Quarterly Disclosure Report. For Six Months Ended December 31, (Unaudited)

Transcription

1 Quarterly Disclosure Report For Six Months Ended December 31, 2009 (Unaudited) Contacts: Mark Amiri Frederick Savelsbergh Vice President and Treasurer Chief Financial Officer

2 TABLE OF CONTENTS Organization Page 1 Key Operating and Financial Indicators Page 1 Financial Operations Summary Page 2 Management Discussion and Analysis: Net Operating Income Page 3 Net Operating Revenue Page 3 Operating Expenses Page 4 Nonoperating Gain (Loss) Page 5 Utilization Statistics Page 5 Liquidity Page 6 Foundations Net Assets Page 7 Combined Balance Sheets Page 8 Combined Statements of Operations Page 9 Combined Statements of Cash Flows Page 10 Notes to Combined Financial Statements Page 11

3 Organization Baylor Health Care System ( the System ) is a Texas 501(c)(3) non-profit corporation operating an integrated health care delivery system with over 2,800 beds serving the health care needs of the ten county Dallas-Fort Worth metroplex. Its affiliates include the System s flagship Baylor University Medical Center (BUMC), nine community hospitals, five specialty limited service hospitals, one research institute, two philanthropic foundations and HealthTexas Provider Network (HealthTexas), a physician practice organization. The combined financial statements, which are unaudited, also include partnerships through Texas Health Ventures Group, LLC ( THVG ) that operate six short-stay surgery hospitals with one additional hospital under development and eighteen ambulatory surgery centers. The Baylor Health Care System Foundation and the All Saints Health Foundation foster support from the Dallas-Fort Worth metroplex to further Baylor's mission within the communities they serve. HealthTexas is a Texas non-profit corporation that owns and operates primary care and specialty practices in the Dallas-Fort Worth metroplex. HealthTexas provides physician recruiting services to the System and as of December 31, 2009, employed over 454 physicians and 69 physician extenders. Baylor s credit ratings are Aa2 Stable with Moody s Investors Service and AA- Stable by Standard and Poor s. Key Operating and Financial Indicators The information contained in this document represents the unaudited financial condition and results of operations of the System for the six months ended December 31, Key Operating and Financial Indicators ($ Thousands) December 31, Total Operating Revenue $ 1,663,667 $ 1,902,069 Operating Margin (net of minority interest) 3.8% 6.0% Adjusted EBITDA* $ 170,240 $ 246,225 Cash and Investments $ 1,230,957 $ 1,662,582 Days in Patient Accounts Receivable Days Cash on Hand (including restricted funds) *EBITDA has been modified to exclude unrealized gain/loss on investments. Page 1

4 Financial Operations Summary Combined Statements of Operations ($ Thousands) Audited June 30, December 31, Total operating revenue $ 3,110,864 $ 3,432,820 $ 1,663,667 $ 1,902,069 Total operating expenses 2,906,492 3,186,412 1,557,070 1,741,479 Income from operations 204, , , ,590 Non-operating gain (loss) and income tax expense (188,686) (160,611) (240,534) 142,362 Excess (deficit) of revenues over expenses before minority interest 15,686 85,797 (133,937) 302,952 Less: Minority interest 79, ,015 52,093 60,742 Excess (deficit) of revenues over expenses $ (63,351) $ (29,218) $ (186,030) $ 242,210 Summary Financial Information ($ Thousands) Audited June 30, December 31, Cash Flow: Cash flow from operating activities (1) $ 362,814 $ 378,354 $ 179,996 $ 145,130 Adjusted EBITDA (2) $ 282,471 $ 349,463 $ 170,240 $ 246,225 Capital expenditures for property and equipment $ 338,631 $ 238,623 $ 95,784 $ 59,606 Financial Ratios: Operating margin 6.6% 7.2% 6.4% 8.4% Adjusted EBITDA (2) 9.1% 10.2% 10.2% 12.8% Days in patient accounts receivable Unrestricted days cash on hand (5) Days cash on hand (including restricted funds) (5) Debt to capitalization (3) 34.5% 39.2% 36.8% 35.6% Debt to cash flow (4) 3.60x 3.30x 2.80x 2.30x (1) Cash flow from operating activities for the six months ended December 31, 2008 has been restated for the cummulative effect of change in accounting principle impact from the adoption of endowment provisions within ASC 958, "Not-for-Profit Entities," during FY (2) Adjusted EBITDA is revenue in excess of expenses after minority interest plus depreciation, amortization, taxes, loss from extinguishment of debt and unrealized gain/loss on investments. (3) Long term debt plus current maturities/(long term debt plus current portion) plus unrestricted net assets. (4) Long term debt plus current maturities/excess of revenues over expenses plus depreciation and amortization less unrealized gain/loss on investment plus long term debt and current portion. (5) As of December 2009, THVG funds due from United Surgical Partners, Inc. (USPI) are excluded from days cash on hand calculations. Previous quarters have been restated to exclude these funds due from USPI. Page 2

5 Management Discussion and Analysis of Financial Condition and Results of Operations Net Operating Income The operating margin for the first six months of fiscal year 2010 was $160.6 million (8.4% of net operating revenue), compared to $106.6 million (6.4%) for the first six months of fiscal year Operating margin, net of joint venture minority interest, was $98.6 million (6.0%) compared to $54.4 million (3.8%) for the same period of fiscal year The positive operating performances resulted from both the BHCS combined hospital operations group and THVG along with the acquisitions of a surgical center acquired through THVG in February 2009 and Baylor Medical Center at Carrollton (BMCC) in June For the six months December 31, 2009, Adjusted EBITDA was a positive $246.2 million (12.8%) of net total revenue versus $170.2 million (10.2%) for the six months ended December 31, Net Operating Revenue The combined year-to-date operating revenue for fiscal year 2010 was $1,902.1 million, an increase of $238.4 million or 14.3% over the same period of fiscal year Net patient care revenue was $1,826.9 million for the first six months of fiscal year 2010, an increase of $239.1 million or 15.1% over the first six months of fiscal year The increase in net patient revenue reflects the impact of increased acuity levels at BUMC and higher patient volumes at several of the THVG facilities and includes $71.6 million associated with the acquisitions previously mentioned above which was partially offset by unfavorable shifts in payor mix. Charity care charges increased $5.0 million or 4.8% to $108.7 million in the first six months of fiscal year 2010 compared to $103.7 million in the same period in fiscal year 2009, or 5.9% and 6.5% as a percentage of net patient revenue for fiscal year 2010 and 2009, respectively. Operating Data (1) Audited June 30, December 31, * 2008* 2009* Beds in Service 2,495 2,619 2,520 2,884 Inpatient Admissions (1) 109, ,790 59,035 64,712 Patient Days 613, , , ,420 Average Length of Stay (Days) Emergency Room Visits 310, , , ,592 Outpatient Surgical Cases 41, ,019 63,286 74,818 Outpatient Registrations 556, , , ,505 Gross Outpatient Revenue as a Percent of Total Revenues 48.2% 50.5% 50.4% 47.2% (1) Admissions include adult and special care nursery. * Included THVG for FY 2009 and the six months ended December 31, 2008 and 2009, respectively. Net assets released from restrictions for operations decreased $2.0 million or 10.5% to $17.0 million in second quarter of fiscal year 2010 compared to $19.0 million in the same period in fiscal year Page 3

6 Operating Expenses Combined operating expenses for the first six months of fiscal year 2010 were $1,741.5 million, an increase of $184.4 million or 11.8% over the first six months of fiscal year Bad debt expense increased $35.6 million or 30.5% to $152.3 million or 8.3% and 7.3% of net patient care revenue for fiscal year 2010 and The increase in bad debt expense between fiscal years was primarily driven by higher patient volumes and includes $16.3 million associated with the acquisitions previously mentioned above, along with a slight unfavorable shift in payor mix. Salaries, wages, and employee benefits increased $79.1 million or 10.9% to $806.5 million for the first six months in fiscal year 2010 compared to $727.4 million for the first six months in fiscal year 2009 and decreased as a percentage of net patient care revenue to 44.1% from 45.8% for the first six months of fiscal year The increase in salaries, wages, and employee benefits expense includes $23.9 million associated with the acquisitions previously mentioned above. Salaries, wages, and employee benefits represented approximately 46.3% and 46.7% of total operating expenses for the first six months of fiscal year 2010 and 2009, respectively. Supplies and other operating expenses increased $56.2 million or 9.3% for first six months of fiscal year 2010 to $659.0 million compared to $602.8 million for the first six months in fiscal year 2009 and represented approximately 36.1% and 38.0% of net patient care revenue as of fiscal years 2010 and 2009, respectively. The increase in supplies and other operating expenses includes $24.7 million associated with the acquisitions previously mentioned above. Supplies and other operating expenses as a percentage of total operating expenses represented approximately 37.8% and 38.7% for fiscal years 2010 and 2009, respectively. Depreciation and amortization increased $6.9 million or 7.8% to $95.1 million for the first six months in fiscal year 2010 compared to $88.2 million for the first six months in fiscal year The increase in depreciation expense was primarily attributable to capital building leases entered into for the BMCC acquisition and the System s completion of a new medical office building on the BUMC campus in June Interest expense increased $6.5 million or 29.5% for the first six months in fiscal year 2010 to $28.5 million compared to $22.0 million for the first six months in fiscal year The increase in interest expense includes $2.9 million associated with the acquisitions previously mentioned above. Operating Expenses ($ Thousands) Audited June 30, December 31, Salaries, wages, and employee benefits $ 1,387,215 $ 1,489,827 $ 727,369 $ 806,509 Supplies and other operating expenses 1,093,833 1,227, , ,027 Bad debt expense 217, , , ,338 Depreciation and amortization 168, ,144 88,246 95,142 Interest expense 39,432 47,227 21,976 28,463 Total operating expenses $ 2,906,492 $ 3,186,412 $ 1,557,070 $ 1,741,479 Page 4

7 Nonoperating Gain (Loss) The System recorded unrealized gains on investments of $122.7 million for the first six months of fiscal year 2010, compared to losses of $242.2 million for the same period in fiscal year 2009, related to the improvements in the financial markets. Realized investment gains were $20.7 million for the first six months of fiscal year 2010 as compared to $2.4 million for the same period in fiscal year 2009, an increase of $18.3 million or 762.5% over the same period in fiscal year Utilization Statistics The System derives its patient revenue from managed care companies, Medicare, Medicaid, commercial insurers, self paying patients and other sources. Self pay and other sources include workers compensation, CHAMPUS, and other government programs. The following table approximates the percentages of both gross and net patient revenue by payor based on available information: Gross Patient Revenue Payor Mix Audited June 30, December 31, Medicare 38.8% 38.8% 38.4% 38.8% Medicaid (including Medicaid Managed Care) 7.8% 8.1% 8.0% 8.3% Managed Care/Commerical Insurance 44.2% 43.6% 44.1% 42.8% Self Pay and Other 9.2% 9.5% 9.5% 10.1% 100.0% 100.0% 100.0% 100.0% Net Patient Revenue Payor Mix Audited June 30, December 31, Medicare 29.1% 28.2% 28.4% 28.2% Medicaid (including Medicaid Managed Care) 6.0% 7.1% 6.6% 7.7% Managed Care/Commerical Insurance 62.7% 61.4% 62.6% 60.7% Self Pay and Other 2.2% 3.3% 2.4% 3.4% 100.0% 100.0% 100.0% 100.0% Page 5

8 Adult and Pediatric Operating Beds December 31, 2009 Baylor All Saints Medical Centers (includes two Fort Worth Hospitals) 487 Baylor Heart and Vascular Hospital 64 Baylor Institute for Rehabilitation 87 Baylor Medical Center at Carrollton 158 Baylor Medical Center at Garland 214 Baylor Medical Center at Irving 210 Baylor Medical Center at Waxahachie 57 Baylor Regional Medical Center at Grapevine 239 Baylor Regional Medical Center at Plano 110 Baylor Specialty Hospital 61 Baylor University Medical Center 889 Our Children's House 55 The Heart Hospital Baylor Plano 116 Texas Health Ventures Group 137 Total 2,884 Liquidity Unrestricted cash and investments (excluding gain (loss) on trading investments, net, and unrealized gain (loss) on investments from other than trading securities totaling approximately $148.2 million) increased by $225.8 million after capital expenditures of $59.6 million since June 30, The debt to capitalization ratio decreased from 39.2% to 35.6% for the six months ended December 31, 2009 as compared to June 30, 2009, as total assets increased 5.8% to $4,174.2 million from June 30, Unrestricted days cash on hand decreased from at June 30, 2009 to days at December 31, Including restricted funds, days cash on hand totaled days at June 30, 2009, compared to days at December 31, Cash and Investments (1), (2), (3) ($ Thousands) Audited June 30, December 31, Cash and short-term investments $ 148,463 $ 253,168 $ 156,692 $ 247,874 Long-term investments Unrestricted 1,054, , ,383 1,120,226 Restricted 190, , , ,260 Investments of insurance operations (2) 69,823 77,075 75,492 78,048 Funds held by trustee 25,499 6,099 8,814 6,174 Total $ 1,489,205 $ 1,435,321 $ 1,230,957 $ 1,662,582 (1) Baylor maintains an invesment policy that governs all investment assets. Current policy allocations for assets are 45% equity, 41% fixed income and cash, and 14% hedge funds and real estate. (2) December 31, 2008 and 2009 includes $72,603 and $75,991, respectively, in self insurance trust (reflected in assets whose use is limited on the balance sheet) and $2,889 and $2,057, respectively, in insurance subsidiaries. (3) The Quarterly Disclosure Report for the three months ended September 30, 2009 included Funds due from USPI that were excluded for purposes of this report. Page 6

9 Foundations Net Assets December 31, 2009 The Baylor Health Care System Foundation and the All Saints Health Foundation foster support from the Dallas-Fort Worth metroplex to further Baylor's mission within the communities they serve. Net assets of the Foundations are as follows: Value of Foundations Net Assets ($ Thousands) Audited June 30, December 31, * 2009 Unrestricted $ 32,760 $ 14,582 $ 9,891 $ 24,866 Temporary Restricted 119, , , ,243 Permanently Restricted 128, , , ,902 Total $ 281,404 $ 254,289 $ 237,494 $ 294,011 * The six months ended December 31, 2008 net assets have been restated for the cumulative effect of change in accounting principle impact from the adoption of endowment provisions within ASC 958, "Not-for-Profit Entities," during FY2009. REMAINDER OF PAGE INTENTIONALY LEFT BLANK Page 7

10 Baylor Health Care System Combined Balance Sheets ($ Thousands) Audited June 30, December 31, 2008* * 2009 Assets Cash and cash equivalents $ 104,055 $ 209,174 $ 120,077 $ 206,696 Short-term investments 44,408 43,994 36,615 41,178 Funds due from United Surgical Partners, Inc. 30,676 70,370 50,712 65,955 Accounts receivable, net 370, , , ,017 Assets held as collateral-securities lending program 114,631 69,704 64, ,783 Other current assets 59,883 79,660 66,835 84,873 Total current assets 724, , , ,502 Long-term investments 1,245,420 1,098, ,959 1,330,486 Assets whose use is limited 92,166 80,503 81,417 82,165 Property and equipment, net 1,454,452 1,613,860 1,465,219 1,578,920 Contributions receivable, net 39,789 49,765 38,918 34,387 Investments of insurance subsidiary 3,156 2,671 2,889 2,057 Interest in related foundation 10,037 7,853 9,946 7,835 Other assets 179, , , ,879 Total assets $ 3,748,907 $ 3,946,129 $ 3,529,142 $ 4,174,231 Liabilities and Net Assets Current liabilities $ 430,331 $ 492,115 $ 465,050 $ 431,488 Long-term debt, less current maturities 804, , , ,574 Payable under securities lending program 114,631 69,704 64, ,783 Other liabilities 364, , , ,821 Total liabilities 1,714,744 1,949,753 1,721,396 1,902,666 Net assets: Unrestricted 1,572,165 1,541,766 1,378,816 1,758,578 Temporarily restricted 330, , , ,654 Permanently restricted 131, , , ,333 Total net assets 2,034,163 1,996,376 1,807,746 2,271,565 Total liabilities and net assets $ 3,748,907 $ 3,946,129 $ 3,529,142 $ 4,174,231 *FY2008 has been restated to conform with the FY2009 audit. Page 8

11 Baylor Health Care System Combined Statements of Operations ($ Thousands) Audited June 30, December 31, 2008* * 2009 Operating Revenue Net patient care revenue $ 2,966,709 $ 3,268,469 $ 1,587,780 $ 1,826,938 Other operating revenue 101, ,537 56,863 58,166 Net assets released from restrictions for operations 42,399 38,814 19,024 16,965 Total operating revenue 3,110,864 3,432,820 1,663,667 1,902,069 Operating Expenses Salaries, wages, and employee benefits 1,387,215 1,489, , ,509 Supplies & other operating expenses 1,093,833 1,227, , ,027 Bad debt expense 217, , , ,338 Depreciation and amortization 168, ,144 88,246 95,142 Interest expense 39,432 47,227 21,976 28,463 Total operating expenses 2,906,492 3,186,412 1,557,070 1,741,479 Income from operations 204, , , ,590 Nonoperating Gain (Loss) (Loss) gain on investments, net (50,153) (159,660) (239,763) 143,432 Other nonoperating gain (loss) (127,003) 4,443 2,413 2,049 Loss from extinguishment of debt (4,678) Income tax expense (6,852) (5,394) (3,184) (3,119) Excess (deficit) of revenues over expenses before minority interest 15,686 85,797 (133,937) 302,952 Less minority interest 79, ,015 52,093 60,742 Excess (deficit) of revenues over expenses (63,351) (29,218) (186,030) 242,210 Unrestricted Net Assets Other changes in unrestricted net assets 228 (1,181) (7,318) (25,398) Cumulative change in accounting principle - ASC 958 (23,280) Increase (decrease) in unrestricted net assets (86,403) (30,399) (193,348) 216,812 Temporarily Restricted Net Assets Contributions 43,263 71,030 23,903 12,996 Investment income, net of unrealized gains (losses) 191 (16,129) (19,224) 16,697 Net assets released for operations (42,399) (38,814) (19,024) (16,965) Transfer of Irving net assets from unrestricted net assets 17,934 3,733 (11,935) 28,954 Other (15,666) (24,588) (4,965) 451 Cumulative change in accounting principle - ASC , Increase (decrease) in temporarily restricted net assets 27,425 (4,768) (31,245) 42,133 Permanently Restricted Net Assets Contributions 7, ,541 Investment income, net of unrealized gains (losses) 1,394 (252) (3,523) 513 Other 4,163 (3,102) Cumulative change in accounting principle - ASC 958 (822) Increase (decrease) in permanently restricted net assets 12,276 (2,620) (1,824) 16,244 Increase (decrease) in net assets (46,702) (37,787) (226,417) 275,189 Net assets, beginning of year 2,080,865 2,034,163 2,034,163 1,996,376 Net assets, end of period $ 2,034,163 $ 1,996,376 $ 1,807,746 $ 2,271,565 *FY2008 has been restated to conform with the FY2009 audit. Page 9

12 Baylor Health Care System Combined Statements of Cash Flows ($ Thousands) Audited June 30, December 31, Cash Flows From Operating Activities: 2008* * 2009 Increase (decrease) in net assets $ (46,702) $ (37,787) $ (226,417) $ 275,189 Adjustments to reconcile increase (decrease) in net assets to net cash provided by operating activities: Loss from extinguishment of debt 4, Unrealized (gain) loss on investments 147, , ,305 (139,866) Realized losses (gains) on sales of investments (44,496) 44,769 12,688 (5,074) Restricted contributions received, net of release for operations (8,405) (21,174) (5,620) (14,296) Gift in kind - property and equipment - (11,776) - 2,724 Bad debt expense 217, , , ,338 Depreciation and amortization 168, ,144 88,246 95,142 Children's Medical Center write-off 142, Loss on sale of assets, net 4,051 1, (1,267) Change in value of split-interest agreements (3,245) 5,213 (328) 331 Deferred rent 6,154 11,411 3, Changes in operating assets and liabilities (net of acquisition): Increase in net patient accounts receivable (230,559) (247,199) (128,733) (156,429) (Increase) decrease in other accounts receivable 33,145 (29,855) (20,596) (4,158) Decrease in interest in net assets of related foundation 795 2, (Increase) in other assets (29,001) (52,362) (31,169) (2,998) Increase (decrease) in trade accounts payable and and accrued liabilities (14,109) 42,748 (29,213) (60,402) Increase in other liabilities 14,163 69, ,441 3,555 Net cash provided by operating activities 362, , , ,130 Cash Flows From Investing Activities: Purchases of property and equipment, net (338,631) (238,623) (95,784) (59,606) Cash proceeds from sales of assets, net of selling expense 3, ,223 Net assets acquired, net of cash acquired (6,331) (6,759) - - (Increase) decrease in THVG funds due from United 4,929 (39,694) (20,036) 4,415 Surgical Partners, Inc. Increase in trading investments (128,573) (94,811) (61,064) (79,329) Decrease (increase) in other than trading investments 9,909 11,918 21,653 (4,753) (Increase) decrease in investments of insurance subsidiaries (151) Decrease (increase) in invested collateral-securities lending program 16,590 44,927 49,730 (32,079) Decrease (increase) in assets whose use is limited 91,368 11,663 10,749 (1,662) Net cash used in investing activities (347,717) (310,705) (94,456) (171,177) Cash Flows From Financing Activities: Principal payments on long-term debt (263,357) (249,040) (28,617) (75,599) Proceeds from issuance of long-term debt 232, ,263 3,209 52,793 (Decrease) increase in payable under securities lending program (16,590) (44,927) (49,730) 32,079 Proceeds from restricted contributions 8,405 21,174 5,620 14,296 Net cash (used in) provided by financing activities (38,805) 37,470 (69,518) 23,569 Net Increase (Decrease) In Cash And Cash Equivalents (23,708) 105,119 16,022 (2,478) Cash And Cash Equivalents, beginning of year 127, , , ,174 Cash And Cash Equivalents, end of period $ 104,055 $ 209,174 $ 120,077 $ 206,696 *FY2008 has been restated to conform with the FY2009 audit. Page 10

13 Notes to Combined Financial Statements (Unaudited) 1. BASIS OF PRESENTATION The accompanying unaudited combined financial statements are prepared on the accrual basis of accounting in accordance with the United States generally accepted accounting principles. They do not include all of the information and notes required by United States generally accepted accounting principles for complete financial statements of Baylor Health Care System ( the System ). Eliminations and reporting adjustments have been made to present the information in accordance with United States generally accepted accounting principles. The data should be read in conjunction with the audited combined financial statements for the fiscal years ended June 30, 2009 and Preliminary information for the six months ended December 31, 2009 is not based upon audited information but, in the opinion of management, is presented on a basis consistent with the audited combined financial statements and includes adjustments consisting of normal recurring adjustments necessary for a fair presentation therein. The preliminary results of operations for the six months ended December 31, 2009 are not necessarily indicative of the audited operating results to be expected for the fiscal year ending June 30, SIGNIFICANT ACCOUNTING POLICIES Cash and Cash Equivalents Cash equivalents are defined as investments which have original maturities of three months or less. Cash equivalents consist primarily of securities issued by the United States government or its agencies, certificates of deposit, commercial paper and dollar denominated foreign issuer investments and certificates of deposit. THVG Funds Due From United Surgical Partners, Inc. THVG participates in a shared services accounts payable program with USPI, whereas USPI has custody of substantially all of THVG s excess cash, paying THVG and its facilities interest income on the net balance at prevailing market rates. Amounts held by USPI on behalf of THVG totaled $65,955,000 and $70,370,000 at December 31 and June 30, 2009, respectively. The funds due from USPI are available on demand. Investments The System has designated all of its investments as trading securities except for those investments held at the Baptist Foundation of Texas (BFT) for the benefit of BHCS Foundation. For all trading investments, the interest and dividends, realized and unrealized losses are included in loss on investments, net, in the accompanying combined statements of operations and changes in net assets. For other than trading investments, interest and dividends and realized (losses) gains are included in loss on investments, net, unless restricted by donor or law. Unrealized losses on other than trading investments are included in other changes in unrestricted net assets, unless restricted by donor or law. Management has evaluated the investments with unrealized losses and has concluded that none of the losses should be considered other than temporary as of December 31, 2009 and 2008, respectively. Items considered in this evaluation included the duration of investments and management s Page 11

14 Notes to Combined Financial Statements (Unaudited) - continued intent and ability to hold certain investments to maturity, as well as discussions with the relevant portfolio managers and review of industry analysts reports and various credit ratings information. Interest and dividends, realized gains (losses) and unrealized gains (losses) as of December 31, 2009 and 2008 consisted of the following: As of December 31, 2009 Interest and Realized Unrealized Dividends gains (losses) gains Total Nonoperating gains $ 5,632 $ 15,091 $ 122,709 $ 143,432 Other changes in unrestricted net assets - - 4,753 4,753 Changes in temporarily restricted net assets 4,991 (23) 11,729 16,697 Changes in permanently restricted net assets 45 (207) $ 10,668 $ 14,861 $ 139,866 $ 165,395 As of December 31, 2008 Interest and Realized Unrealized Dividends gains (losses) (losses) Total Nonoperating gains (losses) $ (13,459) $ 15,885 $ (242,189) $ (239,763) Other changes in unrestricted net assets - - (21,653) (21,653) Changes in temporarily restricted net assets 3,634 (16) (22,842) (19,224) Changes in permanently restricted net assets 113 (15) (3,621) (3,523) $ (9,712) $ 15,854 $ (290,305) $ (284,163) Page 12

15 Notes to Combined Financial Statements (Unaudited) - continued Accounting Pronouncements In June 2009, the Financial Accounting Standards Board also issued Statement No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles (a replacement of FASB Statement No. 162, or SFAS 168, that establishes the FASB Accounting Standards Codification (Codification) as the single source of authoritative US GAAP. The Codification does not create any new GAAP standards but incorporates existing accounting and reporting standards into a new topical structure. The System adopted the new guidance for the quarter ended December 31, 2009, and a new referencing system is now used to identify authoritative accounting standards, replacing the existing references to SFAS, EITF, FSP, etc. Existing standards are designated by their Accounting Standards Codification (ASC) topical reference and new standards will be designated as Accounting Standards Updates, with a year and assigned sequence number. Effective July 1, 2009, the System adopted the provisions of ASC relating to fair value measurements and disclosures with respect to the System s non-financial assets and liabilities that are not permitted or required to be measured at fair value on a recurring basis. The adoption had no impact on the System s results of operations or financial position. Effective July 1, 2008, the System adopted the provisions of ASC as they relate to the System s financial assets and liabilities that are remeasured and reported at fair value each reporting period. There was no material impact on the System s results of operations of financial position. See Note 3, Fair Value of Financial Instruments, for information about financial assets and liabilities measured at fair value as required by ASC In December 2007, the Financial Accounting Standards Board issued ASC 810, Consolidation, which is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, ASC 810 requires a company to clearly identify and present ownership interests in subsidiaries held by parties other than the company in the financial statements within the equity section but separate from the company s equity. It also requires the amounts of consolidated net income attributable to the parent and to the non-controlling interest to be clearly identified and presented on the face of the consolidated statement of operations; changes in ownership interest to be accounted for as equity transactions; and when a subsidiary is deconsolidated, any retained non-controlling equity investment in the former subsidiary and the gain or loss on the deconsolidation of the subsidiary must be measured at fair value. The System has not evaluated all of the provisions of ASC 810, and therefore has not determined the impact on the results of operations or financial position from the adoption of ASC 810 as of December 31, Page 13

16 Notes to Combined Financial Statements (Unaudited) - continued ASC 805, Business Combinations, is applicable to all transactions and other events in which one entity obtains control over one or more other businesses, and it broadens the fair value measurement and recognition of assets acquired, liabilities assumed, and interests transferred as a result of business combinations; and stipulates that acquisition-related costs be expensed rather than included as part of the basis of the acquisition. It sets requirements for disclosures to improve the ability to evaluate the nature and financial effects of business combinations. The impact of the updated provisions in ASC 805, which are effective for business combinations entered into by the System on or after July 1, 2009, will be affected by the level of transactions and acquisitions entered into by the System. The System has not evaluated all of the updated provisions of ASC 805, but does not anticipate a material impact on the results of operations or financial position from the adoption of these provisions as of December 31, ASC 715, Compensation-Retirement Benefits, provides guidance on an employer s disclosures about plan assets of a defined benefit pension or other postretirement plans, including disclosures about investment policies and strategies, categories of plan assets, fair value measurements of plan assets and significant concentrations of risk. The System has not evaluated updated provisions of ASC 715, but does not anticipate a material impact on the results of operations or financial position from the adoption of these provisions as of December 31, ASC 350, Intangibles Goodwill and Other, provides guidance on accounting for a combination of not-for-profit entities, which is a transaction or other event that results in a not-for-profit entity initially recognizing another not-for-profit entity, a business, or a nonprofit activity in its financial statements. ASC 350 applies to a combination that meets the definition of either a merger of not-for-profit entities or an acquisition by a not-for-profit entity. The System has not evaluated all of the updated provisions in ASC 350, which are effective for fiscal years and interim periods within those fiscal years, beginning on or after December 15, The System does not anticipate a material impact on the results of operations or financial position from the adoption of ASC 350. ASC 860, Transfers and Servicing, and ASC 810, Consolidation, both incorporate provisions that change the way entities account for securitizations and other transfers of financial instruments. In addition to increased disclosure, these standards eliminate the concept of qualifying special purpose entities and change the test for consolidation of variable interest entities. The System has not evaluated all of the updated provisions, which are effective for annual reporting periods beginning after November 15, 2009, but does not anticipate a material impact on the results of operations or financial position from the adoption of ASC 860 or ASC 810. Page 14

17 Notes to Combined Financial Statements (Unaudited) - continued 3. FAIR VALUE OF FINANCIAL INSTRUMENTS Cash and cash equivalents and other financial instruments: Estimated fair values of the System s cash and cash equivalents, short-term investments, longterm investments, assets whose use is limited and investments of insurance subsidiaries were comprised as follows (in thousands): December 31, June 30, Cash and cash equivalents $ 206,696 $ 209,174 Restricted cash of Self Insurance Retention Trust and other designated assets $ 23,091 $ 29,392 Mutual funds 67,796 62,553 Restricted investments of Self Insurance Retention Trust: Equity securities 22,446 20,770 Fixed income 36,792 37,842 Other restricted assets Collective investment funds held at Baptist Foundation of Texas (BFT) for BHCS Foundation: Common funds, net of alternative investments 159, ,335 Alternative investments 8,476 9,116 U.S. government securities 48,163 50,387 Mortgage-backed securities 5,408 3,412 Alternative investments: Hedge funds 189,893 97,936 Private equity funds 104,736 92,346 Real estate 17,668 18,890 Other fixed income 411, ,019 Equity securities 358, ,125 Real estate and oil and gas interests carried at lower of cost or market Other 1,923 2,658 Fair value measurements: Page 15 $ 1,455,886 $ 1,226,147 As stated in Note 2, The System adopted the methods of measuring fair value described in ASC 820 on July 1, As defined in ASC 820, fair value is based on the prices that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In order to increase consistency and comparability in fair value measurements, ASC 820 establishes a three-tier fair value hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date.

18 Notes to Combined Financial Statements (Unaudited) - continued 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 by market participants for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Level 3 - Inputs that reflect the reporting entity s own assumptions about the assumptions market participants would use in pricing the asset or liability are unobservable and developed based on the best information available in the circumstances. 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 carrying values of cash and cash equivalents, patient accounts receivable, other receivables, assets held as collateral securities lending program, investments of insurance subsidiaries, accounts payable, accrued liabilities, and estimated third-party payer settlements payable are reasonable estimates of their fair value due to the short-term nature of these financial instruments. Fair values of short-term investments and long-term investments are generally 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. This applies to investments such as domestic equities, U.S. treasuries, exchange-traded mutual funds, and agency securities. The investments in alternative investments are valued by management at fair value utilizing the net asset value (NAV) provided by the underlying investment companies unless management determines some other valuation is more appropriate. Such fair value estimates do not reflect early redemption penalties as the System does not intend to sell such investments before the expiration of the early redemption periods. Alternative investments are comprised of private equity investments, real estate investments and hedge funds, collectively referred to as alternative investments, and are included in unrestricted longterm investments in the accompanying combined balance sheets. Investments held consist of marketable securities as well as securities that do not have readily determinable fair values. The fair values of the securities held by limited partnerships that do not have readily determinable fair values are determined by the general partner and are based on historical cost, appraisals, or other estimates that require varying degrees of judgment. If no public market exists for the investment securities, the fair value is determined by the general partner Page 16

19 Notes to Combined Financial Statements (Unaudited) - continued taking into consideration, among other things, the cost of securities, prices of recent significant placements of securities of the same issuer, and subsequent developments concerning the companies to which the securities relate. As this valuation methodology is based primarily on unobservable inputs, it represents Level 3 assets. Included in collective investment funds held at BFT for the BHCS Foundation are alternative investment interests in private equity funds and oil and gas interests and are included in restricted long-term investments in the accompanying combined balance sheets. These alternative investments are in limited partnership interests and are carried at the NAV provided by the underlying investment companies unless management determines some other valuation is more appropriate. As this valuation methodology is based primarily on unobservable inputs, it represents Level 3 assets. Also included in Level 3 assets for the BHCS foundation are other real estate and oil and gas interests which are carried at lower of cost or market. The BHCS Foundation records charitable remainder trusts for which it is not the trustee at the discounted present value of the estimated future cash flows and is reported in contributions receivable, net, in the accompanying combined balance sheets. When a third-party serves as trustee, the beneficial interest is required to be measured at fair value on a recurring basis. As beneficial interests utilize multiple unobservable inputs, including no active markets, and are measured using management s assumption about risk inherent in the valuation technique, this valuation methodology for beneficial interest in split-interest agreements applies to Level 3 assets. The methods described above may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while the System believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. REMAINDER OF PAGE INTENTIONALY LEFT BLANK Page 17

20 Notes to Combined Financial Statements (Unaudited) - continued The following tables below set forth, by level, the financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2009 and June 30, 2009, respectively (in thousands): December 31, 2009: Assets: Total Level 1 Level 2 Level 3 Cash and cash equivalents $ 206,696 $ 206,696 $ - $ - Short-term and long-term investments assets limited as to use and investments of insurance subsidiaries 1,135, , ,264 - Long-term investments - alternative investments 320, ,774* Beneficial interests in split-interest agreements 11, ,384 Invested collateral - securities lending program 101, , Total assets at fair value $1,775,749 $1,183,327 $260,264 $332,158 Liabilities: Interest rate swap agreements $ 52,899 $ - $ 52,899 $ - Total liabilities at fair value $ 52,899 $ - $ 52,899 $ - June 30, 2009: Assets: Total Level 1 Level 2 Level 3 Cash and cash equivalents $ 209,174 $ 209,174 $ - $ - Short-term and long-term investments assets limited as to use and investments of insurance subsidiaries 1,007, , ,156 - Long-term investments - alternative investments 218, ,288* Beneficial interests in split-interest agreements 11, ,686 Invested collateral - securities lending program 69,704 69, Total assets at fair value $1,516,711 $772,581 $514,156 $229,974 Liabilities: Interest rate swap agreements $ 61,138 $ - $ 61,138 $ - Total liabilities at fair value $ 61,138 $ - $ 61,138 $ - * Includes $133,000 of real estate and oil and gas interests that are carried at lower of cost or market. Page 18

21 Notes to Combined Financial Statements (Unaudited) - continued The following tables are a roll forward of the statement of financial position amounts for financial instruments classified by the System within Level 3 of the valuation hierarchy defined above for the six months ended December 31, 2009 and 2008: Beginning balance at July 1 $ 229,974 $ 247,293 Realized (losses) gains, net (1,574) 5,203 Unrealized gains (losses), net 16,717 (20,594) Purchases, issuances, and settlements, net 87,041 10,075 Balance at December 31 $ 332,158 $ 241, ENDOWMENTS ASC 958, Not-for-Profit Entities, provides guidance on the net asset classification of funds that are subject to an enacted version of the Uniform Prudent Management of Institutional Funds Act of 2006 (UPMIFA). ASC 958 was effective for fiscal years ending after December 15, The state of Texas adopted UPMIFA effective September 1, UPMIFA is a model act approved by the Uniform Law Commission that serves as a guideline for states to use in enacting legislation. ASC 958 enhances disclosures about an organization s endowment funds (both donor-restricted endowment funds and board-designated endowment funds), whether or not the organization is subject to UPMIFA. Under ASC 958, a not-for-profit organization shall disclose information to enable users of financial statements to understand the net asset classification, net asset composition, changes in net asset composition, spending policies and related investment policies of its endowment funds (both donor-restricted and board-designated). The provisions of ASC 958 require the System to report the effects of any net asset reclassification in the earliest comparative period presented for which UPMIFA was effective. The System adopted provisions of ASC 958 for the year ended June 30, 2009 and the initial application resulted in a reclassification of previously reported net assets at September 1, This reclassification resulted in a decrease in unrestricted net assets of approximately $23,280,000, an increase in temporarily restricted net assets of approximately $24,102,000 and a decrease in permanently restricted net assets of approximately $822,000. The System s endowment consists of donor restricted and management-designated endowment funds for a variety of purposes. The net assets associated with endowment funds are classified and reported based on the existence or absence of donor imposed restrictions. The System has interpreted the Uniform Prudent Management of Institutional Funds Act (UPMIFA) as not requiring the maintaining of purchasing power of permanently restricted endowment funds absent explicit donor stipulations to the contrary. As a result of this interpretation, the System classifies as permanently restricted net assets, (a) the original value of gifts donated to the permanent endowment, (b) the original value of subsequent gifts to the permanent endowment, and (c) accumulations to the permanent endowment made in accordance with the direction of the applicable donor gift instrument at the time the accumulation is added to the fund. The remaining portion of the donor-restricted endowment Page 19

22 Notes to Combined Financial Statements (Unaudited) - continued fund that is not classified in permanently restricted net assets is classified as temporarily restricted net assets until those amounts are appropriated for expenditure of the System in a manner consistent with the standard of prudence prescribed by UPMIFA. In accordance with UPMIFA, the System considers the following factors in making a determination to appropriate or accumulate endowment funds: 1) The duration and preservation of the fund 2) The purposes of the Foundation and the donor restricted endowment fund 3) General economic conditions 4) The possible effect of inflation and deflation 5) The expected total return from income and the appreciation of investments 6) Other resources of the organization 7) The investment policies of the organization. Return Objectives and Risk Parameters: The System follows an investment policy that attempts to provide a predictable stream of funding to programs supported by its endowment while seeking to maintain the purchasing power of endowment assets. Under this policy, the return objective for the endowment assets, measured over a full market cycle, shall be to maximize the return against various indices, based on the endowment s target allocation applied to the appropriate individual benchmarks. The System expects its endowment funds over time, to provide an average rate of return of approximately five percent annually. Actual returns in any given year may vary from this amount. To achieve its long-term rate of return objectives, the System relies on a total return strategy in which investment returns are achieved through both capital appreciation (realized and unrealized gains) and current yield (interest and dividends). The System targets a diversified asset allocation that places greater emphasis on equity-based investments to achieve its long-term objectives within prudent risk constraints. Relationship of Endowment Spending Practices to Investment Objectives: The System determines the appropriation of endowment funds for expenditure through the budgeting process prior to the start of each fiscal year. A spending policy related to the System is currently in process subject to approval. Based on projected market performance, a certain level of expenditure reimbursement is approved for distribution in the coming year, typically five percent of the individual endowment fund balance. In order to maintain the purchasing power of endowment assets, subsequent expenditures are based on investment performance and spending is curbed in response to deficit situations. The corresponding calculated spending allocations are distributed at the end of each month from the current net total or accumulated net total investment returns for individual endowment funds. The System considers the expected long term rate of return on endowments in its spending policy. Accordingly, over the long term, the System expects its endowment to grow consistent with its intention to maintain the purchasing power of the endowment assets as well as to provide additional real growth through new gifts. Page 20

23 Notes to Combined Financial Statements (Unaudited) - continued 5. RETIREMENT BENEFITS Effective January 1, 2002, a 401(k) defined contribution plan administered by ING was made available to all eligible employees. Employees are eligible to contribute to the plan immediately with no minimum service or age requirement. The System matches amounts contributed by employees, up to five percent of the employee s base compensation. Employees vest in the System s matching contribution over five years. Retirement benefits equal the amounts accumulated to the employee's individual credit at the date of retirement. Prior to January 1, 2002, BHCS offered a 403(b) defined contribution plan through a contract administered by the Annuity Board of the Southern Baptist Convention to all eligible employees. Employees were eligible to participate in the 403(b) plan immediately. The System matched contributions of up to five percent of the employee s base compensation beginning after one year of continuous service during which the employee was credited with 1,000 or more hours of service, as defined. Retirement benefits under the 403(b) contract equal the amounts accumulated to the employee's individual credit at the date of retirement. On December 31, 2001, the System froze the 403(b) defined contribution plan to discontinue all future employee and employer contributions to this plan. Two defined contribution retirement plans administered by ING were provided for employees of All Saints Health System prior to the purchase by the System. These plans were frozen to employee and employer future contributions as of January 1, 2002, with the purchase by the System and all accounts were immediately vested. All Saints Health System employees now participate in the plans offered through the System. The System and six of its affiliated hospitals provided a defined benefit plan, the Baylor Health Care System Retirement Security Plan (the BEST Plan ), for employees, which was discontinued on January 1, All Saints Health System provided a defined benefit plan, the All Saints Health System Pension Plan (the "All Saints Plan"), for employees of All Saints, which was frozen to future benefit accruals as of January 1, 2002, with the All Saints Health System purchase by the System. 6. CONTINGENCIES The healthcare industry is subject to numerous laws and regulations of federal, state, and local governments. These laws and regulations include, but are not necessarily limited to, matters such as licensure, accreditation, government healthcare program participation requirements, reimbursement for patient services, physician ownership and self-referral, and Medicare and Medicaid fraud and abuse. Government activity has continued with respect to investigations and allegations concerning possible violations of fraud and abuse statutes and regulations by healthcare providers. Violations of these laws and regulations could result in expulsion from government healthcare programs together with the imposition of significant fines and penalties, as well as significant repayments for patient services previously billed. Management believes that the System is in compliance with fraud and abuse as well as other applicable government laws and regulations. Page 21