended September 30, 2012. These factors included hospital reimbursement cuts, reductions to covered lives under the state's AHCCCS program and local economic conditions that adversely impacted elective volumes for these hospitals. Based upon the implementation of certain cost reduction and revenue expansion initiatives, expected improvements in the local economic and state financial conditions and the demographic composition of this market, the Company believes future operating results and cash flows of these hospitals will improve. However, the Company will continue to monitor the operating results of these hospitals and other market environmental factors to determine if further impairment considerations are necessary with respect to the $100.7 million of goodwill for the Arizona hospitals.


10

VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)

6. OTHER ACCRUED EXPENSES AND CURRENT LIABILITIES
The following table presents summaries of items comprising other accrued expenses and current liabilities in the accompanying condensed consolidated balance sheets as of June 30, 2012 and September 30, 2012 (in millions).
 
June 30, 2012
 
September 30, 2012
Property taxes
$
23.0

 
$
23.2

Professional and general liability and workers compensation insurance, current portion
69.7

 
78.5

Accrued income guarantees
4.8

 
4.5

Accrued capital expenditures
24.9

 
0.1

Market-specific contract liabilities
39.7

 
4.0

Other
57.8

 
42.0

 
$
219.9

 
$
152.3

During the three months ended September 30, 2012, the Company made payments for various contract liability settlements related to one of its markets. During the three months ended September 30, 2012, the Company made payments for certain capital items that were received but not invoiced as of June 30, 2012.

7. FINANCING ARRANGEMENTS
A summary of the Company’s long-term debt as of June 30, 2012 and September 30, 2012 follows (in millions).
 
June 30, 2012
 
September 30, 2012
8.0% Senior Unsecured Notes due 2018
$
1,159.1

 
$
1,159.8

7.750% Senior Notes due 2019
722.2

 
722.4

10.375% Senior Discount Notes due 2016
9.9

 
10.1

Term loans payable under credit facility due 2016
798.8

 
796.8

Capital leases and other long term debt
16.6

 
15.5

 
2,706.6

 
2,704.6

Less: current maturities
(11.2
)
 
(12.5
)
 
$
2,695.4

 
$
2,692.1


Redemption of 10.375% Senior Discount Notes

On January 26, 2011, the Company issued, in a private placement, senior discount notes due 2016 (the “Senior Discount Notes”) with a stated principal amount at maturity of approximately $747.2 million. The sale of the Senior Discount Notes generated approximately $444.7 million of gross proceeds. The Senior Discount Notes were not guaranteed by any of the Company’s subsidiaries.

During the three months ended September 30, 2011, the Company used the net proceeds from its initial public offering in June 2011 and the exercise of the over-allotment option by the underwriters in July 2011 to redeem approximately $450.0 million accreted value of the Senior Discount Notes and to pay $27.6 million of redemption premiums related thereto. The redemptions resulted in approximately $14.7 million of remaining unredeemed accreted value of these notes outstanding immediately after the redemptions were completed and resulted in the recognition of debt extinguishment costs of approximately $38.9 million, $25.3 million net of taxes, representing tender premiums and other costs to redeem the Senior Discount Notes and the write-off of net deferred loan costs associated with the redeemed notes. During the fiscal year ended June 30, 2012, subsequent to September 30, 2011, the Company redeemed an additional $6.0 million of Senior Discount Notes through privately negotiated transactions. The remaining outstanding Senior Discount Notes are not callable until February 1, 2013.




11

VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)

Credit Facility Debt

The Company's senior secured credit facilities include a six-year term loan facility (“2010 term loan facility”) in the amount of $815.0 million and a five-year revolving credit facility in the amount of $365.0 million (the “2010 revolving facility” and together with the 2010 term loan facility, the “2010 Credit Facilities”). The Company’s remaining borrowing capacity under the 2010 revolving facility, net of letters of credit outstanding, was $327.2 million as of September 30, 2012.
The 2010 term loan facility bears interest at a rate equal to, at the Company’s option, LIBOR (subject to a 1.50% floor) plus 3.50% per annum or an alternate base rate plus 2.50% per annum. The interest rate applicable to the 2010 term loan facility was approximately 5.00% as of September 30, 2012. The Company also makes quarterly principal payments equal to one-fourth of one percent of the outstanding principal balance of the 2010 term loan facility and will continue to make such payments until the maturity of the term debt.

Any borrowings under the 2010 revolving facility bear interest at a rate equal to, at the Company's option, LIBOR plus an applicable margin ranging from 3.25% to 3.50% per annum or an alternate base rate plus an applicable margin ranging from 2.25% to 2.50% per annum, in each case subject to the lower end of the range should the Company's leverage ratio decrease below a certain designated level. Each of LIBOR and the base rate under the 2010 term loan facility is subject to a minimum rate of interest. The Company also pays a commitment fee to the lenders under the 2010 revolving facility in respect of unutilized commitments thereunder, with that commitment fee being subject to a decrease should the Company's leverage ratio decrease below a certain designated level. The Company also pays customary letter of credit fees under the 2010 revolving facility.

8. DEFINED BENEFIT PENSION PLAN
The components of net pension plan credit for the Company’s defined benefit pension plan, a frozen plan for the benefit of certain current and previous employees in the Company's Michigan market, for the three months ended September 30, 2012 are as follows (in millions):
Interest cost on projected benefit obligation
$
11.7

Expected return on assets
(15.5
)
Total net pension plan credit
$
(3.8
)
The Company recognizes changes in the funded status of the pension plan as a direct increase or decrease to stockholders’ equity through accumulated other comprehensive income (loss). As of June 30, 2012, the Company recognized a change in the funded status of the pension plan as a decrease in equity through accumulated other comprehensive loss of $80.6 million ($49.2 million, net of taxes) based primarily on adjustments related to an increase in its unfunded pension liability due to a decrease in the discount rate used to measure the projected benefit obligation partially offset by an increase in the fair value of plan assets.
The Company made cash contributions of $11.6 million and $32.0 million to the pension plan trust during the three months ended September 30, 2011 and 2012, respectively.
9. ACCUMULATED OTHER COMPREHENSIVE LOSS
The components of accumulated other comprehensive loss, net of taxes, as of June 30, 2012 and September 30, 2012 are as follows (in millions).
 
June 30, 2012
 
September 30, 2012
Unrealized holding gain on investments in securities
$
0.7

 
$
2.9

Defined benefit pension plan
(80.6
)
 
(80.6
)
Post-employment defined benefit plan
0.9

 
0.9

Income tax benefit
30.6

 
29.6

Accumulated other comprehensive loss
$
(48.4
)
 
$
(47.2
)


12

VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)

10. EARNINGS PER SHARE
The Company computes basic earnings (loss) per share using the weighted average number of common shares outstanding. The Company computes diluted earnings (loss) per share using the weighted average number of common shares outstanding, plus the dilutive effect of outstanding stock options, restricted shares, restricted stock units and performance-based restricted stock units, computed using the treasury stock method. Performance-based restricted stock units are included as dilutive shares when the applicable performance measures are achieved.

The following table sets forth the computation of basic and diluted earnings (loss) per share for the three months ended September 30, 2011 and 2012 (dollars in millions, except share and per share amounts).
 
Three months ended September 30,
 
2011
 
2012
Numerator for basic and diluted earnings (loss) per share:
 
 
 
Income (loss) from continuing operations
$
(21.6
)
 
$
13.8

Income (loss) from discontinued operations
(0.1
)
 
0.1

Accretion of redeemable non-controlling interest, net of taxes

 
(0.7
)
 
$
(21.7
)
 
$
13.2

Denominator (in thousands):
 
 
 
Weighted average shares outstanding - basic
74,854

 
75,697

Effect of dilutive securities

 
3,116

  Weighted average shares outstanding - diluted
74,854

 
78,813

Net earnings (loss) per share:
 
 
 
Basic earnings (loss) from continuing operations
$
(0.29
)
 
$
0.18

Diluted earnings (loss) from continuing operations
$
(0.29
)
 
$
0.17


For the three months ended September 30, 2011 and 2012, the Company excluded 6,644,118 and 4,327,784, respectively, of potentially dilutive stock options and other stock-based awards from the calculation of diluted earnings per share because they were anti-dilutive or performance conditions were not met. For the three months ended September 30, 2011, the excluded amount also includes dilutive securities that would have been anti-dilutive based upon the Company's operating loss recognized for the period.

11. STOCK-BASED COMPENSATION

The Company issues stock-based awards, including stock options and other stock-based awards (restricted stock units and
performance-based awards) in accordance with the Company’s various Board-approved compensation plans.

In June 2011, the Company adopted the 2011 Stock Incentive Plan (the “2011 Plan”), which effectively replaced the 2004 Stock Incentive Plan (the "2004 Plan"), from which stock-based awards were granted prior to the Company's initial public offering. No further equity awards will be made under the 2004 Plan. The 2011 Plan allows for the issuance of 14,000,000 shares of common stock, all of which may be granted as incentive stock awards. As of September 30, 2012, there were 8,065,828 shares of common stock available for grant under the 2011 Plan. There were 1,677,081 options, 1,312,098 restricted stock units and 1,073,504 performance-based restricted stock units outstanding as of September 30, 2012 under the 2011 Plan. Stock options issued under the 2011 Plan vest and become exercisable ratably over three years, while the time-based restricted stock and performance units vest ratably over four years. The 1,530,139 restricted shares outstanding at June 30, 2012 vested during the three months ended September 30, 2012.

The actual number of performance units earned may be increased or decreased based upon the Company's financial performance for the fiscal year during which the awards were granted. The Company recognized estimated expense in the three months ended September 30, 2012 for the performance-based awards based upon the Company achieving 100% of its targeted financial performance metrics for fiscal 2013.
During the three months ended September 30, 2011 and 2012, the Company incurred stock-based compensation expense of $0.7 million and $2.2 million, respectively, under its stock incentive plans. Compensation cost related to stock-based awards


13

VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)

will be adjusted for future changes in estimated forfeitures and actual results of performance measures.

12. INCOME TAXES
Significant components of the provision for income taxes from continuing operations are as follows (in millions).
 
Three months ended September 30,
 
2011
 
2012
Current:
 
 
 
Federal
$
0.3

 
$
1.2

State
0.6

 
0.8

Total current
0.9

 
2.0

Deferred:
 
 
 
Federal
(16.9
)
 
5.1

State
0.7

 

Total deferred
(16.2
)
 
5.1

Change in valuation allowance
0.1

 
(2.2
)
Total income tax expense (benefit)
$
(15.2
)
 
$
4.9


Income tax expense for the three months ended September 30, 2012 includes the impact of releasing a $2.2 million valuation allowance for unitary state net operating loss carryforwards.
The Company assesses the realization of its deferred tax assets to determine whether an income tax valuation allowance is required. Based on all available evidence, both positive and negative, and the weight of that evidence to the extent such evidence can be objectively verified, the Company determines whether it is more likely than not that all or a portion of the deferred tax assets will be realized. The main factors that the Company considered include:
cumulative losses in recent years;
income/losses expected in future years;
unsettled circumstances that, if unfavorably resolved, would adversely affect future operations and profit levels;
the availability, or lack thereof, of taxable income in prior carryback periods that would limit realization of tax benefits;
the carryforward period associated with the deferred tax assets and liabilities; and
prudent and feasible tax-planning strategies.
During the three months ended September 30, 2012, management concluded that it was more likely than not that certain unitary state net operating loss deferred tax assets were realizable. Management based this determination on the Company having cumulative pre-tax income in recent years exclusive of nonrecurring expenses associated with its initial public offering as well as forecasted income in the net operating loss carryforward period. The Company continues to maintain valuation allowances on state net operating losses in states without cumulative pre-tax income and in states where net operating loss deductions have been suspended due to uncertainty surrounding its ability to utilize the net operating losses during the prescribed carryforward periods.
As of September 30, 2012, the Company had generated net operating loss carryforwards for federal income tax and state income tax purposes of approximately $3.4 million and $505.0 million, respectively. The federal and state net operating loss carryforwards expire from 2020 to 2029 and 2013 to 2031, respectively. Approximately $1.3 million of these net operating losses are subject to annual limitations for federal purposes. These limitations are not expected to significantly affect the Company’s ability to ultimately recognize the benefit of these net operating losses in future years.
The Company’s U.S. federal income tax returns for tax years 2005 and beyond remain subject to examination by the Internal Revenue Service.


14

VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)

13. SEGMENT INFORMATION
The Company’s acute care hospitals and related health care businesses are similar in their activities and the economic environments in which they operate (i.e. urban markets). Accordingly, the Company’s reportable operating segments consist of 1) acute care hospitals and related health care businesses, collectively, and 2) health plans, including Chicago Health Systems, a contracting entity for outpatient services provided by MacNeal Hospital and Weiss Memorial Hospital and participating physicians in the Chicago area; Phoenix Health Plan, a Medicaid managed health plan operating in Arizona; Abrazo Advantage Health Plan, a Medicare and Medicaid dual eligible managed health plan operating in Arizona; and Valley Baptist Insurance Company, which offers health maintenance organization, preferred provider organization, and self-funded products to its members in the form of large group, small group, and individual product offerings in south Texas.


15

VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)

The following tables provide unaudited condensed financial information by operating segment for the three months ended September 30, 2011 and 2012, including a reconciliation of Segment EBITDA to income (loss) from continuing operations before income taxes (in millions).
 
Three months ended September 30, 2011
 
Acute Care
Services
 
Health
Plans
 
Eliminations
 
Consolidated
Patient service revenues, net (1)
$
1,225.3

 
$

 
$

 
$
1,225.3

Premium revenues

 
211.0

 

 
211.0

Inter-segment revenues
8.6

 

 
(8.6
)
 

Total revenues
1,233.9

 
211.0

 
(8.6
)
 
1,436.3

 
 
 
 
 
 
 
 
Salaries and benefits (excludes stock compensation)
655.2

 
9.1

 

 
664.3

Health plan claims expense (1)

 
164.7

 

 
164.7

Supplies
213.6

 

 

 
213.6

Other operating expenses-external
267.4

 
10.7

 

 
278.1

Operating expenses-intersegment

 
8.6

 
(8.6
)
 

Medicare and Medicaid EHR incentives
(3.1
)
 

 

 
(3.1
)
Segment EBITDA (2)
100.8

 
17.9

 

 
118.7

Less:
 
 
 
 
 
 
 
Interest, net
46.1

 
(0.3
)
 

 
45.8

Depreciation and amortization
61.4

 
1.2

 

 
62.6

Equity method income
(0.1
)
 

 

 
(0.1
)
Stock compensation
0.7

 

 

 
0.7

Gain on disposal of assets
(1.2
)
 

 

 
(1.2
)
Acquisition related expenses
12.2

 

 

 
12.2

Debt extinguishment costs
38.9

 

 

 
38.9

Impairment and restructuring charges
(0.1
)
 

 

 
(0.1
)
Pension credits
(1.0
)
 

 

 
(1.0
)
Income (loss) from continuing operations before income taxes
$
(56.1
)
 
$
17.0

 
$

 
$
(39.1
)
_____________________
(1) 
The Company eliminates in consolidation those patient service revenues earned by its health care facilities attributable to services provided to members in its owned health plans and eliminates the corresponding medical claims expenses incurred by the health plans for those services.
(2) 
Segment EBITDA is defined as income (loss) from continuing operations before income taxes less interest expense (net of interest income), depreciation and amortization, equity method income or loss, stock compensation, gain or loss on disposal of assets, realized gains or losses on investments, monitoring fees and expenses, acquisition related expenses, debt extinguishment costs, impairment and restructuring charges, and pension expense (credits). Management uses Segment EBITDA to measure the performance for the Company’s segments and to develop strategic objectives and operating plans for those segments. Segment EBITDA eliminates the uneven effect of non-cash depreciation of tangible assets and amortization of intangible assets, much of which results from acquisitions accounted for under the purchase method of accounting. Segment EBITDA also eliminates the effects of changes in interest rates, which management believes relate to general trends in global capital markets, but are not necessarily indicative of the operating performance of the Company’s segments. Management believes that Segment EBITDA provides useful information to investors, lenders, financial analysts and rating agencies about the financial performance of the Company’s segments. Additionally, management believes that investors and lenders view Segment EBITDA as an important factor in making investment decisions and assessing the value of the Company. Segment EBITDA is not a substitute for net income (loss), operating cash flows or other cash flow statement data determined in accordance with accounting principles generally accepted in the United States. Segment EBITDA, as presented, may not be comparable to similar measures of other companies.


16

VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)

 
Three months ended September 30, 2012
 
Acute Care
Services
 
Health
Plans
 
Eliminations
 
Consolidated
Patient service revenues, net (1)
$
1,294.3

 
$

 
$

 
$
1,294.3

Premium revenues

 
176.4

 

 
176.4

Inter-segment revenues
10.2

 

 
(10.2
)
 

Total revenues
1,304.5

 
176.4

 
(10.2
)
 
1,470.7

 
 
 
 
 
 
 
 
Salaries and benefits (excludes stock compensation)
669.1

 
8.9

 

 
678.0

Health plan claims expense (1)

 
134.3

 

 
134.3

Supplies
226.1

 

 

 
226.1

Other operating expenses-external
299.2

 
11.2

 

 
310.4

Operating expenses-intersegment

 
10.2

 
(10.2
)
 

Medicare and Medicaid EHR incentives
(11.3
)
 

 

 
(11.3
)
Segment EBITDA (2)
121.4

 
11.8

 

 
133.2

Less:
 
 
 
 
 
 
 
Interest, net
51.3

 
(0.5
)
 

 
50.8

Depreciation and amortization
64.6

 
1.0

 

 
65.6

Equity method income
(0.6
)
 

 

 
(0.6
)
Stock compensation
2.2

 

 

 
2.2

Gain on disposal of assets
(0.9
)
 

 

 
(0.9
)
Realized losses on investments
0.2

 

 

 
0.2

Pension credits
(3.8
)
 

 

 
(3.8
)
Income from continuing operations before income taxes
$
8.4

 
$
11.3

 
$

 
$
19.7

_____________________
(1) 
The Company eliminates in consolidation those patient service revenues earned by its health care facilities attributable to services provided to members in its owned health plans and eliminates the corresponding medical claims expenses incurred by the health plans for those services.
(2) 
Segment EBITDA is defined as income (loss) from continuing operations before income taxes less interest expense (net of interest income), depreciation and amortization, equity method income or loss, stock compensation, gain or loss on disposal of assets, realized gains or losses on investments, monitoring fees and expenses, acquisition related expenses, debt extinguishment costs, impairment and restructuring charges, and pension expense (credits). Management uses Segment EBITDA to measure the performance for the Company’s segments and to develop strategic objectives and operating plans for those segments. Segment EBITDA eliminates the uneven effect of non-cash depreciation of tangible assets and amortization of intangible assets, much of which results from acquisitions accounted for under the purchase method of accounting. Segment EBITDA also eliminates the effects of changes in interest rates, which management believes relate to general trends in global capital markets, but are not necessarily indicative of the operating performance of the Company’s segments. Management believes that Segment EBITDA provides useful information to investors, lenders, financial analysts and rating agencies about the financial performance of the Company’s segments. Additionally, management believes that investors and lenders view Segment EBITDA as an important factor in making investment decisions and assessing the value of the Company. Segment EBITDA is not a substitute for net income (loss), operating cash flows or other cash flow statement data determined in accordance with accounting principles generally accepted in the United States. Segment EBITDA, as presented, may not be comparable to similar measures of other companies.


17

VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)

14. CONTINGENCIES AND HEALTH CARE REGULATION
Contingencies
The Company is presently, and from time to time, subject to various claims and lawsuits arising in the normal course of business. In the opinion of management, the ultimate resolution of these matters is not expected to have a material adverse effect on the Company’s financial position or results of operations, except the matters discussed below under “Governmental Regulation” and "Antitrust Lawsuits" could have a material adverse effect, individually or in the aggregate, on the Company's financial position or results of operations.
Capital Expenditure Commitments
As part of its acquisition of The Detroit Medical Center ("DMC"), effective January 1, 2011, the Company committed to spend a total of $850.0 million over a five-year period, $500.0 million of which related to a specific list of expansion projects. As of September 30, 2012, the Company had spent approximately $195.9 million related to this commitment, including approximately $97.1 million related to the specific project list. Under the terms of the DMC acquisition agreement, the Company was required to spend at least $80.0 million related to the specific list of expansion projects through December 31, 2011. Since this commitment was not met, the Company deposited $41.8 million of cash into an escrow account restricted for the purpose of funding capital expenditures related to the specific project list in February 2012. As of September 30, 2012, the Company has been reimbursed the full $41.8 million from the escrow account resulting from capital expenditures made subsequent to December 2011. In addition, as of September 30, 2012, the Company has spent approximately $17.1 million related to calendar year 2012 commitments and will escrow any shortfall of spending through December 31, 2012 against the $80.0 million commitment by February 2013. As of September 30, 2012, the Company estimated its remaining commitments, excluding those for DMC, to complete all capital projects in process to be approximately $145.0 million.
Professional and General Liability Insurance
Given the nature of its operations, the Company is subject to professional and general liability claims and related lawsuits in the ordinary course of business. The Company maintains professional and general liability insurance with unrelated commercial insurance carriers to provide for losses up to $65.0 million in excess of its self-insured retention (such self-insured retention is maintained through the Company’s captive insurance subsidiaries and/or other of its subsidiaries) of $10.0 million through June 30, 2010 but increased to $15.0 million for its Illinois hospitals subsequent to June 30, 2010.
Due to changes in claims development related to prior fiscal years, the Company reduced its professional and general liability reserve by $1.2 million ($0.7 million, or $0.01 per diluted share, net of taxes) for the three months ended September 30, 2011 and increased its professional and general liability reserve by $6.2 million ($3.8 million, or $0.05 per diluted share, net of taxes) for the three months ended September 30, 2012.
Similarly, the Company decreased its workers compensation reserve related to prior fiscal years by $0.5 million ($0.3 million, or $0.01 per diluted share, net of taxes) and $2.2 million ($1.3 million, or $0.02 per diluted share, net of taxes) during the three months ended September 30, 2011 and 2012, respectively.
Additional adjustments to prior fiscal year estimates for professional and general liability or workers compensation claims may be necessary in future periods as the Company’s reporting history and loss portfolio matures.

Governmental Regulation

ICD Matter

In September 2010 the Company received a letter, which was signed jointly by an Assistant United States Attorney in the Southern District of Florida and an attorney from the U.S. Department of Justice ("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 implantable cardioverter defibrillators ("ICDs") which 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 excludes Medicare coverage for ICDs implanted for primary prevention 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) the DOJ’s initial analysis of claims submitted to Medicare indicates that many of the Company's 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


18

VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)

patient charts and other documents, along with statements under oath; and (6) the Company and its hospitals should ensure the retention and preservation of all information, electronic or otherwise, pertaining or related to ICDs. Upon receipt of this letter, the Company immediately took steps to retain and preserve all of the Company's information and that of its 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 the Company received, rather than subpoenas. DMC received its letter from the DOJ in respect of ICDs in December 2010. The Company understands that the DOJ is investigating hundreds of other hospitals, in addition to its hospitals, for ICD billings, as part of a national enforcement initiative.

The Company has entered into tolling agreements with the DOJ. In addition, the DOJ has advised us that the investigation covers implantations after October 1, 2003, has identified the cases that are the subject of the DOJ’s investigation, and has requested that the Company review the identified cases. The Company understands that the DOJ has made similar requests for self-reviews of the other health systems and hospitals under investigation. The DOJ has issued a set of auditing instructions to all the hospitals being investigated along with a request that the hospitals self-audit the cases previously identified in accordance with those instructions. The Company has engaged outside medical experts to conduct the audit in accordance with the criteria established by the DOJ and understands that the DOJ intends to pursue settlement negotiations based on the results of the audit.
The Company intends to cooperate fully with the investigation of this matter. To date, the DOJ has not asserted any specific claim of damages against the Company or its hospitals. Because the Company still is in the early stages of this investigation, the Company is unable to predict its timing or outcome at this time. However, as the Company understands that this investigation is being conducted under the federal False Claims Act ("FCA"), the Company is at risk for significant damages under the FCA’s treble damages and civil monetary penalty provisions if the DOJ concludes a large percentage of claims for the identified patients are false claims and, as a result, such damages could materially affect the Company's business, financial condition or results of operations.

United States of America ex rel. Brad Graber v. VHS Outpatient Clinics, Inc. d/b/a Abrazo Medical Group and Vanguard Health Systems, Inc.

On July 11, 2012, the Company was served with a summons in a civil action that was originally filed under seal on December 15, 2011 with the U.S. District Court for the District of Arizona. This action was brought by Brad Graber as a private party “qui tam relator” on behalf of the federal government and various state governments. On June 21, 2012, the U.S. Government filed a Notice of Election to Decline Intervention. On June 25, 2012, the court issued an order unsealing the action.

The action brought by Mr. Graber alleges civil violations of the FCA, namely, that the Company entered into arrangements with physicians that failed to meet certain statutory requirements of the Stark Law that compensation be at fair market value and that we retaliated against Mr. Graber. The action seeks damages provided for in the FCA. The Company believes that all of the allegations described above are without merit and intend to vigorously defend ourselves in these actions, if pursued. Management does not believe that the final outcome of this matter will be material.

Antitrust Lawsuits

On June 20, 2006, a federal antitrust class action suit was filed in San Antonio, Texas against the Company's Baptist Health System subsidiary in San Antonio, Texas and two other large hospital systems in San Antonio. In the complaint, plaintiffs allege that the three hospital system defendants conspired with each other and with other unidentified San Antonio area hospitals to depress the compensation levels of registered nurses employed at the conspiring hospitals within the San Antonio area by engaging in certain activities that violated the federal antitrust laws. The complaint alleges two separate claims. The first count asserts that the defendant hospitals violated Section 1 of the federal Sherman Act, which prohibits agreements that unreasonably restrain competition, by conspiring to depress nurses' compensation. The second count alleges that the defendant hospital systems also violated Section 1 of the Sherman Act by participating in wage, salary and benefits surveys for the purpose, and having the effect, of depressing registered nurses' compensation or limiting competition for nurses based on their compensation. The class on whose behalf the plaintiffs filed the complaint is alleged to comprise all registered nurses


19

VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)

employed by the defendant hospitals since June 20, 2002. The suit seeks unspecified damages, trebling of this damage amount pursuant to federal law, interest, costs and attorneys' fees. From 2006 through April 2008, the Company and the plaintiffs worked on producing documents to each other relating to, and supplying legal briefs to the court in respect of, solely the issue of whether the court will certify a class in this suit, the court having bifurcated the class and merit issues. In April 2008, the case was stayed by the judge pending his ruling on plaintiffs' motion for class certification. The Company believes that the allegations contained within this putative class action suit are without merit, and the Company has vigorously worked to defeat class certification. If a class is certified, the Company will continue to defend vigorously against the litigation.

On the same date in 2006 that this suit was filed against the Company in federal district court in San Antonio, the same attorneys filed three other substantially similar putative class action lawsuits in federal district courts in Chicago, Illinois, Albany, New York and Memphis, Tennessee against some of the hospitals or hospital systems in those cities (none of such hospitals or hospital systems being owned by the Company). The attorneys representing the plaintiffs in all four of these cases said in June 2006 that they may file similar complaints in other jurisdictions and in December 2006 they brought a substantially similar class action lawsuit against eight hospitals or hospital systems in the Detroit, Michigan metropolitan area, one of which was DMC. Since representatives of the Service Employees International Union (“SEIU”) joined plaintiffs' attorneys in announcing the filing of all four complaints on June 20, 2006, and as has been reported in the media, the Company believes that SEIU's involvement in these actions appears to be part of a corporate campaign to attempt to organize nurses in these cities, including San Antonio and Detroit. The registered nurses in the Company's hospitals in San Antonio and Detroit are currently not members of any union. In the suit in Detroit against DMC, the court did not bifurcate class and merits issues. On March 22,
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.

If the plaintiffs in the San Antonio and/or Detroit suits (1) are successful in obtaining class certification and (2) are able to prove both liability and substantial damages, which are then trebled under Section 1 of the Sherman Act, such a result could materially affect the Company's business, financial condition or results of operations. However, in the opinion of management, the ultimate resolution of these matters is not expected to have a material adverse effect on the Company's financial position or results of operations.
Reimbursement
Laws and regulations governing the Medicare and Medicaid and other federal health care programs are complex and subject to interpretation. The Company’s management believes that it is in compliance with all applicable laws and regulations in all material respects and is not aware of any pending or threatened investigations involving allegations of potential wrongdoing related to Medicare and Medicaid programs. While no such regulatory inquiries have been made, the Company’s compliance with such laws and regulations is subject to future government review and interpretation. Non-compliance with such laws and regulations could result in significant regulatory action including fines, penalties, and exclusion from the Medicare, Medicaid and other federal health care programs.
Acquisitions
The Company has acquired and expects to continue to acquire businesses with prior operating histories. Acquired companies may have unknown or contingent liabilities, including liabilities for failure to comply with health care laws and regulations, such as billing and reimbursement, fraud and abuse and similar anti-referral laws. Although the Company institutes policies designed to conform practices to its standards following the completion of its acquisitions, there can be no assurance that it will not become liable for past activities of prior owners that may later be asserted to be improper by private plaintiffs or government agencies. Although the Company generally seeks to obtain indemnification from prospective sellers covering such matters, there can be no assurance that any such matter will be covered by indemnification or, if covered, that such indemnification will be adequate to cover potential losses and fines.
Employment-Related Agreements
Effective June 1, 1998, the Company executed employment agreements with three of its current senior executive officers. The Company executed an employment agreement with a fourth current senior executive officer on September 1, 1999. The employment agreements were amended on September 23, 2004 to extend the term of each employment agreement another 5


20

VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)

years and to provide that the Blackstone merger did not constitute a change of control, as defined in the agreements. From November 15, 2007 to December 31, 2008, the Company entered into written employment agreements with four other executive officers for terms expiring five years from the agreement date. The employment agreements will renew automatically for additional one-year periods, unless terminated by the Company or the executive officer. The employment agreements provide, among other things, for minimum salary levels, for participation in bonus plans, and for amounts to be paid as liquidated damages in the event of a change in control or termination by the Company without cause.
The Company has executed severance protection agreements (“severance agreements”) between the Company and each of its other officers who do not have employment agreements. The severance agreements are automatically extended for successive one year terms at the discretion of the Company unless a change in control occurs, as defined in the severance agreement, at which time the severance agreement continues in effect for a period of not less than three years beyond the date of such event. The Company may be obligated to pay severance payments as set forth in the severance agreements in the event of a change in control and the termination of the executive’s employment with the Company.
Guarantees
As part of its contract with the Arizona Health Care Cost Containment System, one of the Company’s health plans, Phoenix Health Plan ("PHP"), is required to maintain a performance guarantee, the amount of which is based upon PHP’s membership and capitation premiums received. As of September 30, 2012, the Company maintained this performance guarantee in the form of $40.0 million of surety bonds with independent third party insurers. The Company also has a surety bond for its Michigan Pioneer ACO in the amount of $3.0 million as part of the requirements set forth by CMS. The Company also holds other miscellaneous surety bonds for various corporate needs.

Redeemable Noncontrolling Interest

In September 2011, the Company obtained a 51% controlling interest in a partnership that holds the assets acquired and liabilities assumed in the purchase of Valley Baptist Health System. The remaining 49% non-controlling interest was granted to the former owner of Valley Baptist Health System (the “seller”) as purchase consideration. The partnership operating agreement includes an option by which the seller may put its 49% non-controlling interest back to the Company upon either the third or fifth anniversary of the transaction date. The redemption value is calculated based upon the operating results and the debt of the partnership, but is subject to a floor value. The Company also has the option to call a stated percentage of the seller's non-controlling interest in the event the seller does not exercise its put option on either of the anniversary dates.
The Company's redeemable noncontrolling interest ("RNCI") resulted from this put option. The carrying value of the redeemable non-controlling interest has been determined based upon the discounted expected redemption value as of September 30, 2012. For each reporting period through the third anniversary of the acquisition, the Company accretes the carrying value of RNCI up to the expected redemption value as of September 1, 2014. If the minority partner exercises this option, the Company may purchase the non-controlling interest with cash or by issuing stock. If the option is exercised, it is the Company’s intent to settle the purchase in cash. If the option were to be settled in shares, approximately 6,056,000 shares of the Company’s common stock would be required to be issued based upon the closing price of the Company’s common stock on September 28, 2012.
15. FINANCIAL INFORMATION FOR SUBSIDIARY GUARANTORS AND NON-GUARANTOR SUBSIDIARIES

The Company conducts substantially all of its business through its subsidiaries. Most of the Company’s subsidiaries jointly and severally guarantee the 8.0% Senior Unsecured Notes due 2018 and the 7.750% Senior Notes due 2019. Certain of the Company’s other consolidated wholly-owned and non-wholly-owned entities do not guarantee these notes in conformity with the provisions of the indentures governing those notes, and do not guarantee the 2010 Credit Facilities in conformity with the provisions thereof. The accompanying consolidating financial information for the parent company, the issuers of the senior notes and term debt, the issuers of the Senior Discount Notes, the subsidiary guarantors, the non-guarantor subsidiaries, certain eliminations and consolidated Company as of June 30, 2012 and September 30, 2012 and for the three months ended September 30, 2011 and September 30, 2012 follows.



21

VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)


VANGUARD HEALTH SYSTEMS, INC.
Condensed Consolidating Balance Sheets
June 30, 2012
 
Parent
 
Issuers of
Senior
Notes and
Term Debt
 
Issuers of
Senior
Discount
Notes
 
Guarantor
Subsidiaries
 
Combined
Non-
Guarantors
 
Eliminations
 
Total
Consolidated
 
(In millions)
ASSETS
 
 
 
 
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$

 
$

 
$

 
$
305.8

 
$
149.7

 
$

 
$
455.5

Restricted cash

 

 

 
0.8

 
1.6

 

 
2.4

Accounts receivable, net

 

 

 
570.8

 
131.3

 

 
702.1

Inventories

 

 

 
93.2

 
3.8

 

 
97.0

Prepaid expenses and other current assets
0.1

 

 

 
281.8

 
44.1

 

 
326.0

Total current assets
0.1

 

 

 
1,252.4

 
330.5

 

 
1,583.0

Property, plant and equipment, net

 

 

 
1,802.6

 
307.5

 

 
2,110.1

Goodwill

 

 

 
680.9

 
87.5

 

 
768.4

Intangible assets, net

 
49.0

 
0.3

 
27.0

 
12.7

 

 
89.0

Investments in consolidated subsidiaries
608.8

 

 

 

 

 
(608.8
)
 

Investments in securities

 

 

 
51.8

 

 

 
51.8

Other assets

 

 

 
65.3

 
120.5

 

 
185.8

Total assets
$
608.9

 
$
49.0

 
$
0.3

 
$
3,880.0

 
$
858.7

 
$
(608.8
)
 
$
4,788.1

 
 
 
 
 
 
 
 
 
 
 
 
 
 
LIABILITIES AND EQUITY
 
 
 
 
 
 
 
 
 
 
 
 

Current liabilities:
 
 
 
 
 
 
 
 
 
 
 
 

Accounts payable
$

 
$

 
$

 
$
316.8

 
$
73.8

 
$

 
$
390.6

Accrued expenses and other current liabilities
0.1

 
73.2

 

 
392.7

 
120.9

 

 
586.9

Current maturities of long-term debt

 
8.2

 

 
2.1

 
0.9

 

 
11.2

Total current liabilities
0.1

 
81.4

 

 
711.6

 
195.6

 

 
988.7

Other liabilities

 

 

 
547.6

 
201.8

 

 
749.4

Long-term debt, less current maturities

 
2,672.0

 
9.9

 
4.2

 
9.3

 

 
2,695.4

Intercompany
307.3

 
(1,674.2
)
 
66.7

 
1,535.4

 
141.7

 
(376.9
)
 

Redeemable non-controlling interests

 

 

 

 
53.1

 

 
53.1

Total equity (deficit)
301.5

 
(1,030.2
)
 
(76.3
)
 
1,081.2

 
257.2

 
(231.9
)
 
301.5

Total liabilities and equity
$
608.9

 
$
49.0

 
$
0.3

 
$
3,880.0

 
$
858.7

 
$
(608.8
)
 
$
4,788.1




22

VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)

VANGUARD HEALTH SYSTEMS, INC.
Condensed Consolidating Balance Sheets
September 30, 2012
 
Parent
 
Issuers of
Senior
Notes and
Term Debt
 
Issuers of
Senior
Discount
Notes
 
Guarantor
Subsidiaries
 
Combined
Non-
Guarantors
 
Eliminations
 
Total
Consolidated
 
(In millions)
ASSETS
 
 
 
 
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$

 
$

 
$

 
$
216.9

 
$
113.3

 
$

 
$
330.2

Restricted cash

 

 

 
2.2

 
1.7

 

 
3.9

Accounts receivable, net

 

 

 
556.5

 
115.9

 

 
672.4

Inventories

 

 

 
86.0

 
10.8

 

 
96.8

Prepaid expenses and other current assets

 

 

 
247.7

 
56.9

 

 
304.6

Total current assets

 

 

 
1,109.3

 
298.6

 

 
1,407.9

Property, plant and equipment, net

 

 

 
1,805.6

 
301.1

 

 
2,106.7

Goodwill

 

 

 
668.1

 
100.3

 

 
768.4

Intangible assets, net

 
47.0

 
0.3

 
28.4

 
11.8

 

 
87.5

Investments in consolidated subsidiaries
608.8

 

 

 

 

 
(608.8
)
 

Investments in securities

 

 

 
56.8

 

 

 
56.8

Other assets

 

 

 
0.4

 
163.7

 

 
164.1

Total assets
$
608.8

 
$
47.0

 
$
0.3

 
$
3,668.6

 
$
875.5

 
$
(608.8
)
 
$
4,591.4

 
 
 
 
 
 
 
 
 
 
 
 
 
 
LIABILITIES AND EQUITY
 
 
 
 
 
 
 
 
 
 
 
 

Current liabilities:
 
 
 
 
 
 
 
 
 
 
 
 

Accounts payable
$

 
$

 
$

 
$
284.6

 
$
58.6

 
$

 
$
343.2

Accrued expenses and other current liabilities
0.1

 
35.8

 

 
324.1

 
110.9

 

 
470.9

Current maturities of long-term debt

 
8.2

 

 
1.9

 
2.4

 

 
12.5

Total current liabilities
0.1

 
44.0

 

 
610.6

 
171.9

 

 
826.6

Other liabilities

 

 

 
553.6

 
145.7

 

 
699.3

Long-term debt, less current maturities

 
2,670.9

 
10.1

 
4.0

 
7.1

 

 
2,692.1

Intercompany
289.5

 
(1,586.3
)
 
66.8

 
1,424.6

 
182.3

 
(376.9
)
 

Redeemable non-controlling interests

 

 

 

 
54.2

 

 
54.2

Total equity (deficit)
319.2

 
(1,081.6
)
 
(76.6
)
 
1,075.8

 
314.3

 
(231.9
)
 
319.2

Total liabilities and equity
$
608.8

 
$
47.0

 
$
0.3

 
$
3,668.6

 
$
875.5

 
$
(608.8
)
 
$
4,591.4




23

VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)


VANGUARD HEALTH SYSTEMS, INC.
Condensed Consolidating Statements of Operations
For the three months ended September 30, 2011
 
Parent
 
Issuers of
Senior
Notes and
Term Debt
 
Issuers of
Senior
Discount
Notes
 
Guarantor
Subsidiaries
 
Combined
Non-
Guarantors
 
Eliminations