Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2014

OR

 

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                     to                     .

COMMISSION FILE NUMBER: 333-117362

 

 

IASIS HEALTHCARE LLC

(Exact name of registrant as specified in its charter)

 

 

 

DELAWARE		20-1150104
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
DOVER CENTRE 117 SEABOARD LANE, BUILDING E FRANKLIN, TENNESSEE		37067
(Address of principal executive offices)		(Zip Code)

(615) 844-2747

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  ¨    NO  x

(Note: As a voluntary filer not subject to the filing requirements of Sections 13 or 15(d) of the Exchange Act, the registrant has filed all reports pursuant to Section 13 or 15(d) of the Exchange Act during the preceding 12 months as if it were subject to such filing requirements.)

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  x    NO  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer		¨		Accelerated filer		¨
Non-accelerated filer		x		Smaller reporting company		¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES  ¨    NO  x

As of August 14, 2014, 100% of the registrant’s common interests outstanding (all of which are privately owned and are not traded on any public market) were owned by IASIS Healthcare Corporation, its sole member.

 

 

 

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TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION			3
Item 1. Financial Statements			3
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			34
Item 3. Quantitative and Qualitative Disclosures about Market Risk			49
Item 4. Controls and Procedures			50
PART II. OTHER INFORMATION			50
Item 1. Legal Proceedings			50
Item 1A. Risk Factors			51
Item 6. Exhibits			51
Signatures			52

 

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PART I.

FINANCIAL INFORMATION

Item 1. Financial Statements

IASIS HEALTHCARE LLC

CONDENSED CONSOLIDATED BALANCE SHEETS

(In Thousands)

 

		June 30,				September 30,
		2014				2013
		(Unaudited)
ASSETS
Current assets
Cash and cash equivalents		$	317,643			$	438,131
Accounts receivable, less allowance for doubtful accounts of $232,819 and $255,725 at June 30, 2014 and September 30, 2013, respectively			336,649				371,006
Inventories			58,282				57,781
Deferred income taxes			15,491				26,096
Prepaid expenses and other current assets			181,224				126,412
Assets held for sale			—				119,141
Total current assets			909,289				1,138,567
Property and equipment, net			843,138				833,169
Goodwill			815,585				816,410
Other intangible assets, net			23,497				25,957
Other assets, net			60,445				66,162
Total assets		$	2,651,954			$	2,880,265
LIABILITIES AND EQUITY
Current liabilities
Accounts payable		$	119,355			$	129,542
Salaries and benefits payable			53,295				62,884
Accrued interest payable			9,682				27,519
Medical claims payable			69,108				57,514
Other accrued expenses and other current liabilities			61,308				92,553
Current portion of long-term debt and capital lease obligations			13,180				13,221
Advance on divestiture			—				144,803
Liabilities held for sale			—				3,208
Total current liabilities			325,928				531,244
Long-term debt and capital lease obligations			1,843,788				1,852,822
Deferred income taxes			114,460				115,592
Other long-term liabilities			117,482				123,120
Non-controlling interests with redemption rights			108,325				105,464
Equity
Member’s equity			132,263				142,262
Non-controlling interests			9,708				9,761
Total equity			141,971				152,023
Total liabilities and equity		$	2,651,954			$	2,880,265

See accompanying notes.

 

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IASIS HEALTHCARE LLC

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(In Thousands)

 

		Quarter Ended								Nine Months Ended
		June 30,								June 30,
		2014				2013				2014				2013
Net revenue
Acute care revenue before provision for bad debts		$	556,318			$	555,413			$	1,692,779			$	1,636,836
Less: Provision for bad debts			(83,437	)			(96,090	)			(281,931	)			(267,014	)
Acute care revenue			472,881				459,323				1,410,848				1,369,822
Premium revenue			200,281				139,804				524,995				422,059
Net revenue			673,162				599,127				1,935,843				1,791,881
Costs and expenses
Salaries and benefits (includes stock-based compensation of $4,442, $947, $8,796 and $2,946, respectively)			234,546				219,896				701,983				670,286
Supplies			80,411				79,462				243,437				240,724
Medical claims			165,943				116,640				436,754				348,556
Rentals and leases			18,796				13,992				56,429				40,635
Other operating expenses			114,933				106,456				325,012				309,987
Medicare and Medicaid EHR incentives			(2,790	)			(4,827	)			(10,233	)			(11,209	)
Interest expense, net			32,275				32,771				98,325				99,987
Depreciation and amortization			23,276				24,492				71,860				72,606
Management fees			1,250				1,250				3,750				3,750
Total costs and expenses			668,640				590,132				1,927,317				1,775,322
Earnings from continuing operations before gain on disposal of assets and income taxes			4,522				8,995				8,526				16,559
Gain on disposal of assets, net			332				481				1,100				649
Earnings from continuing operations before income taxes			4,854				9,476				9,626				17,208
Income tax expense			6,331				3,850				10,198				8,016
Net earnings from continuing operations			(1,477	)			5,626				(572	)			9,192
Earnings (loss) from discontinued operations, net of income taxes			(2,847	)			(531	)			1,821				849
Net earnings (loss)			(4,324	)			5,095				1,249				10,041
Net earnings attributable to non-controlling interests			(2,453	)			(1,941	)			(8,857	)			(3,189	)
Net earnings (loss) attributable to IASIS Healthcare LLC		$	(6,777	)		$	3,154			$	(7,608	)		$	6,852

See accompanying notes.

 

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IASIS HEALTHCARE LLC

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)

(In Thousands)

 

		Quarter Ended								Nine Months Ended
		June 30,								June 30,
		2014				2013				2014				2013
Net earnings (loss)		$	(4,324	)		$	5,095			$	1,249			$	10,041
Other comprehensive income
Change in fair value of highly effective interest rate hedges			201				1,753				1,179				1,643
Other comprehensive income before income taxes			201				1,753				1,179				1,643
Change in income tax expense			(75	)			(651	)			(438	)			(611	)
Other comprehensive income, net of income taxes			126				1,102				741				1,032
Comprehensive income (loss)			(4,198	)			6,197				1,990				11,073
Net earnings attributable to non-controlling interests			(2,453	)			(1,941	)			(8,857	)			(3,189	)
Comprehensive income (loss) attributable to IASIS Healthcare LLC		$	(6,651	)		$	4,256			$	(6,867	)		$	7,884

See accompanying notes.

 

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IASIS HEALTHCARE LLC

CONDENSED CONSOLIDATED STATEMENT OF EQUITY (UNAUDITED)

(In Thousands)

 

		Non-controlling
		Interests with								Non-
		Redemption				Member’s				controlling
		Rights				Equity				Interests				Total Equity
Balance at October 1, 2013		$	105,464			$	142,262			$	9,761			$	152,023
Net earnings (loss)			8,851				(7,608	)			6				(7,602	)
Distributions to non-controlling interests			(13,163	)			—				(59	)			(59	)
Repurchase of non-controlling interests			(600	)			—				—				—
Stock-based compensation			—				8,796				—				8,796
Other comprehensive income			—				741				—				741
Employee withholdings for taxes related to stock option exercise			—				(1,838	)			—				(1,838	)
Acquisition related adjustments to redemption value of non-controlling interests with redemption rights			235				—				—				—
Other			(2,530	)			(31	)			—				(31	)
Tax benefit from parent company			—				9				—				9
Adjustment to redemption value of non-controlling interests with redemption rights			10,068				(10,068	)			—				(10,068	)
Balance at June 30, 2014		$	108,325			$	132,263			$	9,708			$	141,971

See accompanying notes.

 

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IASIS HEALTHCARE LLC

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In Thousands)

 

		Nine Months Ended
		June 30,
		2014				2013
Cash flows from operating activities
Net earnings		$	1,249			$	10,041
Adjustments to reconcile net earnings to net cash provided by (used in) operating activities:
Depreciation and amortization			71,860				72,606
Amortization of loan costs			5,559				5,760
Change in physician minimum revenue guarantees			2,266				2,718
Amortization of deferred gain on sale-leaseback			(1,872	)			—
Stock-based compensation			8,796				2,946
Deferred income taxes			(1,934	)			16,338
Income tax benefit from stock-based compensation			—				16
Income tax benefit from parent company			9				103
Gain on disposal of assets, net			(1,100	)			(649	)
Earnings from discontinued operations, net			(1,821	)			(849	)
Changes in operating assets and liabilities, net of the effect of acquisitions and dispositions:
Accounts receivable, net			(4,544	)			(22,880	)
Inventories, prepaid expenses and other current assets			(41,570	)			(21,628	)
Accounts payable, other accrued expenses and other accrued liabilities			(18,011	)			(55,578	)
Income taxes and other transaction costs payable related to sale-leaseback of real estate			(22,270	)			—
Net cash provided by (used in) operating activities — continuing operations			(3,383	)			8,944
Net cash provided by (used in) operating activities — discontinued operations			(7,161	)			3,967
Net cash provided by (used in) operating activities			(10,544	)			12,911
Cash flows from investing activities
Purchases of property and equipment			(81,402	)			(79,369	)
Cash received (paid) for acquisitions, net			(1,038	)			3,584
Proceeds from sale of assets			1,510				83
Change in other assets, net			(173	)			(2,467	)
Other, net			(3,025	)			—
Net cash used in investing activities — continuing operations			(84,128	)			(78,169	)
Net cash provided by (used in) investing activities — discontinued operations			28				(4,318	)
Net cash used in investing activities			(84,100	)			(82,487	)
Cash flows from financing activities
Payment of debt and capital lease obligations			(10,184	)			(101,765	)
Proceeds from revolving credit facilities			—				147,000
Debt financing costs incurred			—				(1,024	)
Distributions to non-controlling interests			(13,222	)			(5,504	)
Cash received for the sale of non-controlling interests			—				849
Cash paid for the repurchase of non-controlling interests			(600	)			(1,018	)
Other			(1,838	)			12
Net cash provided by (used in) financing activities			(25,844	)			38,550
Change in cash and cash equivalents			(120,488	)			(31,026	)
Cash and cash equivalents at beginning of period			438,131				48,882
Cash and cash equivalents at end of period		$	317,643			$	17,856
Supplemental disclosure of cash flow information:
Cash paid for interest		$	111,176			$	111,687
Cash paid for income taxes, net		$	39,030			$	2,122

See accompanying notes.

 

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IASIS HEALTHCARE LLC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. ORGANIZATION AND BASIS OF PRESENTATION

The unaudited condensed consolidated financial statements as of and for the quarters and nine months ended June 30, 2014 and 2013, reflect the financial position, results of operations and cash flows of IASIS Healthcare LLC (“IASIS” or the “Company”). The Company’s sole member and parent company is IASIS Healthcare Corporation (“Holdings” or “IAS”).

IASIS owns and operates acute care hospitals primarily located in high-growth urban and suburban markets. At June 30, 2014, the Company owned or leased 16 acute care hospital facilities and one behavioral health hospital, with a total of 3,778 licensed beds, several outpatient service facilities and more than 137 physician clinics. The Company operates in various regions, including:

 

•

Salt Lake City, Utah;

 

•

Phoenix, Arizona;

 

•

five cities in Texas, including Houston and San Antonio;

 

•

West Monroe, Louisiana; and

 

•

Las Vegas, Nevada.

The Company also owns and operates Health Choice Arizona, Inc. and related entities (“Health Choice” or the “Plan”) that constitute a provider-owned, managed care organization and insurer that delivers healthcare services to over 266,000 members through multiple health plans, integrated delivery systems and managed care solutions. The Plan is headquartered in Phoenix, Arizona.

The unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial 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 GAAP for complete financial statements. The condensed consolidated balance sheet of the Company at September 30, 2013, has been derived from the audited consolidated financial statements at that date, but does not include all of the information and notes required by GAAP for complete financial statements. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2013, which was filed with the U.S. Securities and Exchange Commission (the “SEC”) on December 20, 2013.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all material adjustments (consisting of normal recurring items) necessary for a fair presentation of results for the interim periods presented. The results of operations for any interim period are not necessarily indicative of results for the full year or any other future periods.

Principles of Consolidation

The unaudited condensed consolidated financial statements include all subsidiaries and entities under common control of the Company. Control is generally defined by the Company as ownership of a majority of the voting interest of an entity. In addition, control is demonstrated in most instances when the Company is the sole general partner in a limited partnership. Significant intercompany transactions have been eliminated.

Use of Estimates

The preparation of the financial statements in conformity with GAAP 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.

Reclassifications

Certain prior year amounts have been reclassified to conform to the current year presentation. These reclassifications have no impact on the Company’s total assets or total liabilities and equity.

 

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IASIS HEALTHCARE LLC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

General and Administrative

The majority of the Company’s expenses are “cost of revenue” items. Costs that could be classified as “general and administrative” by the Company include the IASIS corporate office costs, which were $18.3 million and $9.7 million for the quarters ended June 30, 2014 and 2013, respectively, and $51.0 million and $29.5 million for the nine months ended June 30, 2014 and 2013, respectively.

Cash and Cash Equivalents

The Company considers highly liquid investments with original maturities of three months or less to be cash equivalents. The Company maintains its cash and cash equivalents balance primarily with high credit quality financial institutions. The Company manages its credit exposure by placing its investments in U.S. Treasury securities or other high quality securities, and by periodically evaluating the relative credit standing of the financial institution.

As discussed in Note 3, cash generated from certain asset dispositions may be subject to prepayment requirements under our senior credit agreement and indenture.

Stock-Based Compensation

Although IASIS has no stock option plan or outstanding stock options, the Company, through its parent, IAS, grants stock options for a fixed number of common shares to employees. The Company accounts for this stock-based incentive plan under the measurement and recognition provisions of Financial Accounting Standards Board (“FASB”) authoritative guidance regarding share-based payments (“Share-Based Payments Guidance”). Accordingly, the Company applies the fair value recognition provisions requiring all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on the estimated grant date fair value of each stock-based award. In accordance with the provisions of the Share-Based Payments Guidance, the Company uses the Black-Scholes-Merton model in determining the fair value of its share-based payments. The fair value of compensation costs for time-vested options will generally be amortized on a straight-line basis over the requisite service periods of the awards, generally equal to the awards’ vesting periods, while the fair value of compensation costs for options with market-based conditions are recognized on a graded schedule generally over the awards’ vesting periods.

On October 18, 2013, IAS distributed $115.0 million in a cash dividend to its common stockholders. In connection with this shareholder distribution, the board of directors of IAS authorized management to modify the exercise price of all outstanding stock options to provide protection against the dilutive impact of the common stock dividend on the outstanding options’ intrinsic value. On January 23, 2014, the Company reduced the exercise price for each grant by $7.86 per option. Accordingly, as a result of the modification, an additional $2.8 million of stock-based compensation was recognized in the second quarter of fiscal 2014.

During the quarter ended June 30, 2014, the Company completed certain equity transactions that included the following: (1) the issuance to certain employees of 756,000 options to purchase the common stock of IAS; (2) the exercise by option holders of 1,149,663 options with near-term expiration dates to purchase the common stock of IAS on cashless net settlement basis; (3) the issuance to employees of 992,000 restricted stock units (“RSUs”) that vest at the end of a three year service period; and (4) the exchange of 802,272 out-of-the-money options to purchase the common stock of IAS for RSUs on a 5-for-1 basis that vest at the end of a three year service period. In connection with these equity compensation instruments, the Company recognized $3.7 million of stock-based compensation during the quarter ended June 30, 2014.

Fair Value of Financial Instruments

The Company applies the provisions of FASB authoritative guidance regarding fair value measurements, which provides a single definition of fair value, establishes a framework for measuring fair value, and expands disclosures concerning fair value measurements. The Company applies these provisions to the valuation and disclosure of certain financial instruments. This authoritative guidance establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: (i) Level 1, which is defined as quoted prices in active markets that can be accessed at the measurement date; (ii) Level 2, which is defined as inputs other than quoted prices in active markets that are observable, either directly or indirectly; and (iii) Level 3, which is defined as unobservable inputs resulting from the existence of little or no market data, therefore potentially requiring an entity to develop its own assumptions.

Cash and cash equivalents, accounts receivable, inventories, prepaid and other current assets, accounts payable, salaries payable, accrued interest, medical claims payable, and other accrued expenses and other current liabilities are reflected in

 

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IASIS HEALTHCARE LLC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

the accompanying unaudited condensed consolidated financial statements at amounts that approximate fair value because of the short-term nature of these instruments. The fair value of the Company’s capital leases and other long-term financing obligations also approximate carrying value as they bear interest at current market rates. The estimated fair values of the Company’s 8.375% senior notes due 2019 (the “Senior Notes”) and senior secured term loan facility were based upon quoted market prices at that date and are categorized as Level 2 within the fair value hierarchy.

The carrying values and fair values of the senior secured term loan facility and the Senior Notes as of June 30, 2014 and September 30, 2013 were as follows (in thousands):

 

		Carrying Amount								Fair Value
		June 30, 2014				September 30, 2013				June 30, 2014				September 30, 2013
Senior secured term loan facility		$	989,150			$	996,154			$	996,301			$	1,003,258
Senior Notes			846,287				845,711				907,375				882,938

The Company determines the fair value of its interest rate hedges in a manner consistent with that used by market participants in pricing hedging instruments, which includes using a discounted cash flow analysis based upon the terms of the agreements, the impact of the forward LIBOR curve and an evaluation of credit risk. Given the use of observable market assumptions and the consideration of credit risk, the Company has categorized the valuation of its interest rate hedges as Level 2.

Discontinued Operations

Effective October 1, 2013, the Company completed the sale of its Florida operations which primarily included three hospitals in the Tampa-St. Petersburg area and all related physician operations. Accordingly, the operating results and cash flows of the Florida operations are reported as discontinued operations for all periods presented. The aggregate proceeds from the sale were $144.8 million, which resulted in a gain on the sale of assets totaling $22.2 million in the nine months ended June 30, 2014. This gain is included in discontinued operations in the accompanying unaudited condensed consolidated statement of operations.

The following table provides the components of discontinued operations related to the Company’s Florida operations (in thousands):

 

		Quarter Ended June 30,								Nine Months Ended June 30,
		2014				2013				2014				2013
Net revenue before provision for bad debts		$	(1,325	)		$	61,434			$	(7,604	)		$	183,087
Earnings (loss) before income taxes			(4,711	)			(1,494	)			3,046				516

Recent Accounting Pronouncements

Newly Adopted

In February 2013, the FASB issued Accounting Standards Update (“ASU”) No. 2013-02, “Comprehensive Income — Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” ASU 2013-02 requires entities to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under GAAP to be reclassified in its entirety to net income. For other amounts that are not required under GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under GAAP that provide additional detail about those amounts. ASU 2013-02 is required to be applied prospectively and is effective for fiscal years beginning after December 15, 2012, and interim periods within those years. The Company has adopted this authoritative guidance effective October 1, 2013. At June 30, 2014, the Company’s only component of accumulated other comprehensive loss relates to unrecognized changes in fair value of interest rate swaps. No reclassifications out of accumulated other comprehensive loss into net earnings (loss) were made during the quarter and nine months ended June 30, 2014, as the Company determined that these cash flow hedges were highly effective.

In July 2011, the FASB issued ASU No. 2011-06, “Other Expenses (Topic 720): Fees Paid to the Federal Government by Health Insurers”. Effective January 1, 2014, the Company adopted this new authoritative guidance relating to the recognition and income statement reporting of the mandated health insurer fee (“HIF”) to be paid to the federal government by health insurers, as part of Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010, or collectively, Health Reform Law, which is imposed for calendar years beginning after December 31, 2013. The HIF is based on a company’s share of the industry’s net premiums written during the preceding calendar year, and is payable on September 30 of each year.

 

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IASIS HEALTHCARE LLC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

The Company estimates Health Choice’s portion of the HIF for the 2014 calendar year to be approximately $7.9 million. The final calculation and payment of the HIF will occur in the Company’s fiscal fourth quarter of 2014. The HIF is non-deductible for federal income tax purposes. ASU 2011-06 addresses how the HIF should be recognized and classified in the financial statements of health insurers. In accordance with ASU 2011-06, the Company recorded the estimated liability for the HIF in full with a corresponding deferred asset that is being amortized to expense on a straight-line basis. The Company’s estimated liability for the HIF is recorded within other accrued expenses and other current liabilities on the unaudited condensed consolidated balance sheet. The corresponding deferred asset is recorded within prepaid expenses and other current assets on the unaudited condensed consolidated balance sheet. During the quarter and nine months ended June 30, 2014, the Company recognized $4.0 million in other operating expenses related to amortization of the HIF, with a remaining deferred cost asset balance of $3.9 million. No such amounts were recorded at September 30, 2013 as the qualifying insurance coverage was not provided until January 1, 2014. Because Health Choice primarily serves individuals in government-sponsored programs, Health Choice must secure additional reimbursement from state partners for this added cost. The Company recognizes HIF revenue when there is a contractual commitment from the state to reimburse Health Choice for the full economic impact of the health insurer fee. This HIF revenue is recognized ratably throughout the year.

Recently Issued

In April 2014, the FASB issued ASU No. 2014-08, “Presentation of Financial Statements and Property, Plant, and Equipment—Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.” Among other provisions and in addition to expanded disclosures, ASU 2014-08 changes the definition of what components of an entity qualify for discontinued operations treatment and reporting from a reportable segment, operating segment, reporting unit, subsidiary or asset group to only those components of an entity that represent a strategic shift that has, or will have, a major effect on an entity’s operations and financial results. Additionally, ASU 2014-08 requires disclosure about a disposal of an individually significant component of an entity that does not qualify for discontinued operations presentation in the financial statements, including the pretax profit or loss attributable to the component of an entity for the period in which it is disposed of or is classified as held for sale. The disclosure of this information is required for all of the same periods that are presented in the entity’s results of operations for the period. The provisions of ASU 2014-08 are effective prospectively for all disposals or classifications as held for sale of components of an entity that occur within annual periods beginning on or after December 15, 2014, and interim periods within those years. Early adoption is permitted.

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers” which outlines a single comprehensive model for recognizing revenue and supersedes most existing revenue recognition guidance, including guidance specific to the healthcare industry. In addition, ASU 2014-09 will require new and enhanced disclosures. Companies can adopt the new standard either using the full retrospective approach, a modified retrospective approach with practical expedients, or a cumulative effect upon adoption approach. ASU 2014-09 will become effective for annual and interim reporting periods beginning after December 15, 2016. Early adoption is not permitted. The Company is currently evaluating the effect of the new revenue recognition guidance.

2. ACUTE CARE REVENUE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS

Acute Care Revenue

The Company’s healthcare facilities have entered into agreements with third-party payors, including government programs and managed care health plans, under which the facilities are paid based upon established charges, the cost of providing services, predetermined rates per diagnosis, fixed per diem rates or discounts from established charges. Additionally, the Company offers discounts through its uninsured discount program to all uninsured patients receiving healthcare services who do not qualify for assistance under state Medicaid, other federal or state assistance plans, or charity care.

Acute care revenue is reported at the estimated net realizable amounts from 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 are adjusted, if necessary, in future periods when final settlements are determined. The Company also records a provision for bad debts related to uninsured accounts to reflect its self-pay

 

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accounts receivable at the estimated amounts expected to be collected. The sources of the Company’s hospital net patient revenue by payor before the provision for bad debts are summarized as follows:

 

		Quarter Ended June 30,								Nine Months Ended June 30,
		2014				2013				2014				2013
Medicare			20.3	%			20.5	%			20.6	%			21.3	%
Managed Medicare			10.1	%			9.8	%			10.1	%			10.0	%
Medicaid and managed Medicaid			13.4	%			12.0	%			12.7	%			12.2	%
Managed care and other			40.9	%			38.4	%			39.5	%			37.9	%
Self-pay			15.3	%			19.3	%			17.1	%			18.6	%
Total			100.0	%			100.0	%			100.0	%			100.0	%

Allowance For Doubtful Accounts

The provision for bad debts and the associated allowance for doubtful accounts relate primarily to amounts due directly from patients. The Company’s estimation of its allowance for doubtful accounts is based primarily upon the type and age of the patient accounts receivable and the effectiveness of collection efforts. The Company’s policy is to reserve a portion of all self-pay receivables, including amounts due from the uninsured and amounts related to co-payments and deductibles, as these charges are recorded. The Company monitors accounts receivable balances and the effectiveness of reserve policies on at least a quarterly and reviews various analytics to support the basis for its estimates. These efforts primarily consist of reviewing the following:

 

•

Historical write-off and collection experience using a hindsight or look-back approach;

 

•

Revenue and volume trends by payor, particularly the self-pay components;

 

•

Changes in the aging and payor mix of accounts receivable, including increased focus on accounts due from the uninsured and accounts that represent co-payments and deductibles due from patients;

 

•

Cash collections as a percentage of net patient revenue less bad debts;

 

•

Trending of days revenue in accounts receivable; and

 

•

Various allowance coverage statistics.

The Company performs hindsight procedures to evaluate historical write-off and collection experience throughout the year to assist in determining the reasonableness of the process for estimating the allowance for doubtful accounts. The Company does not pursue collection of amounts related to patients who qualify for charity care under the Company’s guidelines. Charity care accounts are deducted from gross revenue and do not affect the provision for bad debts.

At June 30, 2014 and September 30, 2013, the Company’s net self-pay receivables, including amounts due from uninsured patients and co-payment and deductible amounts due from insured patients, were $287.2 million and $336.2 million, respectively. At June 30, 2014 and September 30, 2013, the Company’s allowance for doubtful accounts was $232.8 million and $255.7 million, respectively.

3. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS

Long-term debt and capital lease obligations consist of the following (in thousands):

 

		June 30, 2014				September 30, 2013
Senior secured term loan facility		$	989,150			$	996,154
Senior Notes			846,287				845,711
Capital leases and other obligations			21,531				24,178
			1,856,968				1,866,043
Less current maturities			13,180				13,221
		$	1,843,788			$	1,852,822

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

As of June 30, 2014, the senior secured term loan facility balance reflects an original issue discount (“OID”) of $2.8 million, which is net of accumulated amortization of $2.3 million. The Senior Notes balance reflects an OID of $3.7 million, which is net of accumulated amortization of $2.4 million.

As of June 30, 2014 and September 30, 2013, capital leases and other obligations includes a financing obligation totaling $10.5 million and $11.1 million, respectively, resulting from the Company’s sale-leaseback transactions which closed on September 26, 2013.

$1.325 Billion Senior Secured Credit Facilities

The Company is party to a senior credit agreement, which was amended on February 20, 2013 (the “Repricing Amendment”) as part of a repricing that lowered the interest rate, (the “Amended and Restated Credit Agreement”). The Amended and Restated Credit Agreement provides for senior secured financing of up to $1.325 billion consisting of (1) a $1.025 billion senior secured term loan facility with a seven-year maturity and (2) a $300.0 million senior secured revolving credit facility with a five-year maturity, of which up to $150.0 million may be utilized for the issuance of letters of credit (together, the “Senior Secured Credit Facilities”). Principal under the senior secured term loan facility is due in consecutive equal quarterly installments in an aggregate annual amount equal to 1% of the principal amount of $1.007 billion outstanding as of the effective date of the Repricing Amendment, with the remaining balance due upon maturity of the senior secured term loan facility. The senior secured revolving credit facility does not require installment payments.

Borrowings under the senior secured term loan facility (giving effect to the Repricing Amendment) bear interest at a rate per annum equal to, at the Company’s option, either (1) a base rate (the “base rate”) determined by reference to the highest of (a) the federal funds rate plus 0.50%, (b) the prime rate of Bank of America, N.A. and (c) a one-month LIBOR rate, subject to a floor of 1.25%, plus 1.00%, in each case, plus a margin of 2.25% per annum or (2) the LIBOR rate for the interest period relevant to such borrowing, subject to a floor of 1.25%, plus a margin of 3.25% per annum. Borrowings under the senior secured revolving credit facility generally bear interest at a rate per annum equal to, at the Company’s option, either (1) the base rate plus a margin of 2.50% per annum, or (2) the LIBOR rate for the interest period relevant to such borrowing plus a margin of 3.50% per annum. In addition to paying interest on outstanding principal under the Senior Secured Credit Facilities, the Company is required to pay a commitment fee on the unutilized commitments under the senior secured revolving credit facility, as well as pay customary letter of credit fees and agency fees.

The Senior Secured Credit Facilities are unconditionally guaranteed by IAS and certain subsidiaries of the Company (collectively, the “Credit Facility Guarantors”) and are required to be guaranteed by all future material wholly-owned subsidiaries of the Company, subject to certain exceptions. All obligations under the Amended and Restated Credit Agreement are secured, subject to certain exceptions, by substantially all of the Company’s assets and the assets of the Credit Facility Guarantors, including (1) a pledge of 100% of the equity interests of the Company and the Credit Facility Guarantors, (2) mortgage liens on all of the Company’s material real property and that of the Credit Facility Guarantors, and (3) all proceeds of the foregoing.

The Amended and Restated Credit Agreement requires the Company to mandatorily prepay borrowings under the senior secured term loan facility with net cash proceeds of certain asset dispositions, following certain casualty events, following certain borrowings or debt issuances, and from a percentage of annual excess cash flow. The Amended and Restated Credit Agreement contains certain restrictive covenants, including, among other things: (1) limitations on the incurrence of debt and liens; (2) limitations on investments other than, among other exceptions, certain acquisitions that meet certain conditions; (3) limitations on the sale of assets outside of the ordinary course of business; (4) limitations on dividends and distributions; and (5) limitations on transactions with affiliates, in each case, subject to certain exceptions. The Amended and Restated Credit Agreement also contains certain customary events of default, including, without limitation, a failure to make payments under the Senior Secured Credit Facilities, cross-defaults, certain bankruptcy events and certain change of control events.

8.375% Senior Notes due 2019

The Company, together with its wholly owned subsidiary IASIS Capital Corporation (“IASIS Capital”) (together, the “Issuers”), have issued $850.0 million aggregate principal amount of Senior Notes, which mature on May 15, 2019, pursuant to an indenture, dated as of May 3, 2011, among the Issuers and certain of the Issuers’ wholly owned domestic subsidiaries that guarantee the Senior Secured Credit Facilities (the “Notes Guarantors”) (the “Indenture”). The Indenture provides that the Senior Notes are general unsecured, senior obligations of the Issuers, and initially will be unconditionally guaranteed on a senior unsecured basis.

The Senior Notes bear interest at a rate of 8.375% per annum, payable semi-annually, in cash in arrears, on May 15 and November 15 of each year.

 

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The Company may redeem the Senior Notes, in whole or in part, at any time on or after May 15, 2014, at a price equal to 106.281% of the aggregate principal amount of the Senior Notes plus accrued and unpaid interest and special interest, if any, to but excluding the redemption date. Each subsequent year the redemption price declines 2.093% until 2017 and thereafter, at which point the redemption price is equal to 100% of the aggregate principal amount of the Senior Notes plus accrued and unpaid interest and special interest, if any, to but excluding the redemption date.

The Indenture contains covenants that limit the Company’s (and its restricted subsidiaries’) ability to, among other things: (1) incur additional indebtedness or liens or issue disqualified stock or preferred stock; (2) pay dividends or make other distributions on, redeem or repurchase the Company’s capital stock; (3) sell certain assets; (4) make certain loans and investments; (5) enter into certain transactions with affiliates; (6) impose restrictions on the ability of a subsidiary to pay dividends or make payments or distributions to the Company and its restricted subsidiaries; and (7) consolidate, merge or sell all or substantially all of the Company’s assets. These covenants are subject to a number of important limitations and exceptions.

The Indenture also provides for events of default, which, if any of them occurs, may permit or, in certain circumstances, require the principal, premium, if any, interest and any other monetary obligations on all the then outstanding Senior Notes to be due and payable immediately. If the Company experiences certain kinds of changes of control, it must offer to purchase the Senior Notes at 101% of their principal amount, plus accrued and unpaid interest and special interest, if any, to but excluding the repurchase date. Under certain circumstances, the Company will have the ability to make certain payments to facilitate a change of control transaction and to provide for the assumption of the Senior Notes by a new parent company resulting from such change of control transaction. If such change of control transaction is facilitated, the Issuers will be released from all obligations under the Indenture and the Issuers and the trustee will execute a supplemental indenture effectuating such assumption and release.

4. INTEREST RATE SWAPS

In August 2011, the Company executed forward starting interest rate swaps with Citibank N.A. and Barclays Bank PLC, as counterparties, with notional amounts totaling $350.0 million, each agreement effective March 28, 2013 and expiring between September 30, 2014 and September 30, 2016. Under these agreements, the Company is required to make quarterly fixed rate payments at annual rates ranging from 1.6% to 2.2%. The counterparties are obligated to make quarterly floating rate payments to the Company based on the three-month LIBOR rate, each subject to a floor of 1.25%. The Company completed an assessment of these cash flow hedges during the quarters and nine months ended June 30, 2014 and 2013, and determined that these hedges were highly effective. Accordingly, no gain or loss related to these hedges has been reflected in the accompanying unaudited condensed consolidated statements of operations, and the change in fair value has been included in accumulated other comprehensive loss as a component of member’s equity.

 

		Total Notional Amounts
Effective Dates		(in thousands)
Effective from March 28, 2013 to September 30, 2014		$	50,000
Effective from March 28, 2013 to September 30, 2015			100,000
Effective from March 28, 2013 to September 30, 2016			200,000

The fair value of the Company’s interest rate hedges at June 30, 2014 and September 30, 2013, reflect liability balances of $4.7 million and $5.9 million, respectively, and are included in other long-term liabilities in the accompanying unaudited condensed consolidated balance sheets. The fair value of the Company’s interest rate hedges reflects a liability because the effect of the forward LIBOR curve on future interest payments results in less interest due to the Company under the variable rate component included in the interest rate hedging agreements, as compared to the amount due the Company’s counterparties under the fixed interest rate component.

5. GOODWILL

The following table presents the changes in the carrying amount of goodwill (in thousands):

 

		Acute Care				Health Choice				Total
Balance at September 30, 2013		$	810,653			$	5,757			$	816,410
Adjustments related to acquisitions			(825	)			—				(825	)
Balance at June 30, 2014		$	809,828			$	5,757			$	815,585

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

6. ACCUMULATED OTHER COMPREHENSIVE LOSS

The components of accumulated other comprehensive loss, net of income taxes, are as follows (in thousands):

 

		June 30, 2014				September 30, 2013
Fair value of interest rate hedges		$	(4,739	)		$	(5,918	)
Income tax benefit			1,851				2,289
Accumulated other comprehensive loss		$	(2,888	)		$	(3,629	)

7. INCOME TAXES

For the quarter ended June 30, 2014, the Company recorded income tax expense of $6.3 million, for an effective tax rate of 130.4%, compared to an income tax expense of $3.9 million, for an effective tax rate of 40.6% in the prior year quarter. For the nine months ended June 30, 2014, the Company recorded income tax expense of $10.2 million, for an effective tax rate of 105.9%, compared to income tax expense of $8.0 million, for an effective tax rate of 46.6% in the prior year period. The increase in the effective tax rate was primarily due to an increase in certain nondeductible expenses including: (1) nondeductible compensation, including stock-based compensation; (2) a $1.1 million expense related to an excess of cumulative compensation deductions over the realized tax benefit upon the exercise of employee stock options; and (3) the HIF imposed by the Health Reform Law beginning in 2014, which is treated as a nondeductible excise tax.

8. COMMITMENTS AND CONTINGENCIES

Net Revenue

The calculation of appropriate payments from the Medicare and Medicaid programs, as well as terms governing agreements with other third-party payors, is complex and subject to interpretation. Final determination of amounts earned under the Medicare and Medicaid programs often occurs subsequent to the year in which services are rendered because of audits by the programs, rights of appeal and the application of numerous technical provisions. In the opinion of management, adequate provision has been made for adjustments that may result from such routine audits and appeals.

Professional, General and Workers’ Compensation Liability Risks

The Company is subject to claims and legal actions in the ordinary course of business, including but not limited to claims relating to patient treatment and personal injuries. To cover these types of claims, the Company maintains professional and general liability insurance in excess of self-insured retentions through a commercial insurance carrier in amounts that the Company believes to be sufficient for its operations, although, potentially, some claims may exceed the scope of coverage in effect. Plaintiffs in these matters may request punitive or other damages that may not be covered by insurance. The Company is currently not a party to any such proceedings that, in the Company’s opinion, would have a material adverse effect on the Company’s business, financial condition or results of operations. The Company expenses an estimate of the costs it expects to incur under the self-insured retention exposure for professional and general liability claims using historical claims data, demographic factors, severity factors, current incident logs and other actuarial analysis. At June 30, 2014 and September 30, 2013, the Company’s professional and general liability accrual for asserted and unasserted claims totaled $67.3 million and $68.2 million, respectively.

The Company is subject to claims and legal actions in the ordinary course of business relative to workers’ compensation matters. To cover these types of claims, the Company maintains workers’ compensation insurance coverage with a self-insured retention. The Company accrues the costs of workers’ compensation claims based upon estimates derived from its claims experience.

Health Choice

Health Choice has entered into capitated contracts whereby the Plan provides managed healthcare services in exchange for fixed periodic and supplemental payments from the Arizona Health Care Cost Containment System (“AHCCCS”), the state of Utah’s Medicaid agency and the Centers for Medicare and Medicaid Services (“CMS”). These services are provided regardless of the actual costs incurred to provide these services. The Company receives reinsurance and other supplemental payments to cover certain costs of healthcare services that exceed certain thresholds. The Company believes that current capitated payments received, together with reinsurance and other supplemental payments, are sufficient to pay for the services Health Choice is obligated to deliver. As of June 30, 2014, the Company has provided a performance guaranty in the form of a letter of credit totaling $44.9 million for the benefit of AHCCCS to support Health Choice’s obligations under its contract to provide and pay for the healthcare services. The amount of the performance guaranty is generally based, in part, upon the membership in the Plan and the related capitation revenue paid to Health Choice.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

Acquisitions

The Company has acquired and in the future may choose to acquire businesses with prior operating histories. Such businesses may have unknown or contingent liabilities, including liabilities for failure to comply with healthcare laws and regulations, such as billing and reimbursement, fraud and abuse and similar anti-referral laws. Although the Company has procedures designed to conform business practices to its policies following the completion of any acquisition, there can be no assurance that the Company will not become liable for previous activities of prior owners that may later be asserted to be improper by private plaintiffs or government agencies. Although the Company generally seeks to obtain indemnification from prospective sellers covering such matters, there can be no assurance that any such matter will be covered by indemnification, or if covered, that such indemnification will be adequate to cover potential losses and fines.

Other

In November 2010, the U.S. Department of Justice (“DOJ”) sent a letter to the Company requesting a 12-month tolling agreement in connection with an investigation into Medicare claims submitted by the Company’s hospitals in connection with the implantation of implantable cardioverter defibrillators (“ICDs”) during the period 2003 to the present. At that time, neither the precise number of procedures, number of claims, nor the hospitals involved were identified by the DOJ. The Company understands that the government is conducting a national initiative with respect to ICD procedures involving a number of healthcare providers and is seeking information in order to determine if ICD implantation procedures were performed in accordance with Medicare coverage requirements. On January 11, 2011, the Company entered into the tolling agreement with the DOJ and, subsequently, the DOJ has provided the Company with a list of 194 procedures involving ICDs at 14 hospitals which are the subject of further medical necessity review by the DOJ. The Company is cooperating fully with the government and, to date, the DOJ has not asserted any claim against its hospitals. Applying the resolution model proposed by the DOJ, the Company believes that at least 131 of these procedure claims were properly documented for medical necessity and billed appropriately. The Company’s outside counsel has submitted to the DOJ summary justifications and supporting evidence relating to the medical claims at six of the Company’s hospitals. The Company continues to provide support for the remaining 63 of these cases that could have some likelihood of enforcement by the DOJ. If the Company is unable to place these claims in a non-enforcement or lesser enforcement category, the government may require repayment, which could impose a multiplier. Given the case-specific nature of the claims and the DOJ’s discretion to compromise claims, the Company is unable at this time to estimate any potential repayment obligation related to this matter. The tolling agreement between the Company and the government, as recently extended, is currently set to expire December 31, 2014.

On September 25, 2013, the Company voluntarily self-disclosed for resolution through the Self-Referral Disclosure Protocol established by CMS non-compliance by ten of its affiliated hospitals with a certain element of an exception of the Stark Law. Provisions of the Affordable Care Act that became effective on September 23, 2011 require, as an element of the Stark Law’s “whole-hospital” exception, that hospitals having physician ownership disclose such ownership on their public websites and in public advertising. The self-disclosure states that, on August 12, 2013, the Company discovered that the ten Company-affiliated hospitals partially owned by physicians did not consistently make such disclosures. The self-disclosure also states that, on August 13, 2013, the hospitals added the disclosures to those public websites that did not previously have them and began to include the disclosures in new public advertising. The self-disclosure explains that, as a result of the absence of the website and advertising disclosures, the referrals of direct and indirect physician owners (and physicians who are immediate family members of direct and indirect owners) to the physician-owned hospitals of Medicare beneficiaries did not consistently qualify for the Stark Law’s “whole-hospital” exception from September 23, 2011 through August 13, 2013. On October 21, 2013, the Company submitted a supplement to its self-disclosure, reporting Medicare payments to these hospitals for services resulting from referrals affected by the non-compliance and the hospitals’ profit distributions to physicians (and known immediate family members of physicians) with respect to their ownership interests in the hospitals during the same period. The Company has been in communication with CMS about resolving this matter but, at present, CMS has made no commitments, as a general matter or in this case, regarding the timing or substance of resolution of self-disclosed Stark Law noncompliance through the voluntary CMS Self-Referral Disclosure Protocol. As a result, the Company expresses no opinion as to its outcome other than to state that it could take up to one year or longer to resolve and, at this time, any repayment obligation or other penalties to be determined by CMS is unknown and not currently estimable.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

9. SEGMENT INFORMATION

The Company’s reportable operating segments consist of (1) acute care hospitals and related healthcare businesses, collectively and (2) Health Choice. The following is a financial summary by business segment for the periods indicated (in thousands):

 

		For the Quarter Ended June 30, 2014
		Acute Care				Health Choice				Eliminations				Consolidated
Acute care revenue before provision for bad debts		$	556,318			$	—			$	—			$	556,318
Less: Provision for bad debts			(83,437	)			—				—				(83,437	)
Acute care revenue			472,881				—				—				472,881
Premium revenue			—				200,281				—				200,281
Revenue between segments			3,262				—				(3,262	)			—
Net revenue			476,143				200,281				(3,262	)			673,162
Salaries and benefits (excludes stock-based compensation)			221,175				8,929				—				230,104
Supplies			80,341				70				—				80,411
Medical claims			—				169,205				(3,262	)			165,943
Rentals and leases			18,348				448				—				18,796
Other operating expenses (excludes expenses related to stock-based compensation)			101,706				13,059				—				114,765
Medicare and Medicaid EHR incentives			(2,790	)			—				—				(2,790	)
Adjusted EBITDA(1)			57,363				8,570				—				65,933
Interest expense, net			32,275				—				—				32,275
Depreciation and amortization			22,244				1,032				—				23,276
Stock-based compensation and related expenses			4,610				—				—				4,610
Management fees			1,250				—				—				1,250
Earnings (loss) from continuing operations before gain on disposal of assets and income taxes			(3,016	)			7,538				—				4,522
Gain on disposal of assets, net			332				—				—				332
Earnings (loss) from continuing operations before income taxes		$	(2,684	)		$	7,538			$	—			$	4,854

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

		For the Quarter Ended June 30, 2013
		Acute Care				Health Choice				Eliminations				Consolidated
Acute care revenue before provision for bad debts		$	555,413			$	—			$	—			$	555,413
Less: Provision for bad debts			(96,090	)			—				—				(96,090	)
Acute care revenue			459,323				—				—				459,323
Premium revenue			—				139,804				—				139,804
Revenue between segments			1,940				—				(1,940	)			—
Net revenue			461,263				139,804				(1,940	)			599,127
Salaries and benefits (excludes stock-based compensation)			212,859				6,090				—				218,949
Supplies			79,422				40				—				79,462
Medical claims			—				118,580				(1,940	)			116,640
Rentals and leases			13,597				395				—				13,992
Other operating expenses			100,463				5,993				—				106,456
Medicare and Medicaid EHR incentives			(4,827	)			—				—				(4,827	)
Adjusted EBITDA(1)			59,749				8,706				—				68,455
Interest expense, net			32,771				—				—				32,771
Depreciation and amortization			23,463				1,029				—				24,492
Stock-based compensation			947				—				—				947
Management fees			1,250				—				—				1,250
Earnings from continuing operations before gain on disposal of assets and income taxes			1,318				7,677				—				8,995
Gain on disposal of assets, net			481				—				—				481
Earnings from continuing operations before income taxes		$	1,799			$	7,677			$	—			$	9,476

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

		For the Nine Months Ended June 30, 2014
		Acute Care				Health Choice				Eliminations				Consolidated
Acute care revenue before provision for bad debts		$	1,692,779			$	—			$	—			$	1,692,779
Less: Provision for bad debts			(281,931	)			—				—				(281,931	)
Acute care revenue			1,410,848				—				—				1,410,848
Premium revenue			—				524,995				—				524,995
Revenue between segments			8,539				—				(8,539	)			—
Net revenue			1,419,387				524,995				(8,539	)			1,935,843
Salaries and benefits (excludes stock-based compensation)			669,527				23,660				—				693,187
Supplies			243,264				173				—				243,437
Medical claims			—				445,293				(8,539	)			436,754
Rentals and leases			55,264				1,165				—				56,429
Other operating expenses (excludes expenses related to stock-based compensation			296,401				28,443				—				324,844
Medicare and Medicaid EHR incentives			(10,233	)			—				—				(10,233	)
Adjusted EBITDA(1)			165,164				26,261				—				191,425
Interest expense, net			98,325				—				—				98,325
Depreciation and amortization			68,723				3,137				—				71,860
Stock-based compensation and related expenses			8,964				—				—				8,964
Management fees			3,750				—				—				3,750
Earnings (loss) from continuing operations before gain on disposal of assets and income taxes			(14,598	)			23,124				—				8,526
Gain on disposal of assets, net			1,100				—				—				1,100
Earnings (loss) from continuing operations before income taxes		$	(13,498	)		$	23,124			$	—			$	9,626
Segment assets		$	2,303,767			$	348,187							$	2,651,954
Capital expenditures		$	80,276			$	1,126							$	81,402
Goodwill		$	809,828			$	5,757							$	815,585

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

		For the Nine Months Ended June 30, 2013
		Acute Care				Health Choice				Eliminations				Consolidated
Acute care revenue before provision for bad debts		$	1,636,836			$	—			$	—			$	1,636,836
Less: Provision for bad debts			(267,014	)			—				—				(267,014	)
Acute care revenue			1,369,822				—				—				1,369,822
Premium revenue			—				422,059				—				422,059
Revenue between segments			5,334				—				(5,334	)			—
Net revenue			1,375,156				422,059				(5,334	)			1,791,881
Salaries and benefits (excludes stock-based compensation)			649,720				17,620				—				667,340
Supplies			240,582				142				—				240,724
Medical claims			—				353,890				(5,334	)			348,556
Rentals and leases			39,443				1,192				—				40,635
Other operating expenses			292,488				17,499				—				309,987
Medicare and Medicaid EHR incentives			(11,209	)			—				—				(11,209	)
Adjusted EBITDA(1)			164,132				31,716				—				195,848
Interest expense, net			99,987				—				—				99,987
Depreciation and amortization			69,510				3,096				—				72,606
Stock-based compensation			2,946				—				—				2,946
Management fees			3,750				—				—				3,750
Earnings (loss) from continuing operations before gain on disposal of assets and income taxes			(12,061	)			28,620				—				16,559
Gain on disposal of assets, net			649				—				—				649
Earnings (loss) from continuing operations before income taxes		$	(11,412	)		$	28,620			$	—			$	17,208
Segment assets		$	2,387,601			$	319,505							$	2,707,106
Capital expenditures		$	78,830			$	539							$	79,369
Goodwill		$	810,969			$	5,757							$	816,726

 

(1)

Adjusted EBITDA represents net earnings from continuing operations before interest expense, income tax expense, depreciation and amortization, stock-based compensation and related expenses, gain on disposal of assets and management fees. Management fees represent monitoring and advisory fees paid to TPG, the Company’s majority financial sponsor, and certain other members of IASIS Investment LLC, majority shareholder of IAS. Management routinely calculates and communicates adjusted EBITDA and believes that it is useful to investors because it is commonly used as an analytical indicator within the healthcare industry to evaluate hospital performance, allocate resources and measure leverage capacity and debt service ability. In addition, the Company uses adjusted EBITDA as a measure of performance for its business segments and for incentive compensation purposes. Adjusted EBITDA should not be considered as a measure of financial performance under GAAP, and the items excluded from adjusted EBITDA are significant components in understanding and assessing financial performance. Adjusted EBITDA should not be considered in isolation or as an alternative to net earnings, cash flows generated by operating, investing, or financing activities or other financial statement data presented in the unaudited condensed consolidated financial statements as an indicator of financial performance or liquidity. Adjusted EBITDA, as presented, differs from what is defined under the Company’s Senior Secured Credit Facilities and may not be comparable to similarly titled measures of other companies.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

10. SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION

The Senior Notes described in Note 3 are fully and unconditionally guaranteed on a joint and several basis by all of the Company’s existing domestic subsidiaries, other than non-guarantor subsidiaries, which include Health Choice and the Company’s non-wholly owned subsidiaries. The guarantees are subject to customary release provisions set forth in the Indenture for the Senior Notes.

Summarized unaudited condensed consolidating balance sheets at June 30, 2014 and September 30, 2013, unaudited condensed consolidating statements of operations for the quarters and nine months ended June 30, 2014 and 2013, unaudited condensed consolidating statements of comprehensive income (loss) for the quarters and nine months ended June 30, 2014 and 2013, and unaudited condensed consolidating statements of cash flows for the nine months ended June 30, 2014 and 2013, for the Company, segregating the parent company issuer, the subsidiary guarantors, the subsidiary non-guarantors and eliminations, are found below.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

IASIS Healthcare LLC

Condensed Consolidating Balance Sheet (unaudited)

June 30, 2014

(in thousands)

 

						Subsidiary				Subsidiary								Condensed
		Parent Issuer				Guarantors				Non-Guarantors				Eliminations				Consolidated
Assets
Current assets
Cash and cash equivalents		$	—			$	304,805			$	12,838			$	—			$	317,643
Accounts receivable, net			—				88,725				247,924				—				336,649
Inventories			—				16,157				42,125				—				58,282
Deferred income taxes			15,491				—				—				—				15,491
Prepaid expenses and other current assets			—				31,423				149,801				—				181,224
Total current assets			15,491				441,110				452,688				—				909,289
Property and equipment, net			—				253,936				589,202				—				843,138
Intercompany			—				(109,718	)			109,718				—				—
Net investment in and advances to subsidiaries			2,051,151				—				—				(2,051,151	)			—
Goodwill			7,407				63,094				745,084				—				815,585
Other intangible assets, net			—				7,747				15,750				—				23,497
Other assets, net			22,853				26,813				10,779				—				60,445
Total assets		$	2,096,902			$	682,982			$	1,923,221			$	(2,051,151	)		$	2,651,954
Liabilities and Equity
Current liabilities
Accounts payable		$	—			$	39,927			$	79,428			$	—			$	119,355
Salaries and benefits payable			—				24,810				28,485				—				53,295
Accrued interest payable			9,682				(3,220	)			3,220				—				9,682
Medical claims payable			—				—				69,108				—				69,108
Other accrued expenses and other current liabilities			—				37,835				23,473				—				61,308
Current portion of long-term debt and capital lease obligations			10,071				3,109				23,605				(23,605	)			13,180
Total current liabilities			19,753				102,461				227,319				(23,605	)			325,928
Long-term debt and capital lease obligations			1,825,687				18,101				528,684				(528,684	)			1,843,788
Deferred income taxes			114,460				—				—				—				114,460
Other long-term liabilities			4,739				112,150				593				—				117,482
Total liabilities			1,964,639				232,712				756,596				(552,289	)			2,401,658
Non-controlling interests with redemption rights			—				108,325				—				—				108,325
Equity
Member’s equity			132,263				332,237				1,166,625				(1,498,862	)			132,263
Non-controlling interests			—				9,708				—				—				9,708
Total equity			132,263				341,945				1,166,625				(1,498,862	)			141,971
Total liabilities and equity		$	2,096,902			$	682,982			$	1,923,221			$	(2,051,151	)		$	2,651,954

 

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IASIS HEALTHCARE LLC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

IASIS Healthcare LLC

Condensed Consolidating Balance Sheet (unaudited)

September 30, 2013

(in thousands)

 

						Subsidiary				Subsidiary								Condensed
		Parent Issuer				Guarantors				Non-Guarantors				Eliminations				Consolidated
Assets
Current assets
Cash and cash equivalents		$	—			$	430,047			$	8,084			$	—			$	438,131
Accounts receivable, net			—				124,700				246,306				—				371,006
Inventories			—				16,015				41,766				—				57,781
Deferred income taxes			26,096				—				—				—				26,096
Prepaid expenses and other current assets			—				26,187				100,225				—				126,412
Assets held for sale			—				119,141				—				—				119,141
Total current assets			26,096				716,090				396,381				—				1,138,567
Property and equipment, net			—				234,910				598,259				—				833,169
Intercompany			—				(218,630	)			218,630				—				—
Net investment in and advances to subsidiaries			2,072,847				—				—				(2,072,847	)			—
Goodwill			7,407				65,246				743,757				—				816,410
Other intangible assets, net			—				7,957				18,000				—				25,957
Other assets, net			27,287				24,895				13,980				—				66,162
Total assets		$	2,133,637			$	830,468			$	1,989,007			$	(2,072,847	)		$	2,880,265
Liabilities and Equity
Current liabilities
Accounts payable		$	—			$	52,257			$	77,285			$	—			$	129,542
Salaries and benefits payable			—				28,686				34,198				—				62,884
Accrued interest payable			27,519				(3,229	)			3,229				—				27,519
Medical claims payable			—				—				57,514				—				57,514
Other accrued expenses and other current liabilities			—				75,900				16,653				—				92,553
Current portion of long-term debt and capital lease obligations			10,071				3,150				23,641				(23,641	)			13,221
Advance on divestiture			—				144,803				—				—				144,803
Liabilities held for sale			—				3,208				—				—				3,208
Total current liabilities			37,590				304,775				212,520				(23,641	)			531,244
Long-term debt and capital lease obligations			1,832,275				20,547				549,200				(549,200	)			1,852,822
Deferred income taxes			115,592				—				—				—				115,592
Other long-term liabilities			5,918				116,601				601				—				123,120
Total liabilities			1,991,375				441,923				762,321				(572,841	)			2,622,778
Non-controlling interests with redemption rights			—				105,464				—				—				105,464
Equity
Member’s equity			142,262				273,320				1,226,686				(1,500,006	)			142,262
Non-controlling interests			—				9,761				—				—				9,761
Total equity			142,262				283,081				1,226,686				(1,500,006	)			152,023
Total liabilities and equity		$	2,133,637			$	830,468			$	1,989,007			$	(2,072,847	)		$	2,880,265

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

IASIS Healthcare LLC

Condensed Consolidating Statement of Operations (unaudited)

For the Quarter Ended June 30, 2014

(in thousands)

 

						Subsidiary				Subsidiary								Condensed
		Parent Issuer				Guarantors				Non-Guarantors				Eliminations				Consolidated
Net revenue
Acute care revenue before provision for bad debts		$	—			$	152,054			$	407,526			$	(3,262	)		$	556,318
Less: Provision for bad debts			—				(19,600	)			(63,837	)			—				(83,437	)
Acute care revenue			—				132,454				343,689				(3,262	)			472,881
Premium revenue			—				—				200,281				—				200,281
Net revenue			—				132,454				543,970				(3,262	)			673,162
Costs and expenses
Salaries and benefits			4,442				88,511				141,593				—				234,546
Supplies			—				23,023				57,388				—				80,411
Medical claims			—				—				169,205				(3,262	)			165,943
Rentals and leases			—				6,612				12,184				—				18,796
Other operating expenses			—				25,604				89,329				—				114,933
Medicare and Medicaid EHR incentives			—				(791	)			(1,999	)			—				(2,790	)
Interest expense, net			32,275				—				12,232				(12,232	)			32,275
Depreciation and amortization			—				8,660				14,616				—				23,276
Management fees			1,250				(8,498	)			8,498				—				1,250
Equity in earnings of affiliates			(23,413	)			—				—				23,413				—
Total costs and expenses			14,554				143,121				503,046				7,919				668,640
Earnings (loss) from continuing operations before gain on disposal of assets and income taxes			(14,554	)			(10,667	)			40,924				(11,181	)			4,522
Gain on disposal of assets, net			—				332				—				—				332
Earnings (loss) from continuing operations before income taxes			(14,554	)			(10,335	)			40,924				(11,181	)			4,854
Income tax expense			6,331				—				—				—				6,331
Net earnings (loss) from continuing operations			(20,885	)			(10,335	)			40,924				(11,181	)			(1,477	)
Earnings (loss) from discontinued operations, net of income taxes			1,876				(4,723	)			—				—				(2,847	)
Net earnings (loss)			(19,009	)			(15,058	)			40,924				(11,181	)			(4,324	)
Net earnings attributable to non-controlling interests			—				(2,453	)			—				—				(2,453	)
Net earnings (loss) attributable to IASIS Healthcare LLC		$	(19,009	)		$	(17,511	)		$	40,924			$	(11,181	)		$	(6,777	)

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

IASIS Healthcare LLC

Condensed Consolidating Statement of Operations (unaudited)

For the Quarter Ended June 30, 2013

(in thousands)

 

						Subsidiary				Subsidiary								Condensed
		Parent Issuer				Guarantors				Non-Guarantors				Eliminations				Consolidated
Net revenue
Acute care revenue before provision for bad debts		$	—			$	165,618			$	391,735			$	(1,940	)		$	555,413
Less: Provision for bad debts			—				(33,440	)			(62,650	)			—				(96,090	)
Acute care revenue			—				132,178				329,085				(1,940	)			459,323
Premium revenue			—				—				139,804				—				139,804
Net revenue			—				132,178				468,889				(1,940	)			599,127
Costs and expenses
Salaries and benefits			947				80,889				138,060				—				219,896
Supplies			—				23,624				55,838				—				79,462
Medical claims			—				—				118,580				(1,940	)			116,640
Rentals and leases			—				5,083				8,909				—				13,992
Other operating expenses			—				28,031				78,425				—				106,456
Medicare and Medicaid EHR incentives			—				(973	)			(3,854	)			—				(4,827	)
Interest expense, net			32,771				—				14,702				(14,702	)			32,771
Depreciation and amortization			—				8,452				16,040				—				24,492
Management fees			1,250				(8,245	)			8,245				—				1,250
Equity in earnings of affiliates			(24,927	)			—				—				24,927				—
Total costs and expenses			10,041				136,861				434,945				8,285				590,132
Earnings (loss) from continuing operations before gain on disposal of assets and income taxes			(10,041	)			(4,683	)			33,944				(10,225	)			8,995
Gain on disposal of assets, net			—				415				66				—				481
Earnings (loss) from continuing operations before income taxes			(10,041	)			(4,268	)			34,010				(10,225	)			9,476
Income tax expense			2,179				—				1,671				—				3,850
Net earnings (loss) from continuing operations			(12,220	)			(4,268	)			32,339				(10,225	)			5,626
Earnings (loss) from discontinued operations, net of income taxes			672				(1,203	)			—				—				(531	)
Net earnings (loss)			(11,548	)			(5,471	)			32,339				(10,225	)			5,095
Net earnings attributable to non-controlling interests			—				(1,941	)			—				—				(1,941	)
Net earnings (loss) attributable to IASIS Healthcare LLC		$	(11,548	)		$	(7,412	)		$	32,339			$	(10,225	)		$	3,154

 

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IASIS HEALTHCARE LLC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

IASIS Healthcare LLC

Condensed Consolidating Statement of Operations (unaudited)

For the Nine Months Ended June 30, 2014

(in thousands)

 

						Subsidiary				Subsidiary								Condensed
		Parent Issuer				Guarantors				Non-Guarantors				Eliminations				Consolidated
Net revenue
Acute care revenue before provision for bad debts		$	—			$	462,240			$	1,239,078			$	(8,539	)		$	1,692,779
Less: Provision for bad debts			—				(72,125	)			(209,806	)			—				(281,931	)
Acute care revenue			—				390,115				1,029,272				(8,539	)			1,410,848
Premium revenue			—				—				524,995				—				524,995
Net revenue			—				390,115				1,554,267				(8,539	)			1,935,843
Costs and expenses
Salaries and benefits			8,796				269,568				423,619				—				701,983
Supplies			—				70,510				172,927				—				243,437
Medical claims			—				—				445,293				(8,539	)			436,754
Rentals and leases			—				19,794				36,635				—				56,429
Other operating expenses			—				72,965				252,047				—				325,012
Medicare and Medicaid EHR incentives			—				(3,769	)			(6,464	)			—				(10,233	)
Interest expense, net			98,325				—				36,816				(36,816	)			98,325
Depreciation and amortization			—				28,876				42,984				—				71,860
Management fees			3,750				(25,727	)			25,727				—				3,750
Equity in earnings of affiliates			(77,791	)			—				—				77,791				—
Total costs and expenses			33,080				432,217				1,429,584				32,436				1,927,317
Earnings (loss) from continuing operations before gain (loss) on disposal of assets and income taxes			(33,080	)			(42,102	)			124,683				(40,975	)			8,526
Gain (loss) on disposal of assets, net			—				1,312				(212	)			—				1,100
Earnings (loss) from continuing operations before income taxes			(33,080	)			(40,790	)			124,471				(40,975	)			9,626
Income tax expense			10,198				—				—				—				10,198
Net earnings (loss) from continuing operations			(43,278	)			(40,790	)			124,471				(40,975	)			(572	)
Earnings (loss) from discontinued operations, net of income taxes			(1,146	)			2,967				—				—				1,821
Net earnings (loss)			(44,424	)			(37,823	)			124,471				(40,975	)			1,249
Net earnings attributable to non-controlling interests			—				(8,857	)			—				—				(8,857	)
Net earnings (loss) attributable to IASIS Healthcare LLC		$	(44,424	)		$	(46,680	)		$	124,471			$	(40,975	)		$	(7,608	)

 

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IASIS HEALTHCARE LLC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

IASIS Healthcare LLC

Condensed Consolidating Statement of Operations (unaudited)

For the Nine Months Ended June 30, 2013

(in thousands)

 

						Subsidiary				Subsidiary								Condensed
		Parent Issuer				Guarantors				Non-Guarantors				Eliminations				Consolidated
Net revenue
Acute care revenue before provision for bad debts		$	—			$	479,303			$	1,162,867			$	(5,334	)		$	1,636,836
Less: Provision for bad debts			—				(89,398	)			(177,616	)			—				(267,014	)
Acute care revenue			—				389,905				985,251				(5,334	)			1,369,822
Premium revenue			—				—				422,059				—				422,059
Net revenue			—				389,905				1,407,310				(5,334	)			1,791,881
Costs and expenses
Salaries and benefits			2,946				244,352				422,988				—				670,286
Supplies			—				70,284				170,440				—				240,724
Medical claims			—				—				353,890				(5,334	)			348,556
Rentals and leases			—				14,646				25,989				—				40,635
Other operating expenses			—				71,881				238,106				—				309,987
Medicare and Medicaid EHR incentives			—				(5,505	)			(5,704	)			—				(11,209	)
Interest expense, net			99,987				—				47,057				(47,057	)			99,987
Depreciation and amortization			—				25,230				47,376				—				72,606
Management fees			3,750				(24,494	)			24,494				—				3,750
Equity in earnings of affiliates			(73,311	)			—				—				73,311				—
Total costs and expenses			33,372				396,394				1,324,636				20,920				1,775,322
Earnings (loss) from continuing operations before gain on disposal of assets and income taxes			(33,372	)			(6,489	)			82,674				(26,254	)			16,559
Gain on disposal of assets, net			—				570				79				—				649
Earnings (loss) from continuing operations before income taxes			(33,372	)			(5,919	)			82,753				(26,254	)			17,208
Income tax expense			6,345				—				1,671				—				8,016
Net earnings (loss) from continuing operations			(39,717	)			(5,919	)			81,082				(26,254	)			9,192
Earnings (loss) from discontinued operations, net of income taxes			(488	)			1,338				(1	)			—				849
Net earnings (loss)			(40,205	)			(4,581	)			81,081				(26,254	)			10,041
Net earnings attributable to non-controlling interests			—				(3,189	)			—				—				(3,189	)
Net earnings (loss) attributable to IASIS Healthcare LLC		$	(40,205	)		$	(7,770	)		$	81,081			$	(26,254	)		$	6,852

 

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IASIS HEALTHCARE LLC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

IASIS Healthcare LLC

Condensed Consolidating Statement of Comprehensive Income (Loss)

For the Quarter Ended June 30, 2014 (unaudited)

(In thousands)

 

						Subsidiary				Subsidiary								Condensed
		Parent Issuer				Guarantors				Non-Guarantors				Eliminations				Consolidated
Net earnings (loss)		$	(19,009	)		$	(15,058	)		$	40,924			$	(11,181	)		$	(4,324	)
Other comprehensive income
Change in fair value of highly effective interest rate hedges			201				—				—				—				201
Other comprehensive income before income taxes			201				—				—				—				201
Change in income tax expense			(75	)			—				—				—				(75	)
Other comprehensive income, net of income taxes			126				—				—				—				126
Comprehensive income (loss)			(18,883	)			(15,058	)			40,924				(11,181	)			(4,198	)
Net earnings attributable to non-controlling interests			—				(2,453	)			—				—				(2,453	)
Comprehensive income (loss) attributable to IASIS Healthcare LLC		$	(18,883	)		$	(17,511	)		$	40,924			$	(11,181	)		$	(6,651	)

 

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IASIS HEALTHCARE LLC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

IASIS Healthcare LLC

Condensed Consolidating Statement of Comprehensive Income (Loss)

For the Quarter Ended June 30, 2013 (unaudited)

(In thousands)

 

						Subsidiary				Subsidiary								Condensed
		Parent Issuer				Guarantors				Non-Guarantors				Eliminations				Consolidated
Net earnings (loss)		$	(11,548	)		$	(5,471	)		$	32,339			$	(10,225	)		$	5,095
Other comprehensive income
Change in fair value of highly effective interest rate hedges			1,753				—				—				—				1,753
Other comprehensive income before income taxes			1,753				—				—				—				1,753
Change in income tax expense			(651	)			—				—				—				(651	)
Other comprehensive income, net of income taxes			1,102				—				—				—				1,102
Comprehensive income (loss)			(10,446	)			(5,471	)			32,339				(10,225	)			6,197
Net earnings attributable to non-controlling interests			—				(1,941	)			—				—				(1,941	)
Comprehensive income (loss) attributable to IASIS Healthcare LLC		$	(10,446	)		$	(7,412	)		$	32,339			$	(10,225	)		$	4,256

 

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IASIS HEALTHCARE LLC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

IASIS Healthcare LLC

Condensed Consolidating Statement of Comprehensive Income (Loss)

For the Nine Months Ended June 30, 2014 (unaudited)

(In thousands)

 

						Subsidiary				Subsidiary								Condensed
		Parent Issuer				Guarantors				Non-Guarantors				Eliminations				Consolidated
Net earnings (loss)		$	(44,424	)		$	(37,823	)		$	124,471			$	(40,975	)		$	1,249
Other comprehensive income
Change in fair value of highly effective interest rate hedges			1,179				—				—				—				1,179
Other comprehensive income before income taxes			1,179				—				—				—				1,179
Change in income tax expense			(438	)			—				—				—				(438	)
Other comprehensive income, net of income taxes			741				—				—				—				741
Comprehensive income (loss)			(43,683	)			(37,823	)			124,471				(40,975	)			1,990
Net earnings attributable to non-controlling interests			—				(8,857	)			—				—				(8,857	)
Comprehensive income (loss) attributable to IASIS Healthcare LLC		$	(43,683	)		$	(46,680	)		$	124,471			$	(40,975	)		$	(6,867	)

 

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IASIS HEALTHCARE LLC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

IASIS Healthcare LLC

Condensed Consolidating Statement of Comprehensive Income (Loss)

For the Nine Months Ended June 30, 2013 (unaudited)

(In thousands)

 

						Subsidiary				Subsidiary								Condensed
		Parent Issuer				Guarantors				Non-Guarantors				Eliminations				Consolidated
Net earnings (loss)		$	(40,205	)		$	(4,581	)		$	81,081			$	(26,254	)		$	10,041
Other comprehensive income
Change in fair value of highly effective interest rate hedges			1,643				—				—				—				1,643
Other comprehensive income before income taxes			1,643				—				—				—				1,643
Change in income tax expense			(611	)			—				—				—				(611	)
Other comprehensive income, net of income taxes			1,032				—				—				—				1,032
Comprehensive income (loss)			(39,173	)			(4,581	)			81,081				(26,254	)			11,073
Net earnings attributable to non-controlling interests			—				(3,189	)			—				—				(3,189	)
Comprehensive income (loss) attributable to IASIS Healthcare LLC		$	(39,173	)		$	(7,770	)		$	81,081			$	(26,254	)		$	7,884

 

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IASIS HEALTHCARE LLC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

IASIS Healthcare LLC

Condensed Consolidating Statement of Cash Flows

For the Nine Months Ended June 30, 2014 (unaudited)

(In thousands)

 

						Subsidiary				Subsidiary								Condensed
		Parent Issuer				Guarantors				Non-Guarantors				Eliminations				Consolidated
Cash flows from operating activities
Net earnings (loss)		$	(44,424	)		$	(37,823	)		$	124,471			$	(40,975	)		$	1,249
Adjustments to reconcile net earnings (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization			—				28,876				42,984				—				71,860
Amortization of loan costs			5,559				—				—				—				5,559
Change in physician minimum revenue guarantees			—				222				2,044				—				2,266
Amortization of deferred gain on sale-leaseback			(1,872	)			—				—				—				(1,872	)
Stock-based compensation			8,796				—				—				—				8,796
Deferred income taxes			(1,934	)			—				—				—				(1,934	)
Income tax benefit from parent company			9				—				—				—				9
Loss (gain) on disposal of assets, net			—				(1,312	)			212				—				(1,100	)
Loss (earnings) from discontinued operations, net			1,146				(2,967	)			—				—				(1,821	)
Equity in earnings of affiliates			(77,791	)			—				—				77,791				—
Changes in operating assets and liabilities, net of the effect of acquisitions and dispositions:
Accounts receivable, net			—				(3,476	)			(1,068	)			—				(4,544	)
Inventories, prepaid expenses and other current assets			—				(6,672	)			(34,898	)			—				(41,570	)
Accounts payable, other accrued expenses and other accrued liabilities			(19,016	)			8,308				(7,303	)			—				(18,011	)
Income taxes and other transaction costs payable related to sale-leaseback of real estate			(18,901	)			(1,048	)			(2,321	)			—				(22,270	)
Net cash provided by (used in) operating activities — continuing operations			(148,428	)			(15,892	)			124,121				36,816				(3,383	)
Net cash used in operating activities —discontinued operations			—				(7,161	)			—				—				(7,161	)
Net cash provided by (used in) operating activities			(148,428	)			(23,053	)			124,121				36,816				(10,544	)
Cash flows from investing activities
Purchases of property and equipment			—				(49,600	)			(31,802	)			—				(81,402	)
Cash paid for acquisitions, net			—				(1,038	)			—				—				(1,038	)
Proceeds from sale of assets			—				1,497				13				—				1,510
Change in other assets, net			—				(3,707	)			3,534				—				(173	)
Other, net			—				(2,724	)			(301	)			—				(3,025	)
Net cash used in investing activities — continuing operations			—				(55,572	)			(28,556	)			—				(84,128	)
Net cash provided by investing activities — discontinued operations			—				28				—				—				28
Net cash used in investing activities			—				(55,544	)			(28,556	)			—				(84,100	)
Cash flows from financing activities
Payment of debt and capital lease obligations			(8,010	)			(100	)			(2,074	)			—				(10,184	)
Distributions to non-controlling interests			—				(13,222	)			—				—				(13,222	)
Cash paid for the repurchase of non-controlling interests			—				(600	)			—				—				(600	)
Other			—				(1,838	)			—				—				(1,838	)
Change in intercompany balances with affiliates, net			156,438				(30,885	)			(88,737	)			(36,816	)			—
Net cash provided by (used in) financing activities			148,428				(46,645	)			(90,811	)			(36,816	)			(25,844	)
Change in cash and cash equivalents			—				(125,242	)			4,754				—				(120,488	)
Cash and cash equivalents at beginning of period			—				430,047				8,084				—				438,131
Cash and cash equivalents at end of period		$	—			$	304,805			$	12,838			$	—			$	317,643

 

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IASIS HEALTHCARE LLC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

IASIS Healthcare LLC

Condensed Consolidating Statement of Cash Flows

For the Nine Months Ended June 30, 2013 (unaudited)

(In thousands)

 

						Subsidiary				Subsidiary								Condensed
		Parent Issuer				Guarantors				Non-Guarantors				Eliminations				Consolidated
Cash flows from operating activities
Net earnings (loss)		$	(40,205	)		$	(4,581	)		$	81,081			$	(26,254	)		$	10,041
Adjustments to reconcile net earnings (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization			—				25,230				47,376				—				72,606
Amortization of loan costs			5,760				—				—				—				5,760
Change in physician minimum revenue guarantee			—				221				2,497				—				2,718
Stock-based compensation			2,946				—				—				—				2,946
Deferred income taxes			16,338				—				—				—				16,338
Income tax benefit from stock-based compensation			16				—				—				—				16
Income tax benefit from parent company			103				—				—				—				103
Loss on disposal of assets, net			—				(570	)			(79	)			—				(649	)
Loss (earnings) from discontinued operations, net			488				(1,338	)			1				—				(849	)
Equity in earnings of affiliates			(73,311	)			—				—				73,311				—
Changes in operating assets and liabilities, net of the effect of acquisitions and dispositions:
Accounts receivable, net			—				9,557				(32,437	)			—				(22,880	)
Inventories, prepaid expenses and other current assets			—				(20,254	)			(1,374	)			—				(21,628	)
Accounts payable, other accrued expenses and other accrued liabilities			(19,621	)			(13,375	)			(22,582	)			—				(55,578	)
Net cash provided by (used in) operating activities — continuing operations			(107,486	)			(5,110	)			74,483				47,057				8,944
Net cash provided by operating activities —discontinued operations			—				3,967				—				—				3,967
Net cash provided by (used in) operating activities			(107,486	)			(1,143	)			74,483				47,057				12,911
Cash flows from investing activities
Purchases of property and equipment			—				(41,596	)			(37,773	)			—				(79,369	)
Cash received (paid) for acquisitions, net			—				(849	)			4,433				—				3,584
Proceeds from sale of assets			—				6				77				—				83
Change in other assets, net			—				3,287				(5,754	)			—				(2,467	)
Net cash used in investing activities — continuing operations			—				(39,152	)			(39,017	)			—				(78,169	)
Net cash used in investing activities — discontinued operations			—				(4,318	)			—				—				(4,318	)
Net cash used in investing activities			—				(43,470	)			(39,017	)			—				(82,487	)
Cash flows from financing activities
Payment of debt and capital lease obligations			(94,598	)			(4,689	)			(2,478	)			—				(101,765	)
Proceeds from revolving credit facilities			147,000				—				—				—				147,000
Debt financing costs incurred			(1,024	)			—				—				—				(1,024	)
Distributions to non-controlling interests			—				(5,504	)			—				—				(5,504	)
Cash received for the sale of non-controlling interests			—				849				—				—				849
Cash paid for the repurchase of non-controlling interest			—				(1,018	)			—				—				(1,018	)
Other			—				1,065				(1,053	)			—				12
Change in intercompany balances with affiliates, net			56,108				27,457				(36,508	)			(47,057	)			—
Net cash provided by (used in) financing activities			107,486				18,160				(40,039	)			(47,057	)			38,550
Change in cash and cash equivalents			—				(26,453	)			(4,573	)			—				(31,026	)
Cash and cash equivalents at beginning of period			—				39,219				9,663				—				48,882
Cash and cash equivalents at end of period		$	—			$	12,766			$	5,090			$	—			$	17,856

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements, the notes to our unaudited condensed consolidated financial statements and the other financial information appearing elsewhere in this report. Data for the quarters and nine months ended June 30, 2014 and 2013, have been derived from our unaudited condensed consolidated financial statements. References herein to “we,” “our” and “us” are to IASIS Healthcare LLC and its subsidiaries. References herein to “IAS” are to IASIS Healthcare Corporation, our parent company.

FORWARD LOOKING STATEMENTS

Some of the statements we make in this report are forward-looking within the meaning of the federal securities laws, which are intended to be covered by the safe harbors created thereby. Those forward-looking statements include all statements that are not historical statements of fact and those regarding our intent, belief or expectations including, but not limited to, the discussions of our operating and growth strategy (including possible acquisitions and dispositions), financing needs, projections of revenue, income or loss, capital expenditures and future operations. Those risks and uncertainties include, among others, changes in governmental healthcare programs that could reduce our revenues, including the impact of sequestration; the uncertain impact of federal health reform; the possibility of Health Choice Arizona, Inc.’s (“Health Choice” or the “Plan”), contract with the Arizona Health Care Cost Containment System (“AHCCCS”) being discontinued and changes in the payment structure under that contract, as well as an inability to control costs at Health Choice; shifts in payor mix from commercial and managed care payors to Medicaid and managed Medicaid; our ability to retain and negotiate reasonable contracts with managed care plans; a growth in the level of uncompensated care at our hospitals; our ability to recruit and retain quality physicians and medical professionals; competition from other hospitals and healthcare providers impacting our patient volume; our failure to continually enhance our hospitals with the most recent technological advances in diagnostic and surgical equipment; the federal health reform law’s significant restrictions on hospitals that have physician owners; a failure of our information systems that would adversely affect our ability to properly manage our operations; failure to effectively and timely implement electronic health record systems; claims brought against our facilities for malpractice, product liability and other legal grounds; difficulties with the integration of acquisitions that may disrupt our ongoing operations; our dependence on key management personnel; potential responsibilities and costs under environmental laws; the possibility of a decline in the fair value of our reporting units that could result in a material non-cash charge to earnings; the risks and uncertainties related to our ability to generate sufficient cash to service our existing indebtedness; our substantial level of indebtedness; the possibility of an increase in interest rates, which would increase the cost of servicing our debt; and the risks associated with us being owned by equity sponsors who have the ability to control our financial decisions. Forward-looking statements involve known and unknown risks and uncertainties that may cause actual results in future periods to differ materially from those anticipated in the forward-looking statements. Those risks and uncertainties, among others discussed in this report, are detailed in our Annual Report on Form 10-K for the fiscal year ended September 30, 2013, filed with the Securities and Exchange Commission (the “SEC”).

Although we believe that the assumptions underlying the forward-looking statements contained in this report are reasonable, any of these assumptions could prove to be inaccurate and, therefore, there can be no assurance that the forward-looking statements included in this report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included in this report, you should not regard the inclusion of such information as a representation by us or any other person that our objectives and plans will be achieved. We undertake no obligation to publicly release any revisions to any forward-looking statements contained herein to reflect events and circumstances occurring after the date hereof or to reflect the occurrence of unanticipated events.

EXECUTIVE OVERVIEW

We are a leading provider of high quality, affordable healthcare services primarily in high-growth urban and suburban markets. As of June 30, 2014, we owned or leased 16 acute care hospital facilities and one behavioral health hospital, with a total of 3,778 licensed beds, several outpatient service facilities, and more than 137 physician clinics. We operate our hospitals with a strong community focus by offering and developing healthcare services targeted to the needs of the markets we serve, promoting strong relationships with physicians and working with local managed care plans. We operate in various regions, including:

 

•

Salt Lake City, Utah;

 

•

Phoenix, Arizona;

 

•

five cities in Texas, including Houston and San Antonio;

 

•

West Monroe, Louisiana; and

 

•

Las Vegas, Nevada.

We also own and operate Health Choice, a provider-owned, managed care organization and insurer that delivers healthcare services to over 266,000 members through multiple health plans, integrated delivery systems and managed care solutions. The Plan is headquartered in Phoenix, Arizona.

 

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In May 2014, Health Choice entered into an agreement with Humana Medical Plan, Inc. (“Humana”), under which Health Choice will provide administrative and managed care services to approximately 80,000 Humana managed Medicaid plan members in the state of Florida. During the quarter and nine months ended June 30, 2014, we incurred $2.0 million and $3.0 million, respectively, in startup related costs associated with Health Choice’s new third-party administration and management services organization business.

Significant Industry Trends

The following sections discuss recent trends that we believe are significant factors in our current and/or future operating results and cash flows. Certain of these trends apply to the entire acute care hospital industry, while others may apply to us more specifically. These trends could be short-term in nature or could require long-term attention and resources. While these trends may involve certain factors that are outside of our control, the extent to which these trends affect our hospitals and health plan operations and our ability to manage the impact of these trends play vital roles in our current and future success. In many cases, we are unable to predict what impact, if any, these trends will have on us.

The Impact of Health Reform

The Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010 (collectively, the “Health Reform Law”) expands coverage of previously uninsured individuals, largely through expansion of Medicaid coverage and establishment of insurance exchanges (“Exchanges”) where individuals may purchase coverage. The Health Reform Law also contains an “individual mandate” that imposes financial penalties on individuals who fail to carry health insurance and employers that do not provide health insurance. In addition, the Health Reform Law reforms certain aspects of health insurance, reduces government reimbursement rates, expands existing efforts to tie Medicare and Medicaid payments to performance and quality, places restrictions on physician-owned hospitals and contains provisions intended to strengthen fraud and abuse enforcement.

As of April 15, 2014, the federal government has released information indicating that approximately 8.5 million individuals have enrolled in healthcare coverage through the Exchanges. Of those enrolled, the federal government states that approximately 80% of those have paid the related premiums, and 83% have selected plans including financial assistance. While the most significant provisions of the Health Reform Law that result in reducing the number of uninsured individuals generally became effective January 1, 2014, the employer mandate, which requires companies with 50 or more employees to provide health insurance or pay fines, as well as insurer reporting requirements, has been delayed until January 1, 2015. For employers with 50 to 99 employees, this requirement has been further delayed until January 1, 2016. Additionally, a number of state governors and legislatures, including Texas and Louisiana, have chosen not to participate in the expanded Medicaid program at this time; however, these states could choose to implement the expansion at a later date. While some states have currently chosen not to participate, other states such as Arizona and Nevada have expanded their Medicaid programs.

Because of the many variables involved, including the law’s complexity, the lack of implementing regulations or interpretive guidance for all of its provisions, gradual and partially delayed implementation, court challenges, possible reductions in funding by the U.S. Congress (“Congress”) and future reductions in Medicare and Medicaid reimbursement, the impact of the Health Reform Law, including how individuals and businesses will respond to the new choices and obligations under the law, is not yet fully known. We believe, however, that trends toward pay-for-performance reimbursement models focused on quality and cost control, which are encouraged by the Health Reform Law, are taking hold among private health insurers and will continue to do so.

One notable provision of the Health Reform Law is an annual health insurer fee (“HIF”) that applies to most health plans, including commercial health plans and Medicaid managed care plans like Health Choice. While characterized as a “fee” in the text of the Health Reform Law, the intent of Congress was to impose a broad based health insurance industry excise tax, with the understanding that the tax could be passed on to consumers, most likely through higher commercial insurance premiums. However, because Medicaid is a government-funded program, Medicaid health plans have no alternative but to look to their respective state partners for payment to offset the impact of this tax. We continue to work with our state partners to obtain reimbursement for the economic impact of this fee, and currently anticipate to be reimbursed in full. Currently, we project that our HIF payable by September 30, 2014 will be approximately $7.9 million.

Two Midnight Rule

In the Medicare program’s hospital inpatient prospective payment system (“IPPS”) final rule for federal fiscal year 2014, the Centers for Medicare and Medicaid Services (“CMS”) issued the “two midnight rule,” which revised its longstanding guidance to hospitals and physicians relating to when hospital inpatient admissions are deemed to be reasonable and necessary for payment under Medicare Part A. Under the two midnight rule, in addition to services that are designated as inpatient-only, surgical procedures, diagnostic tests and other treatments are generally appropriate for inpatient hospital admission and payment under Medicare Part A when the physician (i) expects the beneficiary to require a stay that crosses at least two midnights and (ii) admits the beneficiary to the hospital based upon that expectation. Conversely, hospital stays in which the physician expects the beneficiary to require care that spans less than two midnights are generally inappropriate for payment under Medicare Part A, and should be treated and billed as outpatient services under Part B.

While the IPPS final rule for federal fiscal year 2014 became effective on October 1, 2013, CMS initially indicated that, for a period of 90 days after the effective date of the rule, it would not permit recovery auditors and other Medicare review contractors to review inpatient admissions of one midnight or less that began between October 1, 2013 and December 31, 2013. CMS subsequently extended that delay to inpatient admissions that occur on or prior to September 30, 2014. CMS did, however, instruct Medicare Administrative Contractors (“MACs”) to review, on a pre-payment basis, a small sample (approximately 10 – 25) of inpatient hospital claims relating to admissions that occur between March 31, 2014 and September 30, 2014, and that span less than two midnights after admission in order to determine each hospital’s compliance with the new inpatient admission and medical review criteria. Hospitals can rebill denied inpatient hospital admissions in accordance with the rule.

 

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On April 1, 2014, President Obama signed the Protecting Access to Medicare Act of 2014 (the “PAM Act”) into law. Among other things, the PAM Act extends the delay of the enforcement of the two midnight rule by recovery auditor and other Medicare review contractors through March 31, 2015, and authorizes CMS to continue to allow MACs to review, on a pre-payment basis, a small sample of inpatient hospital claims relating to admissions that span less than two midnights and that occur between March 31, 2014, and March 31, 2015, in order to determine hospital compliance with the new inpatient admission and medical review criteria.

We cannot predict whether Congress or CMS will further delay the review of inpatient admissions of one midnight or less by recovery auditors or other Medicare review contractors, the impact that any such reviews will have on our business and results of operations, or when they are allowed by CMS. In addition, legislation has been introduced in Congress that, among other things, would both generally prohibit Medicare review contractors from denying claims due to the length of a patient’s stay or a determination that services could have been provided in an outpatient setting and require CMS to develop a new payment methodology for services that are provided during short inpatient hospital stays. Federal lawsuits have also been filed challenging the two midnight rule primarily on the grounds that the implementation of the rule itself, and the payment reduction associated with the rule (i.e., 0.2% IPPS payment reduction to hospitals) violate the Administrative Procedure Act. We cannot predict whether legislation will be adopted or, if adopted, the amount of reimbursement that would be paid under any alternative payment methodology that would be developed by CMS. We also cannot predict whether federal court challenges to the two midnight rule will be successful.

Budget Control Act and Sequestration

The Budget Control Act of 2011 (the “BCA”) increased the nation’s borrowing authority and takes steps to reduce federal spending and the deficit. The deficit reduction portion of the BCA imposes caps, which began in federal fiscal year 2012, that reduce discretionary spending by more than $900 billion over ten years. The BCA also requires automatic spending reductions of $1.2 trillion for federal fiscal years 2013 through 2021, minus any deficit reductions enacted by Congress and debt service costs. The spending reductions have been extended through 2024. These automatic spending reductions are commonly referred to as “sequestration.” The spending reductions are split evenly between defense and non-defense discretionary spending, although certain programs (including Medicaid and Children’s Health Insurance Programs (“CHIP”)), are exempt from these automatic spending reductions, and Medicare expenditures cannot be reduced by more than two percent. Sequestration began on March 1, 2013, with CMS imposing a two percent reduction on Medicare claims beginning April 1, 2013. We are unable to predict what other deficit reduction initiatives may be proposed by the President or Congress or whether the President and the Congress will restructure or suspend sequestration. It is possible that changes in the law to end or restructure sequestration will result in greater spending reductions than currently required by the BCA.

Value-Based Reimbursement

The trend in the healthcare industry continues towards value-based purchasing of healthcare services. These value-based purchasing programs include both public reporting and financial incentives tied to the quality and efficiency of care provided by facilities. The Health Reform Law expands the use of value-based purchasing initiatives in federal healthcare programs. We expect programs of this type to become more common in the healthcare industry.

In addition, managed care organizations are implementing programs that condition payment on performance against specified measures. The quality measurement criteria used by managed care and commercial payors may be similar to or even more stringent than Medicare requirements.

As we expect these trends towards value-based purchasing of healthcare services by Medicare and other payors to continue, we believe that our position as a high-quality, low cost provider in certain of our markets will prove beneficial as we continue to move towards a quality and value-based reimbursement system. Because of these trends, if we are unable to meet or exceed quality of care standards in our facilities, our operating results could be significantly impacted in the future.

State Medicaid Budgets

Over recent years, the states in which we operate experienced budget constraints as a result of increased costs and lower than expected tax collections. Health and human services programs, including Medicaid and similar programs, represent a significant portion of state budgets. The states in which we operate responded to these budget concerns, by decreasing funding for Medicaid and other healthcare programs or by making structural changes that resulted in a reduction in hospital reimbursement. In addition, many states have received waivers from CMS in order to implement or expand managed Medicaid programs.

 

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Texas

The Texas legislature and the Texas Health and Human Services Commission (“THHSC”) recommended expanding Medicaid managed care enrollment in the state, and in December 2011, CMS approved a five-year Medicaid waiver that: (1) allows Texas to expand its Medicaid managed care program while preserving hospital funding; (2) provides incentive payments for improvements in healthcare delivery; and (3) directs more funding to hospitals that serve large numbers of uninsured patients. Certain of our acute care hospitals currently receive supplemental Medicaid reimbursement, including reimbursement from programs for participating private hospitals that enter into indigent care affiliation agreements with public hospitals or county governments in the state of Texas. Under the CMS-approved programs, affiliated hospitals, including our Texas hospitals, have expanded the community healthcare safety net by providing indigent healthcare services. Revenue recognized under these Texas private supplemental Medicaid reimbursement programs for the quarter and nine months ended June 30, 2014, was $17.6 million and $53.6 million, respectively, compared to $16.5 million and $45.7 million in the prior year periods. Under the Medicaid waiver, funds are distributed to participating hospitals based upon both the costs associated with providing care to individuals without third party coverage and the investment made to support coordinating care and quality improvements that transform the local communities’ care delivery systems. The responsibility to coordinate and develop plans that address the concerns of the local delivery care systems, including improved access, quality, cost effectiveness and coordination will be controlled primarily by government-owned public hospitals that serve the surrounding geographic areas. Complexities of the underlying methodologies in determining the funding for the state’s Medicaid supplemental reimbursement programs, along with a lack of sufficient resources at THHSC to administer the programs, has resulted in a delay in related reimbursements. As of June 30, 2014, we had $73.6 million in receivables due to our Texas hospitals in connection with these supplemental Medicaid reimbursement programs, including amounts due under the Texas Medicaid Disproportionate Share Hospital program (“Texas Medicaid DSH”), compared to receivables of $66.8 million at September 30, 2013. During the quarter ended June 30, 2014, we received cash of $37.0 million from the state of Texas related to the supplemental Medicaid reimbursement programs.

The THHSC has released proposed rules to change the Texas Medicaid DSH methodology for the state’s fiscal year 2014 and 2015. While changes to the Texas Medicaid DSH methodology have been proposed, details regarding its computation for the state’s upcoming fiscal year have not yet been finalized. Because deliberations regarding the Texas Medicaid DSH program are ongoing, we are unable to estimate the financial impact, if any, that proposed program changes may have on our results of operations. Texas has appropriated $160.0 million for fiscal year 2014 and $140.0 million for fiscal year 2015 to stabilize and improve the Texas Medicaid DSH program, including providing rate adjustments to recognize improvements in quality of patient care, the most appropriate use of care, and patient outcomes. These appropriations provide that the funding is contingent on “measurable progress” by THHSC toward a long-term plan. Funds appropriated for in 2015 may not be spent before the plan is finalized. During the quarter and nine months ended June 30, 2014, we recognized $7.5 million and $22.6 million, respectively, in Texas Medicaid DSH revenues, compared to $7.1 million and $21.4 million in the prior year periods.

Arizona

Beginning in July 2011, in an effort to control its budgeted expenditures and balance its budget, the state of Arizona implemented a plan to reduce its eligible Medicaid beneficiaries, particularly childless adults. Following implementation of this plan by the state of Arizona, Health Choice experienced a significant decline through the end of our fiscal year 2013 in its enrollees, premium revenue and earnings.

Effective January 1, 2014, Arizona expanded its Medicaid program under the Health Reform Law, which includes increased eligibility for adults, children and pregnant women, and the restoration of eligibility to childless adults that was previously eliminated. The expansion of the state’s Medicaid program under the Health Reform Law could potentially result in the addition of approximately 370,000 people to its Medicaid rolls. As a result of the Medicaid expansion, enrollment at Health Choice increased 10.4% for the quarter ended June 30, 2014, compared to the prior year quarter. In addition, in connection with the expanded Medicaid coverage, the state implemented a provider assessment effective January 1, 2014, to fund a portion of the expanded eligibility related to the childless adult population. During the quarter and nine months ended June 30, 2014, we incurred $1.3 million and $2.6 million, respectively, in provider tax assessments.

If additional Medicaid program changes are implemented in the future in Arizona or other states in which we operate, our revenue and earnings could be significantly impacted.

Physician Alignment and Clinical Integration

In an effort to meet community needs and address coverage issues, we have made significant investments in order to align with physicians through various recruitment and employment strategies, as well as alternative means of alignment such as our formation of provider networks in certain markets. We believe that physician alignment promotes clinical integration, enhances quality of care and makes us more efficient and competitive in a healthcare environment trending toward value-based purchasing and pay-for-performance.

As we continue to focus on our physician alignment and integration strategies, we face significant competition for skilled physicians in certain of our markets as more hospital providers adopt a physician staffing model approach, coupled with a general

 

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shortage of physicians across most specialties. This increased competition has resulted in efforts by managed care organizations to align with certain provider networks in the markets in which we operate. In response, we have formed our own provider networks in certain markets that include both employed and non-affiliated physicians, providing the infrastructure through which we are able to contract more efficiently with commercial payors, position ourselves for value based reimbursement and promote clinical integration. While we expect that employing physicians provides relief on cost pressures associated with on-call coverage and other professional fees, we anticipate the addition of new employed physicians would result in increased labor and other start-up related costs as we integrated the physicians and their related support staff into our healthcare delivery systems.

We also face risk from competition for outpatient business. We expect to mitigate this risk through continued focus on our physician employment strategy, the development of new access points of care, our commitment to capital investment in our hospitals, including updated technology and equipment, and our commitment to our quality of care initiatives that some competitors, including individual physicians or physician groups, may not be equipped to implement.

Uncompensated Care

While the amount of uncompensated care, including discounts to the uninsured, bad debts and charity care, we deliver to the communities we serve continues to remain high in comparison to historical levels, we have experienced improvement during the quarter and nine months ended June 30, 2014. During the quarter ended June 30, 2014, our uncompensated care as a percentage of acute care revenue was 20.6%, compared to 23.5% in the prior year quarter. During the nine months ended June 30, 2014, our uncompensated care as a percentage of acute care revenue was 22.3%, compared to 23.9% in the prior year period. We believe the improvement in our uncompensated care as a percentage of acute care revenue can be attributed primarily to the impact of Medicaid expansion in the state of Arizona, which has resulted in lower self-pay volume and revenue for the quarter and nine months ended June 30, 2014, compared to the same prior year periods. During the quarter ended June 30, 2014, our self-pay admissions represented 6.0% of our total admissions, compared to 8.0% in the prior year quarter. During the nine months ended June 30, 2014, our self-pay admissions represented 7.0% of our total admissions, compared to 7.9% in the prior year period. The improvement in our uncompensated care as a percentage of acute care revenue has been mitigated somewhat by the higher acuity levels at which self-pay patients are presenting for treatment through our emergency rooms.

Additionally, the declines in our self-pay volume and revenue are being aided by increasing benefits from recent Exchange enrollment, given that certain Exchange enrollees previously were included in the uninsured population. During the quarter ended June 30, 2014, we experienced 305 Exchange related admissions, compared to 103 in the sequential quarter ended March 31, 2014.

We would expect uninsured volumes to continue to decline in the near future as the impact of the Health Reform Law is fully realized. However, if we were to experience growth in uninsured volume and revenue, our uncompensated care may increase and our results of operations could be adversely affected.

The percentages of our insured and uninsured hospital net receivables are summarized as follows ⁽¹⁾:

 

		June 30, 2014				September 30, 2013
Insured receivables			82.2	%			81.4	%
Uninsured receivables			17.8	%			18.6	%
Total			100.0	%			100.0	%

The percentages of hospital net receivables in summarized aging categories are as follows ⁽¹⁾:

 

		June 30, 2014				September 30, 2013
0 to 90 days			61.0	%			61.8	%
91 to 180 days			20.3	%			20.7	%
Over 180 days			18.7	%			17.5	%
Total			100.0	%			100.0	%

 

(1)	Excludes hospital receivables retained related to our discontinued Florida operations.

Adoption of Electronic Health Records (“EHR”)

The American Recovery and Reinvestment Act of 2009 (“ARRA”) included approximately $26.0 billion in funding for various healthcare information technology (“IT”) initiatives, including Medicare and Medicaid incentives for eligible hospitals and professionals to adopt and meaningfully use certified EHR technology (“EHR Incentive Programs”). In addition, eligible providers that fail to demonstrate meaningful use of certified EHR technology will be subject to reduced payments from Medicare, beginning in federal fiscal year 2015 for eligible hospitals and calendar year 2015 for eligible professionals. Implementation of the EHR Incentive

 

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Programs has been divided into three stages with increasing requirements for participation. Stage 1 requires providers to meet meaningful use objectives specified by CMS, which include electronically capturing health information in structured format, tracking key clinical conditions for coordination of care purposes, implementing clinical decision support tools to facilitate disease and medication management, using EHRs to engage patients and families, and reporting clinical quality measures and public health information. Our hospitals, as well as a number of our physician clinics, substantially met the Stage 1 requirements in our fiscal year 2012. Stage 2 introduces several new meaningful use measures, as well as imposes stricter requirements on certain existing Stage 1 measures. Providers must achieve meaningful use under the Stage 1 criteria before advancing to Stage 2 and are required to meet the criteria for the applicable stage based on their first year of attesting to meaningful use. Our hospitals and physician clinics whose first payment year was 2011 and 2012 are required to meet Stage 2 criteria beginning in 2014. Though we expect to continue to incur certain non-productive and other operating costs, as well as additional investments in hardware and software, we believe our historical investments in advanced clinical and other information systems, as well as quality of care programs, provides a solid platform to build upon for timely compliance with the healthcare IT initiatives and requirements of ARRA. During the quarter and nine months ended June 30, 2014, we recognized Medicare and Medicaid EHR incentives totaling $2.8 million and $10.2 million, respectively, compared to $4.8 million and $11.2 million in the prior year periods.

Revenue and Volume Trends

Total net revenue for the quarter ended June 30, 2014, increased 12.4% to $673.2 million, compared to $599.1 million in the prior year quarter. Total net revenue for the nine months ended June 30, 2014, increased 8.4% to $1.94 billion, compared to $1.79 billion in the prior year period. Total net revenue is comprised of acute care revenue, which is recorded net of the provision for bad debts, and premium revenue. Acute care revenue contributed $13.5 million to the increase in total net revenue for the quarter ended June 30, 2014, compared to the prior year quarter, while premium revenue at Health Choice contributed $60.5 million for the same period. Acute care revenue contributed $41.0 million to the increase in total net revenue for the nine months ended June 30, 2014, compared to the prior year period, while premium revenue at Health Choice contributed $102.9 million for the same period.

Acute Care Revenue

Acute care revenue is comprised of net patient revenue and other revenue. A large percentage of our hospitals’ net patient revenue consists of fixed payment, discounted sources, including Medicare, Medicaid and managed care organizations. Reimbursement for Medicare and Medicaid services are often fixed regardless of the cost incurred or the level of services provided. Similarly, a greater percentage of the managed care companies we contract with reimburse providers on a fixed payment basis regardless of the costs incurred or the level of services provided. Net patient revenue is reported net of discounts and contractual adjustments. The contractual adjustments principally result from differences between the hospitals’ established charges and payment rates under Medicare, Medicaid and various managed care plans. Additionally, discounts and contractual adjustments result from our uninsured discount and charity care programs. Acute care revenue is reported net of the provision for doubtful accounts. Other revenue includes medical office building rental income and other miscellaneous revenue.

Admissions decreased 3.1% and 3.4% for the quarter and nine months ended June 30, 2014, respectively, compared to the same prior year periods. These decreases are reflective of a decline in Medicare 1-day stays, an industry-wide decline in inpatient utilization, and a continued shift towards outpatient services. In addition, respiratory or flu-related volumes declined for the nine months ended June 30, 2014, as compared to the same prior year periods. Adjusted admissions increased 1.9% and 0.7% for the quarter and nine months ended June 30, 2014, compared to the same prior year periods. For the quarter and nine months ended June 30, 2014, our outpatient volumes were positively impacted by increases in outpatient surgeries of 4.5% and 5.1%, respectively, compared to the same prior year periods. Additionally, emergency room visits for the quarter ended June 30, 2014 increased 3.2% compared to the prior year, while decreasing 0.9% in the nine months ended June 30, 2014, compared to the prior year period.

The following table provides the sources of our hospitals’ gross patient revenue by payor:

 

		Quarter Ended June 30,								Nine Months Ended June 30,
		2014				2013				2014				2013
Medicare			27.2	%			29.8	%			27.8	%			29.2	%
Managed Medicare			14.6	%			14.9	%			14.7	%			14.4	%
Medicaid and managed Medicaid			22.3	%			18.3	%			21.4	%			20.2	%
Managed care and other			30.5	%			29.9	%			30.0	%			29.2	%
Self-pay			5.4	%			7.1	%			6.1	%			7.0	%
Total			100.0	%			100.0	%			100.0	%			100.0	%

 

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The following table provides the sources of our hospitals’ net patient revenue by payor before the provision for bad debts:

 

		Quarter Ended June 30,								Nine Months Ended June 30,
		2014				2013				2014				2013
Medicare			20.3	%			20.5	%			20.6	%			21.3	%
Managed Medicare			10.1	%			9.8	%			10.1	%			10.0	%
Medicaid and managed Medicaid			13.4	%			12.0	%			12.7	%			12.2	%
Managed care and other			40.9	%			38.4	%			39.5	%			37.9	%
Self-pay			15.3	%			19.3	%			17.1	%			18.6	%
Total			100.0	%			100.0	%			100.0	%			100.0	%

As noted in the above tables, our gross and net patient revenue by payor is experiencing a shift from self-pay to Medicaid and managed Medicaid and managed care payors. This shift is primarily a result of Arizona’s expansion of its Medicaid program under Health Care Reform, which become effective January 1, 2014, the initial benefit being experienced as Exchange enrollees begin accessing the healthcare system and the early signs of improvement in the underlying economic fundamentals in the markets we serve.

Net patient revenue per adjusted admission, which includes the impact of the provision for bad debts, increased 1.3% and 2.5% for the quarter and nine months ended June 30, 2014, compared to the same prior year periods.

See “Item 1 — Business — Sources of Acute Care Revenue” and “Item 1 — Business — Government Regulation and Other Factors” included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2013, filed with the SEC on December 20, 2013, for a description of the types of payments we receive for services provided to patients enrolled in the traditional Medicare plan, managed Medicare plans, Medicaid plans, managed Medicaid plans and managed care plans. In those sections, we also discussed the unique reimbursement features of the traditional Medicare plan, including the annual Medicare regulatory updates published by CMS that impact reimbursement rates for services provided under the plan. The future potential impact to reimbursement for certain of these payors under the Health Reform Law is also addressed in such Annual Report on Form 10-K.

Premium Revenue

Health Choice contracts with state Medicaid programs in Arizona and Utah to provide specified health services to qualified Medicaid enrollees through contracted providers. Most of its premium revenue is derived through a contract with AHCCCS, the state agency that administers Arizona’s Medicaid program. The contract requires Health Choice to arrange for healthcare services for enrolled Medicaid patients in exchange for fixed monthly premiums, based upon negotiated per capita member rates, and supplemental payments from AHCCCS. Health Choice also contracts with CMS to provide coverage as a Medicare Advantage Prescription Drug (“MAPD”) Special Needs Plan (“SNP”). This contract allows Health Choice to offer Medicare and Part D drug benefit coverage to new and existing dual-eligible members (i.e., those that are eligible for Medicare and Medicaid). In accordance with CMS regulations, SNPs are now expected to meet additional requirements, including requirements relating to model of care, cost-sharing, disclosure of information and reporting of quality measures.

Premium revenue generated by Health Choice represented 29.8% and 27.1% of our consolidated net revenue for the quarter and nine months ended June 30, 2014, respectively, compared to 23.3% and 23.6% in the same prior year periods.

 

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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

A summary of significant accounting policies is disclosed in Note 2 to the consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2013. Our critical accounting policies are further described under the caption “Critical Accounting Policies and Estimates” in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended September 30, 2013. There have been no changes in the nature of our critical accounting policies or the application of those policies since September 30, 2013.

SELECTED OPERATING DATA

The following table sets forth certain unaudited operating data from continuing operations for each of the periods presented.

 

		Quarter Ended June 30,								Nine Months Ended June 30,
		2014				2013				2014				2013
Acute Care
Number of acute care hospital facilities at end of period			16				16				16				16
Licensed beds at end of period (1)			3,778				3,804				3,778				3,804
Average length of stay (days) (2)			5.07				5.09				5.15				5.10
Occupancy rates (average beds in service)			48.5	%			49.7	%			49.6	%			50.6	%
Admissions (3)			26,307				27,155				79,796				82,643
Adjusted admissions (4)			49,103				48,175				144,790				143,750
Patient days (5)			133,488				138,108				409,923				421,159
Adjusted patient days (4)			249,162				245,015				743,804				732,569
Net patient revenue per adjusted admission (6)		$	9,509			$	9,391			$	9,611			$	9,376
Health Choice
Covered lives (7)			213,032				186,111				213,032				186,111
Medical loss ratio (8)			84.5	%			84.8	%			84.8	%			83.8	%

 

(1)	Includes St. Luke’s Behavioral Hospital in Phoenix, Arizona.

(2)	Represents the average number of days that a patient stayed in our hospitals.

(3)	Represents the total number of patients admitted to our hospitals for stays in excess of 23 hours. Management and investors use this number as a general measure of inpatient volume.

(4)	Adjusted admissions and adjusted patient days are general measures of combined inpatient and outpatient volume. We compute adjusted admissions/patient days by multiplying admissions/patient days by gross patient revenue and then dividing that number by gross inpatient revenue.

(5)	Represents the number of days our beds were occupied by inpatients over the period.

(6)	Includes the impact of the provision for bad debts as a component of revenue.

(7)

Represents total lives enrolled across all health plan product lines. Includes dual-eligible lives, which are members eligible for Medicare and Medicaid benefits, under Health Choice’s contract with CMS to provide coverage as a MAPD SNP totaling 8,006 and 4,310 as of June 30, 2014 and 2013, respectively.

(8)	Represents medical claims expense as a percentage of premium revenue, including claims paid to our hospitals.

 

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RESULTS OF OPERATIONS SUMMARY

Consolidated

The following table sets forth, for the periods presented, the results of our consolidated operations expressed in dollar terms and as a percentage of net revenue. Such information has been derived from our unaudited condensed consolidated statements of operations.

 

		Quarter Ended								Quarter Ended								Nine Months Ended								Nine Months Ended
		June 30, 2014								June 30, 2013								June 30, 2014								June 30, 2013
($ in thousands):		Amount				Percentage				Amount				Percentage				Amount				Percentage				Amount				Percentage
Net revenue
Acute care revenue before provision for bad debts		$	556,318							$	555,413							$	1,692,779							$	1,636,836
Less: Provision for bad debts			(83,437	)							(96,090	)							(281,931	)							(267,014	)
Acute care revenue			472,881				70.2	%			459,323				76.7	%			1,410,848				72.9	%			1,369,822				76.4	%
Premium revenue			200,281				29.8	%			139,804				23.3	%			524,995				27.1	%			422,059				23.6	%
Net revenue			673,162				100.0	%			599,127				100.0	%			1,935,843				100.0	%			1,791,881				100.0	%
Costs and expenses
Salaries and benefits			234,546				34.8	%			219,896				36.7	%			701,983				36.3	%			670,286				37.4	%
Supplies			80,411				11.9	%			79,462				13.3	%			243,437				12.6	%			240,724				13.4	%
Medical claims			165,943				24.7	%			116,640				19.5	%			436,754				22.6	%			348,556				19.5	%
Rentals and leases			18,796				2.8	%			13,992				2.3	%			56,429				2.9	%			40,635				2.3	%
Other operating expenses			114,933				17.1	%			106,456				17.8	%			325,012				16.8	%			309,987				17.3	%
Medicare and Medicaid EHR incentives			(2,790	)			(0.4	%)			(4,827	)			(0.8	%)			(10,233	)			(0.5	%)			(11,209	)			(0.6	%)
Interest expense, net			32,275				4.8	%			32,771				5.4	%			98,325				5.2	%			99,987				5.5	%
Depreciation and amortization			23,276				3.4	%			24,492				4.1	%			71,860				3.6	%			72,606				4.1	%
Management fees			1,250				0.2	%			1,250				0.2	%			3,750				0.2	%			3,750				0.2	%
Total costs and expenses			668,640				99.3	%			590,132				98.5	%			1,927,317				99.6	%			1,775,322				99.1	%
Earnings from continuing operations before gain on disposal of assets and income taxes			4,522				0.7	%			8,995				1.5	%			8,526				0.4	%			16,559				0.9	%
Gain on disposal of assets, net			332				0.0	%			481				0.1	%			1,100				0.1	%			649				0.1	%
Earnings from continuing operations before income taxes			4,854				0.7	%			9,476				1.6	%			9,626				0.5	%			17,208				1.0	%
Income tax expense			6,331				0.9	%			3,850				0.7	%			10,198				0.5	%			8,016				0.5	%
Net earnings (loss) from continuing operations			(1,477	)			(0.2	%)			5,626				0.9	%			(572	)			(0.0	%)			9,192				0.5	%
Earnings (loss) from discontinued operations, net of income taxes			(2,847	)			(0.4	%)			(531	)			(0.1	%)			1,821				(0.0	%)			849				0.1	%
Net earnings (loss)			(4,324	)			(0.6	%)			5,095				0.8	%			1,249				0.0	%			10,041				0.6	%
Net earnings attributable to non-controlling interests			(2,453	)			(0.4	%)			(1,941	)			(0.3	%)			(8,857	)			(0.5	%)			(3,189	)			(0.2	%)
Net earnings (loss) attributable to IASIS Healthcare LLC		$	(6,777	)			(1.0	%)		$	3,154				0.5	%		$	(7,608	)			(0.5	%)		$	6,852				0.4	%

 

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Acute Care

The following table and discussion sets forth, for the periods presented, the results of our acute care operations expressed in dollar terms and as a percentage of acute care revenue. Such information has been derived from our unaudited condensed consolidated statements of operations.

 

		Quarter Ended								Quarter Ended								Nine Months Ended								Nine Months Ended
		June 30, 2014								June 30, 2013								June 30, 2014								June 30, 2013
($ in thousands):		Amount				Percentage				Amount				Percentage				Amount				Percentage				Amount				Percentage
Acute care revenue
Acute care revenue before provision for bad debts		$	556,318							$	555,413							$	1,692,779							$	1,636,836
Less: Provision for bad debts			(83,437	)							(96,090	)							(281,931	)							(267,014	)
Acute care revenue			472,881				99.3	%			459,323				99.6	%			1,410,848				99.4	%			1,369,822				99.6	%
Revenue between segments (1)			3,262				0.7	%			1,940				0.4	%			8,539				0.6	%			5,334				0.4	%
Total acute care revenue			476,143				100.0	%			461,263				100.0	%			1,419,387				100.0	%			1,375,156				100.0	%
Costs and expenses
Salaries and benefits			225,785				47.4	%			213,806				46.4	%			678,491				47.8	%			652,666				47.5	%
Supplies			80,341				16.9	%			79,422				17.2	%			243,264				17.1	%			240,582				17.5	%
Rentals and leases			18,348				3.8	%			13,597				2.9	%			55,264				3.9	%			39,443				2.9	%
Other operating expenses			101,706				21.4	%			100,463				21.8	%			296,401				20.9	%			292,488				21.3	%
Medicare and Medicaid EHR incentives			(2,790	)			(0.6	%)			(4,827	)			(1.0	%)			(10,233	)			(0.7	%)			(11,209	)			(0.8	%)
Interest expense, net			32,275				6.8	%			32,771				7.1	%			98,325				6.9	%			99,987				7.2	%
Depreciation and amortization			22,244				4.7	%			23,463				5.0	%			68,723				4.8	%			69,510				5.0	%
Management fees			1,250				0.3	%			1,250				0.3	%			3,750				0.3	%			3,750				0.3	%
Total costs and expenses			479,159				100.7	%			459,945				99.7	%			1,433,985				101.0	%			1,387,217				100.9	%
Earnings (loss) from continuing operations before gain on disposal of assets and income taxes			(3,016	)			(0.7	%)			1,318				0.3	%			(14,598	)			(1.0	%)			(12,061	)			(0.9	%)
Gain on disposal of assets, net			332				0.1	%			481				0.1	%			1,100				0.1	%			649				0.1	%
Earnings (loss) from continuing operations before income taxes		$	(2,684	)			(0.6	%)		$	1,799				0.4	%		$	(13,498	)			(1.1	%)		$	(11,412	)			(0.8	%)

 

(1)	Revenue between segments is eliminated in our consolidated results.

 

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Quarters Ended June 30, 2014 and 2013

Total acute care revenue — Total acute care revenue for the quarter ended June 30, 2014, was $476.1 million, an increase of $14.8 million or 3.2% compared to $461.3 million in the prior year quarter. The increase in total acute care revenue is comprised primarily of an increase in adjusted admissions of 1.9% and an increase in net patient revenue per adjusted admission of 1.3%.

Net adjustments to estimated third-party payor settlements, also known as prior year contractuals, resulted in an increase in total acute care revenue for the quarters ended June 30, 2014 and 2013, of $0.5 million and $3.1 million, respectively.

Salaries and benefits — Salaries and benefits expense for the quarter ended June 30, 2014, was $225.8 million, or 47.4% of total acute care revenue, compared to $213.8 million, or 46.4% of total acute care revenue in the prior year quarter. Excluding the impact of stock-based compensation, salaries and benefits expense as a percentage of total acute care revenue was 46.5% for the quarter ended June 30, 2014, compared to 46.1% in the prior year quarter. This increase is due primarily to an increase in employee benefit costs compared to the prior year quarter, partially offset by a 0.1% improvement in contract labor as the result of cost reduction initiatives.

Supplies — Supplies for the quarter ended June 30, 2014, were $80.3 million, or 16.9% of total acute care revenue, compared to $79.4 million, or 17.2% of total acute care revenue in the prior year quarter. The improvement in supplies as a percentage of total acute care revenue is the result of a decline in supply intensive surgical procedures as evidenced by a 3.1% decline in inpatient surgeries, as well as the impact of supply cost initiatives that have included improved pricing and more effective utilization.

Rentals and leases — Rentals and leases expense for the quarter ended June 30, 2014, was $18.3 million, compared to $13.6 million in the prior year quarter. The increase in rentals and leases expense is primarily due to $4.5 million of additional rent expense in the quarter ended June 30, 2014, resulting from the sale-leaseback of certain hospital real estate, which closed in the fourth quarter of fiscal year 2013.

Other operating expenses — Other operating expenses for the quarter ended June 30, 2014, were $101.7 million, or 21.4% of total acute care revenue, compared to $100.5 million, or 21.8% of total acute care revenue in the prior year quarter. Other operating expenses as a percentage of total acute revenue improved primarily due to a decline in professional fees associated with our supplemental Medicaid reimbursement programs in Texas.

Nine Months Ended June 30, 2014 and 2013

Total acute care revenue — Total acute care revenue for the nine months ended June 30, 2014, was $1.42 billion, an increase of $44.2 million or 3.2% compared to $1.38 billion in the prior year period. The increase in total acute care revenue is comprised primarily of an increase in adjusted admissions of 0.7% and an increase in net patient revenue per adjusted admission of 2.5%.

Net adjustments to estimated third-party payor settlements, also known as prior year contractuals, resulted in an increase in total acute care revenue for the nine months ended June 30, 2014 and 2013, of $4.8 million and $6.6 million, respectively.

Salaries and benefits — Salaries and benefits expense for the nine months ended June 30, 2014, was $678.5 million, or 47.8% of total acute care revenue, compared to $652.7 million, or 47.5% of total acute care revenue in the prior year period. Excluding the impact of stock-based compensation and $3.5 million of compensation expense associated with a special bonus paid to certain members of our leadership team in recognition of the execution of certain recent strategic initiatives, salaries and benefits expense as a percentage of total acute care revenue was 46.9% for the nine months ended June 30, 2014, compared to 47.2% in the prior year period.

Supplies — Supplies for the nine months ended June 30, 2014, were $243.3 million, or 17.1% of total acute care revenue, compared to $240.6 million, or 17.5% of total acute care revenue in the prior year period. The improvement in supplies as a percentage of acute care revenue is the result of a decline in supply intensive surgical procedures as evidenced by a 2.5% decline in inpatient surgeries, as well as the impact of supply cost initiatives that have included improved pricing and more effective utilization.

Rentals and leases — Rentals and leases expense for the nine months ended June 30, 2014, was $55.3 million, compared to $39.4 million in the prior year period. The increase in rentals and leases expense is primarily due to $13.2 million of additional rent expense in the nine months ended June 30, 2014, resulting from of the sale-leaseback of certain hospital real estate, which closed in the fourth quarter of fiscal year 2013.

Other operating expenses — Other operating expenses for the nine months ended June 30, 2014, were $296.4 million, or 20.9% of total acute care revenue, compared to $292.5 million, or 21.3% of total acute care revenue in the prior year period. Other operating expenses as a percentage of total acute care revenue improved primarily due to a decline in professional fees associated with our supplemental Medicaid reimbursement programs in Texas.

 

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Health Choice

The following table and discussion sets forth, for the periods presented, the results of our Health Choice operations expressed in dollar terms and as a percentage of premium revenue. Such information has been derived from our unaudited condensed consolidated statements of operations.

 

		Quarter Ended								Quarter Ended								Nine Months Ended								Nine Months Ended
		June 30, 2014								June 30, 2013								June 30, 2014								June 30, 2013
($ in thousands):		Amount				Percentage				Amount				Percentage				Amount				Percentage				Amount				Percentage
Premium revenue
Premium revenue		$	200,281				100.0	%		$	139,804				100.0	%		$	524,995				100.0	%		$	422,059				100.0	%
Costs and expenses
Salaries and benefits			8,929				4.5	%			6,090				4.4	%			23,660				4.5	%			17,620				4.2	%
Supplies			70				0.0	%			40				0.0	%			173				0.0	%			142				0.0	%
Medical claims (1)			169,205				84.5	%			118,580				84.8	%			445,293				84.8	%			353,890				83.8	%
Other operating expenses			13,059				6.5	%			5,993				4.3	%			28,443				5.4	%			17,499				4.1	%
Rentals and leases			448				0.2	%			395				0.3	%			1,165				0.3	%			1,192				0.3	%
Depreciation and amortization			1,032				0.5	%			1,029				0.7	%			3,137				0.6	%			3,096				0.8	%
Total costs and expenses			192,743				96.2	%			132,127				94.5	%			501,871				95.6	%			393,439				93.2	%
Earnings before income taxes		$	7,538				3.8	%		$	7,677				5.5	%		$	23,124				4.4	%		$	28,620				6.8	%

 

(1)	Medical claims paid to our hospitals of $3.3 million and $1.9 million for the quarters ended June 30, 2014 and 2013, respectively, and $8.5 million and $5.3 million for the nine months ended June 30, 2014 and 2013, respectively, are eliminated in our consolidated results.

Quarters Ended June 30, 2014 and 2013

Premium revenue — Premium revenue from Health Choice was $200.3 million for the quarter ended June 30, 2014, an increase of $60.5 million or 43.3% compared to $139.8 million in the prior year quarter. The increase in premium revenue is attributable to a 14.5% increase in members, driven by growth in all of our product lines. Enrollment in our Medicare and Medicaid product lines increased 81.4% and 10.4%, respectively, compared to the prior year quarter. Our Medicaid product line has been impacted favorably by the expansion of the Medicaid program in Arizona. Additionally, premium revenue on a per member per month basis for the quarter ended June 30, 2014, compared to the prior year quarter, increased 22.6% as a result of changes in the member mix. We also recognized $4.0 million of revenue related to the new HIF as part of the Health Reform Law.

Medical claims — Prior to eliminations, medical claims expense was $169.2 million for the quarter ended June 30, 2014, compared to $118.6 million in the prior year quarter. Medical claims expense as a percentage of premium revenue was 84.5% for the quarter ended June 30, 2014, compared to 84.8% in the prior year quarter. Excluding the impact of the HIF revenue, medical claims as a percentage of premium revenue was 86.2% for the quarter ended June 30, 2014, compared to 84.8% in the prior year quarter. This increase is primarily attributable to additional medical expenses associated with the increase in childless adult members, resulting from the recent expansion of the Medicaid program in Arizona, which typically present for treatment at higher acuity levels. Additionally, we have incurred an increase in pharmacy costs resulting from an increase in specialty drug utilization, including $1.1 million of additional costs associated with a new drug used to cure Hepatitis C.

Other operating expenses — Other operating expenses for the quarter ended June 30, 2014, were $13.1 million, or 6.5% of premium revenue, compared to $6.0 million, or 4.3% of premium revenue in the prior year quarter. Other operating expenses increased primarily as a result of $2.0 million in start-up related costs associated with our new third-party administration and management services organization business and $4.0 million in HIF expense.

Nine Months Ended June 30, 2014 and 2013

Premium revenue — Premium revenue from Health Choice was $525.0 million for the nine months ended June 30, 2014, an increase of $102.9 million or 24.4% compared to $422.1 million in the prior year period. The increase in premium revenue is attributable to a 6.2% increase in members, driven by growth in all of our product lines. Enrollment in our Medicare and Medicaid product lines increased 56.6% and 7.5%, respectively, compared to the prior year period. Our Medicaid product line has been impacted favorably by the expansion of the

 

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Medicaid program in Arizona. Premium revenue on a per member per month basis for the nine months ended June 30, 2014, compared to the prior year period, increased 13.5% as a result of changes in the member mix. Additionally, premium revenue for the nine months ended June 30, 2014, compared to the prior year period, increased as a result of additional reimbursement related to primary care physician Medicaid parity payments, which also includes a pass-through component impacting our medical expenses. We also recognized $4.0 million of revenue related to the new HIF as part of the Health Reform Law.

Medical claims — Prior to eliminations, medical claims expense was $445.3 million for the nine months ended June 30, 2014, compared to $353.9 million in the prior year period. Medical claims expense as a percentage of premium revenue was 84.8% for the nine months ended June 30, 2014, compared to 83.8% in the prior year period. Excluding the impact of the HIF revenue, medical claims as a percentage of premium revenue was 85.5% for the nine months ended June 30, 2014, compared to 83.8% in the prior year period. This increase is primarily attributable to additional medical expenses associated with the increase in childless adult members, resulting from the recent expansion of the Medicaid program in Arizona, which typically present for treatment at higher acuity levels. Additionally, we have incurred an increase in pharmacy costs resulting from an increase in specialty drug utilization, including $3.8 million of additional costs associated with a new drug used to cure Hepatitis C.

Other operating expenses — Other operating expenses for the nine months ended June 30, 2014, were $28.4 million, or 5.4% of premium revenue, compared to $17.5 million, or 4.1% of premium revenue in the prior year period. Other operating expenses increased primarily as a result of $3.0 million in start-up related costs associated with our new third-party administration and management services organization business and $4.0 million in HIF expense.

Income Tax Expense

Quarters ended June 30, 2014 and 2013

For the quarter ended June 30, 2014, we recorded income tax expense of $6.3 million, for an effective tax rate of 130.4%, compared to income tax expense of $3.9 million, for an effective tax rate of 40.6% in the prior year quarter. The increase in the effective tax rate was primarily due to an increase in certain nondeductible expenses including: (1) nondeductible compensation, including stock-based compensation; (2) a $1.1 million expense related to an excess of cumulative compensation deductions over the realized tax benefit upon the exercise of employee stock options; and (3) the HIF imposed by the Health Reform Law beginning in 2014, which is treated as a nondeductible excise tax.

Nine months ended June 30, 2014 and 2013

For the nine months ended June 30, 2014, we recorded income tax expense of $10.2 million, for an effective tax rate of 105.9%, compared to income tax expense of $8.0 million, for an effective tax rate of 46.6% in the prior year period. The increase in the effective tax rate was primarily due to an increase in certain nondeductible expenses including: (1) nondeductible compensation, including stock-based compensation; (2) a $1.1 million expense related to an excess of cumulative compensation deductions over the realized tax benefit upon the exercise of employee stock options; and (3) the HIF imposed by the Health Reform Law beginning in 2014, which is treated as a nondeductible excise tax.

LIQUIDITY AND CAPITAL RESOURCES

Overview of Cash Flow Activities for the Nine Months Ended June 30, 2014 and 2013

Our cash flows are summarized as follows (in thousands):

 

		Nine Month Ended June 30,
		2014				2013
Cash flows from operating activities		$	(10,544	)		$	12,911
Cash flows from investing activities		$	(84,100	)		$	(82,487	)
Cash flows from financing activities		$	(25,844	)		$	38,550

Operating Activities

Cash flows used in continuing operations for the nine months ended June 30, 2014, which declined $12.3 million compared to the prior year period, were impacted by the payment of $22.3 million in income taxes, transaction fees and other costs, as well as $16.9 million of additional rent payments, associated with the recent sale-leaseback of certain hospital real estate. In addition, cash flows used in continuing operations were impacted by the timing of payments related to primary care physician Medicaid parity at Health Choice.

At June 30, 2014, we had $208.9 million in net working capital, compared to $212.9 million at September 30, 2013, both excluding the impact of our sale-leaseback transactions and the sale of our Florida market. Net accounts receivable decreased $34.4 million to $336.6 million at June 30, 2014, from $371.0 million at September 30, 2013. Our days revenue in accounts receivable at June 30, 2014, were 54, compared to 56 at September 30, 2013 and 59 at June 30, 2013.

Investing Activities

Cash flows used in investing activities increased $1.6 million for the nine months ended June 30, 2014, compared to the prior year period. The increase is comprised primarily of an increase in capital expenditures of $2.0 million compared to the prior year period. Included in capital expenditures for the nine months ended June 30, 2014 is $17.0 million of costs associated with the ongoing construction of our new greenfield hospital, Mountain Point Medical Center, in Lehi, Utah. This project is expected to be completed in the spring/summer of 2015.

Financing Activities

Cash flows used in financing activities was $25.8 million for the nine months ended June 30, 2014, compared to cash provided of $38.6 million in the prior year period. The prior year period included proceeds from borrowings on our revolving credit facilities of $147.0 million, along with subsequent debt payments of $101.8 million. The nine months ended June 30, 2014, includes regular debt payments of $10.2 million and distributions to non-controlling interests of $5.2 million associated with the sale-leaseback of certain hospital real estate.

 

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Capital Resources

As of June 30, 2014, we had the following debt arrangements:

 

•

$1.325 billion senior secured credit facilities; and

 

•

$850.0 million in 8.375% senior notes due 2019.

At June 30, 2014, amounts outstanding under our senior secured credit facilities consisted of $992.0 million in term loans. In addition, we had $69.9 million in letters of credit outstanding under the revolving credit facility. The weighted average interest rate of outstanding borrowings under the senior secured credit facilities was 4.6% for both the quarter and nine months ended June 30, 2014, respectively, compared to 4.5% and 4.8% in the prior year periods.

$1.325 Billion Senior Secured Credit Facilities

We are party to a senior credit agreement, which was amended on February 20, 2013 (the “Repricing Amendment”) as part of a repricing that lowered the interest rate, (the “Amended and Restated Credit Agreement”). The Amended and Restated Credit Agreement provides for senior secured financing of up to $1.325 billion consisting of (1) a $1.025 billion senior secured term loan facility with a seven-year maturity and (2) a $300.0 million senior secured revolving credit facility with a five-year maturity, of which up to $150.0 million may be utilized for the issuance of letters of credit (together, the “Senior Secured Credit Facilities”). Principal under the senior secured term loan facility is due in consecutive equal quarterly installments in an aggregate annual amount equal to 1% of the principal amount of $1.007 billion outstanding as of the effective date of the Repricing Amendment, with the remaining balance due upon maturity of the senior secured term loan facility. The senior secured revolving credit facility does not require installment payments.

Borrowings under the senior secured term loan facility (giving effect to the Repricing Amendment) bear interest at a rate per annum equal to, at our option, either (1) a base rate (the “base rate”) determined by reference to the highest of (a) the federal funds rate plus 0.50%, (b) the prime rate of Bank of America, N.A. and (c) a one-month LIBOR rate, subject to a floor of 1.25%, plus 1.00%, in each case, plus a margin of 2.25% per annum or (2) the LIBOR rate for the interest period relevant to such borrowing, subject to a floor of 1.25%, plus a margin of 3.25% per annum. Borrowings under the senior secured revolving credit facility generally bear interest at a rate per annum equal to, at our option, either (1) the base rate plus a margin of 2.50% per annum, or (2) the LIBOR rate for the interest period relevant to such borrowing plus a margin of 3.50% per annum. In addition to paying interest on outstanding principal under the Senior Secured Credit Facilities, we are required to pay a commitment fee on the unutilized commitments under the senior secured revolving credit facility, as well as pay customary letter of credit fees and agency fees.

The Senior Secured Credit Facilities are unconditionally guaranteed by IAS and certain of our subsidiaries (collectively, the “Credit Facility Guarantors”) and are required to be guaranteed by all of our future material wholly owned subsidiaries, subject to certain exceptions. All obligations under the Amended and Restated Credit Agreement are secured, subject to certain exceptions, by substantially all of our assets and the assets of the Credit Facility Guarantors, including (1) a pledge of 100% of our equity interests and that of the Credit Facility Guarantors, (2) mortgage liens on all of our material real property and that of the Credit Facility Guarantors, and (3) all proceeds of the foregoing.

The Amended and Restated Credit Agreement requires us to mandatorily prepay borrowings under the senior secured term loan facility with net cash proceeds of certain asset dispositions, following certain casualty events, following certain borrowings or debt issuances, and from a percentage of annual excess cash flow. The Amended and Restated Credit Agreement contains certain restrictive covenants, including, among other things: (1) limitations on the incurrence of debt and liens; (2) limitations on investments other than, among other exceptions, certain acquisitions that meet certain conditions; (3) limitations on the sale of assets outside of the ordinary course of business; (4) limitations on dividends and distributions; and (5) limitations on transactions with affiliates, in each case, subject to certain exceptions. The Amended and Restated Credit Agreement also contains certain customary events of default, including, without limitation, a failure to make payments under the Senior Secured Credit Facilities, cross-defaults, certain bankruptcy events and certain change of control events.

8.375% Senior Notes due 2019

We and IASIS Capital Corporation (together, the “Issuers”) have issued $850.0 million aggregate principal amount of 8.375% senior notes due 2019 (“Senior Notes”), which mature on May 15, 2019, pursuant to an indenture, dated as of May 3, 2011, among the Issuers and certain of the Issuers’ wholly owned domestic subsidiaries that guarantee the Senior Secured Credit Facilities (the “Notes Guarantors”) (the “Indenture”). The Indenture provides that the Senior Notes are general unsecured, senior obligations of the Issuers, and initially will be unconditionally guaranteed on a senior unsecured basis.

The Senior Notes bear interest at a rate of 8.375% per annum, payable semi-annually, in cash in arrears, on May 15 and November 15 of each year.

 

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We may redeem the Senior Notes, in whole or in part, at any time on or after to May 15, 2014, at a price equal to 106.281% of the aggregate principal amount of the Senior Notes plus accrued and unpaid interest and special interest, if any, to but excluding the redemption date. Each subsequent year the redemption price declines 2.093% until 2017 and thereafter, at which point the redemption price is equal to 100% of the aggregate principal amount of the Senior Notes plus accrued and unpaid interest and special interest, if any, to but excluding the redemption date.

The Indenture contains covenants that limit our (and our restricted subsidiaries’) ability to, among other things: (1) incur additional indebtedness or liens or issue disqualified stock or preferred stock; (2) pay dividends or make other distributions on, redeem or repurchase our capital stock; (3) sell certain assets; (4) make certain loans and investments; (5) enter into certain transactions with affiliates; (6) impose restrictions on the ability of a subsidiary to pay dividends or make payments or distributions to us and our restricted subsidiaries; and (7) consolidate, merge or sell all or substantially all of our assets. These covenants are subject to a number of important limitations and exceptions.

The Indenture also provides for events of default, which, if any of them occurs, may permit or, in certain circumstances, require the principal, premium, if any, interest and any other monetary obligations on all the then outstanding Senior Notes to be due and payable immediately. If we experience certain kinds of changes of control, we must offer to purchase the Senior Notes at 101% of their principal amount, plus accrued and unpaid interest and special interest, if any, to but excluding the repurchase date. Under certain circumstances, we will have the ability to make certain payments to facilitate a change of control transaction and to provide for the assumption of the Senior Notes by a new parent company resulting from such change of control transaction. If such change of control transaction is facilitated, the Issuers will be released from all obligations under the Indenture and the Issuers and the trustee will execute a supplemental indenture effectuating such assumption and release.

Credit Ratings

The table below summarizes our corporate rating, as well as our credit ratings for the Senior Secured Credit Facilities and Senior Notes as of the date of this filing:

 

		Moody’s		Standard & Poor’s
Corporate credit		B2		B
Senior secured term loan facility		Ba3		B
Senior secured revolving credit facility		Ba3		BB-
Senior Notes		Caa1		CCC+
Outlook		Stable		Stable

Other

We are party to interest rate swaps with Citibank, N.A. (“Citibank”) and Barclays Bank PLC (“Barclays”), as counterparties, with notional amounts totaling $350.0 million, each agreement effective March 28, 2013 and expiring between September 30, 2014 and September 30, 2016. Under these agreements, we are required to make quarterly fixed rate payments to the counterparties at annual rates ranging from 1.6% to 2.2%. The counterparties are obligated to make quarterly floating rate payments to us based on the three-month LIBOR rate, each subject to a floor of 1.25%.

 

		Total Notional Amounts
Effective Dates		(in thousands)
Effective from March 28, 2013 to September 30, 2014		$	50,000
Effective from March 28, 2013 to September 30, 2015			100,000
Effective from March 28, 2013 to September 30, 2016			200,000

Capital Expenditures

We plan to finance our proposed capital expenditures with cash generated from operations, borrowings under our Senior Secured Credit Facilities and other capital sources that may become available. We expect our capital expenditures for fiscal 2014 to be $115.0 million to $125.0 million, including the following significant expenditures:

 

•

$50 million to $55 million for growth and new business projects;

 

•

$45 million to $50 million in replacement or maintenance related projects at our hospitals; and

 

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•

$20 million in hardware and software costs related to information systems projects, including healthcare IT stimulus initiatives.

Liquidity

We rely on cash generated from our operations as our primary source of liquidity, as well as available credit facilities, project and bank financings and the issuance of long-term debt. From time to time, we have also utilized operating lease transactions that are sometimes referred to as off-balance sheet arrangements. We expect that our future funding for working capital needs, capital expenditures, long-term debt repayments and other financing activities will continue to be provided from some or all of these sources. Each of our existing and projected sources of cash is impacted by operational and financial risks that influence the overall amount of cash generated and the capital available to us. For example, cash generated by our business operations may be impacted by, among other things, economic downturns, federal and state budget initiatives, weather-related catastrophes and adverse industry conditions. Our future liquidity will be impacted by our ability to access capital markets, which may be restricted due to our credit ratings, general market conditions, leverage capacity and by existing or future debt agreements. For a further discussion of risks that can impact our liquidity, see our risk factors in our Annual Report on Form 10-K for the fiscal year ended September 30, 2013.

Including available cash at June 30, 2014, we have available liquidity as follows (in millions):

 

Cash and cash equivalents		$	317.6
Available capacity under our senior secured revolving credit facility			230.1
Net available liquidity at June 30, 2014		$	547.7

Net available liquidity assumes 100% participation from all lenders currently committed under our senior secured revolving credit facility. In addition to our available liquidity, we expect to generate sufficient operating cash flows in fiscal 2014. We will also utilize proceeds from our financing activities as needed.

Based upon our current level of operations and anticipated growth, we believe we have sufficient liquidity to meet our cash requirements over the short-term (next 12 months) and over the next three years. In evaluating the sufficiency of our liquidity for both the short-term and long-term, we considered the expected cash flow to be generated by our operations, cash on hand and the available borrowings under our Senior Secured Credit Facilities, compared to our anticipated cash requirements for debt service, working capital, capital expenditures and the payment of taxes, as well as funding requirements for long-term liabilities.

We are unable at this time to extend our evaluation of the sufficiency of our liquidity beyond three years. We cannot assure you, however, that our operating performance will generate sufficient cash flow from operations or that future borrowings will be available under our Senior Secured Credit Facilities, or otherwise, to enable us to grow our business, service our indebtedness, or make anticipated capital expenditures and tax payments. For more information, see our risk factors in our Annual Report on Form 10-K for the fiscal year ended September 30, 2013.

One element of our business strategy is to selectively pursue acquisitions and strategic alliances in existing and new markets. Any acquisitions or strategic alliances may result in the incurrence, or assumption by us, of additional indebtedness. We continually assess our capital needs and may seek additional financing, including debt or equity as considered necessary to fund capital expenditures and potential acquisitions or for other corporate purposes. Our future operating performance and our ability to service or refinance our debt will be subject to future economic conditions and to financial, business and other factors, many of which are beyond our control. For more information, see our risk factors in our Annual Report on Form 10-K for the fiscal year ended September 30, 2013.

SEASONALITY

The patient volumes and acute care revenue of our healthcare operations are subject to seasonal variations and generally are greater during the quarter ended March 31 than other quarters. These seasonal variations are caused by a number of factors, including seasonal cycles of illness, climate and weather conditions in our markets, vacation patterns of both patients and physicians and other factors relating to the timing of elective procedures.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

We are subject to market risk from exposure to changes in interest rates based on our financing, investing and cash management activities. At June 30, 2014, the following components of our Senior Secured Credit Facilities bear interest at variable rates at specified margins above either the agent bank’s alternate base rate or the LIBOR rate: (i) a $1.025 billion, seven-year term loan; and (ii) a $300.0 million, five-year revolving credit facility. As of June 30, 2014, we had outstanding variable rate debt of $992.0 million.

 

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We have managed our market exposure to changes in interest rates by implementing a comprehensive interest rate hedging strategy that includes converting variable rate debt to fixed rate debt. We have executed interest rate swaps with Citibank and Barclays, as counterparties, with notional amounts totaling $350.0 million, each agreement effective March 28, 2013, and expiring between September 30, 2014 and September 30, 2016, at rates ranging from 1.6% to 2.2%. Our interest rate hedging agreements expose us to credit risk in the event of non-performance by our counterparties, Citibank and Barclays. However, we do not anticipate non-performance by either of our counterparties.

Although changes in the alternate base rate or the LIBOR rate would affect the cost of funds borrowed in the future, we believe the effect, if any, of reasonably possible near-term changes in interest rates on our remaining variable rate debt or our consolidated financial position, results of operations or cash flows would not be material. Holding other variables constant, including levels of indebtedness, a 0.125% increase in current interest rates would have no estimated impact on pre-tax earnings and cash flows for the next twelve month period given that interest rates would not exceed the 1.25% LIBOR floor that exists in our Senior Secured Credit Facilities.

We currently believe we have adequate liquidity to fund operations during the near term through the generation of operating cash flows, cash on hand and access to our senior secured revolving credit facility. Our ability to borrow funds under our senior secured revolving credit facility is subject to the financial viability of the participating financial institutions. While we do not anticipate any of our current lenders defaulting on their obligations, we are unable to provide assurance that any particular lender will not default at a future date.

Item 4. Controls and Procedures

Evaluations of Disclosure Controls and Procedures

Under the supervision and with the participation of our management team, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended, as of June 30, 2014. Based on this evaluation, the principal executive officer and principal accounting officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic reports.

Changes in Internal Control Over Financial Reporting

During the period covered by this report, there has been no change in our internal control over financial reporting that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

In November 2010, the U.S. Department of Justice (“DOJ”) sent a letter to IAS requesting a 12-month tolling agreement in connection with an investigation into Medicare claims submitted by our hospitals in connection with the implantation of implantable cardioverter defibrillators (“ICDs”) during the period 2003 to the present. At that time, neither the precise number of procedures, number of claims, nor the hospitals involved were identified by the DOJ. We understand that the government is conducting a national initiative with respect to ICD procedures involving a number of healthcare providers and is seeking information in order to determine if ICD implantation procedures were performed in accordance with Medicare coverage requirements. On January 11, 2011, IAS entered into the tolling agreement with the DOJ and, subsequently, the DOJ provided us with a list of 194 procedures involving ICDs at 14 hospitals which are the subject of further medical necessity review by the DOJ. We are cooperating fully with the government and, to date, the DOJ has not asserted any claim against our hospitals. Applying the resolution model proposed by the DOJ, we believe that at least 131 of these procedure claims were properly documented for medical necessity and billed appropriately. Our outside counsel has submitted to the DOJ summary justifications and supporting evidence relating to the medical claims at six of our hospitals. We continue to provide support for the remaining 63 of these cases that could have some likelihood of enforcement by the DOJ. If we are unable to place these claims in a non-enforcement or lesser enforcement category, the government may require repayment, which could impose a multiplier. Given the case-specific nature of the claims and the DOJ’s discretion to compromise claims, we are unable at this time to estimate any potential repayment obligation related to this matter. The tolling agreement between IAS and the government, as recently extended, is currently set to expire December 31, 2014.

On September 25, 2013, we voluntarily self-disclosed for resolution through the Self-Referral Disclosure Protocol established by CMS non-compliance by ten of our affiliated hospitals with a certain element of an exception of the Stark Law. Provisions of the Affordable Care Act that became effective on September 23, 2011 require, as an element of the Stark Law’s “whole-hospital” exception, that hospitals having physician ownership disclose such ownership on their public websites and in public advertising. The self-disclosure states that, on

 

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August 12, 2013, we discovered that the ten of our affiliated hospitals partially owned by physicians did not consistently make such disclosures. The self-disclosure also states that, on August 13, 2013, the hospitals added the disclosures to those public websites that did not previously have them and began to include the disclosures in new public advertising. The self-disclosure explains that, as a result of the absence of the website and advertising disclosures, the referrals of direct and indirect physician owners (and physicians who are immediate family members of direct and indirect owners) to the physician-owned hospitals of Medicare beneficiaries did not consistently qualify for the Stark Law’s “whole-hospital” exception from September 23, 2011 through August 13, 2013. On October 21, 2013, we submitted a supplement to our self-disclosure, reporting Medicare payments to these hospitals for services resulting from referrals affected by the non-compliance and the hospitals’ profit distributions to physicians (and known immediate family members of physicians) with respect to their ownership interests in the hospitals during the same period. We have been in communication with CMS about resolving this matter but, at present, CMS has made no commitments, as a general matter or in this case, regarding the timing or substance of resolution of self-disclosed Stark Law noncompliance through the voluntary CMS Self-Referral Disclosure Protocol. As a result, we express no opinion as to its outcome other than to state that it could take up to one year or longer to resolve and, at this time, any repayment obligation or other penalties to be determined by CMS is unknown and not currently estimable.

Item 1A. Risk Factors

Reference is made to the factors set forth under the caption “Forward-Looking Statements” in Part I, Item 2 of this Form 10-Q and other risk factors described in our Annual Report on Form 10-K for the fiscal year ended September 30, 2013, which are incorporated herein by reference. There have not been any material changes to the risk factors previously disclosed in our Annual Report on Form 10-K for the fiscal year ended September 30, 2013.

Item 6. Exhibits

 

(a)	List of Exhibits:

Exhibits: See the Index to Exhibits at the end of this report, which is incorporated herein by reference.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

				IASIS HEALTHCARE LLC
Date: August 14, 2014				By:		/s/ John M. Doyle
						John M. Doyle
						Chief Financial Officer

 

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EXHIBIT INDEX

 

Exhibit No.		Description
31.1		Certification of Principal Executive Officer pursuant to Rule 15d-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of Principal Financial Officer pursuant to Rule 15d-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
101		The following financial information from our quarterly report on Form 10-Q for the quarter ended June 30, 2014, filed with the SEC on August 14, 2014, formatted in Extensible Business Reporting Language (XBRL): (i) the condensed consolidated balance sheets at June 30, 2014 and September 30, 2013, (ii) the condensed consolidated statements of operations for the quarters and nine months ended June 30, 2014 and 2013, (iii) the condensed consolidated statements of comprehensive income (loss) for the quarters and nine months ended June 30, 2014 and 2013, (iv) the condensed consolidated statement of equity, (v) the condensed consolidated statements of cash flows for the nine months ended June 30, 2014 and 2013, and (vi) the notes to the condensed consolidated financial statements (tagged as blocks of text). (1)

 

(1)

The XBRL related information in Exhibit 101 to this quarterly report on Form 10-Q shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to liability of that section and shall not be incorporated by reference into any filing or other document pursuant to the Securities Act of 1933, as amended, except as shall be expressly set forth by specific reference in such filing or document.

 

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