CAPELLA HEALTHCARE, INC. – 10-K – Management’s Discussion and Analysis of Financial Condition and Results of Operations.

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 The following discussion and analysis of financial condition and results of operations should be read in conjunction with our audited consolidated financial statements, the notes to our audited consolidated financial statements, and the other financial information appearing elsewhere in this report. We intend for this discussion to provide you with information that will assist you in understanding our financial statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes. It includes the following sections:    •   Forward Looking Statements;     •   Executive Overview;     •   Critical Accounting Policies;     •   Results of Operations Summary; and     •   Liquidity and Capital Resources.  

FORWARD LOOKING STATEMENTS

  This report and other materials the Company has filed or may file with the SEC, as well as information included in oral statements or other written statements made, or to be made, by senior management of the Company, contain, or will contain, disclosures that are "forward-looking statements." which are intended to be covered by the safe harbors created by federal securities laws. Forward-looking statements are those statements that are based upon management's current plans and expectations as opposed to historical and current facts and are often identified in this discussion by use of words including but not limited to "may," "believe," "will," "should," "expect," "estimate," "anticipate," "intend," and "plan." These statements are based upon estimates and assumptions made by Capella's 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. Except as required by law, we undertake no obligation to update publicly or to revise any forward-looking statements, whether as a result of new information, future events or otherwise.  In this report, for example, we make forward-looking statements, including statements discussing our expectations about: our business strategy and operating philosophy, including efforts to provide high quality patient care and service excellence, investments in technology, recruitment and retention of physicians and nurses, expansion of service lines, and growth strategies for existing markets and for potential acquisitions; future financial performance and condition; industry and general economic trends, including the impact of the current economic environment, changes to reimbursement, patient volumes and related revenue; our compliance with new and existing laws and regulations, such as the Affordable Care Act, as well as costs and benefits associated with compliance; effects of competition and consolidation on our hospitals' markets; costs of providing care to our patients; the impact of bad debt expenses; future liquidity and capital resources; and existing and future debt.  There are several factors, some beyond our control that could cause results to differ significantly from our expectations. Some of these factors are described in "Part I, Item 1A. Risk Factors." Other factors, such as market, operational, liquidity, interest rate and other risks, are described elsewhere in this section and "Part II, Item 7A. Quantitative and Qualitative Disclosures about Market Risk." Any factor described in this report could by itself, or together with one or more factors, adversely affect our business, results of operations and/or financial condition. There may be factors not described in this report that could also cause results to differ from our expectations. We operate in a continually changing business environment, and new risk factors emerge from time to time. We cannot predict such new risk factors nor can we assess the impact, if any, of such new risk factors on our business or the extent to which any factor or combination of factors may cause actual results to differ materially from those expressed or implied by any forward-looking statements.  

EXECUTIVE OVERVIEW

  We are a provider of general and specialized acute care, outpatient and other medically necessary services in our primarily non-urban communities. We provide these services through a portfolio of acute care hospitals and complementary outpatient facilities and clinics. As of December 31, 2012, we operated 12 acute care hospitals (eleven of which we own and one of which we lease pursuant to a long-term lease) comprised of 1,574 licensed beds in six states. We are focused on enabling our facilities to maximize their potential to deliver high quality care in a patient-friendly environment. We invest our financial and operational resources to establish and support services that meet the needs of our communities. We seek to achieve our objectives by providing exceptional quality care to our patients, establishing strong local management teams, physician leadership groups and hospital boards, developing deep physician and employee relationships and working closely with our communities.                                           35

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Effective March 16, 2012, we acquired the assets of MRTA in Muskogee, Oklahoma. MRTA was integrated into EASTAR Health System's cancer program upon being acquired.

  Effective April 30, 2012, we entered into a joint venture agreement with St. Thomas Health in Tennessee. In exchange for a 6.49% minority ownership at four of our Tennessee hospitals, St. Thomas contributed approximately $0.5 million in equipment. St. Thomas will co-brand our Tennessee hospitals as well as clinically support certain services and future growth opportunities. Our partnership with St. Thomas will be the exclusive development vehicle for a 60-county region in middle Tennessee and southern Kentucky.  Effective July 1, 2012, we executed a long-term lease agreement for MCH, a 45-licensed bed facility located in Muskogee, Oklahoma. Upon execution of the lease, MCH immediately became a campus of Muskogee Regional Medical Center. As part of the transaction, we executed an asset purchase agreement in which we acquired specific components of net working capital, as defined, and certain intangible assets for $21.4 million. Of the purchase price, $8.4 million is in the form of a promissory note payable in fifteen equal installments beginning July 2013. We also executed a master lease agreement for the real property and certain equipment used in the operation of MCH. Under the master lease agreement, we pay a lease payment of $565,000 per month, which payment will be adjusted for inflation beginning in the third year of the lease. We have another option to purchase the leased real property and equipment at fair value on July 20, 2014. If we do not exercise the initial purchase option, we have the option to purchase upon the expiration of the initial lease term (15 years). We also have an option to renew the lease for an additional 15 years, after which we also could exercise a purchase option for fair value.  Effective December 31, 2012, we acquired the assets of the Imaging Centers in Lawton, Oklahoma. The Imaging Centers were integrated into Southwestern Medical Center upon acquisition.  Significant Industry Trends  The following sections discuss recent trends that we believe are significant factors in our current and/or future operating results and cash flows. Certain of these trends apply to the entire hospital industry, while others may apply to us more specifically. These trends could be short-term in nature or could require long-term attention and resources. While these trends may involve certain factors that are outside of our control, the extent to which these trends affect our hospitals and our ability to manage the impact of these trends play vital roles in our current and future success. In many cases, we are unable to predict what impact, if any, these trends will have on us.  

Impact of Healthcare Reform

  The Affordable Care Act dramatically alters the United States healthcare system and is intended to decrease the number of uninsured Americans and reduce the overall cost of healthcare. The Affordable Care Act attempts to achieve these goals by, among other things, requiring most Americans to obtain health insurance, expanding Medicare and Medicaid eligibility, reducing Medicare DSH and Medicaid payments to providers, expanding the Medicare program's use of value-based purchasing programs, tying hospital payments to the satisfaction of certain quality criteria, bundling payments to hospitals and other providers, and instituting certain private health insurance reforms. Although a majority of the measures contained in the Affordable Care Act do not take effect until 2014, certain of the reductions in Medicare spending, such as negative adjustments to the Medicare hospital inpatient and outpatient prospective payment system market basket updates and the incorporation of productivity adjustments to the Medicare program's annual inflation updates, became effective in 2010 and 2011 or will be implemented in 2013. On June 28, 2012, the United States Supreme Court upheld the "individual mandate" provision of the Affordable Care Act that generally requires all individuals to obtain healthcare insurance or pay a penalty. The Supreme Court also held, however, that the provision of the Act that authorized the Secretary of HHS to penalize states that choose not to participate in the expansion of the Medicaid program by removing all existing Medicaid funding was unconstitutional. In response to the ruling, a number of states have already indicated that they will not expand their Medicaid programs. Doing so would result in the Affordable Care Act not providing coverage to some low-income persons in those states. Additionally, several bills have been and will likely continue to be introduced in Congress to repeal or amend all or significant provisions of the Affordable Care Act. It is difficult to predict the full impact of the Affordable Care Act because of its complexity, lack of implementing regulations and interpretive guidance, gradual and potentially delayed implementation, future potential legal challenges, and possible repeal and/or amendment, as well as the inability to foresee how individuals and businesses will respond to the choices afforded them by the Affordable Care Act. As a result, it is difficult to predict the full impact that the Affordable Care Act will have on our revenue and results of operations.  

Adoption of Electronic Health Records

  The HITECH Act includes provisions designed to increase the use of EHR by both physicians and hospitals. We intend to comply with the EHR meaningful use requirements of the HITECH Act in time to qualify for the maximum available Medicare and Medicaid incentive payments. We will recognize income related to the Medicare or Medicaid incentive payments as we are able to satisfy all appropriate contingencies, which includes completing attestations as to our eligible hospitals adopting, implementing or                                           36

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  demonstrating meaningful use of certified EHR technology, and additionally for Medicare incentive payments, deferring income until the related Medicare fiscal year has passed and cost report information used to determine the final amount of reimbursement is known. Our compliance will result in significant costs including professional services focused on successfully designing and implementing our EHR solutions along with costs associated with the hardware and software components of the project. During the years ended December 31, 2011 and 2012, we recognized $7.5 million and $6.4 million, respectively, of other income related to estimated EHR incentive payments. We currently estimate that at a minimum the total costs incurred to comply will be recovered through this initiative.  

Medicare and Medicaid Reimbursement

Medicare payment methodologies have been, and are expected to be, significantly revised based on cost containment and policy considerations. CMS has already begun to implement some of the Medicare reimbursement reductions required by the Affordable Care Act. These revisions will likely be more frequent and significant as more of the Affordable Care Act's changes and cost-saving measures become effective.  In addition, many states in which we operate are facing budgetary challenges and have adopted, or may be considering, legislation that is intended to control or reduce Medicaid expenditures, enroll Medicaid recipients in managed care programs, and/or impose additional taxes on hospitals to help finance or expand their Medicaid programs. Congress has made an effort to address the financial challenges Medicaid is facing by recently increasing the amount of Medicaid funding available to states through the ARRA and the Education, Jobs, and Medicaid Assistance Act, which increased FMAP payments through June 30, 2011. Budget cuts, federal or state legislation, or other changes in the administration or interpretation of government health programs by government agencies or contracted managed care organizations could have a material adverse effect on our financial position and results of operations.  

Pay for Performance Reimbursement

  Many payors, including Medicare and several large managed care organizations, currently require hospital providers to report certain quality measures in order to receive the full amount of payment increases that were awarded automatically in the past. Many large managed care organizations have developed quality measurement criteria that are similar to or even more stringent than these Medicare</org> requirements. While current Medicare guidelines and contracts with most managed care payors provide for reimbursement based upon the reporting of quality measures, we believe significant payors will utilize the quality measures to determine reimbursement rates for hospital services. We have developed key processes and infrastructure that we believe enable us to meet or exceed the current established quality guidelines. We plan to continue to invest in quality initiatives and technology in order to meet the quality demands of our payors in the future.  Value-Based Reimbursement  The trend in the healthcare industry continues towards value-based purchasing of healthcare services. These value-based purchasing programs include both public reporting and financial incentives tied to the quality and efficiency of care provided by facilities. The Affordable Care Act expands the use of value based purchasing initiatives in federal healthcare programs. We expect programs of this type to become more common in the healthcare industry.  Medicare requires providers to report certain quality measures in order to receive full reimbursement increases for inpatient and outpatient procedures that previously were awarded automatically. Historically, CMS has expanded, through a series of rulemakings, the number of patient care indicators that hospitals must report. Additionally, we anticipate that CMS will continue to expand the number of inpatient and outpatient quality measures. We have invested significant capital and resources in the implementation of our advanced clinical system that assists us in monitoring and reporting these quality measures. CMS makes the data submitted by hospitals, including our hospitals, public on its website.  The Affordable Care Act requires the Department to implement a value-based purchasing program for inpatient hospital services. Beginning in federal fiscal year 2013, the Department will reduce inpatient hospital payments for all discharges by a percentage specified by statute and pool the total amount collected from these reductions to fund payments to reward hospitals that meet or exceed certain quality performance standards established by the Department. CMS will evaluate hospitals' performance during a performance period and hospitals will receive points on each of a number of pre-determined measures based on the higher of (i) their level of achievement relative to an established standard or (ii) their improvement in performance from their performance during a prior baseline period. Each hospital's combined scores on all the measures will be translated into value-based incentive payments beginning with inpatient discharges occurring on or after October 1, 2012. In addition, the Affordable Care Act contains a number of other provisions that further tie reimbursement to quality and efficiency. Also beginning in FFY 2013, hospitals that have "excess readmissions" for specified conditions will receive reduced reimbursement. Each hospital's performance will be publicly reported, and HHS has the discretion to determine terms and conditions of the program such as what "excessive readmissions" means. Medicare also no longer pays hospitals additional amounts for the treatment of certain hospital-acquired conditions, also known as HACs, unless the conditions were present at admission. Further, beginning in federal fiscal year 2015, hospitals that rank in the worst 25% of all hospitals nationally for HACs in the previous year will receive reduced Medicare reimbursements. The Affordable Care Act also prohibits the use of federal funds under the Medicaid program to reimburse providers for treating certain provider-preventable conditions.                                           37

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  The Affordable Care Act also requires HHS to implement a value-based purchasing program for inpatient hospital services. The Affordable Care Act requires HHS to reduce inpatient hospital payments for all discharges by a percentage beginning at 1.0% in FFY 2013 and increasing by 0.25% each fiscal year up to 2.0% in FFY 2017 and subsequent years. HHS will pool the amount collected from these reductions to fund payments to reward hospitals that meet or exceed certain quality performance standards established by HHS. HHS will determine the amount each hospital that meets or exceeds the quality performance standards will receive from the pool of dollars created by these payment reductions.  

Physician Alignment

  Our ability to attract skilled physicians to our hospitals is critical to our success. Coordination of care and alignment of care strategies between hospitals and physicians will become more critical as reimbursement becomes more episode-based. We have physician recruitment goals with primary emphasis on recruiting physicians specializing in family practice, internal medicine, general surgery, oncology, obstetrics and gynecology, cardiology, neurology, orthopedics, urology, otolaryngology and inpatient hospital care (hospitalists). To provide our patients access to the appropriate physician resources, we actively recruit physicians to the communities served by our hospitals through employment agreements, relocation agreements or physician practice acquisitions. We invest in the infrastructure necessary to coordinate our physician alignment strategies and manage our physician operations. The costs associated with recruiting, integrating and managing a large number of new physicians will have a negative impact on our operating results and cash flows in the near term. However, we expect to realize improved clinical quality and service expansion capabilities from this initiative that will impact our operating results positively over the long term.  

Cost Pressures

  In order to demonstrate a highly reliable environment of care, we must hire and retain nurses who share our ideals and beliefs with respect to delivering high quality patient care and who have access to the training necessary to implement our clinical quality initiatives. While the national nursing shortage has abated somewhat during the last year, the nursing workforce remains volatile. As a result, we expect continuing pressures on nursing salaries and benefits. These pressures include base wage increases, demands for flexible working hours and other increased benefits as well as higher nurse-to-patient ratios. In addition, inflationary pressures and technological advancements and increased acuity continue to drive supply costs higher. We implemented multiple supply chain initiatives, including consolidation of low-priced vendors, established value analysis teams and coordinated quality of care efforts to encourage group purchasing contract compliance.  

Uncompensated Care

  Like others in the hospital industry, we continue to experience high levels of uncompensated care, including charity care and bad debts. These elevated levels are driven by the number of uninsured and under-insured patients seeking care at our hospitals, the increased acuity levels at which these patients are presenting for treatment, primarily resulting from economic pressures and their related decisions to defer care, increasing healthcare costs and other factors beyond our control, such as increases in the amount of co-payments and deductibles as employers continue to pass more of these costs on to their employees. In addition, as a result of high unemployment and its continued impact on the economy, we believe that our hospitals may continue to experience high levels of or possibly growth in bad debts and charity care. During the year ended December 31, 2012, our same-facility uncompensated care as a percentage of revenue, which includes the impact of uninsured discounts and charity care, was 22.3%, compared to 20.8% in the prior year.  

We anticipate that if we experience further growth in uninsured volume and revenue over the near-term, including increased acuity levels and continued increases in co-payments and deductibles for insured patients, our uncompensated care will increase and our results of operations could be adversely affected.

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Similar to others in the hospital industry, we have a significant amount of self-pay receivables (including co-payments and deductibles from insured patients), and collecting these receivables may become more difficult if economic conditions worsen. The following table provides a summary of our accounts receivable payor class mix as of December 31, 2011 and 2012:

     December 31, 2011         0-90 Days        91-180 Days        Over 180 Days        Total   Medicare(1)                     26.4 %              0.7 %                0.4 %       27.5 %   Medicaid(1)                      6.2                0.7                  0.6          7.5   Managed Care and Other          18.9                1.8                  1.1         21.8   Self-Pay(2)                     10.6                9.6                 23.0         43.2    Total                           62.1 %             12.8 %               25.1 %      100.0 %        December 31, 2012         0-90 Days        91-180 Days        Over 180 Days        Total   Medicare(1)                     26.5 %              0.8 %                0.5 %       27.8 %   Medicaid(1)                      6.1                0.6                  0.5          7.2   Managed Care and Other          18.2                1.8                  0.6         20.6   Self-Pay(2)                     11.4                9.7                 23.3         44.4    Total                           62.2 %             12.9 %               24.9 %      100.0 %     

(1) Includes receivables under managed Medicare or managed Medicaid programs.

(2) Includes both uninsured as well as estimated co-payment and deductible

amounts from insured patients.

   The volume of self-pay accounts receivable remains sensitive to a combination of factors, including price increases, acuity of services, higher levels of insured patient co-payments and deductibles, economic factors and the increased difficulties of uninsured patients who do not qualify for charity care programs to pay for escalating healthcare costs. We have implemented a number of practices to mitigate bad debt expense and increase collections, including increased focus on upfront cash collections, incentive plans for our hospitals' financial counselors and registration personnel, increased focus on payment plans with non-emergent patients, among other efforts. Despite these practices, we believe bad debts will remain a significant risk for us and the rest of the hospital industry in the near term.  

Implementation of Clinical Quality Initiatives

  The integral component of responding to each of the challenge areas previously discussed is quality of care. We have implemented many of our expanded clinical quality initiatives and are in the process of implementing several others. These initiatives include the following:      •   review of the current CMS quality indicators;       •   mock Joint Commission surveys conducted by a third-party;       •   implementation of hourly nursing rounds;             •    alignment of hospital management incentive compensation with quality              and satisfaction indicators;       •   feedback from our LPLGs, NPLG, and PAG;             •    hospital board and medical staff oversight of patient safety and              quality of care; and       •   investment in clinical technology.  

Revenue/Volume Trends

  Revenue for the year ended December 31, 2012, increased 9.3% to $747.6 million, compared to $683.9 million in the prior year. Our revenue depends upon inpatient occupancy levels, outpatient procedures, ancillary services and therapy programs as well as our ability to negotiate appropriate payment rates for services with third-party payors and our ability to achieve quality metrics to maximize payment from our payors.  

Revenue

  The primary sources of our revenue before the provision for bad debts include various managed care payors, including managed Medicare and managed Medicaid programs, the traditional Medicare program, various state Medicaid programs, commercial health plans and patients themselves. We are typically paid less than our gross charges, regardless of the payor source, and report revenue before the provision for bad debts to reflect contractual adjustments and other allowances required by managed care providers and federal and state agencies.                                           39

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  Our Oklahoma facilities participate in the State of Oklahoma's Supplemental Hospital Offset Payment Program, or SHOPP. The legislation related to SHOPP was signed into law by the Governor of Oklahoma on May 13, 2011, but subject to approval by CMS. On January 17, 2012, CMS approved SHOPP with an effective date of July 1, 2011.SHOPP, with an initial term of three fiscal years, allows for the establishment of a hospital provider fee assessment on all non-exempt Oklahoma hospitals. The state plans to use revenue from this assessment to maintain hospital reimbursement from the SoonerCare Medicaid program and to secure additional matching Medicaid funds from the federal government. Since CMS approval of the program did not occur until January 17, 2012, we recorded eighteen months of revenue and expenses (six months from July 1, 2011 through December 31, 2011 and twelve months from January 1, 2012 through December 31, 2012) associated with SHOPP during the year ended December 31, 2012. CMS approval was necessary to meet the revenue recognition criterion that persuasive evidence of an arrangement exists, pursuant to generally accepted accounting principles.  We also recorded revenue and expenses related to the rural floor provision settlement litigation during the year ended December 31, 2012. The Balanced Budget Act of 1997, or BBA, established a rural floor provision, by which an urban hospital's wage index within a particular state could not be lower than the statewide rural wage index. The wage index reflects the relative hospital wage level compared to the applicable average hospital wage level. The BBA also made this provision budget neutral, meaning that total wage index payments nationwide before and after the implementation of this provision must remain the same. To accomplish this, CMS was required to increase the wage index for all affected urban hospitals and to calculate a rural floor budget neutrality adjustment to reduce other wage indexes in order to maintain the same level of payments. Litigation had been pending for several years contending that CMS miscalculated the neutrality adjustment from 1999 through 2011. The litigation, in which we and several other hospital companies participated, was settled effective April 5, 2012.  

During the twelve months ended December 31, 2012, we recorded revenue and expenses related to the prior period SHOPP (for the period of July 1, 2011 through December 31, 2011) and rural floor provision settlement of $13.6 million and $5.1 million, respectively.

  Admissions and adjusted admissions increased 4.8% and 7.7%, respectively, for the year ended December 31, 2012, compared to the prior year. On a same-facility basis, admissions increased 2.8% and adjusted admissions increased 5.4%, each compared to the prior year.  Consolidated inpatient surgeries increased 0.4% for the year ended December 31, 2012, compared to the prior year. Same-facility inpatient surgeries decreased 1.3% for year ended December 31, 2012, compared to the prior year. Consolidated outpatient surgeries increased 6.7% for the year ended December 31, 2012, compared to the prior year. Same-facility outpatient surgeries increased 6.0% for the year ended December 31, 2012, compared to the prior year. The increase in outpatient surgeries for the year ended December 31, 2012 is due, in part, to the addition of a surgery center at one of our hospitals effective July 1, 2011. We also believe that our increase in outpatient surgeries, along with a slight decline in same-facility inpatient surgeries, can be attributed to the continuing industry shift from an inpatient hospital setting to an outpatient setting.  We believe our volumes over the long-term will grow as a result of our business strategies, including the continued investment in our physician alignment strategy, increased efforts to promote our commitment to quality and patient satisfaction, and the general aging of the population.  The following table sets forth the percentages of revenue before the provision for bad debts by payor for the years ended December 31, 2010, 2011 and 2012:                                                 Year Ended December 31,                                         2010        2011(2)       2012(3)               Medicare(1)                 36.8 %        39.3 %        39.0 %               Medicaid(1)                 11.8          12.6          15.0               Managed Care and other      35.0          38.0          35.7               Self-Pay                    16.4          10.1          10.3                Total                      100.0 %       100.0 %       100.0 %     

(1) Includes revenue before the provision for bad debts received under managed

Medicare or managed Medicaid programs.

(2) The shift in our self-pay payor mix from 2010 to 2011 is due primarily to the

impact of our uninsured discount policy, which went into effect January 1,

2011. Under this policy, all patients without insurance are provided a 60%

discount from gross charges at the time of billing. The discount is reflected

as a deduction from revenue before the provision for bad debts instead of an

increase to the provision for bad debts, causing the change in payor mix for

2011.

(3) The increase in Medicaid revenue for fiscal 2012 is due primarily to the

Oklahoma Supplemental Hospital Offset Payment Program, or SHOPP. SHOPP

increased Medicaid revenue for fiscal 2012 by approximately $21.5 million.

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  Revenue per adjusted admission increased 1.5% for the year ended December 31, 2012, compared to the prior year. Our revenue per adjusted admission for the year ended December 31, 2012 was impacted by the revenue recognized from SHOPP and the rural floor provision settlement discussed previously. Excluding the revenue related to SHOPP and the rural floor settlement, our same-facility revenue per adjusted admission declined 0.3% for the year ended December 31, 2012, compared to the prior year. The decrease in our revenue per adjusted admission is primarily due to an increase in uncompensated care and the impact of service line rotation as we saw a higher number of lower acuity cases combined with a decline of higher acuity cases during the year. The increase in lower acuity cases can be attributed, in part, to new service lines such as behavioral health that we have opened at several of our facilities. These new service lines typically result in lower acuity cases. We also have experienced moderating rates of pricing growth resulting from the impact of high unemployment and other industry pressures, including elevated levels of Medicaid and managed Medicaid, which typically result in lower reimbursement on a per adjusted admission basis. Also, the impact of state budgetary issues on Medicaid funding has resulted in some rate cuts to providers, which has caused a decline in pricing related to Medicaid and managed Medicaid volumes. As states continue to work through budgetary issues, any additional cuts to Medicaid funding would impact negatively our future pricing and earnings.                                           41

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CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the reported amounts and related disclosures. We consider an accounting estimate to be critical if:

• it requires assumptions to be made that were uncertain at the time the

              estimate was made; and             •    changes in the estimate or different estimates that could have been              made could have a material impact on our consolidated results of              operations or financial condition.  

Revenue and Revenue Deductions

  We recognize revenue before the provision for bad debts during the period the healthcare services are provided based upon estimated amounts due from payors. We record contractual adjustments to our gross charges to reflect expected reimbursement negotiated with or prescribed by third-party payors. We estimate contractual adjustments and allowances based upon payment terms set forth in managed care health plan contracts and by federal and state regulations. For the majority of our revenue before the provision for bad debts, we apply contractual adjustments to patient accounts at the time of billing using specific payor contract terms entered into the accounts receivable systems, but in some cases we record an estimated allowance until payment is received. If our estimated contractual adjustments as a percentage of gross revenue had been 1% higher for all insured accounts, our revenue before the provision for bad debts would have been reduced by approximately $25.9 million, $28.4 million and $31.6 million for the years ended December 31, 2010, 2011 and 2012, respectively. We derive most of our revenue before the provision for bad debts from healthcare services provided to patients with Medicare (including managed Medicare plans) or managed care insurance coverage.  Services provided to Medicare patients are generally reimbursed at prospectively determined rates per diagnosis, while services provided to managed care patients are generally reimbursed based upon predetermined rates per diagnosis, per diem rates or discounted fee-for-service rates. Medicaid reimbursements vary by state. Other than Medicare and Medicaid, no individual payor represents more than 10% of our revenue.  Medicare regulations and many of our managed care contracts are often complex and may include multiple reimbursement mechanisms for different types of services provided in our healthcare facilities. To obtain reimbursement for certain services under the Medicare program, we must submit annual cost reports and record estimates of amounts owed to or receivable from Medicare. These cost reports include complex calculations and estimates related to indirect medical education, disproportionate share payments, reimbursable Medicare bad debts and other items that are often subject to interpretation that could result in payments that differ from recorded estimates. We estimate amounts owed to or receivable from the Medicare program using the best information available and our interpretation of the applicable Medicare regulations. We include differences between original estimates and subsequent revisions to those estimates (including final cost report settlements) in our consolidated statements of operations in the period in which the revisions are made.  Net adjustments for the final third-party settlements increased revenue and income from continuing operations before income taxes by $0.8 million during the year ended December 31, 2010, decreased revenue and income from continuing operations by $0.2 million during the year ended December 31, 2011 and increased revenue and income from continuing operations before income taxes by $1.1 million during the year ended December 31, 2012. Additionally, updated regulations and contract negotiations with payors occur frequently, which necessitates continual review of revenue estimation processes by management. Management believes that future adjustments to its current third-party settlement estimates will not materially impact our results of operations, cash flows or financial position.  We do not pursue collection of amounts due from uninsured patients that qualify for charity care under our guidelines (generally it is those uninsured patients whose incomes are equal to or less than 200% of the current federal poverty guidelines set forth by HHS). We deduct charity care accounts from gross revenue when we determine that the account meets our charity care guidelines. We also provide discounts from billed charges and alternative payment structures for uninsured patients who do not qualify for charity care but meet certain other minimum income guidelines, primarily those uninsured patients with incomes between 200% and 500% of the federal poverty guidelines. For the years ended December 31, 2010, 2011 and 2012, we estimate that our cost of care provided under our charity care programs were approximately $2.8 million, $2.9 million and $3.4 million, respectively.  

Insurance Reserves

  We are self-insured for substantially all of the medical expenses and benefits of our employees. Our reserve for employee medical benefits primarily reflects the current estimate of incurred but not reported losses, based upon an actuarial calculation.  Given the nature of our operating environment, we are subject to potential medical malpractice lawsuits and other claims as part of providing healthcare services. To mitigate a portion of this risk, we maintain insurance through Auriga in sufficient amounts for malpractice claims, subject to a self-insured retention per occurrence. Auriga has re-insurance for malpractice claims which cover additional amounts in the aggregate. Our reserves for professional and general liability claims are based upon independent actuarial calculations, which consider historical claims data, demographic considerations, severity factors and other actuarial assumptions in determining reserve estimates. Our reserve estimates are discounted to present value using a 1% discount rate.                                           42

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  We are also subject to potential workers' compensation claims as part of providing healthcare services. To mitigate a portion of this risk, we maintain insurance for individual workers' compensation claims exceeding approximately $250,000 per occurrence and $5.0 million in the aggregate per year. Our hospital facility located in the State of Washington and our two facilities located in Oklahoma participate in state-specific programs rather than our established program. Our reserve for workers' compensation is based upon an independent third-party actuarial calculation, which considers historical claims data, demographic considerations, development patterns, severity factors and other actuarial assumptions. Our reserve estimates are undiscounted and are revised on an annual basis. Our reserve for workers' compensation claims reflects the current estimate of all outstanding losses, including incurred but not reported losses, based upon an actuarial calculation.  Our expense for professional and general liability claims and workers' compensation claims each year includes: the actuarially determined estimate of losses for the current year, including claims incurred but not reported ("IBNR"); the change in the estimate of losses for prior years based upon actual claims development experience as compared to prior actuarial projections; amortization of the insurance premiums for losses in excess of our self-insured retention level; the administrative costs of the insurance program; and interest expense related to the discounted portion of the liability.  The following tables summarize our claims loss and claims payment information during the years ended December 31, 2010, 2011 and 2012 and our professional and general liability reserve balances (including the current portions of such reserves, but excluding amounts recoverable from Auriga and third-party insurers) as of December 31, 2011 and 2012.                                                                    Year Ended December 31,                                                             2010           2011          2012                                                                      (In millions)

Accrual for general and professional liability claims at January 1

                                              $    9.7        $ 12.4        $ 12.7 Expense (income) related to(1): Current accident year                                          4.9           4.5           4.6 Prior accident years                                          (0.4 )        (2.5 )        (2.3 )  Total incurred loss and loss expense                           4.5           2.0           2.3  Paid claims and expenses related to: Current accident year                                          0.2           0.2           0.3 Prior accident years                                           1.6           1.5           2.0  Total paid claims and expense                                  1.8           1.7           2.3  Accrual for general and professional liability claims at December 31                                            $   12.4        $ 12.7        $ 12.7     

(1) Total expense, including premiums for insured coverage, was $7.5 million,

$5.6 million and $6.3 million for the years ended December 31, 2010, 2011 and

    2012, respectively.                                            43 

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  Our estimate of professional and general liability and workers compensation IBNR utilizes statistical confidence levels that are below 75%. Using a higher statistical confidence level, while not permitted under GAAP, would increase the estimated reserve. The following table illustrates the sensitivity at reserve estimates at 75% and 90% confidence levels:                                            Professional and          Workers                                         General Liability      Compensation                                                    (In millions)           December 31, 2011 reserve:           As reported                  $              12.7     $         3.3           With 75% confidence level                   14.6               3.6           With 90% confidence level                   17.9               4.0           December 31, 2012 reserve:           As reported                  $              12.7     $         3.4           With 75% confidence level                   14.9               4.0           With 90% confidence level                   18.3               5.0  

If our estimate of the number of unpaid days of employee health claims expense changed by five days, our employee health IBNR estimate would change by approximately $0.5 million.

Income Taxes

  We believe that our income tax provisions are accurate and supportable, but certain tax matters require interpretations of tax law that may be subject to future challenge and may not be upheld under tax audit. To reflect the possibility that all of our tax positions may not be sustained, we maintain tax reserves that are subject to adjustment as updated information becomes available or as circumstances change. We record the impact of tax reserve changes to our income tax provision in the period in which the additional information, including the progress of tax audits, is obtained.  We assess the realization of our 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 verified objectively, we determine whether it is more likely than not that all or a portion of the deferred tax assets will be realized. The factors used in this determination include the following:      •   cumulative losses in recent years;       •   income/losses expected in future years;    

• unsettled circumstances that, if favorably resolved, would adversely

          affect future operations;         •    availability, or lack thereof, of taxable income in prior carryback

         periods that would limit realization of tax benefits;         •    carryforward period associated with the deferred tax assets and          liabilities; and       •   prudent and feasible tax planning strategies.   In addition, financial forecasts used in determining the need for or amount of federal and state valuation allowances are subject to changes in underlying assumptions and fluctuations in market conditions that could significantly alter our recoverability analysis and thus have a material adverse effect on our consolidated financial condition, results of operations or cash flows. We follow the provisions of Financial Accounting Standards Board ("FASB") authoritative guidance regarding income tax uncertainties. No tax adjustment was required upon adoption of this authoritative guidance. Under these provisions, we elected to classify interest paid on an underpayment of income taxes and related penalties as a component of income tax expense.  

Long-Lived Assets and Goodwill

  Long-lived assets, including property, plant and equipment and amortizable intangible assets, comprise a significant portion of our total assets. We evaluate the carrying value of long-lived assets when impairment indicators are present or when circumstances indicate that impairment may exist under the provisions of FASB authoritative guidance regarding the impairment or disposal of long-lived assets. When management believes impairment indicators may exist, projections of the undiscounted future cash flows associated with the use of and eventual disposition of long-lived assets held for use are prepared. If the projections indicate that the carrying values of the long-lived assets are not recoverable, we reduce the carrying values to fair value. These impairment tests are heavily influenced by assumptions and estimates that are subject to change as additional information becomes available. Given the relatively few number of hospitals we own and the significant amounts of long-lived assets attributable to those hospitals, an impairment of the long-lived assets could materially adversely impact our operating results or financial position.                                           44

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  Goodwill also represents a significant portion of our total assets. We review goodwill for impairment annually at October 1 or more frequently if certain impairment indicators arise under the provisions of FASB authoritative guidance regarding goodwill and other intangible assets. Our business comprises a single reporting unit for impairment of goodwill. We compare our carrying value of the consolidated net assets to the estimated fair value based primarily on net present value of our estimated discounted future cash flows. If the carrying value exceeds fair value an impairment indicator exists and an estimate of the impairment loss is calculated. The fair value calculation includes multiple assumptions and estimates, including the projected cash flows and discount rates applied. Changes in these assumptions and estimates could result in goodwill impairment that could materially adversely impact our financial position or results of operations.  

We did not incur any impairment charges, other than with respect to discontinued operations, during the years ended December 31, 2010, 2011 or 2012.

Allowance for Doubtful Accounts and Provision for Doubtful Accounts

  Our ability to collect the self-pay portion of our receivables is critical to our operating performance and cash flows. Our allowance for doubtful accounts was approximately 75% and 75% of self-pay accounts receivable, net of contractual discounts, as of December 31, 2011 and December 31, 2012, respectively. Our additions to the allowance for doubtful accounts are made by means of the provision for doubtful accounts. Accounts written off as uncollectable are deducted from the allowance for doubtful accounts and subsequent recoveries are added. The amount of the provision for doubtful accounts is based upon our assessment of historical and expected net collections, business and economic conditions, trends in federal, state, and private employer healthcare coverage and other collection indicators. The provision for doubtful accounts and the allowance for doubtful accounts relate primarily to uninsured amounts (including copayment and deductible amounts from patients who have healthcare coverage) due directly from patients. We write off accounts when all reasonable internal and external collection efforts have been performed. We consider the return of an account from the primary external collection agency to be the culmination of our reasonable collection efforts and the timing basis for writing off the account balance. We rely on certain analytical tools, including (i) historical trended cash collections compared to net revenue less bad debt; (ii) total bad debt expense, charity care deductions and uninsured discounts as a percentage of self pay revenue; (iii) net days in accounts receivable; and (iv) the allowance for doubtful accounts as a percentage of total self pay accounts receivable. Adverse changes in general economic conditions, billing and collections operations, payor mix, or trends in federal or state governmental healthcare coverage could affect our collection of accounts receivable, cash flows and results of operations. If our uninsured accounts receivable as of December 31, 2012 were 1% higher, our provision for doubtful accounts would have increased by $0.9 million.  Effective January 1, 2011, we adopted a uniform uninsured discount policy. Under this policy, all patients without insurance are provided a 60% discount from gross charges at the time of billing. The discount is reflected as a deduction from revenue in the determination of revenue before provision for bad debts. The amount billed to the patient is subject to our customary collection process and, to the extent not collected, becomes subject to our policy governing our bad debt provision. Prior to January 1, 2011, each of our hospitals utilized a market-specific uninsured discount policy and in each case at an amount less than 60%.                                           45 

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RESULTS OF OPERATIONS

The following table presents summaries of results of operations for the three years ended December 31, 2010, 2011 and 2012.

                                                                   Year Ended December 31,                     Year Ended December 31,                     Year Ended December 31,                                                                           2010                                        2011                                        2012                                                               Amount              Percentage             Amount               Percentage             Amount               Percentage Revenue before provision for bad debts                     $      771.5                 117.6 %        $     762.1                  111.4 %        $     838.8                  112.0 % Provision for bad debts                                          (115.3 )               (17.6 )%             (78.2 )                (11.4 )%             (91.2 )                (12.0 )%  Revenue                                                           656.2                 100.0 %              683.9                  100.0 %              747.6                  100.0 %

Costs and expenses: Salaries and benefits (includes stock compensation of $0.3, $0.8, and $1.0 respectively)

                                319.9                  48.8 %              332.1                   48.6 %              350.4                   46.9 % Supplies                                                          108.3                  16.5 %              111.1                   16.2 %              117.4                   15.7 % Other operating expenses                                          133.7                  20.4 %              155.2                   22.7 %              187.5                   25.0 % Other income                                                         -                     -                  (7.5 )                 (1.1 )%              (6.4 )                 (0.9 )% Depreciation and amortization                                      32.5                   4.9 %               33.7                    4.9 %               39.6                    5.4 % Interest, net                                                      48.4                   7.4 %               51.1                    7.5 %               53.1                    7.1 % Management fee to related party                                     0.2                    -                   0.2                     -                   0.2                     - Loss on refinancing                                                20.8                   3.2 %                 -                      -                    -                      -  Total costs and expenses                                          663.8                 101.2 %              675.9                   98.8 %              741.8                   99.2 %  Income (loss) from continuing operations before income taxes                                                       (7.6 )                (1.2 )%               8.0                    1.2 %                5.8                    0.8 % Income taxes                                                        3.2                   0.5 %                1.4                    0.2 %                3.0                    0.4 %  Income (loss) from continuing operations                          (10.8 )                (1.7 )%               6.6                    1.0 %                2.8                    0.4 % Loss from discontinued operations, net of tax                      (3.4 )                (0.5 )%             (19.9 )                 (2.9 )%             (15.6 )                 (2.1 )%  Net loss                                                   $      (14.2 )                (2.2 )%       $     (13.3 )                 (1.9 )%       $     (12.8 )                 (1.7 )%  Less: Net income attributable to non-controlling interests                                                           1.5                   0.2 %                1.2                    0.2 %                1.3                    0.2 %  

Net loss attributable to Capella Healthcare, Inc. $ (15.7 )

             (2.4 )%       $     (14.5 )                 (2.1 )%       $     (14.1 )                 (1.9 )%                                             46 

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Year Ended December 31, 2012 Compared to Year Ended December 31, 2011

  Revenue. Revenue for the year ended December 31, 2012 was $747.6 million, an increase of $63.9 million, or 9.3%, over the year ended December 31, 2011. The increase in revenue was due to the following: (i) revenue recorded related to the prior period SHOPP, approved by CMS in January 2012 (from July 1, 2011 to December 31, 2011) and rural floor settlement which contributed approximately $13.6 million of revenue and (ii) an increase in adjusted admissions of 7.7%, offset by a decline in revenue per adjusted admission (excluding SHOPP revenue related to the period from July 1, 2011 to December 31, 2011 and the rural floor settlement) of approximately 0.3%. Revenue for the year ended December 31, 2012 includes the results of DeKalb and Stones River for twelve months compared to six months in the prior year.  Our revenue was impacted by an increase in our provision for bad debts, which increased $13.0 million, or 16.6% compared to the year ended December 31, 2011. The increase in bad debts was primarily due to the growth in uninsured patient volume and revenue. Self-pay admissions were 6.3% of total admissions, which increased from 5.7% during the year ended December 31, 2011. Self-pay gross revenue increased 21.6% compared to the prior year.  Salaries and benefits.Salaries and benefits for the year ended December 31, 2012 were $350.4 million, or 46.9% of revenue, compared to $332.1 million, or 48.6% of revenue, during the year ended December 31, 2011. Our salaries and benefits margin was impacted by the prior period SHOPP and rural floor settlement revenue discussed previously. Also, as a result of the rural floor provision settlement, we recorded an additional $2.2 million in incentive compensation for our employees in accordance with our incentive plan provisions during the year ended December 31, 2012. Excluding the revenue and expense related to the prior period SHOPP and rural floor settlement, salaries and benefits as a percentage of revenue were 47.4% for the year ended December 31, 2012, compared to 48.6% in the prior year. Our salaries and benefits margin benefitted from a $3.0 million reduction in contract labor and the focus on continued labor productivity improvements across our facilities.  Supplies. Supplies expense for the year ended December 31, 2012 was $117.4 million, or 15.7% of revenue, compared to $111.1 million, or 16.2%, of revenue for the year ended December 31, 2012. Our supplies margin was impacted by the SHOPP program and rural floor settlement revenue discussed previously. Excluding revenue related to the prior period SHOPP program and rural floor settlement, supplies expense as a percentage of revenue was 16.0%, compared to 16.2% in the same prior year period. The improvement in our supplies margin was due to our continued efforts to manage supply costs.  

Other operating expenses. Other operating expenses include, among other things, professional fees, repairs and maintenance, rents and leases, utilities, insurance, non-income taxes and physician income guarantee amortization.

  Other operating expenses for the year ended December 31, 2012 were $187.5 million, or 25.0% of revenue, compared to $155.2 million, or 22.7%, of revenue for the year ended December 31, 2011. Our other operating expense margin was impacted by the SHOPP program and rural floor settlement discussed previously. Excluding revenue and expenses related to the prior period SHOPP program and rural floor settlement, other operating expenses as a percentage of revenue was 25.2%, compared to 22.7% in the prior year. The increase in other operating expenses margin is due to a $11.0 million increase in provider taxes and fees, a $10.7 million increase in contract services from the implementation of new service lines at our facilities, a $5.1 million increase in professional fees primarily due to the implementation of hospitalist programs at two of our hospitals and a $3.4 million increase in acquisition costs.  Other income. Other income includes EHR incentive payments, which represent those incentives under the HITECH Act for which the recognition criteria have been met. For the year ended December 31, 2012, we recognized approximately $6.4 million of incentive reimbursements, compared to $7.5 million for the year ended December 31, 2011.  Income taxes. Our effective tax rate from continuing operations was approximately 51.7% for the year ended December 31, 2012 compared to17.7% for the year ended December 31, 2011. The change in the effective tax rate is driven by changes in the level of pretax income combined with the Company's net deferred tax liability position and related limitations with respect to deferred tax liabilities associated with indefinite-life intangible assets.  

Year Ended December 31, 2011 Compared to Year Ended December 31, 2010

  Revenue. Revenue for the year ended December 31, 2011 was $683.9 million, an increase of $27.7 million, or 4.2%, over the year ended December 31, 2010. The increase in revenue, which includes the impact of the CCH acquisition effective July 1, 2011, is comprised of a 3.3% increase in adjusted admissions combined with a 0.9% increase in revenue per adjusted admission.  The decline in the provision for bad debts from the prior year is primarily due to the impact of the adoption of our uninsured discount policy which went into effect January 1, 2011. Under this policy, all patients without insurance are provided a 60% discount from gross charges at the time of billing. The discount is reflected as a deduction from revenue in the determination of revenue instead of an increase to the provision for bad debts. Since revenue is now shown net of the provision for bad debts, revenue is comparable for all periods.                                           47

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  Salaries and benefits. Salaries and benefits for the year ended December 31, 2011 increased to $332.1 million, compared to $319.9 million for the year ended December 31, 2010. Salaries and benefits as a percentage of revenue decreased to 48.6% in 2011, compared to 48.8% in 2010. The decrease as a percentage of revenue is due primarily to improved operating efficiencies, particularly a reduction in the amount of contract labor utilized during the year.  Supplies. Supplies for the year ended December 31, 2011 increased to $111.1 million, compared to $108.3 million for the year ended December 31, 2010. Supplies as a percentage of revenue decreased to 16.2% during 2011 compared to 16.5% during 2010. The decrease in supplies expense as a percentage of revenue is due primarily to our success in implementing supply chain initiatives such as increased use of our group purchasing contract and pharmacy formulary management.  Other operating expenses. Other operating expenses for the year ended December 31, 2011 increased to $155.2 million, compared to $133.7 million for the year ended December 31, 2010. Other operating expenses as a percentage of revenue increased to 22.7 % in 2011 compared to 20.4 % in 2010. On a same-facility basis, other operating expenses as a percentage of revenue was 21.0% as of December 31, 2011, compared to 20.4% in the prior year. The increase in same-facility other operating expenses as a percentage of revenue is due to approximately $2.1 million in acquisition related expenses in 2011, as well as an increase in information technology expenses.  Other income. Other income includes EHR incentive payments, which represent those incentives under the HITECH Act for which the recognition criteria has been met. For the year ended December 31, 2011, we recognized approximately $7.5 million of incentive reimbursements.  Interest, net. Net interest increased by $2.7 million during 2011. Interest on the 9 1/4% Senior Unsecured Notes due 2017 (the "9 1/4% Notes") for the year ended December 31, 2011 was $46.3 million, compared to $23.5 million for the year ended December 31, 2010. Interest on borrowings under our previous bank credit facility totaled $20.0 million for the year ended December 31, 2010.  Income taxes. Our effective tax rate from continuing operations was approximately 17.7% during the year ended December 31, 2011 as compared to 42.1% during the year ended December 31, 2010. The change in the effective tax rate is driven by accounting guidance and limitations related to indefinite life deferred tax liabilities.  

LIQUIDITY AND CAPITAL RESOURCES

  The following table shows a summary of our cash flows for the years ended December 30, 2011 and 2012.                                                                  Year Ended                                                              December 31,                                                           2011         2012                                                             (In millions)        Cash provided by operating activities             $  43.0      $ 

44.0

        Cash used in investing activities                   (49.6 )      

(47.4 )

Cash provided by (used in) financing activities 0.7 (5.7 )

   Operating Activities  

Operating cash flows increased $1.0 million for the year ended December 31, 2012, compared to the prior year.

  At December 31, 2012</chron>, we had working capital of $88.0 million, including cash and cash equivalents of $33.3 million, compared to working capital excluding assets held for sale at December 31, 2011 of $109.9 million, including cash and cash equivalents of $42.4 million.  

Investing Activities

  Cash used in investing activities was $49.6 million for the year ended December 31, 2011 compared to $47.4 million for the year ended December 31, 2012. We spent approximately $26.0 million for the acquisitions of MRTA, certain property and working capital of MCH and the Imaging Centers. Capital expenditures for the year ended December 31, 2011 were $31.9 million compared to $33.8 million for the year ended December 31, 2012. During the year ended December 31, 2012, we spent approximately $16.4 million on information technology, $12.1 million on growth capital, with the remainder on routine capital. We also received proceeds of approximately $12.4 million from the disposition of assets.                                           48 

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Financing Activities

  Cash flows provided by financing activities was $0.7 million for the year ended December 31, 2011, compared to cash used in financing activities of $5.7 million for the year ended December 31, 2012. During the year ended December 31, 2012, we paid approximately $2.7 million on our capital leases, $1.7 million in distributions to non-controlling interests and $1.1 million to repurchase non-controlling interests.  

The Refinancing

  In June 2010, we completed a comprehensive refinancing plan, or the Refinancing. Under the Refinancing, we issued $500.0 million of the 9 1/4% Notes in a private placement offering and entered into a new senior secured asset based loan, or the ABL, consisting of a $100.0 million revolving credit facility maturing in December 2014, or the 2010 Revolving Facility. The proceeds from the 9 1/4% Notes were used to repay the outstanding principal and interest related to our previous term loan facility and to pay fees and expenses relating to the Refinancing of approximately $21.7 million.  Effective November 4, 2011, in accordance with a registration rights agreement entered into by us in connection with the private placement offering of the 9 1/4% Notes, we completed the exchange of the 9 1/4% Notes for $500.0 million in registered 9 1/4% Notes with substantially identical terms as the 9 1/4% Notes. We did not receive any proceeds from this exchange.  

Debt Covenants

  The indenture governing the 9 1/4% Notes 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, pay dividends and distributions or repurchase our capital stock, create liens on assets, make investments, engage in mergers or consolidations, and engage in certain transactions with affiliates. At December 31, 2011 and 2012, we were in compliance with all debt covenants that were subject to testing at such dates.  

Capital Resources

  We expect that cash on hand, cash generated from our operations and cash expected to be available to us under the 2010 Revolving Facility will be sufficient to meet our working capital needs and planned capital expenditure programs for the next 12 months and into the foreseeable future. However, we cannot assure you that our operations will generate sufficient cash or that future borrowings under the 2010 Revolving Facility will be available to enable us to meet these requirements.  We had $42.4 million and $33.3 million of cash and cash equivalents as of December 31, 2011 and December 31, 2012, respectively. We rely on available cash, cash flows generated by operations and available borrowing capacity under the 2010 Revolving Facility to fund our operations and capital expenditures. We invest our cash in accounts in high-quality financial institutions. We continually explore various options to increase the return on our invested cash while preserving our principal cash balances. However, the significant majority of our cash and cash equivalents are held in accounts that are not federally-insured and could be at risk in the event of a collapse of the financial institutions at which those accounts are held.  In addition, our liquidity and ability to fund our capital requirements are dependent on our future financial performance, which is subject to general economic, financial and other factors that are beyond our control. If those factors significantly change or other unexpected factors adversely affect us, our business may not generate sufficient cash flows from operations or we may not be able to obtain future financings to meet our liquidity needs. We anticipate that, to the extent additional liquidity is necessary to fund our operations, it would be funded through borrowings under our 2010 Revolving Facility, the incurrence of other indebtedness, additional note issuances or a combination of these potential sources of liquidity. We may not be able to obtain this additional liquidity when needed on terms acceptable to us.  We also intend to continue to pursue acquisitions or partnering arrangements, either in existing markets or new markets, which fit our growth strategies. To finance such transactions, we may draw upon cash on hand, amounts available under our revolving credit facility or seek additional funding sources. We continually assess our capital needs and may seek additional financing, including debt or equity, as considered necessary to fund potential acquisitions, fund capital projects or for other corporate purposes. We may be unable to raise additional equity proceeds from the investment funds affiliated with GTCR, which are our principal investors, or other investors should we need to obtain cash for any of these purposes. Our future operating performance, ability to service our debt and ability to draw upon other sources of capital will be subject to future economic conditions and other business factors, many of which are beyond our control.  

As market conditions warrant, we and our major equity holders, including GTCR, may from time-to-time repurchase debt securities issued by us, in privately negotiated or open market transactions, by tender offer or otherwise.

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Obligations and Commitments

The following table reflects a summary of obligations and commitments outstanding with payment dates as of December 31, 2012 (in millions):

                                                                      Payments Due by Period                                               Within        During          During          After                                               1 Year       Years 2-3       Years 4-5       5 Years       Total Contractual Cash Obligations: Long-term debt (1)                            $  49.6     $      97.5     $     569.4     $      -      $ 716.5 Operating leases (2)                              8.6            13.9             7.1          12.7        42.3 Capital lease obligations, with interest          8.0            43.4             0.6            -         52.0 Estimated self-insurance liabilities (3)          6.8             7.9             3.0           1.7        19.4  Subtotal                                      $  73.0     $     162.7     $     580.1     $    14.4     $ 830.2  Other Commitments: Construction and capital improvements (4)     $   4.8     $        -      $        -      $      -      $   4.8 Letters of credit (5)                             4.6              -               -             -          4.6 Physician commitments (6)                         3.3              -               -             -          3.3 Information technology commitments (7)            6.8            14.1            14.7           7.6        43.2  Subtotal                                      $  19.5     $      14.1     $      14.7     $     7.6     $  55.9  Total obligations and commitments             $  92.5     $     176.8     $     594.8     $    22.0     $ 886.1     

(1) Includes both principal and interest portions of outstanding debt.

(2) These obligations are not reflected in our consolidated balance sheets.

(3) Includes the current and long-term portions of our professional and general

liability, workers' compensation and employee health reserves.

(4) Represents our estimate of amounts we are committed to fund in future periods

through executed agreements to complete projects included as construction in

progress on our consolidated balance sheets.

(5) Amounts relate to instances in which we have letters of credit outstanding

with the third party administrators of our self-insured workers' compensation

program.

(6) Includes physician guarantee liabilities recognized on our consolidated

balance sheets under FASB provisions regarding minimum revenue guarantees and

liabilities for other fixed expenses under physician relocation agreements

not yet paid.

(7) An affiliate of HCA and another third-party vendor provide various

information systems services, including but not limited to, financial,

clinical, revenue cycle management, patient accounting and network

information services, under contracts that expire beginning 2017. The amounts

are based on estimated fees that will be charged to our hospitals with an

annual fee increase to our hospitals that is capped by the consumer price

index increase.

Guarantees and Off-Balance Sheet Arrangements

We are a party to certain master lease agreements and other similar arrangements with non-affiliated entities.

We enter into physician income guarantees and other guarantee arrangements, including parent-subsidiary guarantees, in the ordinary course of business. We do not believe we have engaged in any transaction or arrangement with an unconsolidated entity that is reasonably likely to affect liquidity materially.

We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Accordingly, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

Effects of Inflation and Changing Prices

  Various federal, state and local laws have been enacted that, in certain cases, limit our ability to increase prices. Revenue for acute hospital services rendered to Medicare patients is established under the federal government's prospective payment system. We believe that hospital industry operating margins have been, and may continue to be, under significant pressure because of changes in payor mix and growth in operating expenses in excess of the increase in prospective payments under the Medicare program. In addition, as a result of increasing regulatory and competitive pressures, our ability to maintain operating margins through price increases to non-Medicare patients is limited.                                           50 

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