POLK MEDICAL CENTER, INC. ROME, GEORGIA FINANCIAL STATEMENTS. for the years ended June 30, 2016 and 2015

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1 ROME, GEORGIA FINANCIAL STATEMENTS for the years ended

2 C O N T E N T S Pages Independent Auditor s Report 1-2 Financial Statements: Balance Sheets 3-4 Statements of Operations and Changes in Net Assets 5 Statements of Cash Flows 6-7 Notes to Financial Statements 8-27

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5 BALANCE SHEETS, ASSETS Current assets: Cash and cash equivalents $ 14,534,150 $ 2,701,293 Assets limited as to use, current 392,184 - Patient accounts receivable, net of estimated uncollectibles of approximately $14,800,000 in 2016 and $13,300,000 in ,908,303 5,036,428 Supplies 260, ,422 Other current assets 620, ,108 Total current assets 21,715,787 8,381,251 Assets limited as to use: Under indenture agreement held by trustee 392,184 - Less amount required to meet current obligations 392,184 - Noncurrent assets limited as to use - - Property, plant and equipment, net 33,082,014 38,068,266 Unamortized bond issue costs 364,371 - Total assets $ 55,162,172 $ 46,449,517 3

6 LIABILITIES AND NET ASSETS Current liabilities: Current portion of long-term debt $ 56,465 $ - Accounts payable 1,005, ,290 Accrued salary 116,822 62,697 Accrued benefits 680, ,463 Other accrued expenses 274,580 - Estimated third-party payor settlements 3,721, ,871 Due to Floyd Healthcare Management, Inc. 1,457,176 5,601,627 Total current liabilities 7,313,249 7,654,948 Long-term debt, net of current portion 37,780,792 34,173,156 Total liabilities 45,094,041 41,828,104 Net assets - unrestricted 10,068,131 4,621,413 Total liabilities and net assets $ 55,162,172 $ 46,449,517 See auditor s report and notes to financial statements. 4

7 STATEMENTS OF OPERATIONS AND CHANGES IN NET ASSETS for the years ended Unrestricted revenues, gains and other support: Patient service revenue (net of contractual allowances and discounts) $ 39,787,516 $ 24,972,298 Provision for bad debts (12,645,020) ( 7,340,132) Net patient service revenue 27,142,496 17,632,166 Other operating revenue 574,616 - Total revenue, gains, and other support 27,717,112 17,632,166 Expenses: Operating expenses 17,935,869 10,230,437 Interest expense 890, ,095 Depreciation and amortization 3,449,527 3,467,488 Total expenses 22,276,017 14,029,020 Operating income 5,441,095 3,603,146 Nonoperating income: Investment income 5,623 32,530 Gain on acquisition of Polk Medical Center - 1,044,237 Total nonoperating income 5,623 1,076,767 Excess revenues 5,446,718 4,679,913 Net assets unrestricted, beginning of year 4,621,413 ( 58,500) Net assets unrestricted, end of year $ 10,068,131 $ 4,621,413 See auditor s report and notes to financial statements. 5

8 STATEMENTS OF CASH FLOWS for the years ended Cash flows from operating activities: Changes in net assets $ 5,446,718 $ 4,679,913 Adjustments to reconcile change in net assets to net cash provided by operating activities: Gain on acquisition of Polk Medical Center - ( 1,044,237) Depreciation and amortization 3,449,527 3,467,488 Provision for bad debts 12,645,020 7,340,132 Changes in: Patient accounts receivable (13,516,895) ( 9,690,440) Supplies ( 49,007) ( 78,733) Other current assets ( 188,613) 1,604,880 Accounts payable and accrued expenses 892,297 1,183,700 Due to Floyd Healthcare Management, Inc. 636, ,253 Estimated third-party payor settlements 2,853,990 - Net cash provided by operating activities 12,169,596 7,602,956 Cash flows from investing activities: Purchase of property and equipment ( 192,950) (18,784,221) Cash proceeds from acquisition of Polk Medical Center - 1,268,930 Purchase of investments ( 392,184) - Net cash used by investing activities ( 585,134) (17,515,291) Cash flows from financing activities: Proceeds of long-term debt 34,834,415 12,613,628 Payments on long-term debt (34,216,949) - Payment for issuance of long-term debt ( 369,071) - Net cash provided by financing activities 248,395 12,613,628 Net increase in cash and cash equivalents 11,832,857 2,701,293 Cash and cash equivalents, beginning of year 2,701,293 - Cash and cash equivalents, end of year $ 14,534,150 $ 2,701,293 6

9 STATEMENTS OF CASH FLOWS, for the years ended Supplemental disclosures of cash flow information: Pursuant to the Lease Agreement described in Note 1, in 2015 the Cedartown-Polk Authority transferred all net assets of Polk Medical Center to PMCI. See the table below for non-cash assets and liabilities transferred under the lease agreement: Net accounts receivable $ 2,686,120 Supplies 132,689 Other current assets 914,328 Estimated settlements ( 867,871) Net fixed assets 41,484,136 Due to Floyd Healthcare Management, Inc. ( 4,216,719) Total net non-cash items received $ 40,132,683 Net fixed assets given up as consideration $ 40,357,376 As described in Note 14, PMCI transferred ownership of the Medical Office Building to Floyd Healthcare Management, Inc. during The net book value of the Medical Office Building transferred was approximately $4,781,000. During 2016, PMCI entered into a capital lease with Floyd Healthcare Management, Inc. to lease space in the Medical Office Building as described in Note 7. The non-cash capital asset additions related to the capital lease was $3,072, Cash paid for interest, net of capitalized interest $ 616,000 $ 331,000 See auditor s report and notes to financial statements. 7

10 NOTES TO FINANCIAL STATEMENTS 1. Summary of Significant Accounting Policies Organization Polk Medical Center, Inc. (PMCI) is a Georgia not-for-profit Corporation. On April 1, 2012, The Hospital Authority of Floyd County (Authority) entered into a lease agreement with Cedartown-Polk County Hospital Authority (Cedartown-Polk Authority) to lease all of the assets associated with Polk Medical Center, a Critical Access Hospital providing inpatient and outpatient services. PMCI was created to manage the day to day operations of Polk Medical Center for the Authority through a management agreement. Floyd Healthcare Management, Inc. (Corporation) is the sole member of PMCI. Pursuant to the lease, PMCI applied for and was granted a Certificate of Need to build a new hospital to be owned by the Cedartown-Polk Authority to replace the current facilities at Polk Medical Center at no cost to the Cedartown-Polk Authority. Upon completion of the new hospital in November 2014, the lease between the Authority and Cedartown-Polk Authority ended and a new lease agreement was created between PMCI and the Cedartown-Polk Authority. This lease had a 35 year term and an effective date of November 6, 2014, at which time the assets and operations of Polk Medical Center were transferred to PMCI. Use of 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 disclosure of contingent assets and liabilities at the date of the financial statements. Estimates also affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents Cash and cash equivalents include investments in highly liquid debt instruments with an original maturity of three months or less. 8

11 NOTES TO FINANCIAL STATEMENTS, 1. Summary of Significant Accounting Policies, Allowance for Doubtful Accounts Accounts receivable are reduced by an allowance for doubtful accounts. In evaluating the collectability of accounts receivable, PMCI analyzes its past history and identifies trends for each of its major payor sources of revenue to estimate the appropriate allowance for doubtful accounts and provision for bad debts. Management regularly reviews data about these major payor sources of revenue in evaluating the sufficiency of the allowance for doubtful accounts. For receivables associated with services provided to patients who have third-party coverage, PMCI analyzes contractually due amounts, service dates, and service type and provides an allowance for doubtful accounts and a provision for bad debts, if necessary, based on the anticipated reimbursement. Management also reviews subsequent collection activity to assess the accuracy of the allowance estimated. For receivables associated with self-pay patients (which includes both patients without insurance and patients with deductible and copayment balances due for which third-party coverage exists for part of the bill), PMCI records a significant provision for bad debts in the period of service on the basis of prior payments, service date, service type, and its past experience, which indicates that many patients are unable or unwilling to pay the portion of their bill for which they are financially responsible. The difference between the standard rates and the amounts actually collected after all reasonable collection efforts have been exhausted is charged off against the allowance for doubtful accounts. PMCI s allowance for doubtful accounts for self-pay patients was 93% and 96% of self-pay accounts receivable at, respectively. In addition, PMCI s self-pay write offs, including write offs for charity and indigent patients, increased approximately $8,000,000 from $10,000,000 for fiscal year 2015 to $18,000,000 for fiscal year The increase in write offs was mostly attributed to an overall increase in the volume of patient services, along with 2016 including a full year of patient services. PMCI updated its charity care and uninsured discount policies during 2016 as discussed in Note 2. Supplies Supplies are stated at the lower of cost or market value, using the first-in, first-out method. 9

12 NOTES TO FINANCIAL STATEMENTS, 1. Summary of Significant Accounting Policies, Assets Limited As To Use Assets limited as to use include assets held by trustees under indenture agreements. Amounts required to meet current liabilities of PMCI have been reclassified in the balance sheet at. Property and Equipment PMCI s capital assets are reported at historical cost. Contributed capital assets are reported at their estimated fair value at the time of their donation. Depreciation is provided over the estimated useful life of each depreciable asset and is computed using the straight-line method. The estimated useful life is assigned using AHA Useful Lives Guidelines listed below. Land improvements Buildings and improvements Equipment 15 to 20 years 20 to 40 years 3 to 7 years Impairment of Long-Lived Assets PMCI evaluates on an ongoing basis the recoverability of its assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An impairment loss is required to be recognized if the carrying value of the asset exceeds the undiscounted future net cash flows associated with that asset. The impairment loss to be recognized is the amount by which the carrying value of the long-lived asset exceeds the asset s fair value. In most instances, the fair value is determined by discounted estimated future cash flows using an appropriate interest rate. PMCI has not recorded any impairment charges in the accompanying statements of operations and changes in net assets for the years ended. Costs of Borrowing Interest cost incurred on borrowed funds during the period of construction of capital assets is capitalized as a component of the cost of acquiring those assets. 10

13 NOTES TO FINANCIAL STATEMENTS, 1. Summary of Significant Accounting Policies, Deferred Financing Cost Costs related to the issuance of the 2016 Revenue Certificates were deferred and are being amortized using the effective interest method over the life of the related debt. Net Patient Service Revenue PMCI has agreements with third-party payors that provide for payments to PMCI at amounts different from its established rates. Payment arrangements include prospectively 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 arrangements with third-party payors. Retroactive adjustments are accrued on an estimated basis in the period the related services are rendered and adjusted in future periods as final settlements are determined. Charity Care PMCI provides care to patients who meet certain criteria under its charity care policy without charge or at amounts less than its established rates. Because PMCI does not pursue collection of amounts determined to qualify as charity care, they are not reported as revenues. Excess Revenues The statement of operations and changes in net assets includes excess revenues as a performance indicator. Changes in unrestricted net assets which are excluded from the performance indicator, consistent with industry practice, include permanent transfers of assets to and from affiliates for other than goods and services, and contributions of long-lived assets (including assets acquired using contributions which by donor restriction were to be used for the purpose of acquiring such assets). Risk Management PMCI is exposed to various risks of loss from torts; theft of, damage to, and destruction of assets; business interruption; errors and omissions; employee injuries and illnesses and natural disasters. PMCI has purchased insurance to mitigate the risk of loss for these types of damages. See Notes 8 and 9 for more information. 11

14 NOTES TO FINANCIAL STATEMENTS, 1. Summary of Significant Accounting Policies, Income Taxes PMCI is a not-for-profit corporation that has been recognized as tax-exempt pursuant to Section 501(c)(3) of the Internal Revenue Code. PMCI applies accounting policies that prescribe when to recognize and how to measure the financial statement effects of income tax positions taken or expected to be taken on its income tax returns. These rules require management to evaluate the likelihood that, upon examination by the relevant taxing jurisdictions, those income tax positions would be sustained. Based on that evaluation, PMCI only recognizes the maximum benefit of each income tax position that is more than 50% likely of being sustained. To the extent that all or a portion of the benefits of an income tax position are not recognized, a liability would be recognized for the unrecognized benefits, along with any interest and penalties that would result from disallowance of the position. Should any such penalties and interest be incurred, they would be recognized as operating expenses. Based on the results of management s evaluation, no liability is recognized in the accompanying balance sheet for unrecognized income tax positions. Further, no interest or penalties have been accrued or charged to expense as of or for the years then ended. PMCI s tax returns are subject to possible examination by the taxing authorities. For federal income tax purposes, the tax returns essentially remain open for possible examination for a period of three years after the respective filing deadlines of those returns. Subsequent Event In preparing these financial statements, PMCI has evaluated events and transactions for potential recognition or disclosure through October 24, 2016, the date the financial statements were available to be issued. 2. Net Patient Service Revenue PMCI has arrangements with third-party payors that provide for payments to PMCI at amounts different from its established rates. PMCI does not believe that there are any significant credit risks associated with receivables due from third-party payors. 12

15 NOTES TO FINANCIAL STATEMENTS, 2. Net Patient Service Revenue, PMCI recognizes patient service revenue associated with services provided to patients who have third-party coverage on the basis of anticipated collections and dates of service for services rendered. For uninsured patients that do not qualify for charity care, PMCI recognizes revenue on the basis of its standard rates for services provided (or on the basis of discounted rates, if negotiated or provided by policy). On the basis of historical experience, a significant portion of PMCI s uninsured patients will be unable or unwilling to pay for the services provided. Thus, PMCI records a significant provision for bad debts related to uninsured patients in the period the services are provided. Patient service revenue, net of contractual allowances and discounts (but before the provision for bad debts), from these major payor sources as of June 30, is as follows: Patient Service Revenue (Net of Contractual Allowances and Discounts) Medicare $ 13,008,732 $ 8,082,091 Medicaid 3,945,517 2,776,847 Third-party payors 9,999,181 6,676,723 Self-pay 12,834,086 7,436,637 Net patient service revenue before provision for bad debts 39,787,516 24,972,298 Less provision for bad debts (12,645,020) ( 7,340,132) Net patient service revenue $ 27,142,496 $ 17,632,166 Revenue from Medicare and Medicaid programs accounted for approximately 48% and 15%, respectively, of PMCI s net patient revenue for the year ended 2016 and 46% and 16%, respectively of PMCI s net patient revenue for the year ended Laws and regulations governing the Medicare and Medicaid programs are extremely complex and subject to interpretation. As a result, there is at least a reasonable possibility that recorded estimates will change by a material amount in the near future. 13

16 NOTES TO FINANCIAL STATEMENTS, 2. Net Patient Service Revenue, PMCI believes that it is in compliance with all applicable laws and regulations and is not aware of any pending or threatened investigations involving allegations of potential wrongdoing. However, there has been an increase in regulatory initiatives at the state and federal levels including the initiation of the Recovery Audit Contractor (RAC) program and Medicaid Integrity Contractor (MIC) program. These programs were created to review Medicare and Medicaid claims for medical necessity and coding appropriateness. The RAC s have authority to pursue improper payments with a three year look back from the date the claim was paid. Compliance with such laws and regulations can be subject to future government review and interpretation as well as significant regulatory action including fines, penalties and exclusion from the Medicare and Medicaid programs. A summary of the payment arrangements with major third-party payors follows: Medicare Polk Medical Center was granted Critical Access Hospital (CAH) designation by the Medicare program. The CAH designation places certain restrictions on daily acute care inpatient census and an annual, average length of stay of acute care inpatients. Inpatient acute care and outpatient services rendered to Medicare program beneficiaries are paid based on a cost reimbursement methodology. PMCI is reimbursed for certain reimbursable items at a tentative rate with final settlement determined after submission of annual cost reports by PMCI and audits thereof by the Medicare Administrative Contractor (MAC). PMCI s classification of patients under the Medicare program and the appropriateness of their admission are subject to an independent review by a peer review organization under contract with PMCI. PMCI s Medicare cost reports have been audited by the MAC through June 30, Medicaid Inpatient acute care services rendered to Medicaid program beneficiaries are paid at a prospectively determined rate per admission. These rates vary according to a patient classification system that is based on clinical, diagnostic and other factors. Outpatient services rendered to Medicaid program beneficiaries are reimbursed under a cost reimbursement methodology. 14

17 NOTES TO FINANCIAL STATEMENTS, 2. Net Patient Service Revenue, Medicaid, PMCI is reimbursed at a tentative rate with final settlement determined after submission of annual cost reports by PMCI and audits thereof by the Medicaid fiscal intermediary. PMCI s Medicaid cost reports have been audited by the Medicaid fiscal intermediary through June 30, PMCI has also entered into contracts with certain managed care organizations to receive reimbursement for providing services to selected enrolled Medicaid beneficiaries. Payment arrangements with these managed care organizations consist primarily of prospectively determined rates per discharge, discounts from established charges, or prospectively determined per diems. PMCI participates in the Georgia Indigent Care Trust Fund (ICTF) Program. PMCI receives ICTF payments for treating a disproportionate number of Medicaid and other indigent patients. ICTF payments are based on PMCI s estimated uncompensated cost of services to Medicaid and uninsured patients. The amount of ICTF payments recognized in net patient service revenue was approximately $1,200,000 and $1,150,000 for the years ended, respectively. The Medicare, Medicaid and SCHIP Benefits Improvement and Protection Act of 2000 (BIPA) provides for payment adjustments to certain facilities based on the Medicaid Upper Payment Limit (UPL). The UPL payment adjustments are based on a measure of the difference between Medicaid payments and the amount that could be paid based on Medicare payment principles. The net amount of UPL payment adjustments recognized in net patient service revenue was approximately $143,000 and $19,000 for the years ended, respectively. 15

18 NOTES TO FINANCIAL STATEMENTS, 2. Net Patient Service Revenue, Other Arrangements PMCI has also entered into payment arrangements with certain commercial insurance carriers, health maintenance organizations, and preferred provider organizations. The basis for payment to PMCI under these arrangements includes prospectively determined rates per discharge, discounts from established charges, and prospectively determined daily rates. Uninsured Patients In June 2016, PMCI updated its Financial Assistance Policy (FAP) in accordance with Internal Revenue Code Section 501(r). Based on the FAP, following a determination of financial assistance eligibility, an individual will not be charged more than the Amounts Generally Billed (AGB) for emergency or other medical care provided to individuals with insurance covering that care. AGB is calculated by reviewing claims that have been paid in full (including deductibles and coinsurance paid by the patient) to PMCI for medically necessary care by Medicare and private health insurers during a 12-month look-back period. 3. Uncompensated Charges PMCI was compensated for services at amounts less than its established rates. Charges foregone related to contractual agreements and provision for bad debts for 2016 and 2015 were approximately $73,300,000 and $38,100,000, respectively. Uncompensated charges include charity and indigent care services of approximately $4,700,000 and $2,700,000 in 2016 and 2015, respectively. Charity and indigent care services provided to Polk County residents in 2016 and 2015 were approximately $3,900,000 and $2,300,000, respectively. The cost of charity and indigent care services provided during 2016 and 2015 was approximately $1,000,000 and $700,000, respectively computed by applying a total cost factor to the charges foregone. 16

19 3. Uncompensated Charges, POLK MEDICAL CENTER, INC. NOTES TO FINANCIAL STATEMENTS, The following is a summary of uncompensated charges and a reconciliation of gross patient charges to net patient service revenue for 2016 and 2015: Gross patient charges $ 100,489,193 $ 55,775,468 Uncompensated charges: Charity and indigent care 4,656,285 2,693,865 Medicare 26,195,215 10,201,299 Medicaid 19,033,154 12,747,766 Other allowances 10,817,023 5,160,240 Bad debts 12,645,020 7,340,132 Total uncompensated charges 73,346,697 38,143,302 Net patient service revenue $ 27,142,496 $ 17,632, Concentration of Credit Risk PMCI grants credit without collateral to patients, most of whom are local residents and are insured under third-party payor agreements. The mix of receivables from patients and thirdparty payors were as follows: Medicare 42% 33% Medicaid 13% 11% Other third-party payors 45% 56% Total 100% 100% PMCI maintains deposits with financial institutions which exceed the Federal Depository insurance limits. At June 30, 2016, management believes the credit risk associated with these deposits is minimal. 17

20 5. Assets Limited As To Use POLK MEDICAL CENTER, INC. NOTES TO FINANCIAL STATEMENTS, The composition of assets limited as to use as of June 30, 2016 is set forth in the following table. Assets limited as to use are trading securities and are stated at fair value with Level 1 inputs, which are based on unadjusted quoted market prices with active markets. Assets limited as to use: Under indenture agreement held by trustee: Cash and cash equivalents $ 392,184 Investment income and gains and losses for assets limited as to use and cash and cash equivalents, are comprised of the following for the year ending June 30, 2016: Income: Interest and dividend income $ 5,623 PMCI s investments are exposed to various risks such as interest rate, market and credit risks. Due to the level of risk associated with certain investment securities, it is at least reasonably possible that changes in the values of investment securities will occur in the near term and that such change could materially affect the amounts reported in the accompanying financial statements. 6. Property, Plant and Equipment A summary of property, plant and equipment at follows: Land $ 838,635 $ 838,635 Land improvements 50,509 - Buildings 28,213,898 33,252,083 Fixed equipment 14,858 14,858 Major movable equipment 11,554,566 11,592,305 Building under capital lease 3,072,000-43,744,466 45,697,881 Less accumulated depreciation 10,662,452 7,629,615 Property, plant and equipment, net $ 33,082,014 $ 38,068,266 18

21 NOTES TO FINANCIAL STATEMENTS, 6. Property, Plant and Equipment, Depreciation expense for the years ended amounted to approximately $3,470,000 and $3,467,000, respectively. Accumulated amortization for a building under a capital lease obligation was $115,000 for There was no accumulated amortization for No construction contracts existed at June 30, Long-Term Debt Long-term debt for the years ended follows: Note payable with interest payments due quarterly, paid in full during The note bears a variable interest rate of LIBOR plus 1.50%. The note was guaranteed by the gross revenues of Floyd Healthcare Management, Inc. $ - $ 34,173,156 Revenue Certificates, PMCI Series 2016 payable in installments of $35,000 to $5,515,000 each July 1, until The certificates are guaranteed by the gross revenues of Floyd Healthcare Management, Inc. and Polk Medical Center, Inc. The certificates bear interest rates per annum ranging from 3.00% to 5.00%. 30,415,000 - Capital lease obligation with an interest rate of 3.99% and monthly payments ranging from $14,367 to $25,193. 3,028,207 - Total long-term debt 33,443,207 34,173,156 Unamortized bond premium 4,394,050 - Less: current maturities of long-term debt 56,465 - Long-term debt, net of current maturities $ 37,780,792 $ 34,173,156 19

22 7. Long-Term Debt, POLK MEDICAL CENTER, INC. NOTES TO FINANCIAL STATEMENTS, Scheduled principal repayments on long-term debt and payments on capital lease obligations for the next five years are as follows: Long-Term Debt Capital Lease Obligation 2017 $ - $ 176, , , , , , , , ,410 Thereafter 30,095,000 3,567,379 Less amount representing interest under capital lease obligation - 1,475,091 Total $ 30,415,000 $ 3,028,207 Revenue Anticipation Certificates, PMCI Series 2016 were issued to (i) refund the $34 million Bridge Loan Agreement, (ii) finance certain renovation projects; and (iii) pay costs of issuance of the PMCI Series 2016 Certificates. PMCI, the Authority, and the Corporation are members of the obligated group of the Revenue Anticipation Certificates, PMCI Series In 2013, PMCI entered into a Bridge Loan Agreement which was a delayed draw term note with a credit line of $40,000,000 to construct a new hospital facility. The loan has a stated interest rate of LIBOR plus 1.5%. This note was refinanced during 2016 with the issuance of the PMCI Series 2016 certificates. The loan balance was approximately $34,200,000 at the time of the refinancing. Under the terms of the PMCI Series 2016 indentures, PMCI is required to maintain certain deposits with a trustee. Such deposits are included with assets limited as to use. The indentures also place limits on the incurrence of additional borrowings and require that PMCI satisfy certain measures of financial performance as long as the Certificates are outstanding. In the opinion of management, all measures of financial performance have been satisfied. 20

23 7. Long-Term Debt, Capital Lease Obligation POLK MEDICAL CENTER, INC. NOTES TO FINANCIAL STATEMENTS, In 2016, PMCI entered into a capital lease agreement with the Corporation under which PMCI leases space in a medical office building. The lease term ends in September 2026, with three five-year extensions. A summary of interest cost on borrowed funds during the years ended June 30, 2016 and 2015 follows: Interest cost: Capitalized $ - $ 177,000 Charged to operations 891, ,000 Total $ 891,000 $ 508, Employee Health Insurance PMCI is included in the Corporation s employee health self-insurance program. The Corporation has a self-insurance program for employee health insurance under which a thirdparty administrator processes and pays claims. The Corporation reimburses the third-party administrator monthly for claims incurred and paid to other providers. The charges, less any deductibles and coinsurance for covered services provided to employees by the Corporation, are written off against gross patient service revenue. In addition, the Corporation has entered into a loss financing agreement with ten Georgia hospitals through a program developed by Georgia ADS, LLC. The program is designed to provide for the financing and payment of covered claims between $150 thousand and $500 thousand. The program also buys a reinsurance policy to cover claims reaching $1 million. Further, the Corporation purchased additional insurance to cover claims up to $2 million. Payments received from the program must be repaid over a specified period of time with interest. Under this self-insurance program, PMCI paid or accrued and expensed approximately $915,000 and $436,000 for the years ended, respectively. 21

24 9. Malpractice Insurance POLK MEDICAL CENTER, INC. NOTES TO FINANCIAL STATEMENTS, PMCI is covered by a claims-made general and professional liability insurance policy with a specified deductible of $25,000 per incident and excess coverage on a claims-made basis. Liability limits related to this policy in 2016 are $1 million per occurrence and $3 million in aggregate. In addition, PMCI is covered by an umbrella policy of up to $5 million per occurrence and $5 million aggregate. PMCI uses a third-party administrator to review and analyze incidents that may result in a claim against PMCI. In conjunction with the thirdparty administrator, incidents are assigned reserve amounts for ultimate liability that may result from an asserted claim. Various claims and assertions have been made against PMCI in its normal course of providing services. In addition, other claims may be asserted arising from services provided to patients in the past. In the opinion of management, adequate provision has been made for losses which may occur from such asserted and unasserted claims that are not covered by liability insurance. 10. Commitments and Contingencies Litigation PMCI is involved in litigation arising in the course of business. Pursuant to the Lease described in Note 1, all liabilities resulting from litigation not covered under Polk s insurance policy have been assumed by the Corporation. After consultation with legal counsel, management estimates that these matters will be resolved without material adverse effect on PMCI's future financial position or results from operations. Compliance Plan The healthcare industry has recently been subjected to increased scrutiny from governmental agencies at both the federal and state level with respect to compliance with regulations. Areas of noncompliance identified at the national level include Medicare and Medicaid, Internal Revenue Service, and other regulations governing the healthcare industry. PMCI has implemented a compliance plan focusing on such issues. There can be no assurance that PMCI will not be subjected to future investigations with accompanying monetary damages. 22

25 NOTES TO FINANCIAL STATEMENTS, 10. Commitments and Contingencies, Operating Leases PMCI leases various equipment and facilities under operating leases. Total rental expense in 2016 and 2015 for all operating leases was approximately $84,000 and $52,000, respectively. Health Care Reform In recent years, there has been increasing pressure on Congress and some state legislatures to control and reduce the cost of healthcare at the national and the state levels. In 2010 legislation was enacted which included cost controls on hospitals, insurance market reforms, delivery system reforms and various individual and business mandates among other provisions. The costs of certain provisions will be funded in part by reductions in payments by government programs, including Medicare and Medicaid. There can be no assurance that these changes will not adversely affect PMCI. 11. Functional Expenses PMCI provides general health care services to residents in Northwest Georgia. Expenses related to providing these services, at, are as follows: Health care services $ 15,947,935 $ 9,155,843 General and administrative services 6,328,082 4,873,177 Total $ 22,276,017 $ 14,029, Contribution to City of Cedartown PMCI agreed to make an annual contribution to the City of Cedartown in relation to the construction of new water and sewer infrastructure for the new hospital. Pursuant to the agreement, PMCI will make payments for 20 years. PMCI made contributions in the amount of approximately $310,000 and $337,000 during 2016 and 2015, respectively. 23

26 13. Lease of Polk Medical Center POLK MEDICAL CENTER, INC. NOTES TO FINANCIAL STATEMENTS, On November 6, 2014, PMCI leased Polk Medical Center from the Cedartown-Polk Authority. Accordingly, the results of operations for Polk Medical Center have been included in the accompanying financial statements from that date forward. The lease was made for the purpose of strengthening the Corporation s competitive position in the North Georgia service area. Consideration for the lease comprised the following (at fair value): Buildings $ 33,846,910 Equipment 6,510,466 Total consideration $ 40,357,376 The following assets and liabilities were recognized from the lease (at fair value): Cash $ 1,268,930 Net accounts receivable 2,686,120 Supplies 132,689 Other current assets 914,328 Estimated settlements ( 867,871) Net fixed assets 41,484,136 Due to Floyd Healthcare Management, Inc. ( 4,216,719) Total identifiable assets $ 41,401,613 The following gain was recognized from the lease (at fair value): Net assets received $ 41,401,613 Consideration provided 40,357,376 Gain on acquisition of Polk Medical Center $ 1,044,237 24

27 NOTES TO FINANCIAL STATEMENTS, 13. Lease of Polk Medical Center, The amount of Polk Medical Center s revenues and earnings included in the statements of operations and changes in net assets (from the inception of the lease) are approximately $27,700,000 and $5,400,000 for 2016, and $17,600,000 and $4,700,000 for 2015, respectively. The following pro forma information is based on the assumption that the lease occurred on July 1, Net patient revenue $ 27,100,000 $ 23,700,000 Excess revenues (expenses) $ 5,400,000 $ 5,100, Related Party Transactions PMCI is a wholly owned member of the Corporation and the Corporation makes all payments to employees and vendors on behalf of PMCI. PMCI reimburses the Corporation for these expenditures. During 2015, the Corporation transferred $5,000,000 to PMCI for the construction of a Medical Office Building. Through September 2015, PMCI reimbursed the Corporation by making payments equal to the amount the Corporation paid to service the debt related to constructing the Medical Office Building. On October 1, 2015, PMCI amended the lease agreement with the Corporation, as discussed in Note 1, to transfer ownership of the Medical Office Building to the Corporation. In addition, on October 1, 2015, PMCI entered into a capital lease with the Corporation to lease a portion of the Medical Office Building to PMCI. See Note 7 for a description of the capital lease. PMCI made payments to the Corporation of approximately $125,000 in fiscal year

28 15. Fair Value of Financial Instruments POLK MEDICAL CENTER, INC. NOTES TO FINANCIAL STATEMENTS, The following methods and assumptions were used by the Corporation in estimating the fair value of its financial instruments: Cash and cash equivalents, accounts payable, accrued expenses, and estimated thirdparty payor settlements: The carrying amount reported in the balance sheet approximates its fair value due to the short term nature of these instruments. Assets limited as to use: Amounts reported in the balance sheet are at fair value. Long-term debt: The fair value of the Corporation s long-term debt is estimated based on the quoted market value for same or similar debt instruments. The carrying amounts for the lines of credit approximate its fair value. Based on inputs used in determining the estimated fair value, the Corporation s long-term debt would be classified as Level 2 in the fair value hierarchy. The carrying amounts and fair values of the Corporation s long-term debt at June 30, 2016 and 2015 are as follows: Carrying Amount Carrying Fair Value Amount Fair Value Long-term debt $ 34,809,050 $ 35,597,946 $ 34,173,156 $ 34,173,156 26

29 NOTES TO FINANCIAL STATEMENTS, 16. Electronic Health Record Incentive Payments The Health Information Technology for Economic and Clinical Health Act (HITECH Act) was enacted into law on February 17, 2009 as part of the American Recovery and Reinvestment Act of 2009 (ARRA). The HITECH Act includes provisions designed to increase the use of Electronic Health Records (EHR) by both physicians and hospitals. Beginning with federal fiscal year 2011 and extending through federal fiscal year 2016, eligible hospitals participating in the Medicare and Medicaid programs are eligible for reimbursement incentives based on successfully demonstrating meaningful use of its certified EHR technology. Conversely, those hospitals that do not successfully demonstrate meaningful use of EHR technology are subject to reductions in Medicare reimbursements beginning in FY On July 13, 2010, the Department of Health and Human Services (DHHS) released final meaningful use regulations. Meaningful use criteria are divided into three distinct stages: I, II, III. The final rules specify the initial criteria for physicians and eligible hospitals necessary to qualify for incentive payments; calculation of the incentive payment amounts; payment adjustments under Medicare for covered professional services and inpatient hospital services; eligible hospitals failing to demonstrate meaningful use of certified EHR technology; and other program participation requirements. The final rule set the earliest interim payment date for the incentive payment at May The first year of the Medicare portion of the program is defined as the federal government fiscal year October 1, 2010 to September 30, PMCI recognizes income related to Medicare and Medicaid incentive payments using a grant model based upon when it has determined that it is reasonably assured that PMCI will be using EHR technology in a meaningful way for the applicable period and the cost report information is reasonably estimable. PMCI successfully demonstrated meeting meaningful use of its certified EHR technology prior to June 30, During 2016, PMCI qualified for approximately $474,000 from the Medicare and Medicaid programs. The portion of these funds related to PMCI s fiscal year end were accrued and are reported in other current assets on the balance sheet and other operating revenues on the income statement. 27