As filed with the Securities and Exchange Commission on January 16, 2002
Registration No. 333-71934
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------------------
Amendment No. 3
to
Form S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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VANGUARD HEALTH SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware 6324 62-1698183
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification No.)
20 Burton Hills Boulevard, Suite 100
Nashville, TN 37215
(615) 665-6000
(Address, including zip code, and telephone number, including area code,
of registrant's principal executive offices)
Ronald P. Soltman
Executive Vice President, General Counsel and Secretary
Vanguard Health Systems, Inc.
20 Burton Hills Boulevard, Suite 100
Nashville, TN 37215
(615) 665-6000
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
SEE TABLE OF ADDITIONAL REGISTRANTS
-----------------------
Copies to:
James Florack
Davis Polk & Wardwell
450 Lexington Avenue
New York, New York 10017
(212) 450-4000
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Approximate date of commencement of proposed sale to the public: From time
to time after the effective date of this Registration Statement.
If any of the securities being registered on this form are to be offered
on a delayed or continuous basis pursuant to Rule 415 under the Securities Act
of 1933, check the following box. [X]
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ] ______________________________
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. [ ]
CALCULATION OF REGISTRATION FEE
===========================================================================================================================
Proposed Maximum Proposed Maximum
Title of Each Class Amount to be Offering Price Per Aggregate Offering Amount of
of Securities to be Registered Registered Unit(1) Price(1) Registration Fee(3)
- ---------------------------------------------------------------------------------------------------------------------------
9.75% Senior Subordinated
Notes Due 2011.......................... $300,000,000 100% $300,000,000 $75,000
Guarantees of 9.75% Senior Subordinated
Notes Due 2011.......................... $300,000,000 (2) (2) None
Total................................... $300,000,000 100% $300,000,000 $75,000
===========================================================================================================================
(1) Estimated solely for the purpose of calculating the amount of the registration fee.
(2) No consideration will be received for the guarantees.
(3) Previously paid.
-----------------------
The registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the registrant
shall file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933, as amended or until the Registration Statement
shall become effective on such date as the Commission, acting pursuant to said
Section 8(a), may determine.
===============================================================================
TABLE OF ADDITIONAL REGISTRANTS
Exact Name of Registrant As State or Other I.R.S. Employer Address Including Zip Code, And Telephone
Specified In Its Charter Jurisdiction of Identification Number Including Area Code, Of Registrant's
Incorporation Or Number Principal Executive Offices
Organization
- ----------------------------------------------------------------------------------------------------------------------------------
VHS Acquisition Delaware 62-1730519 20 Burton Hills Boulevard
Corporation Ste. 100
Nashville, TN 37215
(615) 665-6000
VHS of Phoenix, Inc. Delaware 62-1809851 20 Burton Hills Boulevard
Ste. 100
Nashville, TN 37215
(615) 665-6000
VHS Outpatient Clinics, Inc. Delaware 62-1816823 20 Burton Hills Boulevard
Ste. 100
Nashville, TN 37215
(615) 665-6000
VHS of Arrowhead, Inc. Delaware 62-1811285 20 Burton Hills Boulevard
Ste. 100
Nashville, TN 37215
(615) 665-6000
Pleasant Properties, Inc. Arizona 86-0692318 20 Burton Hills Boulevard
Ste. 100
Nashville, TN 37215
(615) 665-6000
VHS of South Phoenix, Inc. Delaware 62-1842396 20 Burton Hills Boulevard
Ste. 100
Nashville, TN 37215
(615) 665-6000
The VHS Arizona Imaging Delaware 72-1503733 20 Burton Hills Boulevard
Centers Limited Partnership Ste. 100
Nashville, TN 37215
(615) 665-6000
VHS Imaging Centers, Inc. Delaware 62-1852828 20 Burton Hills Boulevard
Ste. 100
Nashville, TN 37215
(615) 665-6000
VHS of Anaheim, Inc. Delaware 62-1781813 20 Burton Hills Boulevard
Ste. 100
Nashville, TN 37215
(615) 665-6000
VHS of Orange County, Inc. Delaware 62-1770074 20 Burton Hills Boulevard
Ste. 100
Nashville, TN 37215
(615) 665-6000
VHS Holding Company, Delaware 62-1782796 20 Burton Hills Boulevard
Inc. Ste. 100
Nashville, TN 37215
(615) 665-6000
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Exact Name of Registrant As State or Other I.R.S. Employer Address Including Zip Code, And Telephone
Specified In Its Charter Jurisdiction of Identification Number Including Area Code, Of Registrant's
Incorporation Or Number Principal Executive Offices
Organization
- ----------------------------------------------------------------------------------------------------------------------------------
VHS of Huntington Beach, Delaware 62-1782707 20 Burton Hills Boulevard
Inc. Ste. 100
Nashville, TN 37215
(615) 665-6000
The Anaheim VHS Limited Delaware 62-1782797 20 Burton Hills Boulevard
Partnership Ste. 100
Nashville, TN 37215
(615) 665-6000
The Huntington Beach VHS Delaware 62-1782795 20 Burton Hills Boulevard
Limited Partnership Ste. 100
Nashville, TN 37215
(615) 665-6000
VHS of Illinois, Inc. Delaware 62-1796152 20 Burton Hills Boulevard
Ste. 100
Nashville, TN 37215
(615) 665-6000
MacNeal Health Providers, Illinois 36-3361297 20 Burton Hills Boulevard
Inc. Ste. 100
Nashville, TN 37215
(615) 665-6000
MacNeal Management Illinois 36-3313638 20 Burton Hills Boulevard
Services, Inc. Ste. 100
Nashville, TN 37215
(615) 665-6000
Midwest Claims Processing, Illinois 36-4295667 20 Burton Hills Boulevard
Inc. Ste. 100
Nashville, TN 37215
(615) 665-6000
Pros Temporary Staffing, Illinois 36-4339784 20 Burton Hills Boulevard
Inc. Ste. 100
Nashville, TN 37215
(615) 665-6000
Watermark Physician Illinois 36-4339782 20 Burton Hills Boulevard
Services, Inc. Ste. 100
Nashville, TN 37215
(615) 665-6000
VHS Genesis Labs, Inc. Delaware 62-1803765 20 Burton Hills Boulevard
Ste. 100
Nashville, TN 37215
(615) 665-6000
MacNeal Medical Records, Delaware 62-1807248 20 Burton Hills Boulevard
Inc. Ste. 100
Nashville, TN 37215
(615) 665-6000
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Exact Name of Registrant As State or Other I.R.S. Employer Address Including Zip Code, And Telephone
Specified In Its Charter Jurisdiction of Identification Number Including Area Code, Of Registrant's
Incorporation Or Number Principal Executive Offices
Organization
- ----------------------------------------------------------------------------------------------------------------------------------
Vanguard Health Delaware 62-1686886 20 Burton Hills Boulevard
Management, Inc. Ste. 100
Nashville, TN 37215
(615) 665-6000
Trinity Medcare, Inc. Delaware 62-1684322 20 Burton Hills Boulevard
Ste. 100
Nashville, TN 37215
(615) 665-6000
V-II Acquisition Co., Inc. Pennsylvania 62-1730482 20 Burton Hills Boulevard
Ste. 100
Nashville, TN 37215
(615) 665-6000
Vanguard Health Financial Tennessee 62-1730470 20 Burton Hills Boulevard
Company, Inc. Ste. 100
Nashville, TN 37215
(615) 665-6000
Healthcare Compliance, District of Columbia 52-2033964 20 Burton Hills Boulevard
L.L.C. Ste. 100
Nashville, TN 37215
(615) 665-6000
VHS of Rancocas, Inc. New Jersey 62-1746570 20 Burton Hills Boulevard
Ste. 100
Nashville, TN 37215
(615) 665-6000
VHS Acquisition Subsidiary Delaware 62-1861138 20 Burton Hills Boulevard
Number 1, Inc. Ste. 100
Nashville, TN 37215
(615) 665-6000
VHS Acquisition Subsidiary Delaware 62-1861141 20 Burton Hills Boulevard
Number 2, Inc. Ste. 100
Nashville, TN 37215
(615) 665-6000
VHS Acquisition Subsidiary Delaware 62-1861142 20 Burton Hills Boulevard
Number 3, Inc. Ste. 100
Nashville, TN 37215
(615) 665-6000
VHS Acquisition Subsidiary Delaware 62-1861143 20 Burton Hills Boulevard
Number 4, Inc. Ste. 100
Nashville, TN 37215
(615) 665-6000
VHS Acquisition Subsidiary Delaware 62-1861175 20 Burton Hills Boulevard
Number 5, Inc. Ste. 100
Nashville, TN 37215
(615) 665-6000
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Exact Name of Registrant As State or Other I.R.S. Employer Address Including Zip Code, And Telephone
Specified In Its Charter Jurisdiction of Identification Number Including Area Code, Of Registrant's
Incorporation Or Number Principal Executive Offices
Organization
- ----------------------------------------------------------------------------------------------------------------------------------
VHS Acquisition Subsidiary Delaware 62-1861197 20 Burton Hills Boulevard
Number 6, Inc. Ste. 100
Nashville, TN 37215
(615) 665-6000
VHS Acquisition Subsidiary Delaware 62-1861198 20 Burton Hills Boulevard
Number 7, Inc. Ste. 100
Nashville, TN 37215
(615) 665-6000
VHS Acquisition Subsidiary Delaware 62-1861199 20 Burton Hills Boulevard
Number 8, Inc. Ste. 100
Nashville, TN 37215
(615) 665-6000
VHS Acquisition Subsidiary Delaware 62-1861200 20 Burton Hills Boulevard
Number 9, Inc. Ste. 100
Nashville, TN 37215
(615) 665-6000
VHS Acquisition Subsidiary Delaware 62-1861202 20 Burton Hills Boulevard
Number 10, Inc. Ste. 100
Nashville, TN 37215
(615) 665-6000
VHS Phoenix Health Plan, Delaware 62-1831567 20 Burton Hills Boulevard
Inc. Ste. 100
Nashville, TN 37215
(615) 665-6000
Hospital Development of Delaware 62-1867232 20 Burton Hills Boulevard
West Phoenix, Inc. Ste. 100
Nashville, TN 37215
(615) 665-6000
Hospital Development Delaware 62-1867509 20 Burton Hills Boulevard
Company Number 1, Inc. Ste. 100
Nashville, TN 37215
(615) 665-6000
Hospital Development Delaware 62-1867506 20 Burton Hills Boulevard
Company Number 2, Inc. Ste. 100
Nashville, TN 37215
(615) 665-6000
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EXPLANATORY NOTE
The Registration Statement covers the registration of an aggregate
principal amount of $300,000,000 of 9.75% Senior Subordinated Notes due 2011 of
Vanguard Health Systems, Inc. ("Vanguard") guaranteed by certain of our current
and future domestic restricted subsidiaries (the "new notes") that may be
exchanged for equal principal amounts of Vanguard's outstanding 9.75% Senior
Subordinated Notes due 2011 guaranteed by certain of our current and future
domestic restricted subsidiaries (the "old notes"). This Registration Statement
also covers the registration of the new notes for resale by Morgan Stanley &
Co. Incorporated in market-making transactions. The complete prospectus
relating to the exchange offer (the "exchange offer prospectus") follows
immediately after this Explanatory Note. Following the exchange offer
prospectus are pages relating solely to such market-making transactions (the
"market-making prospectus"), including alternate front and back cover pages, an
alternate "Risk Factors - No public trading market for the notes exists"
section, an alternative "Use of Proceeds" section and an alternate "Plan of
Distribution" section. In addition, the market-making prospectus will include
references merely to "notes" instead of to "old notes" and "new notes" and will
not include the following captions or the information set forth under such
captions in the exchange offer prospectus: "Summary - The Exchange Offer," "The
Exchange Offer" and "Material United States Tax Consequences of the Exchange
Offer." All other sections of the exchange offer prospectus will be included in
the market-making prospectus.
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN
OFFER TO SELL THESE SECURITIES AND WE ARE NOT SOLICITING OFFERS TO BUY THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
PROSPECTUS (SUBJECT TO COMPLETION, DATED __________, 2002)
[GRAPHIC OMITTED]
Offer to Exchange
9.75% Senior Subordinated Notes Due 2011
for
9.75% Senior Subordinated Notes Due 2011
We are offering to exchange up to $300,000,000 of our new 9.75% Senior
Subordinated Notes Due 2011 for up to $300,000,000 of our existing 9.75% Senior
Subordinated Notes Due 2011. The terms of the new notes are identical in all
material respects to the terms of the old notes, except that the new notes have
been registered under the Securities Act, and the transfer restrictions and
registration rights relating to the old notes do not apply to the new notes.
To exchange your old notes for new notes:
o you are required to make the representations described on page 31 to
us
o you must complete and send the letter of transmittal that accompanies
this prospectus to the exchange agent, Bank One Trust Company, by
5:00 p.m., New York time, on , 200_
o you should read the section called "The Exchange Offer" for further
information on how to exchange your old notes for new notes
See "Risk Factors" beginning on page 13 for a discussion of risk factors
that should be considered by you prior to tendering your old notes in the
exchange offer.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of the securities to be issued in the
exchange offer or passed upon the adequacy or accuracy of this Prospectus. Any
representation to the contrary is a criminal offense.
_____________, 2002
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TABLE OF CONTENTS
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Page
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Summary.......................................................................3
Risk Factors.................................................................13
Special Note Regarding Forward-Looking Statements............................24
The Exchange Offer...........................................................25
Use of Proceeds..............................................................32
Capitalization...............................................................32
Selected Historical Consolidated Financial and Operating Data................33
Unaudited Pro Forma Condensed Combined Financial Information.................37
Management's Discussion and Analysis of Financial Condition and
Results of Operations......................................................44
Industry Overview............................................................56
Business.....................................................................58
Reimbursement................................................................70
Government Regulation and Other Factors......................................73
Management...................................................................80
Principal Shareholders.......................................................85
Certain Relationships and Related Party Transactions.........................87
Our PIK Preferred Stock......................................................93
Description of the 2001 Senior Secured Credit Facility.......................94
Description of the Notes.....................................................95
Material United States Federal Income Tax Consequences of the
Exchange Offer............................................................134
Plan of Distribution........................................................134
Legal Matters...............................................................135
Experts.....................................................................135
Where You Can Find More Information.........................................135
Index to Consolidated Financial Statements..................................F-1
You should rely only on the information contained in this document or to
which we have referred you. We have not authorized anyone to provide you with
any information that is different. This document may only be used where it is
legal to sell these securities. The information in this document may only be
accurate as of the date of this document.
ii
SUMMARY
This summary highlights important information about our business and about
this offering. It does not include all information you should consider before
investing in the notes. Please review this prospectus in its entirety,
including the risk factors and our financial statements and the related notes,
before you decide to invest. Unless otherwise noted, the terms the "Company,"
"Vanguard," "we," "us" and "our" refer to Vanguard Health Systems, Inc. and its
subsidiaries.
THE EXCHANGE OFFER
Securities Offered .............. We are offering up to $300,000,000 aggregate
principal amount of 9.75% Senior
Subordinated Notes Due 2011, which have been
registered under the Securities Act of 1933,
as amended ("the Securities Act").
The Exchange Offer .............. We are offering to issue the new notes in
exchange for a like principal amount of your
old notes. We are offering to issue the new
notes to satisfy our obligations contained
in the registration rights agreement entered
into when the old notes were sold in
transactions permitted by Rule 144A under
the Securities Act and therefore not
registered with the Securities and Exchange
Commission ("the SEC"). For procedures for
tendering, see "The Exchange Offer."
Tenders, Expiration Date,
Withdrawal..................... The exchange offer will expire at 5:00 p.m.
New York City time on _________, 200_ unless
it is extended. If you decide to exchange
your old notes for new notes, you must
acknowledge that you are not engaging in,
and do not intend to engage in, a
distribution of the new notes. If you decide
to tender your old notes in the exchange
offer, you may withdraw them at any time
prior to __________, 200_. If we decide for
any reason not to accept any old notes for
exchange, your old notes will be returned to
you without expense to you promptly after
the exchange offer expires.
Federal Income Tax Consequences.. Your exchange of old notes for new notes in
the exchange offer will not result in any
income, gain or loss to you for Federal
income tax purposes. See "Material United
States Federal Income Tax Consequences of
the Exchange Offer."
Use of Proceeds ................. We will not receive any proceeds from the
issuance of the new notes in the exchange
offer.
Exchange Agent .................. Bank One Trust Company is the exchange agent
for the exchange offer.
Failure to Tender Your Old
Notes.......................... If you fail to tender your old notes in the
exchange offer, you will not have any
further rights under the registration rights
agreement, including any right to require us
to register your old notes or to pay you
additional interest.
3
You will be able to resell the new notes without registering them with the SEC
if you meet the requirements described below
Based on interpretations by the SEC's staff in no-action letters issued to
third parties, we believe that new notes issued in exchange for old notes in
the exchange offer may be offered for resale, resold or otherwise transferred
by you without registering the new notes under the Securities Act or delivering
a prospectus, unless you are a broker-dealer receiving securities for your own
account, so long as:
o you are not one of our "affiliates", which is defined in Rule 405 of
the Securities Act;
o you acquire the new notes in the ordinary course of your business;
o you do not have any arrangement or understanding with any person to
participate in the distribution of the new notes; and
o you are not engaged in, and do not intend to engage in, a
distribution of the new notes.
If you are an affiliate of Vanguard, or you are engaged in, intend to
engage in or have any arrangement or understanding with respect to, the
distribution of new notes acquired in the exchange offer, you (1) should not
rely on our interpretations of the position of the SEC's staff and (2) must
comply with the registration and prospectus delivery requirements of the
Securities Act in connection with any resale transaction.
If you are a broker-dealer and receive new notes for your own account in
the exchange offer:
o you must represent that you do not have any arrangement with us or
any of our affiliates to distribute the new notes;
o you must acknowledge that you will deliver a prospectus in connection
with any resale of the new notes you receive from us in the exchange
offer; the letter of transmittal states that by so acknowledging and
by delivering a prospectus, you will not be deemed to admit that you
are an "underwriter" within the meaning of the Securities Act; and
o you may use this prospectus, as it may be amended or supplemented
from time to time, in connection with the resale of new notes
received in exchange for old notes acquired by you as a result of
market-making or other trading activities.
For a period of 90 days after the expiration of the exchange offer, we
will make this prospectus available to any broker-dealer for use in connection
with any resale described above.
4
DESCRIPTION OF THE NOTES
The terms of the new notes and the old notes are identical in all material
respects, except that the new notes have been registered under the Securities
Act, and the transfer restrictions and registrations rights relating to old
securities do not apply to the new notes.
Securities Offered .............. $300,000,000 aggregate principal amount of
9.75% Senior Subordinated Notes Due 2011.
Maturity ........................ August 1, 2011.
Interest ........................ 9.750% per annum, payable semi-annually in
arrears on February 1 and August 1,
commencing on February 1, 2002.
Optional Redemption ............. We may redeem the notes, in whole or in part,
at any time on or after August 1, 2006, at
our option at the redemption prices set
forth herein under the heading "Description
of the Notes--Optional Redemption," plus
accrued and unpaid interest to the
redemption date. On or before August 1,
2004, we may redeem up to 35% of the notes
with the net proceeds from sales of certain
kinds of capital stock at 109.750% of the
principal amount thereof, plus accrued
interest, as long as at least 65% of the
aggregate principal amount of the originally
issued notes remain outstanding. See
"Description of the Notes--Optional
Redemption."
Change of Control ............... Upon a change of control of Vanguard, we
will be required to offer to repurchase the
notes at a price equal to 101% of their
principal amount, plus accrued and unpaid
interest to the date of repurchase. Our
ability to repurchase the notes upon a
change of control will be limited by the
terms of our debt agreements. In addition,
upon a change of control, we may not have
the financial resources to repurchase the
notes. See "Description of the
Notes--Repurchase of Notes upon a Change of
Control."
Guarantees ...................... Our current and future domestic restricted
subsidiaries will fully and unconditionally
guarantee the notes on an unsecured senior
subordinated basis except to the extent they
are not required to be guarantors under our
2001 senior secured credit facility and
subject to certain other exceptions. See
"Description of the Notes - Guarantees" and
"- Guarantees by Restricted Subsidiaries."
Ranking ......................... The notes will be unsecured senior
subordinated obligations of Vanguard and
will be subordinated to all our existing and
future senior indebtedness. The notes will
rank equally with all our other existing and
future senior subordinated indebtedness and
will rank senior to all our subordinated
indebtedness. On September 30, 2001, we had
$12.9 million of senior indebtedness and no
existing senior subordinated indebtedness
(other than the notes) or
5
subordinated indebtedness. The guarantees
will be unsecured senior subordinated
obligations of each subsidiary guaranteeing
the notes and will be subordinated to all
existing and future senior indebtedness of
the subsidiaries who are guarantors. The
term "senior indebtedness" is defined in the
"Description of the Notes --Definitions"
section of this prospectus. The notes will
also be effectively subordinated to the
obligations of any of our subsidiaries that
is not a guarantor, to the extent of such
subsidiary's assets, and to any of our and
our subsidiaries' secured obligations, to
the extent of the assets securing such
obligations. On September 30, 2001, our
subsidiaries who are guarantors and our
subsidiaries who are not guarantors had
$12.9 million of senior indebtedness and no
other indebtedness (other than the
guarantees of the notes issued by our
subsidiaries who are guarantors).
In addition to the $300 million of senior
subordinated indebtedness under the notes
offered hereby, we have a senior secured
credit facility, which we sometimes refer to
as the "2001 senior secured credit
facility", providing for aggregate revolving
loan commitments of $125 million, with no
loans outstanding as of September 30, 2001,
but approximately $5.6 million of which was
then used for outstanding letters of credit.
Restrictive Covenants ........... The indenture governing the notes contains
certain covenants that, among other things,
limit our ability and the ability of certain
of our subsidiaries to:
o incur additional indebtedness;
o create liens;
o sell assets;
o enter into certain transactions with
affiliates;
o make certain restricted payments such as
investments and dividends on or purchases
of our capital stock; and
o merge or consolidate with, or transfer all
or substantially all of our assets to,
another entity.
Use of Proceeds ................. We will not receive any proceeds from the
exchange of new notes for old notes.
6
OUR COMPANY
We are an owner and operator of acute care hospitals and other health care
facilities principally in urban and suburban markets. We acquired our first
hospital in 1998. As of November 15, 2001, we owned nine acute care hospitals
with a total of 1,838 beds and related outpatient service locations
complementary to the hospitals providing health care services to the Phoenix,
Arizona; Orange County, California; and metropolitan Chicago, Illinois markets.
The Company also owns a prepaid Medicaid managed health plan, Phoenix Health
Plan, that serves more than 55,000 members in Arizona. We selectively acquire
hospitals where we identify an opportunity to improve operating performance and
profitability and increase market share, either through a network of hospitals
and other health care facilities or a single well-positioned facility. We have
financed our acquisitions with equity capital provided by management and
various funds controlled by Morgan Stanley Capital Partners and with debt.
On a pro forma basis, reflecting our recent acquisitions and the offering
of the old notes, for the three months ended September 30, 2001 and the year
ended June 30, 2001, we had revenues of $207.3 million and $802.1 million,
respectively, and Adjusted EBITDA of $15.2 million and $54.4 million,
respectively. For the three months ended September 30, 2001 and the year ended
June 30, 2001, approximately 68.7% and 67.6% of our pro forma revenues were
derived from the Phoenix and Orange County markets, respectively, which the
U.S. Census Bureau projects to grow between 2000 and 2005 by 13.4% and 6.2%,
respectively, rates that exceed the projected national average of 4.5%.
Our Competitive Strengths
Diversified Portfolio of Assets with a Broad Range of Services. We own and
operate facilities in three separate geographic markets, which diversifies our
revenue base and reduces our exposure to any one market. Our hospitals offer
general acute care services, including intensive care and coronary care units,
radiology, orthopedic, oncology and outpatient services and selected tertiary
care services, such as open-heart surgery and level II neonatal intensive care.
Concentrated Local Market Positions in Attractive Markets. We have
acquired 8 of our 9 hospitals in the high-growth markets of Phoenix, Arizona
and Orange County, California, with 5 hospitals located in the Phoenix market
and 3 in the Orange County market. We believe that these local markets are
attractive because of their favorable demographics, competitive landscape,
payer mix and opportunities for expansion.
Proven Ability to Complete and Integrate Acquisitions. Over the last three
years, we have successfully completed the acquisition of eight hospitals, one
ambulatory surgery center, five diagnostic imaging centers and a prepaid
Medicaid managed health plan. We believe our success at completing acquisitions
is due in large part to our disciplined approach to making acquisitions.
Strong Management Team with Significant Equity Investment. Our senior
management has an average of more than 20 years of experience in the health
care industry at various organizations, including OrNda Healthcorp and HCA Inc.
Almost all of our senior management has been with our company since its
founding in 1997, and eight of our thirteen members of senior management have
worked together continuously managing health care companies for the last six
years. To date, our senior management has invested over $23 million in our
company and owns more than 18% of our outstanding shares of common stock. We
also rely on strong local management teams at each of our facilities.
Business Strategy
Our objective is to provide high-quality, cost-effective health care
services in the communities we serve. The key elements of our business strategy
include the following:
Grow Through Selective Acquisitions. We will continue to pursue
acquisitions which either expand our network and presence in our existing
markets or allow us to enter new urban and suburban markets. We believe that we
will continue to have substantial acquisition opportunities as other health
care providers choose to divest facilities
7
and as independent hospitals, particularly not-for-profit hospitals, seek to
capitalize on the benefits of becoming part of a larger hospital company.
Improve Operating Margins and Efficiency. We seek to position ourselves as
a cost-effective provider of health care services in each of our markets. As a
result, we will continue to implement initiatives at each of our facilities to
further improve the financial performance and operating efficiency of its
operations.
Increase Revenues Through Expansion of Services. We will continue to
expand our facilities and range of services based on our understanding of the
needs of the communities we serve. Our local management teams work closely with
patients, payers, physicians and medical staff to identify and prioritize the
health care needs of individual communities.
Recruit New Physicians and Maintain Strong Relationships with Existing
Physicians. We recruit both primary and specialty physicians who can provide
services that we believe are currently under served and in demand at our
facilities. We believe we successfully attract physicians as a result of, among
other factors, the quality of our facilities, the strength of our networks and
the additional services we offer them, including training programs, remote
access to clinical information and office space adjacent to our facilities.
Continue to Develop Favorable Managed Care Relationships. We plan to
increase the number of patients at our facilities and improve our profitability
by negotiating more favorable terms with managed care plans and by entering
into contracts with additional managed care plans. We believe that we are
attractive to managed care plans because of the geographic and demographic
coverage of our facilities in their respective markets, the quality and breadth
of our services and the expertise of our physicians. Further, we believe that
as we increase our presence and competitive position in our markets,
particularly as we develop our networks of hospitals, we will be increasingly
attractive to managed care plans and will be even better positioned to
negotiate more favorable managed care contracts.
Recent Developments
On November 1, 2001, we acquired the assets of Paradise Valley Hospital, a
162-bed acute care hospital located in Phoenix, Arizona. We funded the
acquisition with remaining cash proceeds from the July 30, 2001 issuance of the
old notes. The results of operations of Paradise Valley Hospital are not
included in any of the financial statements included herein. We do not believe
that our purchase of this hospital will have a material impact on our results
of operations or financial position.
-----------------------
Our principal executive offices are located at 20 Burton Hills Boulevard,
Suite 100, Nashville, Tennessee 37215 and our telephone number at that address
is (615) 665-6000. Our corporate website address is www.vanguardhealth.com.
Information contained on our website does not constitute a part of this
prospectus.
8
SUMMARY HISTORICAL AND PRO FORMA FINANCIAL AND OPERATING DATA
The following table sets forth, for the periods and as of the dates
indicated, summary historical and pro forma condensed consolidated financial
and operating data of Vanguard. The summary historical financial and operating
data as of and for each of the years ended June 30, 1998, 1999, 2000 and 2001
were derived from our audited consolidated financial statements. The summary
historical financial and operating data as of and for the three months ended
September 30, 2000 and 2001 were derived from our unaudited consolidated
financial statements. These unaudited consolidated financial statements include
all adjustments necessary (consisting of normal recurring adjustments) for a
fair presentation of the financial position and the results of operations for
these periods. Operating results for the three months ended September 30, 2001
are not necessarily indicative of the results that may be expected for the full
fiscal year ending June 30, 2002.
The unaudited pro forma summary financial and operating data for the
fiscal year ended June 30, 2001, give effect to the acquisitions of (i) PMH
Health Services Network, which includes Phoenix Memorial Hospital and Phoenix
Health Plan, purchased May 1, 2001, and (ii) a non-significant acquisition
completed during the period, and give effect to the offering of the old notes
and the application of the proceeds therefrom. The unaudited pro forma summary
financial and operating data for the three months ended September 30, 2001 give
effect to the offering of the old notes and the initial application of the
proceeds therefrom. The pro forma data is not necessarily indicative of future
results.
9
The table should be read in conjunction with the Consolidated Financial
Statements and related notes included elsewhere in this prospectus and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Three Months
Ended Pro Pro
Year Ended June 30, September 30, Forma Forma
------------------------------------- ---------------- --------- ----------
Three
Year Months
Historical Historical Ended Ended
------------------------------------- ---------------- June 30, September 30,
1998 1999 2000 2001 2000 2001 2001 2001
------ ------ ------ ------ ------ ------ -------- -------------
(dollars in millions)
Summary of Operations Data:
Revenues...................... $ 7.0 $91.5 $304.7 $667.8 $158.6 $207.3 $802.1 $ 207.3
Costs and expenses:
Operating expenses............ 7.3 67.3 251.1 559.6 131.1 175.8 681.9 175.8
Provision for doubtful
accounts.................... 1.3 17.3 33.1 56.8 16.4 16.3 65.8 16.3
Depreciation and amortization 0.5 3.9 11.8 23.8 6.1 7.1 28.2 7.1
Interest, net................. 0.2 4.2 8.8 16.6 4.8 6.0 30.0(j) 7.3(j)
Other non-operating expenses 0.4 5.2 0.1 0.3 -- (0.4) 1.3 (0.4)
------ ------ ------ ------ ------ ------ ------ -------
Income (loss) before income
taxes and extraordinary
item....................... (2.7) (6.4) (0.2) 10.7 0.2 2.5 (5.1) 1.2
Net income (loss)
attributable to common
shareholders............... $ (2.8) $ (6.4) $ (2.1) $ 8.5 $ (0.2) $ (4.6) $ (6.8) $ (5.5)
Balance Sheet Data (End of
Period):
Assets........................ $ 88.3 $ 98.1 $549.9 $640.4 $547.7 $790.9 $783.8 $ 790.9
Long-term debt, including
current portion............ 47.5 56.2 153.3 163.4 154.7 312.9 314.3 312.9
Working capital............... 5.0 11.9 39.5 18.0 39.8 159.5 160.2 159.5
Other Data:
Adjusted EBITDA(a)............ $ (1.6) $ 6.9 $ 20.5 $ 51.4 $ 11.1 $ 15.2 $ 54.4 $ 15.2
Net cash (used in) provided by
operating activities....... (2.9) (9.7) 24.5 6.7 (5.4) 11.2
Net cash used in investing
activities................. (71.9) (5.1) (335.9) (38.1) (9.1) (8.6)
Net cash provided by (used in)
financing activities....... 76.8 12.7 327.8 26.7 (1.2) 134.9
Capital expenditures.......... 0.8 1.9 14.3 26.6 7.8 4.6
Number of hospitals at end of
period..................... 1 1 7 8 7 8 8 8
Number of licensed beds at end
of period(b)............... 239 239 1,481 1,676 1,481 1,676 1,676 1,676
Weighted average licensed
beds(c).................... 20 239 771 1,514 1,481 1,676 1,676 1,676
Discharges(d)................. 1,191 12,447 31,864 65,237 15,735 17,352 70,942 17,352
Adjusted discharges-
hospitals(e).................. 1,760 19,811 50,661 104,188 24,411 25,920 112,143 25,920
Average length of stay
(days)(f).................... 3.1 3.2 4.1 4.1 4.0 4.0 4.0 4.0
Average daily census(g)....... 120.0 112.0 701.4 728.8 686.0 745.0 775.8 686.0
Occupancy rate(h)............. 50.2% 46.9% 46.1% 42.5% 46.3% 44.4% 46.3% 44.4%
Ratio of earnings to fixed
charges(i)................. -- -- -- 1.5x 1.0x 1.3x -- 1.1x
Pro forma cash interest
expense, net(j)............ $ 28.7 $ 7.1
Adjusted EBITDA to pro forma
cash interest expense,
net(a)..................... 1.9x 2.1x
10
- -------------------
(a) Adjusted EBITDA represents EBITDA, or net income before interest expense
(net of interest income), income taxes, depreciation, amortization, and is
further adjusted to add back non-cash stock compensation, certain other
non-operating expenses and restructuring and impairment charges. This
definition of Adjusted EBITDA is derived from and consistent with the
Indenture for the new notes. EBITDA is commonly used as an analytical
indicator within the health care industry and serves as a measure of
leverage capacity and debt service ability. We believe the adjustments
made to EBITDA in calculating Adjusted EBITDA are appropriate to reflect
our calculations of the debt leverage and interest coverage ratios under
the Indenture and the 2001 senior secured credit facility. Adjusted EBITDA
should not be considered as a measure of financial performance under
generally accepted accounting principles, and the items excluded in
determining Adjusted EBITDA are significant components in understanding
and assessing financial performance. Because neither EBITDA nor a
calculation of Adjusted EBITDA is a measurement determined in accordance
with generally accepted accounting principles, it is susceptible to
varying calculations, and as a result our calculation of Adjusted EBITDA
as presented may not be comparable to EBITDA or other similarly titled
measures used by other companies.
Three Months
Ended Pro
Year Ended June 30, September 30, Pro Forma
------------------------------------- ---------------- Forma Three
Year Months
Historical Historical Ended Ended
------------------------------------- ---------------- June 30, September 30,
1998 1999 2000 2001 2000 2001 2001 2001
------ ------ ------ ------ ------ ------ -------- -------------
(dollars in millions)
Calculation of Adjusted EBITDA:
Income (loss) before income
taxes and extraordinary
item....................... $ (2.7) $ (6.4) $ (0.2) $ 10.7 $ 0.2 $ 2.5 $ (5.1) $ 1.2
Depreciation and amortization. 0.5 3.9 11.8 23.8 6.1 7.1 28.2 7.1
Interest, net................. 0.2 4.2 8.8 16.6 4.8 6.0 30.0 7.3
Non-cash stock compensation... 0.5 5.0 - - - - - -
Equity method loss(income).... (0.1) 0.2 0.1 (0.2) - (0.1) (0.2) (0.1)
Loss (gain) on sale of
assets...................... - - - 0.5 - (0.3) 0.5 (0.3)
Other non-operating investment
losses..................... - - - - - - 1.0 -
------ ------ ------ ------ ------ ------ ------ ------
Adjusted EBITDA(a) $ (1.6) $ 6.9 $ 20.5 $ 51.4 $ 11.1 $ 15.2 $ 54.4 $ 15.2
====== ====== ====== ====== ====== ====== ====== ======
- -------------------
(b) Licensed beds are those beds for which a facility has been granted
approval to operate from the applicable state licensing agency.
(c) Represents the average number of licensed beds, weighted based on periods
owned.
(d) Represents the total number of patients discharged (in the facility for a
period in excess of 23 hours) from our hospitals and is used by management
and certain investors as a general measure of inpatient volume.
(e) Adjusted discharges-hospitals is used by management and certain investors
as a general measure of combined inpatient and outpatient volume. Adjusted
discharges-hospitals are computed by multiplying discharges by the sum of
gross inpatient and outpatient hospital revenues and then dividing the
result by gross inpatient revenues. This computation "equates" outpatient
revenues to the measure used to measure inpatient volume resulting in a
general measure of combined inpatient and outpatient volume.
(f) Average length of stay represents the average number of days admitted
patients stay in our hospitals.
(g) Represents the average number of patients in the hospitals each day during
our ownership.
(h) Represents the percentage of hospital licensed beds occupied by patients.
Both average daily census and occupancy rate provide measures of the
utilization of inpatient rooms.
(i) The ratio of earnings to fixed charges was computed by dividing (i) income
from continuing operations before fixed charges, equity method income
(loss) of affiliates, income taxes and extraordinary items by (ii) fixed
charges, which consist of interest charges and the portion of rent expense
which is deemed to be equivalent to interest expense. Vanguard's earnings
were insufficient to cover fixed charges for the years ended June 30,
11
1998, 1999 and 2000 by $2.6 million, $6.7 million and $0.1 million,
respectively. Earnings were insufficient to cover fixed charges for the
pro forma year ended June 30, 2001 by $5.3 million.
(j) Excludes amortization of deferred issuance costs and is net of historical
interest income earned; pro forma adjustments are not made for interest
income that might have been earned on increased cash balances.
12
RISK FACTORS
You should carefully consider the following factors in addition to the
other information in this Registration Statement before investing in the notes.
Risks Related to Our Debt
Our high level of debt may limit our ability to successfully operate our
business.
We have a substantial amount of debt. On September 30, 2001, we had $312.9
million of outstanding debt, excluding letters of credit and guarantees,
including $12.9 million of senior indebtedness. Of such total debt, $300
million would have consisted of the notes, and $12.9 million would have
consisted of capitalized lease obligations and other debt, resulting in a pro
forma percentage of debt-to-total capitalization of 49.1%. For the year ended
June 30, 2001, on a pro forma basis, earnings were insufficient to cover fixed
charges by $5.3 million. For the three months ended September 30, 2001, on a
pro forma basis, the ratio of earnings to fixed charges was 1.16. Subject to
the restrictions in the indenture and the 2001 senior secured credit facility,
we and our subsidiaries may be able to incur substantial additional
indebtedness in the future. The 2001 senior secured credit facility permits
revolving borrowings and letters of credit of up to $125 million in the
aggregate outstanding at any one time, all of which would be senior to the
notes and the subsidiary guarantees, and we may borrow substantial additional
indebtedness in the future, some or all of which would also be senior to the
notes and the subsidiary guarantees.
Our substantial indebtedness could have important consequences to you. For
example, it could:
o make it more difficult for us to satisfy our obligations with respect
to the notes;
o increase our vulnerability to general adverse economic, market and
industry conditions and limit our flexibility in planning for, or
reacting to, these conditions;
o increase our vulnerability to interest rate fluctuations because much
of our debt may be at variable interest rates;
o limit our ability to obtain additional financing to fund future
acquisitions and working capital, capital expenditures or other
needs; and
o limit our ability to compete with others who are not as
highly-leveraged.
Our ability to make scheduled payments of principal and interest or to
satisfy our other debt obligations, to refinance our indebtedness, including
the notes, or to fund capital expenditures will depend on our future
performance. Prevailing economic conditions and financial, business and other
factors, many of which are beyond our control, will also affect our ability to
meet these needs. We may not be able to generate sufficient cash flow from
operations or realize anticipated revenue growth or operating improvements, or
obtain future borrowings in an amount sufficient to enable us to pay our debt,
including the notes, or to fund our other liquidity needs. We may need to
refinance all or a portion of our debt, including the notes, on or before
maturity. We may not be able to refinance any of our debt, including our 2001
senior secured credit facility and the notes, when needed on commercially
reasonable terms or at all.
Operating and financial restrictions in our debt agreements will limit our
operational and financial flexibility.
Restrictions and covenants in our existing debt agreements, as well as the
2001 senior secured credit facility and the indenture, and any future financing
agreements, may adversely affect our ability to finance future operations or
capital needs or to engage in other business activities. Specifically, our debt
agreements restrict our ability to:
o declare dividends or redeem or repurchase capital stock;
13
o prepay, redeem or repurchase debt, including the notes;
o incur liens;
o make loans and investments;
o incur additional indebtedness;
o amend or otherwise change debt and other material agreements;
o make capital expenditures;
o engage in mergers, acquisitions and asset sales;
o enter into transactions with affiliates; and
o change our primary business.
Although it is difficult for us to predict future liquidity requirements
with certainty, we believe that the net proceeds from the offering of the old
notes, together with our current cash and cash equivalents, will be sufficient
to meet our anticipated cash needs for working capital and capital expenditures
for at least the next 12 months.
Our acquisition program requires substantial capital resources, and the
operations of our existing hospitals and newly acquired hospitals require
ongoing capital expenditures for renovation, expansion and the addition of
medical equipment and technology. More specifically, we are currently, and may
in the future be, contractually obligated to make significant capital
expenditures relating to the facilities we acquire. Our debt agreements may
restrict our ability to incur additional indebtedness to fund these
expenditures.
Also, our 2001 senior secured credit facility requires us to comply with
the financial ratios included in that facility. If we fail to comply with the
requirements of the 2001 senior secured credit facility, the lenders can
declare the entire amount owed thereunder immediately due and payable and
prohibit us from making payments of interest and principal on the notes until
the default is cured or all such debt is paid or otherwise satisfied in full.
If we are unable to repay such borrowings, such lenders could proceed against
the collateral securing the 2001 senior secured credit facility.
A breach of any of the restrictions or covenants in our debt agreements
could cause a default under our 2001 senior secured credit facility, other debt
or the notes. A significant portion of our indebtedness then may become
immediately due and payable. We are not certain whether we would have, or be
able to obtain, sufficient funds to make these accelerated payments, including
payments on the notes. If any senior debt is accelerated, our assets may not be
sufficient to repay in full such indebtedness and our other indebtedness,
including the notes, in which event the interests of the senior debt lenders
may conflict with the interests of the holders of the notes.
Risks Related to this Offering
Subordination: Your rights to receive payment on the notes will be junior
to our senior debt.
The obligations under the notes will be subordinated to substantially all
of our existing and future senior debt, in particular our 2001 senior secured
credit facility, meaning that, in bankruptcy or insolvency, you will receive
payment on the notes only after the senior debt is paid in full. Any subsidiary
guarantee will be subordinated in right of payment to all senior indebtedness
of the relevant guarantor subsidiary including its guarantee of the 2001 senior
secured credit facility. The notes will also be effectively subordinated to all
of our secured debt to the extent of the assets securing such secured
indebtedness, and to the obligations of any subsidiary that is not a guarantor
to the extent of its assets. As of September 30, 2001, we had $12.9 million of
senior debt, excluding letters of credit and guarantees, with an additional
$125 million of revolving loans available under the 2001 senior secured credit
facility.
14
Our indenture allows us to incur additional indebtedness, which may be senior
indebtedness, based on, among other things, our ability to meet an interest
coverage ratio. See "Description of the Notes - Covenants - Limitation on
Indebtedness" for a description of the additional indebtedness we are allowed
to incur under the indenture.
Our ability to incur additional indebtedness is also currently limited by
the terms of our 2001 senior secured credit facility, even if such debt would
be permitted under our indenture. However, the limitations on indebtedness in
our 2001 senior secured credit facility are subject to a number of exceptions
which permit us to incur debt including, among others, purchase money
obligations and capitalized leases and, with the lending commitment of one or
more lenders under that facility or new lenders and subject to financial tests,
up to $250 million of additional term loans, all of which would be senior
indebtedness.
In a bankruptcy, liquidation, reorganization or dissolution relating to
us, our assets will be available to pay the notes and the subsidiary guarantees
only after all payments have been made on our senior indebtedness. In addition,
all payments on the notes and the subsidiary guarantees will be blocked in the
event of a payment default on our senior debt and may be blocked for up to 179
of 360 consecutive days in the event of certain non-payment defaults on our
senior debt. Holders of the notes will participate in the assets remaining
after we and our guarantor subsidiaries have paid all of the debt senior to the
notes with all other holders of our and our guarantor subsidiaries'
indebtedness which is deemed to be of the same class as the notes. However,
because the indenture requires that amounts otherwise payable to holders of the
notes in a bankruptcy or similar proceeding be paid to holders of debt senior
to the notes under the bankruptcy laws instead, holders of the notes may
receive less, ratably, than holders of trade payables in any such proceeding,
even if such trade payables are not senior debt. In any of these cases, we and
our guarantor subsidiaries may not have sufficient funds to pay all of our
creditors, and holders of notes may receive less, ratably, than the holders of
other debt.
We conduct most of our operations through, and depend on funds from, our
subsidiaries, and funds we receive from our subsidiaries may be insufficient to
make payments on the notes.
We are a holding company with no material assets except for the stock of
our direct subsidiaries. As a holding company, we conduct substantially all of
our operations through our direct and indirect subsidiaries. Moreover, we are
dependent on dividends or other intercompany transfers of funds from our
subsidiaries to meet our debt service and other obligations, including payment
of principal and interest on the notes. The ability of our subsidiaries to pay
dividends or make other payments or advances to us will depend on their
operating results and will be subject to applicable laws and restrictions
contained in agreements governing the debt of such subsidiaries. Initially,
certain of our subsidiaries were not required to provide a guarantee of the
notes. In the future, the lenders under our 2001 senior secured credit facility
may agree that other subsidiaries need not provide guarantees thereunder, in
which case such subsidiaries will not be required to provide guarantees of the
notes. Thus, the assets of these subsidiaries would be available for payment on
the notes and other liabilities of Vanguard (or of any subsidiary guarantor
holding such non-guarantor subsidiary's stock) only after satisfaction of all
of such non-guarantor subsidiary's liabilities.
We may be unable to raise the funds necessary to repurchase the notes upon
a change of control.
In the event of a change of control, we are required to make an offer for
cash to repurchase the notes at 101% of the principal amount of the notes, plus
accrued and unpaid interest, if any, thereon to the repurchase date. However,
our 2001 senior secured credit facility requires that we repay all indebtedness
thereunder or obtain the consent of the lenders prior to such repurchase of
outstanding notes, and any exercise by the holders of the notes of their right
to require us to repurchase the notes may cause an event of default under the
2001 senior secured credit facility. If a change of control occurs at a time
when we are required to pay outstanding amounts under the 2001 senior secured
credit facility or obtain such consents, and if we do not refinance such
borrowings or obtain such consents, we will remain prohibited from repurchasing
the notes, which would constitute an event of default under the indenture which
would, in turn, constitute an event of default under our 2001 senior secured
credit facility and under our other senior indebtedness. If we fail to comply
with the requirements of the 2001 senior secured credit facility, the lenders
can declare the entire amount owed thereunder immediately due and payable and
prohibit us from making payments of interest and principal on the notes until
all such debt is paid or otherwise satisfied in full, and can also enforce
their security interests against our assets. On September 30, 2001, we had
$12.9 million of senior indebtedness, in
15
addition to the $5.6 million of undrawn letters of credit under the 2001 senior
secured credit facility. In addition, we do not now, and would not expect to,
have the financial resources sufficient to repurchase all of the notes if all
our obligations to purchase or repay indebtedness occurred simultaneously upon
a change of control. See "Description of the Notes - Repurchase of Notes Upon a
Change of Control" for a more detailed description of the change of control
provision.
In the event that our subsidiary guarantees are deemed to be fraudulent
conveyances, your claim against a guarantor could be lost or limited.
Certain of our current and future domestic restricted subsidiaries will
guarantee the notes. The issuance of these guarantees could be subject to
review under applicable fraudulent transfer or conveyance laws in a bankruptcy
or other similar proceeding. Under these laws, the issuance of a guarantee will
generally be a fraudulent conveyance if either (1) the guarantor issued the
guarantee with the intent of hindering, delaying or defrauding its creditors or
(2) the guarantor received less than reasonably equivalent value or fair
consideration in return for the guarantee and any of the following is true:
o the guarantor was insolvent or became insolvent when it issued the
guarantee;
o the guarantor was left with an unreasonably small amount of capital
after issuing the guarantee; or
o the guarantor intended to incur, or believed that it would incur,
debts beyond its ability to pay as they matured.
Since our subsidiary guarantors issued the guarantees for our benefit and
only indirectly for their own benefit, the guarantees could be subject to a
claim that they were given for less than reasonably equivalent value or fair
consideration.
Although the definition of "insolvency" differs among jurisdictions, in
general, the guarantor would be considered insolvent when it issued the
guarantee if:
o its liabilities exceeded the fair value of its assets; or
o the present market value of its assets is less than the amount it
would need to pay its total existing debts and liabilities as they
mature (including those contingent liabilities which are likely to
become certain).
We cannot predict which standard a court would apply when determining
whether a guarantor was insolvent when the notes were issued or how the court
would decide this issue regardless of the standard. Even if a court determined
that the guarantor was not insolvent when the notes were issued, you should be
aware that payments under the guarantees may constitute fraudulent transfers on
other grounds.
In addition, the liability of each guarantor under its guarantee is
limited to the amount that will not constitute a fraudulent conveyance or
improper corporate distribution under applicable laws. We cannot predict which
standard a court would apply when determining the maximum liability of each
guarantor.
To the extent that the note guarantee of any guarantor is voided as a
fraudulent conveyance or otherwise held to be unenforceable, your claim against
that guarantor could be lost or limited.
Risks Related to Our Business
We may be unable to achieve our acquisition and growth strategy and we may
have difficulty acquiring not-for-profit hospitals due to regulatory scrutiny.
An important element of our business strategy is expansion by acquiring
hospitals in our existing and in new urban and suburban markets and by entering
into partnerships or affiliations with other health care service providers.
16
The competition to acquire hospitals is significant, including competition from
health care companies with greater financial resources than us, and we may not
be able to make suitable acquisitions on favorable terms, and we may have
difficulty obtaining financing, if necessary, for such acquisitions on
satisfactory terms. In addition, we may not be able to effectively integrate
any acquired facilities with our operations. Even if we continue to acquire
additional facilities and/or enter into partnerships or affiliations with other
health care service providers, Federal and state regulatory agencies may
constrain our ability to grow.
Additionally, many states, including some where we have hospitals and
others where we may in the future attempt to acquire hospitals, have adopted
legislation regarding the sale or other disposition of hospitals operated by
not-for-profit entities. In other states that do not have specific legislation,
the attorneys general have demonstrated an interest in these transactions under
their general obligations to protect charitable assets from waste. These
legislative and administrative efforts focus primarily on the appropriate
valuation of the assets divested and the use of the proceeds of the sale by the
not-for-profit seller. These review and approval processes can add time to the
consummation of an acquisition of a not-for-profit hospital, and future actions
on the state level could seriously delay or even prevent future acquisitions of
not-for-profit hospitals. Furthermore, as a condition to approving an
acquisition, the attorney general of the state in which the hospital is located
may require us to maintain specific services, such as emergency departments, or
to continue to provide specific levels of charity care, which may affect our
decision to acquire or the terms of an acquisition of these hospitals.
Difficulties with integrating our acquisitions may disrupt our ongoing
operations.
We may not be able to profitably or effectively integrate the operations
of, or otherwise achieve the intended benefits from, any acquisitions we make
or partnerships or affiliations we may form. The process of integrating
acquired hospitals may require a disproportionate amount of management's time
and attention, potentially distracting management from its day-to-day
responsibilities. This process may be even more difficult in the case of
hospitals we may acquire out of bankruptcy or otherwise in financial distress.
In addition, poor integration of acquired facilities could cause interruptions
to our business activities, including those of the acquired facilities. As a
result, we may incur significant costs related to acquiring or integrating
these facilities and may not realize the anticipated benefits.
Moreover, acquired businesses may have unknown or contingent liabilities,
including liabilities for failure to comply with health care laws and
regulations. Although our policy is to conform the practices of acquired
facilities to our standards, and generally to obtain indemnification from
sellers covering these matters, we could in the future become liable for past
activities of acquired businesses and such liabilities could be material.
If we are unable to enter into favorable contracts with managed care plans,
our operating revenues may be reduced.
Our ability to negotiate favorable contracts with health maintenance
organizations, preferred provider organizations and other managed care plans
significantly affects the revenue and operating results of our hospitals.
Revenues derived from health maintenance organizations, preferred provider
organizations and other managed care plans accounted for approximately 65% and
61% of our patient revenues for the year ended June 30, 2001 and the three
months ended September 30, 2001, respectively. Managed care organizations
offering prepaid and discounted medical services packages represent an
increasing portion of our admissions, a general trend in the industry which has
limited hospital revenue growth nationwide. In addition, private payers are
increasingly attempting to control health care costs through direct contracting
with hospitals to provide services on a discounted basis, increased utilization
review, including the use of hospitalists, and greater enrollment in managed
care programs such as health maintenance organizations and preferred provider
organizations. Our future success will depend, in part, on our ability to renew
existing managed care contracts and enter into new managed care contracts on
terms favorable to us. Other health care companies, including some with greater
financial resources, greater geographic coverage or a wider range of services,
may compete with us for these opportunities. If we are unable to contain costs
through increased operational efficiencies or to obtain higher reimbursements
and payments from managed care or government payers, our results of operations
and cash flow will be adversely affected. As of September 30, 2001, West
Anaheim Medical Center in Anaheim, California receives payments under a long
term "take-or-pay" contract with a managed care payer which generated
approximately $22.9 million, or 3.4%, of our revenues for the year
17
ended June 30, 2001 and $5.5 million, or 2.7%, of our revenues for the three
months ended September 30, 2001. Under this "take or pay" arrangement the payer
has agreed to purchase in each contractual year a fixed amount of patient days
at a fixed rate per day primarily from West Anaheim Medical Center, except that
a portion of such patient days can also be purchased, at the option of the
payer, at our Huntington Beach Hospital in Huntington Beach, California or at
our two ambulatory surgery centers in Orange County, California. The rate is
adjusted annually to reflect any increases in the consumer price index and may
also be adjusted pursuant to a contractual formula if the level of care for the
patients which the payer directs to our facilities increases. Under this
contract, the payer is obligated to purchase from our facilities patient days
which will cost the payer an aggregate of $22,932,000 for the contract year
ending March 31, 2002. If annual patient days costing less than $22,932,000 are
purchased during the contract year ended March 31, 2002, then the payer must
reimburse the West Anaheim Medical Center for the difference between
$22,932,000 and the total amount of patient days purchased even though no
additional patient days are provided. The managed care payer of this contract
has given us notice that it intends to terminate this contract, effective May
18, 2005. We do not know at this time whether we will be able to extend or
renew this contract beyond May 18, 2005, even if we agreed to reduce our health
care charges to such payer, or replace these revenues with other new business.
If we are unable to renew or replace this contract, our earnings will be
adversely impacted.
Changes in governmental programs may significantly reduce our revenues.
Government health care programs, principally Medicare and Medicaid,
accounted for approximately 20% and 28% of our revenues for the year ended June
30, 2001 and the three months ended September 30, 2001, respectively. Recent
legislative changes, including those enacted as part of the Balanced Budget Act
of 1997, have resulted in limitations on and, in some cases, reductions in
levels of, payments to health care providers for certain services under many of
these government programs. Many changes imposed by the Balanced Budget Act of
1997 are being phased in over a period of years. Certain rate reductions
resulting from the Balanced Budget Act of 1997 are being mitigated by the
Balanced Budget Refinement Act of 1999 and will be further mitigated by the
Benefits Improvement Protection Act of 2000. Nonetheless, the Balanced Budget
Act of 1997 significantly reduced the level of payment under the Medicare and
Medicaid programs. These changes have resulted, and we expect will continue to
result, in significant reductions in payments for our inpatient and outpatient
services. Final regulations implementing Medicare's new prospective payment
system for outpatient hospital services were also promulgated recently. To
date, our cash flows have been somewhat negatively affected by the delays in
processing our claims under this new system. In addition, a number of states
have adopted or are considering legislation designed to reduce their Medicaid
expenditures and to provide universal coverage and additional care, including
enrolling Medicaid recipients in managed care programs and imposing additional
taxes on hospitals to help finance or expand these states' Medicaid systems. We
believe that hospital operating margins across the industry, including ours,
have been, and may continue to be, under continuing pressure because of limited
pricing flexibility and growth in operating expenses in excess of the increase
in prospective payments under the Medicare program.
Competition from other hospitals or health care providers may reduce our
patient volume and profitability.
The hospital industry is highly competitive. Our hospitals face
competition for patients from other hospitals in our markets, large tertiary
care centers and outpatient service providers that provide similar services to
those provided by our hospitals.
Our 5 hospitals with 920 licensed beds licensed in the Phoenix
metropolitan area compete with over 20 other hospitals and numerous outpatient
providers in this market. Our largest competitor in this market is the
not-for-profit Banner Health System which owns 6 hospitals with 2,030 licensed
beds in the Phoenix metropolitan area.
Our 3 hospitals with 491 licensed beds in Orange County, California
compete with over 95 other hospitals and numerous outpatient providers in the
Los Angeles/Orange County metropolitan area. Our largest competitors in this
market are the investor-owned Tenet Healthcare Corporation which owns 28
hospitals with 5,550 licensed beds and the not-for-profit Memorial Health
Services which owns 5 hospitals with 1,615 licensed beds in the Los
Angeles/Orange County metropolitan area.
18
Our MacNeal Hospital with 427 licensed beds in Berwyn, Illinois competes
with over 60 other hospitals and numerous outpatient providers in the Chicago
metropolitan area. Our largest competitors in this market are the not-
for-profit Advocate Health Care which owns 10 hospitals with 3,271 licensed
beds and the not-for-profit Resurrection Health Care which owns 8 hospitals
with 2,596 licensed beds in the Chicago metropolitan area.
Some of the hospitals that compete with ours are owned by governmental
agencies or not-for-profit corporations supported by endowments and charitable
contributions and can finance capital expenditures and operations on a
tax-exempt basis. Some of our competitors are larger and more established, have
greater geographic coverage, offer a wider range of services (including
extensive medical research and medical education programs) or have more capital
or other resources than we do. If our competitors are able to finance capital
improvements, recruit physicians, expand services or obtain favorable managed
care contracts at their facilities, we may experience a decline in patient
volume.
Our prepaid Medicaid managed health care plan also faces competition
within the Arizona market which it serves. As in the case of our hospitals,
some of our competitors in this market are owned by governmental agencies or
not-for-profit corporations with greater financial resources than us. Other
competitors have larger membership bases, are more established and have greater
geographic coverage areas which give them an advantage in competing for a
limited pool of eligible health plan members. Moreover, because our leverage in
negotiating with Arizona's state Medicaid program for higher reimbursement fees
depends, to an extent, upon the number of enrollees in our health plan eligible
for the program, a failure to attract future enrollees may negatively impact
our ability to maintain our profitability in this market.
Our performance depends on our ability to recruit and retain quality
physicians.
The success of our hospitals depends in part on the following factors:
o the number and quality of the physicians on the medical staffs of our
hospitals;
o the admitting practices of those physicians; and
o the maintenance of good relations with those physicians.
Most physicians at our hospitals also have admitting privileges at other
hospitals. If we are unable to provide adequate support personnel or
technologically advanced equipment and facilities that meet the needs of
physicians, they may be discouraged from referring patients to our facilities,
which could adversely affect our profitability.
Our hospitals face competition for staffing, which may increase our labor
costs and reduce profitability.
We compete with other health care providers in recruiting and retaining
qualified management and staff personnel responsible for the day-to-day
operations of each of our hospitals, including nurses and other non-physician
health care professionals. In the health care industry generally, including in
our markets, the scarcity of nurses and other medical support personnel has
become a significant operating issue. This shortage may require us to increase
wages and benefits to recruit and retain nurses and other medical support
personnel or to hire more expensive temporary personnel. We have on several
occasions in the past, and expect to in the future, raised wages for our nurses
and other medical support personnel. We also depend on the available labor pool
of semi-skilled and unskilled employees in each of the markets in which we
operate. If our labor costs increase, we may not be able to raise rates to
offset these increased costs. Because approximately 90% of our revenues consist
of fixed, prospective payments, based on our results of operations for the year
ended June 30, 2001, our ability to pass along increased labor costs is
constrained. Our failure to recruit and retain qualified management, nurses and
other medical support personnel, or to control our labor costs, could have a
material adverse effect on our profitability.
19
We conduct business in a heavily regulated industry, and changes in
regulations or violations of regulations may result in increased costs or
sanctions that could reduce our revenues and profitability.
The health care industry is subject to extensive Federal, state and local
laws and regulations relating to licensing, the conduct of operations, the
ownership of facilities, the addition of facilities and services,
confidentiality, maintenance and security issues associated with medical
records, billing for services; and prices for services. Although we believe
that our facilities are in substantial compliance with such laws and
regulations, if a determination were made that we were in material violation of
such laws or regulations, our operations and financial results could be
materially adversely affected.
In many instances, the industry does not have the benefit of significant
regulatory or judicial interpretation of these laws and regulations,
particularly in the case of Medicare and Medicaid antifraud and abuse
amendments, codified under section 1128B(b) of the Social Security Act and
known as the "Anti-Kickback Statute." This law prohibits providers and others
from soliciting, receiving, offering or paying, directly or indirectly, any
remuneration with the intent to generate referrals of orders for services or
items reimbursable under Medicare, Medicaid and other Federal health care
programs. As authorized by Congress, the United States Department of Health and
Human Services, has issued regulations which describe some of the conduct and
business relationships immune from prosecution under the Anti-Kickback Statute.
The fact that a given business arrangement does not fall within one of these
"safe harbor" provisions does not render the arrangement illegal, but business
arrangements of health care service providers that fail to satisfy the
applicable safe harbor criteria risk increased scrutiny by enforcement
authorities.
Some of the financial arrangements which we maintain with our physicians
do not meet the requirements for safe harbor protection. The regulatory
authorities that enforce the Anti-Kickback Statute may in the future determine
that one or more of these arrangements violate the Anti-Kickback Statute or
other Federal or state laws. A determination that we have violated the
Anti-Kickback Statute or other Federal laws could subject us to liability under
the Social Security Act, including criminal and civil penalties, as well as
exclusion from participation in government programs such as Medicare and
Medicaid or other Federal health care programs.
In addition, the portion of the Social Security Act commonly known as the
"Stark Law" prohibits physicians from referring Medicare and Medicaid patients
to providers of designated health services if the physician or a member of his
or her immediate family has an ownership interest in or compensation
arrangement with that provider. There are exceptions to the Stark Law for
physicians maintaining an ownership interest in an entire hospital, employment
agreements, leases, physician recruitment and certain other physician
arrangements.
Other federal regulation we are subject to include laws and regulations
regarding self-interested referrals, administration of claims and privacy of
information.
All of the states in which we operate have adopted or have considered
adopting similar anti-kickback and physician self-referral legislation, some of
which extends beyond the scope of the Federal law to prohibit the payment or
receipt of remuneration for the referral of patients and physician
self-referrals, irrespective of the source of the payment for the care. Little
precedent exists for the interpretation or enforcement of these laws. Both
Federal and state government agencies have announced heightened and coordinated
civil and criminal enforcement efforts.
Government officials responsible for enforcing health care laws could
assert that we, or any of the transactions in which we are involved, are in
violation of any of these laws. It is also possible that the courts could
ultimately interpret these laws in a manner that is different from our
interpretations. A determination that we have violated these laws, or the
public announcement that we are being investigated for possible violations of
these laws, could have a material adverse effect on our business, financial
condition, results of operations or prospects, and our business reputation
could suffer significantly.
Some states require prior approval for the purchase of major medical
equipment or the purchase, construction, expansion, sale or closure of health
care facilities, based upon a determination of need for additional or expanded
health care facilities or services. The governmental determinations, embodied
in Certificates of Need, may be
20
required for capital expenditures exceeding a prescribed amount, changes in bed
capacity or services and certain other matters. One state in which we currently
own a hospital, Illinois, has Certificate of Need laws affecting acute care
hospital services. We cannot predict whether we will be able to obtain required
Certificates of Need in the future. Any failure to obtain any required
Certificates of Need may impair our ability to operate profitably.
The laws, rules and regulations described above are complex and subject to
interpretation. In the event of a determination that we are in violation of any
of these laws, rules or regulations, or if further changes in the regulatory
framework occur, our results of operations could be significantly harmed. For a
more detailed discussion of the laws, rules and regulations described above,
see "Government Regulation and Other Factors."
Providers in the health care industry have been the subject of Federal and
state investigations, and we may become subject to investigations in the
future.
Both Federal and state government agencies have heightened and coordinated
civil and criminal enforcement efforts as part of numerous ongoing
investigations of hospital companies, as well as their executives and managers.
These investigations relate to a wide variety of topics, including:
o referral, cost reporting and billing practices;
o laboratory and home health care services; and
o physician ownership and joint ventures involving hospitals.
In addition, the Federal False Claims Act permits private parties to bring
qui tam, or whistleblower, lawsuits against companies. Some states have adopted
similar whistleblower and false claims provisions.
The Office of the Inspector General of Health and Human Services and the
Department of Justice have, from time to time, established national enforcement
initiatives that focus on specific billing practices or other suspected areas
of abuse. Initiatives include a focus on hospital billing for outpatient
charges associated with inpatient services, as well as hospital laboratory
billing practices.
As a result of these regulations and initiatives, some of our activities
could become the subject of governmental investigations or inquiries. For
example, we have significant Medicare and Medicaid billings, we provide some
durable medical equipment and home health care services, and we have joint
venture arrangements involving physician investors. In addition, our executives
and managers, many of whom have worked at other health care companies that are
or may become the subject of Federal and state investigations and private
litigation, could be included in governmental investigations or named as
defendants in private litigation. We are aware that several of our hospitals
have been or are being investigated in connection with activities conducted
prior to our acquisition of them. Under the terms of our various acquisition
agreements, the prior owners of our hospitals are responsible for any
liabilities arising from pre-closing violations. The prior owners' resolution
of these matters or failure to resolve these matters, in the event that any
resolution was deemed necessary, may have a material adverse effect on our
business, financial condition or results of operation. See Note 8 of the Notes
to Combined Statements of Operations and Cash Flows of Phoenix Baptist Hospital
and Medical Center, Inc., Arrowhead Community Hospital and Medical Center, Inc.
and Affiliates. Any investigations of us, our executives, managers, facilities
or operations could result in significant liabilities or penalties to us, as
well as adverse publicity.
If any one of the regions in which we operate experiences an economic
downturn or other material change, our overall business results may suffer.
Among our operations as of September 30, 2001, four hospitals, five
diagnostic imaging centers and a prepaid Medicaid managed health plan are
located in Phoenix, Arizona, three hospitals and two ambulatory surgery centers
are located in Orange County, California, and one hospital and its related
clinics are located in metropolitan Chicago, Illinois. For the pro forma year
ended June 30, 2001 and the three months ended September 30, 2001, our revenues
and consolidated Adjusted EBITDA, including corporate overhead, were generated
as follows:
21
Year ended Three months ended
June 30, 2001 September 30, 2001
--------------------- --------------------
Adjusted Adjusted
Revenues EBITDA(1) Revenues EBITDA(1)
Operations -------- --------- -------- ---------
- ----------
Phoenix.......................... 37.2% 30.2% 34.9% 24.6%
Orange County.................... 18.2% 27.1% 18.6% 22.4%
Metropolitan Chicago............. 32.4% 52.4% 31.3% 56.3%
Phoenix Health Plan and other.... 12.2% 9.1% 15.2% 18.3%
Corporate overhead expenses(2)... 0.0% (18.8)% 0.0% (21.6)%
----- ----- ----- -----
100.0% 100.0% 100.0% 100.0%
===== ===== ===== =====
- -------------------
(1) Adjusted EBITDA represents EBITDA, or net income before interest expense
(net of interest income), income taxes, depreciation, amortization, and is
further adjusted to add back non-cash stock compensation, certain other
non-operating expenses and restructuring and impairment charges. This
definition of Adjusted EBITDA is derived from and consistent with the
Indenture for the new notes. EBITDA is commonly used as an analytical
indicator within the health care industry and serves as a measure of
leverage capacity and debt service ability. We believe the adjustments
made to EBITDA in calculating Adjusted EBITDA are appropriate to reflect
our calculations of the debt leverage and interest coverage ratios under
the Indenture and the 2001 senior secured credit facility. Adjusted EBITDA
should not be considered as a measure of financial performance under
generally accepted accounting principles, and the items excluded in
determining Adjusted EBITDA are significant components in understanding
and assessing financial performance. Because neither EBITDA nor a
calculation of Adjusted EBITDA is a measurement determined in accordance
with generally accepted accounting principles, it is susceptible to
varying calculations, and as a result our calculation of Adjusted EBITDA
as presented may not be comparable to EBITDA or other similarly titled
measures used by other companies.
(2) Reflected in Consolidated Financial Statements only.
Any material change in the current demographic, economic, competitive or
regulatory conditions in any of these regions could adversely affect our
overall business results because of the significance of our operations in each
of these regions to our overall operating performance. Moreover, due to the
concentration of our revenues in only three regions, our business is less
diversified and, accordingly, is subject to greater regional risk than that of
some of our larger competitors.
California has a statute and regulations that require hospitals to meet
seismic performance standards, and hospitals that do not meet the standards may
be required to retrofit their facilities. The law requires that these hospitals
evaluate their facilities and develop a plan and schedule for complying with
the standards which, if necessary, must be filed with the State of California
by 2002. We have filed all of the necessary documentation with the State of
California that was required by January 1, 2002. We expect that the cost of
performing the necessary evaluations and filing the documentation will be
approximately $0.3 million. The estimated cost to comply with the seismic
regulations and standards required by 2008, is an additional $10.1 million.
Upon completion of the $10.1 million in improvements, the California facilities
will be compliant with the requirements of the seismic regulations through
2029. We estimate that the majority of the square footage in our facilities
will be compliant with the seismic regulations and standards required by 2030
once we have completed such $10.1 million in improvements, but we are unable at
this time to estimate our costs for full compliance with the 2030 requirements.
We are dependent on our senior management team and local management
personnel, and the loss of the services of one or more of our senior management
team or key local management personnel could have a material adverse effect on
our business.
The success of our business is largely dependent upon the services and
management experience of our senior management team, which includes Charles N.
Martin, Jr., our Chairman and Chief Executive Officer; William L. Hough, our
President and Chief Operating Officer; Joseph D. Moore, our Executive Vice
President, Chief Financial Officer and Treasurer, and Keith B. Pitts, our Vice
Chairman. In addition, we depend on our ability to attract and
22
retain local managers at our hospitals and related facilities, on the ability
of our senior officers and key employees to manage growth successfully and on
our ability to attract and retain skilled employees. We do not maintain key man
life insurance policies on any of our officers. If we were to lose any of our
senior management team or members of our local management teams, or if we are
unable to attract other necessary personnel in the future, it could have a
material adverse effect on our business, financial condition and results of
operations. If we were to lose the services of one or more members of our
senior management team or a significant portion of our hospital management
staff at one or more of our hospitals, we would likely experience a significant
disruption in our operations and failures of the affected hospitals to adhere
to their respective business plans.
Should we be unable to control our health care costs at Phoenix Health Plan,
or if the health plan should lose its governmental contract, our profitability
may be adversely affected.
For the year ended June 30, 2001 and the three months ended September 30,
2001, our Phoenix Health Plan generated approximately 12.2% and 15.2% of our
revenues, respectively, and 9.1% and 18.3%, of our Adjusted EBITDA,
respectively, on a pro forma basis. Phoenix Health Plan derives substantially
all of its revenues through a contract with the Arizona Health Care Cost
Containment System (the "Arizona Health Care System"), which is the state
agency that administers Arizona's state Medicaid program. The Arizona Health
Care System pays capitated rates to Phoenix Health Plan and Phoenix Health Plan
subcontracts with physicians, hospitals and other health care providers to
provide services to its enrollees. If we fail to effectively manage our health
care costs, these costs may exceed the payments we receive. Many factors can
cause actual health care costs to exceed the capitated rates paid by the
Arizona Health Care System, including:
o our ability to contract with cost-effective health care providers;
o the increased cost of individual health care services;
o the type and number of individual health care services delivered; and
o the occurrence of catastrophes, epidemics or other unforeseen
occurrences.
Our contract with the Arizona Health Care System expires on September 30,
2003, and although by its terms it is renewable annually by the Arizona Health
Care System, it is terminable for any reason upon 90 days' notice. If this
contract were terminated or not renewed or further extended, our profitability
could be adversely affected by the loss of these revenues and cash flow.
If claims brought against our facilities exceed the scope of our liability
coverage or coverage is denied, our overall business results may suffer.
Plaintiffs frequently bring actions against hospitals and other health
care providers alleging malpractice, product liability or other legal theories.
Many of these actions involve large claims and significant defense costs. To
cover these claims, we self-insure our general and professional risks up to
$1.0 million on a per-occurrence basis and up to $13.2 million on an aggregate
per-claim basis. For losses above the self-insurance limits, we maintain
insurance from unrelated commercial carriers on an occurrence basis for general
liability and a claims-made basis for professional liability up to $100.0
million per occurrence and in the aggregate. Some of the claims, however, could
exceed the scope of the coverage in effect or coverage of particular claims or
damages could be denied. Furthermore, our insurance coverage may not continue
to be available at a reasonable cost.
23
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains "forward-looking statements" within the meaning
of the federal securities laws which are intended to be covered by the safe
harbors created thereby. 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 herein by use of words
including but not limited to "may," "believe," "will," "project," "expect",
"estimate", "anticipate," and "plan." These statements are based upon estimates
and assumptions made by our 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. These factors, risks and uncertainties include, but are not limited
to, the risks previously identified in the "Risk Factors" section of this
document.
You are cautioned not to rely on such forward-looking statements when
evaluating the information contained in this report. The Company's actual
results, performance or achievements could differ materially from those
expressed in, or implied by, the forward-looking statements. In light of the
significant uncertainties inherent in the forward-looking statements included
herein, you should not regard the inclusion of such information as a
representation by the Company that its 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 results of operations and financial
condition.
24
THE EXCHANGE OFFER
In a registration rights agreement between Vanguard and Morgan Stanley &
Co. Incorporated, Banc of America Securities LLC, Credit Suisse First Boston
Corporation, UBS Warburg LLC and First Union Securities, Inc., the initial
purchasers of the old notes (the "Initial Purchasers"), we agreed
(1) to file a registration statement with respect to an offer to
exchange the old notes for a new issue of notes, with terms substantially
the same as of the old notes but registered under the Securities Act,
(2) to use our best efforts to cause the registration statement to be
declared effective by the SEC on or prior to 180 days after the closing of
the old notes offering and
(3) use our best efforts to consummate the exchange offer and issue
the new notes within 30 business days after the registration statement is
declared effective.
The registration rights agreement provides that, in the event we fail to
consummate the exchange offer within 210 days, we will be required to pay an
additional .5% of interest on the old notes over and above the regular interest
on the notes. Once we complete this exchange offer, we will no longer be
required to pay additional interest on the old notes.
The exchange offer is not being made to, nor will we accept tenders for
exchange from, holders of old notes in any jurisdiction in which the exchange
offer or acceptance of the exchange offer would violate the securities or blue
sky laws of that jurisdiction.
Terms of the Exchange Offer; Period for Tendering Old Notes
This prospectus and the accompanying letter of transmittal contain the
terms and conditions of the exchange offer. Upon the terms and subject to the
conditions included in this prospectus and in the accompanying letter of
transmittal, which together are the exchange offer, we will accept for exchange
old notes which are properly tendered on or prior to the expiration date,
unless you have previously withdrawn them.
o When you tender to us old notes as provided below, our acceptance of
the old notes will constitute a binding agreement between you and us
upon the terms and subject to the conditions in this prospectus and
in the accompanying letter of transmittal.
o For each $1,000 principal amount of old notes surrendered to us in
the exchange offer, we will give you $1,000 principal amount of new
notes.
o We will keep the exchange offer open for not less than 20 business
days, or longer if required by applicable law, after the date that we
first mail notice of the exchange offer to the holders of the old
notes. We are sending this prospectus, together with the letter of
transmittal, on or about the date of this prospectus to all of the
registered holders of old notes at their addresses listed in the
trustee's security register with respect to the old notes.
o The exchange offer expires at 5:00 p.m., New York City time, on ,
200_; provided, however, that we, in our sole discretion, may extend
the period of time for which the exchange offer is open. The term
"expiration date" means , 200_ or, if extended by us, the
latest time and date to which the exchange offer is extended.
o As of the date of this prospectus, $300,000,000 in aggregate
principal amount of the old notes were outstanding. The exchange
offer is not conditioned upon any minimum principal amount of old
notes being tendered.
25
o Our obligation to accept old notes for exchange in the exchange offer
is subject to the conditions that we describe in the section called
"Conditions to the Exchange Offer" below.
o We expressly reserve the right, at any time, to extend the period of
time during which the exchange offer is open, and thereby delay
acceptance of any old notes, by giving oral or written notice of an
extension to the exchange agent and notice of that extension to the
holders as described below. During any extension, all old notes
previously tendered will remain subject to the exchange offer unless
withdrawal rights are exercised. Any old notes not accepted for
exchange for any reason will be returned without expense to the
tendering holder as promptly as practicable after the expiration or
termination of the exchange offer.
o We expressly reserve the right to amend or terminate the exchange
offer, and not to accept for exchange any old notes that we have not
yet accepted for exchange, if any of the conditions of the exchange
offer specified below under "Conditions to the Exchange Offer" are
not satisfied.
o We will give oral or written notice of any extension, amendment,
termination or non-acceptance described above to holders of the old
notes as promptly as practicable. If we extend the expiration date,
we will give notice by means of a press release or other public
announcement no later than 9:00 a.m., New York City time, on the
business day after the previously scheduled expiration date. Without
limiting the manner in which we may choose to make any public
announcement and subject to applicable law, we will have no
obligation to publish, advertise or otherwise communicate any public
announcement other than by issuing a release to the Dow Jones News
Service.
o Holders of old notes do not have any appraisal or dissenters' rights
in connection with the exchange offer.
o Old notes which are not tendered for exchange or are tendered but not
accepted in connection with the exchange offer will remain
outstanding and be entitled to the benefits of the indenture, but
will not be entitled to any further registration rights under the
registration rights agreement.
o We intend to conduct the exchange offer in accordance with the
applicable requirements of the Exchange Act and the rules and
regulations of the SEC thereunder.
o By executing, or otherwise becoming bound by, the letter of
transmittal, you will be making the representations described below
to us. See "--Resales of the New Notes."
Important rules concerning the exchange offer
You should note that:
o All questions as to the validity, form, eligibility, time of receipt
and acceptance of old notes tendered for exchange will be determined
by Vanguard in its sole discretion, which determination shall be
final and binding.
o We reserve the absolute right to reject any and all tenders of any
particular old notes not properly tendered or to not accept any
particular old notes which acceptance might, in our judgment or the
judgment of our counsel, be unlawful.
o We also reserve the absolute right to waive any defects or
irregularities or conditions of the exchange offer as to any
particular old notes either before or after the expiration date,
including the right to waive the ineligibility of any holder who
seeks to tender old notes in the exchange offer. Unless we agree to
waive any defect or irregularity in connection with the tender of old
notes for exchange, you must cure any defect or irregularity within
any reasonable period of time as we shall determine.
o Our interpretation of the terms and conditions of the exchange offer
as to any particular old notes either before or after the expiration
date shall be final and binding on all parties.
26
o Neither Vanguard, the exchange agent nor any other person shall be
under any duty to give notification of any defect or irregularity
with respect to any tender of old notes for exchange, nor shall any
of them incur any liability for failure to give any notification.
Procedures for Tendering Old Notes
What to submit and how
If you, as the registered holder of an old note, wish to tender your old
notes for exchange in the exchange offer, you must transmit a properly
completed and duly executed letter of transmittal to Bank One Trust Company at
the address set forth below under "Exchange Agent" on or prior to the
expiration date.
In addition,
(1) certificates for old notes must be received by the exchange agent
along with the letter of transmittal, or
(2) a timely confirmation of a book-entry transfer of old notes, if
such procedure is available, into the exchange agent's account at the
Depository Trust Company, or the "Depository" using the procedure for
book-entry transfer described below, must be received by the exchange
agent prior to the expiration date, or
(3) you must comply with the guaranteed delivery procedures described
below.
The method of delivery of old notes, letters of transmittal and notices of
guaranteed delivery is at your election and risk. If delivery is by mail, we
recommend that registered mail, properly insured, with return receipt
requested, be used. In all cases, sufficient time should be allowed to assure
timely delivery. No letters of transmittal or old notes should be sent to
Vanguard.
How to sign your letter of transmittal and other documents
Signatures on a letter of transmittal or a notice of withdrawal, as the
case may be, must be guaranteed unless the old notes being surrendered for
exchange are tendered
(1) by a registered holder of the old notes who has not completed the
box entitled "Special Issuance Instructions" or "Special Delivery
Instructions" on the letter of transmittal or
(2) for the account of an eligible institution.
If signatures on a letter of transmittal or a notice of withdrawal, as the
case may be, are required to be guaranteed, the guarantees must be by any of
the following eligible institutions:
o a firm which is a member of a registered national securities exchange
or a member of the National Association of Securities Dealers, Inc.
or
o a commercial bank or trust company having an office or correspondent
in the United States
If the letter of transmittal is signed by a person or persons other than
the registered holder or holders of old notes, the old notes must be endorsed
or accompanied by appropriate powers of attorney, in either case signed exactly
as the name or names of the registered holder or holders that appear on the old
notes and with the signature guaranteed.
If the letter of transmittal or any old notes or powers of attorney are
signed by trustees, executors, administrators, guardians, attorneys-in-fact,
officers or corporations or others acting in a fiduciary or representative
27
capacity, the person should so indicate when signing and, unless waived by
Vanguard, proper evidence satisfactory to Vanguard of its authority to so act
must be submitted.
Acceptance of Old Notes for Exchange; Delivery of New Notes
Once all of the conditions to the exchange offer are satisfied or waived,
we will accept, promptly after the expiration date, all old notes properly
tendered and will issue the new notes promptly after acceptance of the old
notes. See "Conditions to the Exchange Offer" below. For purposes of the
exchange offer, our giving of oral or written notice of our acceptance to the
exchange agent will be considered our acceptance of the exchange offer.
In all cases, we will issue new notes in exchange for old notes that are
accepted for exchange only after timely receipt by the exchange agent of:
o certificates for old notes, or
o a timely book-entry confirmation of transfer of old notes into the
exchange agent's account at the Depository using the book-entry
transfer procedures described below, and
o a properly completed and duly executed letter of transmittal.
If we do not accept any tendered old notes for any reason included in the
terms and conditions of the exchange offer or if you submit certificates
representing old notes in a greater principal amount than you wish to exchange,
we will return any unaccepted or non-exchanged old notes without expense to the
tendering holder or, in the case of old notes tendered by book-entry transfer
into the exchange agent's account at the Depository using the book-entry
transfer procedures described below, non-exchanged old notes will be credited
to an account maintained with the Depository as promptly as practicable after
the expiration or termination of the exchange offer.
Book-Entry Transfer
The exchange agent will make a request to establish an account with
respect to the old notes at the Depository for purposes of the exchange offer
promptly after the date of this prospectus. Any financial institution that is a
participant in the Depository's systems may make book-entry delivery of old
notes by causing the Depository to transfer old notes into the exchange agent's
account in accordance with the Depository's Automated Tender Offer Program
procedures for transfer. However, the exchange for the old notes so tendered
will only be made after timely confirmation of book-entry transfer of old notes
into the exchange agent's account, and timely receipt by the exchange agent of
an agent's message, transmitted by the Depository and received by the exchange
agent and forming a part of a book-entry confirmation. The agent's message must
state that the Depository has received an express acknowledgment from the
participant tendering old notes that are the subject of that book-entry
confirmation that the participant has received and agrees to be bound by the
terms of the letter of transmittal, and that we may enforce the agreement
against that participant.
Although delivery of old notes may be effected through book-entry transfer
into the exchange agent's account at the Depository, the letter of transmittal,
or a facsimile copy, properly completed and duly executed, with any required
signature guarantees, must in any case be delivered to and received by the
exchange agent at its address listed under "--Exchange Agent" on or prior to
the expiration date.
If your old notes are held through the Depository, you must complete a
form called "instructions to registered holder and/or book-entry transfer
facility participant," which will instruct the Depository participant through
whom you hold your notes of your intention to tender your old notes or not
tender your old notes. Please note that delivery of documents to the Depository
in accordance with its procedures does not constitute delivery to the exchange
agent and we will not be able to accept your tender of notes until the exchange
agent receives a letter of transmittal and a book-entry confirmation from the
Depository with respect to your notes. A copy of that form is available from
the exchange agent.
28
Guaranteed Delivery Procedures
If you are a registered holder of old notes and you want to tender your
old notes but your old notes are not immediately available, or time will not
permit your old notes to reach the exchange agent before the expiration date,
or the procedure for book-entry transfer cannot be completed on a timely basis,
a tender may be effected if
(1) the tender is made through an eligible institution,
(2) prior to the expiration date, the exchange agent receives, by
facsimile transmission, mail or hand delivery, from that eligible
institution a properly completed and duly executed letter of transmittal
and notice of guaranteed delivery, substantially in the form provided by
us, stating:
o the name and address of the holder of old notes
o the amount of old notes tendered
o the tender is being made by delivering that notice and guaranteeing
that within three New York Stock Exchange trading days after the date
of execution of the notice of guaranteed delivery, the certificates
of all physically tendered old notes, in proper form for transfer, or
a book-entry confirmation, as the case may be, will be deposited by
that eligible institution with the exchange agent, and
(3) the certificates for all physically tendered old notes, in proper
form for transfer, or a book-entry confirmation, as the case may be, are
received by the exchange agent within three New York Stock Exchange
trading days after the date of execution of the Notice of Guaranteed
Delivery.
Withdrawal Rights
You can withdraw your tender of old notes at any time on or prior to the
expiration date.
A notice of withdrawal sent via facsimile transmission and received by the
exchange agent prior to receipt of the tenders of old notes by mail will be
deemed a valid withdrawal, so long as such notice of withdrawal is received on
or prior to the expiration date.
For a withdrawal to be effective, a written notice of withdrawal must be
received by the exchange agent at one of the addresses listed below under
"Exchange Agent." Any notice of withdrawal must specify:
o the name of the person having tendered the old notes to be withdrawn
o the old notes to be withdrawn
o the principal amount of the old notes to be withdrawn
o if certificates for old notes have been delivered to the exchange
agent, the name in which the old notes are registered, if different
from that of the withdrawing holder
o if certificates for old notes have been delivered or otherwise
identified to the exchange agent, then, prior to the release of those
certificates, you must also submit the serial numbers of the
particular certificates to be withdrawn and a signed notice of
withdrawal with signatures guaranteed by an eligible institution
unless you are an eligible institution
o if old notes have been tendered using the procedure for book-entry
transfer described above, any notice of withdrawal must specify the
name and number of the account at the Depository to be credited with
the withdrawn old notes and otherwise comply with the procedures of
that facility.
29
Please note that all questions as to the validity, form, eligibility and
time of receipt of notices of withdrawal will be determined by us, and our
determination shall be final and binding on all parties. Any old notes so
withdrawn will be considered not to have been validly tendered for exchange for
purposes of the exchange offer.
If you have properly withdrawn old notes and wish to re-tender them, you
may do so by following one of the procedures described under "Procedures for
Tendering Old Notes" above at any time on or prior to the expiration date.
Conditions to the Exchange Offer
Notwithstanding any other provisions of the exchange offer, we will not be
required to accept for exchange, or to issue new notes in exchange for, any old
notes and may terminate or amend the exchange offer, if at any time before the
acceptance of old notes for exchange or the exchange of the new notes for old
notes, that acceptance or issuance would violate applicable law or any
interpretation of the staff of the SEC.
That condition is for our sole benefit and may be asserted by us
regardless of the circumstances giving rise to that condition. Our failure at
any time to exercise the foregoing rights shall not be considered a waiver by
us of that right. Our rights described in the prior paragraph are ongoing
rights which we may assert at any time and from time to time.
In addition, we will not accept for exchange any old notes tendered, and
no new notes will be issued in exchange for any old notes, if at that time any
stop order shall be threatened or in effect with respect to the exchange offer
to which this prospectus relates or the qualification of the indenture under
the Trust Indenture Act.
Exchange Agent
Bank One Trust Company has been appointed as the exchange agent for the
exchange offer. All executed letters of transmittal should be directed to the
exchange agent at one of the addresses set forth below. Questions and requests
for assistance, requests for additional copies of this prospectus or of the
letter of transmittal and requests for notices of guaranteed delivery should be
directed to the exchange agent, addressed as follows:
Deliver To:
Bank One Trust Company, N.A., Exchange Agent
One North State Street, 9th Floor
Chicago, IL 60602
Attention: Exchanges - Carolyn Allen
Facsimile Transmissions:
(312) 407-8853
To Confirm by Telephone
or for Information:
(800) 524-9472
Delivery to an address other than as listed above or transmission of
instructions via facsimile other than as listed above does not constitute a
valid delivery.
Fees and Expenses
The principal solicitation is being made by mail; however, additional
solicitation may be made by telegraph, telephone or in person by our officers,
regular employees and affiliates. We will not pay any additional compensation
to any of our officers and employees who engage in soliciting tenders. We will
not make any payment to brokers, dealers, or others soliciting acceptances of
the exchange offer. However, we will pay the exchange agent
30
reasonable and customary fees for its services and will reimburse it for its
reasonable out-of-pocket expenses in connection with the exchange offer.
The estimated cash expenses to be incurred in connection with the exchange
offer, including legal, accounting, SEC filing, printing and exchange agent
expenses, will be paid by us.
Transfer Taxes
Holders who tender their old notes for exchange will not be obligated to
pay any transfer taxes in connection therewith, except that holders who
instruct us to register new notes in the name of, or request that old notes not
tendered or not accepted in the exchange offer be returned to, a person other
than the registered tendering holder will be responsible for the payment of any
applicable transfer tax thereon.
Resale of the New Notes
Under existing interpretations of the staff of the SEC contained in
several no-action letters to third parties, the new notes would in general be
freely transferable after the exchange offer without further registration under
the Securities Act. The relevant no-action letters include the Exxon Capital
Holdings Corporation letter, which was made available by the SEC on May 13,
1988, and the Morgan Stanley & Co. Incorporated letter, made available on June
5, 1991.
However, any purchaser of old notes who is an "affiliate" of Vanguard or
who intends to participate in the exchange offer for the purpose of
distributing the new notes:
(1) will not be able to rely on the interpretation of the staff of the
SEC,
(2) will not be able to tender its old notes in the exchange offer and
(3) must comply with the registration and prospectus delivery
requirements of the Securities Act in connection with any sale or
transfer of the securities unless that sale or transfer is made using
an exemption from those requirements.
By executing, or otherwise becoming bound by, the Letter of Transmittal
each holder of the old notes will represent that:
(1) it is not our "affiliate";
(2) any new notes to be received by it were acquired in the ordinary
course of its business; and
(3) it has no arrangement or understanding with any person to
participate, and is not engaged in and does not intend to engage, in
the "distribution," within the meaning of the Securities Act, of the
new notes.
In addition, in connection with any resales of new notes, any
broker-dealer participating in the exchange offer who acquired securities for
its own account as a result of market-making or other trading activities must
deliver a prospectus meeting the requirements of the Securities Act. The SEC
has taken the position in the Shearman & Sterling no-action letter, which it
made available on July 2, 1993, that participating broker-dealers may fulfill
their prospectus delivery requirements with respect to the new notes, other
than a resale of an unsold allotment from the original sale of the old notes,
with the prospectus contained in the exchange offer registration statement.
Under the registration rights agreement, we are required to allow participating
broker-dealers and other persons, if any, subject to similar prospectus
delivery requirements to use this prospectus as it may be amended or
supplemented from time to time, in connection with the resale of new notes.
31
USE OF PROCEEDS
We will not receive any cash proceeds from the issuance of the new notes.
The new notes will be exchanged for old notes as described in this prospectus
upon our receipt of old notes. We will cancel all of the old notes surrendered
in exchange for the new notes.
Our net proceeds from the sale of the old notes were approximately $285.0
million, after deduction of the initial purchasers' discounts and commissions
and other expenses of the offering and loan costs associated with the 2001
senior secured credit facility. Of that amount, we used approximately $147.0
million of the net proceeds to repay all outstanding indebtedness, including
approximately $3.2 million of accrued and unpaid interest, under our 2000
credit facility, which debt bore interest at floating rates based in part on a
margin that varied with our consolidated leverage ratio. Such rate was 8.5% on
the date of repayment. The revolving loans and term loans under the 2000 credit
facility matured in February 2005 and February 2006, respectively. The
outstanding indebtedness under our 2000 credit facility was used to repay
amounts outstanding under the previous 1998 credit facility and to fund a
portion of the acquisitions in fiscal 2000. Subsequently, we used a part of the
remaining cash proceeds from the sale of the old notes to fund the acquisition
of Paradise Valley Hospital in Phoenix, Arizona. We intend to use the balance
of the net proceeds for general corporate purposes, which may include future
acquisitions. The information regarding acquisitions in previous fiscal periods
is discussed further in "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
CAPITALIZATION
The following table sets forth our capitalization as of September 30,
2001. This table should be read in conjunction with the information contained
in "Use of Proceeds" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations," as well as the Consolidated Financial
Statements and the notes thereto included in the back of this prospectus.
As of
September 30,
2001
-------------
(dollars in
millions)
Cash and cash equivalents......................................... $149.6
======
Long term debt, including amounts due in one year:
2001 senior secured credit facility:
$125 million revolving credit tranche....................... --
Senior subordinated notes ..................................... 300.0
Capital lease obligations and other debt obligations........... 12.9
------
Total long-term debt...................................... 312.9
------
Payable-In-Kind Preferred Stock ($.01 par value, 150,000
combined shares of preferred stock and
Payable-In-Kind Preferred Stock authorized, 21,600
shares of Payable-In-Kind Preferred Stock issued and
outstanding, at redemption value).............................. 22.7
Stockholders' equity:
Common stock ($.01 par value, 600,000 shares authorized,
203,294 shares issued and
outstanding)(1)............................................. --
Additional paid-in capital..................................... 306.7
Accumulated deficit............................................ (4.7)
------
Total stockholders' equity.................................. 302.0
------
Total capitalization........................................ $637.6
======
- -------------------
(1) Excludes 48,011 shares of common stock issuable upon exercise of stock
options outstanding as of September 30, 2001 with a weighted average
exercise price of $584.79 per share subject to numerous restrictions and
conditions including terms of exercisability.
32
SELECTED HISTORICAL CONSOLIDATED FINANCIAL AND OPERATING DATA
The following table sets forth selected historical financial and operating
data of Vanguard or its predecessor for, or as of the end of, each of the five
years ended June 30, 2001 and for the three months ended September 30, 2000 and
2001. The selected historical financial and operating data as of and for each
of the years ended June 30, 1998, 1999, 2000 and 2001 were derived from our
audited consolidated financial statements that have been audited by Ernst &
Young LLP, independent auditors. The selected financial information for the
year ended June 30, 1997 and the eleven months ended May 31, 1998 has been
derived from unaudited financial statements of the predecessor owner of
Maryvale Hospital Medical Center. The selected historical and operating data
for the three months ended September 30, 2000 and 2001 were derived from our
unaudited consolidated financial statements. These unaudited consolidated
financial statements include all adjustments necessary (consisting of normal
recurring adjustments) for a fair presentation of the financial position and
results of operations for these periods. Operating results for the three months
ended September 30, 2001 are not necessarily indicative of the results that may
be expected for the full fiscal year ending June 30, 2002. Comparability of the
selected historical financial and operating data has been impacted by the
timing of acquisitions completed during fiscal 1998, 2000 and 2001. Please read
the section on "Impact of Acquisitions" included in "Management's Discussion
and Analysis of Financial Condition and Results of Operations." The table
should be read in conjunction with the Consolidated Financial Statements and
notes thereto included in the back of this prospectus and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
33
Predecessor
-----------------
Fiscal Eleven
Year Months Three Months Ended
Ended Ended Year Ended June 30, September 30
June 30, May 31, ------------------------------------- ------------------
1997 1998 1998 1999 2000 2001 2000 2001
-------- ------- ------- ------ ------ ------ ------ ------
(dollars in millions) (dollars in millions)
Summary of Operations:
Revenues ....................... $ 79.2 82.0 $ 7.0 $ 91.5 $304.7 $667.8 $158.6 $207.3
Salaries and benefits .......... 30.7 29.8 3.5 39.3 146.5 323.6 77.1 86.7
Supplies ....................... 9.6 9.3 0.9 12.5 40.5 92.9 22.7 24.8
Other operating expenses ....... 17.5 16.5 2.9 15.5 64.1 143.1 31.2 64.3
Provision for doubtful
accounts .................... 16.6 17.4 1.3 17.3 33.1 56.8 16.4 16.3
Depreciation and
amortization................. 3.7 2.6 0.5 3.9 11.8 23.8 6.1 7.1
Interest, net .................. 1.7 1.5 0.2 4.2 8.8 16.6 4.8 6.0
Non-cash stock
compensation ................ -- -- 0.5 5.0 -- -- -- --
Other non-operating
expenses .................... -- -- (0.1) 0.2 0.1 0.3 0.1 (0.4)
------ ------ ------- ------ ------ ------ ------ ------
79.8 77.1 9.7 97.9 304.9 657.1 158.4 204.8
------ ------ ------- ------ ------ ------ ------ ------
Income (loss) before income
taxes and extraordinary
item.......................... (0.6) 4.9 (2.7) (6.4) (0.2) 10.7 0.2 2.5
Income tax expense.............. -- -- -- -- (0.1) (0.5) -- (0.3)
------ ------ ------- ------ ------ ------ ------ ------
Income (loss) before
extraordinary item............ (0.6) 4.9 (2.7) (6.4) (0.3) 10.2 0.2 2.2
Extraordinary loss on
extinguishment of debt........ -- -- -- (1.1) -- -- (6.4)
------ ------ ------- ------ ------ ------ ------ ------
Net income (loss)............... (0.6) 4.9 (2.7) (6.4) (1.4) 10.2 0.2 (4.2)
Accrued preferred dividends.... -- -- (0.1) -- (0.7) (1.7) (0.4) (0.4)
------ ------ ------- ------ ------ ------ ------ ------
Net income (loss) attributable
to common shareholders........ $ (0.6) 4.9 $ (2.8) $ (6.4) $ (2.1) $ 8.5 $ (0.2) $ (4.6)
====== ====== ======= ====== ====== ====== ====== ======
Balance Sheet Data
(End of Period)(a):
Assets........................ $ 39.7 $ 37.5 $ 88.3 $ 98.1 $549.9 $640.4 $547.7 $790.9
Long-term debt, including
current portion............. -- -- 47.5 56.2 153.3 163.4 154.7 312.9
Payable-In-Kind Preferred
Stock....................... -- -- -- -- 20.7 22.3 21.1 22.7
Working capital............... 15.8 16.1 5.0 11.9 39.5 18.5 39.8 159.5
Other Data:
Adjusted EBITDA(b)............ $ 4.8 $ 9.0 $ (1.6) $ 6.9 $20.5 $51.4 $ 11.1 $ 15.2
Net cash provided by (used in)
operating activities........ 7.2 (2.9) (9.7) 24.5 6.7 (5.4) 11.2
Net cash used in investing
activities.................. (3.5) (71.9) (5.1) (335.9) (38.1) (9.1) (8.6)
Net cash (used in) provided
by financing activities..... (3.6) 76.8 12.7 327.8 26.7 (1.2) 134.9
Number of hospitals at end of
period...................... 1 1 1 1 7 8 7 8
Number of licensed beds at
end of period(c)............ 239 239 239 239 1,481 1,676 1,481 1,676
Weighted average licensed
beds(d)..................... 239 239 20 239 771 1,514 1,481 1,676
Discharges(e)................. 12,630 12,200 1,191 12,447 31,864 65,237 15,735 17,352
Adjusted discharges-
hospitals(f)................ 20,124 18,086 1,760 19,811 50,661 104,188 24,411 25,920
Average length of stay
(days)(g)................... 3.2 3.4 3.1 3.2 4.1 4.1 4.0 4.0
Average daily census(h)....... 111.6 125.0 120.0 112.0 701.4 728.8 745.0 686.0
Occupancy rate(i)............. 46.7% 52.3% 50.2% 46.9% 46.1% 42.5% 46.3% 44.4%
Ratio of earnings to fixed
charges(j).................. -- -- -- -- -- 1.5x 1.0x 1.3x
34
- -------------------
(a) The balance sheet data presented for the predecessor is not comparable to
the balance sheet data of Vanguard due to the capital structure changes
related to the acquisition by Vanguard of the not-for-profit predecessor
and the related effects of purchase accounting.
(b) Adjusted EBITDA represents EBITDA, or net income before interest expense
(net of interest income), income taxes, depreciation, amortization, and is
further adjusted to add back non-cash stock compensation, certain other
non-operating expenses and restructuring and impairment charges. This
definition of Adjusted EBITDA is derived from and consistent with the
Indenture for the new notes. EBITDA is commonly used as an analytical
indicator within the health care industry and serves as a measure of
leverage capacity and debt service ability. We believe the adjustments
made to EBITDA in calculating Adjusted EBITDA are appropriate to reflect
our calculations of the debt leverage and interest coverage ratios
under the Indenture and the 2001 senior secured credit facility. Adjusted
EBITDA should not be considered as a measure of financial performance
under generally accepted accounting principles, and the items excluded in
determining Adjusted EBITDA are significant components in understanding
and assessing financial performance. Because neither EBITDA nor a
calculation of Adjusted EBITDA is a measurement determined in accordance
with generally accepted accounting principles, it is susceptible to
varying calculations, and as a result our calculation of Adjusted EBITDA
as presented may not be comparable to EBITDA or other similarly titled
measures used by other companies.
Predecessor Three Months
----------------- Ended
Fiscal Eleven Year Ended June 30, September 30,
Year Months ------------------------------------- ---------------
Ended Ended Historical Historical
June 30, May 31, ------------------------------------- ---------------
1997 1998 1998 1999 2000 2001 2000 2001
-------- ------- ------ ------ ------ ------ ------ ------
(dollars in millions)
Calculation of Adjusted EBITDA:
Income (loss) before income taxes
and extraordinary item........... $ (0.6) $ 4.9 $ (2.7) $ (6.4) $ (0.2) $ 10.7 $ 0.2 $ 2.5
Depreciation and amortization....... 3.7 2.6 0.5 3.9 11.8 23.8 6.1 7.1
Interest, net....................... 1.7 1.5 0.2 4.2 8.8 16.6 4.8 6.0
Non-cash stock compensation......... -- -- 0.5 5.0 -- -- -- --
Equity method loss(income).......... -- -- (0.1) 0.2 0.1 (0.2) -- (0.1)
Loss (gain) on sale of assets....... -- -- -- -- -- 0.5 -- (0.3)
Other non-operating investment
losses........................... -- -- -- -- -- -- -- --
------ ----- ------ ------ ------ ------ ------ ------
Adjusted EBITDA $ 4.8 $ 9.0 $ (1.6) $ 6.9 $ 20.5 $ 51.4 $ 11.1 $ 15.2
====== ====== ====== ====== ====== ====== ====== ======
- -------------------
(c) Licensed beds are those beds for which a facility has been granted
approval to operate from the applicable state licensing agency.
(d) Represents the average number of licensed beds, weighted based on periods
owned.
(e) Represents the total number of patients discharged (in the facility for a
period in excess of 23 hours) from our hospitals and is used by management
and certain investors as a general measure of inpatient volume.
(f) Adjusted discharges-hospitals is used by management and certain investors
as a general measure of combined inpatient and outpatient volume. Adjusted
discharges-hospitals are computed by multiplying discharges by the sum of
gross inpatient and outpatient hospital revenues and then dividing the
result by gross inpatient revenues. This computation "equates" outpatient
revenues to the measure used to measure inpatient volume resulting in a
general measure of combined inpatient and outpatient volume.
(g) Average length of stay represents the average number of days admitted
patients stay in our hospitals.
(h) Represents the average number of patients in the hospitals each day during
our ownership.
(i) Represents the percentage of hospital licensed beds occupied by patients.
Both average daily census and occupancy rate provide measures of the
utilization of inpatient rooms.
35
(j) The ratio of earnings to fixed charges was computed by dividing (i) income
from continuing operations before fixed charges, equity method income
(loss) of affiliates, income taxes and extraordinary items by (ii) fixed
charges, which consist of interest charges and the portion of rent expense
which is deemed to be equivalent to interest expense. Our earnings were
insufficient to cover fixed charges for the years ended June 30, 1998,
1999 and 2000 by $2.6 million, $6.7 million and $0.1 million,
respectively.
36
UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION
The following tables present our unaudited pro forma condensed combined
financial information and should be read in conjunction with the related notes.
The unaudited pro forma condensed combined statement of operations for the
fiscal year ended June 30, 2001 includes the following:
o our results of operations for the fiscal year ended June 30, 2001;
o the results of operations of PMH Health Services Network (which
includes Phoenix Memorial Hospital and Phoenix Health Plan), acquired
on May 1, 2001, for the period July 1, 2000 through April 30, 2001;
o the results of operations of a certain non-significant acquisition
completed during the period; and
o the effect of the offering of the old notes as if the transaction
occurred as of July 1, 2000, including the application of the net
proceeds therefrom.
The unaudited pro forma condensed combined statement of operations for the
three months ended September 30, 2001 includes the following:
o our results of operations for the three months ended September 30,
2001;
o the effect of the offering of the old notes, as if the transaction
occurred as of July 1, 2001, including the application of the net
proceeds therefrom.
The unaudited pro forma condensed combined statement of operations for the
fiscal year ended June 30, 2001 is presented to reflect the offering of the old
notes and the acquisitions as if the transactions occurred as of July 1, 2000.
The acquisitions have been accounted for as purchases and, in addition to other
identifiable intangibles, goodwill was recorded for the excess of the purchase
price over the fair value of the net assets acquired. The unaudited pro forma
condensed combined statement of operations for the three months ended September
30, 2001 is presented to reflect the offering of the old notes as if the
transaction occurred as of July 1, 2001.
The pro forma condensed combined statements of operations do not give
effect to the cost savings, if any, from any acquisitions for periods prior to
the consummation of such acquisitions.
The adjustments necessary to fairly present the unaudited pro forma
condensed combined financial information have been made based on available
information and in the opinion of management are reasonable. The unaudited pro
forma financial information does not purport to be indicative of the results of
operations that we would have actually achieved had the pro forma transactions
occurred as of the dates specified, nor are they necessarily indicative of the
results of operations that we may achieve in the future.
37
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
For the Fiscal Year Ended June 30, 2001
(dollars in thousands)
Offering
Pro Forma Pro Forma Pro Forma Pro Forma
Vanguard Acquisitions(1) Combined Adjustments Vanguard
--------- --------------- --------- ----------- ---------
Revenues ......................... $ 667,763 $ 134,345 $802,108 $ -- $ 802,108
Costs and expenses:
Operating expenses ............ 559,520 122,331 681,851 -- 681,851
Provision for doubtful accounts 56,846 9,000 65,846 -- 65,846
Depreciation and amortization . 23,799 4,427 28,226 -- 28,226
Interest expense .............. 17,491 1,219 18,710 12,401(2) 31,111
Interest income ............... (933) (223) (1,156) -- (1,156)
Other non-operating expenses .. 369 1,002 1,371 -- 1,371
--------- --------- --------- --------- ---------
657,092 137,756 794,848 12,401 807,249
Income (loss) before income
taxes ...................... 10,671 (3,411) 7,260 (12,401) (5,141)
Income tax expense (benefit) .. 511 -- 511 (511)(3) --
--------- --------- --------- --------- ---------
Net income (loss) from
continuing operations ...... $ 10,160 $ (3,411) $ 6,749 $ (11,890) $ (5,141)
========= ========= ========= ========= =========
Other Data:
Adjusted EBITDA (5).............................................................. $ 54,411
Ratio of earnings to fixed charges (6)............................................ --(7)
See notes to unaudited pro forma condensed combined statement of operations.
38
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
For the three months ended September 30, 2001
(dollars in thousands)
Offering
Pro Forma Pro Forma
Vanguard Adjustments Vanguard
---------- ----------- -----------
Revenues ..................................... $ 207,309 -- $ 207,309
Costs and expenses:
Operating expenses ........................ 175,794 -- 175,794
Provision for doubtful accounts ........... 16,333 -- 16,333
Depreciation and amortization ............. 7,152 -- 7,152
Interest expense, net ..................... 5,965 1,286(2) 7,251
Other non-operating expenses .............. (426) -- (426)
---------- --------- ----------
204,818 1,286(2) 206,104
Income before income taxes and
extraordinary item....................... 2,491 (1,286) 1,205
Income tax expense ........................ 307 (232)(3) 75
---------- --------- ----------
Income before extraordinary item .......... 2,184 (1,054) 1,130
Extraordinary loss on extinguishment
of debt.................................. (6,360) 146(3,4) (6,214)
---------- --------- ----------
Net loss from continuing operations ..... $ (4,176) $ (908) $ (5,084)
========== ========= ==========
Other Data:
Adjusted EBITDA (4).................................................... $ 15,182
Ratio of earnings to fixed charges (5)................................. 1.12
See notes to unaudited pro forma condensed combined statement of operations.
39
NOTES TO UNAUDITED PRO FORMA
CONDENSED COMBINED STATEMENT OF OPERATIONS
(dollars in thousands)
Note 1
The following pro forma condensed combined statement of operations
for the fiscal year ended June 30, 2001, presents the incremental pro forma
operations of PMH Health Services Network and a non-significant acquisition
applying the purchase method as if the acquisitions, completed on May 1, 2001,
and June 1, 2001, respectively, had occurred on July 1, 2000.
PMH Health Non- Acquisitions
Services Significant Acquisitions Pro Forma Pro Forma
Network Acquisition Combined Adjustments Acquisitions
---------- ----------- ------------ ------------ ------------
Revenues ............................ $ 120,911 $ 14,519 $ 135,430 $ (1,085)(lc) $ 134,345
Costs and expenses:
Operating expenses ............... 113,961 11,751 125,712 (2,915)(lc) 122,331
(1,359)(ld)
893 (le)
Provision for doubtful accounts . 9,000 -- 9,000 -- 9,000
Depreciation and amortization ... 3,422 1,876 5,298 (695)(la) 4,427
(176)(lc)
Interest expense ................ 3,190 1,196 4,386 (3,116)(lb) 1,219
(51)(lc)
Interest income ................. (223) -- (223) -- (223)
Other non-operating expenses .... (289) -- (289) 1,291 (lc) 1,002
--------- --------- --------- --------- ---------
129,061 14,823 143,884 (6,128) 137,756
Income (loss) before income
taxes ......................... (8,150) (304) (8,454) 5,043 (3,411)
Income tax expense (benefit) .... -- -- -- -- --
--------- --------- --------- --------- ---------
Net income (loss) from continuing
operations..................... $ (8,150) $ (304) $ (8,454) $ 5,043 $ (3,411)
========= ========= ========= ========= =========
40
NOTES TO UNAUDITED PRO FORMA
CONDENSED COMBINED STATEMENT OF OPERATIONS - (Continued)
(dollars in thousands)
Note 1a
Reflects adjustment to depreciation and amortization for acquisitions as
follows:
June 30,
2001
---------
To eliminate historical depreciation and amortization expense ........ $(5,122)
To record amortization related to the $16.1 million excess
of purchase price over net assets acquired for PMH Health
Services Network assuming a 10 year life ....................... 1,344
To record amortization related to the $14.3 million excess of
purchase price over net assets acquired for the
non-significant acquisition assuming a 10 year life ............ 1,325
To record depreciation on PMH Health Services Network and the
non-significant acquisition assuming lives of 5 to 30 years .... 1,758
-------
To record depreciation and amortization on the 2001 Acquisitions
assuming lives of 5 to 30 years................................. $ (695)
=======
Note 1b
Reflects adjustment to interest expense for acquisitions as follows:
June 30,
2001
----------
To remove historical interest expense on acquisitions ......... $(4,335)
To record interest expense on the acquired hospitals'
capital leases at 10.0% ................................. 1,219
-------
$(3,116)
=======
Note 1c
Reflects the elimination of the PMH Health Services Network operations
related to non-acquired operations as follows:
June 30,
2001
----------
Revenues ...................................................... $(1,085)
=======
Operating expenses ............................................ $(2,915)
=======
Depreciation and amortization ................................. $ (176)
=======
Interest ...................................................... $ (51)
=======
Other non-operating expenses .................................. $ 1,291
=======
41
NOTES TO UNAUDITED PRO FORMA
CONDENSED COMBINED STATEMENT OF OPERATIONS - (Continued)
(dollars in thousands)
Note 1d
June 30,
2001
----------
To eliminate contract costs based upon amended contractual
terms entered into as conditions of closing the PMH Health
Services Network acquisition................................. $(1,359)
=======
Note 1e
June 30,
2001
----------
To record sales and property taxes associated with the
conversion of acquisitions to taxable entities............... $ 893
=======
Note 2
Reflects adjustment to interest expense as follows:
June 30, September 30,
2001 2001
-------- -------------
To record amortization for the $15.0 million payment of
debt issue costs relating to the $300 million of notes in
the offering of the old notes ($11.5 million over 10 years) and the 2001
senior secured credit facility ($3.5 million over 5 years) ........................ $ 1,297 $ 105
To eliminate historical amortization of paid debt issue costs ........................... (863) (85)
To record interest expense related to the issuance of the $300
million of notes in the offering of the old notes reflecting a 9.75% interest rate 29,250 2,356
To eliminate historical interest expense ................................................ (17,283) (1,090)
-------- --------
$ 12,401 $ 1,286
======== ========
Note 3
June 30, September 30,
2001 2001
-------- -------------
To eliminate income tax expense resulting from pro forma losses on acquisitions $ 511 $ --
======== ========
To record income tax effect of adjustments to interest............................... $ -- $ (232)
======== ========
To record effect of adjustments to interest on extraordinary items................... $ -- $ 232
======== ========
Note 4
June 30, September 30,
2001 2001
-------- -------------
To adjust extraordinary loss on extinguishment of debt, for early
termination of collar agreement equal to change in fair market value of
collar agreement.................................................................. $ -- $ (378)
======== ========
42
NOTES TO UNAUDITED PRO FORMA
CONDENSED COMBINED STATEMENT OF OPERATIONS - (Continued)
(dollars in thousands)
Note 5
Adjusted EBITDA represents EBITDA, or net income before interest expense
(net of interest income), income taxes, depreciation, amortization, and is
further adjusted to add back non-cash stock compensation, certain other
non-operating expenses and restructuring and impairment charges. This
definition of Adjusted EBITDA is derived from and consistent with the Indenture
for the new notes. EBITDA is commonly used as an analytical indicator within
the health care industry and serves as a measure of leverage capacity and debt
service ability. We believe the adjustments made to EBITDA in calculating
Adjusted EBITDA are appropriate to reflect our calculations of the debt
leverage and interest coverage ratios under the Indenture and the 2001 senior
secured credit facility. Adjusted EBITDA should not be considered as a measure
of financial performance under generally accepted accounting principles, and
the items excluded in determining Adjusted EBITDA are significant components in
understanding and assessing financial performance. Because neither EBITDA nor a
calculation of Adjusted EBITDA is a measurement determined in accordance with
generally accepted accounting principles, it is susceptible to varying
calculations, and as a result our calculation of Adjusted EBITDA as presented
may not be comparable to EBITDA or other similarly titled measures used by
other companies.
Pro Forma Three Months
Year Ended Ended
June 30, September 30,
2001 2001
---------- -------------
Calculation of Adjusted EBITDA:
Income (loss) before income taxes and extraordinary item.............. $ (5.1) $ 1.2
Depreciation and amortization......................................... 28.2 7.1
Interest, net......................................................... 30.0 7.3
Non-cash stock compensation........................................... -- --
Equity method income.................................................. (0.2) (0.1)
Loss (gain) on sale of assets......................................... 0.5 (0.3)
Other non-operating investment losses................................. 1.0 --
------ ------
Adjusted EBITDA....................................................... $ 54.4 $ 15.2
====== ======
Note 6
The ratio of earnings to fixed charges is computed by dividing (i) income
from continuing operations before fixed charges, equity method income (loss) of
affiliates, income taxes and extraordinary items by (ii) fixed charges, which
consist of interest charges and the portion of rent expense which is deemed to
be equivalent to interest expense.
Note 7
Earnings were insufficient to cover fixed charges for the pro forma year
ended June 30, 2001 by $5.3 million.
43
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion together with our historical
financial statements included elsewhere herein and the related notes and the
information set forth under "Selected Historical Consolidated Financial and
Operating Data" and "Unaudited Pro Forma Condensed Combined Financial
Information" and the related notes thereto.
Overview
We are a for-profit hospital management company with operations in three
urban and suburban markets in the United States. Our facilities are located in
Phoenix, Arizona; Orange County, California; and metropolitan Chicago,
Illinois. As of November 15, 2001 we owned and operated nine general acute care
hospitals and related outpatient service locations complementary to the
hospitals. The Company also owns managed health plans in Chicago, Illinois and
Phoenix, Arizona.
We were formed in July 1997, and have grown through a series of
acquisitions. We acquired our first hospital, Maryvale Hospital Medical Center,
on June 1, 1998.
Impact of Acquisitions
Acquiring acute care hospitals in urban and suburban markets is a key part
of our strategy. Since we have grown each year through acquisitions, and those
acquisitions have each been accounted for as a purchase, it is difficult to
make meaningful comparisons between our financial statements for the fiscal
periods presented. In addition, since we own a relatively small number of
hospitals, each additional acquisition can have a material effect on our
overall operating performance. At the time we acquire a hospital, we generally
implement a number of measures to lower operating costs. We also may make
significant investments in the acquired hospital to expand services, strengthen
the medical staff and improve our market position overall. The impact of both
these cost-saving measures and the investments are not generally felt
immediately. Therefore, the financial performance of a newly-acquired hospital
may adversely affect our overall operating margins in the short term.
Fiscal 1999
We made no material acquisitions during the 1999 fiscal year. The fiscal
1999 results of operations include 12 months of the operations for Maryvale
Hospital Medical Center.
Fiscal 2000 Acquisitions
On September 1, 1999, we acquired the West Anaheim Medical Center in
Anaheim, California, and the Huntington Beach Hospital in Huntington Beach,
California. We financed this acquisition entirely through sales of our common
stock to our existing shareholders. The fiscal 2000 results of operations
include ten months of operations for these two hospitals.
On February 1, 2000, we acquired MacNeal Hospital in Berwyn, Illinois, and
its affiliated primary care and occupational medicine centers located around
the metropolitan Chicago area. We financed this acquisition through sales of
our common stock to our existing shareholders, issuing 20,000 shares of
preferred stock to the seller and by borrowing under our 2000 credit facility.
The fiscal 2000 results of operations include five months of operations for
these facilities.
On April 1, 2000, we acquired La Palma Intercommunity Hospital in La
Palma, California. We financed this acquisition primarily through sales of our
common stock to our existing shareholders. The fiscal 2000 results of
operations include three months of operations for this hospital.
44
On June 1, 2000, we acquired Arrowhead Community Hospital and Medical
Center in Glendale, Arizona, and Phoenix Baptist Hospital and Medical Center in
Phoenix, Arizona. We financed this acquisition through sales of our common
stock to our existing shareholders and by borrowing under our 2000 credit
facility. The fiscal 2000 results of operations include one month of operations
for these two hospitals.
We paid a total of approximately $406.8 million for all the facilities we
acquired in fiscal 2000. We financed these acquisitions through the sale of
approximately $236.7 million of our common stock to our existing shareholders,
the borrowing of approximately $88.7 million under our 2000 credit facility,
the issuance of 20,000 shares of preferred stock valued at $20 million and the
assumption of certain liabilities.
Fiscal 2001 Acquisitions
On May 1, 2001 we acquired Phoenix Memorial Hospital and the Phoenix
Health Plan. We financed this acquisition through sales of our common stock to
our existing stockholders and the assumption of certain liabilities of the
seller. The fiscal 2001 results of operations include two months of operations
for the hospital and health plan.
We also acquired non-significant healthcare related businesses during
fiscal 2001 through the assumption of certain liabilities of the seller and
using available cash. The fiscal 2001 results of operations include operations
for these acquisitions from the date of acquisition through June 30, 2001. We
paid a total of approximately $86.9 million for all the acquisitions completed
in fiscal 2001. We financed these acquisitions through the sale of
approximately $32.9 million of our common stock to our existing shareholders
and the assumption of certain liabilities of the sellers.
Recent Developments
On November 1, 2001, we acquired the assets of Paradise Valley Hospital, a
162-bed acute care hospital located in Phoenix, Arizona. We funded the
acquisition with remaining cash proceeds from the July 30, 2001 issuance of the
old notes. The results of operations of Paradise Valley Hospital are not
included in any of the financial statements included herein. We do not believe
that our purchase of this hospital will have a material impact on our results
of operations or financial position.
General
Our historical financial results have been favorably impacted by our
hospital acquisitions. While we intend to continue to make acquisitions in the
future, we may not able to make sufficient hospital acquisitions to sustain our
current growth rate and we may not be able to successfully integrate the
hospitals we acquire.
Our revenues are primarily derived from managed care plans and Medicare
and Medicaid programs. Our revenues are net of contractual adjustments and
policy discounts of approximately $132.7 million, $556.3 million, $1,191.8
million, $286.1 million and $318.0 million for the fiscal years ended June 30,
1999, 2000, and 2001, and for the three months ended September 30, 2000 and
2001, respectively.
The final determination of amounts earned under Medicare and Medi-Cal,
California's state Medicaid program, often does not occur until subsequent
years due to audits by the administering agency, rights of appeal and the
application of numerous technical provisions. Differences between original
estimates and subsequent revisions, including final settlements, are included
in the statement of operations in the period in which the revisions are made.
We believe that adequate provisions have been made for adjustments that may
result from final determination of amounts earned under the Medicare and
Medi-Cal programs. As part of our acquisitions discussed above, we did not
assume any of the cost report settlements under these programs estimated by the
sellers through the dates of purchase.
The Medicare program accounted for approximately 16%, 22%, 15%, 25% and
23% of our revenues for the fiscal years ended June 30, 1999, 2000 and 2001,
and for the three months ended September 30, 2000 and 2001, respectively.
Medicaid programs accounted for approximately 26%, 6%, 5%, 5% and 6% for the
fiscal years ended
45
June 30, 1999, 2000 and 2001, and for the three months ended September 30, 2000
and 2001, respectively. The percentage of our revenues from Medicaid declined
significantly in fiscal 2000 as a result of the inclusion of results from the
additional facilities we acquired, which had a lower percentage of Medicaid
patients than Maryvale Hospital. Managed care programs accounted for
approximately 50%, 62%, 65%, 61% and 61% of our revenues for the fiscal years
ended June 30, 1999, 2000 and 2001, and for the three months ended September
30, 2000 and 2001, respectively.
Our revenues from managed care plans, Medicare and Medicaid are derived
from fixed payments that are based on the diagnosis of a patient rather than
the actual cost or level of services provided. These fixed payments limit our
ability to increase revenues through rate increases. Fixed payment rates under
the Medicare and Medicaid programs have decreased in recent years as a result
of the Balanced Budget Act of 1997, but we expect these decreases to be
partially offset by increases in future periods due to the Balanced Budget
Refinement Act of 1999 and the Benefits Improvement Protection Act of 2000.
Future legislation could limit these rate increases or restore rate reductions.
In addition, these rate increases could be less than the increases in our
costs, and could be inadequate to reflect increases in costs associated with
improved medical technologies.
Our revenues are also affected by the industry trend towards the provision
of more services on an outpatient rather than an inpatient basis. We expect
this trend to continue due to technological and pharmaceutical advances and
pressures from payers to use lower cost outpatient services. We plan to provide
quality health care services as an extension of our hospitals through a variety
of outpatient activities, including ambulatory surgery, diagnostic imaging and
primary care and occupational medicine clinics. Outpatient services account for
37%, 37%, 37%, 39% and 37% of actual gross patient revenues for the fiscal
years ended June 30, 1999, 2000 and 2001, and for the three months ended
September 30, 2000 and 2001, respectively.
The industry trends toward fixed payments and outpatient services are
outside of our control. To respond effectively to these trends we must increase
patient volume while controlling the costs of the services we provide. If we
are unable to contain costs through operational efficiencies or obtain higher
reimbursements and payments from managed care or government payers, our results
of operations and cash flow will be adversely affected.
46
Results of Operations
The following table presents a summary of our operating results for the
fiscal years ended June 30, 1999, 2000 and 2001 and for the three months ended
September 30, 2000 and 2001:
Fiscal Year Ended June 30, Three Months Ended September 30,
--------------------------------------------------- ----------------------------------
1999 2000 2001 2000 2001
--------------- -------------- --------------- ---------------- ---------------
Amount % Amount % Amount % Amount % Amount %
------ ------ ------ ----- ------ ------ ------ ------ ------ ------
(dollars in millions)
Revenues.............. $ 91.5 100.0% $304.7 100.0% $667.8 100.0% $158.6 100.0% $207.3 100.0%
Salaries and
benefits(1)......... 44.3 48.4 146.5 48.1 323.6 48.4 77.1 48.6 86.7 41.8
Supplies.............. 12.5 13.7 40.5 13.3 92.9 13.9 22.7 14.4 24.8 12.0
Other operating
expenses(2)......... 15.7 17.1 64.2 21.0 143.4 21.5 31.3 19.7 63.9 30.8
Provision for
doubtful accounts... 17.3 18.9 33.1 10.8 56.8 8.5 16.4 10.3 16.3 7.9
Depreciation and
amortization........ 3.9 4.3 11.8 3.9 23.8 3.6 6.1 3.9 7.1 3.4
Interest expense...... 4.2 4.6 8.8 2.9 16.6 2.5 4.8 3.0 6.0 2.9
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
97.9 107.0 304.9 100.0 657.1 98.4 158.4 99.9 204.8 98.8
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Income (loss) from
continuing
operations before
income taxes and
extraordinary
item................ (6.4) (7.0) (0.2) 0.0 10.7 1.6 0.2 0.1 2.5 1.2
Provision for income
taxes............... 0.0 0.0 0.1 0.0 0.5 0.1 - 0.0 0.3 0.1
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Income from
continuing
operations
before
extraordinary
item................ (6.4) (7.0) (0.3) 0.0 10.2 1.5 0.2 0.1 2.2 1.1
Extraordinary
item................ 0.0 0.0 1.1 0.4 - 0.0 - 0.0 (6.4) (3.1)
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Income (loss)
from continuing
operations.......... $ (6.4) (7.0)% $ (1.4) (0.4)% $ 10.2 (1.5)% $ 0.2 (0.1)% $ (4.2) (2.0)%
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
Adjusted EBITDA(3).... $ 6.9 $ 20.5 $ 51.4 $ 11.1 $ 15.2
(1) Includes non-cash stock compensation of $5.0 million in fiscal 1999.
(2) Includes certain other non-operating expenses of $0.2, $0.1, $0.3, $0.0 and
$(0.4) for the fiscal years ended June 30, 1999, 2000 and 2001, and for the
three months ended September 30, 2000 and 2001, respectively.
(3) Adjusted EBITDA represents EBITDA, or net income before interest expense
(net of interest income), income taxes, depreciation, amortization, and is
further adjusted to add back non-cash stock compensation, certain other
non-operating expenses and restructuring and impairment charges. This
definition of Adjusted EBITDA is derived from and consistent with the
Indenture for the new notes. EBITDA is commonly used as an analytical
indicator within the health care industry and serves as a measure of
leverage capacity and debt service ability. We believe the adjustments
made to EBITDA in calculating Adjusted EBITDA are appropriate to reflect
our calculations of the debt leverage and interest coverage ratios under
the Indenture and the 2001 senior secured credit facility. Adjusted EBITDA
should not be considered as a measure of financial performance under
generally accepted accounting principles, and the items excluded in
determining Adjusted EBITDA are significant components in understanding
and assessing financial performance. Because neither EBITDA nor a
calculation of Adjusted EBITDA is a measurement determined in accordance
with generally accepted accounting principles, it is susceptible to
varying calculations, and as a result our calculation of Adjusted EBITDA
as presented may not be comparable to EBITDA or other similarly titled
measures used by other companies.
47
Three Months Ended September 30, 2001 Compared to Three Months Ended
September 30, 2000
Revenues. Revenues increased $48.7 million or 30.7% to $207.3 million for
the three months ended September 30, 2001 from $158.6 million for the three
months ended September 30, 2000. Acquisitions during fiscal 2001 accounted for
$49.9 million of additional revenue during the three months ended September 30,
2001. The increase in revenue also represents a 4.5% increase in revenue per
adjusted patient day and a 6.0% increase in adjusted patient days.
Salaries and Benefits. Salaries and benefits expense increased $9.6
million or 12.5% to $86.7 million for the three months ended September 30, 2001
from $77.1 million for the three months ended September 30, 2000. Of this
increase, $8.2 million related to acquisitions during 2001. As a percentage of
revenue, salaries and benefits expense decreased to 41.6% of revenues for the
three months ended September 30, 2001 from 48.6% of revenues for the three
months ended September 30, 2000. This decrease is due to the fact that the
acquired entities, which include a Medicaid health plan and outpatient
radiology clinics, are much less labor-intensive than our hospitals.
Supplies. Supplies expense increased $2.1 million or 9.2% to $24.8 million
for the three months ended September 30, 2001 from $22.7 million for the three
months ended September 30, 2000. The 2001 acquisitions accounted for
approximately $2.3 million of the increase. As a percentage of revenue, supply
expense decreased to 12.0% for the three months ended September 30, 2001 from
14.4% for the three months ended September 30, 2000. This percentage decrease
was primarily due to the reduced utilization of medical supplies of the 2001
acquisitions. Specifically, the acquisition of Phoenix Health Plan, which
utilizes virtually no supplies, accounts for 2.1% of this decrease. Supplies
expense at our existing facilities decreased slightly to 14.1% for the three
months ended September 30, 2001 from 14.3% of revenues for the three months
ended September 30, 2000. We believe that this decrease demonstrates our
ability to manage increasing pharmaceutical and other supply costs by utilizing
our revenue growth strategy to leverage these costs.
Other operating expenses. Other operating expenses increased by $32.6
million or 104.2% to $63.9 million for the three months ended September 30,
2001 from $31.3 million for the three months ended September 30, 2000. Other
operating expenses include medical claims expense, professional fees, purchased
services, rents and leases, repairs and maintenance, insurance, utilities,
non-income taxes, minority interests and other certain non-operating expenses.
Medical claims expense increased by $24.9 million due to the acquisition on May
1, 2001, of Phoenix Health Plan. Medical claims expense represents the amounts
paid by the Phoenix Health Plan for health care services provided to its
members including an estimate of incurred but not reported claims. Revenues and
expenses, between the Phoenix Health Plan and Vanguard's owned hospitals are
eliminated in consolidation. Operating expenses, other than medical expenses,
for the 2001 acquisitions accounted for approximately $6.3 million of the
increase. Other operating expenses as a percentage of revenues increased to
20.8% for the three months ended September 30, 2001 from 19.7% for the three
months ended September 30, 2000. This increase was primarily due to increases
in malpractice insurance and professional fees.
Provision for Doubtful Accounts. The provision for doubtful accounts
decreased $0.1 million or 0.6% to $16.3 million for the three months ended
September 30, 2001 from $16.4 million for the three months ended
September 30, 2000. The provision for doubtful accounts for the 2001
acquisitions was approximately $2.6 million. As a percentage of revenue, the
provision for doubtful accounts decreased to 7.9% for the three months ended
September 30, 2001 from 10.3% for the three months ended September 30, 2000.
The provision for doubtful accounts at our existing facilities decreased by
$2.7 million representing a decrease as a percentage of revenues to 8.6% for
the three months ended September 30, 2001 from 10.3% for the three months ended
September 30, 2000. The decrease in the provision for doubtful accounts is due
to the acquisition of Phoenix Health Plan which has no provision for doubtful
accounts and focused efforts by management to improve collections processes and
increase productivity of the hospital business offices. The provision for
doubtful accounts for the three months ended September 30, 2000 was negatively
impacted due to the integration of the hospitals acquired during fiscal 2000 to
our methodology of estimating and recording the provision for doubtful
accounts.
Depreciation and amortization. Depreciation and amortization expense
increased $1.0 million or 16.4% to $7.1 million for the three months ended
September 30, 2001 from $6.1 million for the three months ended
48
September 30, 2000. Substantially all of the increase relates to the
depreciation and amortization expense on the property, plant and equipment and
intangible assets acquired as part of the 2001 acquisitions. The remaining
increase relates to capital expenditures incurred during the three months ended
September 30, 2001. On July 1, 2001, we adopted the provisions of SFAS 141 and
142 which resulted in a re-allocation of the excess purchase price over net
assets acquired to goodwill and identifiable intangible assets. Under SFAS 141
and 142, goodwill and indefinite-lived intangible assets are no longer
amortized but are subject to annual impairment tests. The suspension of
goodwill amortization and the changes in classifications of identifiable
intangible assets and related remaining useful lives resulted in a decrease in
amortization expense of approximately $1.1 million for the three months ended
September 30, 2001 and would have decreased the reported amortization expense
for the three months ended September 30, 2000 by $0.5 million had SFAS 141 and
142 been adopted on July 1, 2000.
Interest Expense. Net interest expense increased $1.2 million or 25.0% to
$6.0 million for the three months ended September 30, 2001, compared to $4.8
million for the three months ended September 30, 2000. The increase in net
interest expense is due to the issuance of the old notes on July 30, 2001
offset by the repayment of the amounts outstanding under the 2000 credit
facility and other outstanding term loans of approximately $147.8 million. In
addition, we incurred deferred loan costs of approximately $11.5 million
related to the issuance of the old notes and $3.5 million for the establishment
of the 2001 senior secured credit facility. The deferred loan costs are being
amortized over the respective lives of the notes and the 2001 senior secured
credit facility. The aforementioned increases to net interest expense were
offset by an increase in interest income on invested cash of approximately $0.8
million for the three months ended September 30, 2001 compared to the three
months ended September 30, 2000.
Income from Continuing Operations. Income from continuing operations
before extraordinary items and income taxes increased $2.3 million to $2.5
million for the three months ended September 30, 2001 from $0.2 million for the
three months ended September 30, 2000. This increase reflected the operating
improvements instituted in 2001 and the additional income from acquisitions.
Income from continuing operations decreased $4.4 million to a loss of $4.2
million for the three months ended September 30, 2001 from $0.2 million for the
three months ended September 30, 2000. This decrease is due to an extraordinary
loss of $6.4 million, net of a tax benefit of $0.3 million, for the three
months ended September 30, 2001 and an increase in the provision for income
taxes to $0.3 million for the three months ended September 30, 2001, from
$11,000 for the three months ended September 30, 2000. The extraordinary loss
relates to remaining deferred loan costs under the 2000 credit facility that we
expensed upon entering into the 2001 senior secured credit facility in July
2001, fees incurred to terminate our interest rate collar agreement required by
the 2000 credit facility and fees incurred to terminate certain lease
agreements prior to their maturities.
Fiscal Year Ended June 30, 2001 Compared to the Fiscal Year Ended June 30,
2000
Revenues. Revenues increased $363.1 million to $667.8 million for the
fiscal year ended June 30, 2001 from $304.7 million for fiscal 2000. Of this
increase, $366.7 million related to increased revenue from acquisitions offset
by a decrease of $3.6 million that was primarily related to a decrease in
revenue at Maryvale Hospital. The increase in revenue also represents a 7.4%
increase in revenue per adjusted patient day and a 104.4% increase in adjusted
patient days. The decrease at Maryvale Hospital resulted from the loss of
several key physicians during the 2001 period that relocated their practices
outside of the Maryvale service area. Maryvale has recruited several new
physicians to the market.
Salaries and Benefits. Salaries and benefits increased $177.1 million to
$323.6 million for the fiscal year ended June 30, 2001 from $146.5 for fiscal
2000. This increase was mainly due to our acquisitions during the period. As a
percentage of revenue, salaries and benefits increased to 48.4% for the year
ended June 30, 2001 from 48.1% for the same period in 2000. This increase was
due to the higher level of patient acuity at the facilities we acquired during
fiscal 2000, which were included for the full fiscal year ended June 30, 2001.
Supplies. Supply costs increased $52.4 million to $92.9 million for the
fiscal year ended June 30, 2001 from $40.5 million for fiscal 2000. This
increase was primarily due to our acquisitions during the fiscal year ended
2000 that were included for the full year ended June 30, 2001. As a percentage
of revenue, supply expense increased to 13.9% for fiscal 2001 from 13.3% for
fiscal 2000. This increase was attributable to the higher level of patient
acuity
49
at the facilities we acquired. For example, MacNeal Hospital and Phoenix
Baptist Hospital both provide open-heart surgical procedures and significant
orthopedic procedures, both of which require more expensive surgical supplies.
Other Operating Expenses. Other operating expenses increased $79.2 million
to $143.4 million for the fiscal year ended June 30, 2001 from $64.2 million
for fiscal 2000. These expenses, which include professional fees, purchased
services, repairs and maintenance, rents, utilities, insurance, non-income
taxes and certain other non-operating expenses, increased due to our
acquisitions. As a percentage of revenue, other operating expenses increased to
21.5% for fiscal 2001 from 21.0% for fiscal 2000. This percentage increase
reflected a higher percentage of revenue in purchased service payments and
professional fee arrangements at the facilities acquired in fiscal 2001. As a
percentage of revenue, we have been able to reduce other operating expenses at
facilities owned for the entire fiscal year 2001 by reducing costs associated
with information systems at most of our facilities through staffing reductions
and software conversions. We expect to continue to be able to achieve costs
savings in the area of information systems as well as other purchased services
and professional fees.
Provision for Doubtful Accounts. The provision for doubtful accounts
increased $23.7 million to $56.8 million for the fiscal year ended June 30,
2001 from $33.1 million for fiscal 2000. This increase was due to our
acquisitions. As a percentage of revenue, the provision for doubtful accounts
decreased to 8.5% for fiscal 2001 from 10.8% for fiscal 2000. The decrease as a
percentage of revenue is primarily due to a lower bad debt experience rate at
the acquired facilities than the bad debt percentage at Maryvale Hospital.
Maryvale Hospital has a higher than average bad debt expense rate due to the
demographics of the market it serves. We believe that the recent expansion of
eligibility for the Arizona Medicaid program will help reduce bad debt expenses
at Maryvale Hospital.
Depreciation and Amortization. Depreciation and amortization expense
increased $12.0 million to $23.8 million for the fiscal year ended June 30,
2001 from $11.8 million for fiscal 2000. This increase was due to our
acquisitions. All of the acquisitions were accounted for using the purchase
method of accounting and we recorded approximately $74.5 million of intangible
assets for the acquisitions in fiscal 2001 and fiscal 2000. Amortization of
these intangibles was $5.3 million and $3.0 million in fiscal 2001 and 2000,
respectively.
Interest Expense. Interest expense increased $7.8 million to $16.6 million
for the fiscal year ended June 30, 2001 from $8.8 million for fiscal 2000. This
increase reflected the increase in outstanding debt borrowed from our 2000
credit facility and used as partial consideration to fund our acquisitions
during fiscal 2000. We incurred an additional $95.7 million of debt during
fiscal 2000 to finance our acquisitions and reduce certain assumed liabilities
from these acquisitions, all of which was outstanding for the full fiscal year
ended June 30, 2001.
Income from Continuing Operations. Income from continuing operations
before extraordinary items and income taxes increased $10.9 million to $10.7
million for the fiscal year ended June 30, 2001 from a loss of $0.2 million for
fiscal 2000. This increase reflected the operating improvements instituted in
2001 and the additional income from acquisitions. Income from continuing
operations increased $11.6 million to $10.2 million for the fiscal year ended
June 30, 2001 from a loss of $1.4 million for fiscal 2000. This increase was
due in part to the absence of the $1.1 million extraordinary loss we incurred
in 2000, partly offset by an increase in the provision for income taxes to $.5
million for the fiscal 2001 from $.1 million for fiscal 2000. The extraordinary
loss resulted from the write-off of the remaining unamortized loan costs
associated with our 1998 credit facility, which was repaid in 2000 when we
entered into the 2000 credit facility.
Fiscal Year Ended June 30, 2000 Compared to the Fiscal Year Ended June 30,
1999
Revenues. Revenues increased $213.2 million to $304.7 million for the
fiscal year ended June 30, 2000 from $91.5 million for fiscal 1999. Of this
increase, $221.6 million related to increased revenues from acquisitions and
the remaining decrease of $8.4 million was entirely related to a decrease in
revenues at Maryvale Hospital. The increase in revenue also represents a 3.6%
increase in revenue per adjusted patient day and a 223.0% increase in adjusted
patient days. The decrease at Maryvale Hospital primarily resulted from the
closure of the skilled nursing facility in October 1998, with such closure
having a full year impact in fiscal 2000.
50
Salaries and Benefits. Salaries and benefits, exclusive of non-cash stock
compensation, increased by $107.2 million to $146.5 million for the fiscal year
ended June 30, 2000 from $39.3 million for fiscal 1999. This increase was due
to our acquisitions during fiscal 2000. As a percentage of revenues, salaries
and benefits increased to 48.1% for fiscal 2000, from 43.0% in 1999. This
increase was due to the higher level of patient acuity at the facilities we
acquired during fiscal 2000 and due to efficiencies we achieved in labor
staffing standards at Maryvale Hospital in fiscal 1999 that were not fully
implemented at the acquired facilities in fiscal 2000.
Supplies. Supply costs increased $28.0 million to $40.5 million for the
fiscal year ended June 30, 2000, from $12.5 million for fiscal 1999. This
increase was primarily due to our acquisitions during fiscal 2000. As a
percentage of revenues, supply expense decreased to 13.3% for fiscal 2000, from
13.7% for fiscal 1999. This decrease was primarily due to our supply expense
management at Maryvale Hospital, as well as an existing efficient supply
expense management experience at West Anaheim Hospital and Huntington Beach
Hospital, which were included in our results of operations for ten months of
fiscal 2000.
Other Operating Expenses. Other operating expenses increased by $48.5
million to $64.2 million for the fiscal year ended June 30, 2000, from $15.7
million for fiscal 1999. This increase was due to our acquisitions. As a
percentage of revenues, other operating expenses, which includes professional
fees, purchased services, repairs and maintenance, rents, utilities, insurance,
non-income taxes and certain other non-operating expenses, increased to 21.0%
for fiscal 2000 from 17.1% for fiscal 1999. This increase reflected the higher
operating expense level in the acquired facilities as a percentage of revenues.
MacNeal Hospital, Phoenix Baptist Hospital, Arrowhead Community Hospital and La
Palma Hospital (which collectively represented 44.2% of our revenues for fiscal
2000) were all acquired in the last two quarters of fiscal 2000 and were not
able to implement many of our planned cost saving measures prior to year-end.
Provision for Doubtful Accounts. The provision for doubtful accounts
increased $15.8 million to $33.1 million for the fiscal year ended June 30,
2000, from $17.3 million for fiscal 1999. As a percentage of revenues, the
provision for doubtful accounts decreased to 10.8% for fiscal 2000, from 18.9%
for fiscal 1999. This decrease was primarily due to a lower bad debt expense
rate at the acquired facilities than the bad debt expense rate at Maryvale
Hospital. Maryvale Hospital has a higher than average bad debt expense rate due
to the demographics of the market it serves.
Depreciation and Amortization. Depreciation and amortization expense
increased by $7.9 million to $11.8 million for the fiscal year ended June 30,
2000, from $3.9 million for fiscal 1999. This increase was due to our
acquisitions. All of the acquisitions were accounted for using the purchase
method of accounting and approximately $71.8 million of intangible assets have
been recorded for the acquisition of Maryvale Hospital and MacNeal Hospital.
Amortization of these intangibles was $2.9 million in fiscal 2000 and $2.0
million in fiscal 1999.
Interest Expense. Interest expense increased by $4.6 million to $8.8
million for the fiscal year ended June 30, 2000, from $4.2 million for fiscal
1999. This increase reflects the increase in outstanding debt borrowed from our
existing credit facility and used as partial consideration to fund our
acquisitions during fiscal 2000. Our outstanding debt increased by $97.1
million to $153.3 million at June 30, 2000, from $56.2 million at June 30,
1999.
Income from Continuing Operations. Income from continuing operations
before extraordinary items and income taxes improved by $6.2 million to a loss
of $.2 million for the fiscal year ended June 30, 2000, from a loss of $6.4
million for fiscal 1999. This improvement reflected $8.4 million of additional
income resulting from our acquisitions, a decrease in non-cash stock
compensation of $5.0 million, offset by a decrease in income from continuing
operations at Maryvale Hospital of $7.2 million. This decrease at Maryvale
Hospital was primarily attributable to the loss in revenues noted above. Income
from continuing operations improved by $5.0 million to a loss of $1.4 million
for the fiscal year ended June 30, 2000, from a loss of $6.4 million for fiscal
1999. This improvement reflected the $1.1 million extraordinary loss on
extinguishment of debt we incurred related to the remaining unamortized loan
costs associated with our 1998 credit facility, which was replaced in February
2000. In addition, provision for income taxes increased to $.1 million for
fiscal 2000 from zero in fiscal 1999.
51
Liquidity and Capital Resources
As of September 30, 2001, we had working capital of $159.5 million,
including cash and cash equivalents of $149.6 million, compared to $18.0
million at June 30, 2001. The increase in working capital is primarily due to
an increase in cash from the issuance of the old notes on July 30, 2001. Cash
provided by operating activities increased to $11.2 million for the three
months ended September 30, 2001 from a deficit of $5.4 million for the three
months ended September 30, 2000. We were able to generate cash flows from
operations through improved net income before extraordinary items, improved
collections on accounts receivable and as a result of the timing of payments of
accrued expenses and other current liabilities.
Our liquidity is affected by the legal requirements of the Phoenix Health
Plan. Arizona laws and regulations require us to pay all claims made to the
Phoenix Health Plan within 60 days of receiving a bill for services rendered.
We were also required to post a $9.5 million surety bond for the benefit of the
Arizona Health Care System to support our obligations to pay for health care
services. In addition, we must maintain a ratio of current assets to current
liabilities of at least 1 to 1 at the Phoenix Health Plan.
Cash used in investing activities decreased to $8.6 million for the three
months ended September 30, 2001 from $9.1 million for the three months ended
September 30, 2000. Cash used in investing activities includes capital
expenditures, which we decreased to $4.6 million for the three months ended
September 30, 2001 from $7.8 million for the three months ended September 30,
2000. The funding of capital expenditures is in large part subject to the
timing of certain capital projects at Maryvale Hospital and Medical Center
("Maryvale") and Arrowhead Community Hospital and Medical Center and Phoenix
Baptist Hospital and Medical Center (together the "Phoenix Hospitals") required
pursuant to the respective purchase agreements for these facilities.
Pursuant to the terms of our acquisition of Maryvale Hospital, we agreed
to expend not less than $15.0 million for capital expenditures at Maryvale
Hospital during the first five years of our ownership. If we spend less than
$15.0 million, we must pay the party from which we acquired Maryvale Hospital
the difference between $15.0 million and the amount of capital expenditures we
actually make. As of September 30, 2001 we have made approximately $12.2
million in qualifying capital expenditures at Maryvale Hospital. We expect to
finance all these capital expenditures through our operating cash flow and to
complete this project in the next two to five years.
Pursuant to the terms of our acquisition of Arrowhead Community Hospital
and Medical Center and Phoenix Baptist Hospital and Medical Center we have
agreed to expend not less than $50.0 million for capital expenditures at these
facilities during the first seven years of our ownership and at least $6.0
million during each of the first seven years of our ownership. If we spend less
than $50.0 million, we must pay the party from which we acquired these
facilities the difference between $50.0 million and the amount of capital
expenditures we actually make. As of September 30, 2001 we have made
approximately $10.7 million in capital expenditures at these facilities. We
expect to finance all these capital expenditures through our operating cash
flow and to complete these required expenditures during the first five years
of ownership.
The decrease in capital expenditures was offset by an increase in
acquisition expenditures of approximately $2.1 million to $3.8 million for the
three months ended September 30, 2001 from $1.7 million for the three months
ended September 30, 2000. This increase was primarily due to a working capital
settlement payment made for the acquisition of Phoenix Health Plan.
California has a statute and regulations that require hospitals to meet
seismic performance standards. Hospitals that do not meet the standards may be
required to retrofit their facilities. California law requires that these
hospitals evaluate their facilities and develop a plan and schedule for
complying with the standards. Compliance plans, if necessary, must be filed
with the State of California by 2002. We have filed all of the necessary
documentation with the State of California that was required by January 1, 2002.
We expect that the cost of performing the necessary evaluations and filing the
documentation will be approximately $0.3 million. The estimated cost to comply
with the seismic regulations and standards required by 2008, is an additional
$10.1 million. Upon completion of the $10.1 million in improvements, the
California facilities will be compliant with the requirements of the seismic
regulations
52
through 2029. We estimate that the majority of the square footage in our
facilities will be compliant with the seismic regulations and standards
required by 2030 once we have completed such $10.1 million in improvements, but
we are unable at this time to estimate our costs for full compliance with the
2030 requirements.
Cash provided by financing activities was $134.9 million for the three
months ended September 30, 2001, an increase of $136.1 million from the deficit
of $1.2 million for the three months ended September 30, 2000. The increase was
primarily attributable to the issuance of $300 million of subordinated notes
offset by the repayment of all amounts outstanding under the 2000 credit
facility including the termination of the interest rate collar agreement, early
buyouts of certain capital leases and payments of deferred loan costs incurred
as part of the issuance of the subordinated notes and the execution of the
binding documents in respect of the 2001 senior secured credit facility.
As of September 30, 2001, we had 21,600 shares of Payable-In-Kind
Convertible Redeemable Preferred Stock ("PIK Preferred Stock") outstanding with
a liquidation value of $1,000 per share. The PIK Preferred Stock was issued
February 1, 2000 in connection with the acquisition of MacNeal Hospital. We
record dividends paid in additional shares of PIK Preferred Stock at 8% of the
liquidation value of the PIK Preferred Stock until January 31, 2008 and will
pay cash dividends thereafter until the January 31, 2015 maturity date. The PIK
Preferred Stock will automatically convert to common stock upon an initial
public offering of our common stock with gross proceeds to us of at least $50.0
million at a conversion price equal to the initial public offering price. We
may redeem the PIK Preferred Stock at any time, to the extent we have funds
legally available to do so. We are required to redeem the PIK Preferred Stock,
to the extent we have funds legally available to do so, on the earliest of 90
days after a change in control of Vanguard, 90 days after the sale of all or
substantially all of the assets of MacNeal Hospital, and January 31, 2015. The
price for any redemption will be $1,000 per share plus all accrued and unpaid
dividends to the redemption date. For further information on the terms of this
series of preferred stock, see "Our PIK Preferred Stock."
We believe that the working capital on hand and the availability under our
2001 senior secured credit facility is sufficient to meet our operating and
capital needs for the foreseeable future. Additionally, certain funds
controlled by Morgan Stanley Capital Partners (the "Capital Partners") have
entered into a subscription agreement with us to purchase an additional $322.3
million of our common stock to fund future acquisitions and cash flow needs.
Common stock purchases by the Morgan Stanley Capital Partners Funds ("Capital
Partners Funds") are subject to the approval of the Capital Partners' internal
Investment Committee. We intend to acquire additional hospitals and are
actively seeking acquisitions that fit our corporate growth strategy. These
acquisitions may, however, require financing in addition to the working capital
on hand and future cash flows from operations. Management continually assesses
its capital needs and may seek additional financing, including debt or equity
financing, as considered necessary to fund potential acquisitions or for other
corporate purposes.
Effects of Inflation and Changing Prices
The health care industry is labor intensive. Wages and other expenses
increase during periods of inflation and when labor shortages occur in the
marketplace. Various Federal, state and local laws have been enacted that, in
certain cases, limit our ability to increase prices. Revenues for acute care
hospital services rendered to Medicare patients are 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 deterioration in
inpatient volumes, changes in payer mix and growth in operating expenses in
excess of the increase in prospective payments under the Medicare program. We
expect that the average rate of increase in Medicare prospective payments will
continue to decline. 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.
We were exposed to interest rate changes, primarily as a result of a
floating interest rate on borrowings under our 2000 credit facility. As of
September 30, 2001, we have repaid all amounts outstanding under our 2000
credit facility and terminated the interest rate collar agreement with the
proceeds of the issuance of the old notes. The old
53
notes have a fixed interest rate of 9.75%. Each .125% incremental change in
floating market interest rates results in an annual opportunity cost or savings
to interest expense of approximately $0.8 million on our fixed rate debt.
Health Care Reform
In recent years, an increasing number of legislative proposals have been
introduced or proposed to Congress and in some state legislatures that would
significantly affect the services provided by and reimbursement to health care
providers in our markets. The cost of certain proposals would be funded in
significant part by reduction in payments by government programs, including
Medicare and Medicaid, to health care providers or by taxes levied on hospitals
or other providers. We are unable to predict which, if any, proposals for
health care reform will be adopted. Proposals adverse to our business may be
adopted.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"), which was required to be adopted in
fiscal years beginning after June 15, 1999. In May 1999, the effective date of
SFAS 133 was deferred until fiscal years beginning after June 15, 2000. Because
of our minimal use of derivatives, and the designation of the Collar as an
effective cash flow hedge instrument, the adoption of SFAS 133 did not have an
effect on our results of operations or financial position.
In December 1999, the Commission issued Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements" ("SAB 101"), which was required
to be adopted in the first quarter of fiscal years beginning after December 15,
1999. In June 2000, the effective date of SAB 101 was delayed until the fourth
quarter of calendar 2000 for fiscal years beginning after December 15, 1999.
The application of SAB 101 did not have an effect on our results of operations
or financial position.
In March 2000, the Financial Accounting Standards Board issued Financial
Accounting Standards Board Interpretation No. 44, "Accounting for Certain
Transactions Involving Stock Compensation--an interpretation of APB Opinion No.
25" ("FIN 44"), which became effective July 1, 2000, covering transactions
occurring after December 15, 1998. FIN 44 clarifies the application of APB
Opinion No. 25 relating to the definition of an employee, criteria for
determining whether an option plan qualifies as a noncompensatory option plan,
accounting consequences of various modifications to the terms of a previously
fixed stock option or award and the accounting for an exchange of stock
compensation awards in a business combination. The application of FIN 44 did
not have an effect on our results of operations or financial position.
During July 2001, the Financial Accounting Standards Board issued SFAS
141, "Business Combinations" and SFAS 142, "Goodwill and Other Intangible
Assets." SFAS 141 prohibits the use of the pooling-of-interests method for
business combinations initiated after June 30, 2001. SFAS 141, which also
includes the criteria for the recognition of intangible assets separately from
goodwill, is effective for any business combination accounted for by the
purchase method that is completed after June 30, 2001. SFAS 142, which includes
the requirement to test goodwill and indefinite-life intangible assets for
impairment rather than amortizing them, will be effective for fiscal years
beginning after December 15, 2001, with early adoption permitted for companies
with fiscal years beginning after March 15, 2001. In all cases, SFAS 142 must
be adopted as of the beginning of a fiscal year. We expect to adopt both
pronouncements effective July 1, 2001. Goodwill (excluding other identifiable
intangible assets) amortization expense for the years ended June 30, 1999, 2000
and 2001, was $.7 million, $.9 million and $2.4 million, respectively.
In August 2001, the FASB issued Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," ("SFAS 144") which supersedes SFAS 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," and the
accounting and reporting provisions of APB Opinion No. 30, "Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions." SFAS 144 removes goodwill from
its scope and clarifies other implementation issues related to SFAS 121. SFAS
144 also provides a single framework
54
for evaluating long-lived assets to be disposed of by sale. We do not expect
SFAS 144 to have a material effect on its results of operations or financial
position.
55
INDUSTRY OVERVIEW
The U.S. health care industry is very large and growing. According to the
U.S. Centers for Medicare and Medicaid Services, formerly known as the Health
Care Financing Administration, total annual U.S. health care expenditures grew
by an estimated 8.3% in 2000 to $1.3 trillion, representing 13.1% of the U.S.
gross domestic product. By 2010, it is estimated that total U.S. health care
spending will grow to $2.6 trillion, representing a compound annual growth rate
of 7.2% from 2000, and will account for approximately 15.9% of the total U.S.
gross domestic product.
Hospital care expenditures represent the largest segment of the health
care industry. According to the Centers for Medicare and Medicaid Services, in
2000, hospital care expenditures grew by 6.3% to $416 billion, accounting for
31.7% of total health care expenditures. The Centers for Medicare and Medicaid
Services further estimates that hospital care expenditures will increase to
approximately $721 billion by 2010, representing a compound annual growth rate
of 5.7% from 2000. We believe that there are several trends driving the growth
in the health care industry that will benefit well-positioned hospital
companies.
Hospital Industry Trends
Demographic Trends
According to the U.S. Census Bureau, there are approximately 35 million
Americans aged 65 or older in the United States today, comprising approximately
13% of the total U.S. population. By the year 2030 the number of these elderly
persons is expected to climb to 69 million, or 20% of the total population. Due
to the increasing life expectancy of Americans, the number of people aged 85
years and older is also expected to increase, from 4.3 million now to 8.5
million by the year 2030. This increase in life expectancy will increase demand
for health care services and, as importantly, the demand for innovative, more
sophisticated means of delivering those services. Hospitals, as the largest
category of care in the health care market, will be among the main
beneficiaries of this increase in demand.
Consolidation
During the late 1980s and early 1990s, there was significant industry
consolidation involving large, investor-owned hospital companies seeking to
achieve economies of scale. However, the industry is still dominated by
not-for-profit hospitals. According to the American Hospital Association, the
number of hospitals has declined from approximately 5,400 hospitals in the
United States in 1990 to approximately 5,000 hospitals in 1999, of which
approximately 85% are owned by not-for-profit and government entities, and this
trend is expected to continue for the next five years. While consolidation in
the hospital industry is expected to continue, we believe this consolidation
will now primarily involve not-for-profit hospital systems, particularly those
that are facing significant operating challenges. Among the challenges facing
many not-for-profit hospitals are:
o limited access to the capital necessary to expand and upgrade their
hospital facilities and range of services;
o poor financial performance resulting, in part, from the challenges
associated with changes in reimbursement;
o the need and ability to recruit primary care physicians and
specialists; and
o the need to achieve general economies of scale in order to reduce
operating and purchasing costs.
As a result of these challenges, we believe many not-for-profit hospitals
will increasingly look to be acquired by, or enter into strategic alliances
with, investor-owned hospital companies which can provide them with access to
capital, operational expertise and larger hospital networks.
56
Changing Economic Environment
Due to both cost containment and advancements in medical technology over
the past decade, many procedures that once required hospital visits with
overnight stays are now performed on an outpatient basis. According to the
American Hospital Association, the number of surgeries performed on an
inpatient basis declined from 1995 to 1999 at an average annual rate of 0.4%,
from 9.7 million in 1995 to 9.5 million in 1999. During the same period, the
number of outpatient surgeries increased at an average annual rate of 4.4%,
from 13.5 million in 1995 to 15.8 million in 1999. The mix of inpatient as
compared to outpatient surgeries shifted from a ratio of 41.9% inpatient to
58.1% outpatient in 1995 to a ratio of 37.6% inpatient to 62.4% outpatient in
1999. This trend from inpatient to outpatient services has affected hospital
revenues because it has led to a reduction in the average length of stay and,
as a result, lower inpatient utilization rates. Successful hospitals have been
able to adapt to this shift by offering more outpatient services, such as
ambulatory surgery, diagnostic imaging and primary care and occupational
medical clinics. The revenue impact of this reduction in the average length of
stay has been offset in part by recent increases in hospital admissions due to
the demographic changes and hospital consolidations discussed above. According
to the American Hospital Association, hospital admissions grew from 30.6
million in 1995 to 31.8 million in 1999. This recent increase reverses thirteen
years of declines in admissions beginning in 1984. Hospital revenues have been
enhanced recently as hospitals generally have been able to obtain rate
increases from commercial insurers. In addition, in the wake of the passage of
the Benefits Improvement Protection Act of 2000, hospitals have seen rate
increases from certain government payers as well. We believe that these recent
changes in the economic environment provide opportunities for well-managed
hospital companies to improve their financial performance.
57
BUSINESS
Company Overview
We are an owner and operator of acute care hospitals and other health care
facilities principally in urban and suburban markets. We acquired our first
hospital in 1998. As of November 15, 2001, we owned nine hospitals with a total
of 1,838 beds and related outpatient service locations complementary to the
hospitals providing health care services to the Phoenix, Arizona; Orange
County, California; and metropolitan Chicago, Illinois, markets. As of November
15, 2001, we also owned a Medicaid managed health plan, Phoenix Health Plan,
that serves more than 55,000 members in Arizona. We selectively acquire
hospitals where we identify an opportunity to improve operating performance and
profitability and increase market share, either through a network of hospitals
and other health care facilities or a single well-positioned facility. We have
financed our acquisitions with equity capital provided by management and
various funds controlled by Morgan Stanley Capital Partners and with debt.
On a pro forma basis, reflecting our recent acquisitions (other than our
acquisition of Paradise Valley Hospital on November 1, 2001) and the offering
of the old notes, for the year ended June 30, 2001, and for the three months
ended September 30, 2001, we had revenues of $802.1 million and $207.3 million,
respectively. For the year ended June 30, 2001, and for the three months ended
September 30, 2001, approximately 67.6% and 68.7% of our pro forma revenues
were derived from the Phoenix and Orange County markets, respectively, which
the U.S. Census Bureau projects to grow between 2000 and 2005 by 13.4% and
6.2%, respectively, rates that exceed the projected national average of 4.5%.
Our Competitive Strengths
Diversified Portfolio of Assets with a Broad Range of Services
We own and operate high-quality facilities in three separate geographic
markets, which diversifies our revenue base and reduces our exposure to any one
market. Our hospitals offer general acute care services, including intensive
care and coronary care units, radiology, orthopedic, oncology and outpatient
services and selected tertiary care services, including open-heart surgery and
level II neonatal intensive care. In determining the types of services we
provide, we actively assess the specific local requirements of our communities.
We then meet these requirements either at each of our individual facilities or
through our network of integrated facilities within the area. We believe that
our ability to leverage our network of facilities allows us not only to provide
a broad range of services in a market, but also to provide them in an efficient
and cost-effective manner. For example, in our Orange County market, we
consolidated the obstetrics units at two hospitals into one. The combined unit
was strengthened through increased patient volumes, more efficient staffing,
higher quality of care and lower operating costs, while making additional space
and resources available at the discontinued unit which we are now using to
provide other services.
Concentrated Local Market Positions in Attractive Markets
We have acquired 8 of our 9 hospitals in the high-growth markets of
Phoenix, Arizona and Orange County, California, with 5 hospitals in the Phoenix
market and 3 in the Orange County market. We believe that these local markets
are attractive because of their favorable demographics, competitive landscape,
payer mix and opportunities for expansion. In particular, we entered the
Phoenix and Orange County markets because they both have above average
population growth, attractive demographics and the potential for future
complementary acquisitions. We have further strengthened our presence in these
markets through the acquisitions we have made and the networks of facilities we
have formed. Most recently, in the Phoenix market, we acquired the Phoenix
Health Plan, a prepaid Medicaid managed health plan, which will help us to
broaden our patient base at our Phoenix hospitals by assisting eligible
patients to enroll in Arizona's state Medicaid program. To enter the
metropolitan Chicago area, we purchased a single, well-positioned and
highly-regarded hospital and a network of primary care centers in a market that
has a favorable payer base. In addition, the local market that we serve also
offers us opportunities to improve further the quality and breadth of services
being provided, as well as to reduce operating costs.
58
Proven Ability to Complete and Integrate Acquisitions
As of November 15, 2001, we have successfully completed the acquisition of
nine hospitals and related outpatient service locations complementary to the
hospitals and a prepaid Medicaid managed health plan. We believe our success at
completing acquisitions is due in large part to our disciplined approach to
making acquisitions. Before we acquire a facility we carefully review its
operations and develop a strategic plan that will confirm the feasibility of
improving its operating performance. In identifying ways to achieve this
improvement, we consider a variety of alternatives such as expanding services,
reducing operating costs, upgrading or rationalizing information systems,
implementing more efficient staffing and supply arrangements and improving bill
collection procedures.
Strong Management Team with Significant Equity Investment
Our senior management has an average of more than 20 years of experience
in the health care industry at various organizations, including OrNda
Healthcorp and HCA Inc. Almost all of our senior management has been with us
since our founding in 1997, and eight of our thirteen members of senior
management have worked together continuously managing health care companies for
the last six years. We believe the experience and continuity of our management
team greatly enhances the effective operation of our company. Our senior
management team also has a history of success in managing private and
publicly-owned hospital companies through periods of rapid growth, operating
turnaround and financial restructuring. To date, our senior management has
invested over $23 million in us and owns more than 18% of our outstanding
shares of common stock. We also rely on strong local management teams at each
of our facilities. Our local management teams work with our patients,
physicians and payers to identify the medical service needs of the local
communities we serve and develop clinical programs and capital expenditure
plans to meet these needs. In addition, the local management teams recruit
physicians to our hospitals and directly supervise the quality of patient care.
Business Strategy
Our objective is to provide high-quality, cost-effective health care
services in the communities we serve. The key elements of our business strategy
include the following:
Grow Through Selective Acquisitions
We will continue to pursue acquisitions which either expand our network
and presence in our existing markets or allow us to enter new urban and
suburban markets. In evaluating new acquisitions, we will continue to focus on
a variety of factors, including population growth, demographics, payer mix,
existing competition, opportunities to improve financial performance and
opportunities to expand services. Further, in entering a new market we evaluate
the opportunity to develop a local network of hospitals through additional
acquisitions within the market, as we have done in Phoenix and Orange County.
We believe that we will continue to have substantial acquisition opportunities
as other health care providers choose to divest facilities and as independent
hospitals, particularly not-for-profit hospitals, seek to capitalize on the
benefits of becoming part of a larger hospital company. In addition to
acquisitions, we will also evaluate the possibility of constructing new
facilities and pursuing strategic partnerships or joint ventures with existing
owners to expand our existing market presence or enter new markets.
Improve Operating Margins and Efficiency
We seek to position ourselves as a cost-effective provider of health care
services in each of our markets. As a result, we will continue to implement
initiatives at each of our facilities to further improve the financial
performance and operating efficiency of their operations. Some of our key
initiatives include:
o selectively upgrading information systems to provide more accurate
and timely clinical and financial information or rationalizing legacy
systems to provide information on a more cost-effective basis;
o improving our billing and collection processes to maximize our
collections and reduce our bad debt expense;
59
o implementing more efficient staffing, supply utilization and
inventory management;
o centralizing the provision of certain administrative and business
office functions within a local market or at the corporate level and
reducing outsourcing arrangements; and
o capitalizing on purchasing efficiencies through our relationship with
HealthTrust Purchasing Group, a leading national health care group
purchasing organization.
Increase Revenues Through Expansion of Services
We will continue to expand our facilities and range of services based on
the needs of the communities we serve. For example, we recently added
open-heart surgery at MacNeal Hospital and opened an outpatient surgery center
in Orange County. Our local management teams work closely with patients,
payers, physicians and medical staff to identify and prioritize the health care
needs of individual communities. For the 2002 fiscal year, we intend to make
additional investments at our facilities to:
o expand emergency room and operating room capacity;
o improve the convenience, quality and breadth of our outpatient
services;
o upgrade and expand specialty services, including cardiology, oncology
and obstetrics; and
o update our medical equipment technology, including diagnostic and
imaging equipment.
Recruit New Physicians and Maintain Strong Relationships with Existing
Physicians
We believe that maintaining strong relationships with physicians in each
of our markets improves the quality of services that our hospitals provide and
broadens our access to patients and payers. We recruit both primary and
specialty physicians who can provide services that we believe are currently
under served and in demand at our facilities. We believe we successfully
attract physicians as a result of, among other factors, the quality of our
facilities, the strength of our networks and the additional services we offer
them, including training programs, remote access to clinical information and
office space adjacent to our facilities. In the metropolitan Chicago market,
our affiliation with the University of Chicago, for which we host medical
residency programs, has been a particularly important element in our ability to
attract quality physicians to our hospital and the local community. We believe
that as we continue to strengthen our position in each of our markets, we will
be even better positioned to attract physicians to our facilities.
Continue to Develop Favorable Managed Care Relationships
We plan to increase the number of patients at our facilities and improve
our profitability by negotiating more favorable terms with managed care plans
and by entering into contracts with additional managed care plans. We believe
that we are attractive to managed care plans because of the geographic and
demographic coverage of our facilities in their respective markets, the quality
and breadth of our services and the expertise of our physicians. Further, we
believe that as we increase our presence and competitive position in our
markets, particularly as we develop our networks of hospitals, we will be
increasingly attractive to managed care plans and will be even better
positioned to negotiate more favorable managed care contracts.
Our Markets
Phoenix, Arizona
In the Phoenix market, as of November 15, 2001, we owned and operated five
hospitals with a total of 920 licensed beds and related outpatient service
locations complementary to the hospitals and a prepaid Medicaid managed health
plan. Phoenix is the seventh largest city in the U.S. and has been one of the
fastest growing major
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metropolitan areas in recent years. Our facilities primarily serve Maricopa
County, which encompasses most of the metropolitan Phoenix area. In 2000,
Maricopa County had a population of 3.1 million, representing a 44.8% increase
from 1990. The population in Maricopa County is projected to grow by 13.4%
between 2000 and 2005, which is approximately three times the national average
of 4.5% projected by the U.S. Census Bureau. For the year ended June 30, 2001
and for the three months ended September 30, 2001, exclusive of the Phoenix
Health Plan, we generated approximately 37.2% and 34.9% of our pro forma
revenues, respectively, and 30.2% and 24.6% of our pro forma Adjusted EBITDA,
respectively, in this market. Four of our hospitals in this market were
formerly not-for-profit hospitals with reputations for quality services. All of
the facilities are located in the western or northeastern parts of metropolitan
Phoenix, which are generally recognized as fast-growing residential areas with
younger populations. We believe that payers will choose to contract with us in
order to give their enrollees a comprehensive choice of providers in the
western and northeastern Phoenix areas. With the recent improvements in payer
rates generally and the pending substantial increased funding for low-income
patients provided by Proposition 204, which expands Medicaid coverage to an
estimated 137,600 to 185,000 additional individuals in Arizona, we are
well-positioned to develop our four hospitals into a network providing a
comprehensive range of integrated services, from primary care to tertiary
hospital services, to payers and their patients. See "Business--Phoenix Health
Plan--Proposition 204." We believe this will give us greater ability to
negotiate rate increases with managed care payers. Our recent purchase of five
diagnostic imaging centers will expand our network of services in Phoenix. Our
ownership of the Phoenix Health Plan will allow us to enroll in the health plan
eligible patients who would not otherwise be able to pay for their hospital
expenses. In addition, by managing the care of the health plan members, we
believe we will also increase the availability of medically necessary services
to such patients at our hospitals.
Orange County, California
In the Orange County market, as of October 1, 2001, we owned and operated
three hospitals with a total of 491 licensed beds and related outpatient
service locations complementary to the hospitals. Orange County is generally
regarded as one of the most economically vibrant regions in the U.S. in terms
of income levels and job growth. In 2000, Orange County had a population of 2.8
million, representing an 18.1% increase from 1990. The population in Orange
County is projected to grow by 6.2% between 2000 and 2005, which also exceeds
the national average of 4.5%. For the year ended June 30, 2001 and for the
three months ended September 30, 2001, we generated approximately 18.2% and
18.6% of our pro forma revenues, respectively, and 27.1% and 22.4% of our pro
forma Adjusted EBITDA, respectively, in this market.
Our Orange County health care facilities are well-equipped and
well-established in their respective communities, and together they provide a
full-range of health care services to their payers and patients. Managed care
relationships in Orange County are driven to a significant extent by a
hospital's relationships with physician independent practice associations. Our
senior management has significant experience operating hospitals in the Orange
County market and strong relationships with physician independent practice
associations from their previous employment with other hospital management
companies. As a result, we are leveraging their experience and relationships to
grow our market presence. In addition, we are experiencing revenue growth by
providing competitive pricing while at the same time enjoying locally the
benefits of the national trend of increased payer prices.
Metropolitan Chicago, Illinois
In the Chicago metropolitan area, as of November 15, 2001, we owned and
operated one hospital with 427 licensed beds located in Berwyn, Illinois, and
related outpatient service locations complementary to the hospital. The
community has a generally well-insured population. For the three months ended
September 30, 2001, only 3.4% of MacNeal's gross patient revenue was generated
from self-pay patients. The remaining 96.6% of gross patient revenue was
derived from services provided to patients insured by Medicare, Medicaid or
managed care plans. For the year ended June 30, 2001 and for the three months
ended September 30, 2001, we generated approximately 32.4% and 31.3% of our pro
forma revenues, respectively, and 52.4% and 56.3% of our pro forma Adjusted
EBITDA, respectively, in the metropolitan Chicago area.
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We chose MacNeal Hospital, an excellent former not-for-profit facility, as
our entry into the largely not-for-profit metropolitan Chicago area. MacNeal
Hospital is a large, well-equipped, university-affiliated hospital with a
strong reputation and medical staff. We have captured a large share of the
market for patients in the hospital's immediate surrounding area, which
encompasses the towns of Berwyn and Cicero, Illinois. Recently we have
increased our market share by obtaining a Certificate of Need for and opening
an open heart surgery program at the hospital. As a result, we now offer
tertiary services that patients would otherwise have to travel outside the
local community to receive. We have established a fully-integrated health care
system at MacNeal Hospital by operating free-standing primary care and
occupational medicine centers and a large commercial laboratory and by
employing over 70 physicians on our medical staff there, including more than 40
primary care physicians. Our network of 18 primary care and occupational
medicine centers allows us to draw patients to MacNeal Hospital from around the
metropolitan Chicago area. The hospital also enjoys the distinction of being
one of the few community hospitals in which the prestigious University of
Chicago Medical School has placed its medical students and residents.
Currently, MacNeal Hospital participates in the University of Chicago's
residency programs in internal medicine, general surgery, obstetrics/gynecology
and psychiatry. In addition, MacNeal Hospital runs a successful free-standing
program in family practice, one of the oldest such programs in the state of
Illinois. Our medical education programs help us to attract quality physicians
to both the hospital and our network of primary care and occupational medicine
centers.
Our Facilities
We owned and operated nine acute care hospitals as of November 15, 2001.
The following table contains information concerning our hospitals:
Number of
State Name Location Licensed Beds Date Acquired
- --------- ------------------------------------- ---------------- ------------- ------------------
Arizona Arrowhead Community Hospital and Glendale 115 June 1, 2000
Medical Center
Maryvale Hospital Medical Center Phoenix 239 June 1, 1998
Phoenix Baptist Hospital and Medical Phoenix 209 June 1, 2000
Center
Phoenix Memorial Hospital Phoenix 195 May 1, 2001
Paradise Valley Hospital Phoenix 162 November 1, 2001
California Huntington Beach Hospital Huntington Beach 131 September 1, 1999
La Palma Intercommunity Hospital La Palma 141 April 1, 2000
West Anaheim Medical Center Anaheim 219 September 1, 1999
Illinois MacNeal Hospital Berwyn 427 February 1, 2000
In addition to the hospitals listed in the table above, as of November 15,
2001, we owned certain outpatient service locations complementary to our
hospitals. We also own and operate medical office buildings in conjunction with
our hospitals, some of which are joint ventures, which are primarily occupied
by physicians practicing at our hospitals. Our headquarters are located in
approximately 30,000 square feet of leased space in one office building in
Nashville, Tennessee.
Our hospitals and other facilities are suitable for their respective uses
and are, in general, adequate for our present needs.
In certain circumstances involving the purchase of a not-for-profit
hospital, we have agreed and in the future may agree to certain limitations on
our ability to sell those facilities. In particular, when we acquired MacNeal
Hospital in February 2000, we granted to the seller for three years after
closing a right of first refusal to purchase the
62
hospital if we agreed to sell it to a third party, at the same price on which
we agreed to sell it to the third party. In addition, when we acquired Phoenix
Baptist Hospital and Medical Center and Arrowhead Community Hospital and
Medical Center in June 2000, we agreed not to sell either hospital for five
years after closing and granted to The Foundation for Baptist Health Systems
for ten years after closing a right of first refusal to purchase the hospitals
if we agreed to sell either of them to a third party, at the same price on
which we agreed to sell that hospital to the third party.
Hospital Operations
Our hospitals typically provide the full range of services commonly
available in acute care hospitals, such as internal medicine, general surgery,
cardiology, oncology, neurosurgery, orthopedics, obstetrics, diagnostic and
emergency services, as well as select tertiary services such as open-heart
surgery and level II neonatal intensive care. Our hospitals also generally
provide outpatient and ancillary health care services such as outpatient
surgery, laboratory, radiology, respiratory therapy and physical therapy. We
also provide outpatient services at our ambulatory surgery centers. Certain of
our hospitals have a limited number of licensed psychiatric beds.
Our senior management team has extensive experience in operating
multi-facility hospital networks and focuses on strategic planning for our
facilities. A hospital's local management team is generally comprised of a
chief executive officer, chief financial officer and chief nursing officer, and
it may, in certain cases, manage multiple hospitals in the same market. Local
management teams, in consultation with our corporate staff, develop annual
operating plans setting forth revenue growth strategies through the expansion
of offered services and the recruitment of physicians in each community, as
well as plans to improve operating efficiencies and reduce costs. We believe
that the ability of the local management team to identify and meet the needs of
our patients, medical staff and the community as a whole is critical to the
success of our hospitals. We base the compensation for each local management
team in part on its ability to achieve the goals set forth in the annual
operating plan.
Boards of trustees at each hospital, consisting of local community
leaders, members of the medical staff and the hospital administrator, advise
the local management teams. Members of each board of trustees are identified
and recommended by our local management teams and serve three-year staggered
terms. The boards of trustees establish policies concerning medical,
professional and ethical practices, monitor these practices and ensure that
they conform to our high standards. We maintain company-wide compliance and
quality assurance programs and use patient care evaluations and other
assessment methods to support and monitor quality of care standards and to meet
accreditation and regulatory requirements.
We also implement systematic policies and procedures at each hospital we
acquire in order to improve its operating and financial performance. These
include ethics, quality assurance and compliance programs, supply and equipment
purchasing and leasing contracts, managed care contracting, accounting,
financial and clinical systems, governmental reimbursement, personnel
management and resource management. We provide our local management with
corporate assistance in implementing and maintaining these policies and
procedures. These uniform policies and procedures provide us with consistent
management and financial reports for all our facilities and facilitate the
performance evaluation of each facility. In addition, the managed care
contracting procedures we implement allow us to negotiate with managed care
payers on a market-wide basis and minimize our exposure under any capitated or
"at-risk" contracts.
Hospital revenues depend primarily upon inpatient occupancy levels, the
volume of outpatient procedures and the charges or negotiated payment rates for
the services provided. Reimbursement rates and charges for routine services
vary significantly depending on the type of services provided, the payer and
the market in which the hospital is located.
We believe that the most important factors affecting the utilization of a
hospital are the quality and market position of the hospital and the number,
quality and specialties of physicians and medical staff caring for patients at
the facility. Overall, we believe that the attractiveness of a hospital to
patients, physicians and payers depends on its breadth of services, level of
technology, emphasis on quality of care and convenience for patients and
physicians.
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Other factors which affect utilization include local demographics
and population growth, local economic conditions and managed care market
penetration.
The following tables set forth certain operating statistics for hospitals
owned by us for the periods indicated. Acute care hospital operations are
subject to certain fluctuations due to seasonal cycles of illness and weather,
including increased patient utilization during the cold weather months and
decreases during holiday periods.
Three Months Ended
Year Ended June 30, September 30,
----------------------------------------- -------------------
1998 1999 2000 2001 2000 2001
------ ------ ------- ------- ------ ------
Number of hospitals at end of period......... 1 1 7 8 7 8
Number of licensed beds at end of period(a).. 239 239 1,481 1,676 1,481 1,676
Weighted average licensed beds(b)............ 20 239 771 1,514 1,481 1,676
Discharges(c)................................ 1,191 12,447 31,864 65,237 15,735 17,352
Adjusted discharges-hospitals(d)............. 1,760 19,811 50,661 104,188 24,411 25,920
Patient days(e).............................. 3,611 40,906 123,675 267,438 63,089 68,514
Adjusted patient days - hospitals(f)......... 5,455 64,359 189,419 401,770 97,552 102,298
Average length of stay (days)(g)............. 3.1 3.2 4.1 4.1 4.0 4.0
Average daily census(h)...................... 120.0 112.0 701.4 728.8 745.0 686.0
Occupancy rate(i)............................ 50.2% 46.9% 46.1% 42.5% 46.3% 44.4%
(a) Licensed beds are those beds for which a facility has been granted
approval to operate from the applicable state licensing agency.
(b) Represents the average number of licensed beds, weighted based on periods
owned.
(c) Represents the total number of patients discharged (in the facility for a
period in excess of 23 hours) to our hospitals and is used by management
and certain investors as a general measure of inpatient volume.
(d) Adjusted discharges-hospitals is used by management and certain investors
as a general measure of combined inpatient and outpatient volume and is
computed by multiplying discharges by the sum of gross hospital inpatient
and outpatient revenues and then dividing the result by gross inpatient
revenues. This computation "equates" outpatient revenues to the measure
used to measure inpatient volume resulting in a general measure of
combined inpatient and outpatient volume.
(e) Patient days represent the number of days in which patients stay overnight
at the hospital during the respective period (overnight stay defined as
patients who occupy beds as of midnight of any given day). Management and
certain investors commonly use patient days as an indicator of hospital
volume including length of stay factors.
(f) Adjusted patient days-hospitals is used by management and certain
investors as a general measure of combined inpatient and outpatient volume
representative of admissions and length of stay data. Adjusted patient
days-hospitals is calculated by multiplying patient days by the sum of
hospital gross inpatient and outpatient revenues and then dividing the
result by gross hospital inpatient revenues.
(g) Average length of stay represents the average number of days admitted
patients stay in our hospitals.
(h) Represents the average number of patients in the hospitals each day during
our ownership.
(i) Represents the percentage of hospital licensed beds occupied by patients.
Both average daily census and occupancy rate provide measures of the
utilization of inpatient rooms.
We have responded to the general shift in the industry toward outpatient
care through our ambulatory surgery centers in Orange County, our outpatient
diagnostic imaging centers in Phoenix and our network of primary care and
occupational medicine centers in metropolitan Chicago. In addition, we are
providing more and a greater variety of outpatient services at our hospitals,
where we can deliver needed services on a cost-effective basis. Further,
inpatient care is shifting towards sub-acute care where appropriate, and we
offer cost-effective sub-acute services as appropriate, such as in
rehabilitation units. These units provide a range of necessary services at
lower cost through less intensive staffing levels.
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Phoenix Health Plan
Phoenix Health Plan is a prepaid Medicaid managed health plan in the
Phoenix area that we acquired in connection with the acquisition of Phoenix
Memorial Hospital, effective May 1, 2001. We acquired the Phoenix Health Plan
because it enables us to enroll in the health plan eligible patients at our
hospitals who otherwise would not be able to pay for their hospital expenses.
In addition, we believe we will also increase the availability of medically
necessary services to such patients at our hospitals. We believe the volume of
patients generated through the health plan will help attract quality physicians
to our hospitals.
For the year ended June 30, 2001, and for the three months ended September
30, 2001, we derived approximately $97.4 million and $31.3 million, or 12.2%
and 15.2%, respectively, of our revenues from Phoenix Health Plan. Phoenix
Health Plan had approximately 55,000 enrollees as of October 1, 2001, and
derives substantially all of its revenues through a contract with the Arizona
Health Care Cost Containment System, or the "Arizona Health Care System" which
is Arizona's state Medicaid program. The contract requires Phoenix Health Plan
to arrange for health care services for enrolled Medicaid patients in exchange
for fixed periodic payments and supplemental payments from the Arizona Health
Care System. Phoenix Health Plan subcontracts with physicians, hospitals and
other health care providers to provide services to its enrollees. These
services are provided regardless of the actual costs incurred to provide these
services. We receive reinsurance and other supplemental payments from the
Arizona Health Care System to cover certain costs of health care services that
exceed certain thresholds.
We have provided a performance guaranty in the form of a surety bond in
the amount of $9.5 million for the benefit of the Arizona Health Care System to
support our obligations under the contract to provide and pay for the health
care services required. The amount of the performance guaranty that the Arizona
Health Care System requires is based upon the membership in the health plan and
the related capitation paid to us. We currently do not expect a material
increase in the amount of the performance guaranty during the 2002 fiscal year.
Our contract with the Arizona Health Care System commenced on October 1,
1997, for an initial term of one year and originally reserved to the Arizona
Health Care System the annual option to extend the term of the contract through
September 30, 2002. The Arizona Health Care System and Phoenix Health Plan
recently amended the contract to extend the term through September 30, 2003. In
the event the contract with the Arizona Health Care System were to be
discontinued, our revenues would be reduced and profitability could be
adversely affected.
Proposition 204
Proposition 204 was passed by Arizona voters in November 2000, and
requires that tobacco settlement funds be used to increase the Arizona Health
Care System eligibility income limits for full acute care medical coverage to
100% of the Federal poverty level. Arizona's share of such settlement funds has
been estimated by the State to be $3.2 billion. Prior to Proposition 204,
Arizona Health Care System coverage generally excluded those persons earning
more than 34% of the Federal poverty level, but as of October 1, 2002, coverage
has been expanded to 100% of the federal poverty level. As a result of this
initiative, the State of Arizona estimates that the Arizona Health Care System
will enroll by 2005 between 137,600 and 185,000 new, low-income persons. The
Federal poverty level is a Federal standard that changes each year in April.
Usually, it is adjusted upward by a small percentage. As of June 30, 2001, the
Federal poverty level for a single individual was $8,350 of income per year.
The State of Arizona has announced that the new, more liberal, Arizona
Health Care System enrollment policies will be in place by the end of 2001,
with some categories of enrollees phased in before then. Also, the State has
announced that parents whose children are eligible for the Arizona Health Care
System can apply for coverage with the State commencing July 1, 2001, and that
all other currently uncovered persons can apply for coverage commencing October
1, 2001.
We expect that the effect of Proposition 204 will be to increase our
enrollment in the Phoenix Health Plan by our share of the new enrollees, with a
corresponding increase in the health plan's revenues. In addition, we expect
our hospitals in the Phoenix market will soon see more low income patients who
are covered by the Arizona Health
65
Care System. This should increase paid admissions with a governmental payer
which provides reimbursement for hospital services at rates higher than most
other current payers in the Phoenix market.
Our Information Systems
We believe that our information systems must cost-effectively meet the
needs of our hospital management, medical staff and nurses in the following
areas of our business operations:
o patient accounting, including billing and collection of revenues;
o financial, accounting, reporting and payroll;
o coding and compliance;
o laboratory, radiology and pharmacy systems;
o medical records and document storage;
o materials and asset management; and
o negotiating, pricing and administering our managed care contracts.
Although we map the information systems from each of our hospitals to one
centralized database, we do not automatically standardize our information
systems among all of our hospitals. We carefully review existing systems at the
hospitals we acquire and, if a particular information system is unable to
cost-effectively meet the operational needs of the hospital, we will convert or
upgrade the information system at that hospital to one of several standardized
information systems that can cost-effectively meet these needs. We have
recently converted and upgraded our clinical and financial information systems
in four of our nine hospitals in order to improve efficiency and profitability.
We plan to complete similar conversions at three of our other hospitals no
later than February 2002.
Sources of Revenues
We receive payment for patient services from:
o the Federal government, primarily under the Medicare program;
o state Medicaid programs; and
o health maintenance organizations, preferred provider organizations,
other private insurers and individual patients.
The table below presents the approximate percentage of patient revenues we
received from the following sources for the periods indicated:
Three Months Ended
Year ended June 30, September 30
------------------------------ --------------------
Revenues by Payer Source 1999 2000 2001 2000 2001
------ ------ ------ ------ ------
Medicare................................... 16% 22% 15% 25% 23%
Medicaid................................... 26 6 5 5 6
Managed care plans, private insurance
and other private contracts............ 58 72 80 70 71
--- --- --- --- ---
Total................................ 100% 100% 100% 100% 100%
=== === === === ===
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We believe that reductions in Medicare payments as a percentage of our
revenues, renegotiation of our managed care contracts and increased penetration
of commercial insurance companies in our markets have resulted in an increase
in the percentage of revenues from managed care plans, private insurance
companies and other private sources.
Most of our hospitals offer discounts from established charges to private
managed care plans if they are large group purchasers of health care services.
These discount programs limit our ability to increase charges in response to
increasing costs. Patients generally are not responsible for any difference
between established hospital charges and amounts reimbursed for such services
under Medicare, Medicaid, some private insurance plans, health maintenance
organizations or preferred provider organizations, but are generally
responsible for services not covered by these plans, exclusions, deductibles
and co-insurance features of their coverages. The amount of these exclusions,
deductibles and co-insurance has generally been increasing each year.
Collecting amounts due from individual patients is typically more difficult
than collecting from governmental or private managed care plans.
Competition
The hospital industry is highly competitive. We currently face competition
from established, not-for-profit health care companies, investor-owned hospital
companies, large tertiary care centers and outpatient service providers.
Our 5 hospitals with 920 licensed beds licensed in the Phoenix
metropolitan area compete with over 20 other hospitals and numerous outpatient
providers in this market. Our largest competitor in this market is the
not-for-profit Banner Health System which owns 6 hospitals with 2,030 licensed
beds in the Phoenix metropolitan area.
Our 3 hospitals with 491 licensed beds in Orange County, California
compete with over 95 other hospitals and numerous outpatient providers in the
Los Angeles/Orange County metropolitan area. Our largest competitors in this
market are the investor-owned Tenet Healthcare Corporation which owns 28
hospitals with 5,550 licensed beds and the not-for-profit Memorial Health
Services which owns 5 hospitals with 1,615 licensed beds in the Los
Angeles/Orange County metropolitan area.
Our MacNeal Hospital with 427 licensed beds in Berwyn, Illinois competes
with over 60 other hospitals and numerous outpatient providers in the Chicago
metropolitan area. Our largest competitors in this market are the not-for-
profit Advocate Health Care which owns 10 hospitals with 3,271 licensed beds
and the not-for-profit Resurrection Health Care which owns 8 hospitals with
2,596 licensed beds in the Chicago metropolitan area.
In the future, we expect to encounter increased competition from
companies, like ours, that consolidate hospitals and health care companies in
specific geographic markets. Continued consolidation in the health care
industry will be a leading factor contributing to increased competition both in
markets in which we already have a presence and in markets we may enter in the
future. The competition among hospitals and other health care providers for
patients has intensified in recent years. Some of our competitors are larger
and have more resources than we do.
One of the most important factors in the competitive position of a
hospital is its location, including its geographic coverage, and access to
patients. A location convenient to a large population of potential patients or
a wide geographic coverage area through a hospital network can make a hospital
significantly more competitive. Another important factor is the scope and
quality of services a hospital offers, whether at a single facility or through
a network, compared to the services offered by its competitors. A hospital that
offers a broad range of services and has a strong local market presence is more
likely to obtain favorable managed care contracts. We intend to evaluate
changing circumstances in the geographic areas in which we operate on an
ongoing basis to ensure that we offer the services and have the access to
patients necessary to compete in these managed care markets and, as
appropriate, to form our own, or join with others to form, local hospital
networks.
A hospital's competitive position also depends on the quality and scope of
the practices of physicians associated with the hospital. Physicians refer
patients to hospitals primarily on the basis of the quality and scope of
services
67
provided by the hospital, the quality of the medical staff and employees
affiliated with the hospital, the hospital's location and the quality and age
of the hospital's equipment and physical plant. Although physicians may
terminate their affiliation with our hospitals, we seek to retain physicians of
varied specialties on our medical staffs and to recruit other qualified
physicians by maintaining and improving our level of care and providing quality
facilities, equipment, employees and services for physicians and their
patients.
A number of other factors affect our competitive position, including:
o our reputation;
o our managed care contracting relationships;
o the physical condition of our facilities and medical equipment;
o the amounts we charge for our services; and
o the restrictions of state Certificate of Need laws.
Employees and Medical Staff
As of September 30, 2001, we had approximately 7,300 employees, including
approximately 2,300 part-time employees. Our employees are not subject to
collective bargaining agreements, and we consider our employee relations to be
good. In the industry as a whole, and in our markets, there is currently a
shortage of nurses and other medical support personnel. We recruit and retain
nurses and medical support personnel by creating desirable, professional work
environments and offering competitive wages, benefits and long-term incentives.
In addition, we provide career development and other training programs. In
order to supplement our current employee base, we intend to expand our
relationship with colleges, universities and other medical education
institutions in our markets and recruit nurses and other medical support
personnel from abroad.
Our hospitals are staffed by licensed physicians who have been admitted to
the medical staff of our individual hospitals and may be on the medical staff
of several hospitals, including hospitals not owned by us. A physician who is
not an employee can terminate his affiliation with our hospital at any time.
Although we employ a number of physicians, particularly at MacNeal Hospital, a
physician does not have to be an employee of ours to be a member of the medical
staff of one of our hospitals. Any licensed physician may apply to be admitted
to the medical staff of any of our hospitals, but admission must be approved by
each hospital's medical staff and board of trustees.
Compliance Program
We have voluntarily initiated a company-wide compliance program designed
to ensure that we maintain high standards of conduct in the operation of our
business and implement policies and procedures so that our employees act in
compliance with all applicable laws, regulations and company policies. The
organizational structure of our compliance program includes oversight by our
board of directors and a high level corporate management compliance committee.
The board and this committee has the responsibility for the effective
development and implementation of our program. Our Senior Vice
President--Compliance and Ethics, who reports jointly to our Chief Executive
Officer and to our board of directors, serves as Chief Compliance Officer and
is charged with direct responsibility for the development and implementation of
our compliance program. Other features of our compliance program include
initial and periodic training and effectiveness reviews, the development and
implementation of policies and procedures and a mechanism for employees to
report, without fear of retaliation, any suspected legal or ethical violations.
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Insurance
As is typical in the health care industry, we are subject to claims and
legal actions by patients and others in the ordinary course of business. To
cover these claims, we self-insure our general and professional risks up to
$1.0 million on a per-occurrence basis and up to $13.2 million on an aggregate
per-claim basis. For losses above the self-insurance limits, we maintain
insurance from unrelated commercial carriers on an occurrence basis for general
liability and a claims-made basis for professional liability up to $100.0
million per occurrence and in the aggregate. Losses up to our self-insured
limits and any losses incurred in excess of amounts maintained under such
insurance will be funded from our cash flow. At various times in the past, the
cost of malpractice and other liability insurance has risen significantly. This
insurance may not continue to be available at reasonable prices that will allow
us to maintain adequate levels of coverage. Our future cash flow may not be
adequate to provide for professional and general liability claims in the
future.
Legal Proceedings
We are involved in litigation and proceedings in the ordinary course of
our business. We do not believe the outcome of any such litigation,
individually or in the aggregate, will have a material adverse effect upon our
business, financial condition or results of operations.
We have received a notice objecting to our use of the mark "Vanguard." We
have filed an opposition to the objecting party's registration of the mark,
"Vanguard Healthcare." The Patent and Trademark Office has approved our service
mark application for form and registerability, subject to the issuance or
abandonment of the objecting party's application. We do not brand our hospitals
with the Vanguard name and we do not believe that a negative outcome in this
administrative proceeding would have a material adverse effect upon our
business, financial condition or results of operations.
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REIMBURSEMENT
Medicare
Under the Medicare program, acute care hospitals generally receive
reimbursement under a prospective payment system for inpatient hospital
services. Psychiatric units, long-term care units, rehabilitation units,
specially designated children's hospitals and certain designated cancer
research hospitals, as well as psychiatric or rehabilitation units that are
distinct parts of a hospital and meet the Centers for Medicare and Medicaid
Services criteria for exemption, are currently exempt from the prospective
payment system and are reimbursed on a cost-based system, subject to certain
cost limits known as TEFRA (an acronym for the Tax Equity and Fiscal
Responsibility Act of 1982) limits.
Under the prospective payment system, fixed payment amounts per inpatient
discharge are established based on the patient's assigned diagnosis related
group. Diagnosis related groups classify treatments for illnesses according to
the estimated intensity of hospital resources necessary to furnish care for
each principal diagnosis. Diagnosis related group rates have been established
for each hospital participating in the Medicare program and are based upon a
statistically normal distribution of severity, and adjusted for area wage
differentials, but they do not consider a specific hospital's costs. Diagnosis
related group rates are updated and recalibrated annually and have been
affected by several recent Federal enactments. The index used to adjust the
diagnosis related group rates, known as the "market basket index," gives
consideration to the inflation experienced by hospitals (and entities outside
of the health care industry) in purchasing goods and services. Although for
several years the percentage increases to the diagnosis related group rates
have been lower than the percentage increases in the costs of goods and
services purchased by hospitals, the Benefits Improvement Protection Act of
2000 (the "Benefits Improvement Protection Act") has updated the rates
hospitals receive so that hospitals generally will receive the market basket
index minus 1.1% for discharges occurring on or after October 1, 2000, and
before April 1, 2001, or the market basket index plus 1.1% for discharges
occurring on or after April 1, 2001, and before October 1, 2001. For Federal
fiscal years 2002 and 2003, hospitals generally will receive the market basket
index minus 0.55%. For Federal fiscal year 2004, hospitals generally will
receive the full market basket. Future legislation may decrease the rate of
increase for diagnosis related group payments, which could make it more
difficult for us to grow our revenues and to maintain or improve our operating
margin.
Until August 1, 2000, outpatient services provided at general acute care
hospitals were typically reimbursed by Medicare based on a fee schedule. The
Balanced Budget Act of 1997 (the "Balanced Budget Act") contains provisions
that affect outpatient hospital services, including a requirement that the
Centers for Medicare and Medicaid Services adopt a prospective payment system
for outpatient hospital services, which became effective August 1, 2000. Based
on provisions of the Benefits Improvement Protection Act , the fee schedule is
to be updated by the market basket index minus 0.8% and 1.0% for Federal fiscal
years 2001 and 2002, respectively, and the full market basket index for Federal
fiscal years 2003 and beyond. Similarly, since January 1, 1999, therapy
services rendered by hospitals to outpatients and inpatients not reimbursed
under Medicare are reimbursed according to the Medicare physician fee schedule.
The fiscal intermediaries have had some difficulties processing payments timely
and accurately under the outpatient prospective payment system. The Centers for
Medicare and Medicaid Services identified certain information system issues
relating to the processing of payments for outpatient prospective payment
system claims.
Payments for Medicare skilled nursing facility services and home health
services have historically been paid based on costs, subject to certain
adjustments and limits. Although the Balanced Budget Act mandates a prospective
payment system for skilled nursing facility services, home health services and
inpatient rehabilitation hospital services, the Benefits Improvement Protection
Act has made adjustments to the prospective payment system payments for these
health care service providers. Specifically, for skilled nursing facilities,
the Balanced Budget Act set the annual inflation update at the market basket
index minus 1.0% for 2001 and 2002. However, the Benefits Improvement
Protection Act adjusts the update to the full market basket index in 2001 and
the market basket index minus 0.5% in 2002 and 2003. In addition to the
creation of a prospective payment system for skilled nursing, the Balanced
Budget Act also institutes consolidated billing for skilled nursing facility
services, under which payments for most non-physician services will be made to
the facility for beneficiaries no longer eligible for skilled nursing
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facility care, regardless of whether the item or service was furnished by the
facility, by others under arrangement, or under any other contracting or
consulting arrangement. Consolidated billing is being implemented on a
transition basis.
In addition to establishing a prospective payment system for home health
services, the Balanced Budget Act requires a 15% reduction in limits on
payments to home health agencies, although the Benefits Improvement Protection
Act delayed the implementation of this reduction until 2002.
Payments to prospective payment system-exempt hospitals and units, such as
inpatient psychiatric, rehabilitation and long-term hospital services, are
based upon reasonable cost, subject to a cost-per-discharge target. These
limits are updated annually by a market basket index. Significantly, the
Benefits Improvement Protection Act increases payments to prospective payment
system-exempt hospitals. In particular, total payments for rehabilitation
hospitals in 2002 are to equal the amounts of payments that would have been
made if the rehabilitation prospective payment system had not been enacted, and
rehabilitation facilities are able to make a one-time election before the start
of the prospective payment system to be paid based on a fully phased-in
prospective payment system rate. Furthermore, the Benefits Improvement
Protection Act increases the incentive payments paid for inpatient psychiatric
services from 2% to 3%, raises the national cap on long term care hospital
reimbursement by 2% and increases the individual long-term care hospital target
amounts by 35%.
On November 19, 1999, Congress passed the Balanced Budget Refinement Act
of 1999 (the "Refinement Act") to reduce certain of the perceived adverse
effects of the Balanced Budget Act on various health care providers. Among
other things, the Refinement Act eliminated certain outpatient prospective
payment system reimbursement reductions proposed by the Centers for Medicare
and Medicaid Services as a part of its implementation of a prospective payment
system for outpatient hospital services in an attempt to limit certain losses
hospitals were projected to sustain during the first three years of
implementation of such system. The Refinement Act also provided certain
reimbursement increases for certain skilled nursing facilities, in part by
allowing such facilities the option of choosing to be reimbursed at the new
Federal prospective payment system rate for certain cost reporting periods
beginning after December 15, 1999, as opposed to the three-year phase-in
described above.
Medicaid
Most state Medicaid payments are made under a prospective payment system
or under programs which negotiate payment levels with individual hospitals. In
Arizona, Arizona Health Care System administers the state Medicaid program
through the use of prepaid health plans. Phoenix Health Plan is reimbursed by
Arizona Health Care System for health care costs that exceed stated levels at a
rate of 75% (85% for catastrophic cases) of qualified health care costs in
excess of the stated levels of $5,000 to $35,000, depending on the rate code
assigned to the member. Qualified health care costs are the lesser of the
amount paid by Phoenix Health Plan or the Arizona Health Care System fee
schedule. Phoenix Health Plan then reimburses the hospital at which the patient
received care.
Medicaid reimbursement is often less than a hospital's cost of services.
Medicaid is currently funded jointly by state and Federal governments. The
Federal government and many states are currently considering significant
reductions in the level of Medicaid funding while at the same time expanding
Medicaid benefits, which could adversely affect future levels of Medicaid
reimbursement received by our hospitals.
Annual Cost Reports
All hospitals participating in the Medicare and Medicaid programs, whether
paid on a reasonable cost basis or under a prospective payment system, are
required to meet specific financial reporting requirements. Federal regulations
require submission of annual cost reports identifying medical costs and
expenses associated with the services provided by each hospital to Medicare
beneficiaries and Medicaid recipients. Annual cost reports required under the
Medicare and Medicaid programs are subject to routine audits, which may result
in adjustments to the amounts ultimately determined to be due to us under these
reimbursement programs. The audit process, particularly in the case of
Medicaid, takes several years to reach the final determination of allowable
amounts under the
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programs. Providers also have the right of appeal, and it is common to contest
issues raised in audits of prior years' reports.
Many prior year cost reports of our facilities are still open. If any of
our facilities are found to have been in violation of Federal or state laws
relating to preparing and filing of Medicare or Medicaid cost reports, whether
prior to or after our ownership of these facilities, we and our facilities
could be subject to substantial monetary fines, civil and criminal penalties
and exclusion from participation in the Medicare and Medicaid programs. If an
allegation is lodged against one of our facilities for a violation occurring
during the time period before we acquired the facility, we may have
indemnification rights against the seller of such facility to us. In each of
our acquisitions, we have negotiated customary indemnification and hold
harmless provisions for any damages we may incur in these areas.
Managed Care
The percentage of admissions and revenues attributable to managed care
plans have increased as a result of pressures to control the cost of health
care services. We expect that the trend toward increasing percentages related
to managed care plans will continue in the future. Generally, we receive lower
payments from managed care plans than from traditional commercial/indemnity
insurers; however, as part of our business strategy, we intend to take steps to
improve our managed care position.
Commercial Insurance
Our hospitals provide services to individuals covered by private health
care insurance. Private insurance carriers make direct payments to such
hospitals or, in some cases, reimburse their policy holders, based upon the
particular hospital's established charges and the particular coverage provided
in the insurance policy.
Commercial insurers are continuing efforts to limit the payments for
hospital services by adopting discounted payment mechanisms, including
prospective payment or diagnosis related group-based payment systems, for more
inpatient and outpatient services. To the extent that such efforts are
successful and reduce the insurers' reimbursement to hospitals for the costs of
providing services to their beneficiaries, such reduced levels of reimbursement
may have a negative impact on the operating results of our hospitals.
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GOVERNMENT REGULATION AND OTHER FACTORS
Licensing, Certification and Accreditation
Health care facilities are subject to Federal, state and local regulations
relating to the adequacy of medical care, equipment, personnel, operating
policies and procedures, fire prevention, rate-setting and compliance with
building codes and environmental protection laws. Facilities are subject to
periodic inspection by governmental and other authorities to assure continued
compliance with the various standards necessary for licensing and
accreditation. All of our health care facilities are properly licensed under
appropriate state laws.
All of the hospitals affiliated with us are certified under the Medicare
and Medicaid programs and all are accredited by the Joint Commission on
Accreditation of Health Care Organizations. Should any facility lose its
accreditation from the Joint Commission on Accreditation of Health Care
Organizations or otherwise lose its certification under the Medicare or
Medicaid programs, the facility would be unable to receive reimbursement from
the Medicare and Medicaid programs. We believe that our facilities are in
substantial compliance with current applicable Federal, state, local and
independent review body regulations and standards. The requirements for
licensing, certification and accreditation are subject to change and, in order
to remain qualified, it may be necessary for us to effect changes in our
facilities, equipment, personnel and services.
Certificates of Need
In some states, the construction of new facilities, acquisition of
existing facilities or addition of new beds or services may be subject to
review by state regulatory agencies under a Certificate of Need program.
Illinois is the only state in which we currently operate that requires approval
under a Certificate of Need program. These laws generally require appropriate
state agency determination of public need and approval prior to the addition of
beds or services or other capital expenditures. Failure to obtain necessary
state approval can result in the inability to expand facilities, add services,
complete an acquisition or change ownership. Further, violation may result in
the imposition of civil sanctions or the revocation of a facility's license.
Utilization Review
Federal law contains numerous provisions designed to ensure that services
rendered by hospitals to Medicare and Medicaid patients meet
professionally-recognized standards and are medically necessary, and that
claims for reimbursement are properly filed. These provisions include a
requirement that a sampling of admissions of Medicare and Medicaid patients
must be reviewed by peer review organizations which review the appropriateness
of Medicare and Medicaid patient admissions and discharges, the quality of care
provided, the validity of diagnosis related group classifications and the
appropriateness of cases of extraordinary length of stay or cost. Peer review
organizations may deny payment for services provided, assess fines and
recommend to Health and Human Services that a provider which is in substantial
noncompliance with the standards of the peer review organization be excluded
from participation in the Medicare or Medicaid programs. Utilization review is
also a requirement of most non-governmental managed care organizations.
The Federal False Claims Act and Similar State Laws
A trend affecting the health care industry today is the increased use of
the Federal False Claims Act, and, in particular, an increased number of
actions brought by individuals on the government's behalf under the False
Claims Act's qui tam, or whistleblower, provisions. Whistleblower provisions
allow private individuals to bring actions on behalf of the government alleging
that the defendant has defrauded the Federal government.
When a defendant is determined by a court of law to be liable under the
False Claims Act, the defendant must pay three times the actual damages
sustained by the government, plus mandatory civil penalties of between $5,500
to $11,000 for each separate false claim. Settlements entered into prior to
litigation usually involve a less severe damages methodology. There are many
potential bases for liability under the False Claims Act, although liability
often arises when an entity knowingly submits a false claim for reimbursement
to the Federal government. A number
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of states have adopted their own false claims provisions as well as their own
whistleblower provisions whereby a private party may file a civil lawsuit in
state court. From time to time, companies in the health care industry,
including our company, may be subject to actions under the False Claims Act.
Federal and State Fraud and Abuse
Participation in the Medicare program is heavily regulated by Federal
statute and regulation. If a hospital fails to substantially comply with the
numerous conditions of participation in the Medicare program or performs
certain prohibited acts, that hospital's participation in the Medicare program
may be terminated or civil or criminal penalties may be imposed upon it under
certain provisions of the Social Security Act. For example, the Social Security
Act prohibits providers and others from soliciting, receiving, offering or
paying, directly or indirectly, any remuneration intended to induce referrals
of patients to receive goods or services covered by a Federal health care
program (the "Anti-Kickback Statute"). In addition to felony criminal penalties
(fines of up to $25,000 and imprisonment), the Social Security Act establishes
civil monetary penalties and the sanction of excluding violators from
participation in the Federal health care programs.
The Anti-Kickback Statute has been interpreted broadly by Federal
regulators and the courts to prohibit the intentional payment of anything of
value if even one purpose of the payment is to influence the referral of
Medicare or Medicaid business. Therefore, many commonplace commercial
arrangements between hospitals and physicians could be considered by the
government to violate the Anti-Kickback Statute.
As authorized by Congress, the Office of the Inspector General at the
Department of Health and Human Services has published final safe harbor
regulations that outline categories of activities that are deemed protected
from prosecution under the Anti-Kickback Statute. Currently, there are safe
harbors for various activities, including, but not limited to investment
interests, space rental, equipment rental, practitioner recruitment, personal
services and management contracts, sale of practice, discounts, employees,
investments in group practices and ambulatory surgery centers. The fact that
conduct or a business arrangement does not fall within a safe harbor does not
automatically render the conduct or business arrangement illegal under the
Anti-Kickback Statute. The conduct and business arrangements, however, do risk
increased scrutiny by government enforcement authorities.
We have a variety of financial relationships with physicians who refer
patients to our hospitals. We also have contracts with physicians providing for
a variety of financial arrangements, including employment contracts, leases,
and professional service agreements. Moreover, we provide financial incentives,
including loans and minimum revenue guarantees, to recruit physicians into the
communities served by our hospitals. Our two free-standing surgery centers each
have one or more physician investors. Some of our arrangements with physicians
do not meet requirements for safe harbor protection. The regulatory authorities
that enforce the Anti-Kickback Statute may in the future determine that any of
these arrangements violate the Anti-Kickback Statute or other Federal or state
laws.
The Social Security Act also imposes very broad criminal and civil
penalties for submitting false claims to Medicare and Medicaid. False claims
include, but are not limited to, billing for services not rendered,
misrepresenting actual services rendered in order to obtain higher
reimbursement and cost report fraud. Further, the Health Insurance Portability
and Accountability Act of 1996 (the "Health Insurance Portability and
Accountability Act") created civil penalties for impermissible conduct,
including improper coding and billing for unnecessary goods and services. The
Health Insurance Portability and Accountability Act also broadened the scope of
the fraud and abuse laws by adding several criminal provisions for health care
fraud offenses that apply to all health benefit programs. Among the penalties
provided for by the Health Insurance Portability and Accountability Act is a
program under which individuals can receive up to $1,000 for providing
information on Medicare fraud and abuse that leads to the recovery of at least
$100 of Medicare funds.
The Social Security Act also includes a provision commonly known as the
"Stark Law." This law prohibits physicians from referring Medicare and Medicaid
patients to entities with which they or any of their immediate family members
have a financial relationship if these entities provide certain designated
health services that are reimbursable by Medicare, including inpatient and
outpatient hospital services. Sanctions for violating the Stark Law include
civil money penalties up to $15,000 per prohibited service provided,
assessments equal to twice the dollar
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value of each such service provided and exclusion from the Federal health care
programs. There are a number of exceptions to the self-referral prohibition,
including an exception for a physician's ownership interest in an entire
hospital as opposed to an ownership interest in a hospital department. There
are also exceptions for many of the customary financial arrangements between
physicians and providers, including employment contracts, leases and
recruitment agreements.
On January 4, 2001, the Centers for Medicare and Medicaid Services issued
final regulations subject to comment intended to clarify parts of the Stark Law
and some of the exceptions to it. These regulations are considered Phase I of a
two-phase process, with the remaining regulations to be published at an unknown
future date. Phase I of the regulations become effective January 4, 2002,
although some of the provisions relating to home health agencies became
effective on April 6, 2001. The Centers for Medicare and Medicaid Services
accepted comments on Phase I of the regulations until June 4, 2001, which may
lead to further changes. Consequently, we cannot predict the final form that
these regulations will take or the effect that they will have on our
operations.
Many of the states in which we operate also have adopted laws that
prohibit payments to physicians in exchange for referrals similar to the
Anti-Kickback Statute and the Stark Law, some of which apply regardless of the
source of payment for care. These statutes typically provide criminal and civil
penalties as well as loss of licensing. Little precedent exists for the
interpretation or enforcement of these state laws.
Corporate Practice of Medicine/Fee Splitting
The states in which we operate have laws that prohibit unlicensed persons
or business entities, including corporations, from employing physicians or that
prohibit direct or indirect payments or fee-splitting arrangements between
physicians and unlicensed persons or business entities. Possible sanctions for
violations of these restrictions include loss of a physician's license, civil
and criminal penalties and rescission of business arrangements that may violate
these restrictions. These statutes vary from state to state, are often vague
and seldom have been interpreted by the courts or regulatory agencies. Although
we exercise care to structure our arrangements with health care providers to
comply with the relevant state law and believe these arrangements comply with
applicable laws in all material respects, governmental officials charged with
responsibility for enforcing these laws may in the future assert that we, or
transactions in which we are involved, are in violation of such laws. In
addition, such laws may ultimately be interpreted by the courts in a manner
inconsistent with our interpretations.
Administrative Simplification
The Administrative Simplification Provisions of the Health Insurance
Portability and Accountability Act require the use of uniform electronic data
transmission standards for health care claims and payment transactions
submitted or received electronically. On August 17, 2000, the Centers for
Medicare and Medicaid Services published final regulations establishing
electronic data transmission standards that all health care providers must use
when submitting or receiving certain health care transactions electronically.
Compliance with these regulations is required by October 2002, but we cannot
yet predict the impact that these final regulations will have on us.
The Health Insurance Portability and Accountability Act also requires the
Centers for Medicare and Medicaid Services to adopt standards to protect the
security and privacy of health-related information. Regulations were proposed
on August 12, 1998, but have not yet been finalized. However, as proposed,
these regulations would require health care providers to implement
organizational and technical practices to protect the security of
electronically maintained or transmitted health-related information. In
addition, the Centers for Medicare and Medicaid Services released final
regulations containing privacy standards in December 2000, and which require
compliance by April 2003. As currently drafted, the privacy regulations will
extensively regulate the use and disclosure of individually identifiable
health-related information. The security regulations, as proposed, and the
privacy regulations could impose significant costs on our facilities in order
to comply with these standards. Violations of the Administrative Simplification
provisions of the Health Insurance Portability and Accountability Act could
result in civil penalties of up to $25,000 per type of violation in each
calendar year and criminal penalties of up to $250,000 per violation.
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In addition, our facilities will continue to remain subject to any state
laws that are more restrictive than the regulations issued under the Health
Insurance Portability and Accountability Act, which vary by state and could
impose additional penalties.
Conversion Legislation
Many states have enacted or are considering enacting laws affecting the
conversion or sale of not-for-profit hospitals. These laws, in general, include
provisions relating to attorney general approval, advance notification and
community involvement. In addition, state attorneys general in states without
specific conversion legislation may exercise authority over these transactions
based upon existing law. In many states there has been an increased interest in
the oversight of not-for-profit conversions. The adoption of conversion
legislation and the increased review of not-for-profit hospital conversions may
increase the cost and difficulty of, or prevent the completion of transactions
with, not-for-profit organizations in some states in the future. Moreover, as a
condition to approving an acquisition, the attorney general of the state in
which the hospital is located may require us to maintain specific services,
such as emergency departments, or to continue to provide specific levels of
charity care.
Revenue Ruling 98-15
During March 1998, the Internal Revenue Service issued guidance regarding
the tax consequences of joint ventures between for-profit and not-for-profit
hospitals. We have not determined the impact of the tax ruling on the
development of future ventures. The tax ruling could limit future joint venture
development with not-for-profit hospitals.
The Emergency Medical Treatment and Active Labor Act
The Federal Emergency Medical Treatment and Active Labor Act was adopted
by Congress in response to reports of a widespread hospital emergency room
practice of "patient dumping." At the time of the enactment, patient dumping
was considered to have occurred when a hospital capable of providing the needed
care sent a patient to another facility or simply turned the patient away based
on such patient's inability to pay for his or her care. The law imposes
requirements upon physicians, hospitals and other facilities that provide
emergency medical services. Such requirements pertain to what care must be
provided to anyone who comes to such facilities seeking care before they may be
transferred to another facility or otherwise denied care. Regulations have
recently been adopted that expand the areas within a facility that must provide
emergency treatment to include provider-based outpatient departments. Sanctions
for violations of this statute include termination of a hospital's Medicare
provider agreement, exclusion of a physician from participation in Medicare and
Medicaid programs and civil money penalties. In addition, the law creates
private civil remedies that enable an individual who suffers personal harm as a
direct result of a violation of the law, and a medical facility that suffers a
financial loss as a direct result of another participating hospital's violation
of the law, to sue the offending hospital for damages and equitable relief.
Although we believe that our practices are in material compliance with the law,
we can give no assurance that governmental officials responsible for enforcing
the law will not assert from time to time that our facilities are in violation
of this statute.
Health Care Reform
The health care industry attracts much legislative interest and public
attention. Changes in Medicare, Medicaid and other programs, hospital
cost-containment initiatives by public and private payers, proposals to limit
payments and health care spending and industry-wide competitive factors are
highly significant to the health care industry. In addition, a framework of
extremely complex Federal and state laws, rules and regulations governs the
health care industry and, for many provisions, there is little history of
regulatory or judicial interpretation to rely on.
Many states have enacted or are considering enacting measures designed to
reduce their Medicaid expenditures and change private health care insurance.
Most states, including the states in which we operate, have applied for and
been granted Federal waivers from current Medicaid regulations to allow them to
serve some or all of their Medicaid participants through managed care
providers. We are unable to predict the future course of Federal, state or
local
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health care legislation. Further changes in the law or regulatory framework
that reduce our revenues or increase our costs could have a material adverse
effect on our business, financial condition or results of operations.
Health Care Industry Investigations
Significant media and public attention has focused in recent years on the
hospital industry. There are numerous ongoing Federal and state investigations
regarding multiple issues, including cost reporting and billing practices,
especially those relating to clinical laboratory test claims and home health
agency costs, physician recruitment practices and physician ownership of health
care providers and joint ventures with hospitals. These investigations have
targeted hospital companies as well as their executives and managers. We have
substantial Medicare, Medicaid and other governmental billings, which could
result in heightened scrutiny of our operations. We continue to monitor these
and all other aspects of our business and have developed a compliance program
to assist us in gaining comfort that our business practices are consistent with
both legal principles and current industry standards. However, because the law
in this area is complex and constantly evolving, government investigations
could result in interpretations that are inconsistent with industry practices,
including ours. In public statements surrounding current investigations,
governmental authorities have taken positions on a number of issues, including
some for which little official interpretation previously has been available,
that appear to be inconsistent with practices that have been common within the
industry and that previously have not been challenged in this manner. In some
instances, government investigations that have in the past been conducted under
the civil provisions of Federal law may now be conducted as criminal
investigations.
Many current health care investigations are national initiatives in which
Federal agencies target an entire segment of the health care industry. One
example is the Federal government's initiative regarding hospital providers'
improper requests for separate payments for services rendered to a patient on
an outpatient basis within three days prior to the patient's admission to the
hospital, where reimbursement for such services is included as part of the
reimbursement for services furnished during an inpatient stay. In particular,
the government has targeted all hospital providers to ensure conformity with
this reimbursement rule. Another example involves the Federal government's
initiative regarding health care providers "unbundling" and separately billing
for laboratory tests that should have been billed as a "bundled unit." The
Federal government has also launched a national investigative initiative
targeting the billing of claims for inpatient services related to bacterial
pneumonia, as the government has found that many hospital providers have
attempted to bill for pneumonia cases under more complex and expensive
reimbursement codes, such as diagnosis related group codes. Further, the
Federal government continues to investigate Medicare overpayments to
prospective payment hospitals that incorrectly report transfers of patients to
other prospective payment system hospitals as discharges.
While we are aware that several of our hospitals have been or are being
investigated in connection with activities conducted prior to our acquisition
of them, we are not aware of any governmental investigations involving the
operation of those facilities by us, or involving any of our executives or
managers. Under the terms of our various acquisition agreements, the prior
owners of our hospitals are responsible for any liabilities arising from
pre-closing violations. The prior owners' resolution of these matters or
failure to resolve these matters, in the event that any resolution was deemed
necessary, could have a material adverse effect on our business, financial
condition or results of operation. See Note 8 of the Notes to Combined
Statements of Operations and Cash Flows of Phoenix Baptist Hospital and Medical
Center, Inc., Arrowhead Community Hospital and Medical Center, Inc. and
Affiliates. It is possible that governmental entities could initiate
investigations in the future at facilities operated by us and that such
investigations could result in significant penalties to us as well as adverse
publicity. It is also possible that our executives and managers, many of whom
have worked at other health care companies that are or may become the subject
of Federal and state investigations and private litigation, could be included
in governmental investigations or named as defendants in private litigation.
The positions taken by authorities in any future investigations of us, our
executives or our managers, or other health care providers, and the liabilities
or penalties that may be imposed could have a material adverse effect on our
business, financial condition and results of operations.
77
Phoenix Health Plan Regulatory Matters
Phoenix Health Plan is subject to state and Federal laws and regulations,
and the Centers for Medicare and Medicaid Services and Arizona Health Care
System have the right to audit Phoenix Health Plan to determine the plan's
compliance with such standards. Phoenix Health Plan is required to file
periodic reports with Arizona Health Care System and to meet certain financial
viability standards. Phoenix Health Plan also must provide its enrollees with
certain mandated benefits and must meet certain quality assurance and
improvement requirements. As of October 16, 2002, Phoenix Health Plan must
comply with the standardized formats for electronic transmissions set forth in
the Administrative Simplification Provisions of the Health Insurance
Portability and Accountability Act, and when final regulations become
effective, Phoenix Health Plan will be required to comply with Federal security
and privacy standards for health-related information. We cannot predict the
final form that these regulations will take or the impact that the final
regulations, when fully implemented, will have on us.
The Anti-Kickback Statute has been interpreted to prohibit the payment,
solicitation, offering or receipt of any form of remuneration in return for the
referral of Federal health care program patients or any item or service that is
reimbursed, in whole or in part, by any Federal health care program. Similar
statutes have been adopted in Arizona which apply regardless of the source of
reimbursement. Health and Human Services has adopted safe harbor regulations
specifying certain relationships and activities that are deemed not to violate
the Anti-Kickback Statute which specifically relate to managed care including:
o waivers by health maintenance organizations of Medicare and Medicaid
beneficiaries' obligation to pay cost-sharing amounts or to provide
other incentives in order to attract Medicare and Medicaid enrollees;
o certain discounts offered to prepaid health plans by contracting
providers;
o certain price reductions offered to eligible managed care
organizations; and
o certain price reductions offered by contractors with substantial
financial risk to managed care organizations.
We believe that the incentives offered by Phoenix Health Plan to its
Medicaid enrollees and the discounts it receives from contracting health care
providers should satisfy the requirements of the safe harbor regulations.
However, failure to satisfy each criterion of the applicable safe harbor does
not mean that the arrangement constitutes a violation of the law; rather the
safe harbor regulations provide that an arrangement which does not fit within a
safe harbor must be analyzed on the basis of its specific facts and
circumstances. We believe that Phoenix Health Plan's arrangements comply in all
material respects with the Federal Anti-Kickback Statute and similar Arizona
statutes.
Environmental Matters
We are subject to various Federal, state and local laws and regulations
relating to environmental protection. Our hospitals are not highly regulated
under environmental laws because we do not engage in any industrial activities
at those locations. The principal environmental requirements and concerns
applicable to our operations relate to:
o the proper handling and disposal of hazardous and low level medical
radioactive waste;
o ownership or historical use of underground and above-ground storage
tanks;
o management of impacts from leaks of hydraulic fluid or oil associated
with elevators, chiller units or incinerators;
o appropriate management of asbestos-containing materials present or
likely to be present at some locations; and
78
o the potential acquisition of, or maintenance of air emission permits
for, boilers or other equipment.
We do not expect our compliance with environmental laws and regulations to
have a material effect on us. We may also be subject to requirements related to
the remediation of substances that have been released to the environment at
properties owned or operated by us or at properties where substances were sent
for off-site treatment or disposal. These remediation requirements may be
imposed without regard to fault and whether or not we owned or operated the
property at the time that the relevant releases or discharges occurred.
Liability for environmental remediation can be substantial.
79
MANAGEMENT
Directors and Executive Officers
The table below presents information with respect to our directors and
executive officers as of January 1, 2002.
Name Age Position
- ---- --- --------
Charles N. Martin, Jr.......... 59 Chairman of the Board & Chief Executive Officer; Director
William L. Hough............... 50 President & Chief Operating Officer; Director
Joseph D. Moore................ 55 Executive Vice President, Chief Financial Officer & Treasurer; Director
Ronald P. Soltman.............. 55 Executive Vice President, General Counsel & Secretary; Director
Mark Brenzel................... 47 Senior Vice President-Operations
Bruce F. Chafin................ 45 Senior Vice President-Compliance & Ethics
Robert E. Galloway............. 57 Senior Vice President-Development
James Johnston................. 58 Senior Vice President-Human Resources
Phillip W. Roe................. 41 Senior Vice President, Controller & Chief Accounting Officer
James H. Spalding.............. 43 Senior Vice President, Assistant General Counsel & Assistant Secretary
Alan G. Thomas................. 47 Senior Vice President-Operations Finance
Thomas M. Ways................. 52 Senior Vice President-Managed Care & Physician Integration
Keith B. Pitts................. 44 Vice Chairman; Director
Karen H. Bechtel............... 52 Director
Eric T. Fry.................... 34 Director
Howard I. Hoffen............... 38 Director
Charles N. Martin, Jr. has served as Chairman of the Board of Directors
and Chief Executive Officer of Vanguard since July 1997. Until May 31, 2001, he
was also Vanguard's President. From January 1992 until January 1997, Mr. Martin
was Chairman, President and Chief Executive Officer of OrNda HealthCorp
("OrNda"), a hospital management company. Prior thereto Mr. Martin was
President and Chief Operating Officer of HealthTrust, Inc., a hospital
management company, from September 1987 until October 1991. Mr. Martin is also
a director of HealthStream, Inc., and a number of privately held companies..
William L. Hough has served as Chief Operating Officer and a director of
Vanguard since July 1997. Mr. Hough was elected Vanguard's President on May 31,
2001, and prior thereto he had been an Executive Vice President. From August
1995 until January 1997, he was Executive Vice President and Chief Operating
Officer of OrNda. From September 1987 to April 1995, Mr. Hough served in
various executive positions with HealthTrust, Inc., including Group Vice
President from May 1994 to April 1995, and Regional Vice President from April
1990 to April 1994.
Joseph D. Moore has served as Executive Vice President, Treasurer, Chief
Financial Officer and a director of Vanguard since July 1997. From February
1994 to April 1997, he was Senior Vice President--Development of Columbia/HCA
Healthcare Corporation ("Columbia"), a hospital management company. Mr. Moore
first joined Hospital Corporation of America (a predecessor of Columbia) in
April 1970, rising to Senior Vice President--Finance and Development in January
1993.
Ronald P. Soltman has been Executive Vice President, General Counsel,
Secretary and a director of Vanguard since July 1997. From April 1994 until
January 1997, he was Senior Vice President, General Counsel and Secretary of
OrNda. From February 1994 until March 1994, he was Vice President and Assistant
General Counsel of Columbia. From 1984 until February 1994, he was Vice
President and Assistant General Counsel of Hospital Corporation of America.
Mark Brenzel has served as Senior Vice President-Operations of Vanguard
since May 2000. Prior thereto from February 1998 to October 1999, he was the
Chief Operating Officer of Renal Ventures, Inc., a dialysis provider
80
based in Denver, Colorado. Prior thereto, from May 1995 to December 1997, he
was Chief Operating Officer of the Columbia-HealthOne System, a multi-facility
regional hospital system also based in Denver, Colorado.
Bruce F. Chafin has served as Senior Vice President-Compliance & Ethics of
Vanguard since July 1997. Prior thereto, from April 1995 to January 1997, he
served as Vice President-Compliance & Ethics of OrNda.
Robert E. Galloway has served as Senior Vice President-Development of
Vanguard since October 1997. Prior thereto from August 1993 to September 1997,
he was Vice President-Development of Columbia and its predecessor, Columbia
Hospital Corporation.
James Johnston has served as Senior Vice President-Human Resources of
Vanguard since July 1997. Prior thereto from November 1995 to January 1997, he
served as Senior Vice President-Human Resources of OrNda.
Phillip W. Roe has been Senior Vice President, Controller & Chief
Accounting Officer of Vanguard since July 1997. Prior thereto he was Senior
Vice President, Controller and Chief Accounting Officer of OrNda from September
1996 until January 1997. Prior thereto, from October 1994 until September 1996,
Mr. Roe was Vice President, Controller and Chief Accounting Officer of OrNda.
James H. Spalding has served as Senior Vice President, Assistant General
Counsel and Assistant Secretary of Vanguard since November 1998. Prior thereto
he was Vice President, Assistant General Counsel and Assistant Secretary of
Vanguard from July 1997 until November 1998. Prior thereto from April 1994
until January 1997, he served as Vice President, Assistant General Counsel and
Assistant Secretary of OrNda.
Alan G. Thomas has been Senior Vice President-Operations Finance of
Vanguard since July 1997. Prior thereto, Mr. Thomas was Senior Vice
President-Hospital Financial Operations of OrNda from April 1995 until January
1997. Prior thereto he was Vice President-Reimbursement and Revenue Enhancement
of OrNda from June 1994 until April 1995.
Thomas M. Ways has served as Senior Vice President-Managed Care &
Physician Integration of Vanguard since February 1998. Prior thereto from
February 1997 to January 1998, he was Chief Executive Officer of MSO/Physician
Practice Development for the Southern California Region of Tenet Health Care
Corporation, a hospital management company. Prior thereto from August 1994 to
January 1997, he was Vice President-Physician Integration of OrNda.
Keith B. Pitts has been Vanguard's Vice Chairman since May 2001, a
director of Vanguard since August 1999, and was an Executive Vice President of
Vanguard from August 1999 until May 2001. Prior thereto, from November 1997
until June 1999, he was the Chairman and Chief Executive Officer of Mariner
Post-Acute Network, Inc. and its predecessor, Paragon Health Network, Inc.,
which is a nursing home management company. In January 2000, Mariner Post-Acute
Network, Inc. filed a voluntary petition for relief under Chapter 11 of the
United States Bankruptcy Code. Prior thereto from August 1992 until January
1997, Mr. Pitts served as Executive Vice President and Chief Financial Officer
of OrNda.
Karen H. Bechtel has served as a Director of Vanguard since March 2000.
Ms. Bechtel has been a Managing Director of Morgan Stanley Capital Partners
since 1998 and a Managing Director of Morgan Stanley & Co. Incorporated ("MS &
Co.") since 1986. She also serves as a director of Cross County, Inc. and a
number of privately held companies.
Eric T. Fry has served as a Director of Vanguard since May 1998. He joined
MS & Co. in 1989 and has been a Managing Director of both MS & Co. and Morgan
Stanley Capital Partners since December 2001. He is also a director of ACG
Holdings, Inc. and a number of privately held companies.
Howard I. Hoffen has served as a Director of Vanguard since January 2001.
Mr. Hoffen joined MS & Co. in 1985 and has been a Managing Director of MS & Co.
and Morgan Stanley Capital Partners since 1997, and was appointed as Chairman
and Chief Executive Officer of Morgan Stanley Private Equity in 2001. Mr.
Hoffen also
81
serves as a director of Catalytica Energy Systems., Inc., Allegiance Telecom,
Inc., Choice One Communications, Inc. and a number of privately held companies.
Executive Compensation
The following table sets forth, for the fiscal year ended June 30, 2001,
the compensation earned by our Chief Executive Officer and our four other most
highly compensated executive officers. We refer to these persons as our named
executive officers.
Summary Compensation Table
Annual Compensation Long-Term Compensation
------------------------------------------------ ---------------------------
Other Annual Securities All Other
Fiscal Compensation Underlying Compensation
Name and Principal Position Year Salary($) Bonus($) ($) (a) Options(#) ($) (b)
- ------------------------------------------ ------ --------- -------- ------------ ---------- ------------
Charles N. Martin, Jr.
Chairman of the Board and
Chief Executive Officer.................. 2001 700,008 0 0 0 7,572
William L. Hough
President & Chief Operating Officer...... 2001 428,016 0 0 0 5,250
Joseph D. Moore
Executive Vice President, Chief Financial
Officer & Treasurer...................... 2001 369,504 0 0 0 0
Keith B. Pitts
Vice Chairman............................ 2001 428,016 0 0 8,409 380,155
Ronald P. Soltman
Executive Vice President, General
Counsel & Secretary...................... 2001 272,016 0 0 0 0
(a) No such compensation was paid other than perquisites and other personal
benefits which have not been included because their aggregate value
provided to any of the named executive officers was below the reporting
threshold established by the Securities and Exchange Commission.
(b) The amounts disclosed under All Other Compensation in the Summary
Compensation Table represent for the named executive officers in fiscal
2001 (i) the following amounts of our matching contributions made under
our 401(k) Plan: Mr. Martin: $5,250; Mr. Hough: $5,250; Mr. Moore: $0; Mr.
Pitts: $5,250; and Mr. Soltman: $0; $374,365 for Mr. Pitts to reimburse
him for certain relocation expenses in his move to Nashville to commence
employment with Vanguard; and (iii) the following amounts of insurance
premiums paid by Vanguard with respect to group term life insurance: Mr.
Martin: $2,322; Mr. Hough: $0; Mr. Moore: $0; Mr. Pitts: $540; and Mr.
Soltman: $0.
Stock Option Grants During Fiscal 2001
In the fiscal year ended June 30, 2001, the grants of stock options under
our stock-based employee benefit plans to the named executive officers were as
follows:
Number of Percent of
Securities Total Options Potential Realizable Values
Underlying Granted to Market Price at Assumed Annual Rates
Options Employees in Exercise on Date of Expiration of Stock Price Appreciation
Granted(#) Fiscal Year Price($/Sh) Grant($/Sh) Date for Option Term(a)
---------- ------------ ----------- ------------ ---------- ---------------------------------
0% 5% 10%
--------- ---------- ----------
Charles N. Martin, Jr.. - - - - - - - -
William L. Hough....... - - - - - - - -
Joseph D. Moore........ - - - - - - - -
Keith B. Pitts......... 5,275(b) 59.2% 425.32 1,701.18 08/07/10 6,730,162 12,373,689 21,031,967
3,134(c) 100% 170.12 1,701.18 06/01/08 4,798,342 7,273,663 10,697,177
Ronald F. Soltman...... - - - - - - - -
82
- ---------------
(a) In accordance with the rules of the Securities and Exchange Commission,
shown are the gains or "option spreads" that would exist for the
respective options granted. These gains are based on the assumed rates of
annual compound stock price appreciation of 5% and 10% from the date the
option was granted over the full option term. These assumed annual
compound rates of stock price appreciation are mandated by the rules of
the Securities and Exchange Commission and do not represent our estimate
or projection of our future common stock prices.
(b) 25% of the stock options vested on August 7, 2001 and 25% of the stock
options will vest on August 7 in each of 2002, 2003 and 2004, and the
vested options then become exercisable, generally, upon the occurrence of
a Liquidity Event, as described in "Certain Relationships and Related
Party Transactions-Shareholders Agreement." In addition, 100% of the
non-exercisable options become exercisable upon a change of control (as
defined in the plan). Also, we have agreed to pay a cash bonus to Mr.
Pitts upon his exercise of these options, in whole or in part, in the
aggregate amount of approximately $1,855,000, assuming all such options
are exercised.
(c) 1/7 of the stock options vested on August 7, 2001, and 1/7 of the stock
options will vest on August 7 in each of the years 2002, 2003, 2004, 2005,
2006 and 2007, and the vested options then become exercisable, generally,
upon the occurrence of a Liquidity Event.
Stock Option Exercises, Holdings and Fiscal Year-End Values
The following table sets forth information with respect to the named
executive officers concerning their exercise of stock options during the fiscal
year ended June 30, 2001 and in respect of the number and value of unexercised
options held by each of them as of June 30, 2001.
Number of Securities Underlying Value of Unexercised
Shares Acquired Unexercised Options At In-the-Money Options At
Name on Exercise (#) Value Realized($) Fiscal Year-End(#) Fiscal Year-End($)(a)
- ---- --------------- ----------------- --------------------------------- ----------------------------
Exercisable Unexercisable(b) Exercisable Unexercisable
----------- ---------------- ----------- -------------
Charles N. Martin, Jr... 0 0 587 10,448 898,732 15,996,514
William L. Hough........ 0 0 359 3,134 549,650 4,798,342
Joseph D. Moore......... 0 0 310 3,134 474,629 4,798,342
Keith B. Pitts.......... 0 0 0 8,409 0 11,528,504
Ronald P. Soltman....... 0 0 228 2,687 349,082 4,113,958
- --------------------
(a) There was no public market for our common stock at June 30, 2001. The
dollar values of unexercised in-the-money options represent the difference
between the assumed fair market value of $1,701.18 per share at June 30,
2001 and the exercise prices of the options.
(b) All of the options set forth in this chart (except for 5,275 of the
options granted to Mr. Pitts) were options granted under our Carry Option
Plan, as described in "Certain Relationships and Related Party
Transactions - Our Option Plans."
Board of Directors
General
The board of directors of Vanguard manages its business. Under our
certificate of incorporation and bylaws, the Vanguard board of directors must
consist of not less than three nor more than twenty members, with the exact
number of members being fixed from time to time by our board of directors.
Currently, eight members comprise our board of directors.
Pursuant to our shareholders agreement, our board of directors is to be
made up of eight members, five of which are to be nominated by the management
shareholders and three of which are to be nominated by the Morgan Stanley
Capital Partners Funds ("Capital Partners Funds"). In conformity with the
foregoing, at the current time Ms. Bechtel and Messrs. Fry and Hoffen are
directors nominated by the Capital Partners Funds and Messrs. Hough, Martin,
Moore, Pitts and Soltman are directors nominated by the management
shareholders. Despite the foregoing, at all times the Capital Partners Funds
have the right to nominate four members to our board, in which event one of the
management directors will resign. Also, at any time after January 1, 2005, the
Capital Partners Funds have the right to nominate a majority of our board if
the Capital Partners Funds exercise their additional rights under the
shareholders agreement to require all other shareholders to transfer their
shares to the same prospective purchaser and at the same price at which the
Capital Partners Funds have agreed to sell all their shares of our common
stock. Pursuant to our shareholders agreement each shareholder has agreed to
vote his shares of common stock to elect directors nominated in the manner
described above.
83
Term of Office of Directors
Our directors are elected by the affirmative vote of a plurality of the
votes cast by our shareholders at Vanguard's annual meeting of shareholders.
Once elected, each director serves until the next annual meeting of
shareholders and until his or her successor is duly elected and qualified, or
until his or her earlier death, resignation or removal.
Director Compensation
Directors do not receive any compensation for their services. We do,
however, reimburse them for travel expenses and other out-of-pocket costs
incurred in connection with attendance at board of directors and committee
meetings, and they are eligible to receive options pursuant to certain of our
option plans, as described in "Certain Relationships and Related Party
Transactions-Our Option Plans." To date, however, no non-employee directors
have been granted options.
Committees of the Board of Directors
We currently have no standing committees of our board of directors.
Pursuant to our shareholders agreement, the Capital Partners Funds have the
right to appoint one member to each committee of our board of directors.
84
PRINCIPAL SHAREHOLDERS
The following table presents information regarding beneficial ownership of
shares of our common stock and preferred stock, as of November 15, 2001, by:
o each person we know to be the beneficial owner of 5% or more of our
common stock or our preferred stock;
o each of our executive officers listed in the summary compensation
table;
o the members of our board of directors; and
o all our current directors and executive officers as a group.
When reviewing the following table, you should be aware that:
o The amounts and percentage of common stock and preferred stock
beneficially owned are reported on the basis of regulations of the
SEC governing the determination of beneficial ownership of
securities. Under the rules of the SEC, a person is deemed to be a
"beneficial owner" of a security if that person has or shares "voting
power," which includes the power to vote or to direct the voting of
such security, or "investment power," which includes the power to
dispose of or to direct the disposition of such security. A person is
also deemed to be a beneficial owner of any securities of which that
person has a right to acquire beneficial ownership within 60 days.
Under these rules, more than one person may be deemed a beneficial
owner of securities as to which he has no economic interest.
o Except as otherwise indicated in the footnotes to the table, each
stockholder identified in the table possesses sole voting and
investment power over all shares of stock shown as beneficially owned
by such stockholder.
o We have one series outstanding of preferred stock, our
Payable-In-Kind Cumulative Redeemable Convertible Preferred Stock.
For further information on the terms of this series of preferred
stock, see "Our PIK Preferred Stock."
o Unless otherwise indicated below, the address of each individual or
entity listed in the table is 20 Burton Hills Boulevard, Suite 100,
Nashville, Tennessee 37215.
Common Stock of Vanguard Preferred Stock of Vanguard
--------------------------- -----------------------------
Number of Percent of Number of Percent of
Shares Class Shares Class
--------- ---------- --------- ----------
Beneficial Owners:
Capital Partners Funds(1)............................ 163,189 78.9% - -
The MacNeal Memorial Hospital Association(2)......... - - 21,600 100.0%
Charles N. Martin, Jr.(3)............................ 43,513 21.1 - -
William L. Hough(4).................................. 5,487 2.7 - -
Joseph D. Moore(5)................................... 5,144 2.5 - -
Keith B. Pitts....................................... 118 * - -
Ronald P. Soltman(6)................................. 3,952 1.9 - -
Karen H. Bechtel(7).................................. 163,189 78.9 - -
Eric T. Fry(7)....................................... 163,189 78.9 - -
Howard I. Hoffen (7)................................. 163,189 78.9 - -
All directors and executive officers as a group (16
persons)............................................ 202,998 98.2 - -
- --------------------
* Signifies less than 1%.
85
(1) The Capital Partners Funds consist of Morgan Stanley Capital Partners III,
L.P., MSCP III 892 Investors, L.P., Morgan Stanley Capital Investors,
L.P., Morgan Stanley Dean Witter Capital Partners IV, L.P., MSDW IV 892
Investors, L.P., and Morgan Stanley Dean Witter Capital Investors IV, L.P.
Morgan Stanley & Co. Incorporated is an affiliate of the Capital Partners
Funds and may be deemed to beneficially own the shares of common stock
owned by the Capital Partners Funds. The address of each such entity is
1221 Avenue of the Americas, 33(rd) Floor, New York, New York 10020.
(2) Michael P. Kenahan, President of MacNeal Memorial Hospital Association,
possesses sole voting and investment power over these shares, subject to
specific direction at any time by the Board of Directors of MacNeal
Memorial Hospital Association. The address of The MacNeal Memorial
Hospital Association and of Mr. Kenahan is 3249 South Oak Park Avenue,
Berwyn, Illinois 60402.
(3) Includes 3,396 shares which Mr. Martin has the right to acquire upon the
exercise of stock options. Includes 24,536 shares beneficially owned by
Mr. Martin solely as a result of his rights to vote these 24,536 shares
under the Voting Proxy Agreement discussed below. Mr. Martin has no
economic interest in these 24,536 shares. Mr. Martin beneficially owns
18,977 shares in which he has an economic interest and which represent
9.2% of the class.
(4) Includes 359 shares which Mr. Hough has the right to acquire upon the
exercise of stock options.
(5) Includes 310 shares which Mr. Moore has the right to acquire upon the
exercise of stock options.
(6) Includes 228 shares which Mr. Soltman has the right to acquire upon the
exercise of stock options.
(7) Messrs. Fry and Hoffen and Ms. Bechtel are all associated with the Capital
Partners Funds which beneficially own all of these shares of common stock.
Messrs. Fry and Hoffen and Ms. Bechtel disclaim any beneficial ownership
of such common stock. The address of each such person is 1221 Avenue of
the Americas, 33(rd) Floor, New York, New York 10020.
86
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
Founders
Vanguard was founded in July 1997 by four of its directors and executive
officers mentioned above, Messrs. Martin, Hough, Moore and Soltman, and by an
affiliate of the Capital Partners Funds. Initially, the individual founders
funded the start-up operations of Vanguard with short-term loans. In August
1997 the four individual founders and certain other current members of
management purchased for cash shares of our common stock and the short-term
loans were repaid with the proceeds of the share purchases. In addition, in
August 1997 the affiliate of the Capital Partners Funds purchased for cash
shares of our preferred stock. We redeemed such preferred shares for cash in
June 1998.
Shareholders Agreement
As noted above, the Capital Partners Funds currently own collectively
approximately 80% of our outstanding shares of common stock. The Capital
Partners Funds and all the other shareholders in Vanguard have entered into a
shareholders agreement governing their ownership of our common stock. The
following is a summary of the material terms included in the shareholders
agreement.
o The shareholders agreement provides that our board of directors is to
be made up of eight members, five of which are to be nominated by
management shareholders and three of which are to be nominated by the
Capital Partners Funds. Despite the foregoing, at all times the
Capital Partners Funds have the right to nominate a fourth member to
our board, in which event one of the management directors will
resign. Currently, Ms. Bechtel and Messrs. Fry and Hoffen are
directors nominated by the Capital Partners Funds. Also, at any time
after January 1, 2005, the Capital Partners Funds have the right to
nominate a majority of our board if the Capital Partners Funds
exercise their additional right under the shareholders agreement to
require all other shareholders to transfer their shares to the same
prospective purchaser at the same price at which the Capital Partners
Funds have agreed to sell their shares of our common stock. The
Capital Partners Funds also have the right to designate one member of
each committee of our board.
o The shareholders have agreed in the shareholders agreement not to
transfer any of their shares other than to permitted transferees, and
that their shares will be subject to certain "tag along" and "first
offer" rights upon share transfer.
o After June 1, 2003, in the event that the Capital Partners Funds
determine to sell all of their shares to a third party, they can
require that the other shareholders who are parties to the
shareholders agreement sell all of their shares to a third-party
purchaser chosen by the Capital Partners Funds, at the price
negotiated by the Capital Partners Funds and the third-party
purchaser but, if the sale is prior to January 1, 2005, the other
shareholders have the right to purchase all of the shares held by the
Capital Partners Funds in lieu of selling their shares to such
third-party purchaser.
o Each of the Management Investors, which includes our executive
officers, has agreed to sell to us his or her Initial Shares, which
are the shares they acquired prior to the investments by the Capital
Partners Funds in Vanguard, at a price equal to $100 per share if,
during the four-year period beginning on June 1, 1998, he or she
resigns without Good Reason (defined as a change in control of
Vanguard followed by a functional demotion of the employee, through
such means as a diminishment of responsibilities, a reduction in
salary, a requirement of relocation or a discontinuance of salary or
other benefits, including incentive-based options). In addition, if,
during this four-year period, any of Messrs. Martin, Hough, Moore and
Soltman are terminated for cause, or if any other Management Investor
is terminated by us for any reason, he or she will sell to us his or
her Initial Shares at a price equal to $100 per share. The number of
shares subject to repurchase under this provision decreases ratably
over the four-year period.
87
o Each of the Management Investors has agreed to sell to us all the
shares that he or she owns at cost if, prior to June 1, 2003, his or
her employment is terminated either by him or her without Good Reason
or by us for cause and he or she then engages in an activity
competitive with our business.
o Mr. Martin is generally prohibited from disposing of shares unless,
at the time of the disposition, the proportion of his shareholdings
that he has disposed of does not exceed the proportion of
shareholdings disposed of by the Capital Partners Funds.
o The Capital Partners Funds and the other shareholders, under
specified circumstances and subject to certain conditions, have the
right to require us to register their shares under the Securities Act
and to participate in specified registrations of shares by Vanguard.
o We have agreed to pay reasonable fees and expenses of the Capital
Partners Funds incurred in reviewing the health care facilities which
we propose to purchase from time to time.
o If the Capital Partners Funds receive aggregate net proceeds upon a
Liquidity Event that are less than what they have invested in
Vanguard, they may require us to repurchase from our Management
Investors an aggregate of 24,187 shares at the lower of cost or
market value at the time of such notice. Morgan Stanley Dean Witter
Capital Partners IV, L.P. ("MSCP IV") can require that we, or we can
elect under certain circumstances to, pay the purchase price by
delivery of a 3-year note, at 1% over the 3-year U.S. Treasury bond
rate in lieu of cash. If our credit agreements do not permit such a
purchase, then the Capital Partners Funds are permitted to purchase
the shares directly from the Management Investors for cash.
o So long as the Capital Partners Funds own at least 15% of our
outstanding common stock, we have agreed not to take certain
important actions without the prior approval of MSCP IV including,
but not limited to, the following:
o issuances of equity or equity-type securities or payments of
dividends on our capital stock;
o approval of our annual business plan and budget and of any
long-term strategic plan;
o the appointment or removal of our Chief Executive Officer or any
change in the compensation of our executive management;
o incurrence, refinancing or discharge of indebtedness in excess
of 10% of our consolidated assets;
o purchases or sales of assets having a value in excess of 10% of
our consolidated assets, other than in the ordinary course of
our business;
o a merger, consolidation, reclassification, reorganization,
liquidation, dissolution, voluntary bankruptcy or similar
significant corporate events;
o changes in our auditors, financial accounting policies or tax
policies;
o transactions with our affiliates or affiliates of our
management;
o capital expenditures exceeding 5% of our consolidated assets for
any given project or in any fiscal year;
o employment of investment bankers; and
o any other material transaction.
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The above-mentioned provisions of the shareholders agreement will
terminate in the event of an initial public offering of our common stock, the
sale of our company or the sale by the Capital Partners Funds of their shares
of our common stock (each a "Liquidity Event"). Upon the occurrence of a
Liquidity Event, a separate shareholders agreement will become effective which
will govern the ownership of our common stock among our current shareholders.
The following is a summary of the material terms included in this separate
shareholders agreement.
o Shares received under the Carry Option Plan, described below, may not
be transferred for a period of one year after our initial public
offering.
o Mr. Martin is generally prohibited from disposing of shares unless,
at the time of the disposition, the proportion of his shareholdings
that he has disposed of does not exceed the proportion of
shareholdings disposed of by the Capital Partners Funds.
o The Capital Partners Funds and the other shareholders, under
specified circumstances and subject to certain conditions, have the
right to require us to register their shares under the Securities Act
and to participate in specified registrations of shares by us.
o We have the right to repurchase at cost all shares, including those
received pursuant to the Carry Option Plan, held by each of our
Management Investors if, prior to June 1, 2003, his or her employment
is terminated either by him or her without Good Reason or by us for
cause and he or she then engages in an activity competitive with our
business. This right can be assigned to the other Management
Investors, and the Capital Partners Funds have the right to effect
any such repurchase directly from the Management Investor.
o As long as the Capital Partners Funds own at least 5% of our
outstanding shares, they will have the right to designate two board
members and one member of each committee of our board.
As a result of their stock ownership, their positions with Vanguard and
the shareholders and related agreements described herein, our executive
management and the Capital Partners Funds control us and have the power to
elect all of our directors. As a result of their holding approximately 80% of
our outstanding shares of common stock and their rights under the shareholders
agreement, the Capital Partners Funds have significant influence over our
management and policies and over any action requiring the approval of the
holders of our common stock, including amendments to our certificate of
incorporation, acquisitions or sales of all or substantially all of our assets.
Circumstances may occur in which the interests of the Capital Partners Funds
could be in conflict with your interests. In addition, the Capital Partners
Funds may have an interest in pursuing transactions that, in their judgment,
enhance the value of their equity investment in our company, even though those
transactions may involve risks to you as a holder of the notes.
Subscription Agreement
Under a subscription agreement dated June 1, 2000, between us and certain
investors, including the Capital Partners Funds and our executive officers, to
fund the purchase of hospitals, hospital systems, hospital management companies
and related assets, we authorized the issuance and sale of 235,521 shares of
common stock at a price of $1,701.18 per share. As of November 15, 2001, we
have sold 46,051 shares pursuant to this subscription agreement. According to
its terms, the obligation of the Capital Partners Funds to purchase shares are
subject to the approval of the Capital Partners Investment Committee. The
subscription agreement also entitles the Capital Partners Funds and their
affiliates to have an exclusive right of first offer to provide equity and
equity-linked financing to us (except for equity issued by us or our
subsidiaries in connection with hospital or hospital system acquisitions).
Letter Agreement
On June 1, 1998, we signed a letter agreement with our existing
shareholders at that date under which we agreed that if, in connection with a
Management Investor's ownership of the Initial Shares, we become entitled to
any tax deduction in respect of such Initial Shares, we will pay to such
Management Investor, when we actually
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receive the economic benefit of this deduction, the amount of the benefit. As
of this time, we have not received any benefits which we would be obligated to
pay to the Management Investors under this agreement.
Our Option Plans
In June 1998, we established a stock option plan (the "1998 Stock Option
Plan") which is available for stock option awards from time to time to our
officers, key employees, directors and consultants, including key employees of
acquired hospitals. Except as described below, the terms of this option plan
state that the options will vest ratably over a term of four years and that all
options will accelerate immediately upon a change in control (as defined in the
plan). In addition, all optionees must consent in their option agreements to be
bound by the terms of the shareholders agreements referred to above. A certain
percentage of the options granted pursuant to the 1998 Stock Option Plan (at
least 75% percent of those issued) must be forfeited to us if the investment
gains received by the Capital Partners Funds upon a Liquidity Event are less
than a predetermined amount and, accordingly, these options may not be
exercised prior to a Liquidity Event. The maximum number of shares of our
common stock reserved for the grant of options under this plan is 13,306,
subject to a readjustment upon the occurrence of a Liquidity Event. As of
November 15, 2001, options to purchase 10,329 shares have been granted and
remain outstanding under this plan. Of the remaining 2,977 authorized options,
none of these options are available for our grant, and all remain outstanding
unless a Liquidity Event shall occur and a certain financial test set forth in
the plan relating to shareholder returns on their investment in our shares is
met.
In June 2000, we established another stock option plan (the "2000 Stock
Option Plan") which is available for stock option awards from time to time to
our officers, key employees, directors and consultants, including key employees
of acquired hospitals. The terms of this option plan are substantially similar
to those of the 1998 Stock Option Plan, including the forfeiture provisions
described above. The maximum number of shares of common stock reserved for the
grant of options under this plan is 41,931 shares or a lesser number based upon
a formula relating to recent issuances of our common stock to our shareholders.
As of November 15, 2001, options to purchase 8,094 shares are authorized for
grant under this plan and options to purchase 7,694 shares have been granted
and remain outstanding under this plan.
In June 1998, we established a Carry Option Plan under which options to
purchase our shares may be granted to certain key employees. The options
granted under this plan vest ratably over seven years and become fully vested
upon a Liquidity Event. These options are exercisable only upon a Liquidity
Event and only to an extent determined pursuant to a schedule based on the
returns earned by the Capital Partners Funds on its aggregate investment in our
common stock. Pursuant to our shareholders agreement, the Capital Partners
Funds and certain other shareholders may be obligated to forfeit up to 25% of
the shares of our common stock which they own, depending upon the extent of the
investment gains of the Capital Partners Funds upon a Liquidity Event, to fund
options granted under this plan to employees. Options to purchase 29,822 shares
were authorized for grant under this plan at a price per option equal to 10% of
the fair market value of the related underlying share, and, as of November 15,
2001, all of these options to purchase 29,822 shares have been granted under
this plan to key employees, including Messrs. Martin, Hough, Moore, Pitts and
Soltman.
Effective June 1998, we established a Nonqualified Initial Option Plan
under which we granted options to purchase an aggregate of 3,595 shares to
certain of our employees on June 1, 1998. Most of the options granted under
this plan were made to our employees who worked for us during 1997 and 1998
either with no cash salaries or with salaries below fair market value. These
options were granted with an exercise price equal to 10% of the purchase price
which we charged purchasers of our shares of common stock on June 1, 1998.
All of the options which we have granted under the 1998 Stock Option Plan,
the 2000 Stock Option Plan, the Nonqualified Initial Option Plan and the Carry
Option Plan have been granted to our officers and other employees. We believe
that the past and future grants of options to purchase our common stock under
these plans have and will assist us in retaining and recruiting employees of
outstanding ability. Stock option grants provide an incentive that focuses the
employee's attention on managing or working for the business of our company
from the perspective of an owner with an equity stake in the business and helps
ensure that operating decisions are based on long-term results that benefit the
business and ultimately our shareholders. Usually, each stock option granted
under these plans
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becomes vested and exercisable only over a period of time or upon a Liquidity
Event. Generally, the exercise prices of options granted under the 1998 Stock
Option Plan and the 2000 Stock Option Plan have been equal to the fair market
value at the time of grant, subject to downward adjustment in the event of
superior investment gains by the Capital Partners Funds upon a Liquidity Event,
while options granted under the Carry Option Plan and the Initial Option Plan
are granted at exercise prices equal to 10% of such fair market value. The
number of shares covered by each grant is intended to reflect the grantee's
level of responsibility and past and anticipated contributions.
Each of our option plans provides that, in the event of any
recapitalization, reclassification, merger, consolidation, stock split, or
combination or exchange of shares, or other similar transaction, the number of
shares of our common stock available for awards, the number of such shares
covered by outstanding awards, the option price and any other relevant
provisions of the plan will be equitably adjusted by our board or compensation
committee to reflect such event and preserve the value of such options.
Our Employment Agreements
On June 1, 1998, we entered into written employment agreements with our
Chief Executive Officer, Chief Operating Officer, Chief Financial Officer and
General Counsel (Messrs. Martin, Hough, Moore and Soltman, respectively) for
terms expiring on June 1, 2003, with provisions for renewal. On September 1,
1999, we entered into a written employment agreement with Keith B. Pitts to be
our Executive Vice President for a term expiring on September 1, 2004, with
provisions for renewal. Effective May 31, 2001, Mr. Pitts was promoted to the
position of Vice Chairman of our board. The base salaries of Messrs. Martin,
Hough, Moore, Pitts and Soltman under such written employment agreements are,
as of October 1, 2001, $900,000, $550,000, $500,000, $550,000 and $450,000,
respectively. Pursuant to these agreements these officers are to have an annual
bonus plan giving each of them an opportunity to earn an annual bonus in such
amount as our Board of Directors should determine, as well as pension, medical
and other customary employee benefits. Through our fiscal year ended June 30,
2001, no such bonus plan was made available to such officers. The terms of
these agreements state that if the employee terminates his employment for Good
Reason or if we breach the terms of the agreement and terminate the employee,
he will receive within a specified time after the termination a payment of up
to three times his annual salary plus the average of the bonuses given to him
in the two years immediately preceding his termination.
Our Severance Protection Agreements
We provide our executives at the Vice President level and above (other
than Messrs. Martin, Hough, Moore, Soltman and Pitts) with severance protection
agreements granting them severance payments in amounts of 200% to 250% of
annual salary and bonus. Generally, severance payments are due under these
agreements if a change in control (as defined) should occur and employment of
the officer is terminated during the term of the agreement by us (or our
successor) or by the employee for Good Reason. In addition, these agreements
state that in the event of a Potential Change in Control (defined as the time
at which an agreement which would result in a change in our control is signed,
an acquisition attempt relating to us is publicly announced or there is an
increase in the number of shares owned by one of our ten-percent shareholders
by five percent or more), the employees have an obligation to remain in our
employ until the earliest of (i) six months after the Potential Change in
Control; (ii) a change in control; (iii) a termination of employment by us; or
(iv) a termination of employment by the employee for Good Reason (treating
Potential Change in Control as a change in control for the purposes of
determining whether the employee had a Good Reason) or due to death, disability
or retirement.
Our Voting Proxy Agreement
Each of our shareholders (other than the Capital Partners Funds) has
entered into a voting proxy agreement in which each shareholder has granted Mr.
Martin (or, if Mr. Martin is no longer employed by us or is no longer one of
our directors, Mr. Moore) an irrevocable proxy to vote that shareholder's
shares of common stock in such manner as Mr. Martin, in his sole discretion,
deems proper. Furthermore, Mr. Martin has been authorized under the voting
proxy agreement to issue any consent or waiver on behalf of the shareholder
under our shareholders agreement and related agreements. The voting proxy
agreement terminates upon the earlier of (i) the consummation of a Liquidity
Event and (ii) June 1, 2008.
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Mr. Martin has used his rights under the voting proxy agreement to
nominate himself and Messrs. Hough, Moore, Pitts and Soltman as the directors
to be nominated by the management shareholders pursuant to our shareholders
agreement.
Our Related Party Transactions
Charles N. Martin, Jr., our Chairman and Chief Executive Officer,
beneficially owns in excess of 97% of the membership interests in The
Healthcare Airplane Group, LLC, a Tennessee limited liability company. We own
an approximately 0.4% membership interest in The Healthcare Airplane Group. The
Healthcare Airplane Group's principal asset is a Falcon model 20F-731
10-passenger jet airplane. We paid The Healthcare Airplane Group approximately
$0.4 million, $0.3 million, $0.3 million, $0.1 million and $0.1 million during
the fiscal year ended June 30, 1999, 2000, and 2001, and during the three
months ended September 30, 2000 and 2001, respectively, to charter such plane
from time to time, to fly our employees to and from the sites of our proposed
acquisitions and for other corporate purposes. These charter payments were made
in the ordinary course of our business, and we believe that the prices paid to
The Healthcare Airplane Group for these charter services were more favorable to
us than those charter rates which we could have obtained for comparable plane
services from an independent airplane charter company.
On July 1, 2000, we purchased 100% of the outstanding common stock of
Trinity MedCare, Inc. from its nine shareholders. Trinity is in the business of
managing psychiatric units in acute care hospitals and providing consulting
services for acute care hospitals with psychiatric units. The aggregate
purchase price of these shares was $806,000. Six of our executive officers
mentioned above, Messrs. Hough, Martin, Moore, Pitts, Soltman and Thomas, sold
us their shares of Trinity MedCare, Inc. on July 1, 2000 for $43,420, $283,564,
$21,768, $43,420, $43,420, and $21,768, respectively.
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OUR PIK PREFERRED STOCK
Our board of directors is authorized to issue up to 150,000 shares of
Preferred Stock in series and with powers, designations, preferences and
relative rights as the board determines. In connection with the acquisition of
MacNeal Hospital, we issued 20,000 shares of Payable-In-Kind Convertible
Redeemable Preferred Stock ("PIK Preferred Stock"), at a price of $1,000 per
share. Dividends on the PIK Preferred Stock are payable when, as and if
declared by our board, and are cumulative and accrue at the rate of 8% per
annum from the date of issuance. Dividends on the PIK Preferred Stock are
payable annually in cash or, until the earlier of January 31, 2008, and the
date the first cash dividend is paid on our common stock, are payable at our
option by issuing additional shares of PIK Preferred Stock. No dividends or
distributions may be made on our common stock unless and until all accrued and
unpaid dividends are first paid to the holders of the PIK Preferred Stock.
We may redeem the PIK Preferred Stock at any time, to the extent we have
funds legally available to do so. We are required to redeem the PIK Preferred
Stock, to the extent we have funds legally available to do so, on the earliest
of 90 days after a change in control of Vanguard, 90 days after the sale of all
or substantially all of the assets of MacNeal Hospital, and January 31, 2015.
The price for any redemption will be $1,000 per share plus all accrued and
unpaid dividends to the redemption date. The PIK Preferred Stock has a
liquidation preference over our common stock (and any other class of equity
securities that we may issue that is junior to the PIK Preferred Stock) equal
to the redemption price of $1,000 per share plus all accrued and unpaid
dividends to the date of any liquidation, dissolution or winding up. Our PIK
Preferred Stock will automatically convert into shares of common stock upon an
underwritten public offering in which the gross proceeds to Vanguard are $50
million or more, at a conversion price equal to the per share offering price to
the public.
Holders of PIK Preferred Stock are generally not entitled to vote, except
that in the event that we have failed to pay two annual dividends or to redeem
the PIK Preferred Stock when required, holders of PIK Preferred Stock will be
entitled to elect two additional directors to our board. In addition, the
affirmative vote of the holders of at least a majority of the outstanding PIK
Preferred Stock is required to change the terms and provisions of the PIK
Preferred Stock in a manner that would materially and adversely affect its
rights and preferences or to authorize any issuance of equity securities senior
in right of dividends or liquidation preference to the PIK Preferred Stock.
Except as required by law or as described above, the holders of the PIK
Preferred Stock are not entitled to vote on any matter submitted to a vote of
the shareholders. The redemption of, and payment of cash dividends on, the PIK
Preferred Stock is restricted by the terms of the our 2001 senior secured
credit facility and the indenture governing the notes. For a description of the
ownership of the PIK Preferred Stock, see "Principal Shareholders."
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DESCRIPTION OF THE 2001 SENIOR SECURED CREDIT FACILITY
Concurrently with the completion of the offering of the old notes, we
entered into the 2001 senior secured credit facility, consisting initially of a
five-year revolving credit facility providing for loans and letters of credit
in an aggregate outstanding amount at any time of $125 million. The 2001 senior
secured credit facility also contemplates one or more tranches of term loans,
which will be uncommitted at the time of closing of the 2001 senior secured
credit facility. If we wish to borrow under these term facilities, we will be
required to solicit funding commitments from our existing lenders and new
lenders. If lenders choose in their discretion to make these term loans
available, they will also determine the aggregate amount of the term
facilities, which could be as high as $250 million, as well as the duration,
interest rates and many other terms. We will be permitted to use borrowings
under the revolving credit facility for working capital, capital expenditures
and other general corporate purposes. Any term loan borrowings would be used
for general corporate purposes, which may include acquisitions, determined at
the time we made such borrowings.
Except as otherwise permitted by the lenders from time to time,
obligations under the 2001 senior secured credit facility are and will be
guaranteed by all of our current and future domestic wholly-owned restricted
subsidiaries and are and will be secured by substantially all of our assets and
stock and the assets and stock of the subsidiaries that are guarantors. Pricing
on the loans under the revolving credit facility is based on LIBOR, reset
periodically, plus a margin ranging from 2.25% to 3.25%, depending on the ratio
of our net debt-to-Adjusted EBITDA for our most recently ended four quarters.
We also have the option to borrow at pricing based on a base rate plus a margin
ranging from 1.25% to 2.25% based on our leverage ratio. The base rate is the
higher of the prime rate and .50% in excess of the overnight Federal funds
rate. Pricing on the loans under the term loan facilities will likely also be
based on LIBOR or the base rate plus applicable margins to be agreed upon if
and when the loans are committed.
The revolving credit facility has no amortization schedule. Each tranche
of the term loan facilities will have an amortization schedule to be agreed
upon when the loans are committed. We will be required to prepay loans under
the new bank facility with 100% of the net proceeds of asset sales and
insurance awards (each subject to certain reinvestment allowances) and 100% of
the net proceeds of certain debt issuances. Any term loan facilities we incur
would be subject to additional prepayment events, including 50% of the net
proceeds from a public offering of our equity and 50% of annual excess cash
flow.
The 2001 senior secured credit facility contains covenants limiting our
and our subsidiaries' ability to (1) incur additional debt and additional
liens, (2) enter into sale-leaseback transactions, (3) make dividends and other
payments with respect to our equity securities and certain optional payments
with respect to our debt, including the Notes, (4) enter into transactions with
affiliates and form new subsidiaries, (5) make investments or capital
expenditures, (6) enter into mergers and consolidations and (7) acquire or
dispose of assets. We are also obligated to comply with consolidated financial
tests including an interest coverage ratio and leverage ratio. We will be
required to make customary representations and warranties prior to borrowing.
The 2001 senior secured credit facility also contains events of default
upon the occurrence of certain events, including (1) failure to make payments
when due under the facilities, (2) misrepresentation, (3) failure to comply
with covenants, (4) the occurrence of a default under our other material debt
or the material debt of any subsidiary, (5) the occurrence of a bankruptcy or
insolvency proceeding, (6) legal judgments against us and our subsidiaries
aggregating over a threshold amount to be agreed and (7) a change of control.
The existence of any event of default would permit the lenders under the 2001
senior secured credit facility to accelerate the maturity of the loans and
terminate their commitments to make further revolving credit available. If the
lenders choose to do so in that circumstance, we would not be able to obtain
further credit under the 2001 senior secured credit facility and we would be
required to immediately repay the loans under the 2001 senior secured credit
facility (and collateralize any existing exposure under letters of credit).
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DESCRIPTION OF THE NOTES
Vanguard issued the old notes under an Indenture, dated as of the Closing
Date, among Vanguard, as issuer, the Initial Subsidiary Guarantors, as
guarantors, and Bank One Trust Company, N.A., as trustee ("Trustee"). The terms
of the new notes are identical in all material respects to the terms of the old
notes, except for transfer restrictions relating to the outstanding notes, and,
in both cases, include those terms stated in the Indenture and those made a
part of the Indenture by reference to the Trust Indenture Act. Any old notes
that remain outstanding after the exchange offer, together with the new notes
issued in the exchange offer, will be treated as a single class of securities
under the Indenture for voting purposes. When we refer to the term "notes" in
this "Description of the Notes" section, we are referring to both the old notes
and the new notes to be issued in the exchange offer.
The following is a summary of the material provisions of the Indenture but
does not restate the Indenture in its entirety. You can find the definitions of
certain capitalized terms used in the following summary under the subheading "-
Definitions." We urge you to read the Indenture because it, and not this
description, defines your rights as holders of the notes. A copy of the
proposed form of Indenture is available upon request from Vanguard. For
purposes of this "Description of the Notes," the term "Vanguard" means Vanguard
and its successors under the Indenture, in each case excluding its
subsidiaries.
General
The notes are unsecured senior subordinated obligations of Vanguard,
initially limited to $300 million aggregate principal amount. The notes will
mature on August 1, 2011. Subject to the covenants described below under
"-Covenants" and applicable law, Vanguard may issue additional notes
("Additional Notes") under the Indenture. Any such Additional Notes will have
the same terms as the Notes initially issued under the Indenture, except that
interest will accrue on the Additional Notes from their date of issuance. The
old notes, the new notes and any Additional Notes will be treated as a single
class for all purposes under the Indenture.
Each note will initially bear interest at 9.75% per annum from the Closing
Date or from the most recent interest payment date to which interest has been
paid. Interest on the notes will be payable semiannually on February 1 and
August 1 of each year, commencing February 1, 2002. Interest will be paid to
Holders of record at the close of business on the January 15 or July 15
immediately preceding the Interest Payment Date. Interest is computed on the
basis of a 360-day year of twelve 30-day months on a U.S. corporate bond basis.
The notes may be exchanged or transferred at the office or agency of
Vanguard in the Borough of Manhattan, the City of New York. Initially, the
corporate trust office of the Trustee in New York, New York, will serve as such
office. If you give Vanguard wire transfer instructions, Vanguard will pay all
principal, premium and interest on your notes in accordance with your
instructions. If you do not give Vanguard wire transfer instructions, payments
of principal, premium and interest will be made at the office or agency of the
paying agent which will initially be the Trustee, unless Vanguard elects to
make interest payments by check mailed to the Holders.
The notes will be issued only in fully registered form, without coupons,
in denominations of $1,000 in principal amount and integral multiples of
$1,000. See "-Book-Entry; Delivery and Form." No service charge will be made
for any registration of transfer or exchange of notes, but Vanguard may require
payment of a sum sufficient to cover any transfer tax or other similar
governmental charge payable in connection therewith.
Optional Redemption
Vanguard may redeem the notes at any time on or after August 1, 2006. The
redemption price for the notes (expressed as a percentage of principal amount),
will be as follows, plus accrued and unpaid interest to the redemption date:
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If Redeemed During the 12-Month Period Commencing Redemption Price
- --------------------------------------------------- ----------------
August 1, 2006...................................... 104.875%
August 1, 2007...................................... 103.250
August 1, 2008...................................... 101.625
August 1, 2009 and thereafter....................... 100.000%
In addition, at any time prior to August 1, 2004, Vanguard may redeem up
to 35% of the principal amount of the notes with the Net Cash Proceeds of one
or more sales of its Capital Stock (other than Disqualified Stock) at a
redemption price (expressed as a percentage of principal amount) of 109.750%,
plus accrued and unpaid interest to the redemption date; provided that at least
65% of the aggregate principal amount of notes originally issued on the Closing
Date remains outstanding after each such redemption and notice of any such
redemption is mailed within 90 days of each such sale of Capital Stock.
Vanguard will give not less than 30 days' nor more than 60 days' notice of
any redemption. If less than all of the notes are to be redeemed, selection of
the notes for redemption will be made by the Trustee:
o in compliance with the requirements of the principal national
securities exchange, if any, on which the notes are listed, or,
o if the notes are not listed on a national securities exchange, on a
pro rata basis, by lot or by such other method as the Trustee in its
sole discretion shall deem to be fair and appropriate.
However, no note of $1,000 in principal amount or less shall be redeemed in
part. If any note is to be redeemed in part only, the notice of redemption
relating to such note will state the portion of the principal amount thereof
to be redeemed. A new note in principal amount equal to the unredeemed portion
will be issued upon cancellation of the original note. notes called for
redemption become due on the date fixed for redemption. On and after the
redemption date, interest ceases to accrue on notes or portions of notes
called for redemption.
Mandatory Redemption
Vanguard is not required to make mandatory redemption of, or sinking fund
payments with respect to, the notes.
Guarantees
Except as described under "Guarantees by Restricted Subsidiaries" below,
payment of the principal of, premium, if any, and interest on the notes will be
Guaranteed, jointly and severally, on an unsecured senior subordinated basis by
each Restricted Subsidiary, other than a Foreign Subsidiary, existing on the
Closing Date. In addition, except as so described, each future Restricted
Subsidiary, other than a Foreign Subsidiary, will Guarantee the payment of the
principal of, premium if any and interest on the notes.
The obligations of each Subsidiary Guarantor under its Note Guarantee will
be limited so as not to constitute (after giving effect to all Senior
Indebtedness of the respective Guarantor) a fraudulent conveyance under
applicable Federal or state laws. Each Subsidiary Guarantor that makes a
payment or distribution under its Note Guarantee will be entitled to
contribution from any other Subsidiary Guarantor (which contribution rights may
only be exercised after all Senior Indebtedness of each other Subsidiary
Guarantor has been repaid in full in cash or cash equivalents).
The Note Guarantee issued by any Subsidiary Guarantor will be
automatically and unconditionally released and discharged upon (1) any sale,
exchange or other disposition (including by way of consolidation or merger) to
any Person (other than an Affiliate of Vanguard) of all of the Capital Stock of
such Subsidiary Guarantor or all or substantially all of the assets of such
Subsidiary Guarantor, (2) the designation of such Subsidiary Guarantor as an
Unrestricted Subsidiary, in each case in compliance with the terms of the
Indenture, or (3) such Subsidiary Guarantor no longer being required to provide
a Guarantee pursuant to the "Guarantee by Restricted Subsidiaries" covenant.
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Ranking
Summary
The notes will be senior subordinated Indebtedness of Vanguard. This means
that the payment of the principal, premium and interest on, and all other
amounts owing with respect to, the notes is subordinated to the prior payment
in full in cash or cash equivalents of all existing and future Senior
Indebtedness of Vanguard. See "Risk Factors-The notes will be subordinated to
our senior debt." However, payment from the money or the proceeds of U.S.
Government Obligations held in any defeasance trust described under
"-Defeasance" below, as long as all of the conditions to deposit into such
trust were satisfied at the time of such deposit, will not be subordinated to
any Senior Indebtedness or subject to the restrictions described below.
The Note Guarantees will be senior subordinated Indebtedness of the
Subsidiary Guarantors. The Indebtedness evidenced by the Note Guarantees will
be subordinated on the same basis to Senior Indebtedness of the Subsidiary
Guarantors as the notes are subordinated to Senior Indebtedness of Vanguard.
As of September 30, 2001, Vanguard and the Initial Subsidiary Guarantors
had $312.9 million of consolidated Indebtedness, of which $12.9 million was
Senior Indebtedness, and an additional $125 million of revolving loans
available under the Credit Agreement, all of which, if drawn, would be Senior
Indebtedness.
By reason of the subordination provisions described below, in the event of
liquidation or insolvency, creditors of Vanguard who are not holders of Senior
Indebtedness may recover less, ratably, than holders of Senior Indebtedness and
may recover more, ratably, than Holders of the notes.
Terms of Subordination
Except with respect to the money, securities or proceeds held under any
defeasance trust established in accordance with the Indenture (so long as all
of the conditions to deposit into such trust were satisfied at the time of such
deposit), upon any dissolution or winding up or total or partial liquidation or
reorganization of Vanguard, whether voluntary or involuntary, or in bankruptcy,
insolvency, receivership or other proceedings, all amounts due or to become due
upon all Senior Indebtedness (including any interest accruing subsequent to the
filing of a petition of bankruptcy at the rate provided for in the
documentation with respect thereto, whether or not such interest is an allowed
claim under applicable law) shall first be paid in full, in cash or cash
equivalents, before the Holders of the notes or the Trustee on behalf of the
Holders of the notes shall be entitled to receive (1) any payment by, or on
behalf of, Vanguard on account of Senior Subordinated Obligations, (2) any
payment to acquire any of the notes for cash, property, securities or
otherwise, or (3) any distribution with respect to the notes, whether of cash,
property, securities or otherwise.
Before any payment may be made by, or on behalf of, Vanguard on any Senior
Subordinated Obligations (other than with the money, securities or proceeds
held under any defeasance trust established in accordance with the Indenture,
as long as all of the conditions to deposit into such trust were satisfied at
the time of such deposit) upon any such dissolution, winding up, liquidation or
reorganization, all Senior Indebtedness (including any interest accruing
subsequent to the filing of a petition of bankruptcy at the rate provided for
in the documentation with respect thereto, whether or not such interest is an
allowed claim under applicable law) must be paid in full in cash or cash
equivalents. If any payment or distribution of assets or securities of Vanguard
of any kind or character, whether in cash, property, securities or otherwise,
to which the Holders of the notes or the Trustee on behalf of the Holders of
the notes would be entitled, but for the subordination provisions of the
Indenture, shall be made by Vanguard or by any receiver, trustee in bankruptcy,
liquidating trustee, agent or other similar Person making such payment or
distribution for the Holders of the notes or the Trustee prior to payment in
full in cash or cash equivalents of all Senior Indebtedness, such payment or
distribution shall be held in trust for the holders of Senior Indebtedness and
must be paid directly to the holders of the Senior Indebtedness
(proportionately to such holders on the basis of the respective amounts of
Senior Indebtedness held by such holders) or their representatives or to any
trustee or trustees under any indenture pursuant to which any such Senior
Indebtedness may have been issued, as their respective interests appear, to the
extent necessary to pay all such Senior Indebtedness in full, in cash or cash
equivalents, after
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giving effect to any concurrent payment, distribution or provision therefor to
or for the holders of such Senior Indebtedness.
No direct or indirect payment by or on behalf of Vanguard of Senior
Subordinated Obligations (other than with the money, securities or proceeds
held under any defeasance trust established in accordance with the Indenture,
as long as all of the conditions to deposit into such trust were satisfied at
the time of such deposit), whether pursuant to the terms of the notes or upon
acceleration or otherwise shall be made if, at the time of such payment, there
exists a default in the payment of all or any portion of the obligations on any
Senior Indebtedness of Vanguard and such default shall not have been cured or
waived or the benefits of this sentence waived by or on behalf of the holders
of such Senior Indebtedness. In addition, during the continuance of any other
event of default with respect to any Designated Senior Indebtedness pursuant to
which the maturity thereof may be accelerated, upon receipt by the Trustee of
written notice from the trustee or other representative for the holders of such
Designated Senior Indebtedness (or the holders of at least a majority in
principal amount of such Designated Senior Indebtedness then outstanding), no
payment of Senior Subordinated Obligations (other than with the money,
securities or proceeds held under any defeasance trust established in
accordance with the Indenture, as long as all of the conditions to deposit into
such trust were satisfied at the time of such deposit) may be made by or on
behalf of Vanguard upon or in respect of the notes for a period (a "Payment
Blockage Period") commencing on the date of receipt of such notice and ending
179 days thereafter (unless, in each case, such Payment Blockage Period shall
be terminated by written notice to the Trustee from such trustee of, or other
representative for, such holders or by payment in full in cash or cash
equivalents of such Designated Senior Indebtedness (and any other Designated
Senior Indebtedness with an event of default then permitting acceleration) or
all events of default with respect to all Designated Senior Indebtedness then
outstanding have been cured or waived). Not more than one Payment Blockage
Period may be commenced with respect to the notes during any period of 360
consecutive days. Notwithstanding anything in the Indenture to the contrary,
there must be 180 consecutive days in any 360-day period in which no Payment
Blockage Period is in effect. No event of default that existed or was
continuing (it being acknowledged that any subsequent action or any breach of
any financial covenants for a period commencing after the date of delivery of
such initial payment blockage notice that would, in either case, give rise to
an event of default pursuant to any provision under which an event of default
previously existed or was continuing shall constitute a new event of default
for this purpose) on the date of the commencement of any Payment Blockage
Period with respect to the Designated Senior Indebtedness initiating such
Payment Blockage Period shall be, or shall be made, the basis for the
commencement of a second Payment Blockage Period by the representative for, or
the holders of, such Designated Senior Indebtedness, whether or not within a
period of 360 consecutive days, unless such event of default shall have been
cured or waived for a period of not less than 90 consecutive days.
To the extent that any payment of Senior Indebtedness (whether by or on
behalf of Vanguard, as proceeds of security or enforcement of any right of
setoff or otherwise) is declared to be fraudulent or preferential, set aside or
required to be paid to any receiver, trustee in bankruptcy, liquidating
trustee, agent or other similar Person under any bankruptcy, insolvency,
receivership, fraudulent conveyance or similar law, then if such payment is
recovered by, or paid over to, such receiver, trustee in bankruptcy,
liquidating trustee, agent or other similar Person, the Senior Indebtedness or
part thereof originally intended to be satisfied shall be deemed to be
reinstated and outstanding as if such payment had not occurred. To the extent
that the obligation to repay any Senior Indebtedness is declared to be
fraudulent, invalid, or otherwise set aside under any bankruptcy, insolvency,
receivership, fraudulent conveyance or similar law, then the obligation so
declared fraudulent, invalid or otherwise set aside (and all other amounts that
would come due with respect thereto had such obligation not been so affected)
shall be deemed to be reinstated and outstanding as Senior Indebtedness for all
purposes hereof as if such declaration, invalidity or setting aside had not
occurred.
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Covenants
Overview
In the Indenture, Vanguard has agreed to covenants that limit its and its
Restricted Subsidiaries' ability, among other things, to:
o incur additional debt;
o pay dividends, acquire shares of capital stock, make payments on
subordinated debt or make investments;
o place limitations on distributions from Restricted Subsidiaries;
o issue or sell capital stock of Restricted Subsidiaries;
o issue guarantees;
o sell or exchange assets;
o enter into transactions with Affiliates;
o create liens; and
o effect mergers.
In addition, if a Change of Control occurs, each Holder of notes will have
the right, subject to the terms and conditions hereinafter described, to
require Vanguard to repurchase all or a part of the Holder's notes at a price
equal to 101% of their principal amount, plus any accrued interest to the date
of repurchase.
Limitation on Indebtedness
(a) Vanguard will not, and will not permit any of its Restricted
Subsidiaries to, Incur any Indebtedness (other than the notes, the Note
Guarantees and other Indebtedness existing on the Closing Date); provided that
Vanguard or any Subsidiary Guarantor may Incur Indebtedness, and any Restricted
Subsidiary may Incur Acquired Indebtedness, if, after giving effect to the
Incurrence of such Indebtedness and the receipt and application of the proceeds
therefrom, the Interest Coverage Ratio would be greater than 2.0:1.
Notwithstanding the foregoing, Vanguard and any Restricted Subsidiary
(except as specified below) may Incur each and all of the following:
(1) Indebtedness of Vanguard or any Subsidiary Guarantor under the
Credit Agreement outstanding at any time in an aggregate principal amount
not to exceed the greater of (i) $150.0 million, less any amount of such
Indebtedness permanently repaid as provided under the "Limitation on Asset
Sales" covenant, or (ii) the amount equal to the sum of 85% of the net
book value of accounts receivable and 75% of the net book value of
inventory of Vanguard and its Restricted Subsidiaries on a consolidated
basis when such Indebtedness is incurred, as determined in accordance with
GAAP;
(2) Indebtedness owed (A) to Vanguard or any Subsidiary Guarantor
evidenced by an unsubordinated promissory note or (B) to any other
Restricted Subsidiary; provided that, in the case of Indebtedness
described in clause (B), (x) any event which results in any such
Restricted Subsidiary ceasing to be a Restricted Subsidiary or any
subsequent transfer of such Indebtedness (other than to Vanguard or
another Restricted Subsidiary) shall be deemed, in each case, to
constitute an Incurrence of such Indebtedness not permitted by this clause
(2) and (y) if Vanguard or any Subsidiary Guarantor is the obligor on such
Indebtedness, such Indebtedness, other than Indebtedness represented by
short-term, open account working capital notes entered
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into in the ordinary course of business for cash management purposes and
consistent with past practice, must be expressly subordinated in right of
payment to the notes, in the case of Vanguard or the Note Guarantee, in
the case of a Subsidiary Guarantor;
(3) Indebtedness issued in exchange for, or the net proceeds of which
are used to refinance, refund, defease or renew other Indebtedness (the
"Refinanced Indebtedness") (other than Indebtedness outstanding under
clause (2) or (5)) in an amount not to exceed the amount of the Refinanced
Indebtedness (plus premiums, accrued interest, fees, costs and expenses);
provided that (a) if the Refinanced Indebtedness is the notes or other
Indebtedness that is pari passu with, or subordinated in right of payment
to, the notes or a Note Guarantee, such Refinanced Indebtedness shall only
be permitted under this clause (3) if (x) in case the notes are refinanced
in part or the Refinanced Indebtedness is pari passu with the notes or a
Note Guarantee, such new Indebtedness, by its terms or by the terms of any
agreement or instrument pursuant to which such new Indebtedness is
outstanding, is expressly made pari passu with, or subordinate in right of
payment to, the remaining notes or the Note Guarantee, or (y) in case the
Refinanced Indebtedness is subordinated in right of payment to the notes
or a Note Guarantee, such new Indebtedness, by its terms or by the terms
of any agreement or instrument pursuant to which such new Indebtedness is
issued or remains outstanding, is expressly made subordinate in right of
payment to the notes or the Note Guarantee on terms not less favorable to
the Holders of the notes and the Note Guarantees than those on which the
Refinanced Indebtedness was so subordinated to the notes or the Note
Guarantees, (b) such new Indebtedness, other than Senior Indebtedness,
determined as of the date of Incurrence of such new Indebtedness, does not
mature prior to the Stated Maturity of the Refinanced Indebtedness, and
the Average Life of such new Indebtedness is at least equal to the
remaining Average Life of the Refinanced Indebtedness, and (c) such new
Indebtedness is Incurred by Vanguard or a Subsidiary Guarantor or by the
Restricted Subsidiary who is the obligor on the Refinanced Indebtedness;
(4) Indebtedness of Vanguard, to the extent the net proceeds thereof
are promptly (A) used to purchase notes tendered in an Offer to Purchase
made as a result of a Change in Control or (B) deposited to defease the
notes as described under "Defeasance";
(5) Guarantees of Indebtedness of Vanguard or any Restricted
Subsidiary by any Restricted Subsidiary; provided that the Guarantee of
such Indebtedness is otherwise permitted by and made in accordance with
the terms of the Indenture;
(6) Indebtedness of Vanguard or any Restricted Subsidiary
representing Capitalized Lease Obligations, mortgage financings or
purchase money obligations, in each case, incurred for the purpose of
financing all or any part of the purchase price or cost of construction or
improvement of property, plant or equipment used in the business of
Vanguard or such Restricted Subsidiary, outstanding at any time in an
aggregate principal amount (together with refinancings thereof), not to
exceed the greater of (x) $25 million and (y) 3% of Total Assets
determined at the time of Incurrence;
(7) Physician Support Obligations incurred by Vanguard or any
Restricted Subsidiary;
(8) Guarantees by Vanguard of Indebtedness of any Restricted
Subsidiary; provided such Indebtedness is otherwise permitted by and made
in accordance with this "Limitation on Indebtedness" covenant;
(9) Acquired Indebtedness acquired or assumed by Vanguard or any
Restricted Subsidiary, or resulting from the merger or consolidation of
one or more Persons into or with one or more Restricted Subsidiaries;
provided that after giving effect to any Acquired Indebtedness acquired or
assumed under this clause (9), Vanguard could Incur at least $1.00 of
Indebtedness under the first paragraph of this part (a) of the "Limitation
on Indebtedness" covenant;
(10) Indebtedness of a Securitization Subsidiary Incurred in a
Permitted Receivables Financing; and
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(11) Indebtedness of Vanguard or any Restricted Subsidiary (in
addition to Indebtedness permitted under the preceding clauses of this
paragraph) in an aggregate principal amount outstanding at any time
(together with refinancings thereof) not to exceed $50 million.
(b) Notwithstanding any other provision of this "Limitation on
Indebtedness" covenant, (x) the maximum amount of Indebtedness that may be
Incurred pursuant to this "Limitation on Indebtedness" covenant will not be
deemed to be exceeded, with respect to any outstanding Indebtedness due solely
as the result of fluctuations in the exchange rates of currencies and (y)
Indebtedness resulting from the capitalization or accretion of interest after
the issuance of any Indebtedness shall be deemed not to constitute an
Incurrence of Indebtedness hereunder.
(c) For purposes of determining any particular amount of Indebtedness
under this "Limitation on Indebtedness" covenant, (x) Indebtedness Incurred
under the Credit Agreement on or prior to the Closing Date shall be treated as
Incurred pursuant to clause (1) of the second paragraph of clause (a) of this
"Limitation on Indebtedness" covenant, (y) Guarantees, Liens or obligations
with respect to letters of credit supporting Indebtedness otherwise included in
the determination of such particular amount shall not be included and (z) any
Liens granted pursuant to the equal and ratable provisions referred to in the
"Limitation on Liens" covenant shall not be treated as Indebtedness. For
purposes of determining compliance with this "Limitation on Indebtedness"
covenant, in the event that an item of Indebtedness meets the criteria of more
than one of the types of Indebtedness described above (other than Indebtedness
referred to in clause (x) of the preceding sentence), including under the first
paragraph of part (a), Vanguard, in its sole discretion, shall classify, and
from time to time may reclassify, such item of Indebtedness. Without limiting
the foregoing, it is understood and agreed that term loans and other
Indebtedness may be incurred from time to time pursuant to the Credit Agreement
in reliance on, and in compliance with, the first paragraph of part (a) of this
covenant or pursuant to the relevant numbered exceptions contained in the
second paragraph of part (a) of this covenant and, if so Incurred in accordance
with this covenant, such Indebtedness shall be deemed to constitute
Indebtedness under the Credit Agreement for purposes of the definition of
Senior Indebtedness.
Limitation on Senior Subordinated Indebtedness
Vanguard will not, and will not permit any Subsidiary Guarantor to, Incur
any Indebtedness that is subordinate in right of payment to any Senior
Indebtedness unless such Indebtedness is pari passu with, or subordinated in
right of payment to, the notes or any Note Guarantee; provided that the
foregoing limitation shall not apply to distinctions between categories of
Senior Indebtedness that exist by reason of any Liens or Guarantees arising or
created in respect of some but not all such Senior Indebtedness or priorities
of paydown, from proceeds of collateral or otherwise, among classes or tranches
of any issue of Senior Indebtedness.
Limitation on Restricted Payments
Vanguard will not, and will not permit any Restricted Subsidiary to,
directly or indirectly, (1) declare or pay any dividend or make any
distribution on or with respect to its Capital Stock (other than (x) dividends
or distributions payable solely in shares of its Capital Stock (other than
Disqualified Stock) or in options, warrants or other rights to acquire shares
of such Capital Stock and (y) pro rata dividends or distributions on Capital
Stock of Restricted Subsidiaries to holders of such Capital Stock) held by
Persons other than Vanguard or any of its Restricted Subsidiaries, (2)
purchase, call for redemption or redeem, retire or otherwise acquire for value
any shares of Capital Stock of (A) Vanguard or any Subsidiary Guarantor
(including options, warrants or other rights to acquire such shares of Capital
Stock) held by any Person other than Vanguard or any of its Restricted
Subsidiaries or (B) a Restricted Subsidiary other than a Subsidiary Guarantor
(including options, warrants or other rights to acquire such shares of Capital
Stock) held by any Affiliate of Vanguard (other than a Restricted Subsidiary)
or any holder of 5% or more of the Common Stock of Vanguard, (3) make any
voluntary or optional principal payment, or voluntary or optional redemption,
repurchase, defeasance, or other voluntary acquisition or retirement for value,
of Indebtedness of Vanguard that is subordinated in right of payment to the
notes or any Indebtedness of a Subsidiary Guarantor that is subordinated in
right of payment to a Note Guarantee or (4) make any Investment, other than a
Permitted Investment, in any Person (such payments or any other actions
described in, but not excluded from, clauses (1) through (4) above being
collectively "Restricted Payments") if, at the time of, and after giving effect
to, the proposed Restricted Payment:
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(A) a Default or Event of Default shall have occurred and be
continuing,
(B) Vanguard could not Incur at least $1.00 of Indebtedness under the
first paragraph of part (a) of the "Limitation on Indebtedness" covenant
or
(C) the aggregate amount of all Restricted Payments made after the
Closing Date shall exceed the sum of
(1) 50% of the aggregate amount of the Adjusted Consolidated Net
Income (or, if the Adjusted Consolidated Net Income is a loss, minus
100% of the amount of such loss) accrued on a cumulative basis during
the period (taken as one accounting period) beginning on July 1,
2001, and ending on the last day of the last fiscal quarter preceding
the Transaction Date for which reports have been filed with the SEC
or provided to the Trustee plus
(2) the aggregate Net Cash Proceeds received by Vanguard after
the Closing Date as a capital contribution or from the issuance and
sale of its Capital Stock (other than Disqualified Stock) to a Person
who is not a Subsidiary of Vanguard, including an issuance or sale
permitted by the Indenture of Indebtedness of Vanguard for cash upon
the conversion of such Indebtedness into Capital Stock (other than
Disqualified Stock) of Vanguard, or from the issuance to a Person who
is not a Subsidiary of Vanguard of any options, warrants or other
rights to acquire Capital Stock of Vanguard (in each case, exclusive
of any Disqualified Stock or any options, warrants or other rights
that are redeemable at the option of the holder, or are required to
be redeemed, prior to the Stated Maturity of the notes) plus
(3) an amount equal to the net reduction in Investments (other
than reductions in Permitted Investments) in any Person resulting (A)
from payments of interest on Indebtedness, dividends, repayments of
loans or advances, or other transfers of assets, in each case to
Vanguard or any Restricted Subsidiary, (B) from the Net Cash Proceeds
from the sale of any such Investment (except, in each case, to the
extent any such payment or proceeds are included in the calculation
of Adjusted Consolidated Net Income) or (C) from the release of any
Guarantee plus
(4) an amount equal to the portion (proportionate to Vanguard's
equity interest in an Unrestricted Subsidiary) of the fair market
value of the assets less the liabilities of an Unrestricted
Subsidiary at the time such Unrestricted Subsidiary is designated a
Restricted Subsidiary.
The foregoing provision shall not be violated by reason of:
(1) the payment of any dividend or redemption of any Capital Stock
within 60 days after the related date of declaration or call for
redemption if, at said date of declaration or call for redemption, such
payment or redemption would comply with the preceding paragraph;
(2) the redemption, repurchase, defeasance or other acquisition or
retirement for value of Indebtedness that is subordinated in right of
payment to the notes or any Note Guarantee including premium, if any, and
accrued interest, with the proceeds of, or in exchange for, Indebtedness
Incurred under clause (3) of the second paragraph of part (a) of the
"Limitation on Indebtedness" covenant;
(3) the repurchase, redemption or other acquisition of Capital Stock
of Vanguard or a Subsidiary Guarantor (or options, warrants or other
rights to acquire such Capital Stock) in exchange for, or out of the
proceeds of a capital contribution or a substantially concurrent offering
of, shares of Capital Stock (other than Disqualified Stock) of Vanguard
(or options, warrants or other rights to acquire such Capital Stock);
provided that such options, warrants or other rights are not redeemable
prior to the Stated Maturity of the notes;
(4) the making of any principal payment or the repurchase,
redemption, retirement, defeasance or other acquisition for value of
Indebtedness which is subordinated in right of payment to the notes or any
Note Guarantee in exchange for, or out of the proceeds of, a substantially
concurrent offering of, shares of the Capital Stock (other than
Disqualified Stock) of Vanguard (or options, warrants or other rights to
acquire such Capital
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Stock); provided that such options, warrants or other rights are not
redeemable prior to the Stated Maturity of the notes;
(5) payments or distributions to dissenting stockholders pursuant to
applicable law, pursuant to or in connection with a consolidation, merger
or transfer of assets of Vanguard that complies with the provisions of the
Indenture applicable to mergers, consolidations and transfers of all or
substantially all of the property and assets of Vanguard;
(6) Investments acquired as a capital contribution or in exchange
for, or out of the proceeds of a substantially concurrent offering of,
Capital Stock (other than Disqualified Stock) of Vanguard;
(7) repurchases by Vanguard of Capital Stock deemed to occur upon the
exercise of options or warrants if such Capital Stock represents all or a
portion of the exercise price thereof;
(8) repurchases by Vanguard of its Capital Stock from any of its
directors, officers or employees pursuant to any shareholders agreement in
effect on the date of the Indenture and as amended, modified or replaced
from time to time; provided that the amended, modified or replaced
agreement is not less favorable in any material respect to Vanguard and
its Restricted Subsidiaries than that in effect on the Closing Date;
(9) repurchases by Vanguard of its Capital Stock pursuant to any
management equity subscription plan or agreement, stock option plan or
agreement or employee benefit plan of Vanguard (excluding repurchases
pursuant to clause (8) above), in an aggregate amount not to exceed $2
million in any fiscal year;
(10) dividends payable beginning January 1, 2008 on the PIK Preferred
Stock of Vanguard outstanding on the date of the Indenture, and any
additional PIK Preferred Stock paid in kind as a dividend thereon, in an
aggregate amount not to exceed $3 million in any fiscal year; or
(11) Restricted Payments in an aggregate amount not to exceed $5
million,
provided that, except in the case of clauses (1), (3) and (10), no Default or
Event of Default shall have occurred and be continuing or occur as a
consequence of the actions or payments set forth therein.
Each Restricted Payment permitted pursuant to the preceding paragraph
(other than the Restricted Payment referred to in clause (2) thereof, an
exchange of Capital Stock for Capital Stock or Indebtedness referred to in
clause (3) or (4) thereof and an Investment acquired as a capital contribution
or in exchange for Capital Stock referred to in clause (6) thereof) and the Net
Cash Proceeds from any issuance of Capital Stock referred to in clauses (3),
(4) or (6), shall be included in calculating whether the conditions of clause
(C) of the first paragraph of this "Limitation on Restricted Payments" covenant
have been met with respect to any subsequent Restricted Payments.
For purposes of determining compliance with this "Limitation on Restricted
Payments" covenant, (x) the amount, if other than in cash, of any Restricted
Payment shall be determined in good faith by the board of directors, whose
determination shall be conclusive and evidenced by a board resolution and (y)
in the event that a Restricted Payment meets the criteria of more than one of
the types of Restricted Payments described in the above clauses, including the
first paragraph of this "Limitation on Restricted Payments" covenant, Vanguard,
in its sole discretion, may order and classify, and from time to time may
reclassify, such Restricted Payment if it would have been permitted at the time
such Restricted Payment was made and at the time of such reclassification.
Limitation on Dividend and Other Payment Restrictions Affecting Restricted
Subsidiaries
Vanguard will not, and will not permit any Restricted Subsidiary to,
create or otherwise cause or suffer to exist or become effective any consensual
encumbrance or restriction of any kind on the ability of any Restricted
Subsidiary to (1) pay dividends or make any other distributions permitted by
applicable law on any Capital Stock of such Restricted Subsidiary owned by
Vanguard or any other Restricted Subsidiary, (2) pay any Indebtedness owed to
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Vanguard or any other Restricted Subsidiary, (3) make loans or advances to
Vanguard or any other Restricted Subsidiary or (4) transfer any of its property
or assets to Vanguard or any other Restricted Subsidiary.
The foregoing provisions shall not restrict any encumbrances or
restrictions:
(1) arising pursuant to the Credit Agreement;
(2) existing on the Closing Date in the Indenture or any other
agreements in effect on the Closing Date, and any extensions,
refinancings, renewals or replacements of such agreements; provided that
the encumbrances and restrictions in any such extensions, refinancings,
renewals or replacements taken as a whole are no less favorable in any
material respect to the Holders than those encumbrances or restrictions
that are then in effect and that are being extended, refinanced, renewed
or replaced;
(3) existing under or by reason of applicable law;
(4) existing with respect to any Person or the property or assets of
such Person acquired by Vanguard or any Restricted Subsidiary, existing at
the time of such acquisition and not incurred in contemplation thereof,
which encumbrances or restrictions are not applicable to any Person or the
property or assets of any Person other than such Person or the property or
assets of such Person so acquired and any extensions, refinancings,
renewals or replacements of thereof; provided that the encumbrances and
restrictions in any such extensions, refinancings, renewals or
replacements taken as a whole are no less favorable in any material
respect to the Holders than those encumbrances or restrictions that are
then in effect and that are being extended, refinanced, renewed or
replaced;
(5) in the case of clause (4) of the first paragraph of this
"Limitation on Dividend and Other Payment Restrictions Affecting
Restricted Subsidiaries" covenant:
(A) that restrict in a customary manner the subletting,
assignment or transfer of any property or asset that is a lease,
license, conveyance or contract or similar property or asset, or
(B) existing by virtue of any transfer of, agreement to
transfer, option or right with respect to, or Lien on, any property
or assets of Vanguard or any Restricted Subsidiary not otherwise
prohibited by the Indenture;
(6) arising or agreed to in the ordinary course of business, not
relating to any Indebtedness, and that do not, individually or in the
aggregate, detract from the value of property or assets of Vanguard or any
Restricted Subsidiary in any manner material to Vanguard or any Restricted
Subsidiary;
(7) with respect to a Restricted Subsidiary and imposed pursuant to
an agreement for the sale or disposition of all or substantially all of
the Capital Stock of, or property and assets of, such Restricted
Subsidiary and that are customary for such transactions;
(8) deferral of rights of subrogation pursuant to Guarantees
otherwise permitted under the Indenture;
(9) existing pursuant to any agreement governing Indebtedness
permitted to be incurred pursuant to the "Limitation on Indebtedness"
covenant; provided that the provisions relating to such encumbrance or
restriction contained in such Indebtedness are no less favorable to
Vanguard in any material respect as determined by the board of directors
of Vanguard in their reasonable and good faith judgment than the
provisions contained in the Credit Agreement as in effect on the Closing
Date;
(10) Indebtedness or other contractual requirements of a
Securitization Subsidiary in connection with a Permitted Receivables
Financing; provided that such restrictions apply only to such
Securitization Subsidiary; or
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(11) provisions in joint venture agreements with respect to the
disposition or distribution of assets or property in the ordinary course
of business.
Nothing contained in this "Limitation on Dividend and Other Payment
Restrictions Affecting Restricted Subsidiaries" covenant shall prevent Vanguard
or any Restricted Subsidiary from (1) creating, incurring, assuming or
suffering to exist any Liens otherwise permitted in the "Limitation on Liens"
covenant or (2) restricting the sale or other disposition of property or assets
of Vanguard or any of its Restricted Subsidiaries that secure Indebtedness of
Vanguard or any of its Restricted Subsidiaries.
Limitation on the Issuance and Sale of Capital Stock of Restricted
Subsidiaries
Vanguard will not sell, and will not permit any Restricted Subsidiary,
directly or indirectly, to issue or sell, any shares of Capital Stock of a
Restricted Subsidiary (including options, warrants or other rights to purchase
shares of such Capital Stock) except:
(1) to Vanguard or a Wholly Owned Restricted Subsidiary;
(2) issuances of director's qualifying shares or sales to foreign
nationals of shares of Capital Stock of foreign Restricted Subsidiaries,
to the extent required by applicable law; or
(3) if, immediately after giving effect to such issuance or sale, any
Investment in such Person remaining after giving effect to such issuance
or sale would have been permitted to be made under the "Limitation on
Restricted Payments" covenant if made on the date of such issuance or sale
and the proceeds of any such sale are applied as and to the extent
required by the "Limitation on Asset Sales" covenant.
Guarantees by Restricted Subsidiaries
Vanguard will cause each Restricted Subsidiary other than a Foreign
Subsidiary to execute and deliver a supplemental indenture to the Indenture
providing for a Guarantee (a "Subsidiary Guarantee") of payment of the notes by
such Restricted Subsidiary.
Notwithstanding the foregoing, any Subsidiary Guarantee by a Restricted
Subsidiary may provide by its terms that it shall be automatically and
unconditionally released and discharged (i) upon any sale, exchange or
transfer, to any Person not a Subsidiary of Vanguard, of all of Vanguard's and
each Restricted Subsidiary's Capital Stock in, or all or substantially all the
assets of, such Restricted Subsidiary (which sale, exchange or transfer is not
prohibited by the Indenture), (ii) upon the designation of such Restricted
Subsidiary as an Unrestricted Subsidiary in accordance with the terms of the
Indenture, or (iii) if at any time at which the Credit Agreement shall be in
effect such Restricted Subsidiary shall not be required to be a guarantor under
the Credit Agreement (but only for so long as such Restricted Subsidiary is not
so required to be such a guarantor; upon any requirement that such Restricted
Subsidiary become a guarantor under the Credit Agreement, such Restricted
Subsidiary shall immediately provide a Subsidiary Guarantee pursuant to this
covenant).
Limitation on Transactions with Affiliates
Vanguard will not, and will not permit any Restricted Subsidiary to,
directly or indirectly, enter into, renew or extend any transaction (including,
without limitation, the purchase, sale, lease or exchange of property or
assets, or the rendering of any service) with any Affiliate of Vanguard or any
Restricted Subsidiary, except upon terms no less favorable to Vanguard or such
Restricted Subsidiary than could have been obtained, at the time of such
transaction or, if such transaction is pursuant to a written agreement, at the
time of the execution of the agreement providing therefor, in a comparable
arm's-length transaction with a Person that is not such an Affiliate.
The foregoing limitation does not limit, and shall not apply to:
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(1) transactions (A) approved by a majority of the disinterested
members of the board of directors or (B) for which Vanguard or a
Restricted Subsidiary delivers to the Trustee a written opinion of a
nationally recognized investment banking, accounting, valuation or
appraisal firm stating that the transaction is fair to Vanguard or such
Restricted Subsidiary from a financial point of view;
(2) any transaction solely between Vanguard and any of its Restricted
Subsidiaries or solely among Restricted Subsidiaries;
(3) reasonable fees and compensation paid to, and indemnity and
similar arrangements provided on behalf of, officers, directors or
employees of Vanguard or any Restricted Subsidiary in the ordinary course
of business, as determined in good faith by the board of directors or
senior management of Vanguard;
(4) any payments or other transactions pursuant to any tax-sharing
agreement between Vanguard and any other Person with which Vanguard files
a consolidated tax return or with which Vanguard is part of a consolidated
group for tax purposes;
(5) any sale of shares of Capital Stock (other than Disqualified
Stock) of Vanguard;
(6) any Permitted Investments or any Restricted Payments not
prohibited by the "Limitation on Restricted Payments" covenant;
(7) fees, discounts and expenses reimbursement paid to, and indemnity
and similar arrangements with, any Initial Purchaser in connection with
the offering and sale of the notes and the Bank Agent or any lender in
connection with the Credit Agreement;
(8) customary fees, discounts and expense reimbursement paid to, and
indemnity and similar arrangements with, Affiliates providing investment
banking and commercial banking services, including without limitation
underwriting and other financial advisory services, to Vanguard and its
Restricted Subsidiaries;
(9) any agreement or arrangement in effect on the Closing Date, as
amended, modified or replaced from time to time; provided that the
amended, modified or replaced agreement or arrangement is not less
favorable in any material respect to Vanguard and its Restricted
Subsidiaries than that in effect on the Closing Date;
(10) loans and advances to officers and employees of Vanguard or any
Restricted Subsidiary in the ordinary course of business of Vanguard not
exceeding $5 million in the aggregate outstanding at any time;
(11) Restricted Payments that are permitted pursuant to the
"Limitation on Restricted Payments" covenant;
(12) transactions between Vanguard or a Restricted Subsidiary and an
Insurance Subsidiary, between Vanguard or a Restricted Subsidiary and a
Securitization Subsidiary or between a Securitization Subsidiary and any
Person in which the Securitization Subsidiary has an Investment; or
(13) issuances of securities or payments or distributions in the
ordinary course of business in connection with employment incentive plans,
employee stock plans, employee stock option plans and similar plans and
arrangements approved by the board of directors.
Notwithstanding the foregoing, any transaction or series of related
transactions covered by the first paragraph of this "Limitation on Transactions
with Shareholders and Affiliates" covenant and not covered by clauses (2)
through (13) of this paragraph, (a) the aggregate amount of which exceeds $5
million in value, must be approved or determined to be fair in the manner
provided for in clause (1)(A) or (B) above and (b) the aggregate amount of
which exceeds $10 million in value, must be determined to be fair in the manner
provided for in clause (1)(B) above.
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Limitation on Liens
Vanguard will not, and will not permit any Subsidiary Guarantor to, Incur
any Indebtedness secured by a Lien ("Secured Indebtedness") which is not Senior
Indebtedness unless contemporaneously therewith effective provision is made to
secure the notes or the Note Guarantee equally and ratably with (or, if the
Secured Indebtedness is subordinated in right of payment to the notes or the
Note Guarantees, prior to) such Secured Indebtedness for so long as such
Secured Indebtedness is secured by a Lien.
The foregoing limitation does not apply to:
(1) Liens existing on the Closing Date;
(2) Liens securing obligations under or with respect to the Credit
Agreement which obligations were permitted to be Incurred under the
Indenture;
(3) Liens (including extensions and renewals thereof) upon real or
personal property; provided that (a) such Lien is created solely for the
purpose of securing Indebtedness Incurred, in accordance with the
"Limitation on Indebtedness" covenant, to finance the cost (including the
cost of improvement or construction) of the item of property or assets
subject thereto and such Lien attaches not later than 365 days after the
latest of the date of acquisition of such property, the completion of the
financed improvements or construction and the commencement of full
operation of such property, (b) the principal amount of the Indebtedness
secured by such Lien does not exceed 100% of such cost and (c) any such
Lien shall not extend to or cover any property or assets other than such
item of property or assets and any improvements on such item;
(4) Liens on cash set aside at the time of the Incurrence of any
Indebtedness, or government securities purchased with such cash, in either
case to the extent that such cash or government securities pre-fund the
payment of interest on such Indebtedness and are held in a collateral or
escrow account or similar arrangement to be applied for such purpose;
(5) Liens on property of a Person at the time such Person becomes a
Restricted Subsidiary of Vanguard; provided such Liens were not created in
contemplation thereof and do not extend to any other property of Vanguard
or any Restricted Subsidiary;
(6) Liens on property at the time Vanguard or any Restricted
Subsidiary acquires such property, including any acquisition by means of a
merger or consolidation with or into Vanguard or a Restricted Subsidiary
of such Person; provided such Liens were not created in contemplation of
such acquisition and do not extend to any other property of Vanguard or
any Restricted Subsidiary;
(7) pledges or deposits under worker's compensation laws,
unemployment insurance laws or similar legislation, or good faith deposits
in connection with bids, tenders, contracts or leases, or to secure public
or statutory obligations, surety bonds customs duties and the like, in
each case incurred in the ordinary course of business;
(8) judgment Liens not giving rise to an Event of Default; provided
such Lien is adequately bonded and any appropriate legal proceedings which
may have been duly initiated for the review of such judgment shall not
have been finally terminated or the period within which such proceedings
may be initiated shall not have been expired;
(9) Liens arising in connection with a Permitted Receivables
Financing; provided that in the case of Vanguard and the Subsidiary
Guarantors such Liens shall be limited to receivables referred to in the
definition of Permitted Receivables Financing, and related assets and
proceeds and the Capital Stock of a Securitization Subsidiary;
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(10) Liens securing any Indebtedness under any Commodity Agreement,
Currency Agreement or Interest Rate Agreement that is Indebtedness; and
(11) extensions, renewals or replacements of any Liens referred to in
clauses (1), (5) and (6) in connection with the refinancing of the
obligations secured thereby; provided that such extension, renewal or
replacement Lien is limited to all or part of the same property that was
secured under the original Lien.
Limitation on Asset Sales
Vanguard will not, and will not permit any Restricted Subsidiary to,
consummate any Asset Sale, unless (1) the consideration received by Vanguard or
such Restricted Subsidiary is at least equal to the fair market value of the
assets sold or disposed of and (2) at least 75% of the consideration received
consists of (a) cash or Temporary Cash Investments, (b) the assumption of
Indebtedness or other obligations (other than Indebtedness subordinated to the
notes) of Vanguard or any Subsidiary Guarantor or Indebtedness of any other
Restricted Subsidiary (in each case, other than Indebtedness owed to Vanguard
or any Affiliate of Vanguard); provided that Vanguard, such Subsidiary
Guarantor or such other Restricted Subsidiary is irrevocably and
unconditionally released from all liability under such Indebtedness, (c)
Replacement Assets, and/or (d) any securities, notes or other similar
obligations converted by Vanguard or such Restricted Subsidiary into cash (to
the extent of the cash received in that conversion) within 30 days of the
applicable Asset Sale.
Notwithstanding the foregoing, the 75% limitation referred to in clause
(2) above shall not apply to any Asset Sale in which the amount of
consideration of the type referred to in clauses (a) through (d) of the
preceding paragraph received therefrom, determined in accordance with the
foregoing provision, is equal to or greater than what the after-tax proceeds
would have been had such Asset Sale complied with aforementioned 75%
limitation.
Vanguard may, or may cause the relevant Restricted Subsidiary to, within
twelve months after the date of receipt of Net Cash Proceeds from an Asset
Sale,
(A) apply an amount equal to such Net Cash Proceeds to permanently
repay Senior Indebtedness of Vanguard or any Subsidiary Guarantor or
Indebtedness of any other Restricted Subsidiary (or permanently reduce the
commitments thereunder, in the case of any revolving credit facility
available pursuant to the Credit Agreement or otherwise), in each case
owing to a Person other than Vanguard or any Restricted Subsidiary, or
(B) invest an equal amount, or the amount not so applied pursuant to
clause (A) (or enter into a definitive agreement committing to so invest
within 12 months after the date of such agreement), in Replacement Assets.
The amount of such Net Cash Proceeds available to be applied (or to be
committed to be applied) during such 12-month period as set forth in the
preceding sentence and not applied (or committed) as so required by the end of
such period shall constitute "Excess Proceeds."
If, as of the last day of any calendar month, the aggregate amount of
Excess Proceeds not theretofore subject to an Offer to Purchase pursuant to
this "Limitation on Asset Sales" covenant totals at least $10 million, Vanguard
must commence, not later than 30 days after such date, and consummate an Offer
to Purchase from the Holders (and if required by the terms of any Indebtedness
that is pari passu with the notes ("Pari Passu Indebtedness"), from the holders
of such Pari Passu Indebtedness) on a pro rata basis an aggregate principal
amount of notes (and Pari Passu Indebtedness) equal to the Excess Proceeds on
such date, at a purchase price equal to 100% of their principal amount, plus,
in each case, accrued interest (if any) to the Payment Date. Upon completion of
the Offer to Purchase, Excess Proceeds will be reset at zero, and any Excess
Proceeds remaining after consummation of the Offer to Purchase may be used for
any purpose not otherwise prohibited by the Indenture.
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Designation of Restricted and Unrestricted Subsidiaries
(a) The board of directors of Vanguard may designate any Subsidiary,
including a newly acquired or created Subsidiary, to be an Unrestricted
Subsidiary if no Default or Event of Default shall have occurred and be
continuing at the time of or immediately after giving effect to such
designation and the Subsidiary meets the following qualifications:
(1) (A) the Subsidiary does not (i) own any Disqualified Stock of
Vanguard or any Disqualified Stock of a Restricted Subsidiary or (ii) hold
any Indebtedness of, or any Lien on any property of, Vanguard or any
Restricted Subsidiary, if such Indebtedness could not be Incurred under
the "Limitation on Indebtedness" covenant or such Lien would violate the
"Limitation on Liens" covenant; and (B) the Subsidiary does not own any
Common Stock of a Restricted Subsidiary, and all of its Subsidiaries are
Unrestricted Subsidiaries;
(2) at the time of the designation, the designation would be
permitted under the "Limitation on Restricted Payments" covenant;
(3) any Guarantee or other credit support thereof by Vanguard or any
Restricted Subsidiary is deemed an Incurrence of Indebtedness and an
Investment, and would be permitted under the "Limitation on Indebtedness"
and "Limitation on Restricted Payments" covenants;
(4) the Subsidiary is not party to any transaction, arrangement,
contract, agreement or understanding with Vanguard or any Restricted
Subsidiary that would not be permitted under the "Limitation on
Transactions with Affiliates" covenant; and
(5) neither Vanguard nor any Restricted Subsidiary has any obligation
to subscribe for additional Capital Stock of the Subsidiary or to maintain
or preserve its financial condition or cause it to achieve specified
levels of operating results, except to the extent permitted by the
"Limitation on Indebtedness" and "Limitation on Restricted Payments"
covenants.
Once so designated the Subsidiary will remain an Unrestricted Subsidiary,
subject to paragraph (b) below.
(b) (1) A Subsidiary previously designated an Unrestricted Subsidiary
which fails to meet the qualifications set forth in paragraph (a) above will be
deemed to become at that time a Restricted Subsidiary, subject to the
consequences set forth in paragraph (d) below.
(2) The board of directors may designate an Unrestricted Subsidiary
to be a Restricted Subsidiary if no Default or Event of Default shall have
occurred and be continuing at the time of or immediately after giving
effect to such designation.
(c) Upon a Restricted Subsidiary becoming an Unrestricted Subsidiary,
(1) all existing Investment of Vanguard and the Restricted
Subsidiaries therein (valued at Vanguard's and its Restricted
Subsidiaries' proportionate share of the fair market value of such
Unrestricted Subsidiaries' assets less liabilities) will be deemed made at
that time;
(2) all existing Capital Stock or Indebtedness of Vanguard or a
Restricted Subsidiary held by it will be deemed Incurred at that time, and
all Liens on property of Vanguard or a Restricted Subsidiary held by it
will be deemed incurred at that time;
(3) all existing transactions between it and Vanguard or any
Restricted Subsidiary will be deemed entered into at that time;
(4) it is released at that time from its Note Guarantee, if any; and
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(5) it will cease to be subject to the provisions of the Indenture as
a Restricted Subsidiary.
(d) Upon an Unrestricted Subsidiary becoming, or being deemed to become, a
Restricted Subsidiary,
(1) all of its Indebtedness will be deemed Incurred at that time for
purposes of the "Limitation on Indebtedness" covenant, but will not be
considered the sale or issuance of Capital Stock for purposes of the
"Limitation on the Issuance and Sale of Capital Stock of Restricted
Subsidiaries" or "Limitation on Asset Sales" covenants;
(2) Investments therein previously charged under the "Limitation on
Restricted Payments" covenant will be credited thereunder;
(3) it shall immediately issue a Note Guarantee pursuant to, but only
to the extent required by, the "Guarantees by Restricted Subsidiaries"
covenant; and
(4) it will thenceforward be subject to the provisions of the
Indenture as a Restricted Subsidiary.
(e) Any designation by Vanguard's board of directors of a Subsidiary as a
Restricted Subsidiary or Unrestricted Subsidiary will be evidenced to the
Trustee by promptly filing with the Trustee a copy of the board resolution
giving effect to the designation and an officers' certificate certifying that
the designation complied with the foregoing provisions.
Repurchase of Notes upon a Change of Control
Vanguard must commence, within 30 days of the occurrence of a Change of
Control, and consummate an Offer to Purchase for all notes then outstanding, at
a purchase price equal to 101% of their principal amount, plus accrued interest
(if any) to the Payment Date.
Prior to the commencement (or mailing) of the Offer to Purchase referred
to above, but in any event within 30 days following any Change of Control,
Vanguard covenants to:
(1) repay in full and terminate all commitments under Indebtedness
under the Credit Agreement and all other Senior Indebtedness the terms of
which require repayment upon a Change of Control or offer to repay in full
and terminate all commitments under all Indebtedness under the Credit
Agreement and all other such Senior Indebtedness and to repay the
Indebtedness owed to, and terminate all commitments of, each lender which
has accepted such offer; or
(2) obtain the requisite consents under the Credit Agreement and all
other Senior Indebtedness to permit the repurchase of the notes as
provided above.
If a change of control occurs at a time when we are required to pay
outstanding amounts under the 2001 senior secured credit facility or obtain
such consents, and if we do not refinance such borrowings or obtain such
consents, we will remain prohibited from repurchasing the notes, which would
constitute an event of default under the indenture which would, in turn,
constitute an event of default under our 2001 senior secured credit facility
and under our other senior indebtedness. If we fail to comply with the
requirements of the 2001 senior secured credit facility, the lenders can
declare the entire amount owed thereunder immediately due and payable and
prohibit us from making payments of interest and principal on the notes until
all such debt is paid or otherwise satisfied in full, and can also enforce
their security interests against our assets. Vanguard may not have sufficient
funds available at the time of any Change of Control to make any debt payment
(including repurchases of notes) required by the foregoing covenant (as well as
may be contained in other securities of Vanguard which might be outstanding at
the time).
The above covenant requiring Vanguard to repurchase the notes will require
Vanguard to repay all Indebtedness under the Credit Agreement, and all other
Senior Indebtedness then outstanding which by its terms would prohibit such
note repurchase prior to such note repurchase. If Vanguard does not repay such
indebtedness, Vanguard will
110
remain prohibited from purchasing notes. Vanguard's failure to purchase
tendered notes following a Change of Control would constitute an Event of
Default under the Indenture. The Credit Agreement provides that the occurrence
of certain Change of Control events with respect to Vanguard would constitute a
default under the Credit Agreement. Future debt that Vanguard may incur may
prohibit Vanguard from purchasing notes in the event of a Change of Control,
provide that a Change of Control is a default or require repurchase upon a
Change of Control.
Vanguard will not be required to make an Offer to Purchase upon the
occurrence of a Change of Control if a third party makes an offer to purchase
the notes in the manner, at the times and price and otherwise in compliance
with the requirements of the Indenture applicable to an Offer to Purchase for a
Change of Control and purchases all notes validly tendered and not withdrawn in
such offer to purchase.
SEC Reports and Reports to Holders
At all times from and after the earlier of (1) the date of the
commencement of an Exchange Offer or the effectiveness of the Shelf
Registration Statement (the "Registration") and (2) the date that is six months
after the Closing Date, in either case, whether or not Vanguard is then
required to file reports with the SEC, Vanguard shall file with the SEC (to the
extent accepted by the SEC for filing) all such reports and other information
as it would be required to file with the SEC by Section 13(a) or 15(d) under
the Securities Exchange Act of 1934 if it were subject thereto. Vanguard shall
supply to the Trustee and to each Holder or shall supply to the Trustee for
forwarding to each such Holder, without cost to such Holder, copies of such
reports and other information. In addition, at all times prior to the earlier
of the date of the Registration and the date that is six months after the
Closing Date, Vanguard shall, at its cost, deliver to each Holder of the notes
quarterly and annual reports substantially equivalent to those which would be
required by the Exchange Act. In addition, at all times prior to the
Registration, upon the request of any Holder or any prospective purchaser of
the notes designated by a Holder, Vanguard shall supply to such Holder or such
prospective purchaser the information required under Rule 144A(d)(4) under the
Securities Act.
Events of Default
The following events are defined as "Events of Default" in the Indenture:
(a) default in the payment of principal of (or premium, if any, on)
any note when the same becomes due and payable at maturity, upon
acceleration, redemption or otherwise, whether or not such payment is
prohibited by the provisions described above under "--Ranking";
(b) default in the payment of interest on any note when the same
becomes due and payable, and such default continues for a period of 30
days, whether or not such payment is prohibited by the provisions
described above under "-Ranking";
(c) default in the performance or breach of the covenant in the
Indenture applicable to "Consolidations, Mergers and Sales of Assets" or
the failure by Vanguard to make or consummate an Offer to Purchase in
accordance with the "Limitation on Asset Sales" or "Repurchase of Notes
upon a Change of Control" covenant;
(d) Vanguard or any Subsidiary Guarantor defaults in the performance
of or breaches any other covenant or agreement in the Indenture or under
the notes (other than a default specified in clause (a), (b) or (c) above)
and such default or breach continues for a period of 60 consecutive days
after written notice specifying the default (and demanding that such
default be remedied) by the Trustee or the Holders of 25% or more in
aggregate principal amount of the notes;
(e) there occurs with respect to any issue or issues of Indebtedness
of Vanguard or any Restricted Subsidiary having an outstanding principal
amount of $10 million or more in the aggregate for all such issues of all
such Persons, whether such Indebtedness now exists or shall hereafter be
created, (I) an event of default that has caused the holder thereof to
declare such Indebtedness to be due and payable prior to its Stated
Maturity and such Indebtedness has not been discharged in full or such
acceleration has not been rescinded or annulled within 30 days of such
acceleration and/or (II) the failure to make a principal payment at the
final (but not any
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interim) fixed maturity and such defaulted payment shall not have been
made, waived or extended within 30 days of such payment default;
(f) any final judgment or order (not covered by insurance or
indemnity provided by a reputable and creditworthy Person) for the payment
of money in excess of $10 million in the aggregate for all such final
judgments or orders against all such Persons (treating any deductibles,
self-insurance or retention, or in the case of indemnity, amounts excluded
by baskets, caps, thresholds or similar limitations, as not so covered)
shall be rendered against Vanguard, any Significant Subsidiary or any
group of Restricted Subsidiaries that, taken together, would constitute a
Significant Subsidiary and shall not be paid or discharged, and there
shall be any period of 60 consecutive days following entry of the final
judgment or order that causes the aggregate amount for all such final
judgments or orders outstanding and not paid or discharged against all
such Persons to exceed $10 million during which a stay of enforcement of
such final judgment or order, by reason of a pending appeal or otherwise,
shall not be in effect;
(g) a court having jurisdiction in the premises enters a decree or
order for (A) relief in respect of Vanguard, any Significant Subsidiary or
any group of Restricted Subsidiaries that, taken together, would
constitute a Significant Subsidiary in an involuntary case under any
applicable bankruptcy, insolvency or other similar law now or hereafter in
effect, (B) appointment of a receiver, liquidator, assignee, custodian,
trustee, sequestrator or similar official of Vanguard, any Significant
Subsidiary or any group of Restricted Subsidiaries that, taken together,
would constitute a Significant Subsidiary, or for all or substantially all
of the property and assets of Vanguard, any Significant Subsidiary or any
group of Restricted Subsidiaries that, taken together, would constitute a
Significant Subsidiary, or (C) the winding up or liquidation of the
affairs of Vanguard, any Significant Subsidiary or any group of Restricted
Subsidiaries that, taken together, would constitute a Significant
Subsidiary, and, in each case, such decree or order shall remain unstayed
and in effect for a period of 60 consecutive days;
(h) Vanguard, any Significant Subsidiary or any group of Restricted
Subsidiaries that, taken together, would constitute a Significant
Subsidiary, (A) commences a voluntary case under any applicable
bankruptcy, insolvency or other similar law now or hereafter in effect, or
consents to the entry of an order for relief in an involuntary case under
any such law, (B) consents to the appointment of or taking possession by a
receiver, liquidator, assignee, custodian, trustee, sequestrator or
similar official of Vanguard, any Significant Subsidiary or any group of
Restricted Subsidiaries that, taken together, would constitute a
Significant Subsidiary, or for all or substantially all of the property
and assets of Vanguard, any Significant Subsidiary or any group of
Restricted Subsidiaries that, taken together, would constitute a
Significant Subsidiary, or (C) effects any general assignment for the
benefit of creditors; or
(i) any Subsidiary Guarantor repudiates its obligations under its
Note Guarantee or, except as permitted by the Indenture, any Note
Guarantee is determined to be unenforceable or invalid or shall for any
reason cease to be in full force and effect.
If an Event of Default (other than an Event of Default specified in clause
(g) or (h) above that occurs with respect to Vanguard) occurs and is continuing
under the Indenture, the Trustee or the Holders of at least 25% in aggregate
principal amount of the notes, then outstanding, by written notice to Vanguard
(and to the Trustee if such notice is given by the Holders), may, and the
Trustee at the request of such Holders shall, declare the principal of,
premium, if any, and accrued interest on the notes to be due and payable,
unless there are any amounts outstanding under the Credit Agreement, in which
case the same shall become immediately due and payable upon the first to occur
of an acceleration under the Credit Agreement or five business days after
receipt by Vanguard and the representative or other agent under the Credit
Agreement (as defined therein) of notice of such declaration (but only if such
Event of Default is then continuing). Upon a declaration of acceleration, such
principal of, premium, if any, and accrued interest shall be immediately due
and payable. In the event of a declaration of acceleration because an Event of
Default set forth in clause (e) above has occurred and is continuing, such
declaration of acceleration shall be automatically rescinded and annulled if
the event of default triggering such Event of Default pursuant to clause (e)
shall be remedied or cured by Vanguard or the relevant Restricted Subsidiary
(or Restricted Subsidiaries) or waived by the holders of the relevant
Indebtedness within 60 days after the declaration of acceleration with respect
thereto.
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If an Event of Default specified in clause (g) or (h) above occurs with respect
to Vanguard, the principal of, premium, if any, and accrued interest on the
notes then outstanding shall automatically become and be immediately due and
payable without any declaration or other act on the part of the Trustee or any
Holder. The Holders of at least a majority in principal amount of the
outstanding notes by written notice to Vanguard and to the Trustee, may waive
all past defaults and rescind and annul a declaration of acceleration and its
consequences if (x) all existing Events of Default, other than the nonpayment
of the principal of, premium, if any, and interest on the notes that have
become due solely by such declaration of acceleration, have been cured or
waived and (y) the rescission would not conflict with any judgment or decree of
a court of competent jurisdiction. For information as to the waiver of
defaults, see "-Modification and Waiver."
The Holders of at least a majority in aggregate principal amount of the
outstanding notes may direct the time, method and place of conducting any
proceeding for any remedy available to the Trustee or exercising any trust or
power conferred on the Trustee. However, the Trustee may refuse to follow any
direction that conflicts with law or the Indenture, that may involve the
Trustee in personal liability, or that the Trustee determines in good faith may
be unduly prejudicial to the rights of Holders of notes not joining in the
giving of such direction and may take any other action it deems proper that is
not inconsistent with any such direction received from Holders of notes. A
Holder may not pursue any remedy with respect to the Indenture or the notes
unless:
(1) the Holder gives the Trustee written notice of a continuing Event
of Default;
(2) the Holders of at least 25% in aggregate principal amount of
outstanding notes make a written request to the Trustee to pursue the
remedy;
(3) such Holder or Holders offer the Trustee indemnity satisfactory
to the Trustee against any costs, liability or expense;
(4) the Trustee does not comply with the request within 60 days after
receipt of the request and the offer of indemnity; and
(5) during such 60-day period, the Holders of a majority in aggregate
principal amount of the outstanding notes do not give the Trustee a
direction that is inconsistent with the request.
However, such limitations do not apply to the right of any Holder of a
note to receive payment of the principal of, premium, if any, or interest on,
such note or to bring suit for the enforcement of any such payment, on or after
the due date expressed in the notes, which right shall not be impaired or
affected without the consent of such Holder.
Officers of Vanguard must certify, on or before a date not more than 120
days after the end of each fiscal year, that a review has been conducted of the
activities of Vanguard and its Restricted Subsidiaries and Vanguard's and its
Restricted Subsidiaries' performance under the Indenture and that Vanguard has
fulfilled all obligations thereunder, or, if there has been a default in the
fulfillment of any such obligation, specifying each such default and the nature
and status thereof. Vanguard will also be obligated to notify the Trustee of
any default or defaults in the performance of any covenants or agreements under
the Indenture.
Consolidation, Merger and Sale of Assets
Vanguard will not consolidate with, merge with or into, or sell, convey,
transfer or otherwise dispose of all or substantially all of its property and
assets (as an entirety or substantially an entirety in one transaction or a
series of related transactions) to, any Person or permit any Person (other than
a Restricted Subsidiary) to merge with or into it unless:
(1) it shall be the continuing Person, or the Person (if other than
it) formed by such consolidation or into which it is merged or that
acquired or leased such property and assets of Vanguard (the "Surviving
Person") shall be a corporation organized and validly existing under the
laws of the United States of America or any
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jurisdiction thereof and shall expressly assume, by a supplemental
indenture, executed and delivered to the Trustee, all of Vanguard's
obligations under the Indenture and the notes;
(2) immediately after giving effect to such transaction, no Default
or Event of Default shall have occurred and be continuing;
(3) immediately after giving effect to such transaction on a pro
forma basis, Vanguard or the Surviving Person, as the case may be, shall
have a Consolidated Net Worth equal to or greater than the Consolidated
Net Worth of Vanguard immediately prior to such transaction;
(4) immediately after giving effect to such transaction on a pro
forma basis Vanguard, or the Surviving Person, as the case may be, could
Incur at least $1.00 of Indebtedness under the first paragraph of the
"Limitation on Indebtedness" covenant; provided that this clause (4) shall
not apply to a consolidation, merger or sale of all (but not less than
all) of the assets of Vanguard if all Liens and Indebtedness of Vanguard
or the Surviving Person, as the case may be, and its Restricted
Subsidiaries outstanding immediately after such transaction would have
been permitted (and all such Liens and Indebtedness, other than Liens and
Indebtedness of Vanguard and its Restricted Subsidiaries outstanding
immediately prior to the transaction, shall be deemed to have been
Incurred) for all purposes of the Indenture;
(5) it delivers to the Trustee an officers' certificate (attaching
the arithmetic computations to demonstrate compliance with clauses (3) and
(4)) and opinion of counsel, in each case stating that such consolidation,
merger or transfer and such supplemental indenture complies with this
provision and that all conditions precedent provided for herein relating
to such transaction have been complied with; and
(6) each Subsidiary Guarantor, unless such Subsidiary Guarantor is
the Person with which Vanguard has entered into a transaction under this
"Consolidation, Merger and Sale of Assets" section, shall have by
amendment to its Note Guarantee confirmed that its Note Guarantee shall
apply to the obligations of Vanguard or the Surviving Person in accordance
with the notes and the Indenture;
provided, however, that clauses (2) through (4) above do not apply (i) to the
consolidation or merger of Vanguard with or into a Wholly Owned Restricted
Subsidiary or the consolidation or merger of a Wholly Owned Restricted
Subsidiary with or into Vanguard or (ii) if, in the good faith determination of
the board of directors of Vanguard, whose determination shall be evidenced by a
resolution thereof, the principal purpose of such transaction is to change the
state of incorporation of Vanguard and any such transaction shall not have as
one of its purposes the evasion of the foregoing limitations.
In addition, Vanguard may not, directly or indirectly, lease all or
substantially all of its property and assets (as an entirety or substantially
as an entirety in one transaction or a series of related transactions) to any
Person.
Each Subsidiary Guarantor (other than any Subsidiary Guarantor whose Note
Guarantee is to be released in accordance with the terms of the Indenture) will
not, and Vanguard will not cause or permit any Subsidiary Guarantor to,
consolidate with or merge with or into any Person other than Vanguard or any
other Subsidiary Guarantor unless:
(1) the entity formed by or surviving any such consolidated or merger
(if other than the Subsidiary Guarantor) is a Person organized and
existing under the laws of the United States or any State thereof or the
District of Columbia;
(2) such entity (if other than a Subsidiary Guarantor) assumes by
supplemental indenture all of the obligations of the Subsidiary Guarantor
on its Note Guarantee; and
(3) immediately after giving effect to such transaction, no Default
or Event of Default shall have occurred and be continuing.
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Defeasance
Defeasance and Discharge. The Indenture provides that Vanguard will be
deemed to have paid and will be discharged from any and all obligations in
respect of the notes on the 123rd day after the deposit referred to below, and
the provisions of the Indenture will no longer be in effect with respect to the
notes (except for, among other matters, certain obligations to register the
transfer or exchange of the notes, to replace stolen, lost or mutilated notes,
to maintain paying agencies and to hold monies for payment in trust) if, among
other things:
(A) Vanguard has deposited with the Trustee, in trust, money and/or
U.S. Government Obligations that through the payment of interest and
principal in respect thereof in accordance with their terms will provide
money in an amount sufficient to pay the principal of, premium, if any,
and accrued interest on the notes on the Stated Maturity of such payments
in accordance with the terms of the Indenture and the notes;
(B) Vanguard has delivered to the Trustee (1) either (x) an opinion
of counsel to the effect that Holders will not recognize income, gain or
loss for federal income tax purposes as a result of Vanguard's exercise of
its option under this "Defeasance" provision and will be subject to
federal income tax on the same amount and in the same manner and at the
same times as would have been the case if such deposit, defeasance and
discharge had not occurred, which opinion of counsel must be based upon
(and accompanied by a copy of) a ruling of the Internal Revenue Service to
the same effect unless there has been a change in applicable federal
income tax law after the Closing Date such that a ruling is no longer
required or (y) a ruling directed to the Trustee received from the
Internal Revenue Service to the same effect as the aforementioned opinion
of counsel and (2) an opinion of counsel to the effect that the creation
of the defeasance trust does not violate the Investment Company Act of
1940 and after the passage of 123 days following the deposit, the trust
fund will not be subject to the effect of Section 547 of the United States
Bankruptcy Code or Section 15 of the New York Debtor and Creditor Law;
(C) immediately after giving effect to such deposit on a pro forma
basis, no Event of Default, or event that after the giving of notice or
lapse of time or both would become an Event of Default, shall have
occurred and be continuing on the date of such deposit or during the
period ending on the 123rd day after the date of such deposit, and such
deposit shall not result in a breach or violation of, or constitute a
default under, any other agreement or instrument (including, without
limitation, the Credit Agreement if then in effect) to which Vanguard or
any of its Subsidiaries is a party or by which Vanguard or any of its
Subsidiaries is bound;
(D) Vanguard is not prohibited from making payments in respect of the
notes by the provisions described under "--Ranking";
(E) if at such time the notes are listed on a national securities
exchange, Vanguard has delivered to the Trustee an opinion of counsel to
the effect that the notes will not be delisted as a result of such
deposit, defeasance and discharge; and
(F) Vanguard shall have delivered to the Trustee an officers'
certificate and an opinion of counsel each stating that all conditions
precedent providing for or relating to the respective defeasance have been
satisfied.
Defeasance of Certain Covenants and Certain Events of Default. The
Indenture further provides that the provisions of the Indenture will no longer
be in effect with respect to clauses (3) and (4) under "Consolidation, Merger
and Sale of Assets" and all the covenants described herein under "Covenants,"
clause (c) under "Events of Default" with respect to such clauses (3) and (4)
under "Consolidation, Merger and Sale of Assets," clause (c) and (d) under
"Events of Default" with respect to such other covenants and clauses (e) and
(f) under "Events of Default" shall be deemed not to be Events of Default upon,
among other things, the deposit with the Trustee, in trust, of money and/or
U.S. Government Obligations that through the payment of interest and principal
in respect thereof in accordance with their terms will provide money in an
amount sufficient to pay the principal of, premium, if any, and accrued
interest on the notes on the Stated Maturity of such payments in accordance
with the terms of the Indenture and the notes, the satisfaction of the
provisions described in clauses (B)(2), (C), (D), (E) and (F) of the preceding
paragraph and the delivery by Vanguard to the Trustee of an opinion of counsel
to the effect that, among other
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things, the Holders will not recognize income, gain or loss for federal income
tax purposes as a result of such deposit and defeasance of certain covenants
and Events of Default and will be subject to federal income tax on the same
amount and in the same manner and at the same times as would have been the case
if such deposit and defeasance had not occurred.
Defeasance and Certain Other Events of Default. In the event Vanguard
exercises its option to omit compliance with certain covenants and provisions
of the Indenture with respect to the notes as described in the immediately
preceding paragraph and the notes are declared due and payable because of the
occurrence of an Event of Default that remains applicable, the amount of money
and/or U.S. Government Obligations on deposit with the Trustee will be
sufficient to pay amounts due on the notes at the time of their Stated Maturity
but may not be sufficient to pay amounts due on the notes at the time of the
acceleration resulting from such Event of Default. However, Vanguard will
remain liable for such payments and any Subsidiary Guarantor's Note Guarantee
with respect to such payments will remain in effect.
Modification and Waiver
The Indenture may be amended or supplemented, without the consent of any
Holder, to:
(1) cure any ambiguity, defect or inconsistency in the Indenture;
(2) comply with the provisions described under "Consolidation, Merger
and Sale of Assets" or "Guarantees by Restricted Subsidiaries";
(3) comply with any requirements of the SEC in connection with the
qualification of the Indenture under the Trust Indenture Act;
(4) evidence and provide for the acceptance of appointment by a
successor Trustee;
(5) to provide for uncertificated notes in addition to or in place of
certificated notes;
(6) to provide for or confirm the issuance of Additional Notes; or
(7) make any change that, in the good faith opinion of the board of
directors, does not materially and adversely affect the rights of any
Holder.
Modifications and amendments of the Indenture may be made by Vanguard and
the Trustee with the consent of the Holders of not less than a majority in
aggregate principal amount of the outstanding notes; provided, however, that no
such modification or amendment may, without the consent of each Holder affected
thereby:
(1) change the Stated Maturity of the principal of, or any
installment of interest on, any note;
(2) reduce the principal amount of, or premium, if any, or interest
on, any note;
(3) change the optional redemption dates or optional redemption
prices of the notes from that stated under the caption "Optional
Redemption";
(4) following the occurrence of an Asset Sale, amend, change or
modify the obligation of Vanguard to make and consummate an Offer to
Purchase with respect to such Asset Sale in accordance with the
"Limitation on Asset Sales" covenant, including amending, changing or
modifying any definition relating thereto in any manner materially adverse
to the holders of the notes affected thereby;
(5) following the occurrence of a Change of Control, amend, change or
modify the obligation of Vanguard to make and consummate an Offer to
Purchase with respect to such Change of Control in accordance with the
"Repurchase of Notes Upon a Change of Control" covenant, including
amending, changing or
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modifying any definition relating thereto in any manner materially adverse
to the holders of the notes affected thereby;
(6) change the place or currency of payment of principal of, or
premium, if any, or interest on, any note;
(7) impair the right to institute suit for the enforcement of any
payment on or after the Stated Maturity (or, in the case of a redemption,
on or after the Redemption Date) of any note;
(8) modify the subordination provisions in a manner adverse to the
Holders;
(9) waive a default in the payment of principal of, premium, if any,
or interest on the notes;
(10) release any Subsidiary Guarantor from its Note Guarantee, except
as provided in the Indenture; or
(11) reduce the percentage or aggregate principal amount of
outstanding notes the consent of whose Holders is necessary for waiver of
compliance with certain provisions of the Indenture or for waiver of
certain defaults.
Notwithstanding anything to the contrary contained above, no amendment of, or
supplement or waiver to, the Indenture shall adversely affect the rights of the
holders of any Senior Indebtedness under the subordination provisions of the
Indenture (including any defined terms as used therein) without the consent of
such holders of Senior Indebtedness.
No Personal Liability of Incorporators, Stockholders, Officers, Directors, or
Employees
No recourse for the payment of the principal of, premium, if any, or
interest on any of the notes or for any claim based thereon or otherwise in
respect thereof, and no recourse under or upon any obligation, covenant or
agreement of Vanguard in the Indenture, or in any of the notes or because of
the creation of any Indebtedness represented thereby, shall be had against any
incorporator, stockholder, officer, director, employee or controlling person of
Vanguard or of any successor Person thereof. Each Holder, by accepting the
notes, waives and releases all such liability. The waiver and release are part
of the consideration for the issuance of the notes. Such waiver may not be
effective to waive liabilities under the federal securities laws.
Concerning the Trustee
Except during the continuance of a Default, the Trustee will not be
liable, except for the performance of such duties as are specifically set forth
in the Indenture. If an Event of Default has occurred and is continuing, the
Trustee will use the same degree of care and skill in its exercise of the
rights and powers vested in it under the Indenture as a prudent person would
exercise under the circumstances in the conduct of such person's own affairs.
The Indenture and provisions of the Trust Indenture Act of 1939, as
amended, incorporated by reference therein contain limitations on the rights of
the Trustee, should it become a creditor of Vanguard, to obtain payment of
claims in certain cases or to realize on certain property received by it in
respect of any such claims, as security or otherwise. The Trustee is permitted
to engage in other transactions; provided, however, that if it acquires any
conflicting interest, it must eliminate such conflict or resign.
Book-Entry; Delivery and Form
The certificates representing the new notes will be issued in fully
registered form, without coupons. Except as described below, the new notes will
be deposited with, or on behalf of, The Depository Trust Company, New York, New
York (the "Depository"), and registered in the name of Cede & Co. as the
Depository's nominee, in the form of a global note (the "global registered
note").
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The Global Registered Note. Vanguard expects that pursuant to procedures
established by the Depository (a) upon deposit of the global registered note,
the Depository or its custodian will credit on its internal system interests in
the global registered note to the accounts of persons who have accounts with
the Depository ("participants") and (b) ownership of the global registered note
will be shown on, and the transfer of ownership thereof will be effected only
through, records maintained by the Depository or its nominee, with respect to
interests of participants, and the records of participants with respect to
interests of persons other than participants. Ownership of beneficial interests
in the global registered note will be limited to participants or persons who
hold interests through participants.
So long as the Depository or its nominee is the registered owner or holder
of the new notes, the Depository or such nominee will be considered the sole
owner or holder of the new notes represented by the global registered note for
all purposes under the Indenture. No beneficial owner of an interest in the
global registered note will be able to transfer such interest except in
accordance with the Depository's procedures, in addition to those provided for
under the Indenture with respect to the new notes.
Payments of the principal of, or premium and interest on, the global
registered note will be made to the Depository or its nominee, as the case may
be, as the registered owner thereof. None of Vanguard, the trustee or any
paying agent under the Indenture will have any responsibility or liability for
any aspect of the records relating to or payments made on account of beneficial
ownership interests in the global registered note or for maintaining,
supervising or reviewing any records relating to such beneficial ownership
interest.
We expect that the Depository or its nominee, upon receipt of any payment
of the principal of or premium and interest on the global registered note, will
credit participants' accounts with payments in amounts proportionate to their
respective beneficial interests in the principal amount of such global
registered note as shown on the records of the Depository or its nominee. We
also expect that payments by participants to owners of beneficial interests in
the global registered note held through such participants will be governed by
standing instructions and customary practice as is now the case with securities
held for the accounts of customers registered in the names of nominees for such
customers. Such payments will be the responsibility of such participants.
Transfers between participants in the Depository will be effected in
accordance with the Depository rules and will be settled in immediately
available funds. If a holder requires physical delivery of a certificated
exchange note for any reason, including to sell new notes to persons in states
which require physical delivery of the new notes or to pledge such securities,
such holder must transfer its interest in the global registered note in
accordance with the normal procedures of the Depository and with the procedures
set forth in the Indenture.
The Depository has advised us that the Depository will take any action
permitted to be taken by a holder of new notes, including the presentation of
new notes for exchange as described below, only at the direction of one or more
participants to whose account at the Depository interests in the global
registered note are credited and only in respect of such portion of the
aggregate principal amount of new notes as to which such participant or
participants has or have given such direction. However, if there is an Event of
Default under the indenture, the Depository will exchange the global registered
note for certificated new notes, which it will distribute to its participants.
The Depository has advised us that it is:
(1) a limited purpose trust company organized under the laws of the
State of New York;
(2) a member of the Federal Reserve System;
(3) a "clearing corporation" within the meaning of the Uniform
Commercial Code; and
(4) a "clearing agency" registered pursuant to the provisions of
Section 17A of the Exchange Act.
The Depository was created to hold securities for its participants and
facilitate the clearance and settlement of securities transactions between
participants through electronic book-entry changes in accounts of its
participants, thereby eliminating the need for physical movement of
certificates. Participants include securities brokers and
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dealers, banks, trust companies and clearing corporations and other
organizations. Indirect access to the Depository system is available to others
such as banks, brokers, dealers and trust companies that clear through or
maintain a custodial relationship with a participant, either directly or
indirectly ("indirect participants").
Although the Depository has agreed to the foregoing procedures in order to
facilitate transfers of interest in the global registered notes among
participants, it is under no obligation to perform such procedures, and such
procedures may be discontinued at any time. Neither Vanguard nor the trustee
will have any responsibility for the performance by the Depository or its
participants or indirect participants of their respective obligations under the
rules and procedures governing their operations.
Certificated Notes. Interests in the global registered note will be
exchangeable or transferable, as the case may be, for certificated notes if
(1) the Depository (a) notifies us that it is unwilling or unable to
continue as depositary for the global registered note or (b) has ceased to
be a clearing agency registered under the Exchange Act, and in either
case, we fail to appoint a successor depositary within 90 days,
(2) we, at our option, notify the trustee in writing that we elect to
cause the issuance of the notes in certificated form or
(3) there shall have occurred and be continuing to occur a Default or
an Event of Default with respect to the notes.
In all cases, certificated notes delivered in exchange for the global
registered note or beneficial interests therein will be registered in the
names, and issued in any approved denominations, requested by or on behalf of
the depositary, in accordance with its customary procedures.
Definitions
Set forth below are defined terms used in the covenants and other
provisions of the Indenture. Reference is made to the Indenture for other
capitalized terms used in this "Description of the Notes" for which no
definition is provided.
"Acquired Indebtedness" means Indebtedness of a Person existing at the
time such Person becomes a Restricted Subsidiary or Indebtedness of a
Restricted Subsidiary assumed in connection with an Asset Acquisition by such
Restricted Subsidiary; provided such Indebtedness was not Incurred in
connection with or in contemplation of such Person becoming a Restricted
Subsidiary or such Asset Acquisition.
"Adjusted Consolidated Net Income" means, for any period, the aggregate
net income (or loss) of Vanguard and its Restricted Subsidiaries for such
period determined in conformity with GAAP; provided that the following items
shall be excluded in computing Adjusted Consolidated Net Income (without
duplication):
(1) the net income (or loss) of any Person that is not a Restricted
Subsidiary, except to the extent of the amount of dividends or other
distributions actually paid to Vanguard or any of its Restricted
Subsidiaries during such period;
(2) the net income (or loss) of any Person accrued prior to the date
as of which it becomes a Restricted Subsidiary or is merged into or
consolidated with Vanguard or any of its Restricted Subsidiaries or all or
substantially all of the property and assets of such Person are acquired
by Vanguard or any of its Restricted Subsidiaries;
(3) the net income of any Restricted Subsidiary to the extent that
the declaration or payment of dividends or similar distributions by such
Restricted Subsidiary of such net income is not at the time permitted
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by the operation of the terms of its charter or any agreement, instrument,
judgment, decree, order, statute, rule or governmental regulation
applicable to such Restricted Subsidiary;
(4) any gains or losses (on an after-tax basis) attributable to sales
of assets outside the ordinary course of business of Vanguard and its
Restricted Subsidiaries;
(5) solely for purposes of calculating the amount of Restricted
Payments that may be made pursuant to clause (C) of the first paragraph of
the "Limitation on Restricted Payments" covenant, any amount paid or
accrued as dividends on Preferred Stock of Vanguard owned by Persons other
than Vanguard and any of its Restricted Subsidiaries;
(6) all extraordinary gains and extraordinary losses (each on an
after-tax basis);
(7) the cumulative effect of a change in accounting principles; and
(8) income or losses attributable to discontinued operations,
including, without limitation, operations disposed of during such period
whether or not such operations were classified as discontinued.
"Affiliate" means, as applied to any Person, any other Person directly or
indirectly controlling, controlled by, or under direct or indirect common
control with, such Person. For purposes of this definition, "control"
(including, with correlative meanings, the terms "controlling," "controlled by"
and "under common control with"), as applied to any Person, means the
possession, directly or indirectly, of the power to direct or cause the
direction of the management and policies of such Person, whether through the
ownership of voting securities, by contract or otherwise; provided that
beneficial ownership of 10% or more of the Capital Stock of a Person shall be
deemed to be control. Notwithstanding the foregoing, a Person shall not be
deemed an Affiliate of Vanguard solely by virtue of the beneficial ownership by
the Capital Partners Group of 10% or more of the Capital Stock of such Person.
"Asset Acquisition" means (1) an investment by Vanguard or any of its
Restricted Subsidiaries in any other Person pursuant to which such Person shall
become a Restricted Subsidiary or shall be merged into or consolidated with
Vanguard or any of its Restricted Subsidiaries or (2) an acquisition by
Vanguard or any of its Restricted Subsidiaries of the property and assets of
any Person other than Vanguard or any of its Restricted Subsidiaries that
constitute substantially all of a division or line of business of such Person.
"Asset Disposition" means the sale or other disposition by Vanguard or any
of its Restricted Subsidiaries (other than to Vanguard or another Restricted
Subsidiary) of (1) all or substantially all of the Capital Stock of any
Restricted Subsidiary or (2) all or substantially all of the assets that
constitute a division or line of business of Vanguard or any of its Restricted
Subsidiaries.
"Asset Sale" means any sale, transfer or other disposition (including by
way of merger, consolidation or sale-leaseback transaction) in one transaction
or a series of related transactions by Vanguard or any of its Restricted
Subsidiaries to any Person other than Vanguard or any of its Restricted
Subsidiaries of:
(1) all or any of the Capital Stock of any Restricted Subsidiary,
(2) all or substantially all of the property and assets of an
operating unit or business of Vanguard or any of its Restricted
Subsidiaries or
(3) any other property and assets (other than the Capital Stock or
other Investment in an Unrestricted Subsidiary) of Vanguard or any of its
Restricted Subsidiaries outside the ordinary course of business of
Vanguard or such Restricted Subsidiary and,
in each case, that is not governed by the provisions of the Indenture
applicable to mergers, consolidations and sales of assets of Vanguard or a
Subsidiary Guarantor; provided that "Asset Sale" shall not include:
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(a) sales or other dispositions of inventory, cash management and
portfolio investments, receivables and other current assets,
(b) sales, transfers or other dispositions of assets constituting a
Permitted Investment or Restricted Payment permitted to be made under the
"Limitation on Restricted Payments" covenant,
(c) sales, transfers or other dispositions of assets with a fair
market value not in excess of the greater of (x) $1 million and (y) 1% of
Consolidated EBITDA on a pro forma basis for the most recently completed
four fiscal quarters, when such sale, transfer or disposition is
consummated, in any transaction or series of related transactions,
(d) any sale, transfer, assignment or other disposition of any
property or equipment that has become damaged, worn out, obsolete or
otherwise unsuitable for use in connection with the business of Vanguard
or its Restricted Subsidiaries,
(e) the substantially contemporaneous sale and leaseback of an asset;
provided that the sale and leaseback occurs within 180 days after the date
of the acquisition of the asset by Vanguard or any Restricted Subsidiary,
(f) a Hospital Swap,
(g) any disposition of receivables and related assets, proceeds, or
Capital Stock of a Securitization Subsidiary pursuant to a Permitted
Receivables Financing, or
(h) any disposition or leases of substantially unimproved real
property, pursuant to an overall arrangement deemed by the management of
Vanguard to be fair and reasonable, for the purpose of building on such
real property a medical office building or other building to contain a
healthcare business, or any parking garage or other structure used in
connection with such a building.
"Average Life" means, at any date of determination with respect to any
Indebtedness, the quotient obtained by dividing (1) the sum of the products of
(a) the number of years from such date of determination to the dates of each
successive scheduled principal payment of such debt security and (b) the amount
of such principal payment by (2) the sum of all such principal payments.
"Bank Agent" means the agent for the lenders under the Credit Agreement or
its successors as agent for the lenders under the Credit Agreement.
"Capital Stock" means, with respect to any Person, any and all shares,
interests, participations or other equivalents (however designated, whether
voting or non-voting) in equity of such Person, whether outstanding on the
Closing Date or issued thereafter, including, without limitation, all Common
Stock and Preferred Stock.
"Capitalized Lease" means, as applied to any Person, any lease of any
property (whether real, personal or mixed) of which the discounted present
value of the rental obligations of such Person as lessee, in conformity with
GAAP, is required to be capitalized on the balance sheet of such Person.
"Capitalized Lease Obligations" means the discounted present value of the
rental obligations under a Capitalized Lease.
"Change of Control" means such time as:
(1) the consummation of any transaction, including without limitation
any merger or consolidation, the result of which is that any "person" or
"group" (within the meaning of Sections 13(d) and 14(d)(2) of the Exchange
Act), other than the Existing Stockholders, becomes the ultimate
"beneficial owner" (as defined in
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Rule 13d-3 under the Exchange Act) of Voting Stock representing more than
50% of the total voting power of the Voting Stock of Vanguard on a fully
diluted basis;
(2) the direct or indirect sale, transfer, conveyance or other
disposition, not including a merger or consolidation, in one or a series
of related transactions, of all or substantially all of the properties or
assets of Vanguard and its Restricted Subsidiaries taken as a whole to any
"person" or "group" (as those terms are defined in clause (1) above),
other than to the Existing Stockholders;
(3) the adoption of a plan relating to the liquidation or dissolution
of Vanguard; or
(4) during any consecutive two year period, individuals who at the
beginning of such period constituted the board of directors (together with
any new directors (a) appointed or nominated by one or more Existing
Stockholders or (b) whose election by the board of directors or whose
nomination by the board of directors for election by Vanguard's
stockholders was approved by a vote of at least a majority of the members
of the board of directors then in office who either were members of the
board of directors on the Closing Date or whose election or nomination for
election was previously so approved) cease for any reason during such
period to constitute a majority of the members of the board of directors
then in office.
"Closing Date" means the date on which the notes are originally issued
under the Indenture.
"Commodity Agreement" means any forward contract, commodity swap
agreement, commodity option agreement or other similar agreement or
arrangement.
"Consolidated EBITDA" means, for any period, Adjusted Consolidated Net
Income for such period plus, to the extent such amount was deducted in
calculating such Adjusted Consolidated Net Income:
(1) Consolidated Interest Expense,
(2) income taxes,
(3) depreciation expense,
(4) amortization expense, and
(5) all other non-cash items reducing Adjusted Consolidated Net
Income (except to the extent that such non-cash items will require cash
payments and for which an accrual or reserve is, or is required by GAAP to
be, made), less all non-cash items increasing Adjusted Consolidated Net
Income except to the extent such non-cash items will result in cash
receipts, all as determined on a consolidated basis for Vanguard and its
Restricted Subsidiaries in conformity with GAAP.
"Consolidated Interest Expense" means, for any period, the aggregate
amount of interest in respect of Indebtedness (including, without limitation,
amortization of original issue discount on any Indebtedness and the interest
portion of any deferred payment obligation, calculated in accordance with the
effective interest method of accounting; all commissions, discounts and other
fees and charges owed with respect to letters of credit and bankers' acceptance
financing; the net cash costs associated with Interest Rate Agreements during
such period; the interest of Vanguard and its Restricted Subsidiaries that was
capitalized during such period; and interest in respect of Indebtedness that is
Guaranteed or secured by Vanguard or any of its Restricted Subsidiaries but
only to the extent such interest is paid by Vanguard or any Restricted
Subsidiary; but excluding any amortization of fees and expenses in connection
with the issuance of the notes, the Credit Agreement or any other Indebtedness
Incurred after the Closing Date) and all but the principal component of rentals
in respect of Capitalized Lease Obligations paid, accrued or scheduled to be
paid or to be accrued by Vanguard and its Restricted Subsidiaries during such
period; all net of the cash portion of interest income of Vanguard and its
Restricted Subsidiaries for such period; excluding, however, (i) any interest
expense not payable in cash by its terms, other than amortization of original
issue discount and (ii) any amount of such interest of any Restricted
Subsidiary if the net income of such Restricted Subsidiary is
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excluded in the calculation of Adjusted Consolidated Net Income pursuant to
clause (3) of the definition thereof (but only in the same proportion as the
net income of such Restricted Subsidiary is excluded from the calculation of
Adjusted Consolidated Net Income pursuant to clause (3) of the definition
thereof).
"Consolidated Net Worth" means, at any date of determination,
stockholders' equity as set forth on the most recently available quarterly or
annual consolidated balance sheet of Vanguard and its Restricted Subsidiaries
(which shall be as of a date not more than 90 days prior to the date of such
computation), plus, to the extent not included, any Preferred Stock of
Vanguard, less any amounts attributable to Disqualified Stock or any equity
security convertible into or exchangeable for Indebtedness, the cost of
treasury stock and the principal amount of any promissory notes receivable from
the sale of the Capital Stock of Vanguard or any of its Restricted
Subsidiaries, each item to be determined in conformity with GAAP (excluding the
effects of foreign currency exchange adjustments under Financial Accounting
Standards Board Statement of Financial Accounting Standards No. 52).
"Credit Agreement" means the Credit Agreement among Vanguard, the lenders
from time to time party thereto and Bank of America, N.A., as Administrative
Agent, to be dated July 30, 2001, together with all agreements, notes,
instruments and documents executed or delivered pursuant thereto and in
connection therewith, including, without limitation, all mortgages, other
security documents and guaranties, in each case as amended (including any
amendment and restatement), supplemented, extended, renewed, replaced (by one
or more credit facilities, debt instruments and/or related documentation) or
otherwise modified from time to time, including, without limitation, any
agreement increasing the amount of, extending the maturity of or refinancing in
whole or in part (including, but not limited to, by the inclusion of additional
or different lenders thereunder or additional borrowers or guarantors thereof)
all or any portion of the Indebtedness under such agreement or any successor
agreement or agreements and whether by the same or any other agent, lender or
group of lenders.
"Currency Agreement" means any foreign exchange contract, currency swap
agreement or other similar agreement or arrangement.
"Default" means any event that is, or after notice or passage of time or
both would be, an Event of Default.
"Designated Senior Indebtedness" means (1) any Indebtedness under the
Credit Agreement (except that any Indebtedness which represents a partial
refinancing of Indebtedness theretofore outstanding pursuant to the Credit
Agreement, rather than a complete refinancing thereof, shall only constitute
Designated Senior Indebtedness if such partial refinancing meets the
requirements of clause (2) below), and (2) any other Indebtedness constituting
Senior Indebtedness that, at the date of determination, has an aggregate
principal amount outstanding of at least $25 million and that is specifically
designated by Vanguard, in the instrument creating or evidencing such Senior
Indebtedness, as "Designated Senior Indebtedness."
"Disqualified Stock" means any class or series of Capital Stock of any
Person that by its terms or otherwise is (1) required to be redeemed prior to
the Stated Maturity of the notes for consideration other than Capital Stock
that is not required to be redeemed, (2) required to be redeemed at the option
of the holder of such class or series of Capital Stock at any time prior to the
Stated Maturity of the notes for consideration other than Capital Stock that is
not required to be so redeemed or (3) convertible into or exchangeable for
Capital Stock referred to in clause (1) or (2) above or Indebtedness having a
scheduled maturity or any scheduled amortization prior to the Stated Maturity
of the notes; provided that any Capital Stock that would not constitute
Disqualified Stock but for provisions thereof giving holders thereof the right
to require such Person to repurchase or redeem such Capital Stock upon the
occurrence of an "asset sale" or "change of control" occurring prior to the
Stated Maturity of the notes shall not constitute Disqualified Stock if the
"asset sale" or "change of control" provisions applicable to such Capital Stock
are no more favorable to the holders of such Capital Stock than the provisions
contained in "Limitation on Asset Sales" and "Repurchase of Notes upon a Change
of Control" covenants and such Capital Stock specifically provides that such
Person will not repurchase or redeem any such stock pursuant to such provision
prior to Vanguard's repurchase of such notes as are required to be repurchased
pursuant to the "Limitation on Asset Sales" and "Repurchase of Notes upon a
Change of Control" covenants.
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"Existing Stockholders" means (i) each of the officers of Vanguard on the
Closing Date holding the office of Executive Vice President or a higher office
or (ii) Morgan Stanley Capital Partners III, L.P., MSCP III 892 Investors,
L.P., Morgan Stanley Capital Investors, L.P., Morgan Stanley Dean Witter
Capital Partners IV, L.P., MSDW IV 892 Investors, L.P. and Morgan Stanley Dean
Witter Capital Investors IV, L.P., or any other merchant banking or similar
fund under common control with any entity described in this clause (ii) (the
entities described in clause (ii), collectively, the "MSCP Group").
"fair market value" means the price that would be paid in an arm's-length
transaction between a willing seller under no compulsion to sell and a willing
buyer under no compulsion to buy. Any determination in good faith by the board
of directors shall be conclusive if evidenced by a resolution thereof.
"Foreign Subsidiary" means any Subsidiary of Vanguard that is an entity
which is a controlled foreign corporation under Section 957 of the Internal
Revenue Code.
"GAAP" means generally accepted accounting principles in the United States
of America as in effect as of the Closing Date, including, without limitation,
those set forth in the opinions and pronouncements of the Accounting Principles
Board of the American Institute of Certified Public Accountants and statements
and pronouncements of the Financial Accounting Standards Board or in such other
statements by such other entity as approved by a significant segment of the
accounting profession. All ratios and computations contained or referred to in
the Indenture shall be computed in conformity with GAAP, applied on a
consistent basis, except as expressly required by GAAP, except that
calculations made for purposes of determining compliance with the terms of the
covenants and with other provisions of the Indenture shall be made without
giving effect to (1) the amortization of any expenses incurred in connection
with the offering of the old notes and the Credit Agreement and (2) except as
otherwise provided, the amortization of any amounts required or permitted by
Accounting Principles Board Opinion Nos. 16 and 17.
"Guarantee" means any obligation, contingent or otherwise, of any Person
directly or indirectly guaranteeing any Indebtedness of any other Person and,
without limiting the generality of the foregoing, any obligation, direct or
indirect, contingent or otherwise, of such Person (1) to purchase or pay (or
advance or supply funds for the purchase or payment of) such Indebtedness of
such other Person (whether arising by virtue of partnership arrangements, or by
agreements to keep-well, to purchase assets, goods, securities or services
(unless such purchase arrangements are on arm's-length terms and are entered
into in the ordinary course of business), to take-or-pay, or to maintain
financial statement conditions or otherwise) or (2) entered into for purposes
of assuring in any other manner the obligee of such Indebtedness of the payment
thereof or to protect such obligee against loss in respect thereof (in whole or
in part); provided that the term "Guarantee" does not include endorsements for
collection or deposit in the ordinary course of business. The term "Guarantee"
used as a verb has a corresponding meaning.
"Hospital Swap" means an exchange of assets and, to the extent necessary
to equalize the value of the assets being exchanged, cash by Vanguard or a
Restricted Subsidiary for one or more hospitals and/or one or more businesses
related or ancillary to the business of Vanguard, or for 100% of the Capital
Stock of any Person owning or operating one or more hospitals and/or one or
more such related businesses, provided that cash does not exceed 20% of the sum
of the amount of the cash and the fair market value of the Capital Stock or
assets received or given by Vanguard or a Restricted Subsidiary in the
transaction, unless such excess cash is applied in accordance with the
requirements of the third paragraph of the "Limitations on Asset Sales"
covenant.
"Incur" means, with respect to any Indebtedness, to incur, create, issue,
assume, Guarantee or otherwise become liable for the payment of, contingently
or otherwise, such Indebtedness; provided that (1) any Indebtedness of a Person
existing at the time such Person becomes a Restricted Subsidiary will be deemed
to be incurred by such Restricted Subsidiary at the time it becomes a
Restricted Subsidiary and (2) none of the accrual or capitalization of interest
(whether through the issuance of pay-in-kind securities or otherwise), the
accretion of original issue discount or the payment of dividends on
Disqualified Stock in the form of additional shares of the same class of
Disqualified Stock shall be considered an Incurrence of Indebtedness.
"Indebtedness" means, with respect to any Person at any date of
determination (without duplication):
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(1) all indebtedness of such Person for borrowed money;
(2) all obligations of such Person evidenced by bonds, debentures,
notes or other similar instruments;
(3) all obligations of such Person in respect of letters of credit or
other similar instruments (including reimbursement obligations with
respect thereto, but excluding obligations with respect to letters of
credit (including trade letters of credit) securing obligations (other
than obligations described in (1) or (2) above or (5) or (6) below)
entered into in the ordinary course of business of such Person to the
extent such letters of credit are not drawn upon or, if drawn upon, to the
extent such drawing is reimbursed no later than the 15th day following
receipt by such Person of a demand for reimbursement);
(4) all obligations of such Person to pay the deferred and unpaid
purchase price of property or services, which purchase price is due more
than six months after the date of placing such property in service or
taking delivery and title thereto or the completion of such services, if,
and to the extent that such amount would appear as a liability on the
balance sheet of such Person, except Trade Payables and other accrued
expenses arising in the ordinary course of business and payable within one
year of the Incurrence thereof;
(5) all Capitalized Lease Obligations;
(6) all Indebtedness of other Persons secured by a Lien on any asset
of such Person, whether or not such Indebtedness is assumed by such
Person; provided that the amount of such Indebtedness shall be the lesser
of (A) the fair market value of such asset at such date of determination
and (B) the amount of such Indebtedness;
(7) all Indebtedness of other Persons Guaranteed by such Person to
the extent such Indebtedness is Guaranteed by such Person; and
(8) to the extent not otherwise included in this definition,
obligations under Commodity Agreements, Currency Agreements and Interest
Rate Agreements (other than, except for purposes of the definition of
Senior Indebtedness, Commodity Agreements, Currency Agreements and
Interest Rate Agreements designed to protect Vanguard or its Restricted
Subsidiaries against fluctuations in commodity prices, foreign currency
exchange rates or interest rates and that do not increase the Indebtedness
of the obligor outstanding at any time other than as a result of
fluctuations in commodity prices, foreign currency exchange rates or
interest rates or by reason of fees, indemnities and compensation payable
thereunder).
The amount of Indebtedness of any Person at any date shall be the outstanding
balance at such date of all unconditional obligations as described above and,
with respect to contingent obligations, the maximum liability upon the
occurrence of the contingency giving rise to the obligation; provided that
(A) the amount outstanding at any time of any Indebtedness issued
with original issue discount is the face amount of such Indebtedness less
the remaining unamortized portion of the original issue discount of such
Indebtedness at such time as determined in conformity with GAAP,
(B) money borrowed and set aside at the time of the Incurrence of any
Indebtedness in order to prefund the payment of the interest on such
Indebtedness shall not be deemed to be "Indebtedness" so long as such
money is held to secure the payment of such interest,
(C) the amount of any Indebtedness secured by a Lien on an asset of
such Person but not otherwise the obligation, contingent or otherwise, of
such Person, shall be the lesser of (x) the fair market value of such
asset on the date the Lien attached and (y) the amount of such
Indebtedness,
(D) the amount of any Indebtedness under any Commodity Agreement,
Currency Agreement or Interest Rate Agreement that is Indebtedness shall
be the net amount payable by such Person if such agreement were terminated
at that time, and
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(E) Indebtedness shall not include:
(x) any liability for federal, state, local or other taxes,
(y) performance, surety or appeal bonds provided in the ordinary
course of business or
(z) agreements providing for indemnification, adjustment of
purchase price or similar obligations, or Guarantees or letters of
credit, surety bonds or performance bonds securing any obligations of
Vanguard or any of its Restricted Subsidiaries pursuant to such
agreements, in any case Incurred in connection with the disposition
of any business, assets or Restricted Subsidiary (other than
Guarantees of Indebtedness Incurred by any Person acquiring all or
any portion of such business, assets or Restricted Subsidiary for the
purpose of financing such acquisition), so long as the principal
amount does not to exceed the gross proceeds actually received by
Vanguard or any Restricted Subsidiary in connection with such
disposition.
"Initial Subsidiary Guarantors" means each Restricted Subsidiary of
Vanguard required to provide a Guarantee pursuant to the "Guarantees by
Restricted Subsidiaries" covenant on the Closing Date.
"Insurance Subsidiary" means a Subsidiary of Vanguard or any Restricted
Subsidiary established for the purpose of insuring the health care businesses
or facilities owned or operated by Vanguard or any Subsidiary or any physician
employed by or on the medical staff of any such business or facility.
"Interest Coverage Ratio" means, on any Transaction Date, the ratio of (1)
the aggregate amount of Consolidated EBITDA for the then most recent four
fiscal quarters prior to such Transaction Date for which reports have been
filed with the SEC or provided to the Trustee (the "Four Quarter Period") to
(2) the aggregate Consolidated Interest Expense during such Four Quarter
Period. In making the foregoing calculation:
(A) pro forma effect shall be given to any Indebtedness Incurred or
repaid during the period (the "Reference Period") commencing on the first
day of the Four Quarter Period and ending on the Transaction Date (other
than Indebtedness Incurred or repaid under a revolving credit or similar
arrangement to the extent of the commitment thereunder (or under any
predecessor revolving credit or similar arrangement) in effect on the last
day of such Four Quarter Period unless any portion of such Indebtedness is
projected, in the reasonable judgment of the senior management of
Vanguard, to remain outstanding for a period in excess of 12 months from
the date of the Incurrence thereof), in each case as if such Indebtedness
had been Incurred or repaid on the first day of such Reference Period;
(B) Consolidated Interest Expense attributable to interest on any
Indebtedness (whether existing or being Incurred) computed on a pro forma
basis and bearing a floating interest rate shall be computed as if the
rate in effect on the Transaction Date (taking into account any Interest
Rate Agreement applicable to such Indebtedness if such Interest Rate
Agreement has a remaining term in excess of 12 months or, if shorter, at
least equal to the remaining term of such Indebtedness) had been the
applicable rate for the entire period;
(C) pro forma effect shall be given to Asset Dispositions and Asset
Acquisitions (including giving pro forma effect to (x) the application of
proceeds of any Asset Disposition and (y) any pro forma expense and cost
reductions and other operating improvements that have occurred or are
reasonably expected to occur, in the reasonable judgement of the chief
financial officer of Vanguard, attributable to the assets which are the
subject of the Asset Acquisition) that occur during such Reference Period
as if they had occurred and such proceeds had been applied on the first
day of such Reference Period;
(D) pro forma effect shall be given to asset dispositions and asset
acquisitions (including giving pro forma effect to the application of
proceeds of any asset disposition) that have been made during such
Reference Period by any Person that has become a Restricted Subsidiary or
has been merged with or into Vanguard or any Restricted Subsidiary during
such Reference Period and that would have constituted Asset Dispositions
or Asset Acquisitions had such transactions occurred when such Person was
a Restricted Subsidiary as if such asset dispositions or asset
acquisitions were Asset Dispositions or Asset Acquisitions that occurred
on the first day of
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such Reference Period; provided that to the extent that clause (C) or (D)
of this sentence requires that pro forma effect be given to an Asset
Acquisition or Asset Disposition, such pro forma calculation shall be
based upon the four full fiscal quarters immediately preceding the
Transaction Date of the Person, or division or line of business of the
Person, that is acquired or disposed for which financial information is
available;
(E) the Consolidated EBITDA attributable to discontinued operations,
as determined in accordance with GAAP, shall be excluded; and
(F) the Consolidated Interest Expense attributable to discontinued
operations, as determined in accordance with GAAP, shall be excluded, but
only to the extent that the obligations giving rise to the Consolidated
Interest Expense will not be obligations of Vanguard or any of its
Restricted Subsidiaries following the Transaction Date.
"Interest Rate Agreement" means any interest rate protection agreement,
interest rate future agreement, interest rate option agreement, interest rate
swap agreement, interest rate cap agreement, interest rate collar agreement,
interest rate hedge agreement, option or future contract or other similar
agreement or arrangement.
"Investment" in any Person means any direct or indirect advance, loan or
other extension of credit (including, without limitation, by way of Guarantee
or similar arrangement; but excluding advances to customers or suppliers in the
ordinary course of business that are, in conformity with GAAP, recorded as
accounts receivable, prepaid expenses or deposits on the balance sheet of
Vanguard or its Restricted Subsidiaries and endorsements for collection or
deposit arising in the ordinary course of business) or capital contribution to
(by means of any transfer of cash or other property to others or any payment
for property or services for the account or use of others), or any purchase or
acquisition of Capital Stock, bonds, notes, debentures or other similar
instruments issued by, such Person and shall include (1) the designation of a
Restricted Subsidiary as an Unrestricted Subsidiary and (2) the retention of
the Capital Stock (or any other Investment) by Vanguard or any of its
Restricted Subsidiaries, of (or in) any Person that has ceased to be a
Restricted Subsidiary, including, without limitation, by reason of any
transaction permitted by clause (3) of the "Limitation on the Issuance and Sale
of Capital Stock of Restricted Subsidiaries" covenant. For purposes of the
definition of "Unrestricted Subsidiary" and the "Limitation on Restricted
Payments" covenant, (a) the amount of or a reduction in an Investment shall be
equal to the fair market value thereof at the time such Investment is made or
reduced and (b) in the event Vanguard or a Restricted Subsidiary makes an
Investment by transferring assets to any Person and as part of such transaction
receives Net Cash Proceeds, the amount of such Investment shall be the fair
market value of the assets less the amount of Net Cash Proceeds so received;
provided the Net Cash Proceeds are applied in accordance with clause (A) or (B)
of the "Limitation on Asset Sales" covenant.
"Lien" means any mortgage, pledge, security interest, encumbrance, lien or
charge of any kind (including, without limitation, any conditional sale or
other title retention agreement or lease in the nature thereof).
"Moody's" means Moody's Investors Service, Inc. and its successors.
"Net Cash Proceeds" means:
(a) with respect to any Asset Sale, the proceeds of such Asset Sale
in the form of cash or cash equivalents, including payments in respect of
deferred payment obligations (to the extent corresponding to the
principal, but not interest, component thereof) when received in the form
of cash or cash equivalents and proceeds from the conversion of other
property received when converted to cash or cash equivalents, net of
(1) brokerage commissions and other fees and expenses (including
fees and expenses of counsel and investment bankers) related to such
Asset Sale;
(2) provisions for all taxes (whether or not such taxes will
actually be paid or are payable) as a result of such Asset Sale
without regard to the consolidated results of operations of Vanguard
and its Restricted Subsidiaries, taken as a whole;
127
(3) payments made to repay Indebtedness or any other obligation
outstanding at the time of such Asset Sale that either (x) is secured
by a Lien on the property or assets sold or (y) is required to be
paid as a result of such sale;
(4) payments required to be made to holders of minority
interests in Restricted Subsidiaries as a result of such Asset Sale;
and
(5) appropriate amounts to be provided by Vanguard or any
Restricted Subsidiary as a reserve against any liabilities associated
with such Asset Sale, including, without limitation, pension and
other post-employment benefit liabilities, liabilities related to
environmental matters and liabilities under any indemnification
obligations associated with such Asset Sale, all as determined in
conformity with GAAP.
(b) with respect to any issuance or sale of Capital Stock, or
contribution to its capital, the proceeds of such issuance, sale or
contribution in the form of cash or cash equivalents, including payments
in respect of deferred payment obligations (to the extent corresponding to
the principal, but not interest, component thereof) when received in the
form of cash or cash equivalents and proceeds from the conversion of other
property received when converted to cash or cash equivalents, net of
attorney's fees, accountants' fees, underwriters' or placement agents'
fees, discounts or commissions and brokerage, consultant and other fees
incurred in connection with such issuance or sale and net of taxes paid or
payable as a result thereof.
"Note Document" shall mean the notes, any Note Guarantee, the Indenture
and any other document or instrument entered into in connection with the
issuance of the old notes (including without limitation any registration rights
agreement or similar agreement).
"Note Guarantee" means any Guarantee of the obligations of Vanguard under
the Indenture and the notes by any Subsidiary Guarantor.
"Offer to Purchase" means an offer to purchase notes by Vanguard from the
Holders commenced by mailing a notice to the Trustee and each Holder stating:
(1) the covenant pursuant to which the offer is being made and that
all notes validly tendered will be accepted for payment on a pro rata
basis;
(2) the purchase price and the date of purchase (which shall be a
Business Day no earlier than 30 days nor later than 60 days from the date
such notice is mailed) (the "Payment Date");
(3) that any note not tendered will continue to accrue interest
pursuant to its terms;
(4) that, unless Vanguard defaults in the payment of the purchase
price, any note accepted for payment pursuant to the Offer to Purchase
shall cease to accrue interest on and after the Payment Date;
(5) that Holders electing to have a note purchased pursuant to the
Offer to Purchase will be required to surrender the note, together with
the form entitled "Option of the Holder to Elect Purchase" on the reverse
side of the note completed, to the Paying Agent at the address specified
in the notice prior to the close of business on the Business Day
immediately preceding the Payment Date;
(6) that Holders will be entitled to withdraw their election if the
Paying Agent receives, not later than the close of business on the third
Business Day immediately preceding the Payment Date, a telegram, facsimile
transmission or letter setting forth the name of such Holder, the
principal amount of notes delivered for purchase and a statement that such
Holder is withdrawing his election to have such notes purchased; and
(7) that Holders whose notes are being purchased only in part will be
issued new notes equal in principal amount to the unpurchased portion of
the notes surrendered; provided that each note purchased and each new note
issued shall be in a principal amount of $1,000 or integral multiples of
$1,000.
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On the Payment Date, Vanguard shall (a) accept for payment on a pro rata basis
notes or portions thereof tendered pursuant to an Offer to Purchase; (b)
deposit with the Paying Agent money sufficient to pay the purchase price of all
notes or portions thereof so accepted; and (c) deliver, or cause to be
delivered, to the Trustee all notes or portions thereof so accepted together
with an Officers' Certificate specifying the notes or portions thereof accepted
for payment by Vanguard. The Paying Agent shall promptly mail to the Holders of
notes so accepted payment in an amount equal to the purchase price, and the
Trustee shall promptly authenticate and mail to such Holders a new note equal
in principal amount to any unpurchased portion of the note surrendered;
provided that each note purchased and each new note issued shall be in a
principal amount of $1,000 or integral multiples of $1,000. Vanguard will
publicly announce the results of an Offer to Purchase as soon as practicable
after the Payment Date. The Trustee shall act as the Paying Agent for an Offer
to Purchase. Vanguard will comply with Rule 14e-1 under the Exchange Act and
any other securities laws and regulations thereunder to the extent such laws
and regulations are applicable, in the event that Vanguard is required to
repurchase notes pursuant to an Offer to Purchase.
"Permitted Investment" means:
(1) an Investment in Vanguard or a Restricted Subsidiary or a Person
which will, upon the making of such Investment, become a Restricted
Subsidiary or be merged or consolidated with or into or transfer or convey
all or substantially all its assets to, Vanguard or a Restricted
Subsidiary; provided that such person's primary business is related,
ancillary or complementary to the businesses of Vanguard and its
Restricted Subsidiaries on the date of such Investment;
(2) Temporary Cash Investments;
(3) payroll, travel and similar advances to cover matters that are
expected at the time of such advances ultimately to be treated as expenses
in accordance with GAAP;
(4) stock, obligations or securities received in satisfaction of
judgments;
(5) an Investment in an Unrestricted Subsidiary consisting solely of
an Investment in another Unrestricted Subsidiary;
(6) Commodity Agreements, Interest Rate Agreements and Currency
Agreements designed solely to protect Vanguard or its Restricted
Subsidiaries against fluctuations in commodity prices, interest rates or
foreign currency exchange rates;
(7) Investments by Vanguard or a Subsidiary Guarantor made in
connection with Hospital Swaps;
(8) loans and advances to officers and employees made in the ordinary
course of business of not more than $5 million in the aggregate at any one
time outstanding, which are made in compliance with the "Limitation on
Transactions with Affiliates" covenant;
(9) Physician Support Obligations made by Vanguard or a Subsidiary
Guarantor;
(10) any Investments to the extent that the consideration therefor is
Capital Stock (other than Disqualified Capital Stock), or warrants,
options or other rights to purchase Capital Stock (other than Disqualified
Stock or Indebtedness convertible into Capital Stock);
(11) shares of Capital Stock or other securities received in
settlement of any Indebtedness or other obligation owed to Vanguard or any
Restricted Subsidiary as a result of foreclosure, perfection or
enforcement of any Lien, Indebtedness or other obligation or in connection
with any good faith settlement of a bankruptcy proceeding;
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(12) Investments in a Securitization Subsidiary in connection with
and to facilitate any Permitted Receivables Financing, which Investments
are customary for such transactions;
(13) in the event an Insurance Subsidiary is established, Investments
in such Insurance Subsidiary in an amount which does not exceed the
minimum amount of capital required under the laws of the jurisdiction in
which such Insurance Subsidiary is formed, and any Investment by such
Insurance Subsidiary which is a legal investment for an insurance company
under the laws of the jurisdiction in which the Insurance Subsidiary is
formed and made in the ordinary course of business and rated in one of the
four highest rating categories;
(14) Investments represented by accounts receivable created or
acquired in the ordinary course of business;
(15) any Investment made as a result of the receipt of non-cash
consideration from an Asset Sale that was made pursuant to and in
compliance with the "Limitation on Asset Sales" covenant; and
(16) Investments made solely in reliance on this clause in an amount
not to exceed, at any one time outstanding, the greater of (x) $30 million
and (y) 3% of the Total Assets of Vanguard at the time the Investment is
made.
"Permitted Receivables Financing" means any receivables financing facility
or arrangement pursuant to which a Securitization Subsidiary purchases or
otherwise acquires accounts receivable of Vanguard and any Restricted
Subsidiary and enters into a third party financing thereof on terms that the
board of directors has concluded are customary and market terms, fair to
Vanguard and its Restricted Subsidiaries.
"Person" means any individual, corporation, limited liability company,
partnership, joint venture, association, joint-stock company, trust,
unincorporated organization or government or agency or political subdivision
thereof.
"Physician Support Obligation" means a loan to or on behalf of, or a
guarantee of indebtedness of, (i) a physician or healthcare professional
providing service to patients in the service area of a hospital or other health
care facility operated by Vanguard or any of its Subsidiaries made or given by
Vanguard or any Subsidiary of Vanguard, or (ii) any independent practice
association or other entity majority-owned by any Person described in clause
(i), in each case:
(a) in the ordinary course of its business; and
(b) pursuant to a written agreement having a period not to
exceed five years.
"Replacement Assets" means, on any date, property or assets (other than
current assets) of a nature or type or that are used in a business (or an
Investment in a company having property or assets of a nature or type, or
engaged in a business) similar, related, ancillary or complementary to the
nature or type of the property and assets of, or the business of, Vanguard and
its Restricted Subsidiaries existing on such date.
"Restricted Subsidiary" means any Subsidiary of Vanguard other than an
Unrestricted Subsidiary.
"S&P" means Standard & Poor's Ratings Group, a division of The McGraw-Hill
Companies, and its successors.
"Securitization Subsidiary" means a Subsidiary of Vanguard
(1) that is designated a "Securitization Subsidiary" by the board of
directors;
(2) that does not engage in, and whose charter prohibits it from
engaging in, any activities other than Permitted Receivables Financing and
any activity necessary or incidental thereto;
130
(3) no portion of the Indebtedness or any other obligation,
contingent or otherwise, of which
(A) is Guaranteed by Vanguard or any other Restricted
Subsidiary,
(B) is recourse to or obligates Vanguard or any other Restricted
Subsidiary in any way, or
(C) subjects any property or asset of Vanguard or any other
Restricted Subsidiary, directly or indirectly, contingently or
otherwise, to the satisfaction thereof; and
(4) with respect to which neither Vanguard nor any Restricted
Subsidiary has any obligation to maintain or preserve its financial
condition or cause it to achieve certain levels of operating results;
other than, in respect of clauses (3) and (4), pursuant to customary
representations warranties, covenants and indemnities entered into in
connection with a Permitted Receivables Financing.
"Senior Indebtedness" means the following obligations of Vanguard or any
Subsidiary Guarantor, whether outstanding on the Closing Date or thereafter
Incurred: (1) all Indebtedness and all other monetary obligations (including,
without limitation, expenses, fees, principal, premium, interest (in each case,
including any interest accruing subsequent to the filing of a petition of
bankruptcy at the rate provided for in the documentation with respect thereto,
whether or not such interest is an allowed claim under applicable law),
reimbursement obligations under letters of credit and indemnities payable in
connection therewith) under (or in respect of) the Credit Agreement or any
Commodity Agreement, Interest Rate Agreement or Currency Agreement and (2) all
Indebtedness and all other monetary obligations of Vanguard or any Subsidiary
Guarantor (other than the notes and any Note Guarantee), including principal,
premium, and interest (in each case, including any interest accruing subsequent
to the filing of a petition of bankruptcy at the rate provided for in the
documentation with respect thereto, whether or not such interest is an allowed
claim under applicable law) on such Indebtedness, unless such Indebtedness, by
its terms or by the terms of any agreement or instrument pursuant to which such
Indebtedness is issued, is expressly made pari passu with, or subordinated in
right of payment to, the notes or any Note Guarantee; provided that the term
"Senior Indebtedness" shall not include (a) any Indebtedness of Vanguard or any
Subsidiary Guarantor to a Subsidiary of Vanguard, or to a joint venture in
which Vanguard or any Restricted Subsidiary has an interest, (b) that portion
of any Indebtedness of Vanguard or any Subsidiary Guarantor Incurred in
violation of the "Limitation on Indebtedness" covenant or the "Limitation on
Senior Subordinated Indebtedness" covenant (but, as to any such Indebtedness
under the Credit Agreement, no such violation shall be deemed to exist for
purposes of this clause (b) if the holder(s) of such Indebtedness or their
representative shall have received an officer's certificate of Vanguard to the
effect that the Incurrence of such Indebtedness does not or, in the case of
revolving credit Indebtedness that the Incurrence of the entire committed
amount thereof at the date on the initial borrowing thereunder is made, would
not, violate such provisions of the Indenture), (c) any repurchase, redemption
or other obligation in respect of Disqualified Stock, (d) any Indebtedness to
any employee of Vanguard or any of its Subsidiaries, (e) any liability for
taxes owed or owing by Vanguard or any Subsidiary Guarantor or (f) any Trade
Payables.
"Senior Subordinated Obligations" means any principal of, premium, if any,
and interest (including any interest accruing subsequent to the filing of a
petition of bankruptcy at the rate provided for in the documentation with
respect thereto, whether or not such interest is an allowed claim under
applicable law) on, and any other amounts owing with respect to, the notes
payable pursuant to the terms of the notes, any Note Guarantee or any other
Note Document or upon acceleration, including any amounts received upon the
exercise of rights of rescission or other rights of action (including claims
for damages) or otherwise, to the extent relating to the purchase price of the
notes or amounts corresponding to such principal, premium, if any, or interest
on the notes.
"Significant Subsidiary" means, at any date of determination, any
Restricted Subsidiary that, together with its Subsidiaries, (1) for the most
recent fiscal year of Vanguard, accounted for more than 10% of the consolidated
revenues of Vanguard and its Restricted Subsidiaries or (2) as of the end of
such fiscal year, was the owner of more than 10% of the consolidated assets of
Vanguard and its Restricted Subsidiaries, all as set forth on the most recently
available consolidated financial statements of Vanguard for such fiscal year.
131
"Stated Maturity" means, (1) with respect to any debt security, the date
specified in such debt security as the fixed date on which the final
installment of principal of such debt security is due and payable and (2) with
respect to any scheduled installment of principal of or interest on any debt
security, the date specified in such debt security as the fixed date on which
such installment is due and payable.
"Subsidiary" means, with respect to any Person, any corporation,
association or other business entity of which more than 50% of the voting power
of the outstanding Voting Stock or more than 50% of the equity ownership is
owned, directly or indirectly, by such Person and one or more other
Subsidiaries of such Person or a partnership the sole general partner or the
managing general partner of which is such Person or a Subsidiary of such
Person.
"Subsidiary Guarantor" means any Initial Subsidiary Guarantor and any
other Restricted Subsidiary which provides a Note Guarantee of Vanguard's
obligations under the Indenture and the notes pursuant to the "Guarantees by
Restricted Subsidiaries" covenant.
"Temporary Cash Investment" means any of the following:
(1) direct obligations of the United States of America or any agency
thereof or obligations fully and unconditionally guaranteed by the United
States of America or any agency thereof, in each case maturing within one
year from the date of the acquisition thereof;
(2) time deposit accounts, certificates of deposit and money market
deposits maturing within one year of the date of acquisition thereof
issued by a bank or trust company which is organized under the laws of the
United States of America, any state thereof or any foreign country
recognized by the United States of America, and which bank or trust
company has capital, surplus and undivided profits aggregating in excess
of $100 million (or the foreign currency equivalent thereof);
(3) repurchase obligations with a term of not more than 30 days for
underlying securities of the types described in clause (1) above entered
into with a bank or trust company meeting the qualifications described in
clause (2) above;
(4) commercial paper, maturing not more than one year after the date
of acquisition, issued by a corporation (other than an Affiliate of
Vanguard) organized and in existence under the laws of the United States
of America, any state thereof or any foreign country recognized by the
United States of America with a rating at the time as of which any
investment therein is made of "P-2" (or higher) according to Moody's or
"A-2" (or higher) according to S&P;
(5) securities with maturities of six months or less from the date of
acquisition issued or fully and unconditionally guaranteed by any state,
commonwealth or territory of the United States of America, or by any
political subdivision or taxing authority thereof, and rated at least "A"
by S&P or Moody's; and
(6) any mutual fund that has at least 95% of its assets continuously
invested in investments of the types described in clauses (1) through (5)
above.
"Total Assets" of Vanguard means the total consolidated assets of Vanguard
and its Restricted Subsidiaries as shown on the most recent balance sheet of
Vanguard.
"Trade Payables" means, with respect to any Person, any accounts payable
or any other indebtedness or monetary obligation to trade creditors created,
assumed or Guaranteed by such Person or any of its Subsidiaries arising in the
ordinary course of business in connection with the acquisition of goods or
services.
"Transaction Date" means, with respect to the Incurrence of any
Indebtedness, the date such Indebtedness is to be Incurred and, with respect to
any Restricted Payment, the date such Restricted Payment is to be made.
132
"Unrestricted Subsidiary" means any Subsidiary of Vanguard that at the
time of determination has previously been designated, and continues to be, an
Unrestricted Subsidiary in accordance with "Designation of Restricted and
Unrestricted Subsidiaries."
"U.S. Government Obligations" means securities that are (1) direct
obligations of the United States of America for the payment of which its full
faith and credit is pledged or (2) obligations of a Person controlled or
supervised by and acting as an agency or instrumentality of the United States
of America the payment of which is unconditionally guaranteed as a full faith
and credit obligation by the United States of America, which, in either case,
are not callable or redeemable at the option of the issuer thereof at any time
prior to the Stated Maturity of the notes, and shall also include a depository
receipt issued by a bank or trust company as custodian with respect to any such
U.S. Government Obligation or a specific payment of interest on or principal of
any such U.S. Government Obligation held by such custodian for the account of
the holder of a depository receipt; provided that (except as required by law)
such custodian is not authorized to make any deduction from the amount payable
to the holder of such depository receipt from any amount received by the
custodian in respect of the U.S. Government Obligation or the specific payment
of interest on or principal of the U.S. Government Obligation evidenced by such
depository receipt.
"Voting Stock" means with respect to any Person, Capital Stock of any
class or kind ordinarily having the power to vote for the election of
directors, managers or other voting members of the governing body of such
Person.
"Wholly Owned" means, with respect to any Subsidiary of any Person, the
ownership of all of the outstanding Common Stock of such Subsidiary (other than
any director's qualifying shares or Investments by foreign nationals mandated
by applicable law) by such Person or one or more Wholly Owned Subsidiaries of
such Person.
133
MATERIAL UNITED STATES FEDERAL INCOME TAX CONSEQUENCES OF THE
EXCHANGE OFFER
The exchange of old notes for new notes in the exchange offer will not
constitute a taxable exchange for United States federal income tax purposes.
When a holder exchanges an old note for a new note in the exchange offer, the
holder will not recognize taxable gain or loss as a result of such exchange and
will have the same adjusted basis and holding period in the new note as in the
old note immediately before the exchange.
PLAN OF DISTRIBUTION
Each broker-dealer that receives new notes for its own account in the
exchange offer must acknowledge that it will deliver a prospectus in connection
with any resale of new notes. This prospectus, as it may be amended or
supplemented from time to time, may be used by a broker-dealer in connection
with resales of new notes received in exchange for old notes where old notes
were acquired as a result of market-making activities or other trading
activities. We have agreed that, for a period of 90 days after the expiration
date, we will make this prospectus, as amended or supplemented, available to
any broker-dealer for use in connection with any resale of new notes received
by it in exchange for old notes.
We will not receive any proceeds from any sale of new notes by
broker-dealers.
New notes received by broker-dealers for their own account in the exchange
offer may be sold from time to time in one or more transactions
o in the over-the-counter market
o in negotiated transactions
o through the writing of options on the new notes or
o a combination of those methods of resale
at market prices prevailing at the time of resale, at prices related to
prevailing market prices or negotiated prices.
Any resale may be made
o directly to purchasers or
o to or through brokers or dealers who may receive compensation in the
form of commissions or concessions from any broker-dealer or the
purchasers of any new notes.
Any broker-dealer that resells new notes that were received by it for its
own account in the exchange offer and any broker or dealer that participates in
a distribution of those new notes may be considered to be an "underwriter"
within the meaning of the Securities Act. Any profit on any resale of those new
notes and any commission or concessions received by any of those persons may be
considered to be underwriting compensation under the Securities Act. The letter
of transmittal states that, by acknowledging that it will deliver and by
delivering a prospectus, a broker-dealer will not be considered to admit that
it is an "underwriter" within the meaning of the Securities Act.
For a period of 90 days after the expiration date, we will promptly send
additional copies of this prospectus and any amendment or supplement to this
prospectus to any broker-dealer that requests those documents in the letter of
transmittal. We have agreed to pay all expenses incident to the exchange offer,
including the expenses of one counsel for the holders of the notes, other than
commissions or concessions of any brokers or dealers and will
134
indemnify the holders of the notes, including any broker-dealers, against some
liabilities, including liabilities under the Securities Act.
LEGAL MATTERS
Davis Polk & Wardwell, New York, New York will opine for us on whether the
new notes are valid and binding obligations of Vanguard.
EXPERTS
The consolidated financial statements of Vanguard Health Systems, Inc. and
the combined financial statements of Phoenix Baptist Hospital and Medical
Center, Inc., Arrowhead Community Hospital and Medical Center, Inc. and
Affiliates appearing in this prospectus and Registration Statement have been
audited by Ernst & Young LLP, independent auditors, as set forth in their
reports thereon appearing elsewhere herein, and are included in reliance upon
such reports given on the authority of such firm as experts in accounting and
auditing.
The consolidated financial statements of PMH Health Services Network and
Affiliate at April 30, 2001, and for the ten months then ended, appearing in
this prospectus and Registration Statement have been audited by Ernst & Young
LLP, independent auditors, as set forth in their report thereon appearing
elsewhere herein, and as of and for the years ended June 30, 1999 and 2000, by
Arthur Andersen LLP, independent public accountants, as set forth in their
report thereon appearing elsewhere herein (which includes an explanatory
paragraph with respect to the uncertainty regarding PMH Health Services Network
and Affiliates' ability to continue as a going concern as discussed in Note 1
to the combined financial statements), and are included in reliance upon such
reports given on the authority of such firms as experts in accounting and
auditing.
The consolidated financial statements of MacNeal Health Services
Corporation and Subsidiaries as of and for the years ended September 30, 1998
and 1999, and as of and for the four month period ended January 31, 2000,
included in this prospectus, have been audited by Arthur Andersen LLP,
independent public accountants, as indicated in their reports dated June 15,
2001, with respect thereto, and are included herein in reliance upon the
authority of said firm as experts in giving said reports.
WHERE YOU CAN FIND MORE INFORMATION
We and our subsidiary guarantors have filed with the SEC, Washington, D.C.
20549, a registration statement on Form S-1 under the Securities Act with
respect to our offering of the new notes. This prospectus does not contain all
of the information included in the registration statement and the exhibits and
schedules thereto. You will find additional information about us and the new
notes in the registration statement. Certain items are omitted in accordance
with the rules and regulations of the SEC. For further information with respect
to Vanguard, the subsidiary guarantors and the new notes, reference is made to
the registration statement and the exhibits and any schedules filed therewith.
Statements contained in this prospectus as to the contents of any contract or
other document referred to are not necessarily complete and in each instance,
if such contract or document is filed as an exhibit, reference is made to the
copy of such contract or other document filed as an exhibit to the registration
statement, each statement being qualified in all respects by such reference. As
a result of the exchange offer, Vanguard will become subject to the
informational requirements of the Securities Exchange Act of 1934, as amended,
and will file periodic reports, statements and other information with the SEC.
We do not expect that the subsidiary guarantors will be subject to the
informational requirements of the Exchange Act. A copy of the registration
statement, including the exhibits and schedules thereto, may be read and copied
at the SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C.
20549. Information on the operation of the Public Reference Room may be
obtained by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains
an Internet site at http://www.sec.gov, from which interested persons can
electronically access the registration statement, including the exhibits and
any schedules thereto.
135
If for any reason we are not required to comply with the reporting
requirements of the Securities Exchange Act of 1934, as amended, we are still
required under the Indenture to furnish the holders of the new notes and the
old notes with the information, documents and other reports specified in
Sections 13 and 15(d) of the Exchange Act. In addition, we have agreed that,
for so long as any notes remain outstanding, we will furnish to the holders of
the notes and to securities analysts and prospective investors, upon their
request, the information required to be delivered by Rule 144A(d)(4) under the
Securities Act. We also maintain an Internet site at
http://www.vanguardhealth.com. Our website and the information contained
therein or connected thereto shall not be deemed to be incorporated into this
prospectus or the registration statement of which it forms a part.
136
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
VANGUARD HEALTH SYSTEMS, INC.
Unaudited Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheets as of June 30, 2001 and September 30, 2001.............................. F-2
Condensed Consolidated Statements of Operations for the three months ended September 30, 2000
and 2001.................................................................................................... F-3
Consolidated Statement of Stockholders' Equity for the three months ended September 30, 2001.................. F-4
Condensed Consolidated Statements of Cash Flows for the three months ended September 30, 2000
and 2001.................................................................................................... F-5
Notes to Condensed Consolidated Financial Statements.......................................................... F-6
Consolidated Financial Statements:
Report of Independent Auditors................................................................................ F-17
Consolidated Balance Sheets as of June 30, 2000 and 2001...................................................... F-18
Consolidated Statements of Operations for the years ended June 30, 1999, 2000 and 2001........................ F-20
Consolidated Statements of Stockholders' Equity for the years ended June 30, 1999, 2000 and
2001....................................................................................................... F-21
Consolidated Statements of Cash Flows for the years ended June 30, 1999, 2000 and 2001........................ F-22
Notes to Consolidated Financial Statements.................................................................... F-24
PHOENIX BAPTIST HOSPITAL AND MEDICAL CENTER, INC., ARROWHEAD
COMMUNITY HOSPITAL AND MEDICAL CENTER, INC. AND AFFILIATES
Report of Independent Auditors................................................................................. F-59
Combined Statements of Operations for the years ended August 31, 1998 and 1999 and the nine
months ended May 31, 2000..................................................................................... F-60
Combined Statements of Cash Flows for the years ended August 31, 1998 and 1999 and the nine
months ended May 31, 2000..................................................................................... F-61
Notes to Combined Statements of Operations and Cash Flows...................................................... F-62
PMH HEALTH SERVICES NETWORK AND AFFILIATE
Report of Independent Auditors................................................................................. F-69
Report of Independent Public Accountants....................................................................... F-70
Combined Statement of Changes in Net Assets in Liquidation for the period February 1, 2001 to April
30, 2001...................................................................................................... F-71
Combined Statements of Operations for the years ended June 30, 1999 and 2000 and the ten months
ended April 30, 2001.......................................................................................... F-72
Combined Statements of Cash Flows for the years ended June 30, 1999 and 2000 and the seven months
ended January 31, 2001........................................................................................ F-73
Notes to Combined Financial Statements......................................................................... F-75
MACNEAL HEALTH SERVICES CORPORATION AND SUBSIDIARIES
Report of Independent Public Accountants....................................................................... F-83
Consolidated Balance Sheets as of January 31, 2000, and September 30, 1999 and 1998............................ F-84
Consolidated Statements of Operations for the four-month period ended January 31, 2000, and for the
years ended September 30, 1999 and 1998....................................................................... F-85
Consolidated Statements of Changes in Net Assets for the four-month period ended January 31, 2000,
and for the years ended September 30, 1999 and 1998........................................................... F-86
Consolidated Statements of Cash Flows for the four-month period ended January 31, 2000, and for
the years ended September 30, 1999 and 1998................................................................... F-87
Notes to Consolidated Financial Statements..................................................................... F-88
F-1
VANGUARD HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except shares and par value data)
(Unaudited)
June 30, September 30,
2001 2001
-------- -------------
Assets
Current assets:
Cash and cash equivalents........................................................... $12,079 $149,552
Accounts receivable, net of allowance for uncollectible accounts of
approximately $30,704 and $33,163 at June 30, 2001 and September 30,
2001, respectively................................................................ 128,901 129,673
Supplies............................................................................ 11,363 11,556
Prepaid expenses and other current assets........................................... 16,518 16,039
-------- --------
Total current assets.............................................................. 168,861 306,820
Property, plant and equipment, net of accumulated depreciation....................... 362,964 361,340
Goodwill, net of accumulated amortization............................................ 74,233 76,975
Intangible assets, net of accumulated amortization................................... 28,381 39,485
Other assets......................................................................... 5,959 6,248
-------- --------
Total assets........................................................................ $640,398 $790,868
======== ========
Liabilities and stockholders' equity
Current liabilities:
Accounts payable.................................................................... $41,703 $36,911
Accrued expenses and other current liabilities...................................... 98,799 106,308
Current maturities of long-term debt................................................ 10,332 4,071
-------- --------
Total current liabilities......................................................... 150,834 147,290
Other liabilities.................................................................... 9,185 9,946
Long-term debt, less current maturities.............................................. 153,112 308,867
Payable-In-Kind Preferred Stock; $.01 par value, 150,000 combined shares of
Preferred Stock and Payable-In-Kind Preferred Stock authorized, 21,600 shares
of Payable-In-Kind Preferred Stock issued and outstanding at June 30, 2001 and
September 30, 2001, at redemption value............................................. 22,320 22,752
Stockholders' Equity:
Preferred Stock; $1,000 par value, 150,000 combined shares of Preferred Stock
and Payable-In-Kind Preferred Stock authorized, no shares of Preferred Stock
issued and outstanding............................................................ - -
Common Stock; $.01 par value, 600,000 shares authorized, 203,294 and 203,306
shares issued and outstanding at June 30, 2001 and September 30, 2001,
respectively...................................................................... 2 2
Accumulated other comprehensive loss................................................. (1,654) -
Additional paid in capital........................................................... 307,131 306,719
Retained deficit..................................................................... (532) (4,708)
-------- --------
Total liabilities and stockholders' equity........................................ $640,398 $790,868
======== ========
See accompanying notes.
F-2
VANGUARD HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands)
(Unaudited)
Three Months Ended
September 30
---------------------
2000 2001
-------- --------
Revenues:
Patient service revenues............................................. $149,649 $166,415
Premium revenues..................................................... 8,969 40,894
-------- --------
Total revenues..................................................... 158,618 207,309
Expenses:
Salaries and benefits................................................ 77,138 86,720
Supplies............................................................. 22,748 24,778
Medical claims expense............................................... 3,776 29,653
Purchased services................................................... 10,474 15,832
Provision for doubtful accounts...................................... 16,354 16,333
Other operating expenses............................................. 13,978 15,692
Rents and leases..................................................... 3,042 3,119
Depreciation and amortization........................................ 6,104 7,152
Interest, net........................................................ 4,803 5,965
Other................................................................ (1) (426)
-------- --------
Income before income taxes and extraordinary item..................... 202 2,491
Income tax expense.................................................... 11 307
-------- --------
Income before extraordinary item...................................... 191 2,184
Extraordinary loss on extinguishment of debt.......................... - (6,360)
-------- --------
Net income (loss)..................................................... 191 (4,176)
Preferred stock dividends............................................. (400) (432)
-------- --------
Net loss attributable to common stockholders.......................... $ (209) $ (4,608)
======== ========
See accompanying notes.
F-3
VANGUARD HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(Unaudited)
(In thousands, except share data)
Preferred Stock Common Stock Accumulated
--------------- ----------------- Additional Other Total
Paid-in Retained Comprehensive Stockholders'
Shares Amount Shares Amount Capital Deficit Loss Equity
------ ------ ------- ------ ---------- --------- ------------- -------------
Balance at June 30, 2001.. - $ - 203,294 $ 2 $307,131 $ (532) $(1,654) $ 304,947
Issuance of common
stock.................... - - 12 - 20 - - 20
Reclassification of
accumulated other
comprehensive loss
to extraordinary
loss on
extinguishment of
debt..................... - - - - - - 1,654 1,654
Payable-In-Kind
Preferred Stock
dividends................ - - - - (432) - - (432)
Net loss.................. - - - - - (4,176) - (4,176)
------ ------ ------- ------ -------- ------- ------- ---------
Balance at September 30,
2001...................... - $ - 203,306 $ 2 $306,719 $(4,708) $ - $ 302,013
====== ====== ======= ====== ======== ======= ======= =========
See accompanying notes.
F-4
VANGUARD HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Three Months Ended
September 30
--------------------
2000 2001
------- -------
Operating activities:
Net income (loss)........................................................................... $ 191 $ (4,176)
Adjustments to reconcile net income (loss) to net cash (used in) provided by operating
activities:
Depreciation and amortization.............................................................. 6,104 7,152
Provision for doubtful accounts............................................................ 16,354 16,333
Amortization of loan costs................................................................. 223 374
Extraordinary loss on extinguishment of debt............................................... - 6,360
Changes in operating assets and liabilities, net of effects of acquisitions:
Accounts receivable...................................................................... (19,123) (15,583)
Establishment of accounts receivable of recent acquisitions.............................. (7,236) (1,522)
Supplies................................................................................. 1,348 (193)
Prepaid expenses and other current assets................................................ (218) (700)
Accounts payable......................................................................... (5,300) (4,792)
Accrued expenses and other current liabilities........................................... (915) 7,198
Other liabilities........................................................................ 3,146 761
------- -------
Net cash (used in) provided by operating activities......................................... (5,426) 11,212
Investing activities:
Acquisitions, including working capital settlement payments................................. (1,717) (3,769)
Net purchases of equipment.................................................................. (7,834) (4,554)
Other....................................................................................... 438 (289)
------- -------
Net cash used in investing activities....................................................... (9,113) (8,612)
Financing activities:
Proceeds from long-term debt................................................................ - 300,000
Payments of long-term debt and capital leases............................................... (1,196) (150,506)
Payments of loan costs...................................................................... - (14,641)
Exercise of stock options................................................................... - 20
------- -------
Net cash (used in) provided by financing activities......................................... (1,196) 134,873
Net (decrease) increase in cash and cash equivalents........................................ (15,735) 137,473
Cash and cash equivalents, beginning of period.............................................. 16,812 12,079
------- -------
Cash and cash equivalents, end of period.................................................... $ 1,077 $149,552
======= ========
See accompanying notes.
F-5
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
September 30, 2001
1. Basis of Presentation
The unaudited condensed consolidated financial statements as of September
30, 2001 and for the three months then ended include the accounts of Vanguard
Health Systems, Inc. and its wholly owned subsidiaries and have been prepared
in conformity with accounting principles generally accepted in the United
States for interim reporting and in accordance with Rule 10-01 of Regulation
S-X. Accordingly, they do not include all of the information and notes required
by accounting principles generally accepted in the United States for complete
financial statements.
In the opinion of management, the unaudited condensed consolidated
financial statements reflect all adjustments (consisting of normal recurring
adjustments) necessary for a fair presentation of the financial position and
the results of operations for the three month period presented. The results of
operations for the three month period presented are not necessarily indicative
of the results to be expected for the year ending June 30, 2002. The interim
condensed consolidated financial statements should be read in connection with
the audited consolidated financial statements as of and for the year ended June
30, 2001 included in the Company's registration statement on Form S-1 filed
with the Securities and Exchange Commission on October 19, 2001 (Registration
No. 333-71934).
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the accompanying
unaudited condensed consolidated financial statements and notes. Actual results
could differ from those estimates.
2. Acquisitions
During the fiscal year ended June 30, 2001, the Company completed the
following acquisitions:
Date Entity Location
- ------------ ---------------------------------- --------------
July 2000 Trinity MedCare, Inc. Nashville, TN
September 2000 Pleasant Properties, Inc. Phoenix, AZ
May 2001 PMH Health Resources, Inc. Phoenix, AZ
June 2001 Touchstone Imaging of Arizona, LLC Phoenix, AZ
The Company acquired certain net assets of the aforementioned entities,
which include a hospital, health plan, and imaging centers for a total purchase
price of approximately $90,620,000, comprised of cash of $31,602,000 and the
assumption of certain liabilities of $59,018,000. The excess of the purchase
price over net assets acquired was $31,193,000 and is included as part of net
goodwill and net intangible assets on the accompanying condensed consolidated
balance sheets. The acquisitions were financed with the proceeds from equity
issuances to various affiliates of Morgan Stanley Capital Partners ("Capital
Partners") and certain members of management and internally generated cash. The
2001 acquisitions were accounted for using the purchase method of accounting,
and the operating results of the acquired entities have been included in the
accompanying condensed consolidated statements of operations from the
respective dates of acquisition.
On November 1, 2001, the Company acquired the assets of Paradise Valley
Hospital, a 162-bed acute care hospital located in Phoenix, Arizona. The
Company funded the acquisition with a portion of its cash proceeds from the
July 30, 2001 issuance of its 9.75% senior subordinated notes due 2011. We do
not believe that the Company's purchase of this hospital will have a material
impact on the Company's results of operations or financial position.
F-6
3. Goodwill and Intangible Assets
Effective July 1, 2001, the Company adopted the provisions of SFAS No.
141, Business Combinations ("FAS 141"), and SFAS No. 142, Goodwill and Other
Intangible Assets ("FAS 142"). In accordance with these provisions, the Company
reclassified its previous allocations of excess purchase price over net assets
acquired between goodwill and intangible assets and re-assessed the
amortization lives assigned to intangible assets. The following table provides
information regarding the intangible assets, including deferred loan costs,
included on the accompanying condensed consolidated balance sheets as of June
30, 2001 and September 30, 2001 (in thousands).
Gross Carrying Amount Accumulated Amortization
----------------------------- ------------------------
June 30, September 30, June 30, September 30,
2001 2001 2001 2001
-------- ------------- -------- -------------
Class of Intangible Asset
Amortized intangible assets:
Deferred loan costs..................... $ 4,461 $15,000 $ 1,116 $ 210
Certificate of need..................... 19,351 - 758 -
Assembled workforce..................... 3,580 - 1,874 -
Medical records......................... 6,150 - 2,792 -
Contracts............................... - 7,910 - 445
Customer lists.......................... - 2,250 - 489
Other................................... 2,340 2,717 961 400
------- ------- ------- ------
Subtotal.............................. $35,882 $27,877 $ 7,501 $1,544
Indefinite-lived intangible assets:......
License and accreditation............... - 6,648 - -
Other................................... - 6,504 - -
------- ------- ------- ------
Subtotal.............................. - 13,152 - -
------- ------- ------- ------
Total.................................... $35,882 $41,029 $ 7,501 $1,544
======= ======= ======= ======
The Company estimates amortization expense for these intangible assets,
excluding deferred loan costs which are amortized to interest expense, to
approximate $3,207,000, $2,283,000, $1,109,000, $1,109,000 and $1,109,000 for
the fiscal years ending June 30, 2002, 2003, 2004, 2005 and 2006, respectively.
The following table presents the changes in the carrying amount of
goodwill from the date of transition to September 30, 2001 (in thousands).
Acute Care Health
Services Plans Total
---------- -------- -------
Balance as of July 1, 2001............ $65,586 $ 7,620 $73,206
Working capital settlement adjustment. - 3,769 3,769
------- ------- -------
Balance as of September 30, 2001...... $65,586 $11,389 $76,975
======= ======= =======
The Company completed its transition impairment tests of goodwill and
indefinite-lived intangible assets during the first quarter of fiscal 2002
noting no impairment and will perform its initial annual impairment test later
in fiscal 2002. Amortization of goodwill and indefinite-lived intangible assets
has been suspended in the accompanying condensed consolidated statement of
operations for the three months ended September 30, 2001. The following table
presents net income before extraordinary item and net income (loss) for the
three months ended September 30, 2000 assuming FAS 141 and 142 had been adopted
on July 1, 2000, and for the three months ended September 30, 2001 given the
effects of the adoption of FAS 141 and 142 on July 1, 2001 (in thousands).
F-7
Three Months Ended
September 30
-------------------
2000 2001
------ -------
Reported net income before extraordinary item.......... $ 191 $ 2,184
Extraordinary loss on extinguishment of debt........... - (6,360)
----- -------
Reported net income (loss)............................. 191 (4,176)
Add back: Goodwill amortization....................... 830 -
Adjust: Amortization of intangible assets previously
classified as goodwill (net of taxes of $0).......... (355) -
Adjustments to amortization lives of intangible
assets (net of taxes of $0).......................... - -
----- -------
Adjusted net income (loss)............................ $ 666 $(4,176)
===== =======
4. Financing Arrangements
On July 30, 2001, the Company received $300,000,000 through the issuance
of 9.75% Senior Subordinated Notes (the "Notes") which mature in August 2011.
Interest on the Notes is payable semi-annually on February 1 and August 1. The
Company may redeem the Notes, in whole or in part, at any time from August 1,
2006 to July 31, 2009 at redemption prices ranging from 104.875% to 101.625%,
plus accrued and unpaid interest. The Company may redeem the Notes on or after
August 1, 2009 at a 100.00% redemption price plus accrued and unpaid interest.
Additionally, at any time prior to August 1, 2004, the Company may redeem up to
35% of the principal amount of the Notes with the net cash proceeds of one or
more sales of its capital stock at a redemption price of 109.75% plus accrued
and unpaid interest to the redemption date; provided that at least 65% of the
aggregate principal amount of the Notes originally issued on July 30, 2001
remains outstanding after each such redemption and notice of any such
redemption is mailed within 90 days of each such sale of capital stock.
Payment of the principal and interest of the Notes is subordinate to
amounts owed for existing and future senior indebtedness of the Company and is
guaranteed, jointly and severally, on an unsecured senior subordinated basis by
certain of the Company's subsidiaries. The Company is subject to certain
restrictive covenants under the Indenture governing the Notes. The Company used
the proceeds from the offering to repay all amounts outstanding under its then
existing credit facility ("2000 credit facility") of approximately
$147,012,500.
Concurrent with the issuance of the $300,000,000 Senior Subordinated
Notes, the Company entered into a new senior secured credit facility (the "2001
credit facility") with a syndicate of lenders with Banc of America Securities
LLC and Morgan Stanley Senior Funding, Inc. serving as joint lead arrangers and
book managers and Bank of America, N.A. as administrative agent. The 2001
credit facility initially provides for up to $125 million of outstanding loans
and letters of credit on a revolving basis and contemplates, but the lenders
have not committed to, additional term loans of up to $250 million. The Company
would be required to obtain commitments from its existing or new lenders to
obtain the term loans. The applicable interest rate under the revolving credit
facility is based upon either: 1) LIBOR plus a margin ranging from 2.25% to
3.25% depending on the Company's net debt to Adjusted EBITDA ratio for the most
recent four quarters or 2) a base rate plus a margin ranging from 1.25% to
2.25% depending on the Company's leverage ratio. The Company is subject to
certain restrictive and financial covenants under the 2001 credit facility, for
which the Company is in compliance as of September 30, 2001. Obligations under
the 2001 credit facility are guaranteed by the Company's current and future
wholly owned domestic subsidiaries and are secured by substantially all of the
assets of the Company and its subsidiaries and the stock of the Company's
subsidiaries.
The Company incurred offering costs and loan costs of approximately
$11,500,000 and $3,500,000 for the Notes and the 2001 credit facility,
respectively. The Company capitalized the costs associated with the 2001 credit
facility and the offering of the Notes and is amortizing such costs to interest
expense over the 5-year life of the credit facility and the 10-year life of the
Notes.
F-8
5. Recently Issued Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities ("SFAS 133"), as amended in June 2000 by
SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging
Activities, which requires the Company to recognize all derivatives as assets
or liabilities measured at fair value. Changes in fair value are recognized
through either earnings or other comprehensive income dependent on the
effectiveness of the hedge instrument. The Company entered into a three-year
interest rate collar having a notional principal amount of $67,000,000 with a
large financial institution as a result of a provision of the 2000 credit
facility requiring the Company to maintain a form of interest rate protection.
The collar qualified as a cash flow hedge under SFAS 133 and initially expired
on May 3, 2003. The collar agreement included a 90-day settlement period at
which time the Company made payments to the hedging financial institution for
instances in which 90-day LIBOR dropped below the designated rate floor of
6.865% or received payments from the hedging financial institution for
instances in which the 90-day LIBOR exceeded the designated rate ceiling of
8.0%. The Company terminated the collar agreement in July 2001 commensurate
with the issuance of the Notes and repayment of the amounts outstanding under
the 2000 credit facility - (See Note 6).
In March 2000, the FASB issued Financial Accounting Standards Board
Interpretation No. 44, Accounting for Certain Transactions Involving Stock
Compensation - an interpretation of APB Opinion No. 25 ("FIN 44"), which became
effective July 1, 2000, covering transactions occurring after December 15,
1998. FIN 44 clarifies the application of APB Opinion No. 25 relating to the
definition of an employee, criteria for determining whether a plan qualifies as
a noncompensatory plan, accounting consequences of various modifications to the
terms of a previously fixed stock option or award and the accounting for an
exchange of stock compensation awards in a business combination. The
application of FIN 44 did not have any effect on the Company's results of
operations or financial position.
In August 2001, the FASB issued Statement of Financial Accounting
Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets ("SFAS 144"), which supersedes SFAS 121, Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and the
accounting and reporting provisions of APB Opinion No. 30, Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions. SFAS 144 removes goodwill from
its scope and clarifies other implementation issues related to SFAS 121. SFAS
144 also provides a single framework for evaluating long-lived assets to be
disposed of by sale. The Company does not expect SFAS 144 to have a material
effect on its results of operations or financial position.
The Company adopted the provisions of SFAS 133 effective July 1, 2000 for
its interest rate collar agreement. The adoption of this standard did not have
a significant impact on the Company's results of operations or financial
position.
6. Extraordinary Items
Commensurate with the issuance of the Notes and repayment of the amounts
outstanding under the 2000 credit facility, the Company expensed the remaining
deferred loan costs associated with the 2000 credit facility of approximately
$3,180,000 ($3,039,000 net of taxes) and incurred penalties for the early
termination of certain capital leases of $272,000 ($260,000 net of taxes)
resulting in an extraordinary loss on extinguishment of debt for the three
months ended September 30, 2001. Additionally, the Company paid approximately
$3,737,000 in July 2001 representing accrued interest on the interest rate
collar and a settlement fee to terminate the collar agreement, which was
required under the 2000 credit facility. The termination fee of $3,203,000
($3,061,000 net of taxes) represents the fair market value of the collar
agreement as of the termination date and is reflected on the accompanying
condensed consolidated statement of operations for the three months ended
September 30, 2001 as an extraordinary loss on extinguishment of debt.
7. Segment Information
The Company's acute hospitals and related health care businesses are
similar in their activities and the economic environments in which they operate
(i.e. urban markets). Accordingly, the Company's reportable operating segments
consist of 1) acute care hospitals and related health care businesses,
collectively, and 2) health plans consisting of
F-9
MacNeal Health Providers, a contracting entity for MacNeal Hospital, and
Phoenix Health Plan, a Medicaid managed health plan in Arizona. Prior to the
acquisitions of these entities, the Company determined that it did not have
separately reportable segments as defined under Statement of Financial
Accounting Standards No. 131, Disclosures about Segments of an Enterprise and
Related Information.
The following table provides condensed financial information by business
segment for the three months ended September 30, 2000 and 2001 (amounts shown
in 000's).
Three Months Ended September 30, 2000 Three Months Ended September 30, 2001
---------------------------------------------------- ----------------------------------------------------
Health Acute Care Health Acute Care
Plans Services Eliminations Consolidated Plans Services Eliminations Consolidated
------ ---------- ------------ ------------ ------- ---------- ------------ ------------
Patient service
revenues............ $ - $149,654 $ - $149,654 $ - $166,415 $ - $166,415
Capitation premiums.. 8,969 - - 8,969 40,894 - - 40,894
Inter-segment
revenues............ - 3,794 (3,794) - - 6,190 (6,190) -
------ -------- ------- -------- ------- -------- -------- --------
Total revenues 8,969 153,448 (3,794) 158,623 40,894 172,605 (6,190) 207,309
Operating expenses -
external............ 4,924 153,495 - 158,419 33,521 171,297 - 204,818
Operating expenses -
inter-segment....... 3,794 - (3,794) - 6,190 - (6,190) -
------ -------- ------- -------- ------- -------- -------- --------
Total operating
expenses............ 8,718 153,495 (3,794) 158,419 39,711 171,297 (6,190) 204,818
------ -------- ------- -------- ------- -------- -------- --------
Income (loss) before
income taxes and
extraordinary $ 251 $ (47) $ - $ 204 $ 1,183 $ 1,308 $ - $ 2,491
====== ======== ======= ======== ======= ======== ======== ========
items................
Segment assets....... $4,833 $542,837 $547,670 $42,463 $748,405 $790,868
====== ======== ======== ======= ======== ========
8. Contingencies
Management continually monitors and evaluates contingencies based upon the
best available information and believes that adequate provision for potential
losses associated with contingencies has been made. In management's opinion,
the following risks will not have a material effect on the Company's results of
operations or financial position.
Litigation
The Company is presently, and from time to time, subject to various claims
and lawsuits arising in the normal course of business.
Net Revenue
Final determination of amounts earned under prospective payment and
cost-reimbursement activities is subject to review by appropriate governmental
authorities or their agents.
Governmental Regulation
Laws and regulations governing the Medicare and Medicaid and other federal
health care programs are complex and subject to interpretation. The Company's
management believes that the Company is in compliance with all applicable laws
and regulations in all material respects and is not aware of any pending or
threatened investigations involving allegations of potential wrongdoing. While
no such regulatory inquiries have been made, compliance with such laws and
regulations can be subject to future government review and interpretation as
well as significant regulatory action including fines, penalties, and exclusion
from the Medicare, Medicaid and other federal health care programs.
F-10
Acquisitions
The Company has acquired and will continue to acquire businesses with
prior operating histories. Acquired companies may have unknown or contingent
liabilities, including liabilities for failure to comply with health care laws
and regulations, such as billing and reimbursement, fraud and abuse and similar
anti-referral laws. Although the Company institutes policies designed to
conform practices to its standards following completion of acquisitions, there
can be no assurance that the Company will not become liable for past activities
that may later be asserted to be improper by private plaintiffs or government
agencies. Although the Company generally seeks to obtain indemnification from
prospective sellers covering such matters, there can be no assurance that any
such matter will be covered by indemnification, or if covered, that such
indemnification will be adequate to cover potential losses and fines.
Professional and General Liability Risks
As is typical in the health care industry, the Company is subject to
potential claims and legal actions in the ordinary course of business including
patient care. To mitigate this risk, the Company maintains professional and
general liability insurance in excess of its self-insured retention from
unrelated commercial carriers on an occurrence basis for general liability and
a claims-made basis for professional liability up to $100,000,000 per
occurrence and in the aggregate. The Company retains liability for such risks
up to $1 million per claim and $13,200,000 million in the aggregate.
Liabilities for self-insured professional and general liability risks for both
asserted and unasserted claims are estimated based upon historical claims
payment data, industry trends and current incident logs. Although ultimate
settlement of these liabilities may vary from such estimates, management
believes the amount classified within Other Liabilities on the accompanying
unaudited condensed consolidated balance sheets is adequate.
9. Comprehensive Income
The components of comprehensive income, net of related taxes, follows (in
thousands).
Three months Ended
September 30,
--------------------
2000 2001
----- --------
Net income (loss)......................................... $ 191 $(4,176)
Cumulative effect of change in accounting principle -
fair value of interest rate collar...................... (164) -
Net change in fair value of interest collar............... (398) -
Amortization of transition adjustment..................... (25) -
----- -------
Other comprehensive loss.................................. (587) -
----- -------
Comprehensive income (loss)............................... $(396) $(4,176)
===== =======
Upon the termination of the interest rate collar agreement in July 2001,
the Company reclassified its previously recorded accumulated other
comprehensive loss of $1,654,000 to extraordinary loss on extinguishment of
debt.
10. Financial Information for Subsidiary Guarantors and Non-Guarantor
Subsidiaries
The Company conducts substantially all of its business through its
subsidiaries. Certain of the Company's subsidiaries jointly and severally
guarantee the Company's senior subordinated notes due 2011 on an unconditional
basis. Certain other consolidated entities which are not wholly owned by the
Company have not guaranteed such notes in conformity with the provisions of the
indenture governing the notes. The condensed consolidating financial
information for the parent company, the subsidiary guarantors, the
non-guarantor subsidiaries, certain eliminations, and the consolidated Company
as of September 30, 2001 and for the three months ended September 30, 2000 and
2001, follows:
F-11
VANGUARD HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATING BALANCE SHEETS
September 30, 2001
Wholly-
Owned Combined
Guarantor Non- Total
Parent Subsidiaries Guarantors Eliminations Consolidated
-------- ------------ ---------- ------------ ------------
Assets (In thousands)
Current assets:
Cash and cash equivalents.................. $ - $149,342 $ 210 $ - $149,552
Accounts receivable, net................... - 128,482 1,191 - 129,673
Supplies................................... - 11,465 91 - 11,556
Prepaid expenses and other current assets.. 1,259 14,532 248 - 16,039
-------- -------- ------- --------- --------
Total current assets...................... 1,259 303,821 1,740 - 306,820
Property, plant and equipment, net......... - 356,559 4,781 - 361,340
Goodwill, net.............................. - 76,737 238 - 76,975
Intangible assets, net..................... - 39,446 39 - 39,485
Investments in subsidiaries................ 323,855 - - (323,855) -
Other assets............................... - 6,207 41 - 6,248
-------- -------- ------- --------- --------
Total assets.............................. $325,114 $782,770 $ 6,839 $ (323,855) $790,868
======== ======== ======= ========== ========
Liabilities and stockholders' equity
Current Liabilities:
Accounts payable........................... $ - $ 36,755 $ 156 $ - $ 36,911
Accrued expenses and other current
liabilities............................... 470 105,517 321 - 106,308
Current maturities of long-term debt....... - 3,934 137 - 4,071
-------- -------- ------- --------- --------
Total current liabilities................. 470 146,206 614 - 147,290
Other liabilities.......................... - 9,946 - - 9,946
Long-term debt, less current maturities.... - 306,009 2,858 - 308,867
Intercompany............................... (3,219) 4,527 (1,308) - -
Payable-In-Kind Preferred Stock............ 22,752 - - - 22,752
Stockholders' equity....................... 305,111 316,082 4,675 (323,855) 302,013
-------- -------- ------- --------- --------
Total liabilities and stockholders'
equity..................................... $325,114 $782,770 $ 6,839 $(323,855) $790,868
======== ======== ======= ========== ========
F-12
VANGUARD HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
For the Three Months Ended September 30, 2000
Wholly-
Owned Combined
Guarantor Non- Total
Parent Subsidiaries Guarantors Eliminations Consolidated
-------- ------------ ---------- ------------ ------------
Patient service revenues.................. $ - $147,918 $ 1,731 $ - $149,649
Premium revenues.......................... - 8,969 - - 8,969
-------- -------- ------- --------- --------
Total revenues........................... - 156,887 1,731 - 158,618
Salaries and benefits..................... - 76,723 415 - 77,138
Medical claims expense.................... - 3,776 - - 3,776
Supplies.................................. - 22,460 288 - 22,748
Purchased services........................ - 10,408 66 - 10,474
Other operating expenses.................. 2 13,828 148 - 13,978
Provision for doubtful accounts........... - 16,317 37 - 16,354
Rents and leases.......................... - 2,907 135 - 3,042
Depreciation and amortization............. - 5,946 158 - 6,104
Interest, net............................. - 4,850 (47) - 4,803
Management fees........................... - (39) 39 - -
Other..................................... - (1) - - (1)
-------- -------- ------- --------- --------
2 157,175 1,239 - 158,416
Net income (loss) before income taxes
and extraordinary items.................. (2) (288) 492 - 202
Income tax expense........................ - 11 - - 11
Equity in earnings of subsidiaries........ 193 - - (193) -
-------- -------- ------- --------- --------
Income (loss) before extraordinary items.. 191 (299) 492 (193) 191
Extraordinary loss on extinguishment of
debt.................................... - - - - -
-------- -------- ------- --------- --------
Net income (loss)......................... $ 191 $ (299) $ 492 $ (193) $ 191
======== ======== ======= ========= ========
F-13
VANGUARD HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
For the Three Months Ended September 30, 2001
Wholly-
Owned Combined
Guarantor Non- Total
Parent Subsidiaries Guarantors Eliminations Consolidated
-------- ------------ ---------- ------------ ------------
Patient service revenues.................. $ - $ 164,310 $ 2,105 $ - $ 166,415
Premium revenues.......................... - 40,894 - - 40,894
-------- --------- ------- --------- ---------
Total revenues............................ - 205,204 2,105 - 207,309
Salaries and benefits..................... - 86,232 488 - 86,720
Medical claims expense.................... - 29,653 - - 29,653
Supplies.................................. - 24,419 359 - 24,778
Purchased services........................ - 15,752 80 - 15,832
Other operating expenses.................. 2 15,497 193 - 15,692
Provision for doubtful accounts........... - 16,324 9 - 16,333
Rents and leases.......................... - 2,986 133 - 3,119
Depreciation and amortization............. - 7,031 121 - 7,152
Interest, net............................. (1) 5,948 18 - 5,965
Management fees........................... - (46) 46 - -
Other..................................... - (426) - - (426)
-------- --------- ------- --------- ---------
1 203,370 1,447 - 204,818
Net income (loss) before income taxes
and extraordinary items.................. (1) 1,834 658 - 2,491
Income tax expense........................ - 307 - - 307
Equity earnings of subsidiaries........... (4,175) - - 4,175 -
-------- --------- ------- --------- ---------
Income (loss) before extraordinary items.. (4,176) 1,527 658 4,175 2,184
Extraordinary loss on extinguishment of
debt.................................... - (6,360) - - (6,360)
-------- --------- ------- --------- ---------
Net income (loss)......................... $ (4,176) $ (4,833) $ 658 $ 4,175 $ (4,176)
======== ========= ======= ========= =========
F-14
VANGUARD HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2000
Wholly-
Owned Combined
Guarantor Non- Total
Parent Subsidiaries Guarantors Eliminations Consolidated
-------- ------------ ---------- ------------ ------------
Operating activities:
Net income (loss).............................. $ 191 $ (299) $ 492 $ (193) $ 191
Adjustments to reconcile net income (loss) to
net cash (used in) provided by operating
activities:
Depreciation and amortization................. - 5,946 158 - 6,104
Provision for doubtful accounts............... - 16,317 37 - 16,354
Amortization of loan costs.................... - 223 - - 223
Extraordinary loss on extinguishment of
debt........................................ - - - - -
Changes in operating assets and liabilities,
net of effects of acquisitions:
Equity (loss) in earnings of subsidiaries... (193) - - 193 -
Accounts receivable......................... - (18,920) (203) - (19,123)
Establishment of accounts receivable of
recent acquisitions....................... - (7,236) - - (7,236)
Supplies.................................... - 1,338 10 - 1,348
Prepaid expenses and other current assets... - 1,984 (2,202) - (218)
Accounts payable............................ - (5,293) (7) - (5,300)
Accrued expenses and other current
liabilities............................... 2 (808) (109) - (915)
Other liabilities........................... - 3,329 (183) - 3,146
-------- -------- ------- --------- --------
Net cash (used in) provided by operating
activities................................... - (3,419) (2,007) - (5,426)
Investing activities:
Acquisitions, including working capital
settlement payments.......................... - (1,717) - - (1,717)
Capital expenditures........................... - (7,346) (488) - (7,834)
Other.......................................... - 447 (9) - 438
-------- -------- ------- --------- --------
Net cash used in investing activities.......... - (8,616) (497) - (9,113)
Financing activities:
Proceeds from long-term debt................... - - - - -
Payments of long-term debt and capital leases.. - (1,196) - - (1,196)
Payments of loan costs......................... - - - - -
Cash provided by (used in) intercompany
activity..................................... - - - - -
Exercise of stock options...................... - (2,654) 2,654 - -
-------- -------- ------- --------- --------
Net cash (used in) provided by financing
activities..................................... - (3,850) 2,654 - (1,196)
Net (decrease) increase in cash and cash
equivalents.................................. - (15,885) 150 - (15,735)
Cash and cash equivalents, beginning of
period....................................... - 16,618 194 - 16,812
-------- -------- ------- --------- --------
Cash and cash equivalents, end of period....... $ - $ 733 $ 344 $ - $ 1,077
======== ======== ======= ======== ========
F-15
VANGUARD HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
For the Three Months Ended September 30, 2001
Wholly-
Owned Combined
Guarantor Non- Total
Parent Subsidiaries Guarantors Eliminations Consolidated
-------- ------------ ---------- ------------ ------------
Operating activities:
Net income (loss)............................. $ (4,176) $ (4,834) $ 659 $ 4,175 $ (4,176)
Adjustments to reconcile net income (loss) to
net cash (used in) provided by operating
activities:
Depreciation and amortization................ - 7,031 121 - 7,152
Provision for doubtful accounts.............. - 16,324 9 - 16,333
Amortization of loan costs................... - 374 - - 374
Extraordinary loss on extinguishment of debt. - 6,360 - - 6,360
Changes in operating assets and liabilities,
net of effects of acquisitions:
Equity (loss) in earnings of subsidiaries.. 4,175 - - (4,175) -
Accounts receivable........................ - (15,600) 17 - (15,583)
Establishment of accounts receivable of
recent acquisitions...................... - (1,522) - - (1,522)
Supplies................................... - (209) 16 - (193)
Prepaid expenses and other current assets.. - (665) (35) - (700)
Accounts payable........................... - (4,582) (210) - (4,792)
Accrued expenses and other current
liabilities................................ (273) 7,526 (55) - 7,198
Other liabilities.......................... - 761 - - 761
-------- -------- ------- --------- --------
Net cash (used in) provided by operating
activities.................................. (274) 10,964 522 - 11,212
Investing activities:
Acquisitions, including working capital
settlement payments......................... - (3,769) - - (3,769)
Capital expenditures.......................... - (4,554) - - (4,554)
Other......................................... - (283) (6) - (289)
-------- -------- ------- --------- --------
Net cash used in investing activities......... - (8,606) (6) - (8,612)
Financing activities:.........................
Proceeds from long-term debt.................. - 300,000 - - 300,000
Payments of long-term debt and capital leases. - (150,506) - - (150,506)
Payments of loan costs........................ - (14,641) - - (14,641)
Cash provided by (used in) intercompany
activity.................................... 254 397 (651) - -
Exercise of stock options..................... 20 - - - 20
-------- -------- ------- --------- --------
Net cash (used in) provided by financing
activities.................................. 274 135,250 (651) - 134,873
Net (decrease) increase in cash and cash
equivalents................................... - 137,608 (135) - 137,473
Cash and cash equivalents, beginning of
period...................................... - 11,734 345 - 12,079
-------- -------- ------- --------- --------
Cash and cash equivalents, end of period...... $ - $149,342 $ 210 $ - $149,552
======== ======== ======= ========= ========
F-16
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Vanguard Health Systems, Inc.
We have audited the accompanying consolidated balance sheets of Vanguard
Health Systems, Inc. (the "Company") as of June 30, 2000 and 2001, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the three years in the period ended June 30, 2001. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Vanguard Health Systems, Inc. at June 30, 2000 and 2001, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended June 30, 2001, in conformity with accounting
principles generally accepted in the United States.
As discussed in Note 1 to the consolidated financial statements, effective
July 1, 2000, the Company changed its method of accounting for derivative
instruments to conform with the provisions of Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities."
As discussed in Note 1, the consolidated financial statements of the
Company have been restated effective June 30, 1998 to reflect compensation
expense associated with certain stock options issued to an officer of the
Company.
/s/ Ernst & Young LLP
Nashville, Tennessee
August 15, 2001
F-17
VANGUARD HEALTH SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARES AND PAR VALUE DATA)
June 30,
----------------------
2000 2001
-------- --------
(in thousands)
Assets
Current assets:
Cash and cash equivalents................................................................. $ 16,812 $ 12,079
Accounts receivable, net of allowance for uncollectible accounts of approximately
$45,218 and $30,704, at June 30, 2000 and 2001, respectively............................ 109,813 128,901
Supplies.................................................................................. 9,643 11,363
Prepaid expenses and other current assets................................................. 13,296 14,080
Deferred income taxes..................................................................... 1,294 2,438
-------- --------
Total current assets.................................................................. 150,858 168,861
Property, plant and equipment:
Land and improvements..................................................................... 42,405 51,086
Buildings and improvements................................................................ 205,831 227,697
Equipment................................................................................. 78,485 103,776
Construction in progress (estimated cost to complete after June 30, 2001 --
approximately $3,300)................................................................... 1,628 8,612
-------- --------
328,349 391,171
Less accumulated depreciation............................................................. 9,117 28,207
-------- --------
Net property, plant and equipment.......................................................... 319,232 362,964
Cost in excess of net assets acquired, net of accumulated amortization..................... 45,267 74,233
Intangible assets, net of accumulated amortization......................................... 31,439 28,381
Other assets............................................................................... 3,110 5,959
-------- --------
Total assets.......................................................................... $549,906 $640,398
======== ========
F-18
VANGUARD HEALTH SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(In thousands, except shares and par value data)
June 30,
-----------------------
2000 2001
--------- --------
(in thousands)
Liabilities and stockholders' equity
Current liabilities:
Accounts payable ...................................................................... $ 32,705 $ 41,703
Accrued expenses and other current liabilities......................................... 72,689 98,011
Income tax payable..................................................................... 498 788
Current maturities of long-term debt................................................... 5,485 10,332
-------- --------
Total current liabilities.......................................................... 111,377 150,834
Other liabilities....................................................................... 4,830 9,185
Long-term debt, less current maturities (see Note 5).................................... 147,839 153,112
Payable-In-Kind Preferred Stock; $.01 par value, 150,000 combined shares of
Preferred Stock and Payable-In-Kind Preferred Stock authorized, 20,000 and
21,600 shares of Payable-In-Kind Preferred Stock issued and outstanding at June
30, 2000 and 2001, respectively, stated at redemption value............................ 20,663 22,320
Stockholders' equity:
Preferred Stock; $1,000 par value,
150,000 combined shares of Preferred Stock and Payable-In-Kind Preferred Stock
authorized, no shares of Preferred Stock issued and outstanding...................... -- --
Common Stock; $.01 par value, 600,000 shares authorized, 183,954 and 203,294
shares issued and outstanding at June 30, 2000 and 2001, respectively................ 2 2
Accumulated other comprehensive loss................................................... -- (1,654)
Additional paid-in capital............................................................. 275,887 307,131
Retained deficit....................................................................... (10,692) (532)
-------- --------
Total stockholders' equity......................................................... 265,197 304,947
-------- --------
Total liabilities and stockholders' equity......................................... $549,906 $640,398
======== ========
See accompanying notes.
F-19
VANGUARD HEALTH SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended June 30,
---------------------------------------
1999 2000 2001
------- -------- ----------
(in thousands)
Revenues
Patient service revenues........................................ $ 91,460 $288,886 $612,700
Premium revenue................................................. -- 15,808 55,063
--------- -------- --------
Total revenues.............................................. 91,460 304,694 667,763
Expenses:
Salaries and benefits........................................... 39,287 146,467 323,617
Non-cash stock compensation..................................... 5,046 -- --
Supplies ....................................................... 12,473 40,498 92,952
Medical claims expense.......................................... -- 7,356 30,784
Purchased services.............................................. 8,425 23,618 64,972
Provision for doubtful accounts................................. 17,293 33,138 56,846
Other operating expenses........................................ 4,749 26,264 34,962
Rent and leases ................................................ 2,241 6,836 12,233
Depreciation and amortization................................... 3,916 11,793 23,799
Interest, net................................................... 4,211 8,831 16,558
Other........................................................... 240 74 369
--------- -------- --------
97,881 304,875 657,092
--------- -------- --------
Income (loss) before income taxes and extraordinary item......... (6,421) (181) 10,671
Income tax expense............................................... -- 119 511
--------- -------- --------
Income (loss) before extraordinary item.......................... (6,421) (300) 10,160
Extraordinary loss on extinguishment of debt..................... -- (1,149) --
--------- -------- --------
Net income (loss)................................................ (6,421) (1,449) 10,160
Preferred stock dividends........................................ -- (663) (1,657)
--------- -------- --------
Net income (loss) attributable to common stockholders............ $ (6,421) $ (2,112) $ 8,503
========= ======== ========
See accompanying notes.
F-20
VANGUARD HEALTH SYSTEMS, INC,
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Preferred Stock Common Stock
---------------- -----------------
Accumulated
Additional Other Total
Paid-in Retained Comprehensive Stockholders'
Shares Amount Shares Amount Capital Deficit Loss Equity
------ ------ -------- ------ ---------- ----------- ------------- -------------
(in thousands, except share data)
Balance at June 30, 1998.. -- $ -- 44,800 $ -- $ 34,780 $ (2,822) $ -- $ 31,958
Non-cash stock
compensation........... -- -- -- -- 5,046 -- -- 5,046
Net loss................. -- -- -- -- -- (6,421) -- (6,421)
------ ------ ------- ------ -------- ------- ------- --------
Balance at June 30, 1999.. -- -- 44,800 -- 39,826 (9,243) -- 30,583
Issuance of Common
Stock.................. -- -- 139,154 2 236,724 -- -- 236,726
Payable-In-Kind
Preferred Stock
dividends.............. -- -- -- -- (663) -- -- (663)
Net loss................. -- -- -- -- -- (1,449) -- (1,449)
------ ------ ------- ------ -------- ------- ------- --------
Balance at June 30, 2000.. -- -- 183,954 2 275,887 (10,692) -- 265,197
Issuance of common
stock.................. -- -- 19,340 -- 32,901 -- -- 32,901
Payable-In-kind
Preferred Stock
dividends.............. -- -- -- -- (1,657) -- -- (1,657)
Comprehensive income:
Cumulative effect of
change in accounting
principle -- fair
value of interest rate
collar................. -- -- -- -- -- -- (164) (164)
Net change in fair
value of
interest rate
collar............... -- -- -- -- -- -- (1,590) (1,590)
Amortization of
transition
adjustment........... -- -- -- -- -- -- 100 100
Net income............... -- -- -- -- -- 10,160 -- 10,160
------ ------ ------- ------ -------- ------- ------- --------
Comprehensive income...... -- -- -- -- -- -- -- 8,506
------ ------ ------- ------ -------- ------- ------- --------
Balance at June 30, 2001.. -- $ -- 203,294 $ 2 $307,131 $ (532) $(1,654) $304,947
====== ====== ======= ====== ======== ======= ======= ========
See accompanying notes.
F-21
VANGUARD HEALTH SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended June 30,
--------------------------------
1999 2000 2001
------ ------ ------
(in thousands)
Operating activities
Net income (loss)......................................................................... $ (6,421) $ (1,449) $ 10,160
Adjustments to reconcile net income (loss) to net cash (used in) provided by
operating activities:
Depreciation and amortization.......................................................... 3,916 11,793 23,799
Provision for doubtful accounts........................................................ 17,293 33,138 56,846
Amortization of loan costs............................................................. 250 444 863
Extraordinary loss on extinguishment of debt........................................... -- 1,149 --
Loss on disposal of assets............................................................. -- -- 584
Non-cash stock compensation ........................................................... 5,046 -- --
Deferred income taxes ................................................................. (285) (1,009) (909)
Interest expense on interest rate collar agreement..................................... -- -- 114
Changes in operating assets and liabilities, net of effects of acquisitions:
Accounts receivable................................................................ (29,322) (51,946) (68,555)
Establishment of accounts receivable of recent acquisitions........................ -- (3,653) (7,236)
Supplies........................................................................... (50) (86) (474)
Prepaid expense and other current assets........................................... (1,951) (3,917) 1,259
Income tax receivable ............................................................. (570) 570 --
Accounts payable................................................................... (106) 15,990 8,528
Income tax payable................................................................. -- 498 290
Accrued liabilities and other long-term liabilities................................ 2,484 22,997 (18,607)
--------- --------- --------
Net cash (used in) provided by operating activities....................................... (9,716) 24,519 6,662
Investing activities
Acquisitions.............................................................................. (3,376) (325,484) (10,640)
Net purchases of equipment................................................................ (1,864) (14,289) (26,566)
Other..................................................................................... 174 3,867 (872)
--------- --------- --------
Net cash used in investing activities..................................................... (5,066) (335,906) (38,078)
Financing activities
Proceeds from issuance of common stock ................................................... -- 236,726 32,901
Proceeds from long-term debt.............................................................. 18,000 165,500 --
Payment of long-term debt................................................................. (9,275) (69,835) (5,859)
Receipt of restricted cash ............................................................... 4,000 -- --
Payment of loan costs..................................................................... -- (4,546) (359)
--------- --------- --------
Net cash provided by financing activities................................................. 12,725 327,845 26,683
--------- --------- --------
Increase (decrease) in cash and cash equivalents.......................................... (2,057) 16,458 (4,733)
Cash and cash equivalents at beginning of year............................................ 2,411 354 16,812
--------- --------- --------
Cash and cash equivalents at end of year.................................................. $ 354 $ 16,812 $ 12,079
========= ========= ========
F-22
VANGUARD HEALTH SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Years ended June 30,
--------------------------------
1999 2000 2001
------ ------ ------
(in thousands)
Supplemental cash flow information:
Interest paid $ 3,919 $ 7,414 $13,681
======= ======== =======
Income taxes paid....................................................................... $ 855 $ 60 $ 212
======= ======== =======
Supplemental noncash activities:
Payable-In-Kind Preferred Stock dividends............................................... $ -- $ 663 $ 1,657
======= ======== =======
Acquisitions:
Cash paid, net of cash acquired......................................................... $ 3,376 $325,484 $10,640
Payable-In-Kind Preferred Stock Issued.................................................. -- 20,000 --
------- ------- -------
3,376 345,484 10,640
Fair value of assets acquired........................................................... 628 387,848 38,465
Liabilities assumed..................................................................... 152 61,364 59,018
------- ------- -------
Net assets acquired..................................................................... 476 326,484 (20,553)
------- ------- -------
Cash paid and Payable-In-Kind Preferred Stock issued in excess of net assets acquired... 2,900 19,000 31,193
Reclass of previous investment to excess of purchase price over net assets acquired..... 3,974 -- --
------- -------- -------
Excess of purchase price over net assets acquired........................................ $ 6,874 $ 19,000 $31,193
======= ======== =======
Liabilities assumed in the fiscal 2000 and 2001 acquisitions include capital
lease obligations of $1,434 and $13,657, respectively.
See accompanying notes.
F-23
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2001
1. Basis of Presentation and Summary of Significant Accounting Policies
Organization
Vanguard Health Systems, Inc. (the "Company"), a Delaware corporation, was
incorporated on July 1, 1997. As of June 30, 2001, the Company owned and
managed eight acute care hospitals with 1,676 beds and related outpatient
service locations complementary to the hospitals providing health care services
to the Orange County, California; Chicago, Illinois; and Phoenix, Arizona
markets. The Company also owns managed health plans in Chicago, Illinois and
Phoenix, Arizona.
Basis of Presentation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned and majority-owned subsidiaries. All material
intercompany accounts and transactions have been eliminated. As none of the
Company's common shares are publicly held, no earnings per share information
has been presented in the accompanying financial statements.
Restatement of Prior Periods
The Company's consolidated financial statements have been restated
effective June 30, 1998 to reflect non-cash stock compensation expense
associated with 695 stock options issued to an officer under the Initial Option
Plan effective June 1, 1998 (see Note 11). In addition to the stock options, the
Company agreed to grant a cash bonus to reimburse the officer for the taxes
payable upon exercise of the options. Consistent with other grants under the
Initial Option Plan, these options were issued at an exercise price below the
fair value of the Company's stock on the date of grant. Previously recorded
amounts for non-cash stock compensation and salaries and benefits excluded
compensation expense for the 695 options and related bonus.
The effect of the restatement, including an estimate of the cash bonus
payable upon exercise of the stock options, is as follows:
As Previously
Reported As Restated
------------- ---------------
(in thousands)
As of June 30, 1998:
Statement of Stockholders' Equity:
Additional paid-in capital.................. $34,714 $34,780
Retained deficit............................ (2,727) (2,822)
As of and for the year ended June 30, 1999:
Statement of Stockholders' Equity:
Additional paid-in capital.................. 38,762 39,826
Retained deficit............................ (7,834) (9,243)
Statement of Operations:
Salaries and benefits....................... 38,971 39,287
Non-cash stock compensation................. 4,048 5,046
Net loss.................................... (5,107) (6,421)
F-24
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As Previously
Reported As Restated
------------- ------------
(in thousands)
As of June 30, 2000:
Statement of Stockholders' Equity:
Additional paid-in capital.................... 274,823 275,887
Retained deficit.............................. (9,283) (10,692)
Balance Sheet:
Accrued expenses and other current liabilities 72,344 72,689
As of June 30, 2001:
Statement of Stockholders' Equity:
Additional paid-in capital.................... 306,067 307,131
Retained earnings (deficit)................... 877 (532)
Balance Sheet:
Accrued expenses and other current liabilities 97,666 98,011
Recently Issued Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities", as amended by SFAS Nos. 137 and
138, which the Company adopted effective July 1, 2000. This standard requires
the Company to recognize all derivatives on the balance sheet at fair value.
The classification of gains and losses resulting from changes in the fair
values of derivatives is dependent on the intended use of the derivative and
its resulting designation. Adjustments to reflect changes in fair values of
derivatives that are not considered "highly effective hedges" are reflected in
earnings. Adjustments to reflect changes in fair values of derivatives that are
considered highly effective hedges are either reflected in earnings and largely
offset by corresponding adjustments related to the fair values of the hedged
items, or reflected in comprehensive earnings until the hedged transaction
matures and the entire transaction is recognized in earnings. The Company's
interest rate collar agreement is a cash flow hedge which hedges the
variability in expected cash flows from a portion of its floating rate
liabilities. The Company believes that its hedge is highly effective with
changes in effectiveness expected to be reported in other comprehensive income.
Changes in any ineffectiveness will be reported through earnings. The adoption
of this new FASB standard on July 1, 2000 resulted in a cumulative effect of an
accounting change, net of tax, of approximately $164,000 recognized as other
comprehensive loss.
In March 2000, the Financial Accounting Standards Board issued Financial
Accounting Standards Board Interpretation No. 44 "Accounting for Certain
Transactions involving Stock Compensation--an interpretation of APB Opinion No.
25" ("FIN 44"), which became effective July 1, 2000 covering certain
transactions occurring after December 15, 1998. FIN 44 clarifies the
application of APB Opinion No. 25 relating to the definition of an employee,
criteria for determining whether a plan qualifies as a noncompensatory plan,
accounting consequences of various modifications to the terms of a previously
fixed stock option or award and the accounting for an exchange of stock
compensation awards in a business combination. The application of FIN 44 did
not have any effect on the Company's results of operations or financial
position.
During July 2001, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 141, "Business Combinations" and No. 142, "Goodwill and Other
Intangible Assets." SFAS 141 is effective for transactions completed subsequent
to June 30, 2001 and SFAS 142 is effective for years beginning after December
15, 2001. The Company has elected to adopt the provisions of SFAS 142 at July
1, 2001 under the early adoption provisions. SFAS 141 requires that all
business combinations be accounted for under the purchase method of accounting.
Under the provisions of SFAS
F-25
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
142, goodwill will no longer be amortized but will be subject to annual
impairment tests. Other intangible assets will be amortized over their useful
lives. The Company will apply the new rules on accounting for goodwill and
other intangible assets beginning in the first quarter of fiscal year 2002.
Application of the nonamortization provisions of SFAS 142 is expected to result
in an increase in income before income taxes of approximately $5,064,000 per
year based on the current allocation of intangible costs. During 2002, the
Company will perform the first of the required impairment tests of goodwill and
indefinite lived intangible assets as of July 1, 2001 and does not expect a
material impact on the earnings and financial position of the Company.
Reclassifications
Certain reclassifications have been made to the prior year financial
statements to conform to the 2001 presentation.
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of 90
days or less when purchased to be cash equivalents. The Company maintains its
cash and cash equivalent balances primarily with one high credit quality
financial institution. The Company manages its credit exposure by placing its
investments in high quality securities and by periodically evaluating the
relative credit standing of the financial institution.
Accounts Receivable
The Company's primary concentration of credit risk is patient accounts
receivable, which consists of amounts owed by various governmental agencies,
insurance companies and private patients. The Company manages the receivables
by regularly reviewing its accounts and contracts and by providing appropriate
allowances for uncollectible amounts. Medicare programs comprised approximately
13%, 21% and 14% and Medicaid programs comprised approximately 24%, 18% and 11%
at June 30, 1999, 2000 and 2001, respectively, of net patient receivables.
Remaining receivables relate primarily to various commercial insurance carriers
and HMO/PPO programs. Concentration of credit risk from other payers is limited
by the number of patients and payers.
Supplies
Supply inventory is stated at the lower of cost (first-in, first-out) or
market.
Property, Plant and Equipment
Property, plant and equipment are stated at cost. Routine maintenance and
repairs are charged to expense as incurred. Expenditures that increase values,
change capacities or extend useful lives are capitalized. Depreciation is
computed by the straight-line method over the estimated useful lives of the
assets, which approximate 4 to 40 years.
Depreciation expense was approximately $1,920,000, $8,790,000 and
$18,516,000 for the years ended June 30, 1999, 2000 and 2001, respectively.
Long-Lived Assets
Excess of Purchase Price Over Net Assets Acquired
Costs in excess of the fair value of identifiable net assets of acquired
entities are amortized using the straight-line method over a period ranging
from 3 to 40 years. The amounts reported of approximately $45,267,000 and
$74,233,000 at June 30, 2000 and 2001, respectively, are net of accumulated
amortization of approximately $1,835,000 and
F-26
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
$4,067,000, respectively. Amortization expense was $679,000, $966,000, and
$2,364,000 at June 30, 1999, 2000, and 2001, respectively.
Unamortized Loan Costs
Loan costs which are deferred and amortized over the term of related debt
are included in intangible assets on the accompanying consolidated balance
sheets. The amounts reported of approximately $3,932,000 and $3,345,000 at June
30, 2000 and 2001, respectively, are net of accumulated amortization of
approximately $253,000 and $1,116,000, respectively. Amortization expense was
$250,000, $440,000, and $863,000 at June 30, 1999, 2000, and 2001,
respectively. This expense is included in interest expense in the accompanying
consolidated statement of operations.
Other Intangibles
Based on independent valuations, a portion of the costs of acquired
entities which were allocated to certain identifiable intangible assets,
including a certificate of need, medical records and assembled work force, are
included in intangible assets on the accompanying Consolidated Balance Sheets.
The amounts reported of approximately $27,507,000 and $25,036,000 at June 30,
2000 and 2001, respectively, which are being amortized using the straight-line
method over a period ranging from 5 to 40 years, are net of accumulated
amortization of approximately $3,340,000 and $6,385,000, respectively.
Amortization expense was $1,303,000, $2,037,000, and $2,919,000 at June 30,
1999, 2000, and 2001, respectively.
Other
When events, circumstances, and operating results indicate that the
carrying values of certain long-lived assets and the related identifiable
intangible assets might be impaired, the Company would assess whether the
carrying value of the assets will be recovered through undiscounted future cash
flows expected to be generated from the use of the assets and their eventual
disposition. If the assessment indicated that the recorded cost would not be
recoverable, such cost amounts would be reduced to estimated fair value. As of
June 30, 2001, in the opinion of management, there was no such impairment. The
weighted average life for all intangible assets is 13 years.
Risk Management
General and Professional Liability
At June 30, 2001, the general and professional risks of the Company were
self-insured up to $1,000,000 on a per-occurrence basis and up to $13,200,000
on an aggregate-per-claim basis. For losses above the self-insurance limits,
the Company maintains insurance from unrelated commercial carriers on an
occurrence basis for general liability and a claims-made basis for professional
liability up to $100,000,000 per occurrence and in the aggregate. Liabilities
for self-insured general and professional liability risks for both asserted and
unasserted claims, are estimated based upon historical claims payment data,
industry trends and current incident logs. Although ultimate settlement of
these liabilities may vary from such estimates, management believes the amount
classified within Other liabilities on the accompanying Consolidated Balance
Sheets of approximately $3,413,000 and $4,788,000 at June 30, 2000 and 2001,
respectively, is adequate. In conjunction with its acquisitions, the Company
generally requires the sellers to purchase tail coverage for claims incurred
prior to the date of acquisition.
F-27
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Workers' Compensation
The Company is self-insured for workers' compensation claims up to
$250,000 per occurrence. The reserve for workers' compensation liability risks
is estimated using historical and current claims payment and utilization data,
including industry-specific trend analysis. The reserve is classified within
Other liabilities on the accompanying Consolidated Balance Sheets. The reserve
was approximately $914,000 and $1,704,000 at June 30, 2000 and 2001,
respectively.
Employees Health Self Insurance
The Company maintains self-insured medical and dental plans for employees.
Claims are accrued under these plans as the incidents that give rise to them
occur. Unpaid claim accruals are based on the estimated ultimate cost of
settlement, including claim settlement expenses, in accordance with an average
lag time and past experience. The reserve of approximately $2,502,000 and
$2,948,000 at June 30, 2000 and 2001, respectively, for self-insured medical
and dental plans is included in Accrued expenses and other current liabilities
on the accompanying Consolidated Balance Sheets.
Medical Claims Payable
Monthly capitation payments made by the Company's affiliates to primary
care physicians and other health care providers are expensed in the month
services are contracted to be performed. Claims expense for non-capitated
arrangements is accrued as services are rendered by hospitals, physicians, and
other health care providers during the year.
Medical claims payable include claims received but not paid and an
estimate of claims incurred but not reported. Incurred but not reported claims
are estimated using historical claims payment data and current inpatient
utilization trends based upon preauthorization logs. Medical claims payable of
approximately $3,744,000 and $25,394,000 at June 30, 2000 and 2001,
respectively, are included in Accrued expenses and other current liabilities in
the accompanying Consolidated Balance Sheets.
Revenues
Patient Service Revenue
The Company has agreements with third-party payers that provide for
payments to the Company at amounts different from its established rates. A
summary of the payment arrangements with major third-party payers follows:
o Medicare - Inpatient acute care services rendered to Medicare program
beneficiaries are paid at prospectively determined rates per
diagnosis. These rates vary according to a patient classification
system that is based on clinical, diagnostic and other factors.
Inpatient nonacute services, certain outpatient services and medical
education costs related to Medicare beneficiaries are paid based on a
cost reimbursement methodology subject to various costs limits. The
Company is reimbursed for cost reimbursable items at a tentative rate
with final settlement determined after submission of annual cost
reports by the Company and audits thereof by the Medicare fiscal
intermediary. Outpatient and home health services related to Medicare
beneficiaries provided after August 1, 2000 and October 1, 2000,
respectively, are reimbursed based on prospectively determined rates.
The Company's classification of patients under the Medicare program
and the appropriateness of their admission are subject to an
independent review. The Company derived approximately 16%, 22% and
15% of patient revenue from services provided under the Medicare
program for the years ended June 30, 1999, 2000 and 2001,
respectively.
F-28
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
o Medicaid - Inpatient services rendered to beneficiaries under the
Medi-Cal program (California's Medicaid program) are reimbursed
either under contracted rates or a cost reimbursement methodology at
a tentative rate with final settlement determined after submission of
annual cost reports by the Company and audits thereof by Medi-Cal.
The Company owns three hospitals in California. Inpatient and
outpatient services rendered to Medicaid program beneficiaries in the
other states in which the Company owns hospitals are reimbursed under
contracted rates which generally do not have retroactive cost report
settlement procedures. The Company derived approximately 26%, 6% and
5% of patient revenue from services provided under the Medicaid
program for the years ended June 30, 1999, 2000 and 2001,
respectively.
o Other - The Company also has entered into payment agreements with
certain commercial insurance carriers, health maintenance
organizations and preferred provider organizations. The basis for
payment to the Company under these agreements includes prospectively
determined rates per discharge, discounts from established charges,
prospectively determined daily rates and fixed monthly premiums based
upon negotiated per member rates (generally referred to as capitation
arrangements). Capitation premiums received by the Company's
hospitals are recognized as revenues in the month that members are
entitled to healthcare services regardless of services actually
provided. The Company's hospitals received capitation premiums of
$7,690,000 and $30,629,000 for the years ended June 30, 2000 and
2001, respectively, which have been included in patient service
revenues on the accompanying consolidated Statements of Operations.
Other than Medicare and Medicaid, the Company has no payers which
represent more than 10% of aggregate net patient revenue.
Patient service revenues are recorded at estimated amounts due from
patients and third-party payers for the healthcare services provided in the
period the services are provided. These estimates are based upon calculations
made according to the terms of the agreements noted above under which the
Company is paid based on a percentage of established charges, the cost of
providing services, predetermined rates per diagnosis, fixed per diem rates or
discounts from established charges.
Final determination of amounts earned under the Medicare and Medi-Cal
programs often occur in subsequent years because of audits by the program,
rights of appeal and the application of numerous technical provisions.
Differences between original estimates and subsequent revisions (including
final settlements) are included in the Statement of Operations in the period in
which the revisions are made. Management believes that adequate provisions have
been made for adjustments that may result from final determination of amounts
earned under the Medicare and Medi-Cal programs. As part of the acquisitions,
the Company did not assume any of the settlements under these programs
estimated by the sellers through the dates of purchase.
Revenues are net of contractual adjustments and policy discounts of
approximately $132,726,000, $556,346,000 and $1,191,841,000 for the years ended
June 30, 1999, 2000 and 2001, respectively.
Premium Revenue
The Company's health plans have agreements with the Arizona Health Care
Cost Containment System (the "Arizona Health Care System") and various Health
Maintenance Organizations (HMOs) to contract to provide medical services to
subscribing participants. Under these agreements, the Company's health plans
receive monthly payments based on the number of each HMO's participants and, in
the case of the contract with the Arizona Health Care System, the number of
enrollees in its Medicaid health plan affiliate, Phoenix Health Plan. The
Company's health plans receive these monthly payments and recognize them as
revenue in the month that members are entitled to healthcare services.
F-29
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock-Based Compensation
The Company has elected to record stock options in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," (APB 25) and related interpretations thereof and, accordingly,
recognizes no compensation expense for options granted when the exercise price
equals, or is greater than, the market price of the underlying stock on the
date of grant.
Income Taxes
Income taxes are computed based on the liability method of accounting
whereby deferred tax assets and liabilities are determined based on differences
between financial reporting and tax bases of assets and liabilities and are
measured using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
Fair Value of Financial Instruments
Cash and Cash Equivalents
The carrying amounts reported for cash and cash equivalents approximate
fair value because of the short-term maturity of these instruments.
Accounts Receivable and Accounts Payable
The carrying amounts reported for accounts receivable and accounts payable
approximate fair value because of the short-term maturity of these instruments.
Long-Term Debt
Based upon the borrowing rates currently available to the Company, the
carrying amounts reported for long-term debt approximate fair value.
Interest Rate Collar Agreement
The Company utilizes, on a limited basis, derivative financial instruments
in the form of an interest rate collar to manage its exposure to interest
rates. An interest rate collar is a combination of an interest rate cap and an
interest rate floor. The collar in place allows the Company to manage a portion
of its variable rate borrowings to an acceptable, predetermined range. Under
the collar, no payments are required to be made by the Company or paid to the
Company unless the prevailing market rate (based on the London Interbank
Offered Rate) drops below the floor or exceeds the ceiling. Any payment made or
received by the Company in connection with the settlement of a collar is
reflected as an adjustment to interest expense in the period in which it is
settled. Effective July 1, 2000, the Company began to account for its
derivative financial instruments in accordance with Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and
Hedging Activities".
F-30
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Acquisitions
2001 Acquisitions
During fiscal 2001, the Company completed the following acquisitions:
Date Entity Location
- --------------- --------------------------------- -------------
July 2000 Trinity MedCare, Inc. Nashville, TN
September 2000 Pleasant Properties, Inc. Phoenix, AZ
May 2001 PMH Health Resources, Inc. Phoenix, AZ
June 2001 Touchstone Imaging of Arizona, LLC Phoenix, AZ
The Company acquired certain net assets of the aforementioned entities,
which include a hospital, health plan, and imaging centers for a total purchase
price of approximately $86,851,000, comprised of cash of $27,833,000 and the
assumption of certain liabilities of $59,018,000. The acquisitions were
financed with the proceeds from equity issuances to various affiliates of
Morgan Stanley Capital Partners ("Capital Partners") and certain members of
management.
The following table summarizes the allocation of the aggregate purchase
price of the aforementioned acquisitions (in thousands):
PMH Health Touchstone
Resources Imaging Other Total
---------- ---------- ------- --------
Fair value of assets acquired:
Cash................................................. $16,650 $ - $ 543 $17,193
Other current assets................................. 3,129 141 162 3,432
Property, plant and equipment........................ 18,780 10,210 4,242 33,232
Other assets......................................... 1,800 - 1 1,801
Excess of purchase price over net assets acquired.... 16,130 14,458 605 31,193
------- ------- ------ -------
56,489 24,809 5,553 86,851
Liabilities assumed.................................. 45,559 10,166 3,293 59,018
------- ------- ------ -------
Cash Paid............................................ $10,930 $14,643 $2,260 $27,833
======= ======= ====== =======
The 2001 acquisitions were accounted for using the purchase method of
accounting. Purchase price adjustments have not been finalized as of June 30,
2001, but are not expected by management to be material. The operating results
of the acquired entities have been included in the accompanying Consolidated
Statements of Operations from the respective dates of acquisition. Direct costs
of acquisition capitalized as a component of the purchase price primarily
include legal services, professional and accounting services, travel costs, and
closing costs for the transactions.
2000 Acquisitions
During fiscal 2000, the Company completed the following acquisitions:
F-31
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Date Entity Location
- ------------------ ----------------------------------------------- ---------------------
September 1999 West Anaheim Medical Center Anaheim, CA
September 1999 Huntington Beach Medical Center Huntington Beach, CA
February 2000 MacNeal Health Services Berwyn, IL
April 2000 La Palma Intercommunity Hospital LaPalma, CA
June 2000 Arrowhead Community Hospital and Medical Center Glendale, AZ
June 2000 Phoenix Baptist Hospital and Medical Center Phoenix, AZ
The Company acquired certain net assets of the aforementioned entities,
for a total purchase price of approximately $406,848,000, comprised of cash of
approximately $325,484,000, 20,000 shares of the Company's Payable-In-Kind
Preferred Stock valued at $20,000,000 and assumed liabilities of $61,364,000.
The acquisitions were financed with the proceeds from the 2000 Credit Agreement
and proceeds from equity issuances to various affiliates of Capital Partners
and certain members of management.
The following table summarizes the allocation of the aggregate purchase
price of the aforementioned acquisitions (in thousands):
West
Anaheim and Phoenix
Huntington Baptist and
Beach MacNeal La Palma Arrowhead Total
----------- ------- --------- ----------- --------
Fair value of assets acquired:
Accounts receivable........................... $14,529 $31,022 $ - $24,771 $ 70,322
Other current assets.......................... 1,896 6,579 743 5,620 14,838
Property, plant and equipment................. 36,892 153,300 8,201 73,290 271,683
Other assets.................................. - 6,654 - - 6,654
Excess of purchase price over net assets
acquired.................................... - 19,000 - - 19,000
Other intangibles............................. - 24,351 - - 24,351
------- -------- --------- ------- --------
53,317 240,906 8,944 103,681 406,848
Liabilities assumed................................ 7,774 35,577 1,552 16,461 61,364
------- -------- --------- ------- --------
Net assets acquired................................ 45,543 205,329 7,392 87,220 345,484
Payable-in-kind Preferred Stock issued............. - 20,000 - - 20,000
------- -------- --------- ------- --------
Net cash paid...................................... $45,543 $185,329 $ 7,392 $87,220 $325,484
======= ======== ========= ======= ========
The 2000 acquisitions were accounted for using the purchase method of
accounting. The operating results of the acquired entities have been included
in the accompanying Consolidated Statements of Operations from the respective
dates of acquisition. Direct costs of acquisitions capitalized as a component
of the purchase price primarily include legal services, professional and
accounting services, travel costs, and closing costs for the transactions.
1999 Acquisitions
In fiscal 1999, the Company and Samaritan Health System ("Seller")
received a distribution of 50% of the assets of a 24-hour free standing
outpatient emergency diagnostic clinic ("the Clinic") from West Valley Health
Center LLC (the "Health Center"), for which the Company had an investment in a
joint venture until it was dissolved in August 1999. Concurrent with the
distribution received by the Company and the Seller, the Company acquired the
Seller's 50% interest in the Clinic for approximately $3,376,000.
The following table summarizes the allocation of the aggregate purchase
price (thousands):
F-32
Fair value of assets acquired:
Excess of purchase price over net assets acquired...... $6,874
Supplies............................................... 28
Property, plant and equipment.......................... 600
------
7,502
Liabilities assumed:
Employee benefits...................................... 152
Less previous investment in Clinic....................... 3,974
------
Net cash paid............................................ $3,376
======
Other Information
Pro Forma Results
The following represents the unaudited pro forma results of consolidated
operations as if the aforementioned acquisitions had occurred at the beginning
of the immediate preceding period, after giving effect to certain adjustments,
including the depreciation and amortization of the assets acquired based upon
their fair values, changes in net interest expense resulting from changes in
consolidated debt, and changes in allocated overhead expenses (in thousands):
1999 2000 2001
-------- -------- --------
Revenues........................... $642,434 $815,805 $802,108
Income (loss) before income taxes.. 337 (48,214) 7,260
The pro forma information given above does not purport to be indicative of
what the Company's results of operations would have been if the acquisitions
had in fact occurred at the beginning of the periods presented, and is not
intended to be a projection of the impact on future results or trends.
3. Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets in the accompanying Consolidated
Balance Sheets consist of the following at June 30 (in thousands):
2000 2001
-------- --------
Other receivables............. $ 6,203 $ 8,888
Prepaid expenses.............. 6,191 4,571
Other......................... 902 621
------- -------
$13,296 $14,080
======= =======
4. Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities in the accompanying
Consolidated Balance Sheets consist of the following at June 30 (in thousands):
F-33
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2000 2001
-------- --------
Salaries and benefits............................. $23,086 $21,554
Interest.......................................... 1,670 5,480
Due to third-party payers......................... 14,843 22,806
Property taxes.................................... 5,678 7,461
Accrual for self-insured employee health claims... 2,502 2,948
Medical claims payable............................ 3,744 25,394
Other............................................. 21,166 12,368
------- -------
$72,689 $98,011
======= =======
5. Long-Term Debt
A summary of the Company's long-term debt at June 30 follows (in
thousands):
2000 2001
-------- --------
Term loans payable................................ $141,576 $145,011
Term loans payable to a related party............. 10,349 4,359
Capital leases.................................... 1,399 14,074
-------- --------
153,324 163,444
Less: current maturities.......................... (5,485) (10,332)
-------- --------
$147,839 $153,112
======== ========
2000 Credit Agreement
On February 1, 2000, the Company entered into a credit agreement ("the
2000 Credit Agreement") with various lenders and Morgan Stanley Senior Funding,
Inc., as administrative agent, to fund an acquisition and to repay amounts
outstanding under the 1998 Credit Agreement. The Company initially borrowed
$133,000,000 under two term loans and has up to $35,000,000 available under
revolving loans, less any amounts available under letters of credit. As of June
30, 2000 and 2001, no amounts were outstanding under the revolving loans and
approximately $789,000 and $2,354,000 were outstanding in a letter of credit,
respectively.
Pursuant to an amendment to the 2000 Credit Agreement dated June 1, 2000,
the Company borrowed an additional $20,000,000 under the term loans to fund a
portion of the purchase price of acquisitions.
Interest for each of the two term loans and the revolving loans accrues,
at the option of the Company, at either the applicable base rate or Eurodollar
rate, as defined in the 2000 Credit Agreement, plus the applicable margin (a
range of 1.75% to 4.25% dependent upon the type of the loan and the current
consolidated leverage ratio). Interest is payable quarterly in arrears for base
rate loans or at the end of the applicable interest period but not to exceed
three months for Eurodollar loans. The interest rate on the outstanding
principal balances of the term loans approximated 10.8% and 8.5% as of June 30,
2000 and 2001, respectively. The Company is subject to commitment fees on the
unused portion of the revolving loan equal to .5% per annum.
In order to protect the Company from interest rate volatility, the Company
entered into a three-year interest rate collar agreement ("the derivative")
effective May 3, 2000 with a large international financial institution for a
notional amount of $67,000,000. The agreement qualifies as a cash flow hedge
under SFAS 133 and expires on May 3, 2003. The agreement has a 90-day
settlement period at which time the Company is required to make payments to the
hedging
F-34
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
financial institution for instances in which the 90-day LIBOR rate drops below
the designated rate floor of 6.865% or is entitled to receive payments from the
hedging financial institution for instances in which the 90-day LIBOR rate
exceeds the designated rate ceiling of 8.0%. In accordance with the provisions
of SFAS 133, on July 1, 2000, the Company recorded a liability for the
derivative of approximately $274,000, which represents the fair market value of
the derivative as of the date of adoption of SFAS 133. As of June 30, 2001 the
market value of the derivative was a liability of $2,946,000 which is included
in Accrued expenses and other current liabilities on the accompanying
Consolidated Balance Sheets.
In July 2001, the Company terminated its interest rate collar agreement
with a cash payment of approximately $3,738,000. As a result, the accumulated
other comprehensive loss was reclassified into earnings subsequent to June 30,
2001.
Mandatory repayments under the $33,000,000 term loan and the $120,000,000
term loan were due in quarterly installments beginning April 30, 2000 with any
amounts then outstanding due and payable on February 2005 and February 2006,
respectively. Any amounts outstanding under the revolving loans mature in
February 2005. Subject to certain terms and conditions, the Company may prepay
at any time all or a part of the amounts outstanding under the 2000 Credit
Agreement without penalty.
In connection with the issuance of 9.75% Senior Subordinated Notes on July
2001, the Company repaid amounts outstanding under the 2000 Credit Agreement
and terminated the interest rate collar agreement.
The 2000 Credit Agreement contained certain financial covenants which
included (i) limitations on additional debt, (ii) limitations on sales of
assets, mergers, consolidations and acquisitions, (iii) limitations on capital
expenditures and certain investments, and (iv) restrictions on payments of
dividends. In addition, the 2000 Credit Agreement contained various other
financial covenants that included requirements for the Company to maintain a
minimum interest coverage ratio and maximum leverage ratio. At June 30, 2001,
the Company was in compliance with all such covenants of the 2000 Credit
Agreement.
The 2000 Credit Agreement is collateralized by the assignment of all
rights, title and interest in the Common Stock, or other ownership interests,
of the Company's subsidiaries and joint venture arrangements and by mortgages
and security interests on all of the Company's real and personal property
assets.
Loan Costs
The Company incurred loan costs of approximately $4,546,000 in fiscal 2000
of which approximately $361,000 related to certain amendments to the 1998
Credit Agreement and approximately $4,185,000 related to the 2000 Credit
Agreement. The Company incurred additional loan costs of approximately $275,000
in fiscal 2001 related to the 2000 Credit Agreement. Upon the repayment of the
1998 Credit Agreement in fiscal 2000, the Company wrote off all remaining
unamortized loan costs associated with the 1998 Credit Agreement of
approximately $1,149,000. The loss is classified as extraordinary loss on
extinguishment of debt in the accompanying Consolidated Statements of
Operations.
F-35
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Future Maturities
Future maturities of long-term debt, excluding capital lease obligations,
are as follows (in thousands):
2002................................... $ 6,776
2003................................... 8,327
2004................................... 9,988
2005................................... 36,974
2006................................... 85,687
Thereafter............................. 1,618
--------
$149,370
========
Other Information
Presented below is summarized condensed consolidating financial information
for the Company and its subsidiaries as of and for the years ended June 30,
2000 and 2001 segregating the parent company, the combined wholly-owned
Subsidiary Guarantors, the Combined Non-Guarantors and consolidating
adjustments.
The condensed consolidating financial information for the Company and its
subsidiaries as of and for the year ended June 30, 1999 is not presented as the
Company's only operations as of June 30, 1999 were in the wholly-owned
Subsidiary Guarantor owning Maryvale Hospital Medical Center.
F-36
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Vanguard Health Systems, Inc.
Condensed Consolidating Balance Sheet
June 30, 2000
Wholly-Owned Combined
Guarantor Non- Consolidating Total
Parent Subsidiaries Guarantors Adjustments Consolidated
-------- ------------ ---------- ------------- ------------
(In thousands)
Assets
Current assets:
Cash and cash equivalents......... $ -- $ 16,618 $ 194 $ -- $ 16,812
Accounts receivable, net ......... -- 108,988 825 -- 109,813
Supplies.......................... -- 9,548 95 -- 9,643
Prepaid expenses and other current
assets.......................... -- 14,360 (1,064) -- 13,296
Deferred income taxes............. 1,294 -- -- 1,294
-------- -------- ------ --------- --------
Total current assets 1,294 149,514 50 -- 150,858
Property, plant and equipment:
Land and improvements............. -- 42,073 332 -- 42,405
Buildings and improvements........ -- 203,871 1,960 -- 205,831
Equipment......................... -- 76,036 2,449 -- 78,485
Construction in progress.......... -- 1,628 -- -- 1,628
-------- -------- ------ --------- --------
-- 323,608 4,741 -- 328,349
Accumulated depreciation.......... -- (6,678) (2,439) -- (9,117)
-------- -------- ------ --------- --------
Net property, plant and equipment. -- 316,930 2,302 -- 319,232
Investment in subsidiaries........ 290,954 -- -- (290,954) --
Cost in excess of net assets
acquired........................ -- 45,267 -- -- 45,267
Intangible assets, net............ -- 31,039 400 -- 31,439
Other assets...................... -- 3,110 -- -- 3,110
-------- -------- ------ --------- --------
Total assets...................... $292,248 $545,860 $2,752 $(290,954) $549,906
======== ======== ====== ========= ========
Liabilities and stockholders' equity
Current Liabilities:
Accounts payable.................. $ -- $ 32,462 $ 243 $ -- $32,705
Accrued expenses and other current
liabilities..................... -- 72,383 306 -- 72,689
Income tax payable................ 498 -- -- -- 498
Current maturities of long-term
debt............................ -- 5,485 -- -- 5,485
-------- -------- ------ --------- --------
Total current liabilities............... 498 110,330 549 -- 111,377
Other liabilities................. -- 4,830 -- -- 4,830
Long-term debt, less current
maturities...................... -- 147,839 -- -- 147,839
Intercompany...................... (3,636) 6,082 (2,446) -- --
Payable-in-kind Preferred Stock... 20,663 -- -- -- 20,663
Stockholders' equity.............. 274,723 276,779 4,649 (290,954) 265,197
-------- -------- ------ --------- --------
$292,248 $545,860 $2,752 $(290,954) $549,906
======== ======== ====== ========= ========
F-37
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Vanguard Health Systems, Inc.
Condensed Consolidating Balance Sheet
June 30, 2001
Wholly-Owned Combined
Guarantor Non- Consolidating Total
Parent Subsidiaries Guarantors Adjustments Consolidated
-------- ------------ ---------- ------------- ------------
(In thousands)
Assets
Current assets:
Cash and cash equivalents.......... $ -- $ 11,734 $ 345 $ -- $ 12,079
Accounts receivable, net........... -- 127,684 1,217 -- 128,901
Supplies........................... -- 11,256 107 -- 11,363
Prepaid expenses and other current
assets........................... -- 13,868 212 -- 14,080
Deferred income taxes.............. 1,259 1,179 -- -- 2,438
-------- -------- ------- --------- --------
Total current assets............... 1,259 165,721 1,881 -- 168,861
Property, plant and equipment:
Land and improvements.............. -- 49,996 1,090 -- 51,086
Buildings and improvements......... -- 222,410 5,287 -- 227,697
Equipment.......................... -- 102,461 1,315 -- 103,776
Construction in progress........... -- 8,594 18 -- 8,612
-------- -------- ------- --------- --------
-- 383,461 7,710 -- 391,171
Accumulated depreciation........... -- (25,378) (2,829) -- (28,207)
-------- -------- ------- --------- --------
Net property, plant and equipment.. -- 358,083 4,881 -- 362,964
Investment in subsidiaries......... 323,855 -- -- (323,855) --
Cost in excess of net assets
acquired......................... -- 74,233 -- -- 74,233
Intangible assets, net............. -- 28,077 304 -- 28,381
Other assets....................... -- 5,924 35 -- 5,959
-------- -------- ------- --------- --------
Total assets....................... $325,114 $632,038 $ 7,101 $(323,855) $640,398
======== ======== ======= ========= ========
Liabilities and stockholders' equity
Current Liabilities:
Accounts payable................... $ -- $ 41,337 $ 366 -- $ 41,703
Accrued expenses and other current
liabilities...................... 3 97,626 382 -- 98,011
Income tax payable................. 740 48 -- -- 788
Current maturities of long-term debt -- 10,097 235 -- 10,332
-------- -------- ------- --------- --------
Total current liabilities.......... 743 149,108 983 -- 150,834
Other liabilities.................. -- 9,185 -- -- 9,185
Long-term debt, less current
maturities....................... -- 150,239 2,873 -- 153,112
Intercompany....................... (3,473) 5,053 (1,580) -- --
Payable-in-kind Preferred Stock.... 22,320 -- -- -- 22,320
Stockholders' equity............... 305,524 318,453 4,825 (323,855) 304,947
-------- -------- ------- --------- --------
$325,114 $632,038 $ 7,101 $(323,855) $640,398
======== ======== ======= ========= ========
F-38
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Vanguard Health Systems, Inc.
Condensed Consolidating Statement of Operations
For the Year Ended June 30, 2000
Wholly-Owned Combined
Guarantor Non- Consolidating Total
Parent Subsidiaries Guarantors Adjustments Consolidated
-------- ------------ ---------- ------------- ------------
(In thousands)
Revenues
Patient service revenues........ $ -- $284,270 $ 4,616 $ -- $288,886
Premium revenues................ -- 15,808 -- -- 15,808
-------- -------- ------- --------- --------
Total revenues.................. -- 300,078 4,616 -- 304,694
Salaries and benefits............... -- 145,174 1,293 -- 146,467
Supplies............................ -- 39,681 817 -- 40,498
Medical claims expense.............. -- 7,356 -- -- 7,356
Purchased services.................. -- 23,461 157 -- 23,618
Provision for doubtful accounts..... -- 33,115 23 -- 33,138
Other operating expenses............ 7 25,737 520 -- 26,264
Rent and leases..................... -- 6,404 432 -- 6,836
Management fees..................... -- (35) 35 -- --
Depreciation and amortization....... -- 11,541 252 -- 11,793
Interest, net....................... -- 8,412 419 -- 8,831
Other............................... -- 74 -- -- 74
-------- -------- ------- --------- --------
7 300,920 3,948 -- 304,875
Income (loss) before income taxes
and extraordinary item........... (7) (842) 668 -- (181)
Income tax expense.................. 119 -- -- -- 119
Equity in earnings (loss) of
subsidiaries........................ (1,323) -- -- 1,323 --
-------- -------- ------- --------- --------
Net income (loss) before
extraordinary item............... (1,449) (842) 668 1,323 (300)
Extraordinary loss on
extinguishment of debt.............. -- (1,149) -- -- (1,149)
-------- -------- ------- --------- --------
Net income (loss)................... $ (1,449) $ (1,991) $ 668 $ 1,323 $ (1,449)
======== ======== ======= ========= ========
F-39
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Vanguard Health Systems, Inc.
Condensed Consolidating Statement of Operations
For the Year Ended June 30, 2001
Wholly-Owned Combined
Guarantor Non- Consolidating Total
Parent Subsidiaries Guarantors Adjustments Consolidated
-------- ------------ ---------- ------------- ------------
(In thousands)
Revenues
Patient service revenues......... $ -- $604,679 $ 8,021 $ -- $612,700
Premium revenues................. -- 55,063 -- -- 55,063
-------- -------- -------- --------- --------
Total revenues................... -- 659,742 8,021 -- 667,763
Salaries and benefits................ -- 321,826 1,791 -- 323,617
Supplies............................. -- 91,741 1,211 -- 92,952
Medical claims expense............... -- 30,784 -- -- 30,784
Purchased services................... -- 64,694 278 -- 64,972
Provision for doubtful accounts...... -- 56,745 101 -- 56,846
Other operating expenses............. 6 34,206 750 -- 34,962
Rent and leases...................... -- 11,701 532 -- 12,233
Management fees...................... -- (359) 359 -- --
Depreciation and amortization........ -- 23,380 419 -- 23,799
Interest, net........................ (13) 16,682 (111) -- 16,558
Other................................ - 369 -- -- 369
-------- -------- -------- --------- --------
(7) 651,769 5,330 -- 657,092
Income before income taxes.......... 7 7,973 2,691 -- 10,671
Income tax expense................... 451 60 -- -- 511
Equity in earnings of subsidiaries... 10,604 -- -- (10,604) --
-------- -------- -------- --------- --------
Net income........................... $ 10,160 $ 7,913 $ 2,691 $ (10,604) $ 10,160
======== ======== ======== ========= ========
F-40
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Vanguard Health Systems, Inc.
Condensed Consolidating Statement of Cash Flows
For the Year Ended June 30, 2000
Wholly-Owned Combined
Guarantor Non- Consolidating Total
Parent Subsidiaries Guarantors Adjustments Consolidated
-------- ------------ ---------- ------------- ------------
(In thousands)
Net income (loss).......................... $ (1,449) $ (1,991) $ 668 $ 1,323 $ (1,449)
Adjustments to reconcile net loss to net
Cash provided by operating activities:
Depreciation and amortization........ -- 11,541 252 -- 11,793
Provision for doubtful accounts...... -- 33,115 23 -- 33,138
Amortization of loan costs........... -- 444 -- -- 444
Extraordinary loss................... -- 1,149 -- -- 1,149
Deferred income taxes................ -- (1,009) -- -- (1,009)
Changes in operating assets and liabilities
Equity (loss) in earnings of
subsidiaries....................... 1,323 -- -- (1,323) --
Accounts receivable.................. -- (51,675) (271) -- (51,946)
Establishment of accounts
receivable of recent
acquisitions....................... -- (3,653) -- -- (3,653)
Supplies............................. -- (108) 22 -- (86)
Prepaid expenses and other current
assets............................. -- (5,035) 1,118 -- (3,917)
Income tax receivable................ -- 570 -- -- 570
Accounts payable..................... -- 15,954 36 -- 15,990
Income tax payable................... 119 379 -- -- 498
Accrued liabilities and other long-
term liabilities................... 465 22,623 (91) -- 22,997
-------- -------- ------- --------- --------
Net cash (used in) provided by operating
activities............................... 458 22,304 1,757 -- 24,519
Acquisitions............................... (257,232) (68,252) -- -- (325,484)
Purchases of equipment..................... -- (14,216) (73) -- (14,289)
Other...................................... 506 3,351 10 -- 3,867
-------- -------- ------- --------- --------
Net cash used in investing activities...... (256,726) (79,117) (63) -- (335,906)
Proceeds from issuance of common stock..... 256,726 (20,590) 590 -- 236,726
Proceeds from long-term debt............... -- 165,500 -- -- 165,500
Payment of long-term debt.................. -- (69,174) (661) -- (69,835)
Payment of loan costs...................... -- (4,546) -- -- (4,546)
Cash provided by (used in) intercompany.... (458) 2,353 (1,895) -- --
-------- -------- ------- --------- --------
Net cash provided by (used in) financing
activities............................... 256,268 73,543 (1,966) -- 327,845
Increase (decrease) in cash................ -- 16,730 (272) -- 16,458
Cash at beginning of year.................. -- (110) 464 -- 354
-------- -------- ------- --------- --------
Cash at end of year........................ $ -- $ 16,620 $ 192 $ -- $ 16,812
======== ======== ======= ========= ========
F-41
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Vanguard Health Systems, Inc.
Condensed Consolidating Statement of Cash Flows
For the Year Ended June 30, 2001
Wholly-Owned Combined
Guarantor Non- Consolidating Total
Parent Subsidiaries Guarantors Adjustments Consolidated
-------- ------------ ---------- ------------- ------------
(In thousands)
Net income (loss)........................... $ 10,160 $ 7,913 $ 2,691 $ (10,604) $ 10,160
Adjustments to reconcile net loss to net
cash provided by operating activities:
Depreciation and amortization......... -- 23,380 419 -- 23,799
Provision for doubtful accounts....... -- 56,745 101 -- 56,846
Amortization or deferred loan costs... -- 863 -- -- 863
Loss on disposal of asset............. -- 584 -- -- 584
Deferred income taxes................. (80) (829) -- -- (909)
Interest income from interest collar
agreement........................... -- 114 -- -- 114
Changes in operating assets and liabilities
Equity (loss) in earnings of
subsidiaries........................ (10,604) -- -- 10,604 --
Accounts receivable................... -- (68,063) (492) -- (68,555)
Establishment of accounts receivable
of recent acquisitions.............. -- (7,236) -- -- (7,236)
Supplies.............................. -- (461) (13) -- (474)
Prepaid expenses and other current
assets.............................. -- 2,535 (1,276) -- 1,259
Accounts payable...................... -- 8,405 123 -- 8,528
Income tax payable.................... 740 (450) -- -- 290
Accrued liabilities and other long-
term liabilities................... 393 (19,075) 75 -- (18,607)
-------- -------- ------- --------- --------
Net cash (used in) provided by operating
activities................................ 609 4,425 1,628 -- 6,662
Investing activities
Acquisitions................................ -- (10,640) -- -- (10,640)
Net purchases of equipment.................. -- (26,246) (320) -- (26,566)
Other....................................... -- (872) -- -- (872)
-------- -------- ------- --------- --------
Net cash used in investing activities....... -- (37,758) (320) -- (38,078)
Financing activities
Proceeds from issuance of common stock...... -- 32,901 -- -- 32,901
Payment of long-term debt................... -- (5,787) (72) -- (5,859)
Payment of loan costs....................... -- (359) -- -- (359)
Cash provided by (used in) intercompany..... (609) 1,694 (1,085) -- --
-------- -------- ------- --------- --------
Net cash provided by (used in) financing
activities.................................. (609) 28,443 (1,157) -- 26,683
-------- -------- ------- --------- --------
Change in cash.............................. -- (4,884) 151 -- (4,733)
Cash at the beginning of year............... -- 16,618 194 -- 16,812
-------- -------- ------- --------- --------
Cash at the end of year..................... $ -- $ 11,734 $ 345 $ -- $ 12,079
======== ======== ======= ========= ========
F-42
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. Income Taxes
Significant components of the provision for income taxes attributable to
continuing operations are as follows (in thousands):
1999 2000 2001
------ ------ ------
Current:
Federal............ $ 275 $1,003 $1,200
State.............. 10 125 220
----- ------ ------
Total current.......... 285 1,128 1,420
Deferred:
Federal............ (275) (1,003) (915)
State.............. (10) (6) 6
----- ------ ------
Total deferred......... (285) (1,009) (909)
----- ------ ------
$ -- $ 119 $ 511
===== ====== ======
The effective income tax rate differed from the federal statutory rate for
the years ended June 30, 1999, 2000 and 2001 as follows:
1999 2000 2001
------ ------ ------
Income tax expense (benefit) at federal statutory rate........... (35.0)% (35.0)% 35.0%
Income tax expense (benefit) at state statutory rate............. (6.0) 65.7 7.3
Nondeductible expenses........................................... (1.0) 35.0 1.3
Increase (decrease) in valuation allowance....................... 42.0 -- (38.8)
---- ---- ----
Effective income tax rate........................................ 0.0% 65.7% 4.8%
==== ==== ====
F-43
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Company's deferred tax assets and liabilities as of June 30 are
approximately as follows (in thousands):
2000 2001
------ ------
Deferred tax assets:
Net operating loss carryover............................................ $2,555 $3,512
Excess tax basis over book basis of accounts receivable................. 5,155 3,237
Accrued vacation........................................................ 235 57
Deferred compensation................................................... 1,821 1,777
Deferred start-up costs................................................. 55 215
Accrued expenses........................................................ -- 1,153
Interest rate collar liability ......................................... -- 1,179
Professional liabilities reserves....................................... 1,399 1,915
Minimum tax credit...................................................... 1,294 1,544
Self-insurance reserves................................................. 782 1,861
Deferred project costs.................................................. 33 64
Equity method of accounting for partnerships............................ 281 280
------ ------
Total deferred tax assets..................................................... 13,610 16,794
Valuation allowance..................................................... 5,572 1,433
------ ------
Total deferred tax assets, net of valuation allowance......................... $8,038 $15,361
====== =======
Deferred tax liabilities:
Depreciation, amortization and fixed assets basis differences........... $5,743 $11,697
Excess book basis over tax basis of prepaid assets...................... 1,001 1,226
------ ------
Total deferred tax liabilities................................................ 6,744 12,923
------ ------
Net deferred tax assets and liabilities....................................... $1,294 $2,438
====== ======
For the year ended June 30, 1999 and 2000, the Company generated net
operating loss (NOL) carryforwards for federal and state income tax purposes of
approximately $4,218,000 of which $2,918,000 remains unutilized at June 30,
2001. The unutilized NOL carryforwards expire in 2020. For financial reporting
purposes, a valuation allowance has been recognized to offset the deferred tax
assets related to those carryforwards which are available to offset future
taxable income. The valuation allowance decreased $4,139,000 for the year ended
June 30, 2001.
As part of the MacNeal Health Services acquisition on February 1, 2000,
the Company acquired 100% of the stock of MacNeal Management Services, Inc. The
purchase caused an "ownership change" within the meaning of Section 382 of the
Internal Revenue Code for MacNeal Management Services, Inc. On February 1,
2000, MacNeal Management Services, Inc. had approximately $18,000,000 of net
operating loss carryforwards which have an expiration period of 2001 to 2019.
Due to the ownership change, the allowable federal deductions relating to NOL's
is subject to an annual limitation of approximately $286,000. Therefore, the
maximum amount of MacNeal Management Services, Inc. NOL's for which the Company
could receive a benefit is approximately $5,720,000. On the date of
acquisition, a deferred tax asset and corresponding valuation allowance of
approximately $2,345,000 were recorded by the Company.
F-44
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Stockholder's Equity
The total number of shares of stock which the Company has the authority to
issue is 750,000 shares of capital stock, classified as (i) 150,000 shares of
preferred stock, par value $.01 per share and (ii) 600,000 shares of common
stock, par value $.01 per share.
Common Stock Issuances
In August 1997, the Company issued 25,000 shares of Common Stock ("Initial
Shares") to certain officers ("Management Investors") of the Company at $100
per share. An additional 695 shares were issued to an officer of the Company in
October 1997 at $100 per share.
On June 1, 1998 (the "Effective Date"), the Board of Directors (the
"Board") approved the (i) Subscription Agreement, providing for the issuance
and sale of the Company's Common Stock, (ii) Shareholders Agreement, providing
for, among other things, registration rights for stockholders and restrictions
on the sale, transfer, encumbrance or other disposition of shares of the Common
Stock and to provide for certain rights and obligations relating to the capital
stock of the Company and certain matters relating to the conduct of the
business and the affairs of the Company, and (iii) Surviving Shareholders
Agreement, providing for upon an initial public offering, among other things,
registration rights for stockholders and restrictions on the sale, transfer or
the disposition of shares of the Common Stock. The Company was authorized to
issue 135,535 shares of Common Stock pursuant to the Subscription Agreement.
Under the Amended and Restated Subscription Agreement dated June 1, 2000,
the Company authorized the issuance of 235,521 shares of common stock in
addition to the 135,535 shares originally authorized pursuant to the original
Subscription Agreement dated June 1, 1998. During fiscal 2000, the Company
issued, in accordance with the original Subscription Agreement and the Amended
and Restated Subscription Agreement, 139,154 shares of Common Stock for a price
of $1,701.18 per share to fund a portion of the 2000 acquisitions.
On May 1, 2001, the Company issued, in accordance with the original
Subscription Agreement and the Amended and Restated Subscription Agreement,
19,340 shares of Common Stock at a price of $1,701.18 per share to fund a
portion of the 2001 acquisitions.
Subject to certain terms and conditions of the Amended and Restated
Subscription Agreement, the Company agrees to issue and sell and certain
investors agree to purchase on one or more future dates additional shares of
Common Stock aggregating 193,457 shares at a per share price of $1,701.18. The
proceeds from any subsequent issuance of Common Stock are expected to be used
to fund the purchase from time to time by the Company of hospitals, hospital
systems, hospital management companies and assets related thereto.
Forfeiture of Common Shares by Certain Investors
Each of certain investors in the Company agree to transfer to the Company
upon the occurrence of a Liquidity Event, as defined below, in exchange for no
consideration, its allocated portion of an aggregate number of Common Shares
equal to the Aggregate Carry Amount (as defined in the Carry Option Plan). The
determination of the Aggregate Carry Amount is contingent upon, among other
things, whether the timing of the Liquidity Event occurs prior to or following
the fourth anniversary of the Effective Date and the computed amount of the Net
Morgan Stanley Capital Partners ("Capital Partners") Exit Multiple or Net
Capital Partners Internal Rate of Return, as applicable and as defined in the
Carry Option Plan, immediately after giving effect to such Liquidity Event. Any
such transfer to the Company shall be made as soon as practicable following the
date on which options granted pursuant to certain provisions of the Carry
Option Plan become vested and exercisable.
A Liquidity Event means, subject to further clarification in the
Shareholders Agreement, the first to occur of (i) the consummation of an
initial public offering, (ii) the sale by a certain investor of all or
substantially all of their
F-45
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
aggregate equity interests in the Company, (iii) the sale of all or
substantially all of the assets of the Company, or (iv) the liquidation or
dissolution of the Company.
Repurchase of Common Shares Held by Management Investors
As set forth in the Amended and Restated Shareholders Agreement and the
Surviving Shareholders agreement, the Company shall have the right to purchase
from each Management Investor a certain number of Initial Shares for a purchase
price of $100 per share if a Management Investor is terminated or resigns prior
to the fourth anniversary of the Effective Date.
Similarly, if a Management Investor is terminated or resigns and prior to
June 1, 2003 such Management Investor engages in any competitive activity, the
Company shall have the right to purchase from such Management Investor any and
all shares of capital stock or other equity security of the Company then owned
by such Management Investor for a purchase price equal to the cost thereof.
Upon any Liquidity Event in connection with which Capital Partners is to
receive aggregate net proceeds in an amount that is less than the aggregate
amount of capital invested by Capital Partners in the Company, Capital Partners
may require the Company to purchase from each Management Investor any and all
Initial Shares then owned by such Management Investor for a purchase price per
share equal to the lesser of the cost or fair market value thereof. The maximum
redemption value of the Initial Shares in the event of such purchase is not
material relative to the Company's stockholders' equity as of June 30, 2001.
Payable-In-Kind Preferred Stock
On February 1, 2000, as a portion of the payment for MacNeal Health
Services, the Company issued 20,000 shares of payable-in-kind convertible
redeemable preferred stock ("PIK Preferred Shares") with a par value of $0.01
per share. The stock was valued by an independent appraiser at $1,000 per share
for purposes of the acquisition.
Liquidation Preferences and Conversion Features
Upon liquidation, dissolution, or winding up of the Company, or upon the
Company's option to redeem such shares, the holders of the PIK Preferred Shares
are entitled to be paid in cash equal to $1,000 per each outstanding share plus
accrued dividends. To the extent the Company shall have funds legally available
for payment, the Company shall redeem all outstanding PIK Preferred Shares at
$1,000 per share plus accrued dividends upon the earlier of (i) a change in
control of the Company; (ii) the sale of MacNeal Health Services; or (iii)
January 31, 2015. Otherwise, there are no mandatory redemption or put features
associated with the PIK Preferred Shares. The PIK Preferred Shares are, with
respect to dividend rights and rights on liquidation, dissolution and winding
up, senior to all common shares and may only be junior to other preferred
shares designated as such; such designation requires the majority vote of the
holders of the PIK Preferred Shares voting as a separate class. The PIK
Preferred Shares automatically convert to common shares upon consummation of an
initial public offering with proceeds to the Company of at least $50 million at
a conversion price equal to the initial public offering price.
Dividends
Dividends for the PIK Preferred Shares accrue at an annual rate of $80 per
share. The dividends are payable when, as and if declared by the Board of
Directors, in cash or, at the Company's option, during any period prior to
January 31, 2008 (Pay-In-Kind Period) in additional PIK Preferred Shares at the
rate of 0.08 shares for each $80 of such dividend not paid in cash. The
Pay-In-Kind Period shall terminate upon the Company's payment of a cash
dividend upon any share of its capital stock. However, the provisions of the
2000 Credit Agreement limit the payment of such dividends to the issuance of
additional PIK Preferred Shares.
F-46
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Voting Rights
The holders of the PIK Preferred Shares shall not be entitled to any
voting rights except to the extent voting rights vest under one of the
following occurrences: (i) the point in which dividends payable, whether in the
form of cash or PIK Preferred Shares, shall be in arrears and unpaid on an
amount equal to two full annual dividends or (ii) the Company's failure to
discharge its mandatory redemption obligation. In the event the voting rights
vest under one of these occurrences, the Board of Directors of the Company will
automatically increase by two members, and the holders of the PIK Preferred
Shares shall have the exclusive right, voting as a separate class, to elect the
two additional directors. The voting rights are terminated once the accrued
dividends have been paid or the mandatory redemption obligation has been
fulfilled.
8. Employee Benefit Plans
Carry Option Plan
On June 1, 1998, (the "Effective Date") the Board approved the grant of
23,883 options, each exercisable for one share of Common Stock, at an exercise
price of $170.12 under the Vanguard Health Systems, Inc. Carry Option Plan (the
"Carry Option Plan"). In August 2000, the Board approved a grant of 3,134
options to an officer of the Company. The option price in the case of any other
option issued under the Carry Option Plan shall be ten percent of the fair
market value of one share of Common Stock on the date of grant of such
option(s). Pursuant to the Amended and Restated Shareholders Agreement dated
June 1, 2000, the maximum number of options that may be outstanding at any time
is 29,822. Options available for grant at June 30, 2001 totaled 2,805. Upon and
after the occurrence of a Liquidity Event, no options shall be available for
grant under the Carry Option Plan.
Subject to the terms and conditions of the Carry Option Plan, the options
granted under the Carry Option Plan shall vest upon the earlier of a Liquidity
Event or ratably over seven years. None of the options shall be exercisable
prior to a Liquidity Event. Upon a Liquidity Event, a number of options equal
to the Exercisable Options, as defined in the Carry Option Plan, shall become
exercisable. The determination of Exercisable Options, is contingent upon,
among other things, whether the timing of the Liquidity Event occurs prior to
or following the fourth anniversary of the Effective Date and the computed
amount of the Net Capital Partners Exit Multiple or Net Capital Partners
Internal Rate of Return immediately after giving effect to such Liquidity
Event. Such number of options may only be exercised commencing at such time and
ending on the tenth anniversary of the Effective Date, at which time such
options shall expire. All options held by a grantee in excess of the
Exercisable Options shall, upon the occurrence of a Liquidity Event, be
irrevocably and unconditionally forfeited and canceled without any
consideration payable to the grantee, and the grantee shall have no further
right or consideration therein.
Upon the occurrence of a Liquidity Event, the Company will incur an
immediate compensation expense on all Exercisable Options outstanding at that
time based on the excess of the fair market value of each Common Share over the
exercise price.
Initial Option Plan
The purpose of the Vanguard Health Systems, Inc. Nonqualified Initial
Option Plan ("Initial Option Plan") is primarily to grant option awards to
those employees who agreed to work for the Company for no cash salaries or cash
salaries below fair market value.
On June 1, 1998, (the "Effective Date") the Board approved the grant of
3,595 options, each exercisable for one share of Common Stock, at an exercise
price of $170.12 per share, all of which were granted on that date. The maximum
number of shares of Common Stock reserved for grant of awards under the Initial
Option Plan shall be 3,595.
F-47
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Each of the 3,595 granted options vested and became exercisable by the
respective grantee on June 1, 1999 (one year vesting period). The exercise
period is ten years from the date of the grant of the option.
Since the exercise price of the options granted was below the fair value
of the Company's Common Stock on the date of grant, the Company recorded
approximately $5,046,000 of noncash stock option compensation for the year
ended June 30, 1999, with an offsetting increase to additional paid in capital.
1998 Stock Option Plan
The purpose of the Vanguard Health Systems, Inc. 1998 Stock Option Plan as
amended effective June 1, 2000, (the "1998 Stock Option Plan"), is to afford an
incentive to executive officers, other key employees, directors and consultants
of the Company to acquire a proprietary interest in the Company, to continue as
employees, directors, or consultants, to increase their efforts on behalf of
the Company and to promote the success of the Company's business. As of June
30, 2001, all options granted under the 1998 Stock Option Plan have been
granted to employees of the Company. The 1998 Option Plan shall be administered
by the Board.
The maximum number of shares of Common Stock reserved for the grant of
options under the 1998 Stock Option Plan (the "Maximum Share Number") shall be
recomputed as of a Liquidity Event and under such calculations the options
available for grant may be increased up to an additional 2,977 options. In no
event shall the number of shares of Common Stock with respect to which options
are granted hereunder exceed 50% of the number of shares of Common Stock
authorized as of the effective date of the 1998 Stock Option Plan. As of June
30, 2001, the Maximum Share Number was 10,329.
Options granted under the 1998 Stock Option Plan may be designated as (i)
incentive stock options or non-qualified stock options and (ii) a Liquidity
Event Option or a Non-Liquidity Event Option; although, certain restrictions
exist as to the number of options which can be granted, outstanding, and
exercisable under each designation. The Liquidity Event Options and
Non-Liquidity Event Options vest over a four-year period from the date of grant
but are not exercisable until the occurrence of a Liquidity Event. Liquidity
Event Options are subject to forfeiture if a minimum Net Capital Partners Exit
Multiple or Internal Rate of Return is not met at the date of the Liquidity
Event. The Non-Liquidity Event Options are not subject to this forfeiture
provision. All options under the 1998 Stock Option Plan have a ten-year
exercise period.
As of June 30, 2001, 9,908 options had been granted with 75% of each grant
designated as Liquidity Event Options and 25% designated as Non-Liquidity Event
Options. Of the 9,908 outstanding options, 4,633 options were granted at fair
market value but provide that the exercise price will be reduced to $425.32 if
the Net Capital Partners Exit Multiple and Internal Rate of Return at the date
of the Liquidity Event meets or exceeds certain target amounts. Should the
applicable target amount be met, the Company will incur an immediate
compensation expense on all affected options equal to the excess of fair market
value of a Common Share over the exercise price of each of the affected options.
The remaining 5,275 options were granted to a Company executive during
August 2000 at an exercise price of $425.32 and were attached to a bonus equal
to $351.63 per option exercised. The 5,275 options and related bonus are
accounted for as a combined fixed award and may not be exercised until the
occurrence of a Liquidity Event. On the date of the Liquidity Event, the
Company will incur an immediate compensation expense on the vested options
equal to the excess of fair market value of a Common Share over the exercise
price of these options.
Other
If, while any options remain outstanding under the 1998 Stock Option Plan,
an event occurs which constitutes a change in control of the Company, as
defined in the 1998 Stock Option Plan, the options shall be exercisable or
otherwise nonforfeitable in full, whether or not otherwise exercisable or
forfeitable; provided that, if a Liquidity Event occurs which results in a Net
Capital Partners Internal Rate of Return that is less than or equal to 12.5%,
then all Liquidity Event Options shall be forfeited and canceled.
F-48
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2000 Stock Option Plan
Effective June 1, 2000, the Vanguard Health Systems 2000 Stock Option Plan
(the "2000 Stock Option Plan") was approved by the Board for the same purpose
as the 1998 Stock Option Plan. The 2000 Option Plan shall be administered by
the Board.
The maximum number of shares of Common Stock reserved for the grant of
options under the 2000 Stock Option Plan (the "Maximum Share Number") shall as
of any date be the lesser of (i) the sum of (x) 17.647% of the total number of
the 235,131 common shares set forth on Division I of Schedule 2.01(c) to, and
issued by the Company and purchased by investors pursuant to, the Amended and
Restated Subscription Agreement prior to such date and (y) 10.00% of the total
number of the 4,377 common shares set forth on Division II of Schedule 2.01(c)
to, and issued by the Company and purchased by investors pursuant to, the
Amended and Restated Subscription Agreement prior to such date and (ii) 41,931
shares of Common Stock.
Options granted under the 2000 Stock Option Plan may be designated as (i)
incentive stock options or non-qualified stock options and (ii) a Liquidity
Event Option or a Non-Liquidity Event Option; although, certain restrictions
exist as to the number of options which can be granted, outstanding, and
exercisable under each designation.
The Liquidity Event Options and Non-Liquidity Event Options vest over a
four-year period from the date of grant but are not exercisable until the
occurrence of a Liquidity Event. Liquidity Event Options are subject to
forfeiture if a minimum Net Capital Partners Exit Multiple or Internal Rate of
Return is not met at the date of the Liquidity Event. The Non-Liquidity Event
Options are not subject to this forfeiture provision. All options under the
2000 Stock Option Plan have a ten-year exercise period.
As of June 30, 2001, 7,627 options were outstanding under the 2000 Stock
Option Plan with 75% of each grant designated as Liquidity Event Options and
25% designated as Non-Liquidity Event Options. Should the fair market value of
a Common Share exceed the exercise price of each affected option at the date
of the Liquidity Event, the Company will incur an immediate compensation expense
equal to such excess.
Other
If, while any options remain outstanding under the 2000 Stock Option Plan,
an event occurs which constitutes a change in control of the Company, as
defined in the 2000 Stock Option Plan, the options shall be exercisable or
otherwise nonforfeitable in full, whether or not otherwise exercisable or
forfeitable; provided that, if a Liquidity Event occurs which results in a Net
Capital Partners Internal Rate of Return that is less than or equal to 12.5%,
then all Liquidity Event Options shall be forfeited and canceled.
Other
The following is a summary of option transactions during the years ended
June 30, 1999, 2000 and 2001:
F-49
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Weighted Weighted Weighted Weighted
Carry Average Initial Average Average Average
Option Exercise Option Exercise 1998 Stock Exercise 2000 Stock Exercise
Plan Price Plan Price Option Plan Price Option Plan Price
------ -------- ------- -------- ----------- --------- ----------- --------
Options granted............. 23,883 $170.12 3,595 $170.12 1,902 $ -- -- $ --
------ ------- ----- ------- ----- --------- ----- ---------
Options outstanding at
June 30, 1999............. 23,883 170.12 3,595 170.12 1,902 -- -- --
Options granted............. -- -- -- -- 980 1,701.18 -- --
Options canceled............ -- -- -- -- 30 1,701.18 -- --
------ ------- ----- ------- ----- --------- ----- ---------
Options outstanding at
June 30, 2000............. 23,883 170.12 3,595 170.12 2,852 1,701.18 -- --
Options granted............. 3,134 170.12 -- -- 7,477 621.02 7,657 1,701.18
Options canceled............ -- -- -- -- 421 1,701.18 30
------ ------- ----- ------- ----- --------- ----- ---------
Options outstanding at
June 30, 2001............... 27,017 170.12 3,595 170.12 9,908 958.33 7,627 1,701.18
====== ======= ===== ======= ===== ========= ===== =========
Options available for grant
at June 30, 2001............ 2,805 -- -- -- 421 -- 467 --
====== ======= ===== ======= ===== ========= ===== =========
Options exercisable at
June 30, 2001............... -- $ -- 3,595 $170.12 12 $1,701.18 -- $ --
====== ======= ===== ======= ===== ========= ===== =========
Options Outstanding Options Exercisable
- ------------------------------------------------------------------------------------------ ------------------------------
Weighted
Number Average Weighted Number Weighted
Outstanding Remaining Average Exercise Exercisable Average
Range of Exercisable Prices 6/30/01 Contractual Life Price 6/30/01 Exercise Price
- --------------------------- ----------- ---------------- ---------------- ----------- --------------
$ 170.12 30,612 8.00 $ 170.12 3,595 $170.12
$ 425.32 5,275 10.00 $ 425.32 -- --
$1,701.18 12,260 9.40 $1,701.18 12 $170.12
- ----------------------- ------ -----
$ 170.12 - $1,701.18 48,147* 3,607
====== =====
- --------------------
* Includes options granted under all plans.
Statement of Financial Accounting Standards No. 123 ("SFAS No. 123"),
"Accounting for Stock-Based Compensation," requires those entities electing to
account for stock options under APB 25 to provide certain net income pro forma
information in the footnotes to the financial statements. The fair value of the
Company's stock options was estimated at the date of grant using a Minimum
Value option pricing model with the following weighted-average assumptions for
1999, 2000 and 2001: risk-free interest rate of approximately 5% to 6%,
dividend yield of 0.0%, and a weighted-average expected life of the options of
10 years.
F-50
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For purposes of pro forma disclosures, the estimated fair value of options
is amortized to expense over the options' vesting period. The Company's pro
forma information follows (in thousands):
1999 2000 2001
-------- -------- --------
Net (loss) income............................................. $(6,421) $(1,449) $10,160
Pro forma compensation expense from stock options, net of
taxes (excluding compensation expense from stock options
of $5,046,000 included in net loss as of June 30, 1999)....... (1,787) (3,676) (6,131)
------- ------- ------
Pro forma net (loss) income................................... $(8,208) $(5,125) $4,029
======= ======= ======
The effect of applying SFAS No. 123 for providing pro forma disclosures
are not likely to be representative of the effects on reported net income for
future years.
The weighted-average fair value of options granted are presented in the
table below:
2000
Carry Option Plan Initial Option Plan 1998 Option Plan Option Plan
------------------- ------------------- --------------------------------------------- --------------
Exercise Price
Exercise Price less Exercise Price less Exercise Price less Exercise Price Equal Equal to Market
than Market Price than Market Price than Market Price to Market Price Price
------------------- ------------------- ------------------- -------------------- --------------
1999..... -- -- -- $767.51 --
2000..... -- -- -- $767.51 --
2001..... $1,604.10 -- $1,458.47 $730.38 $716.06
401(k) Plan
Effective June 1, 1998, the Company adopted the Vanguard Health Systems,
Inc. - 401(k) Retirement Savings Plan (the "401(k) Plan"). The 401(k) Plan is a
multiple employer defined contribution plan whereby employees who have
completed one year of service in which they have worked a minimum of 1,000
hours and are age 21 or older are eligible to participate.
The participation requirements of the 401(k) plan do not apply to all
employees as certain employees who had balances under plans of predecessor
companies are eligible to participate in the 401(k) Plan upon employment with
the Company. The 401(k) Plan was restated January 1, 2000 to incorporate the
adoption agreements of a number of employers whereby the respective employer
tailored the terms of the 401(k) Plan, including: contribution limits, vesting
schedule and employer match. The 401(k) Plan was adopted by the corporate
office as of July 1, 1998 and by acquired hospitals upon the respective date of
acquisition.
For purposes of determining eligibility to participate and vesting
percentages in the 401(k) Plan, employees received credit for years of service
with their respective predecessor companies. The 401(k) Plan allows eligible
employees to make contributions of 2% to 20% of their annual compensation.
Employer matching contributions, which vary by employer, vest 20% after three
years of service and continue vesting at 20% per year until fully vested. The
Company's matching expense for the years ended June 30, 1999, 2000 and 2001 was
approximately $539,000, $1,840,000 and $3,677,000, respectively.
F-51
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. Leases
The Company leases real estate properties and equipment under operating
and capital leases with various expiration dates. Future minimum operating and
capital lease payments at June 30, 2001 are approximately as follows (in
thousands):
Operating Leases Capital Leases Total
---------------- -------------- -------
2002............................................ $ 8,885 $ 5,899 $14,784
2003............................................ 6,462 4,254 10,716
2004............................................ 4,511 3,394 7,905
2005............................................ 3,303 2,251 5,554
2006............................................ 2,671 829 3,500
Thereafter...................................... 31,549 28 31,577
------- ------- -------
Total minimum payments.......................... $57,381 16,655 $74,036
======= =======
Less amounts representing interest.............. 2,581
-------
Present value of future minimum lease payments.. $14,074
=======
Assets under Capital Leases
The carrying value of assets under capital leases, which are included with
owned assets in the accompanying Consolidated Balance Sheets, are approximately
as follows (in thousands):
June 30, 2000 June 30, 2001
------------- --------------
Equipment............................ $1,481 $15,363
Less accumulated depreciation........ 18 705
------ -------
Net equipment under capital leases... $1,463 $14,658
====== =======
Amortization of the capitalized amounts is included in depreciation and
amortization expense in the accompanying Consolidated Statements of Operations.
Operations for the years ended June 30, 1999, 2000 and 2001 include rent
expense on operating leases of approximately $2,241,000, $6,836,000 and
$12,233,000, respectively, net of rental payments made by affiliates under
informal sublease agreements in the approximate amount of $341,000, $380,000
and $1,643,000 for 1999, 2000 and 2001, respectively.
F-52
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. Other Information
A summary of activity in the Company's allowance for doubtful accounts
follows (in thousands):
Additions Additions(1)
Balances at Charged to Charged to Accounts
Beginning of Costs and Other Written Off, Net Balance at
Period Expenses Accounts of Recoveries End of Period
------------ ---------- ------------ ---------------- -------------
Allowance for doubtful accounts:
Year ended June 30, 1999 $1,335 $17,293 $ -- $10,061 $ 8,567
Year ended June 30, 2000 8,567 33,138 37,505 33,992 45,218
Year ended June 30, 2001 45,218 56,846 -- 71,360 30,704
- ------------------------
(1) Allowances as a result of acquisitions.
11. Contingencies and Healthcare Regulation
Contingencies
The Company is presently, and from time to time, subject to other various
claims and lawsuits arising in the normal course of business. In the opinion of
management, the ultimate resolution of these matters will not have a material
adverse effect on the Company's financial position or results of operations.
Current Operations
Final determination of amounts earned under prospective payment and
cost-reimbursement activities is subject to review by appropriate governmental
authorities or their agents. In the opinion of the Company's management,
adequate provision has been made for any adjustments that may result from such
reviews.
Laws and regulations governing the Medicare and Medicaid and other federal
health care programs are complex and subject to interpretation. The Company's
management believes that the Company is in compliance with all applicable laws
and regulations in all material respects and is not aware of any pending or
threatened investigations involving allegations of potential wrongdoing. While
no such regulatory inquiries have been made, compliance with such laws and
regulations can be subject to future government review and interpretation as
well as significant regulatory action including fines, penalties, and exclusion
from the Medicare, Medicaid and other federal health care programs.
The Company has acquired and will continue to acquire businesses with
prior operating histories. Acquired companies may have unknown or contingent
liabilities, including liabilities for failure to comply with health care laws
and regulations, such as billing and reimbursement, fraud and abuse and similar
anti-referral laws. Although the Company institutes policies designed to
conform practices to its standards following completion of acquisitions, there
can be no assurance that the Company will not become liable for past activities
that may later be asserted to be improper by private plaintiffs or government
agencies. Although the Company generally seeks to obtain indemnification from
prospective sellers covering such matters, there can be no assurance that any
such matter will be covered by indemnification, or if covered, that such
indemnification will be adequate to cover potential losses and fines.
F-53
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Employment-Related Agreements
Effective June 1, 1998, the Company executed employment agreements with
four of the Company's senior executive officers. The employment agreements have
an initial term of three years and contain provisions for term extensions. The
employment agreements provide, among other things, for minimum salary levels,
for participation in bonus plans, and for amounts to be paid as liquidated
damages in the event of a change in control as defined in the employment
agreements.
Effective June 1, 1998, the Company executed severance protection
agreements ("severance agreements") between the Company and each of its current
senior vice presidents and vice presidents. The severance agreements are
automatically extended for successive one year terms at the discretion of the
Company unless an event of a change in control occurs, as defined in the
severance agreement, at which time the severance agreement shall continue in
effect for a period of not less than three years beyond the date of such event.
The Company is obligated to pay severance payments as set forth in the
severance agreements in the event of a change in control.
In conjunction with the Company's issuance of 695 stock options to an
officer under the Initial Option Plan, the Company agreed to grant a cash bonus
to reimburse the officer for the tax payable upon the exercise of the options.
The bonus is to be paid upon the exercise of the options and is to be
calculated using tax rates in effect and the fair market value of the
underlying stock at the time of exercise of the options. The Company recorded
non-cash stock compensation expense and salaries and benefits expense for these
695 stock options and related bonus during fiscal 1998 and 1999 of
approximately $95,000 and $1,314,000, respectively. The non-cash stock
compensation portion of the $1,314,000 expense is included in the total
non-cash stock compensation expense of $5,046,000 recorded during 1999 as
referenced in Note 8. The Company will adjust the compensation expense as
necessary at each interim reporting period subsequent to the grant date of the
options until the date of exercise to account for the options and bonus as a
combined variable award.
In August 2000, the Company issued 8,409 stock options to an officer of
the Company with 5,275 options granted under the 1998 Option Plan, and 3,134
options granted under the Carry Option Plan. In conjunction with the grant of
the options under the 1998 Option Plan, the Company agreed to grant a cash
bonus to the officer upon the exercise of the options and is limited to
approximately $1,855,000. Upon the occurrence of a Liquidity Event, the bonus
associated with the 1998 Option Plan and the Carry Option Plan will be recorded
immediately as compensation expense.
Capital Expenditures Commitments
In accordance with the terms of the acquisition agreement, the Company
will expend or cause or permit third parties to expend, in the aggregate, not
less than $15,000,000 for capital expenditures at or for the benefit of
Maryvale Hospital Medical Center during the first five years subsequent to the
date of acquisition of June 1, 1998. If the Company fails to expend at least
$15,000,000, the Company shall pay to the seller the difference between
$15,000,000 and the amount actually expended by the Company. The Company has
expended approximately $11,652,000, including the additional investment in the
Emergency Diagnostic Clinic as of June 30, 2001 towards fulfilling this
agreement.
Additionally, in accordance with the terms of the acquisition agreement,
the Company will expend or cause or permit third parties to expend, in the
aggregate, not less than $50,000,000 for capital expenditures at or for the
benefit of Arrowhead Community Hospital and Medical Center and Phoenix Baptist
Hospital and Medical Center during the first seven years subsequent to the date
of acquisition of June 1, 2000, with an average annual expenditure as of the
end of each of the first seven anniversaries of the closing date of not less
than $6,000,000. If the Company fails to expend at least $50,000,000, the
Company shall pay to the seller the difference between $50,000,000 and the
amount actually expended by the Company. The Company has expended approximately
$8,476,000 toward fulfilling this commitment as of June 30, 2001.
F-54
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
California has a statute and regulations that require hospitals to meet
seismic performance standards. Hospitals that do not meet the standards may be
required to retrofit their facilities. California law requires that these
hospitals evaluate their facilities and develop a plan and schedule for
complying with the standards. Compliance plans, if necessary, must be filed
with the State of California by 2002. The Company will file all of the
necessary documentation with the State of California that is required by
January 1, 2002. The Company expects that the cost of performing the necessary
evaluations and filing the documentation will be approximately $0.3 million.
The estimated cost to comply with the seismic regulations and standards
required by 2008, is an additional $ 10.1 million. Upon completion of the $10.1
million in improvements, the California facilities will be compliant with the
requirements of the seismic regulations through 2029. The Company estimates
that the majority of the square footage in its facilities will be compliant
with the seismic regulations and standards required by 2030 once it has
completed such $10.1 million in improvements, but it is unable at this time to
estimate its costs for full compliance with the 2030 requirements.
12. Related Party Transactions
The Company purchases charter airplane services from an affiliate of an
executive officer of the Company. Total costs for such services incurred during
the years ended June 30, 1999, 2000 and 2001 and reported in the accompanying
Consolidated Statements of Operations approximated, $362,000, $332,000 and
$300,000, respectively.
Other receivables in the accompanying Consolidated Balance Sheets include
receivables from various affiliates in the amounts of approximately $135,000
and $61,000 as of June 30, 2000 and 2001, respectively. Such balances represent
amounts due for rent and certain shared office services allocable to the
affiliates.
During 2000 and 2001, the Company paid Capital Partners or its affiliates
approximately $3.2 million and $275,000, respectively, in loan origination fees
associated with the 2000 Credit Agreement. The Company paid Capital Partners or
its affiliates approximately $800,000 in 2000 in acquisition related fees
related to the 2000 Acquisitions.
On July 1, 2000, the Company purchased 100% of the outstanding stock of
Trinity MedCare, Inc. from its nine shareholders. The shareholders of Trinity
MedCare, Inc. included certain members of management and directors of the
Company. These certain members of management and directors received
approximately $457,000 for their interests.
13. Segment Information
The Company's acute care hospitals and related healthcare businesses are
similar in their activities and the economic environments in which they operate
(i.e., urban markets). Accordingly, the Company's reportable operating segments
consist of (1) acute care hospitals and related healthcare businesses,
collectively, and (2) MacNeal Health Providers, the contracting entity for the
Company's hospital in Chicago, and Phoenix Health Plan, its Medicaid managed
health plan, collectively, "Health Plans." Prior to the acquisitions of Phoenix
Health Plan and MacNeal Health Providers, management had determined that the
Company did not have separately reportable segments as defined under Statement
of Financial Accounting Standards No. 131, Disclosures about Segments of an
Enterprise and Related Information.
The following is a financial summary by business segment for the periods
indicated. Adjusted EBITDA represents EBITDA, or net income before interest
expense (net of interest income), income taxes, depreciation, amortization, and
is further adjusted to add back non-cash stock compensation, certain other
non-operating expenses and restructuring and impairment charges. This
definition of Adjusted EBITDA is derived from and consistent with the Indenture
for the new notes. EBITDA is commonly used as an analytical indicator within
the health care industry and serves as a measure of leverage capacity and debt
service ability. We believe the adjustments made to EBITDA in calculating
Adjusted EBITDA are appropriate to reflect our calculations of the debt
leverage and interest coverage ratios under the Indenture and the 2001 senior
secured credit facility. Adjusted EBITDA should not be considered as a measure
of financial performance under generally accepted accounting principles, and
the items excluded in determining Adjusted EBITDA are significant components in
understanding and assessing financial performance. Because neither EBITDA nor a
calculation of Adjusted EBITDA is a measurement determined in accordance with
generally accepted accounting
F-55
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
principles, it is susceptible to varying calculations, and as a result our
calculation of Adjusted EBITDA as presented may not be comparable to EBITDA or
other similarly titled measures used by other companies:
Year Ended June 30, 2000
----------------------------------------------------
Health
Plans Acute Care Services Consolidated
------ ------------------- -------------
(In thousands)
Net patient revenues............................... $ -- $ 288,886 $ 288,886
Capitation premiums................................ 15,808 -- 15,808
-------- ------------ ---------
Net revenues....................................... 15,808 288,886 304,694
Salaries and benefits.............................. 1,157 145,310 146,467
Supplies........................................... 51 40,447 40,498
Purchased services................................. 6,426 17,192 23,618
Provision for bad debts............................ -- 33,138 33,138
Medical claims expense............................. 7,356 -- 7,356
Other operating expenses........................... 50 26,214 26,264
Rent and leases.................................... 111 6,725 6,836
-------- ------------ ---------
Adjusted EBITDA.................................... 657 19,860 20,517
Interest expense, net.............................. (59) 8,890 8,831
Depreciation and amortization...................... 235 11,558 11,793
Other non-operating expenses....................... -- 74 74
-------- ------------ ---------
Earnings (loss) from continuing operations
before income taxes and extraordinary item....... $ 481 $ (662) $ (181)
======== ============ =========
Segment assets..................................... $ 11,396 $ 538,510 $ 549,906
======== ============ =========
Capital expenditures............................... $ 1,407 $ 12,882 $ 14,289
======== ============ =========
F-56
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Year Ended June 30, 2001
-------------------------------------------
Health Acute Care
Plans Services Consolidated
---------- ---------- ------------
(In thousands)
Net patient revenues.................. $ -- $ 612,700 $ 612,700
Capitation premiums................... 55,063 -- 55,063
-------- --------- ---------
Net revenues.......................... 55,063 612,700 667,763
Salaries and benefits................. 3,794 319,823 323,617
Supplies.............................. 88 92,864 92,952
Purchased services.................... 15,912 49,060 64,972
Provision for bad debts............... -- 56,846 56,846
Medical claims expense................ 30,784 -- 30,784
Other operating expenses.............. 1,766 33,196 34,962
Rent and leases....................... 361 11,872 12,233
-------- --------- ---------
Adjusted EBITDA....................... 2,358 49,039 51,397
Interest expense, net................. (370) 16,928 16,558
Depreciation and amortization......... 483 23,316 23,799
Other non-operating expenses.......... -- 369 369
-------- --------- ---------
Earnings (loss) from continuing
operations before income taxes...... $ 2,245 $ 8,426 $ 10,671
======== ========= =========
Segment assets........................ $ 44,177 $ 596,221 $ 640,398
======== ========= =========
Capital expenditures.................. $ -- $ 26,566 $ 26,566
======== ========= =========
14. Comprehensive Income
The components of comprehensive income, net of related taxes (in
thousands):
Year Ended
June 30, 2001
-------------
Net income.................................................. $10,160
Cumulative effect of change in accounting principle --
fair value of interest rate collar........................ (164)
Net change in fair value of interest rate collar............ (1,590)
Amortization of transition adjustment....................... 100
-------
Other comprehensive loss.................................... (1,654)
-------
Comprehensive income........................................ $8,506
======
Accumulated other comprehensive loss, net of related taxes, at June 30,
2001 is comprised of approximately $1,654,000 related to the fair value of the
interest rate collar.
F-57
VANGUARD HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. Subsequent Events
In July 2001, the Company received $300,000,000 through the issuance of
9.75% Senior Subordinated Notes (the "Notes") which are due in 2011. The
Company can redeem the Notes beginning August 1, 2006. The initial redemption
price is 104.875% of their principal amount, plus accrued interest. In
addition, before August 1, 2004, the Company may redeem up to 35% of the Notes
at a redemption price of 109.75% of their principal amount plus accrued
interest, using the proceeds from sales of certain kinds of capital stock.
Interest is payable on February 1 and August 1 of each year.
Also in July 2001, the Company entered into a credit agreement (the "2001
Credit Agreement") with various lenders to fund future acquisitions and general
corporate purposes. Under the 2001 Credit Agreement, the Company has up to
$125,000,000 available under revolving loans.
On September 10, 2001, the Company entered into a definitive agreement for
the acquisition of Paradise Valley Hospital from Triad Hospitals, Inc. The
transaction is expected to close in October 2001 and is not expected to have a
material impact on the Company's earnings or financial position.
F-58
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
Phoenix Baptist Hospital and Medical Center, Inc.,
Arrowhead Community Hospital
and Medical Center, Inc. and Affiliates
We have audited the accompanying combined statements of operations and
cash flows of Phoenix Baptist Hospital and Medical Center, Inc., Arrowhead
Community Hospital and Medical Center, Inc. and Affiliates (collectively, the
"Company") for the years ended August 31, 1998 and 1999 and for the nine months
ended May 31, 2000. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the combined financial statements referred to above
present fairly, in all material respects, the combined results of operations
and cash flows of Phoenix Baptist Hospital and Medical Center, Inc., Arrowhead
Community Hospital and Medical Center, Inc., and Affiliates for the years ended
August 31, 1998 and 1999 and for the nine months ended May 31, 2000 in
conformity with accounting principles generally accepted in the United States.
/s/ Ernst & Young LLP
Nashville, TN
June 1, 2001
F-59
PHOENIX BAPTIST HOSPITAL AND MEDICAL CENTER, INC.,
ARROWHEAD COMMUNITY HOSPITAL AND MEDICAL CENTER, INC. AND AFFILIATES
COMBINED STATEMENTS OF OPERATIONS
For the Years Ended August 31, 1998 and 1999
and the Nine Months Ended May 31, 2000
1998 1999 2000
-------- -------- --------
(in thousands)
Revenue:
Net patient service revenue......................... $118,008 $125,241 $ 96,870
Premium revenue..................................... 26,572 14,283 11,255
Other revenue....................................... 5,301 4,640 3,522
-------- -------- --------
Total revenue....................................... 149,881 144,164 111,647
Expenses:
Salaries and wages.................................. 53,066 59,805 48,280
Employee benefits................................... 9,178 9,569 8,251
Supplies and other.................................. 66,582 70,985 49,421
Provision for doubtful accounts..................... 3,816 5,247 4,384
Depreciation and amortization....................... 6,168 6,719 5,324
Interest............................................ 3,902 4,579 3,953
Corporate allocation expenses....................... 3,737 4,203 2,745
-------- -------- --------
Total expenses...................................... 146,449 161,107 122,358
-------- -------- --------
(Deficiency) excess of revenue over expenses.............. 3,432 (16,943) (10,711)
Unrealized gains (losses) on investments.................. (28) (387) 158
Net asset transfers....................................... 141 355 226
-------- -------- --------
(Decrease) increase in unrestricted net assets............ $ 3,545 $(16,975) $(10,327)
======== ======== ========
See accompanying notes.
F-60
PHOENIX BAPTIST HOSPITAL AND MEDICAL CENTER, INC.,
ARROWHEAD COMMUNITY HOSPITAL AND MEDICAL CENTER, INC. AND AFFILIATES
COMBINED STATEMENTS OF CASH FLOWS
For the Years Ended August 31, 1998 and 1999
and the Nine Months Ended May 31, 2000
1998 1999 2000
------- -------- --------
(in thousands)
Operating Activities:
Change in net assets...................................................... $ 3,545 $(16,975) $(10,327)
Adjustments to reconcile change in net assets to net cash (used in)
provided by operating activities:
Net asset transfers.................................................. (141) (355) (226)
Unrealized (gains) losses on investments............................. 28 387 (158)
Provision for doubtful accounts...................................... 3,816 5,247 4,384
Depreciation and amortization........................................ 6,168 6,719 5,324
Changes in operating assets and liabilities:
Increase in accounts receivable...................................... (11,645) (1,811) (2,003)
Decrease (increase) in inventories, prepaid expenses, and other
current assets..................................................... (641) 910 1,778
Increase (decrease) in accounts payable and accrued expenses......... 1,790 (3,522) 1,922
Increase (decrease) in estimated payables under third-party
reimbursement programs............................................. (3,633) (2,710) 2,492
(Increase) in other assets........................................... (655) (163) (1,932)
Increase (decrease) in other liabilities............................. (157) (714) 821
------- -------- --------
Net cash (used in) provided by operating activities.................. (1,525) (12,987) 2,075
Investing Activities:
(Increase) decrease in short-term investments............................. (934) 2,003 (821)
Decrease (increase) in assets whose use is limited........................ 6,660 (8) 2,327
Decrease in long-term investments......................................... 3,745 12,817 531
Decrease (increase) in notes receivable................................... (140) 138 2
Purchases of property and equipment....................................... (15,559) (8,588) (3,998)
------- -------- --------
Net cash provided by (used in) investing activities.................. (6,228) 6,362 (1,959)
Financing Activities:
Increase in due to affiliates, net........................................ 11,116 6,173 8,573
Principal payments on long-term debt and notes payable to banks........... (2,114) (1,252) (3,617)
------- -------- --------
Net cash provided by financing activities................................. 9,002 4,921 4,956
------- -------- --------
Increase (decrease) in cash and cash equivalents.......................... 1,249 (1,704) 5,072
Cash and cash equivalents at beginning of year............................ 3,039 4,288 2,584
------- -------- --------
Cash and cash equivalents at end of year.................................. $ 4,288 $ 2,584 $ 7,656
======= ======== ========
Supplemental Cash Flow Information:
Interest Paid........................................................ $ 3,140 $ 3,853 $ 3,503
======= ======== ========
See accompanying notes.
F-61
PHOENIX BAPTIST HOSPITAL AND MEDICAL CENTER, INC.,
ARROWHEAD COMMUNITY HOSPITAL AND MEDICAL CENTER, INC. AND AFFILIATES
NOTES TO COMBINED STATEMENTS OF OPERATIONS AND CASH FLOWS
For the Years Ended August 31, 1998 and 1999
and the Nine Months Ended May 31, 2000
1. Description of Business
The accompanying combined financial statements include the accounts of the
following entities (collectively, the Company).
o Phoenix Baptist Hospital and Medical Center (Phoenix Baptist) owns
and operates a 209-bed hospital located in Phoenix, Arizona and is an
Arizona nonprofit corporation exempt from federal and state income
taxes.
o Arrowhead Community Hospital and Medical Center, Inc. (Arrowhead),
owns and operates a 115-bed hospital located in Glendale, Arizona,
and is an Arizona nonprofit corporation exempt from federal and state
income taxes.
o Bethany Enterprises, Inc. owns and operates an office building in
Phoenix, Arizona, and is an Arizona nonprofit corporation exempt from
federal and state income taxes.
o Pleasant Properties, Inc. is an Arizona for-profit corporation which
has an 80 percent interest in a joint venture which owns a medical
office building on the Arrowhead Community Hospital campus. Pleasant
Properties, Inc. is a wholly-owned subsidiary of Baptist Hospitals
and Health Systems, Inc. ("Baptist Hospitals and Health Systems").
o Arizona Network Development, Inc. is an Arizona nonprofit corporation
which develops, operates and leases outpatient treatment centers.
Baptist Hospitals and Health Systems is the sole corporate member of each
entity. Effective June 1, 2000, Baptist Hospitals and Health Systems sold the
operations and certain of the net assets of each of the above entities to
Vanguard Health Systems, Inc.
2. Significant Accounting Policies
Principles of Combination
Significant intercompany accounts and transactions have been eliminated in
combination.
Use of Estimates
The preparation of the Company's combined financial statements in
conformity with accounting principles generally accepted in the United States
requires management to make estimates and assumptions that affect amounts
reported in the combined financial statements and accompanying notes. Actual
results could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents include all highly liquid investments with a
remaining maturity of three months or less at date of acquisition, excluding
amounts whose use is limited by board designation or other arrangements under
trust agreements.
F-62
PHOENIX BAPTIST HOSPITAL AND MEDICAL CENTER, INC.,
ARROWHEAD COMMUNITY HOSPITAL AND MEDICAL CENTER, INC. AND AFFILIATES
NOTES TO COMBINED STATEMENTS OF OPERATIONS AND CASH FLOWS
Investments
Investments are comprised of U.S. Government securities and are recorded
at market value based on quoted market prices. Investments which will not be
liquidated within the next fiscal year are classified as long-term and related
unrealized gains and loses are excluded from the excess of revenues over
expenses. Investment income and gains and losses upon the sale of trading
investments, including assets whose use is limited, are included in other
revenue and totaled approximately $1,766,000 and $1,240,000 for the years ended
August 31, 1998 and 1999, respectively, and $371,000 for the nine months ended
May 31, 2000.
Inventories
Inventories, consisting principally of supplies, are stated at the lower
of cost (first-in, first-out method) or market.
Assets Whose Use is Limited
Assets whose use is limited include assets set aside in accordance with
provisions of the Master Trust Indenture and assets held by trustees under
self-insurance trust arrangements. Income earned on the trust assets is
reported in the accompanying combined statements of operations as other
revenue.
Property and Equipment
Property and equipment is stated on the basis of cost net of amortization
and accumulated depreciation. Depreciation is computed using the straight-line
method over the estimated useful lives of the respective assets. Depreciation
expense totaled approximately $6,088,000 and $6,527,000 for the years ended
August 31, 1998 and 1999, respectively, and $5,210,000 for the nine months
ended May 31, 2000.
Deferred Financing Costs
Costs incurred in connection with the issuance of certain debt have been
deferred. Long-term financing costs are amortized using the interest method
over the respective lives of the related debt. Amortization expense was
approximately $80,000 and $192,000 for the years ended August 31, 1998 and
1999, respectively, and $114,000 for the nine months ended May 31, 2000.
Deficiency or Excess of Revenues over Expenses
The statement of operations includes the deficiency or excess of revenues
over expenses. Changes in unrestricted net assets which are excluded from the
deficiency or excess of revenues over expenses, consistent with industry
practice, include unrealized gains and losses on investments other than trading
securities, permanent transfers of assets to and from affiliates for other than
goods and services, and contributions of long-lived assets (including assets
acquired using contributions which by donor restriction were to be used for the
purposes of acquiring such assets).
Net Patient Service Revenue
Net patient service revenue is reported at the estimated net realizable
amounts from patients, third-party payors, and others for services rendered,
including estimated retroactive adjustments under reimbursement agreements with
third-party payors. Retroactive adjustments are accrued on an estimated basis
in the period the related services are rendered and adjusted in future periods
as final settlements are determined. Provision for doubtful accounts is made at
the time revenue is recorded. Accounts, when determined to be uncollectible,
are charged against the allowance for doubtful accounts. Contractual
adjustments resulting from agreements with various organizations to provide
services for
F-63
PHOENIX BAPTIST HOSPITAL AND MEDICAL CENTER, INC.,
ARROWHEAD COMMUNITY HOSPITAL AND MEDICAL CENTER, INC. AND AFFILIATES
NOTES TO COMBINED STATEMENTS OF OPERATIONS AND CASH FLOWS
amounts which differ from billed charges, including services under Medicare,
Arizona Health Care Cost Containment System (the "Arizona Health Care System"),
and various managed care programs, are recorded as deductions from patient
service revenue.
The Company has agreements with third-party payers that provide for
payments to the Company at amounts different from its established rates. A
summary of the payment arrangements with major third-party payers follows:
Medicare--Inpatient acute care services rendered to Medicare program
beneficiaries are paid at prospectively determined rates per diagnosis. These
rates vary according to a patient classification system that is based on
clinical, diagnostic, and other factors. Inpatient nonacute services, certain
outpatient services and medical education costs related to Medicare
beneficiaries are paid based on a cost reimbursement methodology subject to
various costs limits. The Company is reimbursed for cost reimbursable items at
a tentative rate with final settlement determined after submission of annual
cost reports by the Company and audits thereof by the Medicare fiscal
intermediary. Medicare cost reports through 1998 have been audited by the
fiscal intermediary. The Company's classification of patients under the
Medicare program and the appropriateness of their admission are subject to an
independent review. The Company derived approximately 20% and 19% of net
patient revenue from services provided under Medicare, for the years ended
August 31, 1998 and 1999, respectively, and 18% for the nine months ended May
31, 2000.
Medicaid--Inpatient services rendered to beneficiaries under the Arizona
Health Care Cost Containment System (the "Arizona Health Care System")
(Arizona's Medicaid program) are reimbursed under contracted rates, which
generally do not have retroactive cost report settlement procedures. The
Company derived approximately 9% and 10% of net patient revenue from services
provided under the Arizona Health Care System for the years ended August 31,
1998 and 1999, respectively, and 11% for the nine months ended May 31, 2000.
Other--The Company also has entered into payment agreements with certain
commercial insurance carriers, health maintenance organizations and preferred
provider organizations. The basis for payment to the Company under these
agreements includes prospectively determined rates per discharge, discounts
from established charges, prospectively determined daily rates and fixed
monthly premiums based upon negotiated per member rates (generally referred to
as capitation arrangements). Capitation premiums received by the Company are
recognized as revenues in the month that members are entitled to healthcare
services regardless of services actually provided. Other than Medicare and
Medicaid, the Company has no payers which represent more than 10% of aggregate
net patient revenue.
Final determination of amounts earned under the Medicare program often
occurs in subsequent years because of audits by the program, rights of appeal
and the application of numerous technical provisions. Differences between
original estimates and subsequent revisions (including final settlements) are
included in the statement of operations in the period in which the revisions
are made. Management believes that adequate provisions have been made for
adjustments that may result from final determination of amounts earned under
the Medicare and Medicaid programs.
Laws and regulations governing Medicare and Arizona Health Care System
programs are complex and subject to interpretation. As a result, there is at
least a reasonable possibility that recorded estimates will change by a
material amount in the near term. The Company believes that it is in compliance
with all applicable laws and regulations and is not aware of any pending or
threatening investigations involving allegations of potential wrongdoing that
would have a material effect on the Company's financial statements. Compliance
with such laws and regulations can be subject to future government review and
interpretation as well as significant regulatory action including fines,
penalties and exclusion from the Medicare and Medicaid programs.
On November 24, 1998, Arrowhead was notified that effective December 2,
1998 the hospital would be decertified by the Healthcare Financing
Administration from participation in the Medicare/Medicaid programs due to
alleged noncompliance with the Conditions of Participation (the Conditions).
Arrowhead disagreed with the findings and obtained a temporary restraining
order. On December 24, 1998, the Healthcare Financing Administration rescinded
the termination action. However, Arrowhead remains subject to the Healthcare
Financing Administration performing a
F-64
PHOENIX BAPTIST HOSPITAL AND MEDICAL CENTER, INC.,
ARROWHEAD COMMUNITY HOSPITAL AND MEDICAL CENTER, INC. AND AFFILIATES
NOTES TO COMBINED STATEMENTS OF OPERATIONS AND CASH FLOWS
validation survey at which time Arrowhead must establish that it fully meets
the Conditions. Management is of the opinion that the hospital will maintain
compliance and, therefore, should retain its certification. Management is also
of the opinion that the "provisional" license issued to Arrowhead by the
Arizona Department of Health Services on the basis of related findings will be
reinstated to a full license status.
Charity Care
The Company provides care to all patients meeting certain criteria under
its charity care policy without charge or at amounts less than its established
rates. A patient is classified as a charity patient by reference to policies
established by the Company as to the ability of the patient to pay. The Company
does not pursue collection of amounts determined to qualify as charity care,
and, accordingly, they are not recorded as revenue. Charity care services,
which are excluded from revenue, totaled approximately $4,902,000 and
$7,861,000 for the years ended August 31, 1998 and 1999, respectively, and
$6,503,000 for the nine months ended May 31, 2000 when measured at established
rates.
Premium Revenue
The Company has agreements with various managed care organizations to
provide medical services to subscribing participants. Under these agreements,
the Company receives monthly capitation payments based on the number of
participants, regardless of services actually performed by the Company. The
Company recognizes revenues in the month that members are entitled to health
care services regardless of services actually provided.
Corporate Allocation Expense
Baptist Hospitals and Health Systems incurs various corporate general and
administrative expenses. These corporate overhead expenses are allocated to the
Company based on gross revenues. In the opinion of management, this allocation
method is reasonable.
Data Processing Expense
Baptist Hospitals and Health Systems maintains a centralized data
processing center for the benefit of the Company. Expenses are allocated to the
Company based upon the hours of usage by the entities comprising the Company.
In the opinion of management, this allocation method is reasonable. Data
processing expenses totaled approximately $3,928,000 and $5,424,000 for the
years ended August 31, 1998 and 1999, respectively, and $3,825,000 for the nine
months ended May 31, 2000. These expenses are included as a component of
supplies and other in the accompanying combined statements of operations.
Intercompany Interest
Certain of the entities comprising the Company are charged interest
expense or accrue interest income at the prime interest rate as applied to the
prior month's outstanding intercompany balance. Interest expense totaled
approximately $271,000 and $549,000 for the years ended August 31, 1998 and
1999, respectively, and $1,059,000 for the nine months ended May 31, 2000.
3. Concentrations of Credit Risk
The Company grants credit without collateral to its patients, most of whom
are local residents of the areas surrounding the hospitals, or are skilled
nursing facility or retirement center patients or residents, and are insured
under third-party payor agreements. The payor mix of accounts receivables as of
August 31, 1998 and 1999 and May 31, 2000 are as follows:
F-65
PHOENIX BAPTIST HOSPITAL AND MEDICAL CENTER, INC.,
ARROWHEAD COMMUNITY HOSPITAL AND MEDICAL CENTER, INC. AND AFFILIATES
NOTES TO COMBINED STATEMENTS OF OPERATIONS AND CASH FLOWS
1998 1999 2000
---- ---- ----
Medicare and Arizona Health Care System programs.. 22% 21% 19%
Other insurance payors............................ 63 60 66
Patient pay....................................... 15 19 15
--- --- ---
100% 100% 100%
=== === ===
4. Long-Term Debt
Series 1996 Revenue Bonds
In 1996, Phoenix Baptist, Arrowhead, and the affiliated entities jointly
issued $32,540,000 of Series 1996 Industrial Development Authority Revenue
Bonds (Series 1996 Revenue Bonds) to provide for the payment of certain
construction and renovation projects at Phoenix Baptist, Arrowhead, and
affiliated entities. The Series 1996 Revenue Bonds bear interest rates ranging
from 4.30 percent to 5.75 percent payable semiannually, with principal payable
annually through September 1, 2027.
Series 1995 Refunding Bonds
In 1995, Phoenix Baptist, Arrowhead, and affiliated entities in connection
with the sale of Manatee Hospitals and Health Systems, Inc. (Manatee), jointly
issued $56,020,000 of Series 1995 Industrial Development Authority Revenue
Refunding Bonds (Series 1995 Refunding Bonds) to refinance Phoenix Baptist's
and an affiliated entity's Series 1993 Refunding Bonds and Arrowhead's Series
1985 Revenue Bonds. A portion of the proceeds from the 1995 sale of Manatee was
used to defease the remaining Manatee Series 1985, 1987, 1988 and 1991 bonds
along with the Phoenix Baptist and an affiliated entity Series 1992 bonds in
advance of their stated maturities. The proceeds of the Series 1995 Refunding
Bonds along with proceeds from the sale of Manatee, were used to pay issuance
costs and the remainder was used to purchase U.S. Government Securities which
have been deposited into escrow accounts administered by the trustee. The
earnings and principal maturities of the securities in the trust will be
sufficient to provide adequate funds for payment of all principal and interest
on the refinanced bonds. The Series 1995 Refunding bonds bear interest rates
ranging from 3.90 percent to 5.75 percent payable semiannually, with principal
payable semiannually through September 1, 2016.
Other
Baptist Hospitals and Health Systems sold the operations and certain of
the net assets of the Company to Vanguard Health Systems, Inc. effective June
1, 2000. In connection with this transaction, the obligations referred to above
were retired subsequent to May 31, 2000.
5. Self-Insurance Program
Professional Malpractice and General Liability
Baptist Hospitals and Health Systems maintains an occurrence-based
insurance policy with an outside insurance carrier for professional malpractice
and general liability risks of the Company. Under this policy, Baptist
Hospitals and Health Systems is self-insured for 50 percent of the first
$200,000 of each paid claim with no aggregate limit. Baptist Hospitals and
Health Systems accrues and maintains a liability for the self-insured portion
of both known claims and estimated claims that have been incurred but have not
yet been reported. The related expenses are allocated by Baptist Hospitals and
Health Systems to the Company based on actuarially determined rates.
Professional malpractice and general liability expenses were approximately
$1,505,000 and $1,145,000 for the years ended August 31, 1998 and 1999,
respectively, and $722,000 for the nine months ended May 31, 2000.
F-66
PHOENIX BAPTIST HOSPITAL AND MEDICAL CENTER, INC.,
ARROWHEAD COMMUNITY HOSPITAL AND MEDICAL CENTER, INC. AND AFFILIATES
NOTES TO COMBINED STATEMENTS OF OPERATIONS AND CASH FLOWS
Workers' Compensation
Baptist Hospitals and Health Systems maintains, on behalf of the Company,
a retrospectively rated, occurrence-based insurance policy with a commercial
insurer with regard to workers compensation claims incurred by the Company. The
costs associated with this policy are allocated to the Company by Baptist
Hospitals and Health Systems based on actuarially determined rates. The cost
incurred by the Company was approximately $540,000 and $458,000 for the years
ended August 31, 1998 and 1999, respectively, and $333,000 for the nine months
ended May 31, 2000.
Employee Health and Dental
Baptist Hospitals and Health Systems maintains a self-insurance program
for employee health and dental claims for the Company. Baptist Hospitals and
Health Systems estimates and maintains the liability for both known and
incurred but not reported claims and allocates the related expense to the
Company based on actuarially determined rates. Additionally, Baptist Hospitals
and Health Systems allocates a claim processing fee to the Company equal to 6
percent of monthly paid claims. Health and dental expenses, including the claim
processing fees, were approximately $3,475,000 and $3,764,000 for the years
ended August 31, 1998 and 1999, respectively, and $2,963,000 for the nine
months ended May 31, 2000.
6. Pension Plan
Baptist Hospitals and Health Systems sponsors a defined benefit retirement
plan covering all employees meeting eligibility requirements. Benefits are
based on an employee's average compensation for a consecutive five-year period.
Pension plan expenses were approximately $627,000 and $786,000 for the years
ended August 31, 1998 and 1999, respectively, and $613,000 for the nine months
ended May 31, 2000.
7. Functional Expenses
A summary of expenses by functional classification for the years ended
August 31, 1999 and 1998 and for the nine months ended May 31, 2000 follows:
1998 1999 2000
-------- ------- --------
(in thousands)
Patient services.............. $129,754 $137,311 $109,413
General and administrative.... 16,695 23,796 12,945
-------- -------- --------
$146,449 $161,107 $122,358
======== ======== ========
8. Commitments and Contingencies
Leases
The Company leases office space and certain equipment under both operating
and capital lease agreements. Future minimum lease payments under noncancelable
operating leases with terms greater than one year and capital leases at May 31,
2000, are as follows:
F-67
PHOENIX BAPTIST HOSPITAL AND MEDICAL CENTER, INC.,
ARROWHEAD COMMUNITY HOSPITAL AND MEDICAL CENTER, INC. AND AFFILIATES
NOTES TO COMBINED STATEMENTS OF OPERATIONS AND CASH FLOWS
Operating Capital
--------- -------
(in thousands)
2001........................................ $ 682 $ 983
2002........................................ 459 860
2003........................................ 360 676
2004........................................ 317 536
Thereafter.................................. 18 --
------ ------
1,836 3,055
Amount representing interest................ 376
------
Present value of minimum lease payments..... $2,679
======
Total rent expense under operating leases was approximately $2,852,000 and
$3,156,000 for the years ended August 31, 1998 and 1999, respectively, and
$2,811,000 for the nine months ended May 31, 2000.
Threatened Claim
Management is aware of a threatened claim against Phoenix Baptist Hospital
and Medical Center, Inc. and Arrowhead Community Hospital and Medical Center,
Inc. and others. However, management is precluded by court order from
disclosing the nature or substance of the claim. Because of the court order,
management is unable at this time to make an evaluation of the claim or an
estimate of the potential loss. Management can say that the companies
identified above are responding to the threatened claim and are working toward
resolving the matter on acceptable terms, or failing that, defending against
the claim if required to do so.
Other
The Company is a party to various assertions and legal actions arising in
the normal course of operations. In this regard, there are known incidences
that might result in the assertion of additional claims. Based on consultation
with counsel and an evaluation of such matters, management is of the opinion
that such matters are either adequately covered by insurance or valid defenses
exist, and accordingly, the outcome of such matters should not have a material
adverse effect on the consolidated financial position of the Company.
F-68
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
PMH Health Services Network and Affiliate
We have audited the accompanying combined statements of operations and
cash flows of PMH Health Services Network and Affiliate (the "Network") for the
seven months ended January 31, 2001 and the combined statements of operations
and changes in net assets in liquidation for the period from February 1, 2001
to April 30, 2001. These financial statements are the responsibility of the
Network's management. Our responsibility is to express an opinion on these
financial statements based on our audit. The financial statements of the
Network for the years ended June 30, 2000 and 1999 were audited by other
auditors whose report, dated June 14, 2001, expressed an unqualified opinion on
those statements and included an explanatory paragraph that disclosed a going
concern uncertainty.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
As described in Note 1 to the financial statements, the Network executed
an agreement to sell substantially all of its assets on January 31, 2001. In
addition, the Network filed for reorganization under Chapter 11 of the U.S.
Bankruptcy Code. As a result, the company has changed its basis of accounting
for periods subsequent to January 31, 2001 from the going-concern basis to the
liquidation basis.
In our opinion, the 2001 financial statements referred to above present
fairly, in all material respects, the results of operations and cash flows for
the seven months ended January 31, 2001 and the results of operations and
changes in net assets in liquidation for the period from February 1, 2001 to
April 30, 2001, in conformity with accounting principles generally accepted in
the United States applied on the bases described in the preceding paragraph.
/s/ Ernst & Young LLP
Nashville, TN
July 27, 2001
F-69
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Vanguard Health Systems, Inc.
We have audited the accompanying combined statements of operations,
changes in net assets and cash flows of PMH HEALTH SERVICES NETWORK (an Arizona
not-for-profit corporation) and affiliate (the Network) (see Note 1) for each
of the two years in the period ended June 30, 2000. These combined financial
statements are the responsibility of the Network's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the combined financial statements referred to above of the
Network present fairly, in all material respects, the results of their
operations and their cash flows for each of the two years in the period ended
June 30, 2000, in conformity with accounting principles generally accepted in
the United States.
The accompanying combined financial statements have been prepared assuming
that the Network will continue as a going concern. As discussed in Note 1 to
the financial statements, the Network has incurred substantial losses from
operations, has a working capital deficit and defaulted on its bonds payable.
As a result of these and other matters, the Network filed a voluntary petition
for reorganization under Section 363 of Chapter 11 of the U.S. Bankruptcy Code
in February 2001. Also in May 2001, a substantial portion of the Network's
assets and certain of its liabilities were sold to a third party. The Network
is presently operating its business as a debtor-in-possession under Chapter 11
and is subject to the jurisdiction of the U.S. Bankruptcy Court. These factors
raise substantial doubt as to the ability of the Network to continue as a going
concern. These matters are more fully discussed in Note 1 of the accompanying
combined financial statements. The accompanying combined financial statements
do not include any adjustments relating to the recoverability and
classification of recorded asset carrying amounts or the amount and
classification of liabilities, other than as described in Note 1, that might
result should the Network be unable to continue as a going concern.
/s/ ARTHUR ANDERSEN LLP
Phoenix, Arizona
June 14, 2001
F-70
COMBINED STATEMENT OF CHANGES IN NET ASSETS IN LIQUIDATION
(Liquidation Basis)
For the period February 1, 2001 to April 30, 2001
(in thousands)
Net assets at February 1, 2001......................... $(48,425)
Loss from operations................................... (36)
Adjustment to liquidation basis........................ (851)
--------
Net assets in liquidation at April 30, 2001............ $(49,312)
========
See accompanying notes.
F-71
PMH HEALTH SERVICES NETWORK AND AFFILIATE
COMBINED STATEMENTS OF OPERATIONS
(Liquidation
(Going Concern Basis) Basis)
---------------------------------------------- ---------------
Year ended Year ended February 1,
June 30, June 30, July 1, 2000 to 2001 to April
1999 2000 January 31, 2001 30, 2001
---------- ---------- ---------------- --------------
(in thousands)
Unrestricted revenue, gains and other support
Net patient revenue................................. $ 57,217 $ 58,425 $31,374 $ 9,733
Premium revenue -- patient services................. 91,336 107,363 51,850 24,189
Other revenue....................................... 2,386 2,169 2,432 1,333
-------- -------- ------- -------
Total revenue, gains and other support............ 150,939 167,957 85,656 35,255
-------- -------- ------- -------
Expenses:
Salaries and wages.................................. 35,757 34,010 16,471 6,574
Employee benefits................................... 5,413 5,964 2,873 1,259
Medical fees, net of reinsurance.................... 82,993 91,521 44,162 17,581
Supplies............................................ 11,921 12,027 5,573 2,310
Purchased services and other........................ 20,207 20,563 13,617 2,963
Depreciation and amortization....................... 3,303 3,869 2,366 1,056
Interest............................................ 2,441 2,831 2,192 775
Provision for doubtful accounts..................... 8,217 16,579 6,227 2,773
Loss on asset impairment............................ -- 13,261 -- --
-------- -------- ------- -------
Total expenses.................................... 170,252 200,625 93,481 35,291
-------- -------- ------- -------
Loss before adjustment to liquidation basis......... (19,313) (32,668) (7,825) (36)
Adjustment to liquidation basis................... -- -- -- (851)
-------- -------- ------- -------
Net loss............................................. (19,313) (32,668) (7,825) (887)
Unrestricted contribution of property and equipment
by affiliate and other transfers.................... -- 2,373 562 --
-------- -------- ------- -------
Decrease in unrestricted net assets.................. $(19,313) $(30,295) $(7,263) $ (887)
======== ======== ======= =======
See accompanying notes.
F-72
PMH HEALTH SERVICES NETWORK AND AFFILIATE
COMBINED STATEMENTS OF CASH FLOWS
(Going Concern Basis)
----------------------------------------------------------
Year ended Year ended July 1, 2000 to
June 30, 1999 June 30, 2000 January 31, 2001
------------- ------------- ----------------
(in thousands)
Cash flows from operating activities:
Decrease in net assets............................................ $(19,289) $(30,344) $(7,263)
Adjustments to reconcile increase in net assets to net cash
provided by (used in) operating activities
Depreciation and amortization..................................... 3,303 3,869 2,366
Provision for doubtful accounts................................... 8,217 16,579 6,227
Unrestricted contribution of property and equipment by
affiliate........................................................ -- (2,318) (562)
Loss on asset impairment.......................................... -- 13,261 --
Loss on disposal of assets........................................ 158 -- --
Changes in certain assets and liabilities:
Decrease (increase) in
Accounts receivable............................................ (4,976) (11,563) (1,855)
Other receivables.............................................. 152 310 1,682
Inventories.................................................... 195 (5) (55)
Other current assets........................................... (445) 651 315
Increase (decrease) in
Accounts payable............................................... 8,741 (480) 4,280
Accrued liabilities............................................ (61) 329 352
Accrued medical claims......................................... 4,163 5,942 (3,936)
Due to third party programs.................................... 756 (1,844) 529
Other liabilities.............................................. 36 (118) (572)
-------- -------- -------
Net cash provided by (used in) operating activities.......... 950 (5,731) 1,508
-------- -------- -------
Cash flows from investing activities:
Payments for purchase of property and equipment.................. (4,455) (2,340) (513)
Proceeds from sale of property and equipment..................... 11 -- --
(Increase) decrease in investments limited as to use............. (103) (101) 301
Decrease in noncurrent receivables and other assets.............. 622 912 1,582
-------- -------- -------
Net cash (used in) provided by investing activities............ (3,925) (1,529) 1,370
-------- -------- -------
Cash flows from financing activities:
Borrowings under short-term financing activities................. -- 8,667 8,769
Payment of long-term debt, capital lease obligations and short
term borrowings................................................ (745) (1,712) (10,406)
Decrease (increase) in due from affiliates....................... (483) 62 --
-------- -------- -------
Net cash (used in) provided by financing activities............ (1,228) 7,017 (1,637)
-------- -------- -------
Increase (decrease) in cash and cash equivalents.................. (4,203) (243) 1,241
Cash and cash equivalents, beginning of year...................... 6,794 2,591 2,348
-------- -------- -------
Cash and cash equivalents, end of year............................ $ 2,591 $ 2,348 $ 3,589
======== ======== =======
F-73
PMH HEALTH SERVICES NETWORK AND AFFILIATE
COMBINED STATEMENTS OF CASH FLOWS (Continued)
(Going Concern Basis)
------------------------------------------------------
July 1, 2000 to
Year ended Year ended January 31,
June 30, 1999 June 30, 2000 2001
------------- ------------- ---------------
(in thousands)
Supplemental disclosure of cash flow information:
Cash paid for interest, net of amount capitalized........... $2,449 $3,029 $1,974
====== ====== ======
Noncash investing and financing activities:
Equipment purchased under capital lease..................... $ -- $5,189 $ --
====== ====== ======
Unrestricted contribution of property and equipment by
affiliate................................................. $ -- $2,318 $ --
====== ====== ======
See accompanying notes.
F-74
PMH HEALTH SERVICES NETWORK AND AFFILIATE
NOTES TO COMBINED FINANCIAL STATEMENTS
For the Years Ended June 30, 1999 and 2000 and
for the Ten Months Ended April 30, 2001
1. Organization and Operations
Organization
PMH Health Services Network (an Arizona not-for-profit corporation) (the
"Network") was incorporated in 1994. PMH Health Resources, Inc. (an Arizona
not-for-profit corporation) is the sole corporate member of the Network.
The principal operations of the Network include a 223-bed comprehensive
acute care medical center ("Medical Center") and the Phoenix Health Plan LLC
(the "Phoenix Health Plan"). The Phoenix Health Plan, an Arizona Limited
Liability Company, is a contractor with the Arizona Health Care Cost
Containment System (the "Arizona Health Care System"), a publicly funded
alternative to Medicaid in the State of Arizona. The Network is a member of a
group of affiliated health care organizations (collectively, the "Companies")
each of which is controlled by PMH Health Resources, Inc. and which have common
representation on certain boards of governance. The Network's primary service
area includes the southwest Phoenix area. During fiscal 2001, the Network
ceased operations of its skilled nursing unit.
A significant portion of the Network's revenues are earned under the
contract with the Arizona Health Care System. Arizona Health Care System
requires compliance with certain operating and other guidelines by all of its
contractors and has the authority to impose sanctions and restrictions, as
defined in its contractor agreements (see Note 6).
The Network is exempt from federal income taxes under Section 501(c)(3) of
the Internal Revenue Code. The accompanying combined financial statements
include the accounts of the Medical Center and the Phoenix Health Plan. The
Medical Center provides services to members of the Phoenix Health Plan at rates
which approximate market rates. The Network also provides administrative
services to the Phoenix Health Plan, at amounts approximating cost, under an
arrangement with the Arizona Health Care System. Significant intercompany
activities have been eliminated in combination.
Transaction with Vanguard
Effective January 31, 2001, the Companies entered into a definitive
agreement (the "Asset Purchase Agreement") to sell, other than in the ordinary
course of business, substantially all of the assets of the Network to Vanguard
Health Systems, Inc. ("Vanguard"). Pursuant to the Asset Purchase Agreement,
Vanguard agreed to purchase the buildings, land and operating equipment of the
Medical Center, the operating equipment of Phoenix Health Plan, and agreed to
assume certain liabilities including the net medical claims payable of Phoenix
Health Plan up to $22 million, and other liabilities defined in the Asset
Purchase Agreement. The total purchase price paid by Vanguard, including
assumed liabilities, for the identified assets of the Network was $38.9
million. The transaction was consummated effective May 1, 2001.
The following assets of the Network were specifically excluded from the
Asset Purchase Agreement:
o All cash and accounts receivable of the Medical Center, and all other
current assets, except inventory and supplies and usable prepaid
expenses, and long-term notes receivable,
o All funds held by trustees pursuant to the Series 1991 Bonds,
o Cost report settlement receivables,
o Ownership or investments in the Palm Valley Medical Building Limited
Partnership, the 1021 Medical Office Building Limited Partnership,
the Homecare Network of Arizona, LLC and the South Valley Medical
Center Partnership,
F-75
PMH HEALTH SERVICES NETWORK AND AFFILIATE
NOTES TO COMBINED FINANCIAL STATEMENTS
o Assets restricted as to use, and
o All rights of the Network to take title to the real property at
Estrella Mountain Ranch.
Network Operations Under Chapter 11
On February 1, 2001 (the "Filing Date"), PMH Health Resources, Inc. and
Affiliates (including the Network), filed voluntary petitions for
reorganization under Section 363 of Chapter 11 of the U.S. Bankruptcy Code
(Chapter 11). The Companies and the Network are presently operating as a
debtor-in-possession under Chapter 11 and are subject to the jurisdiction of
the U.S. Bankruptcy Court (the "Bankruptcy Court"). Under Chapter 11, certain
claims against the Network in existence prior to the Filing Date are stayed
while the Network continues its operations as a debtor-in-possession.
Additional Chapter 11 claims have arisen and may continue to arise subsequent
to the Filing Date resulting from the rejection of executory contracts,
including leases, and from the determination by the Bankruptcy Court of allowed
claims for contingencies and other disputed amounts. Claims secured by the
Network's assets (secured claims) also are stayed although the holders of such
claims have the right to petition the Bankruptcy Court for relief from the
automatic stay to permit such creditors to foreclose on the property securing
their claim.
The Network has determined that, generally, the fair market value of the
collateral is less than the principal amount of its related secured prepetition
debt obligations. The Network received approval from the Bankruptcy Court to
pay or otherwise honor certain of its prepetition obligations, including
employee wages and benefits.
Under the Bankruptcy Court, the Network may elect to assume or reject real
estate leases, employment contracts, personal property leases, services
contracts and other unexpired executory prepetition contracts, subject to
Bankruptcy Court approval. The Network cannot presently determine with
certainty the ultimate aggregate liability which will result from the filing of
claims relating to such contracts which have been or may be rejected.
2. Significant Accounting Policies
Basis of Presentation
As a result of the Asset Purchase Agreement and the reorganization
petition, the Network has begun the liquidation process and, in accordance with
generally accepted accounting principles, the Network's financial statements
for periods subsequent to January 31, 2001 have been prepared on a liquidation
basis. Accordingly, the carrying value of the Network's assets are presented at
estimated net realizable amount and all liabilities are presented at estimated
settlement amounts, including estimated costs associated with carrying out the
liquidation. Preparation of the financial statements on a liquidation basis
requires significant assumptions by management, including the estimate of
liquidation costs and the resolution of any contingent liabilities. There may
be differences between the assumptions and the actual results because events
and circumstances may not occur as expected. Those differences, if any, could
result in a change in the net assets recorded in the statement of changes in
net assets in liquidation for the period from February 1, 2001 to April 30,
2001.
Use of Estimates
The preparation of the Network's combined financial statements in
conformity with accounting principles generally accepted in the United States
requires management to make estimates and assumptions that affect amounts
reported in the combined financial statements and accompanying notes. Actual
results could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents include all highly liquid investments with a
remaining maturity of three months or less at date of acquisition, excluding
amounts whose use is limited by board designation or other arrangements under
trust agreements.
F-76
PMH HEALTH SERVICES NETWORK AND AFFILIATE
NOTES TO COMBINED FINANCIAL STATEMENTS
Inventories
Inventories, consisting principally of supplies, are stated at the lower
of cost (first-in, first-out method) or market.
Property and Equipment
Property and equipment is recorded on the basis of cost if purchased or
fair market value at the date of donation, net of accumulated depreciation.
Depreciation is computed using the straight-line method over the estimated
useful lives of the respective assets. Estimated useful lives by classification
were as follows:
Land improvements.................................. 5 to 25 years
Buildings and leasehold improvements............... 5 to 40 years
Equipment and building service equipment........... 3 to 30 years
Depreciation expense totaled approximately $3,134,000, $3,741,000 and
$3,422,000 for the years ended June 30, 1999 and 2000 and for the ten months
ended April 30, 2001.
Long-Lived Assets
The Network periodically evaluated the carrying value of long-lived assets
in accordance with Statement of Financial Accounting Standards (SFAS) No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of. Under SFAS 121, long-lived assets to be held and used in
operations are reviewed for impairment whenever events or circumstances
indicate that the carrying amount of an asset may not be fully recoverable. An
impairment loss is recognized if the sum of the expected long-term undiscounted
cash flows is less than the carrying amount of the long-lived assets being
evaluated. For the year ended June 30, 2000, the Network recognized an
impairment loss of approximately $13,261,000 related to the land and buildings
of the Medical Center. The amount of the impairment estimate was based upon a
discounted cash flow analysis prepared by management and values established by
the Vanguard Asset Purchase Agreement.
Accrued Medical Claims
Phoenix Health Plan's expense for hospitalization, medical compensation
and ancillary services is included in medical fees in the combined statements
of operations, and includes estimates for incurred but not reported ("IBNR")
medical claims. These estimates are periodically revised by management based on
current claims data. Medical fees expense is reported net of reinsurance
recoveries as discussed further in the Premium Revenue -- Patient Services
portion of Note 2.
Donor Restricted Gifts
Unconditional promises to give cash and other assets to the Network are
reported at fair value at the date the promise is received. Conditional
promises to give and indications of intentions to give are reported at fair
value at the date the gift is received. The gifts are reported as temporarily
restricted support if they are received with donor stipulations that limit the
use of the donated assets. When a donor restriction expires, that is, when a
stipulated time restriction ends or the restriction is satisfied, temporarily
restricted net assets are reclassified as unrestricted net assets and reported
in the combined statements of operations as net assets released from
restrictions. Donor restricted contributions whose restrictions are met within
the same year as received are reported as unrestricted contributions in the
accompanying combined financial statements. During 2000 and 2001, the Phoenix
Memorial Health Foundation, an uncombined affiliate whose sole corporate member
is PMH Health Resources, Inc., contributed property and equipment to the
Network of approximately $2,318,000 and $562,000, respectively.
F-77
PMH HEALTH SERVICES NETWORK AND AFFILIATE
NOTES TO COMBINED FINANCIAL STATEMENTS
Management Fees
PMH Health Resources, Inc. provides management and other services to its
affiliates, including the Network. These charges, at cost, were $1,793,000,
$2,079,000 and $1,528,000 for the years ended June 30, 1999 and 2000 and for
the ten months ended April 30, 2001, respectively. Such amounts are included in
purchased services and other in the accompanying combined statements of
operations.
Net Patient Revenue
The Network records all patient revenues on the basis of customary charges
to private patients. The Network provides services to beneficiaries of
Medicare, Arizona Health Care System and other programs for which it is
reimbursed at amounts which vary from customary charges. The difference between
charges and reimbursement from these programs is reflected as a reduction in
charges in determining net patient revenue.
Inpatient acute care services rendered to Medicare program beneficiaries
are paid at prospectively determined rates per discharge. These rates vary
according to a patient classification system that is based on clinical,
diagnostic and other factors. For the years ended June 30, 1999 and 2000,
outpatient and home health services related to Medicare beneficiaries were paid
based on a cost reimbursement methodology with final settlement determined
after submission of annual cost reports by the Medical Center and audits
thereof by the Medicare fiscal intermediary. These cost reports have been
audited by the Medicare fiscal intermediary through June 30, 1998. Outpatient
and home health services related to Medicare beneficiaries provided after
August 1, 2000 and October 1, 2000, respectively, are reimbursed based on
prospectively determined rates. Approximately 40%, 44% and 37% of net patient
revenue was derived from services provided to Medicare patients, including
those patients covered by commercial Medicare plans for the years ended June
30, 1999 and 2000 and for the ten months ended April 30, 2001, respectively.
Final determination of amounts earned under the Medicare program often
occurs in subsequent years because of audits by the program, rights of appeal
and the application of numerous technical provisions. Differences between
original estimates and subsequent revisions (including final settlements) are
included in the statement of operations in the period in which the revisions
are made. Management believes that adequate provisions have been made for
adjustments that may result from final determination of amounts earned under
the Medicare and programs.
Revenues for services to members of Phoenix Health Plan are described
below. Care is also provided at negotiated fees to Arizona Health Care System
patients who are not members of Phoenix Health Plan. Other Arizona Health Care
System plans accounted for less than 10% of net patient revenue in fiscal 1999,
2000 and 2001. Reimbursement under Arizona Health Care System contracts is less
than charges and the discounts are included in determining net patient revenue.
Premium Revenue - Patient Services
Phoenix Health Plan receives capitated payments under its Arizona Health
Care System contract based upon the number of enrollees. The payments are
recorded as premium revenue -- patient services in the period earned, which is
generally the period when payment is received. Expenses related to healthcare
services provided to Phoenix Health Plan members are recorded when incurred.
Phoenix Health Plan is required to provide all healthcare services to its
members and is at risk for hospital and other medical service claims which
exceed its capitation. Phoenix Health Plan refers a portion of its inpatients
and outpatients to the Medical Center and subcontracts with physician
specialists and unaffiliated hospitals to provide covered services to patients
enrolled in Phoenix Health Plan on a negotiated basis. Transactions with the
Medical Center eliminate in combination. Additionally, Phoenix Health Plan
receives reimbursement from the Arizona Health Care System program for certain
medical costs incurred for members requiring extended lengths of stay
(reinsurance). Reinsurance recoveries are accounted for as a reduction of the
related medical fee expenses incurred in the period services are provided and
Arizona Health Care System mandated reinsurance requirements are met. Medical
fees expense has been reduced by reinsurance recoveries of approximately
$3,388,000, $3,741,000 and $2,730,000 for the fiscal years 1999, 2000 and the
ten months ended April 30, 2001, respectively.
F-78
PMH HEALTH SERVICES NETWORK AND AFFILIATE
NOTES TO COMBINED FINANCIAL STATEMENTS
Phoenix Health Plan accounted for substantially all of the premium revenue -
patient services during fiscal years 1999, 2000 and the ten months ended April
30, 2001.
Charity Care
In addition to the Network's sponsorship and support of various community
service programs and projects, the Network provides care to all patients
meeting certain criteria under its charity care policy without charge or at
amounts less than its established rates. A patient is classified as a charity
patient by reference to policies established by the Network as to the ability
of the patient to pay. The Network does not pursue collection of amounts
determined to qualify as charity care, and, accordingly, they are not recorded
as revenue.
Other Revenue
Other revenue consists of revenue generated from nutrition services, gift
shop sales, and interest income.
3. Adjustment to Liquidation Basis
On April 30, 2001, in accordance with the liquidation basis of accounting,
assets were adjusted to estimated net realizable value and liabilities were
adjusted to estimated settlement amounts, including estimated costs associated
with carrying out the liquidation. The net adjustment required to convert from
the going concern (historical cost) basis to the liquidation basis of
accounting was a decrease in net assets of $851,000 which is included in the
accompanying combined statement of changes in net assets in liquidation.
4. Concentrations of Credit Risk
The Network grants credit without collateral to its patients, most of whom
are local residents of the areas surrounding the Medical Center and are insured
under third-party payor agreements. The payor mix of accounts receivables as of
June 30, 1999 and 2000 and April 30, 2001 is as follows:
1999 2000 2001
---- ---- ----
Medicare and Arizona Health Care System programs.. 57% 64% 62%
Other insurance payors............................ 36 24 25
Patient pay....................................... 7 12 13
--- --- ---
100% 100% 100%
=== === ===
5. Debt and Obligations Under Capital Leases
Series 1991 Hospital Refunding Revenue Bonds
The Network has a Loan and Trust Agreement (the "Agreement") with the
Arizona Health Facilities Authority (the "Authority") covering $32,255,000 of
Arizona Health Facilities Authority Hospital Refunding Revenue Bonds Series
1991 ("Series 1991 Bonds"). The Series 1991 Bonds were issued at a discount to
yield an effective interest rate of 8.22%. The discount was approximately
$577,000 and prior to the conversion from the going concern to the liquidation
basis of accounting, was being amortized over the term of the Series 1991 Bonds
using the effective interest method.
The Series 1991 Bonds have coupon rates of 5.75% to 8.20% and are secured
by certain property and accounts receivable of the Network as defined in the
agreement.
F-79
PMH HEALTH SERVICES NETWORK AND AFFILIATE
NOTES TO COMBINED FINANCIAL STATEMENTS
The Network paid approximately $946,000 in issue costs related to the
Series 1991 Bonds. These issue costs were capitalized and, prior to the
conversion from the going concern to the liquidation basis of accounting, were
being amortized over the term of the Series 1991 Bonds using the effective
interest method.
Short-Term and Debtor-In-Possession Financing
On May 15, 2000, the Network entered into a short-term financing agreement
which permits the Network to borrow up to $9.0 million, based on eligible
accounts receivable as defined in the agreement. At April 30, 2001, the Network
had borrowed approximately $5,555,000. The loan is secured by accounts
receivable at the Medical Center and bears interest at 9.75%. At the time of
the bankruptcy filing, the outstanding amount under the short-term financing
agreement was $7,479,000.
Subsequent to February 2001, the Network entered into another short-term
financing agreement to provide the Network with debtor-in-possession financing
(the "DIP Financing Agreement"). The DIP Financing Agreement provides for
maximum borrowings by the Network of $5.5 million. As of April 30, 2001, the
Network had an outstanding balance under the DIP Financing Agreement of
$5,491,000. Effective May 1, 2001, in connection with the sale of certain
assets to Vanguard and pursuant in the Asset Purchase Agreement, the
outstanding amount was repaid in full from the proceeds of the sale.
Obligations Under Capital Leases
The Network leases certain equipment under leases which have been
capitalized. Amortization of the capitalized amounts is included in
depreciation and amortization expense.
6. Commitments and Contingencies
Arizona Health Care System Compliance
Phoenix Health Plan's revenues comprised approximately 61%, 64% and 61% of
the Network's net revenues during 1999, 2000 and the ten months ended April 30,
2001, respectively. Phoenix Health Plan operates under a contract with the
Arizona Health Care System which expires on September 30, 2003. Under the
contract with the Arizona Health Care System, Phoenix Health Plan maintains a
performance bond in the amount of approximately $8.3 million. The performance
bond expires December 31, 2001, and is secured by certain real estate of the
Network. Phoenix Health Plan increased the performance bond to 125% of
capitation in January 2001, as required by the Arizona Health Care System.
The Arizona Health Care System contract contains financial viability and
performance measures which Phoenix Health Plan must meet, including a current
ratio of at least 1.0, equity per member of at least $150, a medical expense
ratio of at least 85%, an administrative cost ratio of no more than 10%, and
days outstanding for received but unpaid claims of no more than 30 days. For
the ten months ended April 30, 2001, Phoenix Health Plan was not in compliance
with the current ratio, equity per member and the days outstanding for received
but unpaid claims requirements.
As a result of the foregoing, the Arizona Health Care System placed a
temporary restriction on new member enrollment in March 2000, a restriction
that was removed on October 1, 2000, pursuant to the agreement described in the
following paragraph. In addition, to comply with Arizona Health Care System
regulations, subsequent to June 30, 1999, the Network transferred the
operations of Phoenix Health Plan to a newly formed separate legal entity,
Phoenix Health Plan LLC.
Through June 30, 2000, Phoenix Health Plan had made cash advances to the
Network totaling approximately $40.2 million. The Arizona Health Care System
requested a repayment plan of the advances made by Phoenix Health Plan to
the Network. Subsequent to June 30, 2000, management entered into an agreement
with the Arizona Health Care System to facilitate repayment of the advances.
Under the agreement, Phoenix Health Plan will withhold a percentage of payments
due to the Network for medical or administrative services and use such amounts
to reduce the advances. The
F-80
Network also agreed to have the amount in excess of $1,000,000 of its Medicaid
disproportionate share payment for fiscal 2000 applied to the advances.
Subsequent to June 30, 2000, the Network received approximately $739,000 of
excess Medicaid disproportionate payments for fiscal 2000 which were applied to
the advances. None of the Medicaid disproportionate share payment for fiscal
2001 was applied to the advances. In addition, management agreed to use $15
million in funds received as a result of the transaction with Vanguard to
reduce advances. The intercompany balances between the Network and Phoenix
Health Plan have been eliminated in the preparation of these combined financial
statements.
Leases
Total lease expense for the years ended June 30, 1999 and 2000 and the ten
months ended April 30, 2001 was approximately $3,350,000, $3,128,000 and
$2,197,000, respectively, and is included in purchased services and other
expenses in the combined statements of operations.
Retirement Plan
The PMH Health Services Network Retirement Plan (the Plan) is a defined
contribution tax deferred annuity plan. Under the terms of the Plan, all
employees who are at least 21 years of age are eligible to participate in the
Plan and may contribute up to $10,000 per plan year. For each employee who has
worked at least 3 years, the Network will annually contribute 50% of the
employees' contribution, up to a maximum of 3% of their annual compensation.
All contributions are immediately 100% vested and are invested by Lincoln
National Pension Company in the annuity account selected by the employees. Both
fixed and variable annuity accounts are offered by the Plan. The Network's
contributions to the Plan amounted to approximately $578,000 and $349,000 for
the years ended June 30, 1999 and 2000, respectively. There were no
contributions to the Plan by the Network for the ten months ended April 30,
2001. Network contributions are included in the employee benefits in the
accompanying combined statements of operations.
Litigation
The Network is party to pending or threatened lawsuits arising out of, or
incident to, the ordinary course of business for which it carries professional
and general liability coverage and other insurance coverages. In the opinion of
management, upon consultation with legal counsel, none of the pending or
threatened lawsuits will have a material effect upon the combined financial
position or operations of the Network.
Compliance with Laws and Regulations
The healthcare industry is subject to numerous laws and regulations of
federal, state and local governments. These laws and regulations include, but
are not necessarily limited to, matters such as licensure, accreditation,
government healthcare program participation requirements, reimbursement for
patient services, and Medicare and Medicaid fraud and abuse regulations.
Management believes that the Network is in compliance with fraud and abuse
regulations as well as other applicable government laws and regulations. While
no regulatory inquiries have been made, compliance with such laws and
regulations can be subject to future government review and interpretation as
well as regulatory actions unknown or unasserted at this time.
Medical Malpractice Insurance
The Network maintains professional and general liability insurance
coverage through modified occurrence-based policies which provide coverage for
individual claims of up to $20 million. Under these policies the Network is
responsible for deductible amounts of up to $10,000 per occurrence. These
policies cover claims for occurrences reported up to 84 months after
termination of such policies. Subsequent to April 30, 2001, in accordance with
the Asset Purchase Agreement, the Network purchased tail insurance. The amounts
were paid by Vanguard and reflected as a reduction of the purchase price.
Management believes that its medical malpractice insurance is adequate.
F-81
PMH HEALTH SERVICES NETWORK AND AFFILIATE
NOTES TO COMBINED FINANCIAL STATEMENTS
7. Functional Expenses
The Network provides general healthcare services to residents within its
geographic location. Expenses related to providing these services for the years
ended June 30, 1999 and 2000 and for the ten months ended April 30, 2001 were
as follows (in thousands):
1999 2000 2001
-------- -------- --------
Healthcare services........... $165,546 $182,668 $125,295
General and administrative.... 4,706 4,696 3,477
Asset impairment loss......... -- 13,261 --
-------- -------- --------
$170,252 $200,625 $128,772
======== ======== ========
F-82
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
MacNeal Health Services Corporation:
We have audited the accompanying consolidated balance sheets of MACNEAL
HEALTH SERVICES CORPORATION (an Illinois not-for-profit corporation) AND
SUBSIDIARIES (the "Corporation") as of January 31, 2000, and September 30, 1999
and 1998, and the related consolidated statements of operations, changes in net
assets and cash flows for the four-month period ended January 31, 2000, and for
each of the two years in the period ended September 30, 1999. These
consolidated financial statements are the responsibility of the Corporation's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of MacNeal
Health Services Corporation and Subsidiaries as of January 31, 2000, and
September 30, 1999 and 1998, and the results of their operations and cash flows
for the four-month period ended January 31, 2000, and for each of the two years
in the period ended September 30, 1999, in conformity with accounting
principles generally accepted in the United States.
/s/ ARTHUR ANDERSEN LLP
Chicago, Illinois
June 15, 2001
F-83
MACNEAL HEALTH SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of January 31, 2000, and September 30, 1999 and 1998
January 31, September 30,
2000 1999 1998
----------- ------ ------
(in thousands)
ASSETS
Current assets:
Cash and cash equivalents.................................. $ 8,857 $ 4,095 $ 2,587
Trustee held assets........................................ 1,653 1,563 1,563
Patient accounts receivable, less allowances
of $9,341, $8,063 and, $5,949 for doubtful
accounts in 2000, 1999 and 1998, respectively............ 44,919 43,689 38,106
Managed care incentives receivable......................... 4,635 2,712 3,266
Receivable from joint ventures............................. 1,801 1,069 2,317
Inventories................................................ 1,624 1,885 1,858
Prepaid expenses........................................... 6,065 2,829 4,850
Due from third-party payors................................ -- 603 8,650
Other...................................................... 2,691 3,601 4,664
-------- -------- --------
Total current assets................................. 72,245 62,046 67,861
-------- -------- --------
Investments in Joint Ventures............................... 3,383 3,677 3,732
-------- -------- --------
Investments:
Internally designated for donor-restricted purposes........ 318 379 388
Internally designated for board-directed purposes.......... 9,186 39,252 43,850
Self-insurance trust fund.................................. 1,874 2,081 8,829
-------- -------- --------
Total investments.................................... 11,378 41,712 53,067
-------- -------- --------
Property, Plant and Equipment, at cost:
Land and improvements...................................... 12,200 12,032 10,903
Leasehold improvements..................................... 5,047 5,345 4,893
Buildings and service equipment............................ 131,179 130,116 117,353
Equipment.................................................. 127,189 124,335 91,747
Construction in progress................................... 7,757 5,321 19,520
-------- -------- --------
283,372 277,149 244,416
Less--Accumulated depreciation and amortization............ (132,759) (127,053) (113,603)
-------- -------- --------
Net property, plant and equipment.................... 150,613 150,096 130,813
-------- -------- --------
Other assets................................................ 4,640 6,027 5,377
-------- -------- --------
$242,259 $263,558 $260,850
======== ======== ========
LIABILITIES AND NET ASSETS
Current liabilities:
Current maturities of long-term debt....................... $ 4,402 $ 4,263 $ 3,985
Note payable to bank....................................... 15,000 15,000 --
Accounts payable........................................... 8,337 10,194 10,984
Due to third-party payors.................................. 4,567 4,233 789
Medical claims payable..................................... 1,940 2,551 5,515
Accrued expenses--payroll related.......................... 10,772 10,582 10,389
Accrued expenses--other.................................... 10,129 11,515 16,684
-------- -------- --------
Total current liabilities............................ 55,147 58,338 48,346
-------- -------- --------
Insurance Reserves.......................................... 11,411 9,889 12,500
-------- -------- --------
Long-term Debt, less current maturities..................... 69,201 69,454 73,664
-------- -------- --------
Commitments and Contingencies
Net Assets:
Unrestricted............................................... 106,182 125,498 125,952
Temporarily restricted..................................... 318 379 388
-------- -------- --------
Total net assets..................................... 106,500 125,877 126,340
-------- -------- --------
$242,259 $263,558 $260,850
======== ======== ========
The accompanying notes to consolidated financial statements are an integral
part of these balance sheets.
F-84
MACNEAL HEALTH SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Four-Month Period Ended January 31, 2000, and
For the Years Ended September 30, 1999 and 1998
Four Months
Ended Years Ended
January 31, September 30,
------------ -----------------------
2000 1999 1998
------------ -------- --------
(in thousands)
Unrestricted Revenue:
Net patient service revenue.................................. $ 64,913 $204,875 $206,329
Managed care contract revenue................................ 15,434 48,719 51,390
Investment income, net....................................... 243 2,595 3,670
Other revenue..................................................... 2,780 8,074 5,786
-------- -------- --------
Total unrestricted revenue.................................... 83,370 264,263 267,175
-------- -------- --------
Expenses:
Salaries, wages, benefits and contract termination payments.. 57,790 131,793 126,610
Purchased services, utilities and insurance.................. 13,145 33,772 36,964
Supplies and drugs........................................... 8,697 26,564 25,052
Depreciation and amortization................................ 6,510 17,465 14,988
Contracted health services................................... 4,693 16,050 19,104
Provision for bad debts...................................... 4,487 10,976 11,053
Interest..................................................... 1,673 4,596 4,304
Other........................................................ 5,721 22,618 17,781
-------- -------- --------
Total expenses................................................ 102,716 263,834 255,856
-------- -------- --------
(Deficiency) Excess of Unrestricted Revenue over Expenses.......... (19,346) 429 11,319
Net Unrealized Gains (Losses) on Investments....................... 30 (883) 149
-------- -------- --------
(Decrease) Increase in Unrestricted Net Assets..................... $(19,316) $ (454) $ 11,468
======== ======== ========
The accompanying notes to consolidated financial statements
are an integral part of these statements.
F-85
MACNEAL HEALTH SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS
For the Four-Month Period Ended January 31, 2000, and
For the Years Ended September 30, 1999 and 1998
Four Months
Ended Years Ended
January 31, September 30,
------------ -----------------------
2000 1999 1998
------------ -------- --------
(in thousands)
Unrestricted Net Assets:
(Deficiency) excess of unrestricted revenue over expenses... $(19,346) $ 429 $ 11,319
Net unrealized gains (losses) on investments................ 30 (883) 149
-------- -------- --------
(Decrease) increase in unrestricted net assets............ (19,316) (454) 11,468
-------- -------- --------
Temporarily Restricted Net Assets:
Contributions received...................................... -- 104 110
Net assets released from restrictions....................... (61) (113) (82)
-------- -------- --------
(Decrease) increase in temporarily restricted net assets.. (61) (9) 28
-------- -------- --------
(Decrease) Increase in Net Assets................................. (19,377) (463) 11,496
Net Assets, beginning of period................................... 125,877 126,340 114,844
-------- -------- --------
Net Assets, end of period......................................... $106,500 $125,877 $126,340
======== ======== ========
The accompanying notes to consolidated financial statements
are an integral part of these statements.
F-86
MACNEAL HEALTH SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Four-Month Period Ended January 31, 2000, and
For the Years Ended September 30, 1999 and 1998
Four Months
Ended Years Ended
January 31, September 30,
------------ -----------------------
2000 1999 1998
------------ -------- --------
(in thousands)
Cash Flows from Operating Activities:
(Decrease) increase in net assets................................... $(19,377) $ (463) $11,496
Adjustments to reconcile (decrease) increase in net assets
to net cash (used in) provided by operating activities:
Net change in temporarily restricted net assets..................... 61 9 (28)
Net unrealized (gains) losses on marketable securities.............. (30) 883 (149)
Gain on disposal of fixed assets.................................... -- (1,093) (646)
Depreciation and amortization....................................... 6,583 17,652 15,127
Net change in:
Patient accounts receivable, net.................................. (1,230) (5,583) (437)
Receivable from joint ventures.................................... (732) 1,248 (631)
Other current and long-term assets................................ (2,601) 1,210 (3,353)
Accounts payable and accrued liabilities.......................... (3,053) (5,058) 5,446
Medical claims payable............................................ (611) (2,964) 602
Due to/from third party payors.................................... 937 11,491 (5,607)
Insurance reserves................................................ 1,522 (2,611) 4,200
-------- ------- -------
Net cash (used in) provided by operating activities............. (18,531) 14,721 26,020
-------- ------- -------
Cash Flows from Investing Activities:
Capital expenditures, net............................................ (7,070) (34,799) (25,848)
Decrease (increase) in investments internally designated
for board-directed purposes......................................... 30,066 3,968 (791)
(Increase) decrease in trustee held assets........................... (90) -- 132
Decrease in self-insurance trust fund................................. 207 6,495 1,237
Distributions from investments in joint ventures...................... 294 55 2,551
-------- ------- -------
Net cash provided by (used in) investing activities............. 23,407 (24,281) (22,719)
-------- ------- -------
Cash Flows from Financing Activities:
Payments of long-term debt........................................... (114) (3,932) (3,716)
Proceeds from issuance of short-term debt............................ -- 15,000 --
-------- ------- -------
Net cash provided by (used in) financing activities.............. (114) 11,068 (3,716)
-------- ------- -------
Net Increase (Decrease) in Cash and cash equivalents.................. 4,762 1,508 (415)
Cash and cash equivalents, beginning of period ....................... 4,095 2,587 3,002
-------- ------- -------
Cash and cash equivalents, end of period.............................. $ 8,857 $ 4,095 $ 2,587
======== ======= =======
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for interest............................. $ 2,558 $ 4,252 $ 4,133
======== ======= =======
The accompanying notes to consolidated financial statements
are an integral part of these statements.
F-87
MACNEAL HEALTH SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Operations
MacNeal Health Services Corporation was established to provide a diverse
array of health services to the residents of Berwyn, Illinois, and the
surrounding communities. MacNeal Health Services Corporation, an Illinois
not-for-profit corporation, is the sole corporate member of MacNeal Memorial
Hospital Association (the "Hospital"), an Illinois not-for-profit corporation,
and the sole shareholder of MacNeal Management Services, Inc. ("MacNeal
Management Services"), an Illinois for-profit taxable corporation. MacNeal
Health Providers, Inc. ("MacNeal Health Providers"), an Illinois for-profit
taxable corporation, is a wholly owned subsidiary of MacNeal Management
Services. Beginning May 1, 1998, MacNeal Health Providers became the sole
shareholder of Chicago Health System, Inc. ("Chicago Health System"), an
Illinois for-profit taxable corporation.
MacNeal Health Services Corporation
MacNeal Health Services Corporation employs approximately 150 primary and
specialty care physicians to provide physician healthcare services through a
network of clinical office locations. Additionally, MacNeal Health Services
Corporation owns and operates various joint ventures including a one-third
interest in RML Specialty Hospital, a ventilator, long-term acute care hospital
venture. MacNeal Health Services Corporation also owns Genesis, an operating
division which provides laboratory services, and Azron, a majority owned
software development operation with no significant revenue to date.
Hospital
The Hospital, located in Berwyn, Illinois, provides inpatient, outpatient
and emergency care services to area residents.
MacNeal Management Services (including MacNeal Health Providers and
Chicago Health System)
MacNeal Management Services was established to provide managerial and
billing services to MacNeal Health Services Corporation physicians and
affiliated corporations and to corporations which are not affiliated with
MacNeal Health Services Corporation. MacNeal Management Services is also the
sole shareholder of MacNeal Health Providers. MacNeal Health Providers oversees
the managed care alternative to traditional healthcare delivery through
contractual agreements with health maintenance organizations ("HMOs") and
preferred provider organizations ("PPOs") on behalf of MacNeal Health Services
Corporation physicians and other healthcare providers who provide healthcare
services to enrollees. MacNeal Health Providers accepts monthly capitation
payments from HMOs and contracts with various physicians (including those
employed by MacNeal Health Services Corporation) and the Hospital for covered
healthcare services for enrollees. MacNeal Health Providers is the sole
shareholder of Chicago Health System. Chicago Health System provides claims
processing and other contract administration services to MacNeal Health
Providers. Prior to May 1, 1998, MacNeal Health Providers owned 30% of Chicago
Health System and accounted for this investment under the equity method, with
the remaining ownership held by unrelated third-parties.
2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements include the accounts of
MacNeal Health Services Corporation and its subsidiaries, which include the
Hospital, MacNeal Management Services, MacNeal Health Providers and Chicago
Health System. All significant intercompany transactions and balances have been
eliminated in consolidation.
F-88
MACNEAL HEALTH SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements. Estimates also affect the reported amounts of revenue
and expenses during the reporting period. Estimates are used in recording
patient accounts receivable, net settlement amounts owed from third party
payors, medical claims payable amounts, insurance reserves and certain accrued
expenses, among others. Actual results could differ from those estimates.
Cash Equivalents
Investments with original maturities of three months or less are
considered cash equivalents.
Inventories
Inventories are carried at the lower of cost or market, utilizing the
first-in, first-out (FIFO) method.
Property, Plant and Equipment
Property, plant and equipment acquisitions are recorded at cost. Costs
incurred to maintain or repair property, plant and equipment that do not
significantly enhance its useful life are expensed when incurred. MacNeal
Health Services Corporation and its subsidiaries depreciate property, plant and
equipment using the straight-line basis. One-half year's depreciation is
recorded in the year of acquisition. Approximate average depreciable lives by
classification are as follows:
Land improvements................... 12 years
Leasehold improvements.............. 10-20 years
Buildings and service equipment..... 20 years
Equipment........................... 8 years
Investments in Joint Ventures
MacNeal Health Services Corporation and its subsidiaries account for joint
venture investments under the equity method of accounting. Equity in the
earnings and losses of joint venture investments are included in other expenses
in the accompanying consolidated statements of operations.
Investments
Investments are recorded at their fair value in the accompanying
consolidated balance sheets. Fluctuations in the fair value of these
investments results in the recognition of unrealized gains and losses in the
accompanying consolidated statements of operations as a change in unrestricted
net assets.
Debt Financing Costs
Financing costs incurred in connection with the various debt offerings
issued by the Hospital are included in other assets and are being amortized
over the life of the related debt under an approach which approximates the
effective interest method.
F-89
MACNEAL HEALTH SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Medical Claims Payable
MacNeal Management Services recognizes liabilities for medical claims when
enrollees (through HMO contracts of MacNeal Health Providers) receive covered
medical services. A liability for incurred but unreported claims is estimated
on the basis of claims experience and is included in medical claims payable in
the accompanying consolidated balance sheets. In management's opinion, the
ultimate disposition of the medical claims liability will not have a material
adverse effect on the financial position of MacNeal Health Services Corporation
and its subsidiaries.
Temporarily Restricted Net Assets
Temporarily restricted net assets as of January 31, 2000, and September
30, 1999 and 1998, were available for donor-directed purposes, including
support for educational programs, hospital services and research.
Net Patient Service Revenue
Net patient service revenue is reported at estimated net realizable
amounts from patients, third-party payors, and others as services are rendered
and includes estimated retroactive revenue adjustments due to future audits,
reviews, and investigations. Payments under these agreements and programs are
based on either a specific amount per case, cost, as defined, of rendering
services to program beneficiaries, or contracted price. Retroactive adjustments
are considered in the recognition of revenue on an estimated basis in the
period the related services are rendered, and such amounts are adjusted in
future periods as adjustments become known or as years are no longer subject to
such audits, reviews, and investigations.
Revenue from Medicare and Medicaid programs and managed care payors
accounted for 91%, 89% and 88% of MacNeal Health Services Corporation and its
subsidiaries' gross patient service revenue in 2000, 1999 and 1998,
respectively. Laws and regulations governing the Medicare and Medicaid programs
are extremely complex and subject to interpretation. As a result, there is at
least a reasonable possibility that recorded estimates will change by a
material amount in the near term.
Managed Care Contract Revenue
MacNeal Health Providers has contracts with various HMOs to provide
healthcare services to covered patients (enrollees) under capitated (prepaid)
arrangements. The contracts provide for fixed monthly rates to be paid to
MacNeal Health Providers for each covered enrollee. Under certain of the
capitated contracts, MacNeal Health Providers may receive incentive and bonus
funds relating to certain operational targets including hospital utilization,
patient access and pharmaceutical usage. MacNeal Health Providers monitors its
performance against these targets and records estimated amounts due from these
incentive programs as additional revenue. Additionally, MacNeal Health
Providers has purchased reinsurance which provides for secondary coverage of
healthcare services provided and/or paid for by MacNeal Health Providers that
exceed certain defined limits. MacNeal Health Providers records these monthly
capitated fees and incentives in the period earned.
Donor-Restricted Contributions
Donor-restricted contributions are reported as temporarily restricted
support if they are received with donor stipulations that limit the use of the
donated assets. When donor-restricted contributions are met or expire,
temporarily restricted net assets are reclassified as unrestricted net assets
and reported in the consolidated statement of operations as other revenue or
net assets released from restrictions used for property and equipment
acquisitions.
F-90
MACNEAL HEALTH SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Charity Care
MacNeal Health Services Corporation treats patients in immediate need of
medical services without regard to their ability to pay for such services.
MacNeal Health Services Corporation provided care without charge or at amounts
less than its established rates to patients who meet certain criteria under its
charity care policy. The estimated difference between the cost of services
provided to Medicaid patients and the reimbursement from the State of Illinois
for patient care is also monitored. During 2000, 1999 and 1998, the following
amounts were incurred:
2000 1999 1998
------- ------ ------
Estimated costs and expenses incurred for charity care.... $756 $1,685 $1,847
Excess of cost over reimbursement for Medicaid patients... 1,504 4,590 4,349
------ ------ ------
$2,260 $6,275 $6,196
====== ====== ======
Estimated Professional and General Liability Costs
The provision for estimated professional and general liability claims
includes estimates of the ultimate costs for both reported claims and claims
incurred but not reported, and is included in purchased services, utilities and
insurance expense in the accompanying consolidated statements of operations.
Tax Status
MacNeal Health Services Corporation and the Hospital are exempt from
federal and state income tax under Section 501(c)(3) of the Internal Revenue
Code. MacNeal Management Services accounts for income taxes under Statement of
Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes."
As of January 31, 2000, September 30, 1999 and 1998, MacNeal Management
Services had generated deferred tax assets resulting primarily from accumulated
losses incurred (net operating loss ("NOL") carryforwards) that may be used to
offset future taxable income and from timing differences relative to the
deductibility of certain medical claims payable. A portion of the NOL
carryforwards may be limited as to their use in a single year subject to
certain restrictions including change in ownership and other limitations.
The resulting deferred tax assets of approximately $7,500, $6,000 and
$4,000 have been fully reserved as of January 31, 2000, September 30, 1999 and
1998, respectively, due to uncertainty of their ultimate realizability. No
other significant net tax assets or liabilities resulting from timing
differences existed in 1999 and 1998. The difference between the statutory
federal income tax rate and the effective tax rate (0%) for MacNeal Management
Services is primarily due to changes in the valuation allowance as discussed
above.
Fair Value of Financial Instruments
Cash and cash equivalents--Cash and equivalents are recorded at their
approximate fair value.
Accounts receivable and payable--Accounts receivable and payable are
recorded at their approximate fair value.
Investments--Investments in marketable equity and debt securities are
recorded at their approximate fair value based on quoted market prices for
securities of the same or similar nature.
Long Lived Assets
MacNeal Health Services Corporation continually evaluates whether
circumstances have occurred that would indicate the remaining estimated useful
life of long-lived assets may warrant revision or that the remaining balance of
such assets may not be recoverable. When factors indicate that such assets
should be evaluated for possible impairment,
F-91
MACNEAL HEALTH SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MacNeal Health Services Corporation uses an estimate of the undiscounted cash
flows over the remaining life of the asset in measuring whether the asset is
recoverable. To date, no such impairments have been necessary.
Reclassifications
Certain amounts in the 1999 and 1998 financial statements have been
reclassified to conform with the 2000 presentation.
3. Concentrations of Credit Risk
MacNeal Health Services Corporation and its subsidiaries grant credit
without collateral to its patients, most of whom are local residents and are
insured under third-party payor agreements. The mix of receivables from
patients and third-party payors as of January 31, 2000 and September 30, 1999
and 1998 are as follows:
2000 1999 1998
---- ---- ----
Managed care......................... 29% 38% 38%
Medicare............................. 16 18 17
Medicaid............................. 9 7 5
Self-pay, commercial and other....... 46 37 40
--- --- ---
Total............................... 100% 100% 100%
=== === ===
4. Investments
Investments include amounts internally designated for donor-restricted and
board-directed purposes. Trustee held funds includes amounts held by a trustee
to fund current long-term debt related obligations. Accordingly, the trustee
held funds are included in current assets in the accompanying consolidated
balance sheets.
Investments were composed of the following:
2000 1999 1998
------- ------- -------
(in thousands)
Investments were composed for board-directed purposes:
Cash and cash equivalents............................. $ 525 $10,109 $13,189
Corporate obligations................................. 1,017 1,028 2,199
Government obligations................................ 7,644 28,115 28,462
------- ------- -------
9,186 39,252 43,850
------- ------- -------
Internally designated for donor-restricted purposes:
Cash and cash equivalents............................. 318 379 388
------- ------- -------
Self-insurance trust fund:
Cash and cash equivalents............................. 120 233 408
Corporate obligations................................. 29 32 908
Government obligations................................ 1,725 1,816 7,513
------- ------- -------
1,874 2,081 8,829
------- ------- -------
Total investments................................... $11,378 $41,712 $53,067
======= ======= =======
Trustee held funds:
Cash and cash equivalents............................. $ 1,653 $ 1,563 $ 1,563
======= ======= =======
F-92
MACNEAL HEALTH SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Income earned on investments, excluding unrealized gains and losses, is
recorded as investment income. Investment income was composed of the following
for the four-month period ended January 31, 2000, and for the years ended
September 30, 1999 and 1998:
2000 1999 1998
---- ------ ------
(in thousands)
Interest, dividends and realized gains..... $243 $2,595 $3,670
Net unrealized gains (losses).............. 30 (883) 149
---- ------ ------
Total................................... $273 $1,712 $3,819
==== ====== ======
5. Other Assets
Included in other assets are intangible assets relating primarily to the
purchase of physician practices of approximately $1,699, $1,768, and $2,046,
net of accumulated amortization of $1,044, $975 and $817 at January 31, 2000,
and September 30, 1999 and 1998, respectively.
6. Debt
Debt at January 31, 2000, and September 30, 1999 and 1998, consisted of
the following:
2000 1999 1998
------- ------- -------
(in thousands)
Variable rate revenue refunding bonds, Series 1985A......................... $19,100 $19,100 $19,800
6.6% to 6.7% revenue bonds, Series 1991..................................... 1,135 1,135 1,650
4.5% to 6.0% revenue bonds, Series 1995..................................... 52,970 52,970 55,535
Note payable to commercial bank, accruing interest at a variable rate....... 15,000 15,000 --
Other long-term debt........................................................ 398 512 664
------- ------- -------
88,603 88,717 77,649
Less-Current maturities..................................................... (4,402) (4,263) (3,985)
Less-Note payable to bank................................................... (15,000) (15,000) --
------- ------- -------
Long-term debt, less current maturities..................................... $69,201 $69,454 $73,664
======= ======= =======
Estimated fair value of long-term debt, based on quoted market prices
of securities of the same or similar nature................................. $89,000 $90,000 $81,000
======= ======= =======
Series 1985A Bonds
In November, 1985, the City of Berwyn, Illinois, issued $25,000 of revenue
refunding bonds, Series 1985A, on behalf of the Hospital to provide for the
refunding and retirement of outstanding revenue bonds and to reimburse the
Hospital for the costs of certain improvements to the hospital facility.
The variable interest rate on the Series 1985A bonds is based on the
91-day U.S. Treasury bill rate, and is determined by the Remarketing Agent. The
weighted average interest rate that accrued on the bonds during 2000, 1999 and
1998 was 3.6%. Principal and interest are payable quarterly to the bond trustee
through June 2013.
The Series 1985A bonds can be tendered for payment at any time, at which
time the bonds can be remarketed. Any Series 1985A bonds not promptly
remarketed after tender will be purchased by the Hospital through financing
provided
F-93
MACNEAL HEALTH SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
under a line of credit. The terms of the line of credit, which expired in
December, 2000, provided for quarterly payments of interest based on the prime
rate and a commitment fee of 0.2% per annum. No amounts were drawn under this
line of credit.
Series 1991 Bonds
In August 1991, the City of Berwyn, Illinois, issued $18,200 of revenue
bonds, Series 1991, on behalf of the Hospital. The proceeds of the Series 1991
bonds were used to reimburse the Hospital for the cost of certain equipment and
construction expenditures at the hospital facility and an outpatient center
constructed in Bridgeview, Illinois.
The Series 1991 revenue bonds may be redeemed prior to maturity, beginning
June 2001, at 102%, decreasing ratably to 100% in June 2003. Principal and
interest are payable quarterly to the bond trustee through June 2001.
Series 1995 Bonds
In December, 1995, the City of Berwyn, Illinois, issued $59,880 of revenue
bonds, Series 1995, to advance refund a portion of the outstanding balances of
the Series 1987 and Series 1991 bonds, to pay or reimburse the Hospital for
capital expenditures and to pay certain of the expenses incurred in connection
with the issuance of the Series 1995 bonds.
The weighted average interest rate that accrued on the Series 1995 bonds
during 2000, 1999 and 1998 was 5.5%, 5.4% and 5.4%, respectively, and is paid
quarterly, together with principal, to the bond trustee through May 2015.
Note Payable to Commercial Bank
On January 5, 1999, MacNeal Health Services Corporation borrowed $15
million from a commercial bank under a secured loan agreement. Proceeds were
used for the purchase of certain assets including land and buildings. This loan
is renewable annually and accrues interest at a variable rate based on the
lender's prime rate. This note has been renewed until July 2001.
Debt Maturities and Security
The required payments on debt outstanding at January 31, 2000, excluding
note payable to commercial bank, are as follows:
2000.......................................... $ 4,402
2001.......................................... 4,459
2002.......................................... 4,475
2003.......................................... 4,755
2004.......................................... 5,035
Thereafter through 2015....................... 50,477
-------
$73,603
=======
Under a Master Trust Indenture, unrestricted receivables of the Hospital
have been pledged as security for the Series 1985A, 1991 and 1995 Bonds
discussed above. Additionally, the Hospital is required to maintain certain
financial and non-financial covenants.
F-94
MACNEAL HEALTH SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Retirement Plans
MacNeal Health Services Corporation and its subsidiaries sponsor defined
contribution plans which are available to substantially all employees who work
at least 1,000 hours per year. MacNeal Health Services Corporation and its
subsidiaries make annual discretionary contributions to the retirement plans
based on salaries of participating employees. In 1999 and 1998, MacNeal Health
Services Corporation and its subsidiaries expensed $592 and $1,821,
respectively, related to these plans. There was no discretionary contribution
for 2000. Subsequent to January 31, 2000 MacNeal Health Services Corporation
and its subsidiaries had a change in plan sponsor, recordkeeper and trustee for
the defined contribution plans.
Additionally, MacNeal Management Services sponsors a nonqualified deferred
compensation program for certain members of its management. The program
provides, in general, for the awarding of defined annual amounts which vest to
the participants over periods ranging up to eight years, with provisions of
forfeiture of unvested amounts upon termination of employment. Approximately
$290, $860 and $800 was expensed in 2000, 1999 and 1998 under this program.
8. Commitments and Contingencies
Professional and General Liability Insurance
MacNeal Health Services Corporation and its subsidiaries insure against
general and professional liability through a retained risk and purchased
insurance program. The risk retention levels are $2,000 per occurrence with a
$2,000 annual aggregate for general liability risks and $3,000 per occurrence
with a $6,000 annual aggregate for professional liability risks. Through the
normal course of operations, MacNeal Health Services Corporation and its
subsidiaries become subject to claims alleging professional malpractice.
Although the outcome of such claims cannot be predicted with certainty,
management believes that the ultimate disposition of these claims will be
within available insurance limits.
MacNeal Health Services Corporation's liability for general and
professional self-insurance is actuarially determined based upon estimated
claim reserves and various assumptions and represents the estimated present
value of self-insurance claims that will be settled in the future. MacNeal
Health Services Corporation had self-insurance reserves of $11,411, $9,889 and
$12,500, discounted at 7% at January 31, 2000, September 30, 1999 and 1998,
respectively. The undiscounted reserves at January 31, 2000, were approximately
$14,600. Insurance expense for professional and general liability was $4,140,
$7,004 and $7,353 for 2000, 1999 and 1998, respectively.
Employment Related Matters
MacNeal Management Services has entered into employment agreements with
certain senior management members that provide for minimum salary levels,
participation in deferred compensation and performance bonus plans and amounts
to be paid in the event of a change in control.
Additionally, as part of the sale transaction, in 1999 MacNeal Health
Services Corporation and its subsidiaries entered into agreements with various
management and key employee members to provide for "stay-bonus" payments if the
employee remained employed through defined dates in the agreement. Expenses
related to these agreements is recognized in the period incurred, and is
included in salaries, wages, benefits and contract termination payments in the
accompanying consolidated statement of operations.
F-95
MACNEAL HEALTH SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Healthcare Legislation and Regulation
The healthcare industry is subject to numerous laws and regulations of
federal, state and local governments. These laws and regulations include, but
are not necessarily limited to, matters such as licensure, accreditation,
government healthcare program participation requirements, reimbursement for
patient services and Medicare and Medicaid fraud and abuse. Government activity
has continued with respect to investigations and allegations concerning
possible violations of various statutes and regulations by healthcare
providers. Violations of these laws and regulations creates a possibility of
significant repayments for patient services previously billed. Compliance with
such laws and regulations can be subject to future government review and
interpretation as well as regulatory actions unknown or not yet asserted at
this time. Management believes that MacNeal Health Services Corporation and its
subsidiaries were in compliance with applicable fraud and abuse regulations, as
well as other government laws and regulations.
9. Other Expenses
Other expenses on the accompanying consolidated statements of operations
includes: short-term facility and equipment rental, service contract expense,
telecommunications, marketing and printing, and software licensing fees.
10. Functional Expenses
MacNeal Health Services Corporation and its subsidiaries provided general
healthcare services to residents of Berwyn and the surrounding communities.
Expenses related to providing these services were as follows:
2000 1999 1998
-------- -------- --------
Healthcare services........... $ 98,094 $221,621 $220,036
General and administrative.... 4,622 42,213 35,820
-------- -------- --------
$102,716 $263,834 $255,856
======== ======== ========
11. Sale of Business
On February 1, 2000, MacNeal Health Services Corporation and the Hospital
sold substantially all of its operations and assets for total consideration of
approximately $210 million, in addition to the assumption of certain
liabilities. As a result of the transaction, the Series 1985A, 1991 and 1995
debt became due and was paid and/or defeased subsequent to January 31, 2000. In
addition, in connection with the transaction, MacNeal Health Services
Corporation and the Hospital entered into a risk portfolio transfer agreement
with a commercial insurer to transfer its retained self-insured risk for
professional and general liability claims, for which it paid a premium over the
recorded reserve at January 31, 2000 of approximately $7.5 million.
Related to the sale, certain transaction related costs of approximately
$2,300 and $1,400, respectively, were deferred and included in prepaid expenses
at January 31, 2000 and September 30, 1999, respectively. These amounts were
expensed against the gain on sale of business subsequent to year-end.
Additionally, relative to the retirement plans, effective March 30, 2000,
MacNeal Health Services Corporation and its subsidiaries had a change in plan
sponsor, recordkeeper and trustee for the defined contribution plans. Lastly,
certain members of management received employment contract termination payments
as a result of the sale. These amounts are included in salaries, wages,
benefits and contract termination payments in the accompanying consolidated
statement of operations for 2000.
F-96
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN
OFFER TO SELL THESE SECURITIES AND WE ARE NOT SOLICITING OFFERS TO BUY THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
[ALTERNATE FRONT COVER FOR MARKET-MAKING PROSPECTUS]
SUBJECT TO COMPLETION DATED _______ __, 2001
Vanguard Health Systems, Inc.
$300,000,000
9.75% Senior Subordinated Notes Due 2011
PROSPECTUS
- --------------------------------------------------------------------------------
Vanguard Health Systems, Inc:
o We are an owner and operator of acute care hospitals and other health care
facilities principally in urban and suburban markets. As of October 1,
2001, we owned eight hospitals with a total of 1,716 beds in the Phoenix,
Arizona; Orange County, California; and metropolitan Chicago, Illinois
markets. We also operated, as of October 1, 2001, two ambulatory surgery
centers, five diagnostic imaging centers and a prepaid Medicaid managed
health plan, Phoenix Health Plan, that serves more than 55,000 members in
Arizona.
o Our address is
20 Burton Hills Boulevard, Suite 100
Nashville, TN 37215
(615) 665-6000
The Original Offering:
o We issued the notes in , 2001, in an exchange offer registered under the
Securities Act of 1933 pursuant to which the notes were exchanged for
otherwise identical notes originally issued in a private offering on June
30, 2001.
o We used the net proceeds of the private offering to repay all outstanding
indebtedness under our old senior secured credit facility and for general
corporate purposes.
The Notes:
o Interest Payments: semi-annually in cash in arrears on February 1 and
August 1, commencing on February 1, 2002.
o Redemption: the senior subordinated notes will be redeemable on or after
August 1, 2006. Up to 35% of the senior subordinated notes will be
redeemable prior to August 1, 2004, with the net proceeds of a public
equity offering.
o Ranking of senior subordinated notes: general unsecured obligations,
junior to senior obligations and secured obligations, including any
borrowings and reimbursement obligations with respect to letters of credit
under our credit facility.
The Guarantees:
o Guarantees: fully and unconditionally guaranteed on a senior subordinated
basis by certain of our current and future domestic restricted
subsidiaries. The guarantees will be general unsecured obligations of
these subsidiaries.
This investment involves risk. See Risk Factors beginning on page .
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of the securities or passed upon the
adequacy or accuracy of this prospectus. Any representation to the contrary
is a criminal offense.
This prospectus will be used by Morgan Stanley & Co. Incorporated in
connection with offers and sales in market-making transactions at negotiated
prices related to prevailing market prices. There is currently no public market
for the notes. We do not intend to list the notes on any securities exchange or
to seek admission thereof to trading in the National Association of Securities
Dealers Automated Quotation System. Morgan Stanley & Co. Incorporated has
advised us that it currently intends to make a market in the notes; however, it
is not obligated to do so and may stop at any time. Morgan Stanley & Co.
Incorporated may act as principal or agent in any such transaction. We will not
receive the proceeds of the sale of the notes but will bear the expenses of
registration. If Morgan Stanley conducts any market-making activities, it may
be required to deliver a "market-making prospectus" when effecting offers and
sales of the notes because of the equity ownership of Vanguard Health Systems
by affiliates of Morgan Stanley. For so long as a market-making prospectus is
required to be delivered, the ability of Morgan Stanley to make a market in the
notes may be dependent, in part, on the ability of Vanguard Health Systems to
maintain a current market-making prospectus.
- --------------------------------------------------------------------------------
Morgan Stanley & Co. Incorporated
The date of this Prospectus is , 2001.
[ALTERNATE SECTIONS FOR MARKET-MAKING PROSPECTUS]
No public trading market for the notes exists.
There is no existing trading market for the notes, and we cannot assure
you about the future development of a market for the notes or your ability to
sell the notes or the price at which you may be able to sell the notes. If such
market were to develop, the notes could trade at prices that may be higher or
lower than the initial offering price of the notes depending on many factors,
including prevailing interest rates, our operating results and the market for
similar securities. Although it is not obligated to do so, Morgan Stanley & Co.
Incorporated ("Morgan Stanley") intends to make a market in the notes. Any such
market-making activity may be discontinued at any time, for any reason, without
notice at the sole discretion of Morgan Stanley. We do not intend to list the
notes on any securities exchange or to seek admission thereof to trading in the
National Association of Securities Dealers Automated Quotation System. No
assurance can be given as to the liquidity of or the trading market for the
notes.
Morgan Stanley may be deemed to be our "affiliate" (as defined in the
Securities Act) and, as such, may be required to deliver a prospectus in
connection with its market-making activities in the notes. Pursuant to the
purchase agreement that we signed with Morgan Stanley in connection with the
initial sale of the notes, we have agreed to file and maintain a registration
statement that would allow Morgan Stanley to engage in market-making
transactions in the notes for so long as, in the judgement of Morgan Stanley,
it or any of its affiliates, is required to deliver a prospectus in connection
with its market-marking activities. We have agreed to bear substantially all
the costs and expenses related to registration. For so long as a market-making
prospectus is required to be delivered, the ability of Morgan Stanley to make a
market in the notes may be dependent, in part, on the ability of Vanguard
Health Systems to maintain a current market-making prospectus.
PROCEEDS
This prospectus is delivered in connection with the sale of the notes by
Morgan Stanley in market-making transactions. We will not receive any of the
proceeds from such transactions.
PLAN OF DISTRIBUTION
This prospectus is to be used by Morgan Stanley in connection with offers
and sales of the new notes in market-making transactions effected from time to
time. Morgan Stanley may act as a principal or agent in such transactions,
including as agent for the counterparty when acting as principal or as agent
for both counterparties, and may receive compensation in the form of discounts
and commissions, including from both counterparties when it acts as agent for
both. Such sales will be made at prevailing market prices at the time of sale,
at prices related thereto or at negotiated prices.
Various funds controlled by affiliates of Morgan Stanley beneficially own
approximately 80% of the common stock of Vanguard. Vanguard and its
subsidiaries may from time to time enter into financial advisory or other
investment banking relationships with Morgan Stanley or one of its affiliates
pursuant to which Morgan Stanley or its affiliates will receive customary fees
and will be entitled to reimbursement for all reasonable disbursements and
out-of-pocket expenses incurred in connection therewith. Vanguard expects that
any such arrangement will include provisions for the indemnification of Morgan
Stanley or its affiliates against some liabilities, including liabilities under
the federal securities laws. See "Certain Relationships and Related Party
Transactions."
Morgan Stanley has informed Vanguard that it does not intend to confirm
sales of the new notes to any accounts over which it exercises discretionary
authority without the prior specific written approval of such transactions by
the customer.
Vanguard has been advised by Morgan Stanley that, subject to applicable
laws and regulations, Morgan Stanley currently intends to make a market in the
new notes following completion of the exchange offer. However, Morgan Stanley
is not obligated to do so and any such market-making may be interrupted or
discontinued at any time without
notice, in Morgan Stanley's sole discretion. For so long as a market-making
prospectus is required to be delivered, the ability of Morgan Stanley to make a
market in the notes may be dependent, in part, on the ability of Vanguard
Health Systems to maintain a current market-making prospectus. In addition,
such market-making activity will be subject to the limits imposed by the
Securities Act and the Exchange Act. There can be no assurance that an active
trading market will develop or be sustained. See "Risk Factors - No public
trading market for the notes exists."
Morgan Stanley and Vanguard have entered into an agreement with respect to
the use by Morgan Stanley of this prospectus. Pursuant to such agreement,
Vanguard agreed to bear all registration expenses incurred under such
agreement, and Vanguard agreed to indemnify Morgan Stanley against some
liabilities, including liabilities under the Securities Act.
[BACK COVER FOR MARKET-MAKING PROSPECTUS]
================================================================================
9.75% Senior Subordinated Notes Due 2011
Vanguard Health Systems, Inc.
--------------------
PROSPECTUS
--------------------
Morgan Stanley
, 2001
- --------------------------------------------------------------------------------
We have not authorized any dealer, salesperson or other person to give you
written information other than this prospectus or to make representations as to
matters not stated in this prospectus. You must not rely on unauthorized
information. This prospectus is not an offer to sell these securities or our
solicitation of your offer to buy the securities in any jurisdiction where that
would not be permitted or legal. Neither the delivery of this prospectus nor
any sales made hereunder after the date of this prospectus shall create an
implication that the information contained herein or the affairs of Vanguard
have not changed since the date hereof.
- --------------------------------------------------------------------------------
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution.
The following table sets forth the expenses expected to be incurred in
connection with the issuance and distribution of the notes registered hereby,
all of which expenses, except for the Securities and Exchange Commission
registration fee, are estimated.
Securities and Exchange Commission registration fee....... $ 75,000
Printing and engraving fees and expenses.................. $ 20,000
Legal fees and expenses................................... $150,000
Accounting fees and expenses.............................. $300,000
Exchange agent fees and expenses.......................... $ 25,000
Miscellaneous expenses.................................... $ 10,000
--------
Total................................................. $580,000
========
Item 14. Indemnification of Directors and Officers.
Section 145 of the Delaware General Corporation Law provides that a
corporation may indemnify directors and officers against expenses (including
attorneys' fees), judgments, fines and amounts paid in settlement actually and
reasonably incurred by such person in connection with any threatened, pending
or completed actions, suits or proceedings in which such person is made a party
by reason of such person being or having been a director or officer to Vanguard
Health Systems, Inc. The Delaware General Corporation Law provides that Section
145 is not exclusive of other rights to which those seeking indemnification may
be entitled under any bylaw, agreement, vote of stockholders or disinterested
directors or otherwise. Vanguard Health Systems, Inc.'s Certificate of
Incorporation and Bylaws provide for indemnification by Vanguard Health
Systems, Inc. of its directors and officers to the fullest extent permitted by
the Delaware General Corporation Law.
Section 102(b)(7) of the Delaware General Corporation Law permits a
corporation to provide in its certificate of incorporation that a director of
the corporation shall not be personally liable to the corporation or its
stockholders for monetary damages for breach of fiduciary duty as a director,
except for liability for any breach of the director's duty of loyalty to the
corporation or its stockholders, for acts or omissions not in good faith or
which involve intentional misconduct or a knowing violation of law, for
unlawful payments of dividends or unlawful stock repurchases, redemptions or
other distributions, or for any transaction from which the director derived an
improper personal benefit. Vanguard Health Systems, Inc.'s Certificate of
Incorporation provides for such limitation of liability.
The Registration Rights Agreement filed as Exhibit 1 to this Registration
Statement provides for indemnification of directors and officers of Vanguard
Health Systems, Inc. by the initial purchasers against certain liabilities.
Item 15. Recent Sales of Unregistered Securities.
On September 1, 1999 we sold to the Capital Partners Funds, members of our
management and other third-party investors an aggregate of 26,452 shares of our
common stock for an aggregate purchase price of $44,999,613.36. On February 1,
2000 we sold to the Capital Partners Funds, members of our management and other
third-party investors an aggregate of 69,364 shares of our common stock for an
aggregate purchase price of $118,000,649.52. On June 1, 2000 we sold to the
Capital Partners Funds, members of our management and other third-party
investors an aggregate of 43,338 shares of our common stock for an aggregate
purchase price of 73,725,738.84. On May 1, 2001, we sold 18,913 shares of our
common stock to the Capital Partners funds, 398 shares to Charles N. Martin,
Jr., our Chairman and Chief Executive Officer, and 29 shares to Jeffrey Norman,
the Chief Executive Officer of one of the hospitals we own, Phoenix Baptist
Hospital and Medical Center in Phoenix, Arizona, for an aggregate purchase
price of $32,900,821.20. On August 28, 2001 we issued to Art Layne, a former
member of management, 12 shares of our common stock, for an aggregate
II-1
purchase price of $20,414.16, upon his exercise of stock options previously
issued to him under our 1998 Stock Option Plan. All of these purchases of
common stock were for cash consideration at a purchase price of $1,701.18 per
share.
On February 1, 2000, as part of the purchase price for our MacNeal
Hospital in Berwyn, Illinois, we issued to the seller of the hospital to us,
The MacNeal Memorial Hospital Association, 20,000 shares of our Payable-in-Kind
Convertible Redeemable Preferred Stock at a purchase price of $1,000 per share.
On March 31, 2001, we issued to The MacNeal Memorial Hospital Association an
additional 1,600 shares of such preferred stock in payment of the 8% annual
dividend on such shares.
None of the above-described transactions was registered under the
Securities Act of 1933, as amended, pursuant to the exemption provided by
Section 4(2) thereof for a transaction not involving any public offering.
Item 16. Exhibits and Financial Statement Schedules
(a) The following exhibits are filed with this registration statement.
Exhibit No. Document
- ----------- --------
1 Registration Rights Agreement dated as of July 30, 2001 between Vanguard Health Systems, Inc.
and Morgan Stanley & Co. Incorporated, Banc of America Securities LLC, Credit Suisse First
Boston Corporation, UBS Warburg LLC and First Union Securities, Inc., as Initial Purchasers*
3.1 Certificate of Incorporation*
3.2 By-Laws*
4.1 Indenture, dated as of July 30, 2001 between Vanguard Health Systems, Inc., other Guarantors and
the Trustee*
4.2 First Supplemental Indenture, dated as of September 21, 2001 between Vanguard Health Systems,
Inc., other Guarantors and the Trustee*
4.3 Second Supplemental Indenture, dated as of October 2, 2001 between Vanguard Health Systems,
Inc., other Guarantors and the Trustee*
4.4 Amended and Restated Subscription Agreement dated June 1, 2000 between Vanguard Health
Systems, Inc., funds controlled by Morgan Stanley Capital Partners and certain investors*
4.5 Voting Proxy Agreement dated as of June 1, 1998, among certain holders and Vanguard Health
Systems, Inc.*
4.6 Amended and Restated Shareholders Agreement, dated as of June 1, 2000 among Vanguard
Health Systems, Inc., funds controlled by Morgan Stanley Capital Partners and certain holders*
4.7 Surviving Shareholders Agreement dated as of June 1, 1998 among Vanguard Health Systems,
Inc., funds controlled by Morgan Stanley Capital Partners and certain holders*
4.8 Letter Agreement dated as of June 1, 1998 among Vanguard Health Systems, Inc., funds
controlled by Morgan Stanley Capital Partners and certain investors*
5 Opinion of Davis Polk & Wardwell with respect to the new notes*
10.1 Security Agreement, dated as of July 30, 2001 between Vanguard Health Systems, Inc. and the
Collateral Agent*
10.2 Pledge Agreement, dated as of July 30, 2001 between Vanguard Health Systems, Inc. and the
Collateral Trustee*
10.3 Credit Agreement, dated as of July 30, 2001 between Vanguard Health Systems, Inc. and various
lenders*
10.4 1998 Stock Option Plan*
10.5 2000 Stock Option Plan*
10.6 Nonqualified Initial Option Plan*
10.7 Carry Option Plan*
10.8 Employment Agreement between Vanguard Health Systems, Inc. and Charles N. Martin, Jr. dated
as of June 1, 1998 and amendment dated as of May 31, 2001*
10.9 Employment Agreement between Vanguard Health Systems, Inc. and William L. Hough dated as
of June 1, 1998 and amendment dated as of May 31, 2001*
II-2
Exhibit No. Document
- ----------- --------
10.10 Employment Agreement between Vanguard Health Systems, Inc. and Joseph D. Moore dated as of
June 1, 1998 and amendment dated as of July 31, 2001*
10.11 Employment Agreement between Vanguard Health Systems, Inc. and Ronald P. Soltman dated as
of June 1, 1998 and amendment dated as of July 31, 2001*
10.12 Employment Agreement between Vanguard Health Systems, Inc. and Keith B. Pitts dated as of
June 1, 1998 and amendment dated as of May 31, 2001*
10.13 Agreement for Purchase and Sale of Assets between Vanguard Health Systems and various
affiliates and Baptist Health Systems and its various affiliates, dated as of March 31, 2000*
10.14 Amendment dated as of June 1, 2000 to Agreement for Purchase and Sale of Assets between
Vanguard Health Systems and various affiliates and Baptist Health Systems and its various
affiliates*
10.15 Asset Purchase Agreement by and among MacNeal Health Services Corporation and various
affiliates and VHS of Illinois, Inc. and Vanguard Health Systems, Inc., dated as of October 4,
1999*
10.16 Amendment, dated as of February 1, 2000 to Asset Purchase Agreement by and among MacNeal
Health Services Corporation and various affiliates and VHS of Illinois, Inc. and Vanguard Health
Systems, Inc.*
10.17 Arizona Health Care Cost Containment System Administration contract with VHS Phoenix Health
Plan, dated as of October 1, 2001 and amendment dated as of October 1, 2001*
10.18 Vanguard Health Systems, Inc. 2001 Annual Incentive Plan*
12 Computation of Ratio of Earnings to Fixed Charges*
21 Subsidiaries of the Company*
23.1 Consent of Davis Polk & Wardwell (contained in their opinion filed as Exhibit 5)*
23.2 Consent of Ernst & Young LLP
23.3 Consent of Arthur Andersen LLP*
23.4 Consent of Arthur Andersen LLP*
24 Power of Attorney (included on signature page)*
25 Statement of Eligibility of Bank One Trust Company, as Trustee, on Form T-1.*
99.1 Form of Letter of Transmittal*
99.2 Form of Notice of Guaranteed Delivery*
99.3 Form of Letter to Clients*
99.4 Form of Letter to Nominees*
99.5 Form of Instructions to Registered Holder and/or Book-Entry Transfer Participant from Owner*
- --------------------
* Denotes documents previously filed.
(b) Financial Statement Schedules
All schedules have been omitted because they are not required, are not
applicable or the information is included in the selected consolidated
financial data or notes to consolidated financial statements appearing
elsewhere in this registration statement.
Item 17. Undertakings
(a) The undersigned hereby undertakes:
(1) To file during any period in which offers or sales are being made, a
post-effective amendment to this registration statement:
(i) to include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933;
II-3
(ii) to reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the aggregate,
represent a fundamental change in the information set forth in the
registration statement. Notwithstanding the foregoing, any increase or
decrease in the volume of notes offered (if the total dollar value of
notes offered would not exceed that which was registered) and any
deviation from the low or high end of the estimated maximum offering range
may be reflected in the form of prospectus filed with the Commission
pursuant to Rule 424(b) if, in the aggregate, the changes in volume and
price represent no more than a 20 percent change in the maximum aggregate
offering price set forth in the "Calculation of Registration Fee" table in
the effective registration statement; and
(iii) to include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or any
material change to such information in the registration statement;
provided, however, that paragraphs (a)(1)(i) and (a)(1)(ii) do not
apply if the registration statement is on Form S-3, Form S-8 or Form F-3,
and the information required to be included in a post-effective amendment
by those paragraphs is contained in periodic reports filed with or
furnished to the Commission by the registrant pursuant to Section 13 or
15(d) of the Securities Exchange Act of 1934 that are incorporated by
reference in the registration statement.
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed to
be a new registration statement relating to the notes offered therein, and the
offering of such notes at that time shall be deemed to be the initial bona fide
offering thereof.
(3) To remove from registration by means of a post-effective amendment any
of the notes being registered which remain unsold at the termination of the
offering.
(b) Insofar as indemnification for liabilities arising under the
Securities Act of 1933 may be permitted to our directors, officers and
controlling persons pursuant to the foregoing provisions, or otherwise, we have
been advised that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by us of expenses incurred or paid by
one of our directors, officers or controlling persons in the successful defense
of any action, suit or proceeding) is asserted by such director, officer or
controlling person in connection with the notes being registered, we will,
unless in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the Act and
will be governed by the final adjudication of such issue.
II-4
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, Vanguard
Health Systems, Inc. has duly caused this Amendment No. 3 to the Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Nashville, State of Tennessee, on January 16, 2002.
VANGUARD HEALTH SYSTEMS, INC.
By: /s/ Ronald P. Soltman
--------------------------------
Ronald P. Soltman
Executive Vice President
Pursuant to the requirements of the Securities Act of 1933, this Amendment
No. 3 to the Registration Statement has been signed by the following persons in
the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
*
- -------------------------- Chairman of the Board & Chief
Charles N. Martin, Jr. Executive Officer; Director
*
- -------------------------- President & Chief Operating Officer;
William L. Hough Director
*
- -------------------------- Executive Vice President, Chief
Joseph D. Moore Financial Officer & Treasurer; Director
/s/ Ronald P. Soltman
- -------------------------- Executive Vice President, General
Ronald P. Soltman Counsel & Secretary; Director
*
- -------------------------- Senior Vice President, Controller and
Phillip W. Roe Chief Accounting Officer
*
- -------------------------- Vice Chairman; Director
Keith B. Pitts
- -------------------------- Director
Karen H. Bechtel
- -------------------------- Director
Eric T. Fry
- -------------------------- Director
Howard I. Hoffen
II-5
The undersigned, by signing his or her name hereto, does sign and execute
this Amendment No. 3 to the Registration Statement on Form S-1 pursuant to the
Powers of Attorney executed by the above named directors and officers of
Vanguard Health Systems, Inc. and previously filed with the Securities and
Exchange Commission on behalf of such directors and officers.
*By: /s/ Ronald P. Soltman
--------------------------------
Ronald P. Soltman
Attorney-in-Fact
II-6
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, each of the
following corporations have duly caused this Amendment No. 3 to the
Registration Statement to be signed on their behalf by the undersigned,
thereunto duly authorized, in the City of Nashville, State of Tennessee, on
January 16, 2002.
VHS ACQUISITION CORPORATION
VHS OF PHOENIX, INC.
VHS OUTPATIENT CLINICS, INC.
VHS OF ARROWHEAD, INC.
PLEASANT PROPERTIES, INC.
VHS OF SOUTH PHOENIX, INC.
VHS IMAGING CENTERS, INC.
VHS OF ANAHEIM, INC.
VHS OF ORANGE COUNTY, INC.
VHS HOLDING COMPANY, INC.
VHS OF HUNTINGTON BEACH, INC.
VHS OF ILLINOIS, INC.
MACNEAL HEALTH PROVIDERS, INC.
MACNEAL MANAGEMENT SERVICES, INC.
MIDWEST CLAIMS PROCESSING, INC.
PROS TEMPORARY STAFFING, INC.
WATERMARK PHYSICIAN SERVICES, INC.
VHS GENESIS LAB, INC.
MACNEAL MEDICAL RECORDS, INC.
VANGUARD HEALTH MANAGEMENT, INC.
TRINITY MEDCARE, INC.
V-II ACQUISITION CO., INC.
VANGUARD HEALTH FINANCIAL COMPANY, INC.
VHS OF RANCOCAS, INC.
VHS ACQUISITION SUBSIDIARY NUMBER 1, INC.
VHS ACQUISITION SUBSIDIARY NUMBER 2, INC.
VHS ACQUISITION SUBSIDIARY NUMBER 3, INC.
VHS ACQUISITION SUBSIDIARY NUMBER 4, INC.
VHS ACQUISITION SUBSIDIARY NUMBER 5, INC.
VHS ACQUISITION SUBSIDIARY NUMBER 6, INC.
VHS ACQUISITION SUBSIDIARY NUMBER 7, INC.
VHS ACQUISITION SUBSIDIARY NUMBER 8, INC.
VHS ACQUISITION SUBSIDIARY NUMBER 9, INC.
VHS ACQUISITION SUBSIDIARY NUMBER 10, INC.
VHS PHOENIX HEALTH PLAN, INC.
HOSPITAL DEVELOPMENT OF WEST PHOENIX, INC.
HOSPITAL DEVELOPMENT COMPANY NUMBER 1, INC.
HOSPITAL DEVELOPMENT COMPANY NUMBER 2, INC.
By: /s/ Ronald P. Soltman
-----------------------------------------------
Ronald P. Soltman
Executive Vice President
Duly authorized to sign on behalf of
each of the foregoing entities
II-7
Pursuant to the requirements of the Securities Act of 1933, this Amendment
No. 3 to the Registration Statement has been signed by the following persons in
the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
*
- -------------------------- President and Chief Executive Officer
Charles N. Martin, Jr.
*
- -------------------------- Executive Vice President, Chief
Joseph D. Moore Financial Officer and Treasurer
*
- -------------------------- Senior Vice President, Controller and
Phillip W. Roe Chief Accounting Officer
*
- -------------------------- Director
Deborah T. McCormick
/s/ Ronald P. Soltman Director
- --------------------------
Ronald P. Soltman
*
- -------------------------- Director
James H. Spalding
The undersigned, by signing his or her name hereto, does sign and execute
this Amendment No. 3 to the Registration Statement on Form S-1 pursuant to the
Powers of Attorney executed by the above named directors and officers of
Vanguard Health Systems, Inc. and previously filed with the Securities and
Exchange Commission on behalf of such directors and officers.
*By: /s/ Ronald P. Soltman
------------------------------------
Ronald P. Soltman
Attorney-in-Fact
II-8
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, The VHS
Arizona Imaging Centers Limited Partnership has duly caused this Amendment No.
3 to the Registration Statement to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Nashville, State of Tennessee, on
January 16, 2002.
THE VHS ARIZONA IMAGING CENTERS LIMITED
PARTNERSHIP
By: VHS Imaging Centers, Inc.,
its General Partner
By: /s/ Ronald P. Soltman
------------------------------------
Ronald P. Soltman
Executive Vice President
Pursuant to the requirements of the Securities Act of 1933, this Amendment
No. 3 to the Registration Statement has been signed by the following persons in
the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
*
- -------------------------- President and Chief Executive Officer
Charles N. Martin, Jr.
*
- -------------------------- Executive Vice President, Chief
Joseph D. Moore Financial Officer and Treasurer
*
- -------------------------- Senior Vice President, Controller and
Phillip W. Roe Chief Accounting Officer
*
- -------------------------- Director
Deborah T. McCormick
/s/ Ronald P. Soltman Director
- --------------------------
Ronald P. Soltman
*
- -------------------------- Director
James H. Spalding
II-9
The undersigned, by signing his or her name hereto, does sign and execute
this Amendment No. 3 to the Registration Statement on Form S-1 pursuant to the
Powers of Attorney executed by the above named directors and officers of
Vanguard Health Systems, Inc. and previously filed with the Securities and
Exchange Commission on behalf of such directors and officers.
*By: /s/ Ronald P. Soltman
-------------------------------------
Ronald P. Soltman
Attorney-in-Fact
II-10
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, The Anaheim
VHS Limited Partnership has duly caused this Amendment No. 3 to the
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of Nashville, State of Tennessee, on January 16,
2002.
THE ANAHEIM VHS LIMITED PARTNERSHIP
By: VHS of Anaheim, Inc.,
its General Partner
By: /s/ Ronald P. Soltman
------------------------------------
Ronald P. Soltman
Executive Vice President
Pursuant to the requirements of the Securities Act of 1933, this Amendment
No. 3 to the Registration Statement has been signed by the following persons in
the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
*
- -------------------------- President and Chief Executive Officer
Charles N. Martin, Jr.
*
- -------------------------- Executive Vice President, Chief
Joseph D. Moore Financial Officer and Treasurer
*
- -------------------------- Senior Vice President, Controller and
Phillip W. Roe Chief Accounting Officer
*
- -------------------------- Director
Deborah T. McCormick
/s/ Ronald P. Soltman Director
- --------------------------
Ronald P. Soltman
*
- -------------------------- Director
James H. Spalding
II-11
The undersigned, by signing his or her name hereto, does sign and
execute this Amendment No. 3 to the Registration Statement on Form S-1
pursuant to the Powers of Attorney executed by the above named directors and
officers of Vanguard Health Systems, Inc. and previously filed with the
Securities and Exchange Commission on behalf of such directors and officers.
*By: /s/ Ronald P. Soltman
-------------------------------------
Ronald P. Soltman
Attorney-in-Fact
II-12
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, The Huntington
Beach VHS Limited Partnership has duly caused this Amendment No. 3 to the
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of Nashville, State of Tennessee, on January 16,
2002.
THE HUNTINGTON BEACH VHS LIMITED
PARTNERSHIP
By: VHS of Huntington Beach, Inc.,
its General Partner
By: /s/ Ronald P. Soltman
------------------------------------
Ronald P. Soltman
Executive Vice President
Pursuant to the requirements of the Securities Act of 1933, this Amendment
No. 3 to the Registration Statement has been signed by the following persons in
the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
*
- -------------------------- President and Chief Executive Officer
Charles N. Martin, Jr.
*
- -------------------------- Executive Vice President, Chief
Joseph D. Moore Financial Officer and Treasurer
*
- -------------------------- Senior Vice President, Controller and
Phillip W. Roe Chief Accounting Officer
*
- -------------------------- Director
Deborah T. McCormick
/s/ Ronald P. Soltman Director
- --------------------------
Ronald P. Soltman
*
- -------------------------- Director
James H. Spalding
II-13
The undersigned, by signing his or her name hereto, does sign and execute
this Amendment No. 3 to the Registration Statement on Form S-1 pursuant to the
Powers of Attorney executed by the above named directors and officers of
Vanguard Health Systems, Inc. and previously filed with the Securities and
Exchange Commission on behalf of such directors and officers.
*By: /s/ Ronald P. Soltman
------------------------------------
Ronald P. Soltman
Attorney-in-Fact
II-14
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, Healthcare
Compliance, L.L.C. has duly caused this Amendment No. 3 to the Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Nashville, State of Tennessee, on January 16,
2002.
HEALTHCARE COMPLIANCE, L.L.C.
By: Vanguard Health Management, Inc.,
its Member
By: /s/ Ronald P. Soltman
------------------------------------
Ronald P. Soltman
Executive Vice President
Pursuant to the requirements of the Securities Act of 1933, this Amendment
No. 3 to the Registration Statement has been signed by the following persons in
the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
*
- -------------------------- President and Chief Executive Officer
Charles N. Martin, Jr.
*
- -------------------------- Executive Vice President, Chief
Joseph D. Moore Financial Officer and Treasurer
*
- -------------------------- Senior Vice President, Controller and
Phillip W. Roe Chief Accounting Officer
*
- -------------------------- Director
Deborah T. McCormick
/s/ Ronald P. Soltman Director
- --------------------------
Ronald P. Soltman
*
- -------------------------- Director
James H. Spalding
II-15
The undersigned, by signing his or her name hereto, does sign and
execute this Amendment No. 3 to the Registration Statement on Form S-1
pursuant to the Powers of Attorney executed by the above named directors and
officers of Vanguard Health Systems, Inc. and previously filed with the
Securities and Exchange Commission on behalf of such directors and officers.
*By: /s/ Ronald P. Soltman
------------------------------------
Ronald P. Soltman
Attorney-in-Fact
II-16