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VANGUARD HEALTH SYSTEMS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.

Edgar Online, Inc.
The purpose of this section, Management's Discussion and Analysis of Financial
Condition and Results of Operations, is to provide a narrative explanation of
our financial statements that enables investors to better understand our
business, to enhance our overall financial disclosures, to provide the context
within which our financial information may be analyzed, and to provide
information about the quality of, and potential variability of, our financial
condition, results of operations and cash flows. This section should be read in
conjunction with the accompanying condensed consolidated financial statements.

Forward-Looking Statements
This report on Form 10-Q contains "forward-looking statements" within the
meaning of the federal securities laws that are intended to be covered by safe
harbors created thereby. Forward-looking statements are those statements that
are based upon management's plans, objectives, goals, strategies, future events,
future revenue or performance, capital expenditures, financing needs, plans or
intentions relating to acquisitions, business trends and other information that
is not historical information. These statements are based upon estimates and
assumptions made by management that, although believed to be reasonable, are
subject to numerous factors, risks and uncertainties that could cause actual
outcomes and results to be materially different from those projected. When used
in this report on Form 10-Q, the words "estimates," "expects," "anticipates,"
"projects," "plans," "intends," "believes," "forecasts," "continues" or future
or conditional verbs, such as "will," "should," "could" or "may," and variations
of such words or similar expressions are intended to identify forward-looking
statements.
These factors, risks and uncertainties include, among others, the following:
• our high degree of leverage and interest rate risk;


• our ability to incur substantially more debt;

• operating and financial restrictions in our debt agreements;

• our ability to generate cash necessary to service our debt;

• weakened economic conditions and volatile capital markets;

• potential adverse impact of pre-payment and post-payment claims reviews

by governmental agencies;

• our ability to grow our business and successfully implement our business

strategies, including growing our ambulatory care services platform;

• our ability to successfully integrate hospitals or ambulatory care

facilities acquired in the future or to recognize expected synergies from

        such acquisitions;


•       potential acquisitions could be costly, unsuccessful or subject us to
        unexpected liabilities;


•       conflicts of interest that may arise as a result of our control by a
        small number of stockholders;

• the highly competitive nature of the health care industry;

Executive Positions Available for Seasoned Marketers

• the geographic concentration of our operations;

• the impact of a natural disaster or other catastrophic event in one of

our geographic markets and our ability to recover from such disaster or

event;

• governmental regulation of the health care industry, including Medicare

        and Medicaid reimbursement levels in general and with respect to the
        impact of the Budget Control Act of 2011 and other future deficit
        reduction plans;

• a reduction or elimination of supplemental Medicare and Medicaid payments

on which we depend, including disproportionate share payments, indirect

medical education/graduate medical education payments, upper payment

        limit programs ("UPL") and other similar payments;





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•       pressures to contain costs by managed care organizations and other
        insurers and our ability to negotiate acceptable terms with these third
        party payers;


•       our ability to attract and retain qualified management and health care
        professionals, including physicians and nurses;


•       the currently unknown effect on us of the major federal health care
        reforms enacted by Congress in March 2010, including the Patient
        Protection and Affordable Care Act, as amended by the Health Care and
        Education Reconciliation Act of 2010, or other potential additional
        federal or state health care reforms, including that states may opt out
        of the Medicaid expansion;

• potential adverse impact of known and unknown governmental investigations

and audits;

• increased compliance costs from further government regulation of health

care and our failure to comply, or allegations of our failure to comply,

with applicable laws and regulations;

• our failure to adequately enhance our facilities with technologically

        advanced equipment;


•       the availability of capital to fund our corporate growth strategy and
        improvements to our existing facilities;

• potential lawsuits or other claims asserted against us;

• our ability to maintain or increase patient membership and control costs

Executive Positions Available for Seasoned Marketers

of our managed health care plans;

• failure of the Arizona Health Care Cost Containment System ("AHCCCS") to

renew its contract with, or award future contracts with similar terms and

scope to, Phoenix Health Plan;

• PHP's ability to comply with the terms of its contract with AHCCCS;


•       our inability to accurately estimate and manage health plan claims
        expense within our health plans;

• our inability to accurately estimate and manage employee medical benefits

expense within our health plans;

• reductions in the enrollment of our health plans;


•       changes in general economic conditions nationally and regionally in our
        markets;

• our exposure to the increased amounts of and collection risks associated

with uninsured accounts and the co-pay and deductible portions of insured

accounts;

• dependence on our senior management team and local management personnel;

• volatility of professional and general liability insurance for us and the

physicians who practice at our hospitals and increases in the quantity

and severity of professional liability claims;

• our ability to achieve operating and financial targets and to maintain

and increase patient volumes and control the costs of providing services,

including salaries and benefits, supplies and other operating expenses;

• technological and pharmaceutical improvements that increase the cost of

providing, or reduce the demand for, health care services and shift

demand for inpatient services to outpatient settings;

• a failure of our information systems;

• delays in receiving payments for services provided, especially from

governmental payers;

Executive Positions Available for Seasoned Marketers

• changes in revenue mix, including changes in Medicaid eligibility

criteria and potential declines in the population covered under managed

        care agreements;


•       costs and compliance risks associated with Section 404 of the
        Sarbanes-Oxley Act of 2002;


•       material non-cash charges to earnings from impairment of goodwill

associated with declines in the fair market value of our reporting units;





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• cash payments that may be necessary to fund an underfunded defined

        benefit pension plan of The Detroit Medical Center;


•       volatility of materials and labor costs for, or state efforts to
        regulate, potential construction projects that may be necessary for
        future growth;

• our reliance on payments from our subsidiaries, which may be restricted

by our credit agreement and the indentures governing our senior notes;

• changes in accounting practices; and


•       our ability to demonstrate meaningful use of certified electronic health
        record technology and to receive the related Medicare or Medicaid
        incentive payments.


Our forward-looking statements speak only as of the date made. Except as
required by law, we undertake no obligation to publicly update or revise any
forward-looking statements contained herein, whether as a result of new
information, future events or otherwise. We advise you, however, to consult any
additional disclosures we make in our other filings with the Securities and
Exchange Commission (the "SEC"). You are cautioned not to rely on such
forward-looking statements when evaluating the information contained in this
report on Form 10-Q. In light of significant uncertainties inherent in the
forward-looking statements included in this report on Form 10-Q, you should not
regard the inclusion of such information as a representation by us that the
objectives and plans anticipated by the forward-looking statements will occur or
be achieved or, if any of them do, what impact they will have on our financial
condition, results of operations or cash flows.


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Executive Overview

Our mission is to transform the delivery of health services we provide to our
communities by implementing innovative population health models and creating a
patient-centered experience in a high performance environment of integrated
care. We plan to grow our business by continually improving our quality of care,
transforming the delivery of care to a fee-for-value basis, expanding services
to further our continuum of care, and selectively developing or acquiring other
health care businesses where we see an opportunity to improve our operating
performance and expand our mission. We believe this business strategy provides a
framework for long-term success in an industry that is undergoing significant
change; however, we expect to continue to experience operating challenges in the
short-term until the general economy improves and our initiatives are fully
implemented.
As of December 31, 2012, we owned and operated 28 hospitals with a total of
7,064 licensed beds and related outpatient service facilities complementary to
the hospitals in San Antonio, Harlingen and Brownsville Texas; metropolitan
Detroit, Michigan; metropolitan Phoenix, Arizona; metropolitan Chicago,
Illinois; and Massachusetts. As of December 31, 2012, we also owned five health
plans with approximately 236,000 members. Our health plans include Chicago
Health Systems ("CHS"), a contracting entity for outpatient services provided by
MacNeal Hospital and Weiss Memorial Hospital and participating physicians in the
Chicago area; Phoenix Health Plan ("PHP"), a Medicaid managed health plan
operating in Arizona; Abrazo Advantage Health Plan ("AAHP"), a Medicare and
Medicaid dual eligible managed health plan operating in Arizona; ProCare Health
Plan ("ProCare"), a Medicaid managed health plan operating in Michigan; and
Valley Baptist Insurance Company ("VBIC"), which offers health maintenance
organization, preferred provider organization, and self-funded products to its
members in the form of large group, small group, and individual product
offerings in south Texas.

During the three months and six months ended December 31, 2012, our revenue
growth was impacted by ongoing challenges including less demand for elective
services, some of which related to a weak general economy, and a shift from
services provided to patients with managed care coverage to uninsured patients.
We believe these challenges will not subside significantly in the near future.
Capitation rate decreases at PHP implemented by Arizona'sMedicaid plan and
changes in eligibility qualification for certain categories of members that went
into effect on October 1, 2011 caused a decrease in health plan revenues during
the six months ended December 31, 2012. PHP was able to make adjustments to
Medicaid reimbursement rates paid to health care providers resulting in
decreased claims expense to offset a portion of the revenue decrease. We have
been able to reduce certain costs to mitigate the impact of our limited revenue
growth, but we are not certain these cost reduction measures will be sustainable
if economic weakness persists during the remainder of fiscal 2013 and beyond.

Operating Environment
We believe that the operating environment for hospital operators continues to
evolve, which presents both challenges and opportunities for us. In order to
remain competitive in the markets we serve, we must transform our operating
strategies to not only accommodate changing environmental factors but to make
them operating advantages for us relative to our peers. These factors will
require focus on the expansion of ambulatory and population health services, the
quality of care we provide, and reducing our costs in response to governmental
regulation and changes in our payer mix as further outlined below.
Expansion of ambulatory and population health services

As we attempt to remain flexible and competitive in a dynamic health care
environment, we have added focus and resources to our ambulatory care endeavors.
As of December 31, 2012, we employed approximately 700 non-resident physicians
and will continue to recruit primary care and specialty physicians and physician
groups to the communities that we serve as market-specific needs warrant. We
have invested heavily in the infrastructure necessary to coordinate our
physician alignment strategies and manage our physician operations. During the
first quarter of fiscal 2013, we entered into a joint venture arrangement with a
leading national physician practice management company to add efficiencies to
these practices and help prepare us for the transition to fee-for-value
reimbursement. We have also established Physician Leadership Councils, comprised
of physicians focused on driving clinical and operational performance, at most
of our hospitals to align the quality goals of our hospitals with those of the
physicians who practice in our hospitals. We believe our hospitalist employment
strategy is a key element of our focus on patient-centered care. Because these
initiatives require significant upfront investment and may take years to fully
implement, our operating results and cash flows could be negatively impacted
during the short-term.

We also continue to pursue the expansion of certain strategic health risk
products, through either acquisition or partnership opportunities, to leverage
the skill sets we have within our existing health plans. Further, in our
existing markets, we are pursuing the acquisition or development of ambulatory
care facilities, such as ambulatory surgery centers, home health agencies,
cancer centers and imaging centers, in an attempt to create a more comprehensive
network of health care services.


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Management believes that the added focus on ambulatory care, together with the addition of new risk-based initiatives, will enable us to take advantage of future opportunities in a fee-for-value era.

Implementation of our Clinical Quality Initiatives


Quality of care will have a greater impact on governmental reimbursement in the
future. We have implemented many clinical quality initiatives and are in the
process of implementing several others. These initiatives include monthly review
of reportable Centers for Medicare and Medicaid Services ("CMS") quality
indicators, rapid response teams, continued focus on work flow efficiency and
process improvement, establishing clinical standards of care across key system
service lines, improving transition of care to reduce hospital readmissions and
aligning hospital management incentive compensation with quality performance
indicators.
Governmental Regulation
Health Reform Law. The provisions included in the Patient Protection and
Affordable Care Act, as amended by the Health Care and Education Reconciliation
Act of 2010 (collectively, the "Health Reform Law"), enacted in March 2010,
provide for, among other things, increased access to health benefits for a
significant number of uninsured individuals through the creation of health
insurance exchanges and expanded Medicaid programs; reductions in future
Medicare reimbursement, including market basket and disproportionate share
payments; development of a payment bundling pilot program and similar programs
to promote accountability and coordination of care; continued efforts to tie
reimbursement to quality of care, including penalties for excessive readmissions
and hospital-acquired conditions; and changes to premiums paid and the
establishment of profit restrictions on Medicare managed care plans and Exchange
insurance plans. The Health Reform Law is also under considerable scrutiny from
Congress, and the states are moving at different speeds to implement portions of
the Health Reform Law left to their discretion. We are unable to predict how the
Health Reform Law will impact our future financial position, operating results
or cash flows, but we hope to transform our delivery of care to adapt to the
changes from the Health Reform Law that will be implemented during the next
several years.

Budget Control Act. On August 2, 2011, Congress enacted the Budget Control Act
of 2011.  This law increased the nation's borrowing authority while taking steps
to reduce federal spending and the deficit.  The deficit reduction component is
being implemented in two phases.  In the first phase, the law imposed caps that
reduce discretionary (non-entitlement) spending by more than $900 billion over
ten years, beginning in federal fiscal year ("FFY") 2012.  Under a second phase,
if spending and deficit amounts reach certain thresholds, an enforcement
mechanism called "sequestration" will be triggered under which a total of $1.2
trillion in automatic, across-the board spending reductions were to be
implemented over ten years.  The deadline for congressional action was January
2, 2013, but, as part of the American Taxpayer Relief Act of 2012, which was
enacted on January 2, 2013, the deadline for sequestration has been extended to
March 1, 2013. The spending reductions are to be split evenly between defense
and non-defense discretionary spending, although certain programs (including the
Medicaid and Children's Health Insurance Program ("CHIP")) are exempt from these
automatic spending reductions and Medicare expenditures cannot be reduced by
more than two percent.  If sequestration goes into effect and these reductions
are implemented, Medicare payments to hospitals and payments for other services
could be reduced.  Congress may take additional action prior to March 1, 2013 to
further reduce federal spending and the deficit to avoid sequestration being
triggered.  If so, Medicare, Medicaid and CHIP spending could be reduced
further, and provider payments under those programs could be substantially
reduced.

Accountable Care Organizations. The Health Reform Law requires the establishment
of Medicare shared savings plans ("MSSPs") that promote accountability and
coordination of care through the creation of Accountable Care Organizations
("ACOs"). MSSP ACOs receive payment from Medicare on a fee-for-service basis and
may receive additional "shared savings" payments or be at-risk for the payment
to CMS of "shared losses" based on an increase or decrease in annual
fee-for-service payments to the ACO. CMS estimates that approximately 50-270
organizations will enter into ACO agreements with an estimated aggregate median
impact of $1.31 billion in bonus payments to ACOs for calendar years 2012-2015.
In addition to the MSSP ACO model, CMS developed the "Pioneer ACO" model. The
Pioneer ACO model generally requires compliance with the MSSP ACO program rules
in the final regulations, but differs from the finalized MSSP ACO model in
several ways, including, but not limited to, higher levels of sharing and risk,
opportunity for population-based payments, requirements for outcomes-based
payment contracting with other payers and a higher number of assigned
beneficiaries.

We were approved to become a Pioneer ACO effective January 1, 2012 in our
Michigan market. We have also been awarded MSSP ACOs, effective July 1, 2012, in
Illinois and Texas and two additional MSSP ACOs, effective January 1, 2013, in
Massachusetts and Arizona. We expect to continue to explore opportunities to
develop or enhance ACOs in our markets.


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Medicare and Medicaid EHR Incentive Payments. The American Recovery and
Reinvestment Act of 2009 provides for Medicare and Medicaid incentive payments
that began in calendar 2011 for eligible hospitals and professionals that adopt
and meaningfully use certified electronic health record ("EHR") technology. Our
pre-tax income was positively impacted by combined Medicare and Medicaid EHR
incentives of $21.3 million and $14.5 million for the three months ended
December 31, 2011 and 2012, respectively, and $24.4 million and $25.8 million
for the six months ended December 31, 2011 and 2012, respectively. We believe
that the operational benefits of EHR technology, including improved clinical
outcomes and increased operating efficiencies, will contribute to our long-term
ability to grow our business. We incur both capital expenditures and operating
expenses in connection with the implementation of our various EHR initiatives.
The amount and timing of these expenditures do not directly correlate with the
timing of our cash receipts or recognition of the EHR incentives as other
income.
Payer Mix Shifts

During the three months and six months ended December 31, 2012 compared to the
prior year periods, we provided more health care services to patients who were
uninsured and provided fewer health care services to patients who had insurance
coverage. Much of this shift resulted from general economic weakness in the
markets we serve and Medicaid eligibility reductions in Arizona. Our acquisition
of The Detroit Medical Center ("DMC") increased the percentage of services we
provide to Medicaid patients compared to periods prior to this acquisition. We
are uncertain how long the economic weakness will continue, but believe that
conditions will not improve during the remainder of our 2013 fiscal year.

Sources of Revenues
Hospital revenues depend upon inpatient occupancy levels, the medical and
ancillary services ordered by physicians and provided to patients, the volume of
outpatient procedures, and the charges or payment rates for such services.
Reimbursement rates for inpatient services vary significantly depending on the
type of payer, the type of service (e.g., acute care, intensive care or
subacute) and the geographic location of the hospital. Inpatient occupancy
levels fluctuate for various reasons, many of which are beyond our control.
We receive payment for patient services from:
• the federal government, primarily under the Medicare program;


• state Medicaid programs;

• health maintenance organizations, preferred provider organizations,

        managed Medicare providers, managed Medicaid providers and other private
        insurers; and


• individual patients.




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The following table sets forth the percentages of net patient revenues by payer for the three months and six months ended December 31, 2011 and 2012.

                   Three months ended December 31,        Six months ended December 31,
                       2011                2012              2011                2012
Medicare                 28.2 %               27.1 %           27.4 %               27.3 %
Medicaid                 13.9                 13.4             14.3                 13.5
Managed Medicare         11.1                 11.7             10.7                 11.5
Managed Medicaid          8.7                 10.2              9.6                 10.1
Managed care             34.5                 34.1             34.8                 34.1
Self pay                  1.2                  2.0              1.3                  2.0
Other                     2.4                  1.5              1.9                  1.5
Total                   100.0 %              100.0 %          100.0 %              100.0 %


See "Business - Sources of Revenues," included in Part I, Item 1 of our Annual
Report on Form 10-K for our fiscal year ended June 30, 2012 for a description of
the types of payments we receive for services provided to patients enrolled in
the traditional Medicare plan (both for inpatient and outpatient services),
managed Medicare plans, Medicaid plans, managed Medicaid plans and managed care
plans. In that section, we also discuss the unique reimbursement features of the
traditional Medicare plan, including disproportionate share, outlier cases and
direct graduate and indirect medical education, including the annual Medicare
regulatory updates published by CMS in August 2012 that impact reimbursement
rates under the plan for services provided during the FFY beginning October 1,
2012 and the impact of the Health Reform Law on these reimbursements.
Volumes by Payer
During the six months ended December 31, 2012 compared to the six months ended
December 31, 2011, discharges increased 1.7% and adjusted discharges increased
3.2% primarily due to the impact of our acquisition of Valley Baptist Health
System effective September 1, 2011. On a same store basis, discharges decreased
1.8% and adjusted discharges decreased 0.2%. The following table provides
details of discharges by payer for the three months and six months ended
December 31, 2011 and 2012.
                      Three months ended December 31,              Six 

months ended December 31,

                          2011                  2012                 2011                 2012
Medicare          21,220         29.5 %   20,658     29.1 %    40,485     28.9 %    40,587     28.5 %
Medicaid           8,514         11.8      6,942      9.8      15,630     11.2      13,810      9.7
Managed Medicare   8,712         12.1      9,026     12.7      17,126     12.2      17,747     12.5
Managed Medicaid  11,824         16.4     12,916     18.2      23,944     17.1      26,225     18.4
Managed care      16,404         22.8     15,838     22.3      32,186     23.0      32,026     22.5
Self pay           4,954          6.9      5,216      7.4      10,032      7.1      11,297      7.9
Other                333          0.5        384      0.5         719      0.5         769      0.5
Total             71,961        100.0 %   70,980    100.0 %   140,122    100.0 %   142,461    100.0 %


Payer Reimbursement Trends
In addition to the volume factors described above, patient mix, acuity factors
and pricing trends affect our patient service revenues. Net patient revenue per
adjusted discharge on a same store basis was $9,383 and $9,598 for the six
months ended December 31, 2011 and 2012, respectively. Growth in this ratio
continues to be limited by the payer mix shifts we have experienced since the
prior year periods. During the six months ended December 31, 2012 compared to
the six months ended December 31, 2011, a greater percentage of our discharges
was attributable to patients who were uninsured as opposed to those with managed
care coverage.
Health care spending comprises a significant portion of total spending in the
United States and has been growing at annual rates that exceed inflation, wage
growth and gross national product. There is considerable pressure on
governmental payers, managed Medicare/Medicaid payers and commercial managed
care payers to control costs by either reducing or


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limiting increases in reimbursement to health care providers or limiting
benefits to enrollees. The current weakness in the United States economy
continues to magnify these pressures.
The demand for Medicaid coverage has increased during the past two years due to
job losses that have left many individuals without health insurance. Medicaid
remains the highest individual program cost for most states, including those in
which we operate. To balance their budgets, many states, either directly or
through their Medicaid or managed Medicaid programs, have enacted and may enact
further health care spending cuts or defer cash payments to health care
providers to avoid raising taxes during periods of economic weakness. Medicaid
rate cuts in Arizona, Texas, and Illinois during the past 12 to 18 months have
negatively impacted our revenues.
Managed care payers also face economic pressures during periods of economic
weakness due to lower enrollment resulting from higher unemployment rates and
the inability of individuals to afford private insurance coverage. These payers
may respond to these challenges by reducing or limiting increases to health care
provider reimbursement rates or reducing benefits to enrollees.
In recent years, both the Medicare program and several large managed care
companies have changed our reimbursement to link some of their payments,
especially their annual increases in payments, to our performance with respect
to certain quality of care measures. We expect this trend to
"pay-for-performance" to increase in the future.
Accounts Receivable Collection Risks Leading to Increased Bad Debts
Similar to other companies in the hospital industry, we face continued pressures
in collecting outstanding accounts receivable primarily due to volatility in the
uninsured and underinsured populations in the markets we serve. The following
table provides a summary of our accounts receivable payer class mix as of each
respective period presented.
June 30, 2012               0-90 days     91-180 days     Over 180 days     Total
Medicare                        16.5 %         1.5 %             1.2 %      19.2 %
Medicaid                         5.7           1.9               1.8         9.4
Managed Medicare                 6.7           0.6               0.5         7.8
Managed Medicaid                11.2           1.4               1.0        13.6
Managed care                    19.8           2.5               3.0        25.3
Self pay(1)                     11.1           4.9               2.5        18.5
Self pay after primary(2)        1.1           1.8               0.9         3.8
Other                            1.3           0.5               0.6         2.4
Total                           73.4 %        15.1 %            11.5 %     100.0 %


December 31, 2012           0-90 days     91-180 days     Over 180 days     Total
Medicare                        15.2 %         0.8 %             1.7 %      17.7 %
Medicaid                         4.3           1.6               2.6         8.5
Managed Medicare                 7.0           0.5               0.8         8.3
Managed Medicaid                 9.6           1.4               1.6        12.6
Managed care                    18.8           2.4               3.6        24.8
Self pay(1)                     13.1           5.3               2.5        20.9
Self pay after primary(2)        1.2           1.8               1.3         4.3
Other                            1.5           0.6               0.8         2.9
Total                           70.7 %        14.4 %            14.9 %     100.0 %


_____________________

(1) Includes uninsured patient accounts only.

(2) Includes patient co-insurance and deductible amounts after payment has been

     received from the primary payer.






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Our combined allowances for doubtful accounts, uninsured discounts and charity
care covered more than 100% of combined self-pay and self-pay after primary
accounts receivable as of June 30, 2012 and December 31, 2012.
The volume of self-pay accounts receivable remains sensitive to a combination of
factors, including price increases, acuity of services, higher levels of patient
deductibles and co-insurance under managed care plans, economic factors and the
increased difficulties of uninsured patients who do not qualify for charity care
programs to pay for escalating health care costs. We have implemented policies
and procedures designed to expedite upfront cash collections and promote
repayment plans for our patients. However, we believe bad debts will remain a
significant risk for us and the rest of the hospital industry in the near term.

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 in order to identify those claims most likely to contain
overpayments, such as incorrectly coded services, incorrect payment amounts,
non-covered services and duplicate payments.  CMS has given RACs the authority
to look back at claims up to three years from the date the claim was paid.
Claims identified as overpayments are subject to an appeals process.  RACs are
paid a contingency fee based on the overpayments they identify and collect.

We maintain a reserve for estimates of potential claims repayments from RAC
audits based upon actual claims already audited but for which repayment has not
yet occurred; claims for which we have 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, we reduced
our RAC reserve estimate for the Michigan market by $14.5 million ($8.9 million
net of taxes or $0.11 per diluted share) as a result of further analysis related
to each component of the estimate during the period. The $14.5 million reduction
in our RAC reserve estimate increased patient service revenues on the
accompanying condensed consolidated statement of operations during the six
months ended December 31, 2012.
Premium Revenues
We recognize premium revenues from our five health plans. Premium revenues from
these plans decreased $30.1 million, or 7.5%, during the six months ended
December 31, 2012 compared to the six months ended December 31, 2011. PHP's
average membership decreased to approximately 188,100 for the six months ended
December 31, 2012 compared to approximately 205,000 for the six months ended
December 31, 2011. PHP's decrease in revenues resulted from a 5% capitation
payment rate reduction by AHCCCS implemented in November 2011 (retroactive to
October 1, 2011) and changes made by AHCCCS effective October 1, 2011 to limit
health plan profitability for the remaining enrollee groups not previously
subject to settlement.


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Critical Accounting Policies
Our consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States. In preparing
these financial statements, we make estimates and assumptions that affect the
reported amounts of assets, liabilities, revenues and expenses included in the
financial statements. Management bases its estimates on historical experience
and other available information, the results of which form the basis of the
estimates and assumptions. We consider the following accounting policies to be
critical because they involve highly subjective and complex assumptions and
assessments, are subject to a great degree of fluctuation period over period and
are the most critical to our operating performance:
• Revenues, Revenue Deductions and Uncompensated Care;


• Insurance Reserves;

• Health Plan Claims Reserves;

• Income Taxes; and

• Long-Lived Assets and Goodwill.



There have been no changes in the nature or application of our critical
accounting policies during the six months ended December 31, 2012 when compared
to those described in our Annual Report on Form 10-K for our fiscal year ended
June 30, 2012. However, given our significant amount of goodwill, we continue to
monitor our Arizona hospitals and the market challenges that negatively impacted
its results of operations and cash flows during the fiscal year ended June 30,
2012 and such challenges continued through the six months ended December 31,
2012. These challenges include hospital reimbursement cuts, reductions to
covered lives under the 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 and state financial condition and the
demographic composition of this market, we believe the future operating results
and cash flows of these hospitals will improve. However, we 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.
In addition, we have $79.4 million of goodwill related to PHP. PHP's current
contract with AHCCCS, Arizona's state Medicaid program, expires September 30,
2013. During the three months ended March 31, 2013, PHP will be bidding to
obtain a new contract with AHCCCS. If a new contract is not awarded by AHCCCS or
if the new contract is significantly less in scope, either with respect to
pricing or enrollment, than PHP's previous contract, PHP's operating results and
cash flows would be adversely affected and may cause PHP's goodwill to be
impaired.



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Selected Operating Statistics
The following table sets forth certain operating statistics on a consolidated
and same store basis for each of the periods presented. We have excluded two
hospitals that were acquired during the six months ended December 31, 2011 from
the same store statistics for the six months ended December 31, 2011 and 2012.
                                   Three months ended December 31,          

Six months ended December 31,

                                     2011                   2012                2011                 2012
CONSOLIDATED: (a)
Number of hospitals at end of
period                                     28                      28                 28                   28
Licensed beds at end of
period                                  7,064                   7,064              7,064                7,064
Discharges                             71,961                  70,980            140,122              142,461
Adjusted discharges                   129,089                 130,924            254,345              262,430
Average length of stay                   4.39                    4.47               4.37                 4.44
Patient days                          316,075                 317,369            612,154              632,924
Adjusted patient days                 566,997                 585,394          1,111,161            1,165,919
Net patient revenue per
adjusted discharge            $         9,506         $         9,647     $        9,397       $        9,525
Inpatient surgeries                    16,910                  16,345             32,987               32,937
Outpatient surgeries                   31,876                  31,444             61,852               62,575
Observation cases (b)                  17,750                  19,170             34,107               38,398
Emergency room visits                 299,075                 317,069            591,914              632,104
Health plan member lives              249,500                 236,000            249,500              236,000
Health plan claims expense
percentage                               78.0 %                  77.5 %             78.0 %               76.8 %



                                  Three months ended December 31,           Six months ended December 31,
                                     2011                 2012                2011                 2012
SAME STORE: (a)
Number of hospitals at end of
period                                     28                    28                 26                   26
Licensed beds at end of
period                                  7,064                 7,064              6,198                6,198
Total revenues, including
premium revenues (in
millions)                     $       1,475.4       $       1,513.1     $      2,771.4       $      2,769.0
Net patient service revenues
(in millions)                 $       1,286.6       $       1,319.8     $      2,382.7       $      2,420.8
Discharges                             71,961                70,980            130,868              128,520
Adjusted discharges                   129,089               130,924            241,323              240,792
Average length of stay                   4.39                  4.47               4.34                 4.42
Patient days                          316,075               317,369            567,700              567,483
Adjusted patient days                 566,997               585,394          1,046,849            1,063,223
Net patient revenue per
adjusted discharge            $         9,506       $         9,647     $        9,383       $        9,598
Inpatient surgeries                    16,910                16,345             30,205               28,921
Outpatient surgeries                   31,876                31,444             58,605               57,401
Observation cases (b)                  17,750                19,170             31,799               34,683
Emergency room visits                 299,075               317,069            565,499              586,747
Health plan claims expense
percentage                               78.0 %                77.5 %             78.2 %               76.8 %


_____________________

(a) With the exception of "Observation cases" defined in (b) below, the

definitions for statistics included above are defined in "Management's

Discussion and Analysis of Financial Condition and Results of Operations -

Selected Operating Statistics" set forth in Part II, Item 7 of our Annual

       Report on Form 10-K for the fiscal year ended June 30, 2012.



(b)    Observation cases represent the number of patients classified as

outpatient, during which time medical necessity is being evaluated prior

to the patient being transferred to an inpatient status or being released

       from care.




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Results of Operations
The following tables present summaries of our operating results for each of the
three months and six months ended December 31, 2011 and 2012.
                                                          Three months ended December 31,
                                                          2011                      2012
                                                               (Dollars in millions)
Patient service revenues, net                    $ 1,286.6       87.2  %   $ 1,319.8       87.2  %
Premium revenues                                     188.8       12.8          193.3       12.8
Total revenues                                     1,475.4      100.0        1,513.1      100.0

Salaries and benefits (includes stock
compensation of $3.9 and $2.7, respectively)         702.4       47.6          698.1       46.1
Health plan claims expense                           147.3       10.0          149.8        9.9
Supplies                                             227.9       15.4          232.5       15.4
Other operating expenses                             283.4       19.2          312.1       20.6
Medicare and Medicaid EHR incentives                 (21.3 )     (1.4 )        (14.5 )     (1.0 )
Depreciation and amortization                         65.8        4.5           67.8        4.5
Interest, net                                         43.2        2.9           49.7        3.3
Acquisition related expenses                           0.4          -            0.1          -
Other                                                 (1.8 )     (0.1 )         (1.8 )     (0.1 )
Income from continuing operations before income
taxes                                                 28.1        1.9           19.3        1.3
Income tax expense                                   (11.3 )     (0.8 )         (7.2 )     (0.5 )
Income from continuing operations                     16.8        1.1           12.1        0.8
Loss from discontinued operations net of taxes        (0.3 )        -              -          -
Net income                                            16.5        1.1           12.1        0.8
Net loss (income) attributable to
non-controlling interests                             (0.8 )     (0.1 )          0.1          -
Net income attributable to Vanguard Health
Systems, Inc. stockholders                       $    15.7        1.1  %   $    12.2        0.8  %




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                                                           Six months ended December 31,
                                                          2011                      2012
                                                               (Dollars in millions)
Patient service revenues, net                    $ 2,511.9       86.3  %   $ 2,614.1       87.6  %
Premium revenues                                     399.8       13.7          369.7       12.4
Total revenues                                     2,911.7      100.0        2,983.8      100.0

Salaries and benefits (includes stock
compensation of $4.6 and $4.9, respectively)       1,367.4       47.0        1,378.3       46.2
Health plan claims expense                           312.0       10.7          284.1        9.5
Supplies                                             441.5       15.2          458.6       15.4
Other operating expenses                             561.5       19.3          622.5       20.9
Medicare and Medicaid EHR incentives                 (24.4 )     (0.8 )        (25.8 )     (0.9 )
Depreciation and amortization                        128.4        4.4          133.4        4.5
Interest, net                                         89.0        3.1          100.5        3.4
Acquisition related expenses                          12.6        0.4            0.1          -
Debt extinguishment costs                             38.9        1.3              -          -
Other                                                 (4.2 )     (0.1 )         (6.9 )     (0.2 )
Income (loss) from continuing operations before
income taxes                                         (11.0 )     (0.4 )         39.0        1.3
Income tax benefit (expense)                           3.9        0.1          (12.1 )     (0.4 )
Income (loss) from continuing operations              (7.1 )     (0.2 )         26.9        0.9
Income (loss) from discontinued operations net
of taxes                                              (0.4 )        -            0.1          -
Net income (loss)                                     (7.5 )     (0.3 )         27.0        0.9
Net loss (income) attributable to
non-controlling interests                              1.5        0.1           (0.9 )        -
Net income (loss) attributable to Vanguard
Health Systems, Inc. stockholders                $    (6.0 )     (0.2 )%   $    26.1        0.9  %





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Three months ended December 31, 2012 and 2011

Acute care services on a consolidated and same store basis. Net patient service revenues increased $33.2 million, or 2.6%, during the three months ended December 31, 2012 compared to the prior year quarter. The increase in net patient service revenues during the three months ended December 31, 2012 is primarily the result of a 1.4% increase in adjusted discharges and a 1.5% increase in patient revenue per adjusted discharge.


Our percentage of uncompensated care (defined as the sum of uninsured discounts,
charity care and the provision for doubtful accounts) as a percentage of net
patient revenues (prior to uncompensated care deductions) increased to 21.3%
during the three months ended December 31, 2012 compared to 20.0% during the
prior year quarter. This increase primarily resulted from an increase in
self-pay discharges as a percentage of total discharges during the three months
ended December 31, 2012 and price increases implemented since the prior year
quarter.

Discharges decreased 1.4% while adjusted discharges and emergency room visits
increased 1.4% and 6.0%, respectively, during the three months ended
December 31, 2012 compared to the prior year quarter. Inpatient and outpatient
surgeries decreased 3.3% and 1.4%, respectively, during the three months ended
December 31, 2012 compared to the prior year quarter.

Health plan premium revenues. Health plan premium revenues increased $4.5
million, or 2.4%, during the three months ended December 31, 2012 compared to
the prior year quarter. PHP's average membership decreased 7.5% during the three
months ended December 31, 2012 compared to the prior year quarter. Health plan
premium revenues increased despite a decrease in average PHP membership due to
differences in the mix of enrollee populations between the comparative periods
and the supplemental revenues for these populations.

Membership in our health plans as of December 31, 2011 and 2012 was as follows:
                                                                   Membership
Health Plans                                        Location     2011       2012
PHP - managed Medicaid                              Arizona    200,100    186,200
AAHP - managed Medicare and Dual Eligible           Arizona      2,600      

4,000

CHS - capitated outpatient and physician services Illinois 34,400 31,700 VBIC - health maintenance organization

              Texas       12,400     12,000
ProCare - managed Medicaid                          Michigan       n/a      2,100
                                                               249,500    236,000


Costs and expenses. Total costs and expenses from continuing operations,
exclusive of income taxes, were $1,493.8 million, or 98.7% of total revenues,
during the three months ended December 31, 2012 compared to $1,447.3 million, or
98.1% of total revenues, during the prior year quarter. Salaries and benefits,
health plan claims and supplies represent the most significant of our recurring
costs and expenses and those typically subject to the greatest level of period
to period fluctuation.
•      Salaries and benefits. Salaries and benefits as a percentage of total

revenues was 46.1% for the three months ended December 31, 2012 compared

to 47.6% during the prior year quarter. For the acute care services

operating segment, salaries and benefits as a percentage of patient

service revenues was 51.8% during the three months ended December 31, 2012

compared to 53.4% during the prior year quarter. As of December 31, 2012,

we had approximately 40,400 full-time and part-time employees compared to

approximately 40,900 as of December 31, 2011. We have made a concerted

       effort to adjust staffing levels to better address volume and acuity
       trends during the current year period.

• Health plan claims. Health plan claims expense as a percentage of premium

       revenues decreased to 77.5% during the three months ended December 31,
       2012 compared to 78.0% during the prior year quarter. As enrollment
       decreases, this ratio becomes increasingly sensitive to the mix of

members, including covered groups based upon age and gender and county of

residence. Revenues and expenses between our health plans and our

hospitals and related outpatient service providers of $9.5 million, or

6.0% of gross health plan claims expense, were eliminated in consolidation

during the three months ended December 31, 2012 compared to $10.5 million,

       or 6.7% of gross health plan claims expense, during the prior year
       quarter.




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• Supplies. Supplies as a percentage of acute care services segment revenues

were flat during the three months ended December 31, 2012 compared to the

prior year quarter. We expect that our transition to a single group

purchasing organization effective January 1, 2013 will reduce supplies

       costs in future periods. However, supplies costs may be pressured in
       future periods due to our growth strategies that include expansion of
       higher acuity services and due to inflationary pressures.


Other operating expenses. Other operating expenses include, among others,
purchased services, insurance, non-income taxes, rents and leases, repairs and
maintenance and utilities. Other operating expenses as a percentage of total
revenues increased to 20.6% during the three months ended December 31, 2012
compared to 19.2% during the prior year quarter primarily due to an increase in
professional and general liability insurance, an increase in medical specialist
fees associated with payments under Bexar County UPL and community benefit
programs and an increase in management fees associated with our outsourced
physician services management program that began in July 2012.
Medicare and Medicaid EHR incentives. During the three months ended December 31,
2012, we recognized $14.5 million of Medicare and Medicaid EHR incentives
compared to $21.3 million during the prior year quarter.
Other. Depreciation and amortization increased by $2.0 million, or 3.0%, during
the three months ended December 31, 2012 compared to the prior year quarter as a
result of our capital improvement and expansion initiatives. Net interest
increased by $6.5 million, or 15.0%, during the three months ended December 31,
2012 compared to the prior year quarter as a result of the issuance of the
additional $375.0 million 7.750% Senior Notes due 2019 during the quarter ended
March 31, 2012.
Income taxes. Our effective tax rate was approximately 37.3% during the three
months ended December 31, 2012. Our effective income tax rate was approximately
40.2% during the prior year quarter.
Net income (loss) attributable to Vanguard Health Systems, Inc. stockholders.
Net income attributable to Vanguard Health Systems, Inc. stockholders was $12.2
million ($0.14 earnings per diluted share) and $15.7 million ($0.20 earnings per
diluted share) during the three months ended December 31, 2012 and 2011,
respectively.


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Six months ended December 31, 2012 and 2011


Acute care services on a consolidated basis. Net patient service revenues
increased $102.2 million, or 4.1%, during the six months ended December 31, 2012
compared to the prior year period. The increase in net patient service revenues
during the six months ended December 31, 2012 is primarily the result of our
acquisition of Valley Baptist Health System on September 1, 2011.

Our percentage of uncompensated care (defined as the sum of uninsured discounts,
charity care and the provision for doubtful accounts) as a percentage of net
patient revenues (prior to uncompensated care deductions) increased to 21.5%
during the six months ended December 31, 2012 compared to 19.0% during the prior
year period. This increase primarily resulted from an increase in self-pay
discharges as a percentage of total discharges during the six months ended
December 31, 2012 and price increases implemented since the prior year period.

Discharges, adjusted discharges and emergency room visits increased 1.7%, 3.2%
and 6.8%, respectively, during the six months ended December 31, 2012 compared
to the prior year period. Inpatient surgeries decreased 0.2%, while outpatient
surgeries increased 1.2% during the six months ended December 31, 2012 compared
to the prior year period.

Acute care services on a same store basis. Net patient service revenues
increased $38.1 million, or 1.6%, during the six months ended December 31, 2012
compared to the prior year period resulting from a 2.3% increase in patient
revenue per adjusted discharge combined with a 0.2% decrease in adjusted
discharges. We define same store as those facilities that we owned for the
entirety of both six-month comparative periods. We excluded two hospitals and
related health care facilities from our same store analysis for these six-month
periods.

Our percentage of uncompensated care as a percentage of net patient revenues, as
previously defined, increased to 20.2% during the six months ended December 31,
2012 compared to 18.0% during the prior year period. This increase primarily
resulted from an increase in same store self-pay discharges as a percentage of
total discharges during the six months ended December 31, 2012 and price
increases implemented since the prior year period.

Discharges and adjusted discharges decreased 1.8% and 0.2%, respectively, while
emergency room visits increased 3.8% during the six months ended December 31,
2012 compared to the prior year period. Inpatient and outpatient surgeries
decreased 4.3% and 2.1%, respectively, during the six months ended December 31,
2012 compared to the prior year period.

Health plan premium revenues. Health plan premium revenues decreased $30.1
million, or 7.5%, during the six months ended December 31, 2012 compared to the
prior year period primarily due to the AHCCCS reimbursement and program
eligibility reductions previously described. This decrease in health plan
premium revenues would have been greater had we not acquired VBIC effective
October 2011 and ProCare effective October 2012.
Costs and expenses. Total costs and expenses from continuing operations,
exclusive of income taxes, were $2,944.8 million, or 98.7% of total revenues,
during the six months ended December 31, 2012 compared to $2,922.7 million, or
100.4% of total revenues, during the prior year period. Debt extinguishment
costs of $38.9 million incurred during the prior year period related to the
redemption of our Senior Discount Notes represent the primary change in
operating expenses during the current year period. Salaries and benefits, health
plan claims and supplies represent the most significant of our recurring costs
and expenses and those typically subject to the greatest level of period to
period fluctuation.
•      Salaries and benefits. Salaries and benefits as a percentage of total

revenues was 46.2% for the six months ended December 31, 2012 compared to

47.0% during the prior year period. On a same store basis, salaries and

benefits as a percentage of total revenues was 46.4% during the six months

       ended December 31, 2012 compared to 47.2% during the prior year period.


•      Health plan claims. Health plan claims expense as a percentage of premium

revenues decreased to 76.8% during the six months ended December 31, 2012

compared to 78.0% during the prior year period. Revenues and expenses

between our health plans and our hospitals and related outpatient service

providers of $19.7 million, or 6.5% of gross health plan claims expense,

were eliminated in consolidation during the six months ended December 31,

       2012 compared to $19.1 million, or 5.8% of gross health plan claims
       expense, during the prior year period.

• Supplies. Supplies as a percentage of acute care services segment revenues

       were flat during the six months ended December 31, 2012 compared to the
       prior year period.




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Other operating expenses. Other operating expenses include, among others,
purchased services, insurance, non-income taxes, rents and leases, repairs and
maintenance and utilities. Other operating expenses as a percentage of total
revenues increased to 20.9% during the six months ended December 31, 2012
compared to 19.3% during the prior year period primarily as a result of
increased purchased services assumed in connection with our acquisitions,
increased professional and general liability costs and management fees
associated with our outsourced physician services management program.
Medicare and Medicaid EHR incentives. During the six months ended December 31,
2012, we recognized $25.8 million of Medicare and Medicaid EHR incentives
compared to $24.4 million during the prior year period.
Other. Depreciation and amortization increased by $5.0 million, or 3.9%, during
the six months ended December 31, 2012 compared to the prior year period as a
result of our capital improvement and expansion initiatives and the Valley
Baptist Health System acquisition. Net interest increased by $11.5 million, or
12.9%, during the six months ended December 31, 2012 compared to the prior year
period as a result of the issuance of the additional $375.0 million of 7.750%
Senior Notes due 2019 during the quarter ended March 31, 2012. Debt
extinguishment costs were $38.9 million during the prior year period due to the
redemption of substantially all of the outstanding Senior Discount Notes in the
first quarter of fiscal year 2012. We incurred $12.6 million of
acquisition-related expenses during the prior year period in connection with the
Valley Baptist Health System acquisition.
Income taxes. Our effective tax rate was approximately 31.0% during the six
months ended December 31, 2012. Our effective income tax rate was approximately
35.5% during the prior year period. The effective tax rate during the current
year period was positively impacted by the reversal of certain valuation
allowances on state net operating loss carryforwards.
Net income (loss) attributable to Vanguard Health Systems, Inc. stockholders.
Net income attributable to Vanguard Health Systems, Inc. stockholders was $26.1
million ($0.31 earnings per diluted share) during the six months ended
December 31, 2012 compared to a net loss of $6.0 million ($0.08 loss per share)
during the six months ended December 31, 2011, which included the $38.9 million
of debt extinguishment costs previously discussed.



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Liquidity and Capital Resources
Operating Activities
As of December 31, 2012, we had working capital of $493.2 million, including
cash and cash equivalents of $357.8 million. Cash flows from operating
activities improved by $81.1 million during the six months ended December 31,
2012 compared to the prior year period. Changes in net operating assets and
liabilities, net of the impact of acquisitions, negatively impacted operating
cash flows by $92.9 million during the six months ended December 31, 2012
compared to a negative impact of $172.2 million during the prior year period.
Cash flows from operations during the six months ended December 31, 2012 were
impacted by the following payments, receipts and other working capital changes:
•       interest and income tax payments of $98.2 million during the six months
        ended December 31, 2012, which was $16.6 million higher than these
        payments were during the prior year period;

• employer contributions of $32.3 million to the DMC defined benefit

pension plan;

• improved cash collections on our patient accounts receivable;

• the timing of payments on accounts payable and certain accrued expenses,

        including incentive compensation based upon achieving our fiscal year
        2012 financial performance goals; and


•       the receipt of certain settlement receivables from the federal
        government, net of payments made to third parties utilizing most of these
        proceeds.


Investing Activities
Cash flows used in investing activities decreased from $334.8 million during the
six months ended December 31, 2011 to $178.3 million during the six months ended
December 31, 2012, primarily as a result of the cash paid for the acquisition of
Valley Baptist Health System during the prior year period. Capital expenditures
increased 36.4% to $187.2 million during the six months ended December 31, 2012
compared to the prior year period due to increased spending related to the DMC
specified project commitments and the start of construction of a new hospital in
New Braunfels, Texas. We also recognized a net cash inflow of $20.3 million for
cash reimbursement from the DMC capital commitment escrow fund during the
current year period.
Financing Activities
Cash flows used in financing activities decreased by $422.6 million during the
six months ended December 31, 2012 compared to the six months ended December 31,
2011 primarily due to the redemption of the Senior Discount Notes during the
prior year period. During the six months ended December 31, 2011, we redeemed
approximately $450.0 million of the Senior Discount Notes using proceeds from
our initial public offering, including the exercise of the underwriters'
over-allotment option. We recorded debt extinguishment costs of $38.9 million,
$25.3 million net of taxes, representing tender premiums and other costs to
redeem the Senior Discount Notes and the write-off of net deferred loan costs
associated with the redeemed Senior Discount Notes. The accreted value of the
remaining outstanding Senior Discount Notes was approximately $10.4 million as
of December 31, 2012.
As of December 31, 2012, our outstanding debt was $2,703.2 million, and we had
$327.2 million of remaining borrowing capacity under our revolving credit
facility.
Debt Covenants
Our senior secured credit agreement contains a number of covenants that, among
other things, restrict, subject to certain exceptions, our ability, and the
ability of our subsidiaries, to: sell assets; incur additional indebtedness or
issue preferred stock; repay other indebtedness (including the 8.0% Senior
Unsecured Notes, the 7.750% Senior Notes and the Senior Discount Notes); pay
certain dividends and distributions or repurchase our capital stock; create
liens on assets; make investments, loans or advances; make certain acquisitions;
engage in mergers or consolidations; create a health care joint venture; engage
in certain transactions with affiliates; amend certain material agreements
governing our indebtedness, including the 8.0% Senior Unsecured Notes, the
7.750% Senior Notes and the Senior Discount Notes; change the business conducted
by our subsidiaries; enter into certain hedging agreements; and make capital
expenditures above specified levels. In addition, the senior secured credit
agreement includes a minimum consolidated interest coverage ratio and a maximum
consolidated leverage ratio. The following table sets forth the interest
coverage and leverage covenant tests as of December 31, 2012.


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                                     Debt Covenant Ratio     Actual Ratio
Interest coverage ratio requirement             2.10 x            3.34 x
Total leverage ratio limit                      5.75 x            3.63 x


Factors outside our control may make it difficult for us to comply with these
covenants during future periods. These factors include, among others, a
prolonged economic recession, a higher number of uninsured or underinsured
patients and decreased governmental or managed care payer reimbursement, any or
all of which could negatively impact our results of operations and cash flows
and cause us to violate one or more of these covenants. Violation of one or more
of the covenants could result in an immediate call of the outstanding principal
amount under our senior secured credit agreement or the necessity of lender
waivers with more onerous terms, including adverse pricing or repayment
provisions or more restrictive covenants. A default under our senior secured
credit agreement would also result in a default under the indenture governing
our 8.0% Senior Unsecured Notes and the indentures governing the 7.750% Senior
Notes and the Senior Discount Notes.
Capital Resources
We anticipate spending a total of $510.0 million to $530.0 million in capital
expenditures during fiscal year 2013. Under the terms of the DMC acquisition
agreement, we committed to spend $500.0 million for specified capital projects
and $350.0 million for routine capital projects for a five-year period
subsequent to the acquisition. This commitment includes a requirement to spend
at least $80.0 million on specified expansion projects during calender year 2012
as part of the $500.0 million total commitment for specified capital projects,
and to escrow any shortfall from this amount in February 2013. As of
December 31, 2012, we had spent $52.2 million toward this calendar year 2012
specified capital projects commitment leaving an estimated escrow funding
commitment of $27.8 million. Since the date of acquisition, we have spent $240.5
million of the total $850.0 million DMC capital commitment. As of December 31,
2012, we estimate our remaining commitments, excluding those for DMC, to
complete all capital projects in process to be approximately $140.3 million.
As part of the Valley Baptist acquisition, we issued a redeemable
non-controlling interest to the seller that enables the seller to require us to
redeem all or a portion of its 49% equity interest in the partnership on the
third or fifth anniversary of the acquisition date at a stated redemption value.
If the seller exercises this put option, we may purchase the non-controlling
interest with cash or by issuing stock. It is our intent to settle in cash, if
the put option is exercised. These potential cash outflows could limit our
ability to fund our other operating needs, including acquisitions or other
growth opportunities.
We had $357.8 million of cash and cash equivalents as of December 31, 2012. We
rely on available cash, cash flows generated by operations and available
borrowing capacity under our revolving credit facility to fund our operations
and capital expenditures. We believe that we invest our cash accounts in
high-quality financial institutions. We continually explore various options to
increase the return on our invested cash while preserving our principal cash
balances. However, the majority of our cash and cash equivalents, deposits and
investments are not federally-insured and could be at risk in the event of a
collapse of those financial institutions.
As of December 31, 2012, we held $57.9 million in total available-for-sale
investments in securities held by one of our wholly-owned captive insurance
subsidiaries. We may not be able to utilize these investments to fund our
operating or capital expenditure funding needs due to statutory limitations
placed on this captive insurance subsidiary.
Liquidity Outlook
We expect that cash on hand, the capacity under our revolving credit facility,
and cash generated from our operations will be sufficient to fund our operating
and capital needs during the next 12 months and into the foreseeable future.
However, if our projections are proved wrong, we cannot be certain that cash on
hand, cash flows from operations and the capacity under our revolving credit
facility will be sufficient to fund our operating and capital needs and debt
service requirements during the long-term.
We intend to continue to pursue acquisitions, partnership arrangements and
service expansion or de novo development opportunities, either in existing
markets or new markets, that fit our growth strategies. These opportunities may
require significant additional investment. We also have significant capital
commitments remaining under our DMC purchase agreement to be funded during the
next few years. To finance these growth opportunities and our capital
commitments or for other general corporate needs, we may increase borrowings
under our term loan facility, issue additional senior or subordinated notes, use
available cash on hand, utilize amounts available under our revolving credit
facility or seek additional financing, including debt or equity. As market
conditions warrant, we and our major equity holders, including Blackstone and
its affiliates, may from time to time repurchase debt securities issued by us,
in privately negotiated or open market transactions, by tender offer or
otherwise. Our future operating performance, ability to service existing debt or
opportunities to obtain additional financing on


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favorable terms may be limited by economic or other market conditions or
business factors, many of which are beyond our control.
Obligations and Commitments
There have been no material changes to our obligations and commitments
previously disclosed in our Annual Report on Form 10-K for the fiscal year ended
June 30, 2012.

Guarantees and Off Balance Sheet Arrangements
We are currently a party to a certain rent shortfall agreement with a certain
unconsolidated entity. We also enter into physician income guarantees and
service agreement guarantees and other guarantee arrangements, including
parent-subsidiary guarantees, in the ordinary course of business. We have not
engaged in any transaction or arrangement with an unconsolidated entity that is
reasonably likely to materially affect our liquidity.
We had standby letters of credit outstanding of $37.8 million as of December 31,
2012, which primarily relate to security for the payment of claims as required
by various insurance programs.
In connection with the closing of the DMC transaction, we placed into escrow for
the benefit of DMC a contingent unsecured subordinated promissory note payable
to the legacy DMC entity in the original principal amount of $500.0 million to
collateralize our $500.0 million specified project capital commitment. The
principal amount of the promissory note is reduced automatically as we expend
capital or escrow cash related to this capital commitment.


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