Financial Statements. Years Ended September 30, 2012 and 2011

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1 Financial Statements Years Ended September 30, 2012 and 2011 The report accompanying these financial statements was issued by BDO USA, LLP, a Delaware limited liability partnership and the U.S. member of BDO International Limited, a UK company limited by guarantee.

2 Financial Statements Years Ended September 30, 2012 and 2011

3 Contents Independent Auditors Report 3 Financial Statements Statements of Financial Position 5-6 Statements of Operations 7 Statements of Changes in Net Assets 8 Statements of Cash Flows

4

5 Financial Statements

6 Statements of Financial Position September 30, Assets Current assets Cash and cash equivalents $ 30,960,621 $ 18,354,730 Short-term investments 9,872,243 14,668,877 Assets limited as to use 11,766,358 11,837,294 Patient accounts receivable, less bad debt allowances of $5,997,410 and $5,598,285, respectively 38,074,467 31,614,665 Receivable from affiliate 1,142,140 1,207,799 Other receivables 3,218, ,743 Inventories 4,123,933 3,343,540 Prepaid expenses and other current assets 2,511,986 2,606,787 Quality assurance fee receivable 4,890,219 - California Hospital Foundation grant receivable 1,423,685 - Prepaid quality assurance fees - 4,710,252 Total current assets 107,984,600 88,989,687 Assets limited as to use, less current portion 4,907,825 4,604,978 Property, plant and equipment, net 133,216, ,751,595 Pledged lease 2,590,680 2,629,504 Deferred financing costs, net 7,326,344 7,876,733 Other assets 2,785,893 1,125,350 Total assets $ 258,811,680 $ 245,977,847 5

7 Statements of Financial Position September 30, Liabilities and Net Assets Current liabilities Current portion of long-term debt $ 3,010,000 $ 2,885,000 Current portion of obligations under capitalized leases 881, ,814 Accounts payable 9,075,562 11,075,696 Accrued payroll and benefits 13,770,582 12,436,128 Accrued expenses 1,157,301 1,032,128 Accrued interest 2,914,010 2,979,597 Quality assurance fee payable 6,313,904 - Deferred quality assurance fee income - 4,710,252 Total current liabilities 37,122,808 35,870,615 Long-term debt, less current portion 113,645, ,677,761 Obligations under capitalized leases, less current portion 10,087,818 10,969,267 Deferred contribution revenue 2,590,680 2,629,504 Accrued malpractice liability 4,878,000 3,748,000 Total liabilities 168,324, ,895,147 Commitments and contingencies Net assets Temporarily restricted 1,235,039 1,017,780 Unrestricted 89,252,136 75,064,920 Total net assets 90,487,175 76,082,700 Total liabilities and net assets $ 258,811,680 $ 245,977,847 See independent auditors report and accompanying notes to financial statements. 6

8 Statements of Operations Years Ended September 30, Unrestricted revenues Net patient service revenue $ 239,445,334 $ 215,235,795 Provision for bad debts (15,878,659) (8,657,369 ) Net patient service revenue less provision for bad debts 223,566, ,578,426 Nonpatient revenue 2,437,247 1,604,935 California Hospital Foundation grant revenue 5,839,609 3,581,075 Net assets released from restrictions used for operations 247, ,524 Total unrestricted revenues 232,090, ,119,960 Expenses Salaries and wages 77,013,341 74,047,434 Employee benefits 23,107,859 22,099,481 Registry 7,565,175 6,859,908 Supplies 31,852,455 29,857,027 Purchased services 20,167,715 21,631,227 Repairs and maintenance 4,461,957 3,069,624 Interest 7,508,943 7,558,821 Depreciation and amortization 15,545,729 13,843,213 Insurance, net 2,421,299 2,263,631 Facility costs 4,504,785 4,598,650 Quality assurance fee hospital tax 17,669,775 13,978,356 Other operating costs 12,239,526 10,211,639 Total expenses 224,058, ,019,011 Operating income 8,032,324 2,100,949 Other income (loss) Contributions 38,824 40,746 Interest income 428,103 41,133 Other nonoperating income, net 3, ,287 Electronic health records grant income 2,296,996 - Equity in income of Joint Venture 606, ,050 Excess of revenues over expenses 11,406,419 2,920,165 Net assets released from restrictions used for purchases of property, plant and equipment 2,780,797 1,887,292 Net increase in unrestricted net assets $ 14,187,216 $ 4,807,457 See independent auditors report and accompanying notes to financial statements. 7

9 Statements of Changes in Net Assets Years Ended September 30, Unrestricted net assets Excess of revenues over expenses $ 11,406,419 $ 2,920,165 Net assets released from restrictions used for purchases of property, plant and equipment 2,780,797 1,887,292 Net increase in unrestricted net assets 14,187,216 4,807,457 Temporarily restricted net assets Contributions 3,245,588 2,147,755 Net assets released from restrictions (3,028,329) (2,242,816 ) Net increase (decrease) in temporarily restricted net assets 217,259 (95,061 ) Increase in net assets 14,404,475 4,712,396 Net assets, beginning of year 76,082,700 71,370,304 Net assets, end of year $ 90,487,175 $ 76,082,700 See independent auditors report and accompanying notes to financial statements. 8

10 Statements of Cash Flows Years Ended September 30, Cash flows from operating activities Increase in net assets $ 14,404,475 $ 4,712,396 Adjustments to reconcile change in net assets to net cash provided by operating activities: Depreciation and amortization 15,545,729 13,843,213 Provision for bad debts 15,878,659 8,657,369 Amortization of deferred financing costs, net 527, ,602 Equity in income of Joint Venture (606,568 ) (578,050 ) Distribution from Joint Venture 535, ,000 Capitalization of interest - (162,714 ) (Gain) loss on disposal of fixed assets - (26,024 ) (Gain) loss on investments 170,490 (199,176 ) Changes in assets and liabilities: Patient accounts receivable (22,338,461 ) (8,060,574 ) Receivable from affiliate 65,659 (328,611 ) Other receivables (2,573,205 ) 386,069 Inventories (780,393 ) (134,541 ) Prepaid expenses and other current assets 94,801 (95,873 ) Prepaid quality assurance fees tax 4,710,252 (4,710,252 ) Quality assurance fee receivable (4,890,219 ) - California Hospital Foundation grant receivable (1,423,685 ) - Other assets (117,397 ) 113,531 Accounts payable (2,000,134 ) (2,052,056 ) Accrued payroll and benefits 1,334,454 1,771,045 Accrued expenses 125,173 (550,942 ) Accrued interest (65,587 ) (56,369 ) Deferred quality assurance fee income 1,603,652 4,710,252 Accrued malpractice liability (341,000 ) (61,000 ) Net cash provided by operating activities 19,859,522 18,157,295 Cash flows from investing activities Acquisition of property, plant and equipment (8,010,472 ) (22,726,624 ) Proceeds from sale of short-term investments 4,625,566 10,344,855 Advances to Joint Venture - (93,255 ) Decrease in assets limited as to use 17,633,376 23,512,281 Increase in assets limited as to use (17,865,287 ) (23,734,194 ) Net cash used in investing activities (3,616,817 ) (12,696,937 ) Cash flows from financing activities Payments on long-term debt (2,885,000 ) (2,770,000 ) Payments on capital lease obligations (751,814 ) (817,066 ) Net cash used in financing activities (3,636,814 ) (3,587,066 ) 9

11 Statements of Cash Flows (Continued) Years Ended September 30, Net increase in cash and cash equivalents 12,605,891 1,873,292 Cash and cash equivalents, beginning of year 18,354,730 16,481,438 Cash and cash equivalents, end of year $ 30,960,621 $ 18,354,730 Supplemental disclosure of cash flow information Cash paid for interest during the year $ 7,046,705 $ 7,238,302 Supplemental disclosure of non-cash transactions Pledged lease (See Note 12) $ (38,824 ) $ (38,246) Bond premium amortization (See Note 6) $ (22,563 ) $ (22,957) See independent auditors report and accompanying notes to financial statements. 10

12 1. Organization Henry Mayo Newhall Memorial Hospital (the Company or Hospital ) is a California not-for-profit public service benefit acute care hospital providing patient services to individuals in Santa Clarita, California. The Hospital is affiliated with Santa Clarita Health Care Association, Inc. and its affiliates through common management. Santa Clarita Health Care Association and one of its subsidiaries, Santa Clarita Health Care Management Group, Inc., had no activity during the years ended September 30, 2012 and In addition, the Hospital is also affiliated with Henry Mayo Newhall Memorial Health Foundation (the Foundation ). The Foundation shares some members of management with the Hospital, however, the Hospital has no control over the Foundation or any ongoing interests in the net assets of the Foundation. 2. Summary of Significant Accounting Policies Basis of Presentation The Company prepares its financial statements in accordance with the Financial Accounting Standards Board ( FASB ) Accounting Standards Codification ( ASC ) 954, Health Care Entities. The Company s accounting policies used in the preparation of the accompanying financial statements are in conformity with accounting principles generally accepted in the United States of America and have been consistently applied. Management s Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. The significant estimates made in the preparation of the Company s financial statements relate to the assessment of the carrying value of accounts receivable and bad debt allowances, accruals for malpractice liability and other similar risks, amounts payable or receivable under health insurance plans and amounts payable or receivable from the government. While management believes that these estimates are reasonable, actual results could be materially different from those estimates. Cash and Cash Equivalents Cash and cash equivalents include certain highly liquid investments with original maturities of three months or less when purchased, that are not held as collateral. Short-Term Investments Short-term investments are comprised of certificates of deposits ( CD s) with maturities of three months to one year, short-term bonds and commercial paper. Short-term bonds and commercial paper at September 30, 2012 and 2011 in the amounts of $9,872,243 and $12,164,222, respectively, are recorded at fair value. 11

13 Patient Accounts Receivable Patient accounts receivable are stated at the amounts billed to patients or third-party payors and others less contractual allowances. The carrying amount of patient accounts receivable is reduced by bad debt allowances that reflect management s best estimate of the amounts that will not be collected. Bad debt allowances are based on management s review of the historical collection experience of all balances. The Company provides for an allowance against patient accounts receivable for an amount that could become uncollectible, whereby such receivables are reduced to their estimated net realizable value. The Company estimates this allowance based on the aging of their accounts receivable, historical collection experience from the payors, and other relevant factors. There are various factors that can impact the collection trends, such as changes in the economy, which in turn have an impact on unemployment rates and the number of uninsured and underinsured patients, volume of patients through the emergency department, the increased burden of copayments to be made by patients with insurance and business practices related to collection efforts. These factors continuously change and can have an impact on collection trends and the Company s estimation process. These impacts may be material. The Company s policy is to attempt to collect amounts due from patients, including co-payments and deductibles due from patients with insurance, at the time of service while complying with all federal and state laws and regulations, including, but not limited to, the Emergency Medical Treatment and Labor Act ( EMTALA ). Certain classes of patient accounts receivable are charged off against allowances after a designated period of collection efforts. Subsequent cash recoveries are recognized as income in the period when they occur. The Company provides outpatient and emergency trauma services ( AB99 ) for Medi-Cal and other beneficiaries. The Hospital has been designated as a Private Trauma Hospital, as defined by the Centers for Medicare & Medicaid Services ( CMS ), in the County of Los Angeles, and receives supplemental reimbursements for such trauma services that it provides during its fiscal year. Based on agreements entered into and related reimbursements received to date, the Company determined that no reserves were necessary for its receivables relating to the California AB99 payor category totaling approximately $1,777,000 and $0 as of September 30, 2012 and 2011, respectively. There are various factors that can impact the supplemental reimbursements and the changes in these factors can have a material impact on future collection of these amounts. Inventories Inventories consist primarily of pharmaceuticals and medical supplies and are stated at the lower of cost, which is determined using the weighted-average method, or market. Assets Limited as to Use Assets limited as to use include assets set aside by trustees under indenture agreements. These investments, consisting primarily of U.S. federated treasury obligations, U.S. agency securities, and a guaranteed investment contract are stated at fair value. The guaranteed investment contract is stated at fair value, which approximates contract value. Assets limited as to use that are required for obligations classified as current liabilities are reported as current assets. 12

14 Investment income or loss (including realized gains and losses on investments, interest and dividends) is included in the excess of revenues over expenses. Unrealized gains and losses on investments are included in the excess of revenues over expenses unless the investments are trading securities. At September 30, 2012 and 2011, unrealized gains were approximately $15,000 and $62,000, respectively. Property, Plant and Equipment Property, plant and equipment are stated at cost. Depreciation is provided over the estimated useful life of each class of depreciable asset and is computed using the straight-line method. Equipment under capital lease obligations is amortized on the straight-line method over the shorter period of the lease term or the estimated useful life of the equipment. Such amortization is included in depreciation and amortization in the financial statements. The estimated useful lives of the related assets are as follows: Building and improvements Equipment and furniture 10 to 40 years 2 to 15 years Maintenance, repairs and investments in minor equipment are charged to operations. Expenditures which materially increase the value of properties or extend the useful lives are capitalized. Deferred Financing Costs Deferred financing costs are amortized using the effective interest method, over the terms of the related bonds or loans. Deferred financing costs, net, totaled $7,326,344 and $7,876,733 as of September 30, 2012 and 2011, respectively. Of these amounts, $2,833,011 and $3,085,393 relate to the issuance of the 2001 Bonds (see Note 6), which is amortized over the life of the bonds. $4,493,333 and $4,791,340 relate to the 2007 Bond Series A & B, as of September 30, 2012 and 2011, respectively, which are also amortized over the life of the bonds. Amortization expense of approximately $550,000 and $563,000 was recorded for the years ended September 30, 2012 and 2011, respectively. Amortization expenses is expected to be approximately $538,000, $524,000, $510,000, $495,000, $479,000 and $4,781,000 for the years ending September 30, 2013, 2014, 2015, 2016, 2017 and thereafter, respectively. Fair Value Measurements FASB ASC 820, Fair Value Measurements and Disclosures, ( ASC 820 ) provides a framework for measuring fair value and requires enhanced disclosures about fair value measurements. These guidelines clarify that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. ASC 820 requires disclosure about how fair value is determined for assets and liabilities and establishes a hierarchy for which these assets and liabilities must be grouped, based on significant levels of inputs as follows: Level 1 quoted prices in active markets for identical assets or liabilities; Level 2 quoted prices in active markets for similar assets and liabilities and inputs that are observable for the asset or liability; or Level 3 unobservable inputs for the asset or liability, 13

15 such as discounted cash flow models or valuations. The determination of where assets and liabilities fall within this hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The following is a description of the valuation methodologies used for instruments measured at fair value, including the general classification of such instruments pursuant to the valuation hierarchy: Level 1: These assets include the part of the Company s cash equivalents, short-term investments, and assets limited as to use which consist of money market mutual funds, U.S. federated treasury obligations, corporate bonds, commercial paper, and U.S. agency securities. Level 2: These assets include the part of the Company s assets limited as to use which consists of a guaranteed investment contract. The following table presents the financial instruments carried at fair value as of September 30, 2012 (as described above): Level 1 Level 2 Level 3 Total Short-term investments: Corporate bonds $ 9,872,243 $ - $ - $ 9,872,243 Assets limited as to use: U.S. federated treasury obligations 12,154, ,154,559 U.S. agency securities 1,464, ,464,124 Guaranteed investment contract - 3,055,500-3,055,500 Total assets at fair value $ 23,490,926 $ 3,055,500 $ - $ 26,546,426 The following table presents the financial instruments carried at fair value as of September 30, 2011 (as described above): Guaranteed Investment Contract Level 1 Level 2 Level 3 Total Short-term investments: Corporate bonds $ 12,164,222 $ - $ - $ 12,164,222 Assets limited as to use: U.S. federated treasury obligations 11,905, ,905,258 U.S. agency securities 1,481, ,481,514 Guaranteed investment contract - 3,055,500-3,055,500 Total assets at fair value $ 25,550,994 $ 3,055,500 $ - $ 28,606,494 The Hospital invests in a guaranteed investment contract with Transamerica Occidental Life Insurance Company ( TOL ). This has a guaranteed interest rate of 4.99% and is paid semiannually. 14

16 The Hospital may withdraw all or any portion of the principal balance to the extent permitted by delivery of two (2) business days prior written notice to TOL hereto specifying the portion of the principal balance to be withdrawn on the withdrawal date specified in such notice. Withdrawals may be made only for the purposes specified in the bond agreements, as defined (see Note 6). Such withdrawals shall be (a) necessary to avoid a payment default on the bonds, (b) in connection with a partial or complete refunding of the bonds, (c) in connection with a partial or complete defeasance of the bonds or (d) to preserve the tax-exempt status of the bonds. Withdrawals may not be made for reinvestment purposes. Furthermore, without TOL s prior written consent, amounts may not be withdrawn from the deposit fund in connection with the delivery of a letter of credit, surety bond or other security instrument in substitution for the cash held in the bond fund, whether or not permitted under the bond agreements. TOL shall not be obligated to permit (i) more than one (1) withdrawal per month hereunder pursuant to this Section, (ii) a withdrawal in an amount less than $1,000 or (iii) any withdrawal without first receiving written notice in accordance with the terms of the contract. Excess of Revenues over Expenses The statements of operations include excess of revenues over expenses. Changes in unrestricted net assets which are excluded from excess of revenues over expenses, consistent with industry practice, include unrealized gains and losses on investments other than trading securities, permanent transfers of assets to and from affiliates for other than goods and services, and contributions of long-lived assets (including assets acquired using contributions which by donor restriction are to be used for the purposes of acquiring such assets). Temporarily and Permanently Restricted Net Assets Temporarily restricted net assets are those whose use by the Hospital has been limited by donors to a specific time period or purpose. Permanently restricted net assets are those that must be maintained by the Hospital in perpetuity. At September 30, 2012 and 2011, the Hospital had $1,235,039 and $1,017,780 of temporarily restricted net assets, respectively. The Hospital did not have any permanently restricted net assets at September 30, 2012 and California Quality Assurance Fee Program The State of California enacted Assembly Bill 1383 ( AB 1383 ) effective January 1, 2010, as amended by Assembly Bill 1653 (collectively, the Program ), to provide one-time supplemental payments to certain medical facilities such as the hospitals owned and operated by the Company s subsidiaries that serve a disproportionate share of indigent and low-income patients. The Hospital paid $13,978,356 in fees which are reflected in total expenses in the statement of operations. The Hospital received $13,978,356 in supplemental payments related to the program for the year ended September 30, 2011, $10,397,281 of which is recorded as a reduction to contractual adjustments in net patient service revenue and $3,581,075 is recorded as Foundation grant revenue from the California Hospital Foundation & Trust ( CHFT ) in the statements of operations for the year ended September 30, On April 13, 2011, SB 90 provided a six-month extension of the Hospital Fee Program for dates of service from January 1, 2011 through June 30, The Hospital paid $4,710,252 in fees which are reflected in total expenses in the statements of operations. The Hospital received $4,771,404 15

17 in supplemental payments related to the program through September 30, 2012, $3,740,020 of which is recorded as a reduction to contractual adjustments in net patient service revenue and $1,031,384 is recorded as Foundation grant revenue from the CHFT in the statements of operations for the year ended September 30, These amounts were deferred at September 30, 2011 as CMS granted final approval of SB90 on December 29, In September 2011, the State of California enacted Senate Bill ( SB 335 ) which provides a 30- month extension of the Hospital Fee Program for date of service from July 1, 2011 through December 31, The elements related to the fee-for-service payments were approved by CMS on June 22, 2012 and final CMS approval for managed care payments is expected in Implementation of SB 335 was delayed to August 2012 as a result of pending legal advice obtained by the California Hospital Association, although certain technical changes to the legislation required by CMS are included in Senate Bill 920. Through September 30, 2012, the Hospital has recognized $12,959,523 in fees which are reflected in total expenses in the statements of operations. The Hospital has recognized $12,959,523 in supplemental payments to be received related to the program for the year ended September 30, 2012, $8,151,298 of which is recorded as a reduction to contractual adjustments in net patient service revenue and $4,808,225 is recorded as Foundation grant revenue from the CHA in the statements of operations for the year ended September 30, As of September 30, 2012, the Hospital has paid $6,313,904 in fees and received $3,261,079 in supplemental payments from the program and $3,384,540 in Foundation grant payments from the CHFT related to SB 335 with future programs fees of $6,645,619 in fees and $4,890,219 in supplemental payments and $1,423,685 in Foundation grants recorded as a current asset and current liability in the statements of financial position. Electronic Health Records Incentive Program The American Recovery and Reinvestment Act of 2009 ( ARRA ) established incentive payments under the Medicare and Medicaid programs for certain professionals and hospitals that meaningfully use certified electronic health record ( EHR ) technology or adopt or implement such technology. The Medicare incentive payments will be paid out to qualifying hospitals over four consecutive years on a transitional schedule. To qualify for Medicare incentives, hospitals and physicians must meet EHR meaningful use criteria that become more stringent over three stages that have yet to be finalized by CMS. The Medi-Cal programs require hospitals to register for the program prior to 2016, to engage in efforts to adopt, implement or upgrade certified EHR technology in order to qualify for the initial year of participation, and to demonstrate meaningful use of certified EHR technology in order to qualify for payment for up to three additional years. For the year ended September 30, 2012, the Hospital has recorded $2,296,996 related to the Medicare and Medi-Cal programs in other income in the statements of operations. These incentives have been recognized following the gain contingency model, whereby recognition of gain contingencies under ASC 450 are not allowed until there is satisfactory resolution of the uncertainty that realization has occurred. Net Patient Service Revenue The Hospital recognizes net patient service revenue in the period in which services are performed. The Hospital has agreements with third-party payors that provide for payments to the Hospital at amounts different from its established charges. Payment arrangements include prospectively 16

18 determined rates per discharge, reimbursed costs, discounted charges, and per diem payments. Net patient service revenue is reported at the estimated net realizable amounts from patients, third-party payors, and others for services rendered, including estimated retroactive adjustments under reimbursement agreements with third-party payors (including the Medicare and Medi-Cal programs). Retroactive adjustments are accrued on an estimated basis in the period the related services are rendered and adjusted in future periods as final settlements are determined. These retroactive adjustments may be material. Patient service revenue, net of contractual allowances and discounts (but before the provision for bad debts), recognized in the period from these major payor sources, are as follows: Years ended September 30, Medicare $ 70,461,253 $ 61,667,212 Medi-Cal 16,243,403 9,141,933 HMO/PPO 138,223, ,297,741 Self-Pay 13,814,618 10,523,885 Others 702, ,024 Charity Care $ 239,445,334 $ 215,235,795 The Hospital provides care without charge or at amounts less than its established rates to patients who meet certain criteria under its charity care policy. In fiscal 2011, the charity care policy was broadened and now includes criteria such as patients with a prior history of bad debt without payments, patients who have expired, homeless patients, incarcerated patients whose services were provided prior to arrest, and patients with a history of unemployment, or a history of ongoing major illness causing multiple hospitalizations. Other types of exceptions to the above categories require management approval on a specific case by case basis. Net patient service revenue is reflected net of the charity care reserves. Charity care reserves are based on gross revenue foregone. The actual costs for charity care in accordance with the Hospitals charity care policy aggregated approximately $7,606,000 and $11,673,000 for the years ended September 30, 2012 and 2011, respectively. Charity care reserves included in contractual discounts and the provision for bad debts each year are as follows: Years ended September 30, Provision of bad debt $ 15,878,659 $ 8,657,369 Charity care reserve 12,565,976 16,542,069 Total charity care and provision for bad debts $ 28,444,635 $ 25,199,438 17

19 Advertising Advertising costs are expensed as incurred. Advertising expense during the years ended September 30, 2012 and 2011 was approximately $850,000 and $735,000, respectively. Donated Services Volunteers perform various services. The services donated are not reflected in the accompanying financial statements as expense and income from donations, as these services do not meet the criteria for recognition. Interest Expense Interest expense, which includes amortization of deferred financing costs, during the years ended September 30, 2012 and 2011 was approximately $7,509,000 and $7,559,000, respectively. Total interest costs capitalized during the years ended September 30, 2012 and 2011 was approximately $0 and $163,000, respectively. Income Taxes The Hospital is a not-for-profit corporation and has been recognized as tax-exempt pursuant to Section 501 (c)(3) of the Internal Revenue Code ( IRC ). Under FASB ASC 740, Uncertainty in Income Taxes, interest and penalties, if any, are recorded to interest expense and other operating costs, respectively. There were no interest or penalties recorded for the years ended September 30, 2012 and The tax years subject to examination by major tax jurisdictions include the years 2008 and forward by the U.S. Internal Revenue Service ( IRS ). For California, the tax years subject to examination include the years 2007 and forward. Impairment of Long-Lived Assets The Company periodically reviews the carrying values of its long-lived assets for possible impairment. Whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable, the Company records an adjustment to reduce the related assets to their net realizable value. The Company believes that no material impairment of its long-lived assets exists at September 30, 2012 and 2011, respectively. Accrual for General and Professional Liability Risks The Company records reserves for claims when they are probable and reasonably estimable. The Company maintains reserves, which are based on actuarial estimates by an independent third party, for the portion of their professional liability risks, including incurred but not reported claims. The Company estimates reserves for losses and related expenses using expected lossreporting patterns. Reserves are not discounted. There can be no assurance that the ultimate liability will not exceed the Company s estimates. Adjustments to the estimated reserves are recorded in the Company s statements of operations in the periods when such amounts are determined. These adjustments may be material. 18

20 New Accounting Pronouncements In August 2010, the FASB issued ASU , Health Care Entities (Topic 954): Measuring Charity Care for Disclosures a consensus of the FASB Emerging Issues Task Force. The amendments in this ASU require that cost be used as the measurement basis for charity care disclosure purposes and that cost be identified as the direct and indirect costs of providing the charity care. The amendments in this ASU also require disclosure of the method used to identify or determine such costs. This ASU is effective for fiscal years beginning after December 15, 2010 and should be applied retrospectively to all prior periods presented. The Company adopted this amendment during the fiscal year ended September 30, 2012 with retrospective offset to the fiscal years ended September 30, 2011 and it did not have a material impact on the Company s financial position and results of operations. In August 2010, the FASB issued ASU , Health Care Entities (Topic 954): Presentation of Insurance Claims and Related Insurance Recoveries (a consensus of the FASB Emerging Issues Task Force). This ASU clarifies that a health care entity should not net insurance recoveries against a related claim liability. Additionally, the amount of the claim liability should be determined without consideration of insurance recoveries. This ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, A cumulative effect adjustment should be recognized in opening retained earnings in the period of adoption if a difference exists between any liabilities and insurance receivables recorded as a result of applying the amendments in this ASU. Retrospective application and early application are both permitted. The Company adopted this amendment during the fiscal year ended September 30, The Company recorded a receivable and corresponding liability in the amount of $1.4 million for the year ended September 30, 2012 but did not elect retrospective application for the year ended September 30, In July 2011, the FASB issued Accounting Standards Update ( ASU ) No , Health Care Entities (Topic 954): Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts for Certain Health Care Entities. The ASU represents a consensus of the EITF on Issue No. 09-H, Health Care Entities: Presentation and Disclosure of Net Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts. The amendments in this ASU require certain health care entities to change the presentation in their statements of operations by reclassifying the provision for bad debts associated with patient service revenue from an operating expense to a deduction from patient service revenue (net of contractual allowances and discounts). Additionally, those health care entities are required to provide enhanced disclosure about their policies for recognizing revenue and assessing bad debts. The amendments also require disclosures of patient service revenue (net of contractual allowances and discounts) as well as qualitative and quantitative information about changes in the allowance for doubtful accounts. The Hospital early adopted this amendment, as permitted, during the year ended September 30, During fiscal year 2012, the Company adopted FASB ASU No , Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, which amends ASC 820, Fair Value Measurement. This ASU requires the categorization by level for items that are required to be disclosed at fair value and information about transfers between Level 1 and Level 2 and additional disclosure for Level 3 measurements. In addition, the ASU provides guidance on measuring the fair value of financial instruments managed within a portfolio and the application of premiums and discounts on fair value measurements. The adoption did not have a material effect on the Company s financial statements. 19

21 Subsequent Events Management has evaluated events that have occurred subsequent to September 30, 2012 through December 21, 2012, the date on which the financial statements were available to be issued. 3. Net Patient Service Revenue Gross patient service revenue is recorded on the basis of the Company s usual and customary charges. The Company has agreements with third-party payors that provide for payments to the Company at amounts different from its established rates. The difference between charges generated from agreements with third-party payors and the related payment amounts are reflected as contractual discounts as shown below: Years ended September 30, Gross patient service revenue $ 1,178,429,918 $ 1,107,085,414 Contractual discounts (938,984,584 ) (891,849,619 ) Net patient service revenue $ 239,445,334 $ 215,235,795 A summary of the payment arrangements with major third party payors is as follows: Medicare Inpatient acute services rendered to Medicare program beneficiaries are paid at prospectively determined rates per discharge ( DRGs ). These rates vary according to a patient classification system that is based on clinical, diagnostic and other factors. Outpatient services related to Medicare beneficiaries are paid at prospectively determined rates according to Ambulatory Payment Classifications ( APCs ). Other payments, including disproportionate share and Medicare bad debt expense reimbursement, are based on the Hospital s cost reports, and are estimated using historical trends and current factors. The Hospital is reimbursed at a tentative rate, with final settlement determined after submission of annual cost reports and audits thereof by the Medicare fiscal intermediary. The Hospital s Medicare Cost reports have been final settled by the Medicare fiscal intermediary through September 30, 2007 and audited by the Medicare fiscal intermediary through September 30, The 2012 cost report has not been filed as of the date of the financial statements. Annual cost reports are generally due five months after the financial year end. Laws and regulations governing the Medicare program are complex and subject to interpretation. As a result, there is at least a reasonable possibility that recorded estimates could change by a material amount in the near term. Cost report settlement estimates are recorded based upon as-filed cost reports and are usually not adjusted until a final Notice of Program Reimbursement ( NPR ) is issued. Due to litigation in class action suits over the determination of the Supplemental Security Income ( SSI ) percentage which affects the disproportionate share reimbursement, the Centers for Medicare and Medicaid Services ( CMS ) suspended issuing any NPRs for 2007 cost reporting years and forward. On March 16, 2012, CMS began issuing updated SSI ratios for 2006 through 2009, and on October 17, 2012, 20

22 CMS issued updated SSI ratios for The issuance of final NPRs could result in changes to existing cost reporting estimates and these changes could be material to the Hospital. Accordingly the Company updated its estimates relating to open cost reporting of prior years using the revised SSI ratios and recorded a receivable, in aggregate, of approximately $1,020,000 during the year ended September 30, Additionally, the Company joined a second round of litigation relating to Medicare s recent settlement with providers relating to the manner in which CMS handled the budget neutrality adjustment associated with the rural floor wage index in setting the Medicare inpatient prospective system rates ( Rural Floor ). The Company has not yet recorded any settlement revenue relating to the Rural Floor litigation. The Hospital is currently undergoing an audit under the Recovery Audit Contractor ( RAC ) Program. The final results of this audit are not estimable at this time; however, the impact may be material to the financial statements. The Hospital recorded a reserve accrual of approximately $499,000 which is included, net of patient accounts receivable in the statements of financial position. HMO/PPO The Company also has entered into payment agreements with certain commercial insurance carriers, health maintenance organizations ( HMOs ), and preferred provider organizations ( PPOs ). The basis for payment to the Company under these agreements includes prospectively determined rates per discharge, discounts from established charges, and prospectively determined daily rates. Self-Pay and Other The Hospital offers managed care-style discounts to most uninsured patients, which enables the Hospital to offer lower rates to those patients who historically have been charged standard gross charges. Under this method, the discount offered to uninsured patients is recognized as a contractual allowance instead of provision for bad debts, which reduces net patient revenues at the time the uninsured patient accounts are recorded and reduces provision for bad debts. The uninsured patient accounts, net of contractual allowances recorded, are further reduced to their net realizable value through provision for bad debts or as charity care based on historical collection trends and other factors that affect the estimation process. For the years ended September 30, 2012 and 2011, provision for bad debts were approximately $15,879,000 and $8,657,000, respectively. See Charity Care under Note 2 for further information. The other payor category is comprised primarily of indemnity, workers compensation, and other commercial payors. Payment usually occurs on a negotiated settlement basis at some discount to the Hospital s gross charges. Medi-Cal Inpatient services rendered to Medi-Cal program beneficiaries are reimbursed at a negotiated per diem rate. Outpatient services are reimbursed based upon fee schedules. For the years ended September 30, 2012 and 2011, the State of California s Enhanced Medi-Cal Trauma program (AB 99) provided approximately $0 and $2,727,000, respectively, in additional receipts for this class of net patient service revenues. 21

23 4. Assets Limited as to Use The composition of assets limited as to use at September 30, 2012 and 2011, is set forth in the following table. Investments are stated at fair value (see Note 2) Under indenture agreement, held by trustees: U.S. federated treasury obligations $ 12,154,559 $ 11,905,258 U.S. agency securities 1,464,124 1,481,514 Guaranteed insurance contract 3,055,500 3,055,500 Total assets limited as to use 16,674,183 16,442,272 Less current portion 11,766,358 11,837,294 Noncurrent portion $ 4,907,825 $ 4,604, Property, Plant and Equipment A summary of property, plant and equipment at September 30, 2012 and 2011, is as follows: Building and improvements $ 155,551,359 $ 146,409,149 Equipment and furniture 89,876,497 83,250,110 Building, improvements and equipment under capital leases 13,379,607 13,379, ,807, ,038,866 Less accumulated depreciation and amortization (134,596,861 ) (119,142,803 ) 124,210, ,896,063 Construction-in-progress 6,892,303 14,742,099 Land 2,113,433 2,113,433 Property, plant and equipment, net $ 133,216,338 $ 140,751,595 Depreciation expense for the years ended September 30, 2012 and 2011 amounted to approximately $15,546,000 and $13,843,000, respectively. At September 30, 2012 and 2011, assets held under capital lease obligations, amounted to $13,379,607 for both years, and related accumulated depreciation amounted to $9,948,107 and $9,481,222, respectively. 6. Long-Term Debt 2001 Series A Hospital Refunding Revenue Bonds On February 1, 2001, California Statewide Communities Development Authority issued $54,895,000 of 2001 Series A Hospital Refunding Revenue Bonds (the 2001 Bonds ). The 2001 Bonds are

24 insured by the State of California and secured by a deed of trust on substantially all of the Hospital's property. The Hospital is allowed to secure up to $7,000,000 of operating financing with a senior lien. Accordingly, the Hospital obtained the loan financing which was subsequently paid off. The proceeds of the 2001 Bonds were used to pay off the 1988 bonds, construction liens from the costs of repairing the facility from the January 1994 Northridge earthquake, and to provide working capital. The bond regulation agreement, as amended, also requires the Hospital and its related affiliate, the Foundation, to maintain certain financial covenants including a maximum annual debt service coverage ratio of 1.25 times, a current ratio of at least 2.0 times, and days cash on hand of 30 days and other reporting requirements. The bond agreement also contains certain restrictions on other borrowings and spending of the Hospital and its related affiliates. The Hospital was in compliance with the covenants as of September 30, The 2001 Bonds bear interest at annual rates ranging from 4.0% to 5.125%, payable semi-annually. A principal payment was made in the amount of $1,375,000 in fiscal year Beginning 2012, the Hospital must establish a sinking fund, which is held by the trustee of the bonds, that requires annual payments ranging from $1,375,000 in that year to $3,345,000 in The sinking fund will provide for two principal installments of $13,125,000 on October 1, 2018, and $32,525,000 on October 1, At September 30, 2012 and 2011, the carrying values of the 2001 Bonds were as follows: September 30, Current $ 1,440,000 $ 1,375,000 Noncurrent 42,835,000 44,275,000 Maturities of the 2001 Bonds subsequent to September 30, 2012, are as follows: Years ending September 30, 23 Principal 2013 $ 1,440, ,515, ,590, ,670, ,755, and thereafter 36,305,000 Insured Revenue Bonds Series 2007A & 2007B $ 44,275,000 $ 45,650,000 $ 44,275,000 On August 1, 2007, California Statewide Communities Development Authority issued $45,000,000 of Insured Revenue Bonds Series 2007A (the 2007 Bonds Series A ), and $30,000,000 of Insured Revenue Bonds Series 2007B (the 2007 Bonds Series B ), (collectively, the 2007 Bonds ). The proceeds of the 2007 Bonds are to be used to finance and refinance acquisition, construction, improvement and equipping of healthcare facilities owned and operated by the Hospital, fund a bond reserve account and finance the costs of issuance of the bonds. The 2007 Bonds are insured

25 by the Office of Statewide Health Planning and Development ( OSHPD ) of the State of California pursuant to the California Health Facility Construction Loan Insurance Law. The 2007 Bonds Series B are further insured by Ambac Assurance Corporation. If monies are not available to pay the principal or interest on the 2007 Bonds Series B and the insurance from the OSHPD is not in full force and effect, or the OSHPD is in default of the payment, the trustee will take such steps as are necessary to collect upon the payments. The obligations of the 2007 Bonds are on parity with the obligations with respect to the 2001 Bonds. The bond regulation agreement also requires the Hospital and its related affiliate, the Foundation, to maintain certain financial covenants including a maximum annual debt service coverage ratio of 1.25 times, a current ratio of at least 2.0 times, and to maintain at the end of each year at least 30 days cash on hand and other reporting requirements. The bond agreement also contains certain restrictions on other borrowings and spending of the Hospital and its related affiliates as of September 30, The Hospital was in compliance with the covenants listed at September 30, The 2007 Bond Series B were originally issued as variable rate bonds subject to change at each auction period. These bonds however have a built in conversion feature, whereby they could be converted to fixed rate bonds at the option of the Company, which the Company converted during fiscal year The 2007 Bonds Series A bear interest, at annual rates ranging from 4.25% to 5.00%, payable semiannually. Principal payments are due annually in amounts ranging from $775,000 starting in fiscal year 2011 to $1,070,000 in Beginning 2019, the Company must establish a sinking fund, which is held by the trustee of the bonds, that requires annual payments ranging from $1,125,000 in that year to $1,245,000 in Beginning in 2022, the Company must establish a sinking fund that requires annual payments ranging from $1,305,000 in that year to $1,765,000 in Finally, beginning in 2029, the Company must establish a sinking fund that requires annual payments ranging from $1,855,000 in that year to $2,910,000 in 2038, the final year of maturity. The 2007 Bonds Series A are secured by present and future gross revenues of the Hospital, as defined. At September 30, 2012 and 2011, the carrying values of the 2007 Bonds Series A were as follows: September 30, Current $ 845,000 $ 810,000 Noncurrent 42,570,000 43,415,000 Original Issue Premium, net 340, ,761 Net $ 43,755,199 $ 44,587,761 24

26 Maturities of the 2007 Bonds Series A subsequent to September 30, 2012, are as follows: Years ending September 30, Principal 2013 $ 845, , , , ,020, and thereafter 38,775,000 The 2007 Bonds Series B bear interest, at annual rates ranging from 4.00% to 5.20%, payable semiannually. In fiscal year 2011, the Company established a sinking fund, which is held by the trustee of the bonds, that requires annual payments ranging from $675,000 in that year to $775,000 in fiscal year Beginning in 2016, the Company must establish a sinking fund that requires annual payments ranging from $800,000 in that year to $875,000 in Beginning in 2020, the Company must establish a sinking fund that requires annual payments ranging from $900,000 in that year to $1,200,000 in Finally, beginning in 2030, the Company must establish a sinking fund that requires annual payments ranging from $1,225,000 in that year to $1,575,000 in 2038, the final year of maturity. The 2007 Bonds Series B are secured by present and future gross revenues of the Hospital, as defined. At September 30, 2012 and 2011, the carrying values of the 2007 Bonds Series B were as follows: Maturities of the 2007 Bonds Series B subsequent to September 30, 2012, are as follows: $ 43,415,000 September 30, Current $ 725,000 $ 700,000 Noncurrent 27,900,000 28,625,000 $ 28,625,000 $ 29,325,000 Years ending September 30, Principal 2013 $ 725, , , , , and thereafter 24,750,000 $ 28,625,000 25

27 7. Pension Plan The Hospital maintains a deferred compensation annuity plan (defined as an IRC Section 403(b) plan), which covers employees who elect to participate. The Hospital provides matching contributions equal to 5% of participants eligible annual compensation up to the amount allowed by the Internal Revenue Service for the calendar year. Employer matching contributions are funded annually based on the calendar year. For the years ended September 30, 2012 and 2011, the Company s matching contributions were approximately $1,732,000 and $1,675,000, respectively. 8. Receivable from Affiliate ASC Transfers of Assets to a Not-For-Profit Organization or Charitable Remainder Trust That Raises or Holds Contributions for Others requires organizations similar to the Hospital and the Foundation to record on the designated organization as a temporarily restricted asset, those funds raised by the Foundation for the benefit of the Hospital. The amounts raised on behalf of the Hospital by the Foundation or due from the Foundation are recorded as a receivable from affiliate as follows: September 30, Program receivables $ 1,128,533 $ 1,017,780 Other receivables, net 13, , Related Party Transactions $ 1,142,140 $ 1,207,799 The Foundation received contributions of approximately $2,545,000 and $1,815,000 for the benefit of Hospital programs such as the ICU and NICU for the years ended September 30, 2012 and 2011, respectively (see Note 10). At September 30, 2012 and 2011, the Hospital had a net receivable from the Foundation in the amount of $1,142,140 and $1,207,799, respectively (see Note 8). During the years ended September 30, 2012 and 2011, funds in the amount of approximately $2,434,000 and $1,677,000, respectively, were received from the Foundation and spent by the hospital on these programs. Hospital contributed $665,000 and $0 to the Foundation for general operations the fiscal year ended September 30, 2012 and 2011, respectively. 10. Temporarily Restricted Net Assets Funds received from the Foundation for the benefit of Hospital programs such as the ICU, NICU and Emergency Room are recorded as temporarily restricted contributions. For the years ended September 30, 2012 and 2011, approximately $304,000 and $334,000 in grant monies had been received, and approximately $594,000 and $649,000 had been incurred in accordance with the Bioterrorism grant program, respectively. Various compliance requirements exist surrounding the grants received from the county of Los Angeles. Noncompliance with certain of these requirements may result in repayment of the monies received to the county. 26