CentraCare Health. Consolidated Financial and Compliance Report With Independent Auditor s Reports Thereon June 30, 2017 and 2016

Transcription

1 Consolidated Financial and Compliance Report With Independent Auditor s Reports Thereon June 30, 2017 and 2016

2 Contents Independent auditor s report 1-2 Financial statements Consolidated balance sheets 3-4 Consolidated statements of operations and changes in net assets 5 Consolidated statements of cash flows 6 Notes to consolidated financial statements 7-29 Independent auditor s report on internal control over financial reporting and on compliance and other matters based on an audit of financial statements performed in accordance with Government Auditing Standards Independent auditor s report on compliance for the major federal program; report on internal control over compliance; and report on schedule of expenditures of federal awards required by the Uniform Guidance Compliance Schedule of expenditures of federal awards 34 Notes to schedule of expenditures of federal awards 35 Schedule of findings and questioned costs Summary schedule of prior audit findings 38

3 Independent Auditor s Report To the Board of Directors CentraCare Health Report on the Financial Statements We have audited the accompanying consolidated financial statements of CentraCare Health System (CentraCare), which comprise the consolidated balance sheets as of June 30, 2017 and 2016; the related consolidated statements of operations and changes in net assets, and cash flows for the years then ended; and the related notes to the consolidated financial statements (collectively, the financial statements). Management s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error. Auditor s Responsibility Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. 1

4 Opinion In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of CentraCare as of June 30, 2017 and 2016, and the results of its operations and changes in net assets, and its cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America. Other Reporting Required by Government Auditing Standards In accordance with Government Auditing Standards, we have also issued our report dated September 26, 2017, on our consideration of CentraCare s internal control over financial reporting and on our tests of its compliance with certain provisions of laws, regulations, contracts and grant agreements, and other matters. The purpose of that report is to describe the scope of our testing of internal control over financial reporting and compliance and the results of that testing, and not to provide an opinion on the internal control over financial reporting or on compliance. That report is an integral part of an audit performed in accordance with Government Auditing Standards in considering CentraCare s internal control over financial reporting and compliance. Minneapolis, Minnesota September 26,

5 Consolidated Balance Sheets June 30, 2017 and 2016 Assets Current assets: Cash and cash equivalents $ 86,761 $ 69,244 Short-term investments 50,620 50,100 Accounts receivable: Patients and residents, less allowance for uncollectible accounts of $18,998 in 2017 and $17,532 in , ,546 Other receivables 21,800 13,913 Inventories 15,561 16,463 Prepaid expenses and other 13,200 13,330 Current portion of funds held by trustees under bond indentures 1 59 Total current assets 353, ,655 Assets whose use is limited: Funds held by trustee under trust and escrow agreements 681 3,581 Funds held by trustee under bond indentures, net of current portion 14,211 55,434 Funds designated by Board for future property and equipment replacement and expansion 576, ,574 Assets whose use is limited, net of current portion 591, ,589 Property and equipment, net 754, ,269 Other assets 31,663 33,372 Total assets $ 1,730,788 $ 1,554,885 See notes to consolidated financial statements. 3

6 Liabilities and Net Assets Current liabilities: Current maturities of long-term debt $ 15,685 $ 14,709 Accounts payable 50,396 41,742 Third-party payor settlements 5,696 5,605 Accrued salaries and benefits 115, ,881 Accrued interest and other 2,535 2,240 Total current liabilities 189, ,177 Long-term liabilities: Long-term debt 476, ,914 Interest rate swap instruments 23,046 23,778 Accrued pension liability 37,204 50,563 Other liabilities 20,082 24,796 Total long-term liabilities 557, ,051 Total liabilities 746, ,228 Net assets: Unrestricted 968, ,421 Unrestricted noncontrolling interest 3,661 4,405 Temporarily restricted 11,635 10,561 Permanently restricted Total net assets 984, ,657 Total liabilities and net assets $ 1,730,788 $ 1,554,885 4

7 Consolidated Statements of Operations and Changes in Net Assets Years Ended June 30, 2017 and Revenue: Patient and resident service revenue, net of contractual adjustments $ 1,247,746 $ 1,181,272 Provision for bad debts (18,517) (18,772) Net patient and resident service revenue 1,229,229 1,162,500 Other operating revenue 36,092 37,151 Total revenue 1,265,321 1,199,651 Expenses: Salaries and employee benefits 775, ,105 Supplies and other 372, ,702 Interest 10,498 12,158 Depreciation and amortization 64,523 59,344 Total expenses 1,223,107 1,149,309 Operating income 42,214 50,342 Nonoperating gains (losses): Investment income and gains (losses), net 69,955 (13,891) Gain (loss) on interest rate swaps, net 20,770 (33,395) Loss on debt refinancing - (25,794) Other losses, net (1,372) (3,690) Total nonoperating gains (losses), net 89,353 (76,770) Revenue and gains in excess of (less than) expenses and losses 131,567 (26,428) Less revenues in excess of expenses attributable to noncontrolling interest (1,456) (794) Revenue and gains in excess of (less than) expenses and losses attributable to CentraCare 130,111 (27,222) Other changes in unrestricted net assets: Net assets released from restrictions 3,038 3,258 Adjustment to the funded status of the pension plan 14,501 (17,267) Other changes in unrestricted net assets, net 371 1,714 Change in unrestricted net assets 148,021 (39,517) Temporarily restricted net assets: Contributions 4,112 3,552 Net assets released from restrictions (3,038) (3,258) Change in temporarily restricted net assets 1, Change in net assets 149,095 (39,223) Net assets at beginning of year, CentraCare 831, ,475 Net assets at end of year, CentraCare $ 980,347 $ 831,252 See notes to consolidated financial statements. 5

8 Consolidated Statements of Cash Flows Years Ended June 30, 2017 and Cash flows from operating activities: Change in net assets $ 149,095 $ (39,223) Adjustments to reconcile change in net assets to net cash provided by operating activities: Depreciation and amortization 64,523 59,344 Provision for bad debts 18,517 18,772 Adjustment to the funded status of the pension plan (14,501) 17,267 Loss on debt refinancing - 25,794 Change in fair value of interest rate swaps, net (27,242) 33,685 Loss from disposition of property and equipment 1, Capital equipment contributions (371) (269) Restricted contributions (4,112) (3,552) Changes in assets and liabilities: Short-term investments (520) (50,100) Accounts receivable from patients and residents (11,395) (28,769) Other current assets 577 (1,996) Assets whose use is limited, including net realized and unrealized gains and losses (58,440) 20,994 Accounts payable and other current liabilities 12,970 20,657 Other long-term assets and liabilities 21,181 (42,824) Net cash provided by operating activities 151,358 30,274 Cash flows from investing activities: Purchases of property and equipment, net (125,633) (87,931) Acquisitions and affiliations, net of cash acquired (39,531) - Net cash used in investing activities (165,164) (87,931) Cash flows from financing activities: Proceeds from long-term debt and lease transactions 52, ,630 Payments on defeasance of long-term debt (8,425) (156,700) Deferred financing costs, including premium amounts (119) 24,266 Principal payments on long-term debt and capital leases (16,427) (14,243) Restricted contributions 4,112 3,552 Net cash provided by financing activities 31,323 47,505 Net increase (decrease) in cash and cash equivalents 17,517 (10,152) Cash and cash equivalents at beginning of year 69,244 79,396 Cash and cash equivalents at end of year $ 86,761 $ 69,244 Supplemental disclosures of cash flow information: Interest paid on long-term debt, leases and swap instruments $ 21,137 $ 20,765 See notes to consolidated financial statements. 6

9 Note 1. Organization and Basis of Presentation CentraCare Health System (CentraCare) was organized in 1995 for the purpose of creating an integrated, multi-organizational health care system. CentraCare strives to improve the quality and expand the clinical scope of, enhance access to, and assure affordability of health services for residents in the St. Cloud and central Minnesota area. Due to powers reserved by CentraCare relating to significant operational decisions of The Saint Cloud Hospital (the Corporation) and its right to the residual interest in the Corporation, CentraCare is considered to be the parent of the Corporation. The corporate members of the Corporation are two representatives of the Sisters of the Order of Saint Benedict, two representatives of the Diocese of St. Cloud, and four other corporate members appointed by the four representatives. The corporate members serve as representatives of the local Catholic Church of Saint Cloud. The Corporation operates St. Cloud Hospital, an acute-care hospital (the Hospital); an extended-care facility (Saint Benedict s Senior Community, Health Care & Housing for Older Adults); a retirement living facility (Benedict Village); and certain other health care operations. CentraCare is the sole corporate member of CentraCare Health System Melrose (CCH Melrose), CentraCare Health System Long Prairie (CCH Long Prairie), CentraCare Health System Sauk Centre (CCH Sauk Centre), CentraCare Health Foundation (the Foundation), and CentraCare Clinic (the Clinic). CentraCare also is the sole member shareholder of CentraCare Health Monticello (CCH Monticello), CentraCare Health Paynesville (CCH Paynesville), Central Minnesota Emergency Physicians (CMEP), CentraCare Pharmacy Services, Inc. (CentraCare Pharmacies), CentraCare Surgery Center, LLC, Central Minnesota ACO, LLC, Central Minnesota Health Network, LLC, and CentraCare Holdings, Inc. Effective October 7, 2016, CentraCare Holdings, Inc. acquired 100 percent of the outstanding stock of St. Cloud Medical Group, PA. Effective January 1, 2017, CentraCare Health affiliated with Midsota Plastic and Reconstructive Surgeons, P.A.. See Note 12, Acquisitions and Affiliations, for further discussion. CentraCare, the Corporation, the Clinic, CCH Melrose, CCH Long Prairie, CCH Sauk Centre, and the Foundation have been determined to qualify as tax-exempt organizations under Section 501(c)(3) of the Internal Revenue Code. CCH Monticello and CCH Paynesville, as disregarded LLCs under Internal Revenue Service regulations, achieve tax-exempt treatment based on the exempt status of their parent, CentraCare Health System. At June 30, 2017 and 2016, there were no uncertain tax positions. For branding and marketing purposes, CentraCare Health System does business as CentraCare Health. The legal names of the entities all remain the same. Use of estimates: The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in these consolidated financial statements and accompanying notes. Although estimates are considered to be fairly stated at the time the estimates are made, actual results could differ from those estimates. Principles of consolidation: The consolidated financial statements include the accounts of CentraCare and its wholly or majority-controlled affiliates and wholly or majority-owned subsidiaries, which include both tax-exempt and taxable entities. All significant inter-affiliate balances and transactions have been eliminated in consolidation. 7

10 Note 2. Summary of Significant Accounting Policies Cash and cash equivalents: Cash equivalents include highly liquid, undesignated investments with original maturities of three months or less when purchased. CentraCare has cash balances at financial institutions that may exceed federal depository insurance limits. To date, CentraCare has not experienced any losses on such accounts. Short-term investments: Short-term investments include money market funds and short-term fixedincome mutual funds. CentraCare intends to utilize these funds for strategic initiatives or operations. Income earned on short-term investments is reported as other operating revenue. Inventories: Inventories consist of medical drugs and supplies and are recorded at the lower of cost, determined primarily on an average cost basis, or market value. Assets whose use is limited: Assets whose use is limited include investments held by trustees under indenture agreements for construction and debt service payments, investments held by trustees in conjunction with certain trust and escrow agreements, and investments designated by the Board of Directors (over which the Board of Directors retains control and may, at its discretion, subsequently use for other purposes) for future property and equipment replacement and expansion. Investments in marketable equity and debt securities are carried at fair value and are classified as trading investments. Investment securities are exposed to various risks, such as interest rate, credit and overall market volatility. CentraCare invests in alternative investment funds (the funds) that hold interests in real estate, diversified hedge funds, private equity, and venture capital funds. Investments in alternative funds are stated at fair value using the practical expedient based on net asset values as reported in the funds audited financial statements, adjusted by management for additional investments, distributions received, and unaudited interim market performance since the fund audit date, as provided by the fund. CentraCare classifies these funds as trading investments. Certain interest earned on funds held by the bond trustee is reported as other operating revenue because the interest expense on the related bonds is reported as an operating expense. All other investment returns, including unrealized gains and losses on trading investments, are reported as nonoperating gains. Realized gains and losses are included in nonoperating gains and are determined using the specificidentification method. Derivative financial instruments: CentraCare uses certain derivatives to manage identified risk exposures but not for speculative purposes. Swap instruments are recognized as either assets or liabilities and are measured at fair value. CentraCare s derivative instruments are not designated as hedges, as such changes in fair value of interest rate swaps, together with the related difference between interest received and interest paid, are recorded as nonoperating gains and losses. 8

11 Note 2. Summary of Significant Accounting Policies (Continued) Derivative transactions contain credit risk in the event the parties are unable to meet the terms of the contract, which is generally limited to the fair value due from counterparties on outstanding contracts. At June 30, 2017, CentraCare s swap counterparty had Standard & Poor s credit rating of A-. Property and equipment: Property and equipment are stated at cost, if purchased, or at fair market value on the date received, if donated or acquired through affiliation, less accumulated depreciation. Major renewals and improvements are capitalized to the property and equipment accounts and depreciated accordingly. Replacements, maintenance and repairs that do not improve or extend the lives of the assets are expensed currently. When items are disposed of, the cost and accumulated depreciation are eliminated from the accounts, and any gain or loss is recognized at that time. CentraCare depreciates property and equipment using the straight-line method. The estimated useful life is based on guidance provided by the American Hospital Association. CentraCare periodically evaluates the carrying value of property, equipment and other long-lived assets. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Capitalized interest: Interest cost incurred on borrowings designated for construction purposes, net of interest earned on such borrowed funds, is capitalized over the duration of the related construction projects. Imputed interest cost incurred on construction financed through internally generated funds or other borrowings is capitalized over the duration of the related construction projects. For the years ended June 30, 2017 and 2016, CentraCare capitalized interest totaling $2,116 and $843, respectively. Long-term debt and deferred debt acquisition costs: Discounts and premiums on bonds, which are recorded as a reduction or addition, respectively, of long-term debt, are amortized over the life of the related indebtedness using the straight-line method. Deferred debt acquisition costs are amortized over the life of the related indebtedness using the effective-interest method. Noncontrolling interest: CCH Monticello has controlling interest in an operating entity. An unrelated entity owns a noncontrolling interest. CentraCare consolidates the activities of the operating entity, and the noncontrolling interest portion is recorded in unrestricted net assets. Net assets: Unrestricted net assets are used to account for all transactions related to patient care and other operating activities. Unrestricted net assets also include assets whose use is limited through designation by the Board of Directors and requirements of bond indentures. Temporarily restricted net assets are those assets whose use by CentraCare has been limited by donors or grantors to a specific purpose or time period. Permanently restricted net assets have been restricted by donors and are required to be maintained in perpetuity. Donor-restricted gifts: Unconditional promises to give cash and other assets to CentraCare are reported at fair value at the date the promise is received. Conditional promises and indications of intentions to give are reported at fair value at the date the conditions are met. 9

12 Note 2. Summary of Significant Accounting Policies (Continued) Receipts of unconditional promises to give with payments due in future periods are reported as temporarily restricted net assets, unless explicit donor stipulations or circumstances surrounding the receipt of a promise make clear that the donor intended it to be used to support activities of the current period. When a timing restriction expires, temporarily restricted net assets are reclassified as unrestricted net assets and reported in the consolidated statements of operations and changes in net assets as a change in unrestricted net assets. Donor-restricted contributions whose restrictions are met within the same year as received are included in nonoperating gains in the accompanying consolidated financial statements. Permanently restricted net assets are held in perpetuity. CentraCare has received pledge contributions from various corporations, foundations and individuals. Current pledge receivables, net of allowances, of $6,760 and $4,384 are included in other receivables at June 30, 2017 and 2016, respectively. All pledges are expected to be collected within five years. Net patient and resident service revenue: Revenues are recorded when services have been performed. Net patient and resident service revenue consists of gross charges for patient services less deductions (contractual adjustments) on services provided to enrollees of Medicare, Medicaid, Blue Cross and other third-party payor programs. Contractual adjustments arising from various reimbursement arrangements with third-party payors are recognized on an estimated basis in the period in which the services are rendered. Certain reimbursement arrangements are subject to retroactive audit and adjustment. Differences between amounts originally recorded and finally settled are included in operations in the year in which the differences are known. Adjustments to revenue related to prior periods increased net patient and resident service revenue by approximately $2,053 for the year ended June 30, 2017, and decreased net patient and resident service revenue by approximately $691 for the year ended June 30, 2016, which represented 0.2 percent and 0.1 percent, respectively, of net patient and resident service revenue. Accounts receivable: Patient and resident accounts receivable are reduced by an allowance for uncollectible accounts. The provision for uncollectible accounts is based upon management s assessment of expected net collections, considering historical net collection, business and economic conditions, trends in health care coverage, and other collection indicators. Periodically throughout the year, management assesses the adequacy of the allowance for uncollectible accounts based upon historical write-off experience by payor category. The results of this review are then used to make any modifications to the provision for uncollectible accounts to establish an appropriate allowance for uncollectible accounts. After satisfaction of amounts due from insurance, CentraCare follows established guidelines for placing certain past-due patient balances with collection agencies, subject to the terms of certain restrictions on collection efforts as determined by CentraCare. Charity care: CentraCare provides care without charge or at amounts less than its established rates to patients who meet certain criteria under its charity care policy. Since CentraCare does not pursue collection of amounts due from patients who have been determined to qualify for its charity care program, these amounts are excluded from net patient and resident service revenue. The cost of charity care provided was approximately $4,366 and $3,711 for the years ended June 30, 2017 and 2016, respectively. The cost of providing charity care is estimated by applying an overall costto-charge ratio to the charity charges incurred. The cost-to-charge ratio is calculated based on total operating expenses less adjustments, as defined by the Internal Revenue Service in the instructions for Form 990 Schedule H. 10

13 Note 2. Summary of Significant Accounting Policies (Continued) Other operating revenue: Other operating revenue includes reimbursement of license fees and other expenses related to other organizations use of CentraCare s electronic medical records system, food sales to employees and visitors, pharmacy and ancillary sales, and grant revenue. Statements of operations and changes in net assets: The consolidated statements of operations and changes in net assets have been segregated into operating and nonoperating activities. Operating activities include health care related services. Nonoperating activities include primarily investment income, realized and unrealized investment gains and losses, gains and losses on interest rate swaps, loss on debt refinancing, and unrestricted contributions net of related expenses of the Foundation. The results of operating and nonoperating activities are included in revenue and gains in excess of expenses. Contributions of property and equipment, changes and adjustments in CentraCare s defined benefit plans, and net assets released from restrictions are presented as other changes in unrestricted net assets and excluded from revenue and gains in excess of expenses. Business combinations: The fair values of the assets acquired and the liabilities assumed represent CentraCare s estimate of fair values at the acquisition date. CentraCare determines fair value through a combination of methods, which include outside valuations and appraisals, internal rate of return calculations, discounted cash flow models, and consideration of market conditions. Transaction and integration costs associated with business combinations are expensed as incurred. The results of the acquisitions are included in the accompanying consolidated statements of operations and changes in net assets from the respective acquisition dates forward. Reclassification: Certain amounts in the prior year s consolidated financial statements have been reclassified to conform to the current year s presentation. These reclassifications have no impact on the changes in net assets as previously reported. New accounting standards: In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No , Revenue from Contracts with Customers, which converged and replaced existing revenue recognition guidance, including industry-specific guidance. This ASU requires revenue to be recognized in an amount that reflects the consideration to which the entity expects to be entitled in an exchange of goods or services. The update is effective July 1, 2018, for CentraCare. CentraCare is currently assessing the impact of this new standard on its consolidated financial statements. In April 2015, the FASB issued ASU No , Interest Imputation of Interest (Subtopic ): Simplifying the Presentation of Debt Issuance Costs, which changes the presentation of debt issuance costs. This ASU requires presentation of debt issuance costs as a direct reduction of the related debt liability. The new standard was effective July 1, 2016, for CentraCare and has been incorporated into the presentation of these consolidated financial statements. The prior-year issuance costs were reclassified to conform with current-year presentation. In January 2016, the FASB issued ASU No , Financial Instruments Overall (Subtopic ): Recognition and Measurement of Financial Assets and Financial Liabilities, which updates certain aspects of recognition, measurement, presentation and disclosures of financial instruments. The update is effective beginning July 1, 2018, for CentraCare. CentraCare elected to early adopt the amendment within ASU that no longer requires disclosure of the fair value of financial instruments that are not measured at fair value, and as such, these disclosures are not included herein. CentraCare has started to evaluate the impact the remaining provisions of this new standard will have on its consolidated financial statements. 11

14 Note 2. Summary of Significant Accounting Policies (Continued) In February 2016, the FASB issued ASU No , Leases (Topic 842). The guidance in this ASU supersedes the leasing guidance in Topic 840, Leases. Under the new guidance, lessees are required to recognize lease assets and lease liabilities on the consolidated balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the statement of operations. The update is effective beginning July 1, 2019, for CentraCare. CentraCare is currently evaluating the impact of the pending adoption of the new standard on its consolidated financial statements. In March 2016, the FASB issued ASU No , Investments Equity Method and Joint Ventures (Topic 323). This ASU simplifies the accounting for equity method investments, and requires the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. Therefore, upon qualifying for the equity method of accounting, no retroactive adjustment of income is required. The update is effective beginning July 1, 2018, for CentraCare. CentraCare is currently evaluating the impact of the pending adoption of the new standard on its consolidated financial statements. In August 2016, the FASB issued ASU No , Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities. This guidance amends the requirements for financial statements and notes presented by a not-for-profit entity to a) present on the face of the consolidated balance sheet amounts for two classes of net assets at the end of the period, rather than for the currently required three classes; b) present on the face of the consolidated statement of operations and changes in net assets the amount of the change in either of the two classes of net assets rather than that of the currently required three classes; c) provide enhanced disclosures in the notes to the financial statements; d) report investment return net of external and direct internal investment expenses; and e) utilize, in the absence of explicit donor stipulations, the placed-in-service approach for reporting expirations of restrictions on gifts of cash or other assets to be used to acquire or construct a long-lived asset. The update is effective July 1, 2018, for CentraCare. CentraCare is currently evaluating the impact of the pending adoption of the new standard on its consolidated financial statements. In March 2017, the FASB issued ASU No , Compensation Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Costs and Net Periodic Postretirement Benefit Costs, related to the presentation of defined benefit pension costs in the statement of operations. ASU requires an employer to report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. It also provides explicit guidance requiring presentation of the other components of net benefit costs in the statement of activities separately from the service cost component and outside a subtotal of income from operations. The update is effective July 1, 2018, for CentraCare. CentraCare is currently evaluating the impact of the pending adoption of the new standard on its consolidated financial statements. In August 2017, the FASB issued ASU No , Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. This update better aligns an entity s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. To meet that objective, this ASU expands and refines hedge accounting for both nonfinancial and financial risk components and aligns the recognition and presentation of the effect of the hedging instrument and the hedged item in the financial statements. The update is effective July 1, 2019, for CentraCare. CentraCare is currently evaluating the impact of the pending adoption of the new standard on its consolidated financial statements. 12

15 Note 3. Net Patient and Resident Service Revenue and Contractual Agreements With Third- Party Payors CentraCare has agreements with third-party payors that provide for payments to CentraCare at amounts different from its established rates. A summary of the payment arrangements with major third-party payors is as follows: Medicare: Inpatient acute-care services rendered at the Corporation to Medicare program beneficiaries and defined capital costs related to Medicare beneficiaries are paid at prospectively determined rates per discharge, which vary according to a patient classification system that is based on clinical, diagnostic and other factors. Certain outpatient services and defined capital costs related to Medicare beneficiaries are paid prospectively, while other outpatient services payments are based on fee schedules. Certain hospital, clinic and nursing home operations are reimbursed for cost-reimbursable items at a tentative rate, with final settlement determined after submission of annual cost reports and audits thereof by the Medicare fiscal intermediary. Medicare services rendered to clinic patients are paid at the Medicare Part B physician fee schedule rate. Medicaid: Inpatient services rendered to Medicaid program beneficiaries who are not covered by Medicaid managed care are reimbursed at a prospectively determined per case or per diem rate. Outpatient services are reimbursed based on a stated fee schedule. Managed care payors: Payment arrangements are established under negotiated contracts and include reimbursement based on prospectively determined rates per discharge and daily rates, discounted charges, or per diem payments. Laws and regulations governing the Medicare and Medicaid programs are complex and subject to interpretation. 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. As a result, there is at least a reasonable possibility that recorded estimates could change by a material amount in the near term. CentraCare 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 that would have a material effect on its consolidated financial statements. As a service to the patient, CentraCare bills third-party payors directly and bills the patient when the patient s liability is determined. Accounts receivable are reduced by an allowance for uncollectible accounts. CentraCare s allowance for uncollectible accounts was 11.4 percent and 10.4 percent of accounts receivable at June 30, 2017 and 2016, respectively. The increase in the allowance for uncollectible accounts as a percentage of accounts receivable was the result of variation in the timing of write-offs of patient accounts and the composition of accounts receivable at year-end. In addition, CentraCare s write-offs were $13,941 and $19,240 for the years ended June 30, 2017 and 2016, respectively. 13

16 Note 3. Net Patient and Resident Service Revenue and Contractual Agreements With Third- Party Payors (Continued) Gross patient and resident service charges at established rates less third-party payor contractual adjustments consisted of the following for the years ended June 30: Gross patient and resident service charges $ 2,831,723 $ 2,666,174 Contractual adjustments (1,583,977) (1,484,902) Patient and resident service revenue, net of contractual adjustments 1,247,746 1,181,272 Provision for bad debts (18,517) (18,772) Net patient and resident service revenue $ 1,229,229 $ 1,162,500 Patient and resident service revenue (before provision for bad debts) by payor for the years ended June 30 was as follows: Medicare 38% 37% Medicaid 13% 14% Blue Cross 18% 19% Commercial insurance 23% 22% Self-pay and other 8% 8% 100% 100% CentraCare grants credit without collateral to its patients, most of whom are insured under third-party payor agreements. The mix of net receivables from patients and other third-party payors was as follows at June 30: Medicare 32% 30% Medicaid 11% 13% Blue Cross 13% 15% Commercial insurance 22% 20% Self-pay and other 22% 22% 100% 100% 14

17 Note 4. Assets Whose Use Is Limited and Short-Term Investments The carrying value of CentraCare s investment portfolio and classification in the consolidated balance sheets at June 30 are summarized as follows: Cash and cash equivalents $ 26,777 $ 27,093 Commercial paper 3,769 16,507 Certificates of deposit U.S. Treasury debt securities 1,068 - Municipal securities 1,800 3,606 Corporate debt securities ,193 Fixed-income mutual funds 153, ,449 Asset-backed securities 6,854 1 Equity mutual funds 359, ,704 Marketable equity securities Alternative investments 87,689 97,163 $ 642,430 $ 583, Short-term investments $ 50,620 $ 50,100 Current portion of funds held by trustees under bond indentures 1 59 Funds held by trustee under trust and escrow agreements 681 3,581 Funds held by trustee under bond indentures, net of current portion 14,211 55,434 Funds designated by Board for future property and equipment replacement and expansion 576, ,574 $ 642,430 $ 583,748 Investment gains (losses) and their classification in the consolidated statements of operations and changes in net assets for the years ended June 30 are summarized as follows: Interest and dividend income $ 14,659 $ 9,120 Net realized gains ,932 Net change in unrealized gains (losses) 55,057 (42,940) Investment income and gains (losses), net $ 70,301 $ (13,888) Other operating revenue $ 346 $ 3 Nonoperating income and gains (losses), net 69,955 (13,891) Investment income and gains (losses), net $ 70,301 $ (13,888) 15

18 Note 4. Assets Whose Use Is Limited and Short-Term Investments (Continued) The following tables disclose the fair value and redemption frequency for those assets whose fair value is estimated using the net asset value (NAV) per share as of June 30, 2017 and 2016: 2017 Fair Value Estimated Using Net Asset Value Per Share Unfunded Redemption Redemption Fair Value Commitment Frequency Notice Period Hedge funds of funds (A) $ 2,603 $ - Quarterly 95 days Hedge funds of funds (B) 23,472 - Semiannual 95 days Hedge fund (C) 28,890 - Quarterly 65 days Private equity (D) 9,345 11,140 More than 1 year NA Private equity (E) 2,449 3,000 More than 1 year NA Real estate partnership (F) 20,478 - Quarterly 60 days Venture capital (G) 452 4,521 More than 1 year NA $ 87,689 $ 18, Fair Value Estimated Using Net Asset Value Per Share Unfunded Redemption Redemption Fair Value Commitment Frequency Notice Period Hedge funds of funds (A) $ 25,261 $ - Quarterly 95 days Hedge funds of funds (B) 21,309 - Semiannual 95 days Hedge fund (C) 23,154 - Quarterly 65 days Private equity (D) 6,031 13,675 More than 1 year NA Private equity (E) 2,133 3,000 More than 1 year NA Real estate partnership (F) 19,275 - Quarterly 60 days $ 97,163 $ 16,675 (A) The fund seeks an attractive risk-adjusted return with moderate directional market exposure over a full market cycle. The fund utilizes an absolute return strategy, including equity hedge, relative value, event-driven and tactical strategies. (B) The fund seeks high risk-adjusted return by capitalizing on the prospects resulting from market dislocations by investing opportunistically. The fund utilizes various strategies, including equity hedge, tactical/directional relative value and event-driven. (C) The fund seeks high total returns by investing in a diversified portfolio composed of collateralized loan obligations and other structured credit investments backed primarily by bank loans. (D) The fund seeks global exposure to the private asset subclasses of venture capital, buyouts, debt, real estate, and real assets through a diversified fund of funds. (E) The fund seeks strong capital appreciation focused on investing in majority buyouts of established, profitable, growing companies headquartered in Minnesota or adjacent geographies. (F) The fund actively manages a core portfolio of primarily equity real estate investments in the United States. The fund s real return performance objective is to achieve at least a 5 percent real rate of return (inflation-adjusted return), before advisory fees, over any given three- to five-year period. (G) The fund generates investment returns by investing in venture and growth equity investments in health care information technology and services, and medical devices and diagnostics that fit within strategic priorities of the limited partner health systems. 16

19 Note 5. Fair Value Measurements The Fair Value Measurements and Disclosures section of the FASB Accounting Standards Codification establishes a framework for measuring fair value. The framework consists of a three-level valuation hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows: Level 1: Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2: Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Level 3: Inputs to the valuation methodology are unobservable and significant to the fair value measurement. A financial instrument s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The following table presents the financial instruments carried at fair value as of June 30, 2017, by investment classification, analyzed by the fair value hierarchy and NAV: 2017 Level 1 Level 2 Level 3 NAV Total Assets: Assets whose use is limited: Cash and cash equivalents $ 25,979 $ 798 $ - $ - $ 26,777 Commercial paper - 3, ,769 Certificates of deposit U.S. Treasury debt securities 1, ,068 Municipal debt securities - 1, ,800 Corporate debt securities Fixed-income mutual funds 153, ,961 Asset-backed securities - 6, ,854 Equity mutual funds 359, ,357 Equity securities Alternative investments ,689 87,689 Total assets $ 540,676 $ 13,922 $ 143 $ 87,689 $ 642,430 Liabilities: Interest rate swap instruments $ - $ 23,046 $ - $ - $ 23,046 17

20 Note 5. Fair Value Measurements (Continued) The following table presents the financial instruments carried at fair value as of June 30, 2016, by investment classification, analyzed by the fair value hierarchy and NAV: 2016 Level 1 Level 2 Level 3 NAV Total Assets: Cash and cash equivalents $ 26,307 $ 786 $ - $ - $ 27,093 Commercial paper - 16, ,507 Certificates of deposit Municipal securities - 3, ,606 Corporate debt securities - 35, ,193 Fixed-income mutual funds 135, ,449 Asset-backed securities Equity mutual funds 268, ,704 Equity securities Alternative investments ,163 97,163 Total assets $ 430,460 $ 55,975 $ 150 $ 97,163 $ 583,748 Liabilities: Interest rate swap instruments $ - $ 23,778 $ - $ - $ 23,778 Following is a description of CentraCare s valuation methodologies for assets and liabilities measured at fair value. Fair values for Level 1 securities are based upon quoted market prices. Fair values for Level 2 assets are based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets. Inputs are obtained from various sources, including market participants, dealers and brokers. Fair values for Level 2 liabilities are based primarily on a discounted cash flow method. The valuations also reflect a credit spread adjustment to the London interbank offered rate (LIBOR) discount curve in order to reflect the credit value adjustment for nonperformance risk. The credit spread adjustment is derived from other comparably rated entities bonds priced in the market. Fair values for Level 3 securities are based on nonbinding broker estimates of midmarket pricing information. Investments at NAV include alternative investments that are measured based on the practical expedient being net asset value, based on the net asset value of the fund as provided for in the audited financial statements and other fund reporting, as adjusted by management, where appropriate. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the consolidated balance sheet. 18

21 Note 5. Fair Value Measurements (Continued) The methods described above and those recorded at NAV may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While CentraCare believes its valuation methods are appropriate and consistent with other market participants, the use of different methods or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. The following table is a rollforward of the balance sheet amounts for financial instruments classified by CentraCare within Level 3 of the valuation hierarchy defined above: Corporate Debt Asset-Backed Equity Securities Securities Securities Fair value at June 30, 2015 $ 164 $ 1 $ 17 Purchases, sales and maturities, net (84) - - Realized gains Unrealized gains Fair value at June 30, Purchases, sales and maturities, net (16) - - Realized gains Unrealized gains - - (1) Fair value at June 30, 2017 $ 126 $ 1 $ 16 Net unrealized losses related to corporate debt securities held at June 30, 2017 and 2016, were $(6) and $(32), respectively. Note 6. Property and Equipment Property and equipment at June 30 consisted of the following: Land $ 31,301 $ 28,836 Buildings 838, ,791 Equipment 411, ,691 Construction in progress 64,409 36,813 1,346,586 1,200,131 Accumulated depreciation and amortization (592,333) (543,862) $ 754,253 $ 656,269 Depreciation expense was $64,293 and $58,567 for the years ended June 30, 2017 and 2016, respectively, which includes amortization expense of assets under capital leases. Assets recorded under capital leases at June 30, 2017 and 2016, totaled $3,739 and $4,148, respectively, net of accumulated amortization of $2,137 and $3,349 at June 30, 2017 and 2016, respectively. 19

22 Note 7. Long-Term Debt Long-term debt at June 30, 2017 and 2016, consisted of the following: Health Care Revenue Bonds, Series 2016A, maturing through 2046, at annual fixed interest rates from 3.0% to 5.0% (inclusive of unamortized premium of $24,828 in 2017 and $25,881 in 2016) $ 215,458 $ 216,511 Term loan agreement, principal payments through 2027, at an annual fixed interest rate of 3.3% 48,200 - Health Care Revenue Refunding Bonds, Series 2014B, maturing through 2024, at annual fixed interest rates from 4.0% to 5.0% (inclusive of unamortized premium of $6,043 in 2017 and $6,927 in 2016) 46,323 47,477 Health Care Facilities Revenue Bonds, Series 2014A, maturing through 2042, variable-rate interest at an average annual interest rate of 1.0% in 2017 and 0.8% in , ,965 Term loan agreement, principal payments through 2023, at an annual fixed interest rate of 3.1% 4,110 4,750 Health Care Revenue Bonds, Series 2011A, maturing through 2019, at an annual fixed interest rate of 2.1% 8,420 8,750 Health Care Refunding Revenue Bonds, Series 2011B, maturing through 2021, variable-rate interest at an average annual interest rate of 1.3% in 2017 and 1.1% ,260 19,930 Health Care Revenue Bonds, Series 2010A, maturing through 2030, at annual fixed interest rates from 4.3% to 5.1% (net of unaccreted discount of $54 in 2017 and $58 in 2016) 15,566 18,507 Health Care Revenue Bonds, Series 2010B, maturing through 2020, at annual fixed interest rates from 4.3% to 5.0% (inclusive of unamortized premium of $319 in 2017 and $443 in 2016) 6,904 9,028 Other notes and loan obligations, maturing through 2034, at annual interest rates from 1.0% to 3.5% 8,880 19,147 Capital leases, due through fiscal year ,838 1,233 Debt issuance costs (2,564) (2,675) 492, ,623 Current portion of long-term debt included in current liabilities (15,685) (14,709) $ 476,980 $ 452,914 The City of St. Cloud, Minnesota, has issued the Obligated Group Revenue Bonds on behalf of the CentraCare Obligated Group (Obligated Group), which consists of the Corporation, CentraCare, CCH Melrose and CCH Long Prairie. The bonds are the sole obligation of the Obligated Group and are secured by unrestricted receivables and certain pass-through obligations. 20

23 Note 7. Long-Term Debt (Continued) The other notes and loan obligations are related to non-obligated Group members, of which interest and principal payments are assumed through lease and affiliation agreements with the entity. CentraCare has entered into guarantee agreements on the existing lease agreement for CCH Sauk Centre. The guarantee and respective values are limited to the payment of all rent and other sums payable under the terms of the lease. CentraCare has made no payments under the guarantee, and expectation of future payment is deemed remote. In December 2016, CentraCare entered into a $50,000 fixed-rate taxable term loan with a financial institution to fund the acquisition cost of four medical office buildings and related properties, to fund general capital expenditures, and to current refund certain indebtedness of CCH Monticello and CCH Paynesville. The term loan will mature on January 1, In May 2016, CentraCare issued the Series 2016A Health Care Revenue Bonds. The proceeds of the Series 2016A Bonds were used to advance refund the Series 2008D Bonds, partially advance refund the Series 2010A Bonds, deposit $53,000 into a project fund, and fund issuance costs. Both the advance refunding of the Series 2008D Bonds and partial advance refunding of the Series 2010A Bonds were undertaken to reduce CentraCare s total debt service payments and resulted in a loss from advance refunding of $25,794 in the year ended June 30, Aggregate maturities and sinking fund requirements of long-term debt for each of the next five years are as follows: Years ending June 30: 2018 $ 15, , , , ,207 CentraCare employs interest rate related derivative instruments to manage its exposure to interest cost on its variable-rate debt instruments and its exposure to fair value changes on its fixed-rate debt due to changes in interest rates. CentraCare does not enter into derivative instruments for any purpose other than risk management purposes. The derivative financial instruments expose CentraCare to counterparty credit risk and market risk. Counterparty credit risk is the failure of the counterparty to perform under the terms of the derivative contracts. When the fair value of the derivative contract is positive, the counterparty owes CentraCare, which creates counterparty credit risk for CentraCare. When the fair value of a derivative contract is negative, CentraCare owes the counterparty and therefore does not possess counterparty credit risk. The market risk associated with interest rate changes is managed by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken. Management also mitigates risk through periodic reviews of CentraCare s derivative positions in the context of its total blended cost of capital. 21

24 Note 8. Interest Rate Swap Instruments The following is a summary of the outstanding positions under interest rate swap agreements at June 30, 2017: Instrument Original Notional Maturity Interest Interest Rate Type Bond Series Amount Date Rate Paid Received Interest rate swap 2008 $ 120,000 May 1, % 68% of 1-month LIBOR Interest rate swap ,000 May 3, % 68% of 1-month LIBOR Interest rate swap ,260 October 2, % 70% of 1-month LIBOR The derivative instruments identified in the table above are not integrated with the underlying debt and, as such, are not hedge transactions as defined by accounting standards. The fair value of derivative instruments on a gross basis is as follows at June 30: Consolidated Balance Sheet Location Derivatives Interest rate swap instruments liability $ (57,951) $ (85,193) Collateral posted for derivatives Interest rate swap instruments liability 34,905 61,415 $ (23,046) $ (23,778) CentraCare s derivative instruments include certain collateralization requirements based on the market value of these transactions. The amount required for collateral is determined daily based on the current market value of the derivative instruments and compared to the predetermined collateral threshold. CentraCare offsets fair value amounts recognized for the derivative instruments and fair value amounts recognized for the right to reclaim cash collateral (a receivable) based on the terms of the master netting agreement with the counterparties. 22

25 Note 8. Interest Rate Swap Instruments (Continued) The effect of derivative instruments on the consolidated statements of operations and changes in net assets is as follows: Amount of (Loss) Gain on Derivatives Recognized in Revenue and Gains in Derivatives Not Location Within Consolidated Excess of Expenses and Losses, Designated as Statement of Operations and Years Ended June 30 Hedging Instruments Changes in Net Assets Realized gains (losses) on derivatives Gain (loss) on interest rate swaps, net $ (6,472) $ 290 Unrealized gains (losses) on derivatives Gain (loss) on interest rate swaps, net 27,242 (33,685) $ 20,770 $ (33,395) Note 9. Pension Plans The Corporation participates in a noncontributory defined benefit plan sponsored by the Sisters of the Order of Saint Benedict; the Hospital; and Saint Benedict s Senior Community, Health Care & Housing for Older Adults. In addition, CentraCare sponsors two smaller defined benefit plans. Effective June 30, 2003, the defined benefit plans were frozen. The Corporation s plans cover substantially all employees who attained age 21 and worked for at least one year with 1,000 hours or more of annual service prior to curtailment of the plans. Benefits are based on each employee s years of service and compensation. CentraCare s funding policy is to contribute annually at least the amount necessary to prevent a deficiency in the accounts using a calculation of the normal cost plus a 10-year amortization of the unfunded actuarial accrued liability, with interest, to the end of the plan. The normal cost is the portion of the present value of benefits that is allocated to the current year. CentraCare s Investment Committee approves the investment policy and asset allocation of the pension plan. The Investment Committee s activities are supported by an independent investment manager. The investment policy covers responsibilities of the investment manager, investment objectives, asset allocation targets, and asset guidelines (including permissible and nonpermissible holdings). The Investment Committee reviews asset allocations quarterly to determine if the current structure is appropriate and whether any changes are necessary. 23

26 Note 9. Pension Plans (Continued) The current target allocation and the actual asset allocation as of June 30 are as follows: Asset Allocation Target Equity securities 43% 44% 41% Fixed-income securities 51% 46% 49% Real estate partnerships 6% 10% 10% 100% 100% 100% The plan s investments in real estate partnerships are similar to those described in Notes 4 and 5. The following is a summary of the change in projected benefit obligation and change in plan assets for the years ended June 30: Change in projected benefit obligation: Projected benefit obligation at beginning of year $ 172,034 $ 164,374 Interest cost 5,439 6,594 Benefits paid (9,258) (12,938) Actuarial (gain) loss (7,487) 14,009 Amendments - (5) Effect of settlement (82) - Projected benefit obligation at end of year 160, ,034 Change in plan assets: Fair value of plan assets at beginning of year 121, ,929 Employer contributions 61 - Actual gain on plan assets 11,310 2,349 Benefits paid (9,258) (12,939) Effect of settlement (82) - Fair value of plan assets at end of year 123, ,339 Funded status of the plans (underfunded) $ (37,276) $ (50,695) The accumulated benefit obligation at June 30, 2017 and 2016, was $160,646 and $172,034, respectively. 24

27 Note 9. Pension Plans (Continued) Changes in plan assets and benefit obligations recognized in unrestricted net assets during the years ended June 30 consist of the following: Actuarial (gain) loss $ (9,416) $ 21,339 Prior service cost (credit) (1) (5) Amortization of prior service cost Settlement loss recognized (37) (67) Amortization of actuarial loss, net (5,333) (4,285) Total $ (14,501) $ 17,267 At June 30, 2017 and 2016, actuarial losses of $57,607 and $72,108, respectively, which have not been recognized in the net periodic pension (benefit) cost, are included in unrestricted net assets. Actuarial losses (gains) included in unrestricted net assets and expected to be recognized in net periodic pension (benefit) cost during the year ending June 30, 2018, are $4,454 of estimated net loss and $(287) of unrecognized prior service credit. Unrecognized actuarial gains (losses) are amortized as a component of net periodic pension (benefit) cost, only if the gains (losses) exceed 10 percent of the greater of the projected benefit obligation or the market-related value of plan assets. Net periodic pension cost (benefit) consisted of the following for the years ended June 30: Interest cost $ 5,439 $ 6,595 Expected return on plan assets (9,380) (9,679) Amortization of unrecognized prior service cost (286) (285) Settlement loss Amortization of unrecognized net actuarial loss 5,332 4,285 Net periodic pension cost (benefit) $ 1,142 $ 983 Weighted-average assumptions for the years ended June 30 were as follows: Discount rate at beginning of year (used to determine net periodic benefit cost) 3.27% 4.15% Discount rate at end of year (used to determine benefit plan obligation) 3.58% 3.27% Expected long-term return on plan assets 7.60% 7.60% 25

28 Note 9. Pension Plans (Continued) The overall weighted-average return on plan assets is determined by applying management s judgment to the results of computer modeling, historical trends, and benchmarking data. During the year ending June 30, 2018, CentraCare expects to make contributions to the plan of $71. The following benefits, which reflect expected future service, are expected to be paid: Years ending June 30: 2018 $ 7, , , , , ,525 The plan assets measured at fair value on a recurring basis were recorded using the fair value hierarchy and NAV at June 30, 2017, as follows: 2017 Level 1 Level 2 Level 3 NAV Total Cash and cash equivalents $ 85 $ - $ - $ - $ 85 Corporate debt securities Fixed-income mutual funds 56, ,455 Asset-backed securities Equity mutual funds 54, ,403 Real estate partnership ,358 12,358 Total plan assets $ 110,943 $ - $ 69 $ 12,358 $ 123,370 The plan assets measured at fair value on a recurring basis were recorded using the fair value hierarchy and NAV at June 30, 2016, as follows: 2016 Level 1 Level 2 Level 3 NAV Total Cash and cash equivalents $ 86 $ - $ - $ - $ 86 Corporate debt securities Fixed-income mutual funds 59, ,634 Asset-backed securities Equity mutual funds 49, ,913 Real estate partnership ,634 11,634 Total plan assets $ 109,633 $ - $ 72 $ 11,634 $ 121,339 Fair value methodologies for Level 1, Level 2 and Level 3 investments are consistent with the inputs described in Note 5. 26

29 Note 9. Pension Plans (Continued) The following table is a rollforward of the securities classified within Level 3 of the pension plan asset valuation hierarchy: Fair value at June 30, 2015 $ 90 Net sales and investment gains and losses (18) Fair value at June 30, Net sales and investment gains and losses (3) Fair value at June 30, 2017 $ 69 CentraCare sponsors a defined contribution retirement plan that covers substantially all employees. Contributions are based on a percentage of eligible employees salaries. In addition, CentraCare sponsors a defined contribution savings plan, whereby employees can contribute a portion of their salaries as savings. Under this plan, CentraCare will match 50 percent of the initial 3 percent of contributions made by employees. Total amounts expensed for all defined contribution plans were $30,595 and $29,779 for the years ended June 30, 2017 and 2016, respectively. Note 10. Commitments and Contingencies At June 30, 2017, CentraCare had capital commitments for construction and equipment acquisitions of approximately $41,351 expected to be funded by a combination of project funds remaining and operating cash funds. CentraCare has operating leases for occupancy space and computer, medical, communications and other equipment. Rental expense associated with the operating leases was $7,712 and $9,379 for the years ended June 30, 2017 and 2016, respectively. Future minimum lease payments on operating leases in effect on June 30, 2017, for each of the next five years are as follows: Years ending June 30: 2018 $ 7, , , , $ 4,802 27,828 CentraCare is insured with external carriers for professional liability claims on a claims-made basis and for general liability and workers compensation on an occurrence basis. Under the professional liability and workers compensation policies, CentraCare has self-insured deductible amounts. If claims-made policies presently in force are not renewed or replaced with equivalent insurance, claims asserted after the end of the policy term will be uninsured. CentraCare is self-insured for employee health claims with stop-loss coverage above certain limits. At June 30, 2017 and 2016, CentraCare had estimated a liability for claims incurred that have not yet been reported based on historical claims experience, which was $6,652 and $6,061, respectively. These benefits are reported as accrued salaries and employee benefits on the consolidated statements of operations and changes in net assets. 27

30 Note 10. Commitments and Contingencies (Continued) CentraCare is a party in various legal proceedings and potential claims arising in the ordinary course of business. Although the outcome of these lawsuits cannot be predicted with certainty, management believes the ultimate disposition of such matters will not have a material adverse effect on CentraCare s consolidated financial condition or operations. Note 11. Functional Expenses CentraCare provides general health care services to residents within its geographic location. Expenses related to providing these services included in the consolidated statements of operations and changes in net assets for the years ended June 30 are as follows: Health care services $ 982,383 $ 935,540 General and administrative 240, ,769 $ 1,223,107 $ 1,149,309 Note 12. Acquisitions and Affiliations Effective October 7, 2016, CentraCare Holdings, Inc. acquired 100 percent of the outstanding stock of St. Cloud Medical Group, PA. Effective January 1, 2017, CentraCare Health affiliated with Midsota Plastic and Reconstructive Surgeons, P.A., purchasing selected assets and assuming certain liabilities of the businesses operations. The operating results of these entities have been included in the consolidated financial statements since their respective dates of acquisition/affiliation and have been accounted for as business combinations. Total revenues and excess of expenses over revenues included are $28,817 and $(2,991), respectively. These business combinations further CentraCare s strategy to grow health care services in the St. Cloud, Minnesota, and surrounding areas. In addition to the purchase price for assets acquired, net of liabilities assumed, CentraCare has committed to post-closing payments related to these business combinations, with approximately $2,200 remaining to be paid as of June 30, Post-closing payments are recognized as operating expense through January Following is a summary of the purchase price allocation of the assets acquired and liabilities assumed of the business combinations described above: Current assets $ 5,856 Property and equipment 37,349 Other assets 3,997 Current liabilities (7,671) Total assets acquired, net of liabilities assumed $ 39,531 28

31 Note 12. Acquisitions and Affiliations (Continued) The following table presents unaudited consolidated pro forma financial information for the year ended June 30, 2017, as if the closing of the acquired/affiliated entities had occurred on July 1, 2016: Total revenue $ 1,278,711 Excess of revenue over expenses 130,087 Changes in unrestricted net assets 147,997 The unaudited consolidated pro forma financial information is not necessarily indicative of the results of operations that would have occurred if the acquisition/affiliation had been completed on the date indicated, nor is it indicative of future operating results. Note 13. Subsequent Events Subsequent to June 30, 2017, CentraCare has concluded affiliation discussions with Anesthesia Associates of St. Cloud, Ltd, an independent medical group providing general anesthesiology services in the St. Cloud, Minnesota, area for an approximate total cost of $2,900. Closing of this transaction is scheduled for October 2017 and is subject to customary post-closing adjustments. During May 2017, CentraCare entered into Letters of Intent with Affiliated Community Medical Centers (ACMC), a Minnesota professional corporation, and Rice Memorial Hospital (RMH), a division of the City of Willmar, Minnesota. An affiliation with ACMC and RMH would create a comprehensive health system serving the patients, families and communities of west central and southwestern Minnesota. Negotiation of the terms of an affiliation have continued subsequent to June 30, 2017, are not final, and would be subject to customary approvals by CentraCare, ACMC, RHM and regulatory agencies. An estimate of the financial impact of this affiliation cannot be made at this time. CentraCare has evaluated events and transactions occurring subsequent to June 30, 2017, through September 26, 2017, the date of issuance of the consolidated financial statements. During this period, there were no other subsequent events requiring recognition or disclosure in the consolidated financial statements. 29

32 Compliance

33 Report on Internal Control Over Financial Reporting and on Compliance and Other Matters Based on an Audit of Financial Statements Performed in Accordance With Government Auditing Standards Independent Auditor s Report To the Board of Directors CentraCare Health We have audited, in accordance with the auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States, the consolidated financial statements of CentraCare Health System (CentraCare), which comprise the consolidated balance sheets as of June 30, 2017, and the related consolidated statements of operations and changes in net assets and cash flows for the year then ended June 30, 2017, and the related notes to the consolidated financial statements, and have issued our report thereon dated September 26, Internal Control Over Financial Reporting In planning and performing our audit of the financial statements, we considered CentraCare s internal control over financial reporting (internal control) to determine the audit procedures that are appropriate in the circumstances for the purpose of expressing our opinion on the consolidated financial statements, but not for the purpose of expressing an opinion on the effectiveness of CentraCare s internal control. Accordingly, we do not express an opinion on the effectiveness of CentraCare s internal control. A deficiency in internal control exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent, or detect and correct, misstatements on a timely basis. A material weakness is a deficiency, or a combination of deficiencies, in internal control, such that there is a reasonable possibility that a material misstatement of the entity s financial statements will not be prevented, or detected and corrected, on a timely basis. A significant deficiency is a deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness, yet important enough to merit attention by those charged with governance. Our consideration of internal control was for the limited purpose described in the first paragraph of this section and was not designed to identify all deficiencies in internal control that might be material weaknesses or significant deficiencies. Given these limitations, during our audit we did not identify any deficiencies in internal control that we consider to be material weaknesses. However, material weaknesses may exist that have not been identified. 30

34 Compliance and Other Matters As part of obtaining reasonable assurance about whether CentraCare s financial statements are free from material misstatement, we performed tests of its compliance with certain provisions of laws, regulations, contracts and grant agreements, noncompliance with which could have a direct and material effect on the determination of financial statement amounts. However, providing an opinion on compliance with those provisions was not an objective of our audit and, accordingly, we do not express such an opinion. The results of our tests disclosed no instances of noncompliance or other matters that are required to be reported under Government Auditing Standards. Purpose of This Report The purpose of this report is solely to describe the scope of our testing of internal control and compliance and the results of that testing, and not to provide an opinion on the effectiveness of the entity s internal control or on compliance. This report is an integral part of an audit performed in accordance with Government Auditing Standards in considering the entity s internal control and compliance. Accordingly, this communication is not suitable for any other purpose. Minneapolis, Minnesota September 26,

35 Report on Compliance for the Major Federal Program; Report on Internal Control Over Compliance; and Report on Schedule of Expenditures of Federal Awards Required by the Uniform Guidance Independent Auditor s Report To the Board of Directors CentraCare Health Report on Compliance for the Major Federal Program We have audited CentraCare Health System s (CentraCare) compliance with the types of compliance requirements described in the OMB Compliance Supplement that could have a direct and material effect on CentraCare s major federal program for the year ended June 30, CentraCare s major federal program is identified in the summary of auditor s results section of the accompanying schedule of findings and questioned costs. Management s Responsibility Management is responsible for compliance with the federal statutes, regulations, and the terms and conditions of its federal awards applicable to its federal programs. Auditor s Responsibility Our responsibility is to express an opinion on compliance for CentraCare s major federal program based on our audit of the types of compliance requirements referred to above. We conducted our audit of compliance in accordance with auditing standards generally accepted in the United States of America; the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States; and the audit requirements of Title 2 U.S. Code of Federal Regulations Part 200, Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards (Uniform Guidance). Those standards and the Uniform Guidance require that we plan and perform the audit to obtain reasonable assurance about whether noncompliance with the types of compliance requirements referred to above that could have a direct and material effect on a major federal program occurred. An audit includes examining, on a test basis, evidence about CentraCare s compliance with those requirements and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion on compliance for the major federal program. However, our audit does not provide a legal determination of CentraCare s compliance. Opinion on the Major Federal Program In our opinion, CentraCare complied, in all material respects, with the types of compliance requirements referred to above that could have a direct and material effect on its major federal program for the year ended June 30,

36 Report on Internal Control Over Compliance Management of CentraCare is responsible for establishing and maintaining effective internal control over compliance with the types of compliance requirements referred to above. In planning and performing our audit of compliance, we considered CentraCare s internal control over compliance with the types of requirements that could have a direct and material effect on the major federal program to determine the auditing procedures that are appropriate in the circumstances for the purpose of expressing an opinion on compliance for the major federal program and to test and report on internal control over compliance in accordance with the Uniform Guidance, but not for the purpose of expressing an opinion on the effectiveness of internal control over compliance. Accordingly, we do not express an opinion on the effectiveness of CentraCare s internal control over compliance. A deficiency in internal control over compliance exists when the design or operation of a control over compliance does not allow management or employees, in the normal course of performing their assigned functions, to prevent, or detect and correct, noncompliance with a type of compliance requirement of a federal program on a timely basis. A material weakness in internal control over compliance is a deficiency, or combination of deficiencies, in internal control over compliance, such that there is a reasonable possibility that material noncompliance with a type of compliance requirement of a federal program will not be prevented, or detected and corrected, on a timely basis. A significant deficiency in internal control over compliance is a deficiency, or combination of deficiencies, in internal control over compliance with a type of compliance requirement of a federal program that is less severe than a material weakness in internal control over compliance, yet important enough to merit attention by those charged with governance. Our consideration of internal control over compliance was for the limited purpose described in the first paragraph of this section and was not designed to identify all deficiencies in internal control over compliance that might be material weaknesses or significant deficiencies. We did not identify any deficiencies in internal control over compliance that we consider to be material weaknesses. However, material weaknesses may exist that have not been identified. The purpose of this report on internal control over compliance is solely to describe the scope of our testing of internal control over compliance and the results of that testing based on the requirements of the Uniform Guidance. Accordingly, this report is not suitable for any other purpose. Report on Schedule of Expenditures of Federal Awards Required by the Uniform Guidance We have audited the consolidated financial statements of CentraCare as of and for the year ended June 30, 2017, and have issued our report thereon dated September 26, 2017, which contained an unmodified opinion on those consolidated financial statements. Our audit was conducted for the purpose of forming an opinion on the consolidated financial statements as a whole. The accompanying schedule of expenditures of federal awards is presented for purposes of additional analysis as required by the Uniform Guidance and is not a required part of the consolidated financial statements. Such information is the responsibility of management and was derived from and relates directly to the underlying accounting and other records used to prepare the consolidated financial statements. The information has been subjected to the auditing procedures applied in the audit of the consolidated financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the consolidated financial statements, or to the consolidated financial statements themselves, and other additional procedures in accordance with auditing standards generally accepted in the United States of America. In our opinion, the schedule of expenditures of federal awards is fairly stated in all material respects in relation to the consolidated financial statements as a whole. Minneapolis, Minnesota September 26,

37 Schedule of Expenditures of Federal Awards Year Ended June 30, 2017 Federal Passed Federal Grantor/Pass-Through CFDA Pass-Through Entity Through to Federal Grantor/Program or Cluster Title Number Identifying Number Subrecipients Expenditures U.S. Department of Health and Human Services: Pass-through programs from: Minnesota Department of Health: National Bioterrorism Hospital Preparedness Program /37134 $ 116,646 $ 601,867 Hospital Preparedness Ebola Preparedness & Response ,497 Support Oral Health Workforce Activities T12HP ,395 Total Minnesota Department of Health 116, ,759 Minnesota Department of Human Services: Block Grants for Prevention and Treatment of Substance Abuse GRK%25976/GRK% ,240 Regional Trauma Advisory Committee / ,540 Substance Abuse and Mental Health Services Administration Not available - 98,750 Total Minnesota Department of Human Services - 853,530 Research and development cluster: From National Institute of Health pass-through programs: State Innovation Model (SIMS ) ,291 Brigham & Women s Health Cardiovascular Inflammation Reduction Trial U01HL ,200 Rural Health Care Services Outreach Grant Program Not available - 157,218 Total research and development cluster - 329,709 State of Minnesota Commissioner of Minnesota Department of Health: Small Rural Hospital Improvement Grant Program H W - 51,875 Total State of Minnesota Commissioner of Minnesota Department of Health - 51,875 Total U.S. Department of Health and Human Services pass-through programs 116,646 1,943,873 U.S. Department of Justice: Pass-through programs from: Minnesota Office of Justice VOCA A-CVS-2017-CCH-00049/ ,461 Total U.S. Department of Justice pass-through program - 77,461 U.S. Department of Agriculture: Pass-through programs from: Minnesota Department of Agriculture and Rural Development: Supplemental Nutrition Assistance Program H ,350 Total U.S. Department of Agriculture pass-through program - 30,350 Total expenditures of federal awards $ 116,646 $ 2,051,684 See notes to schedule of expenditures of federal awards. 34

38 Notes to Schedule of Expenditures of Federal Awards Note 1. Basis of Presentation The accompanying schedule of expenditures of federal awards (the Schedule) includes the federal award activity of CentraCare Health System (CentraCare) under programs of the federal government for the year ended June 30, The information in the Schedule is presented in accordance with the requirements of Title 2 U.S. Code of Federal Regulations Part 200, Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards (Uniform Guidance). Because the Schedule presents only a selected portion of the operations of CentraCare, it is not intended to, and does not, present the financial position, changes in net assets, or cash flows of CentraCare. Note 2. Summary of Significant Accounting Policies Expenditures reported on the Schedule are reported on the accrual basis of accounting. Such expenditures are recognized following the cost principles contained in the Uniform Guidance, wherein certain types of expenditures are not allowable or are limited as to reimbursement. Note 3. Indirect Cost Rate CentraCare has elected to use the 10 percent de minimis indirect cost rate as allowed under the Uniform Guidance. 35

39 Schedule of Findings and Questioned Costs Year Ended June 30, 2017 I. SUMMARY OF AUDITOR S RESULTS A. Financial Statements 1. Type of auditor s report issued: Unmodified 2. Internal control over financial reporting: Material weakness(es) identified? Yes X No Significant deficiencies identified? Yes X None reported 3. Noncompliance material to financial statements noted? Yes X No B. Federal Awards 1. Internal control over major programs: Material weakness(es) identified? Yes X No Significant deficiencies identified? Yes X None reported 2. Type of auditor s report issued on compliance for major federal programs: Unmodified Any audit findings disclosed that are required to be reported in accordance with Section 2 CFR (a)? Yes X No 3. Identification of major programs: CFDA Number(s) Name of Federal/State Program or Cluster National Bioterrorism Hospital Preparedness Program Dollar threshold used to distinguish between Type A and Type B programs: $750,000 Auditee qualified as low-risk auditee? X Yes No (Continued) 36

40 Schedule of Findings and Questioned Costs (Continued) Year Ended June 30, 2017 II. FINANCIAL STATEMENT FINDINGS None reported. III. FINDINGS AND QUESTIONED COSTS FOR FEDERAL AWARDS None reported. 37

41 Summary Schedule of Prior Audit Findings Year Ended June 30, 2017 No prior-year audit findings reported. 38

42