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VANGUARD HEALTH SYSTEMS 10-Q 2013
VHS-2013.3.31-10Q
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 March 31, 2013
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 April 30, 2013, there were 77,843,947 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
 
March 31, 2013
 
(In millions, except share and
per share amounts)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
455.5

 
$
522.8

Restricted cash
2.4

 
6.0

Accounts receivable, net of allowance for doubtful accounts of $366.5 and $371.4, respectively
702.1

 
653.1

Inventories
97.0

 
99.2

Deferred tax assets
89.6

 
65.0

Prepaid expenses and other current assets
236.4

 
223.3

Total current assets
1,583.0

 
1,569.4

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

 
2,202.6

Goodwill
768.4

 
772.5

Intangible assets, net of accumulated amortization
89.0

 
85.7

Deferred tax assets, noncurrent
71.2

 
83.9

Investments in securities
51.8

 
59.3

Escrowed cash for capital commitments
20.3

 
17.3

Other assets
94.3

 
100.2

Total assets
$
4,788.1

 
$
4,890.9

LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
390.6

 
$
368.9

Accrued salaries and benefits
226.0

 
223.8

Accrued health plan claims and settlements
67.8

 
55.7

Accrued interest
73.2

 
27.8

Other accrued expenses and current liabilities
219.9

 
165.5

Current maturities of long-term debt
11.2

 
14.5

Total current liabilities
988.7

 
856.2

Professional and general liability and workers compensation reserves
304.8

 
287.8

Unfunded pension liability
269.9

 
226.0

Other liabilities
174.7

 
126.2

Long-term debt, less current maturities
2,695.4

 
2,980.8

Total liabilities
4,433.5

 
4,477.0

Commitments and contingencies

 

Redeemable non-controlling interests
53.1

 
56.4

Equity:
 
 
 
Vanguard Health Systems, Inc. stockholders’ equity:
 
 
 
Common Stock of $0.01 par value; 500,000,000 shares authorized; 75,474,000 and 77,840,000 shares issued and outstanding, respectively
0.8

 
0.8

Additional paid-in capital
403.3

 
405.9

Accumulated other comprehensive loss
(48.4
)
 
(45.6
)
Retained deficit
(60.6
)
 
(13.2
)
Total Vanguard Health Systems, Inc. stockholders’ equity
295.1

 
347.9

Non-controlling interests
6.4

 
9.6

Total equity
301.5

 
357.5

Total liabilities and equity
$
4,788.1

 
$
4,890.9


See accompanying notes.
1


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

 
Three months ended March 31,
 
Nine months ended March 31,
 
2012
 
2013
 
2012
 
2013
 
(In millions, except share and per share amounts)
Patient service revenues
$
1,525.5

 
$
1,467.2

 
$
4,305.1

 
$
4,412.6

Less: Provision for doubtful accounts
(133.8
)
 
(151.2
)
 
(401.5
)
 
(482.5
)
Patient service revenues, net
1,391.7

 
1,316.0

 
3,903.6

 
3,930.1

Premium revenues
190.8

 
182.1

 
590.6

 
551.8

Total revenues
1,582.5

 
1,498.1

 
4,494.2

 
4,481.9

 
 
 
 
 
 
 
 
Salaries and benefits (includes stock compensation of $1.9, $0.6, $6.5 and $5.5, respectively)
721.8

 
695.3

 
2,089.2

 
2,073.6

Health plan claims expense
146.6

 
137.3

 
458.6

 
421.4

Supplies
235.5

 
229.1

 
677.0

 
687.7

Purchased services
144.6

 
155.6

 
405.0

 
451.0

Rents and leases
19.0

 
19.4

 
55.7

 
57.2

Other operating expenses
142.7

 
124.4

 
407.1

 
413.7

Medicare and Medicaid EHR incentives
(2.4
)
 
(5.4
)
 
(26.8
)
 
(31.2
)
Depreciation and amortization
62.9

 
60.7

 
191.3

 
194.1

Interest, net
43.4

 
48.8

 
132.4

 
149.3

Acquisition related expenses
1.2

 
0.1

 
13.8

 
0.2

Debt extinguishment costs

 
1.3

 
38.9

 
1.3

Other
(2.2
)
 
(4.9
)
 
(6.4
)
 
(11.8
)
Income from continuing operations before income taxes
69.4

 
36.4

 
58.4

 
75.4

Income tax expense
(24.3
)
 
(12.4
)
 
(20.4
)
 
(24.5
)
Income from continuing operations
45.1

 
24.0

 
38.0

 
50.9

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

 
(0.5
)
 
0.1

Net income
45.0

 
24.0

 
37.5

 
51.0

Net loss (income) attributable to non-controlling interests
(1.0
)
 
(2.7
)
 
0.5

 
(3.6
)
Net income attributable to Vanguard Health Systems, Inc. stockholders
$
44.0

 
$
21.3

 
$
38.0

 
$
47.4

 
 
 
 
 
 
 
 
Amounts attributable to Vanguard Health Systems, Inc. stockholders:
 
 
 
 
 
 
 
Income from continuing operations, net of taxes
$
44.1

 
$
21.3

 
$
38.5

 
$
47.3

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

 
(0.5
)
 
0.1

Net income attributable to Vanguard Health Systems, Inc. stockholders
$
44.0

 
$
21.3

 
$
38.0

 
$
47.4

 
 
 
 
 
 
 
 
Earnings per share attributable to Vanguard Health Systems, Inc. stockholders:
 
 
 
 
 
 
 
Basic earnings per share
$
0.58

 
$
0.27

 
$
0.49

 
$
0.59

Diluted earnings per share
$
0.55

 
$
0.26

 
$
0.47

 
$
0.57

 
 
 
 
 
 
 
 
Weighted average shares (in thousands):
 
 
 
 
 
 
 
Basic
75,383

 
77,619

 
75,187

 
76,907

Diluted
78,933

 
80,115

 
78,762

 
79,475


See accompanying notes.
2


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

 
Three months ended March 31,
 
Nine months ended March 31,
 
2012
 
2013
 
2012
 
2013
 
(In millions)
Net income
$
45.0

 
$
24.0

 
$
37.5

 
$
51.0

Other comprehensive income:
 
 
 
 
 
 
 
Change in unrealized holding gains on investments in securities, net
3.0

 
1.6

 
1.2

 
4.9

Other comprehensive income before taxes
3.0

 
1.6

 
1.2

 
4.9

Change in income tax expense
(1.0
)
 
(0.7
)
 
(0.2
)
 
(2.1
)
Other comprehensive income, net of taxes
2.0

 
0.9

 
1.0

 
2.8

Comprehensive income
47.0

 
24.9

 
38.5

 
53.8

Net loss (income) attributable to non-controlling interests
(1.0
)
 
(2.7
)
 
0.5

 
(3.6
)
Comprehensive income attributable to Vanguard Health Systems, Inc. stockholders
$
46.0

 
$
22.2

 
$
39.0

 
$
50.2




See accompanying notes.
3


VANGUARD HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENT OF EQUITY
Nine months ended March 31, 2013
(Unaudited)
 
Vanguard Health Systems, Inc. Stockholders
 
 
 
 
 
Common Stock
 
Additional Paid-In Capital
 
Accumulated Other Comprehensive Loss
 
Retained Deficit
 
Non-Controlling Interests
 
Total Equity
 
Shares
 
Amount
 
 
 
 
 
 
(In millions, except share amounts)
Balance at June 30, 2012
75,474,000

 
$
0.8


$
403.3

 
$
(48.4
)
 
$
(60.6
)
 
$
6.4

 
$
301.5

Net income

 

 

 

 
47.4

 
3.6

 
51.0

Stock compensation (non-cash)

 

 
5.5

 

 

 

 
5.5

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

 

 
(1.2
)
 

 

 

 
(1.2
)
Common stock issued for stock-based awards exercised and related taxes
2,366,000

 

 
1.6

 

 

 

 
1.6

Distributions to non-controlling interests and other, net

 

 

 

 

 
(0.4
)
 
(0.4
)
Accretion of redeemable non-controlling interest

 

 
(3.3
)
 

 

 

 
(3.3
)
Other comprehensive income, net of taxes

 

 

 
2.8

 

 

 
2.8

Balance at March 31, 2013
77,840,000

 
$
0.8

 
$
405.9

 
$
(45.6
)
 
$
(13.2
)
 
$
9.6

 
$
357.5



See accompanying notes.
4


VANGUARD HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Nine months ended March 31,
 
2012
 
2013
 
(In millions)
Operating activities:
 
 
 
Net income
$
37.5

 
$
51.0

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
191.3

 
194.1

Amortization of loan costs
4.8

 
6.7

Accretion of principal on notes
6.2

 
3.2

Acquisition related expenses
13.8

 
0.2

Stock compensation
6.5

 
5.5

Deferred income taxes
15.4

 
12.8

Debt extinguishment costs
38.9

 
1.3

Other
(0.9
)
 
1.6

Changes in operating assets and liabilities, net of the impact of acquisitions
(303.1
)
 
(186.4
)
Net cash provided by operating activities
10.4

 
90.0

 
 
 
 
Investing activities:
 
 
 
Acquisitions and related expenses, net of cash acquired
(213.7
)
 
(7.2
)
Capital expenditures
(196.1
)
 
(289.4
)
Proceeds from sale of investments in securities
77.8

 
76.2

Purchases of investments in securities
(66.0
)
 
(79.1
)
Net reimbursements from (deposits to) restricted cash and escrow fund
(40.6
)
 
0.3

Other investing activities
2.4

 
(0.4
)
Net cash used in investing activities
(436.2
)
 
(299.6
)
 
 
 
 
Financing activities:
 
 
 
Payments of long-term debt and capital lease obligations
(547.7
)
 
(19.1
)
Proceeds from debt borrowings
452.2

 
300.0

Payments of debt issuance costs
(7.5
)
 
(2.6
)
Proceeds from issuance of common stock
67.5

 

Payments of IPO related costs
(6.9
)
 

Payments of tender premiums on note redemptions
(27.6
)
 
(0.5
)
Other financing activities
(3.2
)
 
(0.9
)
Net cash provided by (used in) financing activities
(73.2
)
 
276.9

Net increase (decrease) in cash and cash equivalents
(499.0
)
 
67.3

Cash and cash equivalents, beginning of period
936.6

 
455.5

Cash and cash equivalents, end of period
$
437.6

 
$
522.8

Supplemental cash flow information:
 
 
 
Net cash paid for interest
$
143.8

 
$
187.4

Net cash paid for income taxes
$
0.9

 
$
18.9


See accompanying notes.
5

VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2013
(Unaudited)


1. BUSINESS AND BASIS OF PRESENTATION
Vanguard Health Systems, Inc. (the “Company”) is an investor-owned health care company whose subsidiaries and affiliates own and operate hospitals and related health care businesses in urban and suburban areas. As of March 31, 2013, the Company’s subsidiaries and affiliates owned and operated 28 acute care hospitals with 7,081 licensed beds and related outpatient service locations complementary to the hospitals providing health care services in San Antonio, Harlingen and Brownsville, Texas; metropolitan Detroit, Michigan; metropolitan Phoenix, Arizona; metropolitan Chicago, Illinois; and Massachusetts. The Company also owns managed health plans in Chicago, Illinois; Detroit, Michigan; Harlingen, Texas; and Phoenix, Arizona; and two surgery centers in Orange County, California.
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 corporate office costs of the Company, which approximated $14.1 million and $10.0 million for the three months ended March 31, 2012 and 2013, respectively, and $41.0 million and $43.0 million for the nine months ended March 31, 2012 and 2013, respectively.

The unaudited condensed consolidated financial statements as of March 31, 2013 and for the three months and nine months ended March 31, 2012 and 2013 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 the Company's 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.
Use of Estimates
In preparing the Company’s financial statements in conformity with accounting principles generally accepted in the United States, the Company's 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.



6

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

2. REVENUES AND REVENUE DEDUCTIONS
Patient Service Revenues Before Provision for Doubtful Accounts

The Company recognizes patient service revenues associated with services provided to patients who have third-party payer coverage on the basis of contractual rates for the services rendered. For uninsured patients that do not qualify for charity care, the Company recognizes revenues on the basis of its standard rates for services provided (or on the basis of discounted rates, if negotiated or provided by policy). The Company's revenues from third-party payers, the uninsured and other sources are summarized in the following table (dollars in millions).
 
Three months ended March 31,
 
Nine months ended March 31,
 
2012
 
2013
 
2012
 
2013
Medicare
$
408.0

 
29.3
 %
 
$
361.8

 
27.5
 %
 
$
1,068.1

 
27.4
 %
 
$
1,055.4

 
26.9
 %
Medicaid
189.0

 
13.6

 
156.5

 
11.9

 
535.0

 
13.7

 
499.5

 
12.7

Managed Medicare
145.7

 
10.5

 
161.6

 
12.3

 
403.0

 
10.3

 
451.5

 
11.5

Managed Medicaid
129.3

 
9.3

 
140.6

 
10.7

 
364.1

 
9.3

 
398.2

 
10.1

Managed care
444.4

 
31.9

 
411.3

 
31.3

 
1,280.9

 
32.8

 
1,268.5

 
32.3

Commercial
17.4

 
1.3

 
22.0

 
1.7

 
50.7

 
1.3

 
62.3

 
1.6

 
1,333.8

 
95.8

 
1,253.8

 
95.3

 
3,701.8

 
94.8

 
3,735.4

 
95.0

Self pay
131.6

 
9.5

 
152.8

 
11.6

 
421.2

 
10.8

 
502.1

 
12.8

Other
60.1

 
4.3

 
60.6

 
4.6

 
182.1

 
4.7

 
175.1

 
4.5

Patient service revenues before provision for doubtful accounts
1,525.5

 
109.6

 
1,467.2

 
111.5

 
4,305.1

 
110.3

 
4,412.6

 
112.3

Provision for doubtful accounts
(133.8
)
 
(9.6
)
 
(151.2
)
 
(11.5
)
 
(401.5
)
 
(10.3
)
 
(482.5
)
 
(12.3
)
Patient service revenues, net
$
1,391.7

 
100.0
 %
 
$
1,316.0

 
100.0
 %
 
$
3,903.6

 
100.0
 %
 
$
3,930.1

 
100.0
 %

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 12-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 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 estimates of the allowance for doubtful accounts and recoveries of accounts previously written off determine the amount of its provision for doubtful accounts to record during a period. The Company records the 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 $366.5 million and $371.4 million as of June 30, 2012 and March 31, 2013, respectively. These balances as a percentage of accounts receivable net of contractual adjustments were 34.3% and 36.3% as of June 30, 2012 and March 31, 2013, respectively. The percentage increase in allowance for doubtful accounts primarily related to the increase in uninsured patient volumes during the nine months ended March 31, 2013 compared to the year ended June 30, 2012. General market and economic conditions impacted the Company's payer mix and resulted in more services provided to patients who were uninsured, which increased the Company's allowance for doubtful accounts in the current period. The Company’s combined allowances for doubtful accounts, uninsured discounts and charity care covered more than 100.0% of combined uninsured and self-pay after insurance accounts receivable as of June 30, 2012 and March 31, 2013. In addition, the Company's total uncompensated care, prior to uncompensated care deductions, increased from $290.5 million during the nine


7

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

months ended March 31, 2012 to $323.9 million during the nine months ended March 31, 2013 primarily due to the increase in uninsured patient volumes coupled with slight deterioration within the aging of these payers.
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 U.S. 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. The Company deducted $57.4 million and $62.9 million of charity care from revenues during the three months ended March 31, 2012 and 2013, respectively, and $169.2 million and $180.0 million during the nine months ended March 31, 2012 and 2013, respectively. The estimated cost incurred by the Company to provide services to patients who qualified for charity care was $15.3 million and $14.7 million for the three months ended March 31, 2012 and 2013, respectively, and $45.0 million and $42.0 million for the nine months ended March 31, 2012 and 2013, respectively. These estimates were determined using a ratio of cost to gross charges calculated from the Company’s most recently filed Medicare cost reports and applying that ratio to the gross charges associated with providing charity care for the respective periods.
Program 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 income statements in the period in which the revisions are made. Management believes that adequate provision has been made for adjustments that may result from final determination of amounts earned under the Medicare and Medicaid programs and other managed care plans with settlement provisions.
Net adjustments for final third party settlements positively impacted the Company’s income from continuing operations before income taxes by $1.8 million ($1.1 million net of taxes or $0.01 per diluted share) and negatively impacted income from continuing operations before income taxes by $0.3 million ($0.2 million net of taxes) for the three months ended March 31, 2012 and 2013, respectively. Final third party settlements positively impacted the Company's income from continuing operations before income taxes by $6.7 million ($4.1 million net of taxes or $0.05 per diluted share) and $0.8 million ($0.5 million net of taxes or $0.01 per diluted share) for the nine months ended March 31, 2012 and 2013, respectively.
Recovery Audit Program
The Recovery Audit Program relies on private recovery audit contractors (“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 to identify those claims most likely to contain overpayments, such as incorrectly coded services, incorrect payment amounts, non-covered services and duplicate payments. The Centers for Medicare and Medicaid Services (“CMS”) has given RACs the authority to look at a claim up to three years after the date the claim was paid.  Claims identified as overpayments are subject to an appeals process.  RACs are paid a contingency fee based on the overpayments they identify and collect.
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 quarter 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 component 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 income statements during the nine months ended March 31, 2013.  As of June 30, 2012 and March 31, 2013, the Company's current portion of RAC reserves was $1.9 million and $2.2 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 March 31, 2013, the Company's non-current portion of RAC reserves was


8

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

$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 provided for Medicare and Medicaid incentive payments beginning in calendar year 2011 for eligible hospitals and professionals that implement and achieve meaningful use of certified EHR technology. The Company utilizes the contingency model to account for Medicare and Medicaid EHR incentive payments. Under the contingency model, EHR incentive payments are recognized when all contingencies relating to the incentive payment have been satisfied. For Medicaid EHR incentive payments, recognition occurs at the time meaningful use criteria are met and formal state acceptance is documented since Medicaid payments for the states in which the Company operates are based upon historical cost reports with no subsequent payment adjustment. For Medicare EHR incentive payments, recognition is deferred until both the Medicare federal fiscal year during which EHR meaningful use was demonstrated ends and the cost report information utilized to determine the final amount of reimbursement is known.
The Company recognized other income related to Medicare and Medicaid EHR incentives under the contingency model of $2.4 million and $5.4 million for the three months ended March 31, 2012 and 2013, respectively, and $26.8 million and $31.2 million for the nine months ended March 31, 2012 and 2013, respectively. 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 March 31, 2013, the Company had $2.7 million and $1.7 million in Medicaid and Medicare EHR receivables, respectively, on its condensed consolidated balance sheets. In addition, as of June 30, 2012 and March 31, 2013, the Company had $4.3 million and $2.0 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 March 31, 2013 (in millions).
 
March 31, 2013
 
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Cash and cash equivalents
$
33.3

 
$
33.3

 
$

 
$

Corporate bonds
14.3

 

 
14.3

 

Common stock - domestic
11.7

 

 
11.7

 

Investments in securities
$
59.3

 
$
33.3

 
$
26.0

 
$

Investments in securities
As of March 31, 2013, the Company held $59.3 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. The investments in securities are held by one of the Company's wholly-owned captive insurance subsidiaries. The Company may not be able to utilize these investments to fund operating or capital expenditure needs due to statutory limitations placed on the captive insurance subsidiary.


9

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

Investments in corporate bonds, valued at $14.3 million at March 31, 2013, consist of corporate bonds and other fixed income investments. The average expected maturity of the investments in corporate bonds at March 31, 2013 was 6.6 years, compared to the average scheduled maturity of 11.2 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 $53.7 million as of March 31, 2013.
The following table provides a reconciliation of activity for the Company's investments in securities for the nine months ended March 31, 2013 (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 March 31, 2013
Investment in securities
$
51.8

 
$
(76.2
)
 
$
79.1

 
$
(0.3
)
 
$
4.9

 
$
59.3

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 condensed consolidated income statement in the period in which the loss occurs. The cumulative gross unrealized gain for the securities was approximately $5.6 million ($3.6 million, net of taxes) which is included in accumulated other comprehensive loss on the condensed consolidated balance sheet at March 31, 2013.
Supplemental information regarding the Company's available-for-sale investment securities held as of March 31, 2013 is set forth in the table below (in millions).
 
Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
Cash and cash equivalents
$
33.3

 
$

 
$

 
$
33.3

Corporate bonds
11.3

 
3.0

 

 
14.3

Common stock - domestic
9.1

 
2.6

 

 
11.7

 
$
53.7

 
$
5.6

 
$

 
$
59.3

As of March 31, 2013, the Company held no investments in securities with unrealized loss positions greater than 12 months.
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 term loans, capital leases and other long-term debt was approximately $2,030.8 million, based upon stated market prices (Level 1), at March 31, 2013. The fair values of the Company's term loan facility, capital leases and other long-term debt was approximately $1,116.7 million, based upon quoted market prices and interest rates (Level 2), at March 31, 2013.

5. GOODWILL

During the nine months ended March 31, 2013, goodwill increased by $4.1 million, with approximately $0.8 million and $3.3 million of this increase related to acute care services segment acquisitions and health plan services segment acquisitions, respectively.

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 impairment 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 and such challenges have continued through the nine


10

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

months ended March 31, 2013. These challenges included hospital reimbursement cuts, reductions to covered lives under the Arizona Health Care Cost Containment System (“AHCCCS”) program and local economic conditions that adversely impacted elective surgery 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 the 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.

The Company has $79.4 million of goodwill related to the Phoenix Health Plan (“PHP”), which is included in the Company's health plan services segment. PHP's current contract with AHCCCS, Arizona's state Medicaid program, expires September 30, 2013. On March 22, 2013, the Company was 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 March 31, 2013. Pursuant to the terms of PHP's agreement with AHCCCS, PHP will not file a protest of any of the 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 contracting period, except if 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. During the quarter ended March 31, 2013, the Company assessed whether goodwill had been impaired for the health plan reporting unit based upon the significant differences between the terms of its current contract with AHCCCS and the terms of the capped contract beginning October 1, 2013. Based upon the Company's current projections of future cash flows (Level 3 inputs) for the health plan reporting unit, management concluded that goodwill associated with its health plan reporting unit is not impaired. However, the Company will continue to monitor the projections of future cash flows in the health plan reporting unit as impacted by this contractual change. The Company's calculations used to determine the fair value of the health plan reporting unit require significant judgment, assumptions, and estimation, the most significant of which is projected membership levels, and may be revised in the future as additional information becomes available. If these estimates and assumptions prove to be materially inaccurate, an impairment charge could be required in a future period.

6. OTHER ACCRUED EXPENSES AND OTHER LIABILITIES
The following table presents a summary of items comprising other accrued expenses and current liabilities in the accompanying condensed consolidated balance sheets as of June 30, 2012 and March 31, 2013 (in millions).
 
June 30, 2012
 
March 31, 2013
Property taxes
$
23.0

 
$
19.7

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

 
81.3

Accrued income and service guarantees
5.3

 
3.4

Accrued capital expenditures
35.7

 
29.9

Market-specific contract liabilities
39.7

 
7.6

Other
46.5

 
23.6

Other accrued expenses and current liabilities
$
219.9

 
$
165.5


During the nine months ended March 31, 2013, the Company made payments for various contract liability settlements in one of its markets.

As of June 30, 2012 and March 31, 2013, the Company had other non-current liabilities of $174.7 million and $126.2 million, respectively, in other liabilities on the accompanying condensed consolidated balance sheets. During the nine months ended March 31, 2013, the Company paid resident FICA claims of $39.5 million using proceeds from a settlement with the Internal Revenue Service.


11

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

7. FINANCING ARRANGEMENTS
A summary of the Company’s long-term debt as of June 30, 2012 and March 31, 2013 follows (in millions).
 
June 30, 2012
 
March 31, 2013
8.0% Senior Unsecured Notes due 2018
$
1,159.1

 
$
1,161.2

7.750% Senior Notes due 2019
722.2

 
722.6

10.375% Senior Discount Notes due 2016
9.9

 

Term loans payable under credit facility due 2016
798.8

 
1,092.9

Capital leases and other long-term debt
16.6

 
18.6

 
2,706.6

 
2,995.3

Less: current maturities
(11.2
)
 
(14.5
)
 
$
2,695.4

 
$
2,980.8


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 are not guaranteed by any of the Company’s subsidiaries.

The Company used the net proceeds from its initial public offering in June 2011 and the exercise of the over-allotment option by the underwriters in July 2011 to redeem $453.6 million accreted value ($724.0 million principal balance) of the Senior Discount Notes and to pay $27.6 million of redemption premiums related thereto. The redemptions resulted in approximately $14.7 million of remaining unredeemed accreted value of these notes outstanding immediately after the redemptions were completed and resulted in the recognition of debt extinguishment costs during the nine months ended March 31, 2012 of $38.9 million, $25.3 million net of taxes, representing tender premiums and other costs to redeem the Senior Discount Notes and the write-off of net deferred loan costs associated with the redeemed notes. During the fiscal year ended June 30, 2012, subsequent to September 30, 2011, the Company redeemed $6.0 million accreted value ($8.9 million principal balance) of Senior Discount Notes through privately negotiated transactions.

On March 19, 2013, the Company redeemed the remaining $10.7 million accreted value ($14.3 million principal balance) of the Senior Discount Notes. In connection with the redemption, the Company paid $0.5 million of tender premiums to redeem the Senior Discount Notes.

7.750% Senior Notes

On January 26, 2011, Vanguard Health Holding Company II, LLC and Vanguard Holding Company II, Inc., wholly-owned subsidiaries of the Company (the “Issuers”), issued an aggregate principal amount of $350.0 million of 7.750% senior notes due 2019 (the “Senior Notes”), in a private placement. The obligations under the Senior Notes were fully and unconditionally guaranteed on a senior basis by the Company and certain of its subsidiaries.

The Senior Notes bear interest at a rate of 7.750% per annum. The Company pays cash interest semi-annually in arrears on February 1 and August 1 of each year. The Senior Notes are unsecured general obligations of the Issuers and rank pari passu in right of payment to all existing and future unsecured indebtedness of the Issuers. The Senior Notes mature on February 1, 2019. The Company used the proceeds from the Senior Notes for general corporate purposes, including acquisitions, and to pay the related transaction fees and expenses of the offering and the offering of the Senior Discount Notes.

On June 14, 2011, substantially all of the outstanding Senior Notes were exchanged for new 7.750% senior notes with identical terms and conditions, except that the exchange notes were registered under the Securities Act of 1933 (the "Securities Act"). Terms and conditions of the exchange offer were set forth in the registration statement on Form S-4 filed with the Securities and Exchange Commission on April 8, 2011, that became effective on May 4, 2011.

On March 30, 2012, the Company issued an additional $375.0 million ($372.2 million cash proceeds net of original issue discount) aggregate principal amount of Senior Notes (the “New Notes”) in a private placement pursuant to the indenture, dated


12

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

as of January 26, 2011, governing the Senior Notes. The New Notes generally have the same terms and features as the Senior Notes. The New Notes mature on February 1, 2019. The New Notes were issued at an offering price of 99.25% plus accrued interest from February 1, 2012. The discount of $2.8 million will be accreted to par over the remaining term of the New Notes.

The New Notes are treated as a single series with the existing Senior Notes, except that the New Notes are subject to a separate registration rights agreement. On March 13, 2013, the Company completed the exchange of substantially all of the outstanding New Notes for new 7.750% senior notes with identical terms and conditions, except that the exchange notes are registered under the Securities Act. Terms and conditions of the exchange offer were set forth in the registration statement on Form S-4 filed with the Securities and Exchange Commission on December 14, 2012, that became effective on January 25, 2013.
Credit Facility Debt and Amendment

On March 14, 2013, certain of the Company's subsidiaries amended (the "amendment") its Credit Agreement, dated January 29, 2010 (the “Credit Agreement”). Pursuant to the amendment, the Company borrowed an additional $300.0 million in term loans and refinanced its outstanding term loans. Initially, the Credit Agreement provided that the Company's term loan facility (the “term loan facility”) bore interest at a rate equal to, at the Company's option, LIBOR (subject to a 1.50% floor) plus 3.50% per annum or an alternate base rate (subject to a 2.50% floor) plus 2.50% per annum. The amendment provides that the term loan facility bears interest at a rate equal to, at the Company's option, LIBOR (subject to a 1.00% floor) plus 2.75% per annum or an alternate base rate (subject to a 2.00% floor) plus 1.75% per annum. The term loan facility matures on January 29, 2016. The interest rate applicable to the term loan facility was 3.75% as of March 31, 2013. A portion of the $300.0 million in additional borrowings was used to redeem the outstanding principal and interest related to the Company's previously outstanding Senior Discount Notes and to pay the associated fees related to the amendment. The remaining proceeds will be used to finance other general operating and investing activities.

Subsequent to the $300.0 million amendment, the Company's senior secured credit facilities include a term loan facility, which matures in January 2016, in the amount of $1,092.9 million and a revolving credit facility, which matures in January 2015, in the amount of $365.0 million (the “2010 revolving facility”). The Company’s remaining borrowing capacity under the 2010 revolving facility, net of letters of credit outstanding, was $327.2 million as of March 31, 2013. The Company makes quarterly principal payments equal to one-fourth of one percent of the outstanding principal balance of the term loan facility and will continue to make such payments until the maturity of the term loan facility.

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

Debt Extinguishment Costs

In connection with the redemption of the remaining Senior Discount Notes and the $300.0 million amendment to the Company's Credit Agreement in March 2013, the Company recorded debt extinguishment costs of $1.3 million ($0.9 million net of taxes, or $0.01 per diluted share). The debt extinguishment costs include $0.5 million of tender premiums to redeem the Senior Discount Notes; $0.3 million of previously capitalized net deferred loan costs related to the Senior Discount Notes; $0.1 million of loan costs incurred related to the term loan facility that the Company expensed in accordance with accounting guidance related to modifications or exchanges of debt instruments for which carryover lenders' cash flows changed by more than 10%; and $0.4 million of third party costs related to the refinancing of the term loan facility.

During the nine months ended March 31, 2013, the Company capitalized an additional $2.8 million of deferred loan costs, whereas $5.0 million of the previously unamortized deferred loan costs will continue to be capitalized as intangible assets under the carryover lender provisions.





13

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

8. DEFINED BENEFIT PENSION PLAN
The components of net pension plan credits 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 and nine months ended March 31, 2012 and 2013 are as follows (in millions).
 
Three months ended March 31,
 
Nine months ended March 31,
 
2012
 
2013
 
2012
 
2013
Interest cost on projected benefit obligation
$
13.0

 
$
11.8

 
$
39.0

 
$
35.2

Expected return on plan assets
(14.3
)
 
(15.7
)
 
(42.9
)
 
(46.8
)
Total net pension plan credits
$
(1.3
)
 
$
(3.9
)
 
$
(3.9
)
 
$
(11.6
)
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 loss. At 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 $19.2 million and $32.3 million to the pension plan trust during the nine months ended March 31, 2012 and 2013, respectively.
9. ACCUMULATED OTHER COMPREHENSIVE LOSS
The components of accumulated other comprehensive loss, net of taxes, as of June 30, 2012 and March 31, 2013 are as follows (in millions).
 
June 30, 2012
 
March 31, 2013
Unrealized holding gain on investments in securities
$
0.7

 
$
5.6

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

 
0.9

Income tax benefit
30.6

 
28.5

Accumulated other comprehensive loss
$
(48.4
)
 
$
(45.6
)


14

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

10. EARNINGS PER SHARE
The Company computes basic earnings per share using the weighted average number of common shares outstanding. The Company computes diluted earnings 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 per share for the three months and nine months ended March 31, 2012 and 2013 (in millions, except per share amounts).
 
Three months ended March 31,
 
Nine months ended March 31,
 
2012
 
2013
 
2012
 
2013
Numerator for basic and diluted earnings per share:
 
 
 
 
 
 
 
Income from continuing operations
$
44.1

 
$
21.3

 
$
38.5

 
$
47.3

Income (loss) from discontinued operations
(0.1
)
 

 
(0.5
)
 
0.1

Accretion of redeemable non-controlling interest, net of taxes
(0.4
)
 
(0.7
)
 
(0.8
)
 
(2.0
)
Income available to common stockholders
$
43.6

 
$
20.6

 
$
37.2

 
$
45.4

 
 
 
 
 
 
 
 
Denominator (in thousands):
 
 
 
 
 
 
 
Weighted average shares outstanding - basic
75,383

 
77,619

 
75,187

 
76,907

Effect of dilutive securities
3,550

 
2,496

 
3,575

 
2,568

Weighted average shares outstanding - diluted
78,933

 
80,115

 
78,762

 
79,475

 
 
 
 
 
 
 
 
Basic earnings per share:
 
 
 
 
 
 
 
Continuing operations
$
0.58

 
$
0.27

 
$
0.50

 
$
0.59

Discontinued operations

 

 
(0.01
)
 

Basic earnings per share
$
0.58

 
$
0.27

 
$
0.49

 
$
0.59

 
 
 
 
 
 
 
 
Diluted earnings per share:
 
 
 
 
 
 
 
Continuing operations
$
0.55

 
$
0.26

 
$
0.48

 
$
0.57

Discontinued operations

 

 
(0.01
)
 

Diluted earnings per share
$
0.55

 
$
0.26

 
$
0.47

 
$
0.57


For the three months ended March 31, 2012 and 2013, the Company excluded 4,647,000 and 3,090,000, respectively, and for the nine months ended March 31, 2012 and 2013, the Company excluded 4,320,000 and 4,221,000, respectively, of potentially dilutive stock options and other stock-based awards from the calculation of diluted earnings per share because such stock-based awards were anti-dilutive or performance conditions were not met.


15

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

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 equity compensation plans that have been approved by the Company's Board of Directors.

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 March 31, 2013, there were 8,257,394 shares of common stock available for grant under the 2011 Plan. As of March 31, 2013, there were 1,610,665 options, 1,233,933 restricted stock units and 983,322 performance-based restricted stock units outstanding under the 2011 Plan. The 2011 Plan also includes 1,530,139 restricted shares that vested during the nine months ended March 31, 2013. Stock options issued under the 2011 Plan vest and become exercisable ratably over three years, while the time-based restricted stock units and performance units vest ratably over four years.

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 for the three months and nine months ended March 31, 2013 related to the performance-based awards based upon the Company achieving 100% of its targeted financial performance metrics for fiscal year 2013.
During the three months ended March 31, 2012 and 2013, under its stock incentive plans, the Company incurred stock-based compensation expense of $1.9 million and $0.6 million, respectively, and incurred $6.5 million and $5.5 million for the nine months ended March 31, 2012 and 2013, respectively. Compensation cost related to stock-based awards 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).
 
Nine months ended March 31,
 
2012
 
2013
Current:
 
 
 
Federal
$
2.2

 
$
11.5

State
2.8

 
0.2

Total current
5.0

 
11.7

Deferred:
 
 
 
Federal
13.4

 
13.9

State
0.7

 
0.4

Total deferred
14.1

 
14.3

Change in valuation allowance
1.3

 
(1.5
)
Total income tax expense
$
20.4

 
$
24.5


Income tax expense for the nine months ended March 31, 2013 includes the impact of releasing a $1.6 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 considers 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;


16

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

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 nine months ended March 31, 2013, 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 March 31, 2013, the Company had generated net operating loss carryforwards for federal income tax and state income tax purposes of approximately $3.4 million and $515.0 million, respectively. The federal and state net operating loss carryforwards expire from 2020 to 2029 and 2013 to 2030, respectively.
The Company’s U.S. federal income tax returns for tax years 2005 and beyond remain subject to examination by the Internal Revenue Service.

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 and suburban areas). Accordingly, the Company’s reportable operating segments consist of 1) acute care hospitals and related health care businesses, collectively, and 2) health plans, including Chicago Health Systems, a contracting entity for outpatient services provided by MacNeal Hospital and Weiss Memorial Hospital and participating physicians in the Chicago area; Phoenix Health Plan, a Medicaid managed health plan operating in Arizona; Abrazo Advantage Health Plan, a Medicare and Medicaid dual eligible managed health plan operating in Arizona; ProCare Health Plan, a Medicaid managed health plan operating in Michigan; and Valley Baptist Insurance Company, which offers health maintenance organization, preferred provider organization, and self-funded products to its members in the form of large group, small group, and individual product offerings in south Texas.


17

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

The following tables provide unaudited condensed financial information by operating segment for the three months and nine months ended March 31, 2012 and 2013, including a reconciliation of Segment EBITDA to income from continuing operations before income taxes (in millions).
 
Three months ended March 31, 2012
 
Acute Care
Services
 
Health
Plans
 
Eliminations
 
Consolidated
Patient service revenues, net (1)
$
1,391.7

 
$

 
$

 
$
1,391.7

Premium revenues

 
190.8

 

 
190.8

Inter-segment revenues
13.0

 

 
(13.0
)
 

Total revenues
1,404.7

 
190.8

 
(13.0
)
 
1,582.5

 
 
 
 
 
 
 
 
Salaries and benefits (excludes stock compensation)
710.4

 
9.5

 

 
719.9

Health plan claims expense (1)

 
146.6

 

 
146.6

Supplies
235.5

 

 

 
235.5

Other operating expenses-external
297.5

 
8.8

 

 
306.3

Operating expenses-intersegment

 
13.0

 
(13.0
)
 

Medicare and Medicaid EHR incentives
(2.4
)
 

 

 
(2.4
)
Segment EBITDA (2)
163.7

 
12.9

 

 
176.6

Less:
 
 
 
 
 
 
 
Interest, net
43.9

 
(0.5
)
 

 
43.4

Depreciation and amortization
61.9

 
1.0

 

 
62.9

Equity method income
(1.1
)
 

 

 
(1.1
)
Stock compensation
1.9

 

 

 
1.9

Loss on disposal of assets
0.2

 

 

 
0.2

Acquisition related expenses
1.2

 

 

 
1.2

Pension credits
(1.3
)
 

 

 
(1.3
)
Income from continuing operations before income taxes
$
57.0

 
$
12.4

 
$

 
$
69.4

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


18

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

 
Three months ended March 31, 2013
 
Acute Care
Services
 
Health
Plans
 
Eliminations
 
Consolidated
Patient service revenues, net (1)
$
1,316.0

 
$

 
$

 
$
1,316.0

Premium revenues

 
182.1

 

 
182.1

Inter-segment revenues
9.4

 

 
(9.4
)
 

Total revenues
1,325.4

 
182.1

 
(9.4
)
 
1,498.1

 
 
 
 
 
 
 
 
Salaries and benefits (excludes stock compensation)
684.9

 
9.8

 

 
694.7

Health plan claims expense (1)

 
137.3

 

 
137.3

Supplies
229.1

 

 

 
229.1

Other operating expenses-external
287.8

 
11.6

 

 
299.4

Operating expenses-intersegment

 
9.4

 
(9.4
)
 

Medicare and Medicaid EHR incentives
(5.4
)
 

 

 
(5.4
)
Segment EBITDA (2)
129.0

 
14.0

 

 
143.0

Less:
 
 
 
 
 
 
 
Interest, net
48.1

 
0.7

 

 
48.8

Depreciation and amortization
59.7

 
1.0

 

 
60.7

Equity method income
(1.4
)
 

 

 
(1.4
)
Stock compensation
0.6

 

 

 
0.6

Loss on disposal of assets
0.3

 

 

 
0.3

Realized losses on investments
0.1

 

 

 
0.1

Acquisition related expenses
0.1

 

 

 
0.1

Debt extinguishment costs
1.3

 

 

 
1.3

Pension credits
(3.9
)
 

 

 
(3.9
)
Income from continuing operations before income taxes
$
24.1

 
$
12.3

 
$

 
$
36.4

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


19

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

 
Nine months ended March 31, 2012
 
Acute Care
Services
 
Health
Plans
 
Eliminations
 
Consolidated
Patient service revenues, net (1)
$
3,903.6

 
$

 
$

 
$
3,903.6

Premium revenues

 
590.6

 

 
590.6

Inter-segment revenues
32.1

 

 
(32.1
)
 

Total revenues
3,935.7

 
590.6

 
(32.1
)
 
4,494.2

 
 
 
 
 
 
 
 
Salaries and benefits (excludes stock compensation)
2,054.8

 
27.9

 

 
2,082.7

Health plan claims expense (1)

 
458.6

 

 
458.6

Supplies
676.9

 
0.1

 

 
677.0

Other operating expenses-external
836.2

 
31.6

 

 
867.8

Operating expenses-intersegment

 
32.1

 
(32.1
)
 

Medicare and Medicaid EHR incentives
(26.8
)
 

 

 
(26.8
)
Segment EBITDA (2)
394.6

 
40.3

 

 
434.9

Less:
 
 
 
 
 
 
 
Interest, net
133.8

 
(1.4
)
 

 
132.4

Depreciation and amortization
188.0

 
3.3

 

 
191.3

Equity method income
(1.8
)
 

 

 
(1.8
)
Stock compensation
6.5

 

 

 
6.5

Gain on disposal of assets
(0.6
)
 

 

 
(0.6
)
Acquisition related expenses
13.8

 

 

 
13.8

Debt extinguishment costs
38.9

 

 

 
38.9

Impairment and restructuring charges
(0.1
)
 

 

 
(0.1
)
Pension credits
(3.9
)
 

 

 
(3.9
)
Income from continuing operations before income taxes
$
20.0

 
$
38.4

 
$

 
$
58.4

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


20

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

 
Nine months ended March 31, 2013
 
Acute Care
Services
 
Health
Plans
 
Eliminations
 
Consolidated
Patient service revenues, net (1)
$
3,930.1

 
$

 
$

 
$
3,930.1

Premium revenues

 
551.8

 

 
551.8

Inter-segment revenues
29.1

 

 
(29.1
)
 

Total revenues
3,959.2

 
551.8

 
(29.1
)
 
4,481.9

 
 
 
 
 
 
 
 
Salaries and benefits (excludes stock compensation)
2,039.3

 
28.8

 

 
2,068.1

Health plan claims expense (1)

 
421.4

 

 
421.4

Supplies
687.6

 
0.1

 

 
687.7

Other operating expenses-external
888.1

 
33.8

 

 
921.9

Operating expenses-intersegment

 
29.1

 
(29.1
)
 

Medicare and Medicaid EHR incentives
(31.2
)
 

 

 
(31.2
)
Segment EBITDA (2)
375.4

 
38.6

 

 
414.0

Less:
 
 
 
 
 
 
 
Interest, net
149.7

 
(0.4
)
 

 
149.3

Depreciation and amortization
191.0

 
3.1

 

 
194.1

Equity method income
(1.8
)
 

 

 
(1.8
)
Stock compensation
5.5

 

 

 
5.5

Loss on disposal of assets
1.3

 

 

 
1.3

Realized losses on investments
0.3

 

 

 
0.3

Acquisition related expenses
0.2