RADY CHILDREN S HOSPITAL AND HEALTH CENTER. Single Audit Reports. June 30, (With Independent Auditors Reports Thereon)

Transcription

1 Single Audit Reports June 30, 2017 (With Independent Auditors Reports Thereon)

2 Table of Contents Page Independent Auditors Report 1 Consolidated Financial Statements: Consolidated Balance Sheets 3 Consolidated Statements of Operations and Changes in Net Assets 4 Consolidated Statements of Cash Flows 6 7 Independent Auditors 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 39 Independent Auditors Report on Compliance for Each Major Federal Program; Report on Internal Control over Compliance; and Report on Schedule of Expenditures of Federal Awards Required by the Uniform Guidance 41 Schedule of Expenditures of Federal Awards 44 Notes to Schedule of Expenditures of Federal Awards 46 Schedule of Findings and Questioned Costs 47 Corrective Action Plan 49

3 KPMG LLP Suite Executive Drive San Diego, CA Independent Auditors Report The Board of Trustees Rady Children s Hospital and Health Center: Report on the Financial Statements We have audited the accompanying consolidated financial statements of Rady Children s Hospital and Health Center and its subsidiaries, which comprise the consolidated balance sheets as of, and the related consolidated statements of operations, changes in net assets, and cash flows for the years then ended, and the related notes to the consolidated financial statements. Management s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with U.S. generally accepted accounting principles; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditors Responsibility Our responsibility is to express an opinion on these consolidated 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 consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditors judgment, including the assessment of the risks of material misstatement of the consolidated 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 consolidated 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 consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Rady Children s Hospital and Health Center and its subsidiaries as of, and the results of their operations and their cash flows for the year then ended, in accordance with U.S. generally accepted accounting principles. KPMG LLP is a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity.

4 Other Reporting Required by Government Auditing Standards In accordance with Government Auditing Standards, we have also issued our report dated September 25, 2017 on our consideration of Rady Children s Hospital and Health Center and its subsidiaries 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 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 Rady Children s Hospital and Health Center and its subsidiaries internal control over financial reporting and compliance. San Diego, California September 25,

5 Consolidated Balance Sheets Assets Current assets: Cash and cash equivalents 16,196 6,483 Investments 1,035, ,684 Patient accounts receivable, net of allowance for doubtful accounts of 14,955 and 15,714 at, respectively 153, ,290 Other receivables 50,310 70,908 Assets limited as to use required for current liabilities Inventory 10,565 9,486 Other current assets 10,994 8,531 Total current assets 1,276,757 1,131,526 Assets limited as to use, net of current portion 51,180 76,425 Property and equipment, net 487, ,900 Investments, noncurrent 126, ,401 Other assets 40,140 35,860 Total 1,982,131 1,818,112 Liabilities and Net Assets Current liabilities: Accounts payable and accrued expenses 95, ,031 Accrued salaries and related benefits 48,000 42,614 Current portion of long-term debt 9,701 3,093 Deferred revenue 14,780 11,408 Total current liabilities 167, ,146 Long-term debt, net of current portion 372, ,050 Interest rate swaps 66,799 97,192 Other long-term liabilities 103, ,630 Payable to beneficiaries under deferred giving arrangements 1,001 1,262 Total liabilities 710, ,280 Net assets: Unrestricted 1,184, ,909 Temporarily restricted 55,881 45,827 Permanently restricted 31,237 30,096 Total net assets 1,271,601 1,050,832 Total 1,982,131 1,818,112 See accompanying notes to consolidated financial statements. 3

6 Consolidated Statements of Operations and Changes in Net Assets Years ended Operating revenues: Net patient service revenue before provision for bad debts 737, ,408 Provision for bad debts (12,524) (8,621) Net patient service revenue 724, ,787 Provider fee program 37,633 69,712 Premium revenue 156, ,348 Grants and contracts 42,105 39,143 Other government revenue 31,332 31,118 Physician management services revenue 47,793 44,266 Other revenue 37,055 38,964 Net assets released from restrictions used for operations 15,658 7,602 Total operating revenues 1,092,965 1,058,940 Operating expenses: Salaries and employee benefits 452, ,036 Supplies 125, ,332 Professional fees 218, ,976 Purchased services 131, ,899 Provider fee program 16,763 21,651 Insurance 9,809 10,053 Depreciation and amortization 40,642 40,326 Interest 15,668 17,239 Other 39,203 40,842 Total operating expenses 1,049, ,354 Operating income 43,268 73,586 Nonoperating income (expenses): Contributions 8,101 10,635 Fundraising expenses (9,266) (7,587) Change in fair value of interest rate swaps 30,393 (35,492) Investment income (loss), net 110,731 (5,847) Loss on extinguishment of debt (1,277) Income tax (expense) benefit (280) 477 Excess of revenue over expenses 182,947 34,495 4

7 Consolidated Statements of Operations and Changes in Net Assets Years ended Unrestricted net assets: Excess of revenues over expenses 182,947 34,495 Third-party funding for property and equipment 5,348 6,444 Matching program of temporarily restricted funds (2,930) (118) Net assets released from restrictions used for purchase of property and equipment Change in unrecognized defined benefit plan cost not yet recognized in net periodic benefit cost 23,372 (50,070) Increase (decrease) in unrestricted net assets 209,574 (8,783) Temporarily restricted net assets: Contributions 21,171 10,658 Matching program of temporarily restricted funds 2, Permanent restriction of previously temporarily restricted funds (321) Change in value of split-interest agreements 64 (121) Investment income (loss), net 2,705 (205) Net assets released from restrictions (16,495) (8,068) Increase in temporarily restricted net assets 10,054 2,382 Permanently restricted net assets: Contributions ,810 Investment income, net 32 Permanent restriction of previously temporarily restricted funds 321 Increase in permanently restricted net assets 1,141 12,810 Total increase in net assets 220,769 6,409 Net assets at beginning of year 1,050,832 1,044,423 Net assets at end of year 1,271,601 1,050,832 See accompanying notes to consolidated financial statements. 5

8 Consolidated Statements of Cash Flows Years ended Cash flows from operating activities: Increase in net assets 220,769 6,409 Adjustments to reconcile increase in net assets to net cash provided by operating activities: Third-party funding for property and equipment (5,348) (6,444) Change in unrecognized defined benefit plan cost not yet recognized in net periodic benefit cost (23,372) 50,070 Depreciation and amortization 40,642 40,326 Amortization of debt issuance costs and discount (1,176) (79) Provision for bad debts 12,524 8,621 Net realized and unrealized losses on investments (103,991) 16,790 Change in fair value of interest rate swaps (30,393) 35,492 Contributions restricted to property and endowments (910) (14,023) Loss on disposal of property and equipment Loss on extinguishment of debt 1,277 Changes in assets and liabilities: Patient accounts receivable (54,492) (14,383) Other receivables 20,598 (6,264) Inventory (1,079) (300) Other current assets (2,463) (3,009) Interest rate swap collateral 21,562 (22,956) Other assets (4,385) (5,663) Accounts payable and accrued expenses (6,798) (6,088) Accrued salaries and related benefits 5,386 1,018 Deferred revenue 3,372 10,132 Other long-term liabilities ,831 Payable to beneficiaries under deferred giving arrangements (261) (430) Net cash provided by operating activities 91, ,764 Cash flows from investing activities: Purchases of trading investments (572,269) (464,028) Proceeds from sales and maturities of trading investments 539, ,781 Acquisition of property and equipment (55,356) (47,250) Decrease (increase) in assets limited as to use 3,735 (3,258) Net cash used in investing activities (84,610) (188,755) Cash flows from financing activities: Cash received for contributions restricted to property and endowments ,023 Cash received from third-party for property and equipment 5,348 6,444 Payment of long-term debt issuance costs (993) Net proceeds from issuing long-term debt 61,553 Repayment of long-term debt (3,093) (70,846) Changes in short-term borrowings: Proceeds from working capital line of credit 5, Repayments of working capital line of credit (5,000) (235) Net cash provided by financing activities 3,165 10,181 Net increase (decrease) in cash and cash equivalents 9,713 (70,810) Cash and cash equivalents, beginning of year 6,483 77,293 Cash and cash equivalents, end of year 16,196 6,483 Supplemental disclosures of cash flow information: Interest paid during the year, net of amounts capitalized 16,188 18,234 Property additions recorded in accounts payable 4,817 6,000 See accompanying notes to consolidated financial statements. 6

9 (1) Organization Rady Children s Hospital and Health Center (RCHHC) is an academic integrated pediatric health care system that is the primary provider of pediatric hospital services and the sole pediatric trauma center serving San Diego and Imperial Counties. RCHHC also serves as a tertiary and quaternary referral center for treatment of critically ill and seriously injured children throughout the Southwestern United States. The mission of RCHHC is to restore, sustain and enhance the health and developmental potential of children through excellence in care, education, research and advocacy. RCHHC is dedicated to providing the best health care for its patients and serving as a valuable community resource to improve the health and well-being of children in the community. RCHHC is the sole member of the following not-for-profit, tax-exempt entities, which are referred to in these consolidated financial statements as the affiliates of RCHHC: Rady Children s Hospital San Diego (RCHSD) Rady Children s Hospital Foundation San Diego (the Foundation) Rady Children s Hospital Research Center (RCHRC) doing business as Rady Children s Institute for Genomic Medicine (RCIGM) During the fiscal year ended June 30, 2017, Rady Children s Health Services San Diego (RCHSSD), a not-for-profit, tax exempt entity changed its sole member from RCHHC to RCHSD. In addition, RCHHC owns the following for-profit subsidiaries: Children s Hospital Integrated Risk Protective Limited (CHIRPL) Rady Children s Physician Management Services, Inc. (RCPMS) A brief description of each of the entities follows: Rady Children s Hospital and Health Center was formed to acquire, establish, maintain, conduct, operate, raise funds for, and otherwise support, directly or indirectly through its affiliates, facilities, and programs for the benefit of children and adults with diseases, disorders, and other health problems of pediatric origin, including providing resources for charity care, research, and education. To further its mission, RCHHC solicits and receives grants and donations to be used to promote and advance the activities of its affiliates. Rady Children s Hospital San Diego provides comprehensive inpatient acute and intensive care and outpatient pediatric services. RCHSD is composed of the acute care hospital, with 524 licensed beds at June 30, 2017, including neonatal intensive care and pediatric medical/surgical beds at its main location and at joint venture sites operated under its license; the convalescent hospital, with 43 licensed skilled nursing and subacute care beds at June 30, 2017; the inpatient child and adolescent psychiatric services program, with 24 licensed beds at June 30, 2017; Children s Emergency Transport (CHET) that provides 24-hour emergency pediatric and neonatal critical care transport; and a home care program with a home health agency and home infusion pharmacy services to address the ongoing health needs of newborns, infants, and pediatric patients in the home-based setting. RCHSD is the sole Level I Pediatric Trauma Center serving San Diego and Imperial Counties. RCHSD also provides 7

10 numerous programs that benefit the community through various departments, including Developmental Services, Chadwick Center for Children and Families, and Center for Healthier Communities. The majority of RCHSD s outpatient pediatric care services are provided through its medical practice foundation, Rady Children s Specialists of San Diego (RCSSD), which is an operating division of RCHSD formed in September RCSSD was established in collaboration with Children s Specialists of San Diego (CSSD) and the University of California, San Diego School of Medicine Department of Pediatrics (UCSD) in compliance with California Health and Safety Code, Sections 1206(g) and 1206(l). Pursuant to a Professional Services Agreement (PSA) and an Administrative Services Agreement (ASA) between RCSSD and CSSD, CSSD provides physicians and other medical professionals to perform clinical professional services and administrative services for RCSSD. RCSSD provides facilities, personnel and equipment for the outpatient clinics. Revenue for clinical services is included as a component of patient revenue and premium revenue in the accompanying consolidated statements of operations and changes in net assets. The PSA is a 10-year agreement that provides that the compensation provisions are negotiated every three years. RCSSD incurred operating expenses, including compensation paid under the PSA and ASA, of 193,113 and 181,518 for the 12 months ended, respectively. In March 2014, RCHSD established an integrated delivery system through an operating division known as Rady Children s Health Network (RCHN) to maintain a network of professional pediatric health care providers to satisfy the terms of global professional managed care contracts with various health plans. RCHN assumed an existing Integrated Delivery System Professional Services Agreement (IDS PSA) between RCSSD and unrelated medical groups. Pursuant to the IDS PSA, RCHN also entered into reimbursement agreements with various health plans. RCHSD is the largest entity within RCHHC and constituted approximately 96% and 100% of the consolidated RCHHC total excess of revenues over expenses for the fiscal years ended June 30, 2017 and 2016, respectively, and 91% of the consolidated RCHHC total assets as of June 30, 2017 and Rady Children s Hospital Foundation San Diego was formed to advance, promote, raise funds for, and otherwise support the activities of RCHHC and its affiliates. Funds are raised through major and planned gifts, corporate giving, community development, grants, and fundraising events. Also, the Foundation has a dedicated group of volunteers through its Hospital Foundation Auxiliary that supports RCHHC through its fundraising, advocacy, education, and outreach efforts. Rady Children s Hospital Research Center doing business as Rady Children s Institute for Genomic Medicine, engages in scientific medical research and conducts clinical research in diseases and disorders affecting children and adolescents. This research is primarily funded by philanthropic contributions, support from RCHSD, grants and contracts from government and private agencies. Rady Children s Health Services San Diego was initially formed to aid and assist RCHHC in carrying out the charitable purposes and programs of RCHHC and its affiliates. During the fiscal year ended June 30, 2017, this changed to aiding and assisting RCHSD in carrying out the charitable purposes and programs of RCHSD. 8

11 Children s Hospital Integrated Risk Protective Limited is a holding company for Children s Hospital Insurance Limited (CHIL). CHIL is an offshore captive insurance company domiciled in Bermuda, which underwrites the professional liability, general liability, and employment practices liability insurance risk exposures of RCHHC and its affiliates and subsidiaries. Rady Children s Physician Management Services, Inc. is a management services organization providing facilities, personnel, and management services to pediatric medical groups. Services include practice management, finance and accounting, patient billing and accounts receivable, centralized information systems, human resources, quality assurance, and risk management. (2) Affiliation with Health Related Organizations In 2001, RCHHC and RCHSD (collectively, Rady Children s) entered into a Joint Powers Affiliation Agreement with The Regents of the University of California (University) on behalf of UCSD to support their respective missions of community service, provision of acute care hospital and outpatient services to children, basic and clinical research, and medical education to students, residents, and fellows. Pursuant to the agreement, certain clinical services were transferred to Rady Children s. The corporate bylaws of RCHHC and RCHSD were amended to provide that one-third of the RCHHC Board of Trustees (the Board) and RCHSD Board of Directors shall be representatives of the University. The affiliation agreement provides for Rady Children s to make annual payments to UCSD to support UCSD s academic and clinical programs. RCHSD paid UCSD 29,963 and 31,535 in 2017 and 2016, respectively, for this support and various services purchased from UCSD. RCHSD received payments from UCSD of 7,028 and 7,273 in 2017 and 2016, respectively, for services provided to UCSD. As of June 30, 2017 and 2016, RCHSD s consolidated balance sheets include 5,571 and 3,575, respectively, of other receivables from UCSD and accounts payable and accrued expenses to UCSD of 18,991 and 20,590, respectively. (3) Summary of Significant Accounting Policies (a) Basis for Presentation The accompanying consolidated financial statements present the financial position, results of operations, changes in net assets, and cash flows of RCHHC and its affiliates after elimination of intercompany transactions and balances. Certain prior year amounts have been reclassified to conform to current year presentation. (b) Use of Estimates The preparation of financial statements in conformity with U.S. generally accepted accounting principles (U.S. GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Key estimates include valuation of patient accounts receivable, self-insured liabilities, fair value of investments, interest rate swap agreements, and pension obligations. 9

12 (c) Cash and Cash Equivalents For purposes of the consolidated financial statements, all cash and highly liquid investments with maturities of three months or less at the time of acquisition, other than holdings within the investment portfolio, are classified as cash and cash equivalents and are deposited in financial institution accounts that are federally insured in limited amounts. Cash equivalents potentially subject RCHHC to concentrations of credit risk to the extent amounts on deposit exceed the federally insured limits. RCHHC maintained cash balances in excess of federally insured limits by 28,408 and 24,821 as of, respectively. (d) Investments RCHHC classifies its investments as trading assets. All investments in debt securities and investments in equity securities with readily determinable fair values are measured at fair value in the consolidated balance sheets. Alternative investments, certain domestic equity funds, and fixed income funds are generally reported at the net asset value (NAV) reported by the investment managers, which is used as a practical expedient to estimate the fair value of RCHHC s interest therein, unless it is probable that all or a portion of the investment will be sold for an amount different from the NAV. As of June 30, 2017 and 2016, RCHHC had no plans or intentions to sell any of the investments at amounts significantly different from the NAV. Because alternative investments are not readily marketable, their estimated value is subject to uncertainty and may differ from the value that would have been used had a ready market for such investments existed. Such differences could be material. Investment income or loss (including interest, dividends, and realized and unrealized gains (losses) on investments) is included as nonoperating income (expenses) within excess of revenues over expenses unless the income or loss is restricted by donor or law, in which case the investment income or loss is recorded directly to temporarily or permanently restricted net assets. Investment transactions are recorded on a trade date basis using the specific identification method. (e) Inventory Inventory is valued at the lower of cost or market using the weighted average cost method. (f) Property and Equipment Property and equipment are recorded at cost when purchased or at fair market value if contributed. Improvements and replacements are capitalized and repairs and maintenance costs are expensed in the period incurred. Depreciation of assets is recorded on a straight-line basis over the shorter of the period in which the assets are estimated to be in service and of value to the organization or the lease term. RCHHC evaluates the carrying value of its property, equipment and other long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset, or related group of assets, may not be recoverable. When the carrying value of an asset exceeds the estimated recoverability, an asset impairment charge is recognized. As of June 30, 2017 and 2016, no impairment charge was recognized. 10

13 (g) Fair Value Estimates The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, accounts receivable, accounts payable, and accrued liabilities approximate fair value due to their short maturities. The fair value of investments is disclosed in note 5 and the fair value of debt and derivative financial instruments are disclosed in note 8. (h) Cost of Borrowing Interest expense is recorded as incurred; however, when money is borrowed for construction or renovation of facilities, the net interest cost on that debt during the period of construction is capitalized as part of the cost of the asset. Any interest income earned on tax-exempt borrowed funds during construction is accounted for as a reduction of capitalized interest cost. Interest expense, net of capitalized interest, is recorded as interest expense within operating income in the consolidated statements of operations and changes in net assets. Net interest rate swap payments are recorded within interest expense in the consolidated statements of operations and changes in net assets. Costs associated with issuing debt are presented in the balance sheet as a direct deduction from the carrying amount of the debt liability and amortized using a method that approximates the effective interest method. (i) Net Assets Net assets that are not restricted by donors are included in unrestricted net assets. Gifts of long-lived operating assets, such as property or equipment, are reported as direct additions to unrestricted net assets and are excluded from excess of revenues over expenses. Net assets restricted by donors for a specified time or purpose are reported as temporarily restricted net assets. Net assets that have been restricted by donors to be maintained in perpetuity are reported as permanently restricted net assets. (j) Performance Indicator RCHHC considers excess of revenues over expenses to be RCHHC s performance indicator. Excess of revenues over expenses includes all changes in unrestricted net assets except third-party funding for property and equipment, matching program of temporarily restricted funds, net assets released from restrictions used for purchase of property and equipment, and change in unrecognized defined benefit plan cost not yet recognized in net periodic benefit cost. (k) Contributions Donations and bequests are reported at fair value at the date of the donation as contributions. Conditional promises to give for which conditions have not been met, but a gift has been received, are reported at fair value as deferred revenue. When the condition is met or the promise becomes unconditional, the contribution is recognized. Gifts are reported as either temporarily or permanently restricted support if they are received with donor stipulations that limit the use of the donated assets. When a donor restriction expires, that is, when a stipulated time restriction ends or purpose restriction is accomplished, temporarily restricted net assets are reported in the consolidated statements of operations and changes in net assets as net assets released from restrictions. When a donor restriction expires on contributions restricted for the purchase of property and equipment, temporarily restricted 11

14 net assets are reported in the consolidated statements of operations and changes in net assets as net assets released from restrictions used for purchase of property and equipment. (l) Fundraising The Foundation conducts all fundraising activities on behalf of RCHHC and its affiliates. During the years ended, restricted and unrestricted contributions totaled 30,060 and 34,103, respectively. RCHHC periodically engages in fundraising campaigns whereby RCHHC matches every dollar donated to certain programs or activities. During the fiscal years ended, RCHHC matched 2,930 and 118. (m) Charity Care and Community Benefit RCHSD provides services without charge or at amounts less than its established rates to patients who meet certain criteria under its patient financial assistance and charity care policy. Because RCHSD does not pursue collection of amounts determined to qualify as charity care, these amounts are not reported as revenue. Cost of charity care is determined using a ratio of cost to gross charges. The estimated cost of charity care services provided during the years ended was 2,723 and 4,634, respectively. In addition to amounts provided for charity care, RCHHC also sponsors numerous educational and community outreach programs and provides pediatric public support within its service area. Some of these programs, which are referred to as community benefit, include child safety and injury prevention, pediatric dental services, trauma counseling, mental health counseling, high-risk infant clinic, developmental screening, family support, health referral services, pediatric research and clinical education. (n) Income Taxes RCHHC and most of its affiliates are organizations exempt from taxation under Section 501(c)(3) of the Internal Revenue Code and Section 23701d of the California Revenue and Taxation Code and are generally not subject to federal or state income taxes. However, RCHHC is subject to income taxes on any net income that is derived from a trade or business, regularly carried on, that is not in furtherance of the purpose for which it is granted exemption, or that is generated by any of its for-profit affiliates. Deferred tax assets and liabilities are recognized in other assets or liabilities, as applicable, for the estimated future tax effects attributable to temporary differences between the carrying costs of assets and liabilities for income tax reporting and financial statement purposes. RCHHC provides a valuation allowance against net deferred tax assets unless, based upon available evidence, it is more likely than not that the deferred tax assets will be realized. RCHHC recognizes and measures the tax benefit from uncertain tax positions only if it is more likely than not that the tax position will be sustained, based solely on its technical merits, with the taxing authority having full knowledge of all relevant information. RCHHC records liabilities for unrecognized tax benefits from uncertain tax positions as discrete tax adjustments in the first period that the more likely than not threshold is not met. 12

15 RCHHC is subject to routine audits by taxing jurisdictions; an Internal Revenue Service income tax audit is currently in progress for the fiscal year ending June 30, RCHHC believes it is no longer subject to income examinations for years prior to U.S. GAAP requires management to evaluate tax positions taken by RCHHC and recognize a tax liability (or asset) if the organization has taken an uncertain tax position that more likely than not would not be sustained upon examination by the Internal Revenue Service. RCHHC has not taken any significant uncertain tax positions; therefore, no liability (or asset) has been recognized as of June 30, (o) Recent Accounting Pronouncements In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No , Revenue from Contracts with Customers, (Topic 606). This pronouncement requires revenue recognition to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Management is currently evaluating the potential impact of this guidance, which is effective for RCHHC beginning July 1, In July 2015, the FASB issued ASU , Inventory (Topic 330): Simplifying the Measurement of Inventory, which changes the measurement principle for inventory from the lower of cost or market to lower of cost or net realizable value. The ASU also eliminates the requirement for these entities to consider replacement cost or net realizable value. Management is currently evaluating the potential impact of this guidance, which is effective for RCHHC beginning July 1, 2017 and does not expect it to have a material impact on RCHHC s consolidated financial statements. In November 2015, the FASB issued ASU , Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes, which requires entities with a classified balance sheet to present all deferred tax assets and liabilities as noncurrent. Management is currently evaluating the potential impact of this guidance, which is effective for RCHHC beginning July 1, 2018, and does not expect it to have a material impact on RCHHC s consolidated financial statements. In January 2016, the FASB issued ASU , Financial Instruments Overall (Subtopic ): Recognition and Measurement of Financial Assets and Financial Liabilities. This pronouncement will change the income statement impact of equity investments and the recognition of changes in fair value of financial liabilities when the fair value option is elected. Management is currently evaluating the potential impact of this guidance, which is effective for RCHHC beginning July 1, 2018 and does not expect it to have a material impact on RCHHC s consolidated financial statements. In February 2016, the FASB issued ASU , Leases, which, among other things, requires lessees to recognize most leases on the balance sheet. Management is currently evaluating the potential impact of this guidance, which is effective for RCHHC beginning July 1, In August 2016, the FASB issued ASU , Presentation of Financial Statements of Not-for-Profit Entities, which changes how not-for-profit entities, including health care entities, report net asset 13

16 classes, expenses, and liquidity in their financial statements. Management is currently evaluating the potential impact of this guidance, which is effective for RCHHC beginning July 1, In November 2016, the FASB issued ASU , Statement of Cash Flows (Topic 230): Restricted Cash, which requires companies to include cash and cash equivalents that have restrictions on withdrawal or use in total cash and cash equivalents on the statement of cash flows. Management is currently evaluating the potential impact of this guidance, which is effective for RCHHC beginning July 1, In January 2017, the FASB issued ASU , Intangibles Goodwill and Other. This pronouncement eliminates the need to perform procedures to determine the fair value at the impairment test date of its assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets and liabilities assumed in a business combination. Management is currently evaluating the potential impact of this guidance, which is effective for RCHHC beginning July 1, In May 2017, the FASB issued ASU , Compensation Retirement Benefits, which requires the service cost component to be disaggregated from the other components of net benefit cost and allows only the service cost component of net benefit cost to be eligible for capitalization. Management is currently evaluating the potential impact of this guidance, which is effective for RCHHC beginning July 1, (4) Revenue (a) Net Patient Revenue RCHSD has agreements with third-party payors that provide for payments at amounts different from its established rates. Payment arrangements include per diem payments, per discharge payments, reimbursed costs, and discounted charges. Net patient revenue is reported at the estimated net realizable amounts from patients, third-party payors, and others for services rendered, including estimated settlements under reimbursement agreements with third-party payors. Settlements are accrued on an estimated basis in the period in which the related services are rendered and adjusted in future periods as final settlements are determined. RCHSD contracts with the State of California (the State) to provide acute hospital inpatient services to Medi-Cal beneficiaries, which are reimbursed using an All Patient Refined Diagnosis Related Group (APR-DRG) payment methodology. Outpatient services to Medi-Cal beneficiaries are reimbursed according to a State fee schedule. Convalescent hospital services are reimbursed by Medi-Cal at a rate per day, which is based on prior year costs that are subject to audit by the State, and is limited by the state median cost per day for similar facilities. All applicable Medi-Cal program cost reports for hospital services have been audited by the State through Accounts receivable from Medi-Cal and California Children s Services (CCS) represented 19% and 28% of patient accounts receivable as of, respectively. 14

17 RCHSD recognizes significant amounts of patient service revenue at the time the services are rendered even though a patient s ability to pay is not yet assessed. RCHSD records its provision for bad debts based upon historical experience, as well as collection trends for major payor types. Patient service revenues, net of contractual allowances and discounts, recognized for the years ended June 30 are as follows: 2017 Gross patient revenue: Government Commercial Self-pay and others Contractual allowances and discounts Net patient revenue before provision for bad debts 1,564,534 1,064,686 49,639 1,499, ,449 34,322 2,678,859 2,467,676 (1,941,407) (1,785,268) 737,452 Provision for bad debts (12,524) Net patient revenue , ,408 (8,621) 673,787 RCHSD recognizes patient service revenue associated with services provided to patients who have third-party payor coverage on the basis of contractual rates for the services rendered. For uninsured patients that do not qualify for charity care, RCHSD recognizes revenue on the basis of its standard rates for services provided, or on the basis of discounted rates if negotiated or provided by policy. On the basis of historical experience, a significant portion of RCHSD s uninsured patients are unable or unwilling to pay for the services provided. Thus, RCHSD records a provision for bad debts related to uninsured patients in the period services are provided. Patient service revenue, net of contractual allowances and discounts (but before the provision for bad debts), recognized for the years ended June 30 are as follows: 2017 Revenue (net of contractual allowances and discounts): Third-party payors Self-pay Total ,560 17, ,802 10, , ,408

18 The self-pay reserves as a percentage of self-pay accounts receivable were 73% and 67% for the years ended, respectively. The increase is due to lower charity care recognition for the self-pay population. The allowance for doubtful accounts as a percentage of accounts receivable decreased to 9% from 12% between fiscal years 2017 and In addition, the amounts written off related to bad debt were 13,220 and 3,289 for the years ended June 30, 2017 and 2016, respectively. The increase is due to lower charity care recognition during the year ended June 30, RCHSD did not change its charity care or discount policies during fiscal years 2017 and (b) Premium Revenue RCHSD, RCSSD, and RCHN have agreements with health maintenance organizations to provide pediatric health care services to enrollees. Under these agreements, RCHSD, RCSSD, and RCHN have negotiated monthly capitation payments based on the number of enrollees, regardless of services actually performed. (c) Provider Fee Program The State enacted legislation for a hospital provider fee program that assesses provider fees on California hospitals to obtain federal matching funds that are then issued as supplemental Medi-Cal payments to hospitals. There have been four such programs. In connection with the implementation of the hospital fee program, the California Hospital Association (CHA) created a private program that aggregates and distributes financial resources to various California hospitals. RCHHC recognizes revenue and expenses in connection with each individual program in the period in which the Centers for Medicare and Medicaid Services (CMS) approves the program. Periodically, adjustments are recorded to reflect revisions in the estimated amounts to be paid or received under the program. Other receivables included 2,640 and 31,774 as of, respectively. Accounts payable and accrued expenses included zero and 6,692 as of, respectively. During the year ended June 30, 2017, RCHSD received 7,334 payments prior to the approval from CMS which were included in deferred revenue. 16

19 The following revenue and expenses have been recognized under these programs in the consolidated statements of operations and changes in net assets: 2017 Revenue Fee-for-service portion of a 30-month program beginning July 1, 2011 through December 31, 2013 Managed care portion of a 30-month program beginning July 1, 2011 through December 31, 2013 Fee-for-service portion of the program beginning January 1, 2014 through December 31, 2016 Managed care portion of a program beginning January 1, 2014 through December 31, Expense Revenue Expense 2,410 11,010 10,929 63,233 21,840 26,623 5,834 4,069 37,633 16,763 69,712 21,651 (189) (d) Grants and Contracts Advances received under various research grants and contracts are recorded as deferred revenue until the related research costs are incurred. RCHHC receives reimbursement for indirect costs on certain research grants and contracts based on a rate applied to direct costs. Direct and indirect costs reimbursed by the U.S. government and certain other agencies are subject to audit by such agencies. (e) Other Government Revenue RCHSD qualifies as a disproportionate share hospital under State Senate Bill 855 (SB 855) and receives related funding from the State. RCHSD also receives from the State supplemental funding for emergency services and patient care (SB 1100) and funds for the reimbursement of certain capital project financing costs (SB 1732). RCHSD also participates in the federal Children s Hospital Graduate Medical Education (CHGME) program, which provides funds to freestanding children s hospitals to support the training of pediatric and other residents. RCHSD is no longer participating in the Medi-Cal Electronic Health Record (EHR) Incentive Program (also known as Meaningful Use funding) after receiving four annual payments. 17

20 Other government revenue for the years ended includes the following: 2017 SB 1100 Hospital supplemental payment program SB 855 Disproportionate Share Hospital program SB 1732 Capital project financing program CHGME Medi-Cal EHR incentive program Other Total other government revenue ,175 9,587 1,681 4, ,088 9,743 1,976 3, ,332 31,118 (f) Physician Management Services Revenue Revenue from services provided by RCPMS to pediatric medical groups represents management fees and payments for the costs incurred in the operation of the practices. (5) Fair Value The fair value of certain assets and liabilities has been estimated using available market information and appropriate valuation methodologies. A fair market value hierarchy for valuation inputs has been established to prioritize the valuation inputs into three levels based on the extent to which inputs used in measuring fair value are observable in the market. Each fair value measurement is reported in one of three levels, which is determined by the lowest level input that is significant to the fair value measurement in its entirety. These levels are as follows: Level 1 inputs are quoted prices (unadjusted) available in active markets for identical assets or liabilities as of the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are generally unobservable for the asset or liability and include situations where there is little, if any, market activity for the investment. The inputs into the determination of fair value require management s judgment or estimation of assumptions that market participants would use in pricing the assets or liabilities. The fair values are, therefore, determined using factors that involve judgment including private and public comparables, third-party appraisals, discounted cash flow models, and fund manager estimates. RCHHC adopted, and retrospectively applied, the provisions of Accounting Standards Update (ASU) , Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent). ASU amends ASC Topic No. 820, Fair Value Measurement, to remove the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value (NAV) per share practical expedient. 18

21 The fair value of RCHHC s assets and liabilities measured on a recurring basis at June 30, 2017 consists of the following: Quoted prices in active markets for identical assets (Level 1) Assets: Investments: Cash and cash equivalents Common and preferred stocks Domestic equity funds International equity funds Fixed income funds Alternative investments Real assets and other Investments measured at NAV: Cash and cash equivalents Common and preferred stocks Domestic equity funds International equity funds Fixed income funds Alternative investments Real assets and other Total liabilities Total balance at June 30, ,353 99, ,305 16, , , ,483 2,484 48, ,709 62, , , ,528 1,161, ,396 43, ,396 43,630 1,673 1, , , ,528 1,215,747 (66,799) (66,799) (66,799) (66,799) Funds under indenture agreement, held by trustee Restricted cash Swap collateral fund held by trustee Charitable gift annuities, trusts, and other, held by trustee Trustee held assets valued at NAV: Charitable gift annuities, trusts, and other, held by trustee Split-interest agreements, held by trustees Liabilities: Interest rate swaps Significant unobservable inputs (Level 3) 16, , ,178 2,484 Total investments Total assets Significant other observable inputs (Level 2) 19

22 The fair value of RCHHC s assets and liabilities measured on a recurring basis at June 30, 2016 consists of the following: Quoted prices in active markets for identical assets (Level 1) Assets: Investments: Cash and cash equivalents Common and preferred stocks Domestic equity funds International equity funds Fixed income funds Alternative investments Real assets and other Investments measured at NAV: Cash and cash equivalents Common and preferred stocks Domestic equity funds International equity funds Fixed income funds Alternative investments Real assets and other Total liabilities Total balance at June 30, , ,844 72,869 4, , , ,223 2,334 83,074 71, , , ,426 1,025, ,430 65, ,430 65,192 1,251 1, , , ,426 1,103,966 (97,192) (97,192) (97,192) (97,192) Funds under indenture agreement, held by trustee Restricted cash Swap collateral fund held by trustee Charitable gift annuities, trusts, and other, held by trustee Trustee held assets valued at NAV: Charitable gift annuities, trusts, and other, held by trustee Split-interest agreements, held by trustees Liabilities: Interest rate swaps Significant unobservable inputs (Level 3) 4, , , ,354 2,334 Total investments Total assets Significant other observable inputs (Level 2) There were no transfers to or from Level 1, 2, or 3 during the years presented. 20

23 Significant Level 2 and Level 3 instruments listed in the fair value hierarchy tables above use the following valuation techniques and inputs: Domestic equity funds, international equity funds, and fixed income funds consist of marketable securities such as U.S. and foreign equity securities, government securities, and corporate bonds. Where identical quoted market prices are not readily available, fair value is determined using quoted market prices and/or other market data for comparable instruments and transactions in establishing prices, as well as discounted cash flows models and other pricing models. These inputs to fair value are included in industry-standard valuation techniques such as the income or market approach. RCHHC classifies such investments as Level 2. For assets such as alternative investments, which comprise private equity and hedge funds, fair value is determined using NAV as fair value based on pricing that is not readily determinable. The value of underlying investments of private equity or hedge funds includes estimates determined based on recent filings, operating results, balance sheet stability, growth, and other business and market sector fundamentals. The fair value of interest rate swap instruments classified as Level 2 is determined using an industry standard valuation model that is based on a market approach. A credit risk spread (in basis points) is added as a flat spread to the discount curve used in the valuation model. Each leg is discounted and the difference between the present value of each leg s cash flows equals the market value of the swap. The fair value also considers the risk of each counterparty by including a credit valuation adjustment determined by taking into account the nonperformance risk of each counterparty to the swap. The following table and explanations identify attributes relating to the nature and risk of RCHHC investments valued at NAV as of : Fair value 2017 Domestic equity funds International equity funds Fixed income funds Alternative investments: Fixed income hedge funds Fixed income hedge funds Fixed income hedge funds Global macro Global macro Equity long/short hedge funds Equity long/short hedge funds Equity long/short hedge funds Equity long/short hedge funds Event driven hedge funds 2016 Redemption frequency Redemption notice period 48, ,709 62,915 83,074 71,112 Monthly Monthly Monthly 1 day 1 day 1 90 days ,066 24,298 24,550 26,856 27,292 57,916 48,912 18,598 44, ,551 20,518 16,201 22,062 24,757 49,770 17,388 16,796 39,003 Monthly Quarterly Rolling three years Monthly Quarterly Monthly Quarterly Rolling one year Rolling two years Quarterly 1 day 85 days 90 days days 90 days 90 days days 180 days 65 days 65 days 21

24 Fair value 2017 Private equity funds Real assets Real assets Total alternative investments Real assets and other Total Investments valued at NAV (1) ,370 20,457 22,648 52,740 10,197 20, , , , ,527 Redemption frequency Redemption notice period Illiquid(1) Illiquid(1) Monthly N/A N/A 30 days Daily 1 day These categories include private equity and real assets funds that invest in a variety of investment groups including venture capital, leveraged buyout, real estate, infrastructure and other strategies. In connection with these funds, RCHHC, as limited partner, is committed to invest amounts subscribed to by agreement. The aggregate amount of these capital commitments is 197,755 and 184,793 at, respectively, of which 112,144 and 107,387 have been funded as of, respectively. As of June 30, 2017, it is estimated that these funds will be liquidated within the next two to 12 years, and they are classified as noncurrent investments. Fair value estimates are made at a specific point in time and are based on relevant market information about the financial instrument. Changes in assumptions could significantly affect these estimates. Since the fair value is estimated as of June 30, 2017, the amounts that will actually be realized or paid at settlement or maturity of the instruments could be significantly different. (6) Investments and Assets Limited as to Use At, the fair value of investments and assets limited as to use is summarized as follows: 2017 Cash Common and preferred stocks Domestic equity funds International equity funds Fixed income funds Alternative investments Real assets and other Less assets limited as to use Total investments 22 66, , , , ,022 3,105 (51,408) 1,161, , , , , ,151 2,540 (76,569) 1,025,085

25 At, assets limited as to use are held for the following purposes: 2017 Under indenture agreement, held by trustee Restricted cash Interest rate swap collateral Charitable gift annuities, held by trustee Executive compensation, held by trustee Total assets limited as to use, including current portion ,396 43, , ,430 65, ,024 51,408 76,569 For the years ended, investment income (loss) comprises the following: 2017 Unrestricted: Interest and dividends Net realized gains on investments Net unrealized gains (losses) on investments Total Restricted: Interest and dividends Net realized gains on investments Net unrealized gains (losses) on investments Total ,271 43,703 57,757 10,484 26,281 (42,612) 110,731 (5,847) 206 1,060 1, (1,006) 2,737 (205)

26 (7) Property and Equipment, Net As of, property and equipment are summarized as follows: Useful lives Buildings and improvements Equipment 5 40 years 5 15 years 2017 Less accumulated depreciation Land Construction in progress Property and equipment, net , , , , , ,483 (408,850) (379,376) 428, ,107 19,591 38,760 19,591 56, , ,900 Depreciation expense for the years ended was 40,537 and 40,221, respectively, and no interest was capitalized for the years ended. (8) Debt As of, long-term debt is summarized as follows: 2017 Under the master trust indenture: Variable Rate Revenue Bonds, Series 2008A due in varying installments to 2047; interest payable weekly at a variable rate (weighted average of 1.07% and 0.79% for the years ended, respectively) Variable Rate Revenue Bonds, Series 2008B due in varying installments to 2047; interest payable monthly at a variable rate (weighted average of 1.05% and 0.84% for the years ended, respectively) Variable Rate Revenue Bonds, Series 2008C due in varying installments to 2036; interest payable weekly at a variable rate (weighted average of 1.06% and 0.59% for the years ended, respectively) Variable Rate Revenue Bonds, Series 2008D due in varying installments to 2041; interest payable monthly at a variable rate (weighted average of 1.03% and 0.78% for the years ended, respectively) ,305 62,715 63,320 63,765 50,575 50,575 50,580 50,580

27 2017 Fixed Rate Revenue Bonds, Series % to 5.50% serial and term bonds, payable in varying installments to 2041; interest payable semiannually Fixed Rate Insured Revenue Bonds, Series 2016A 3.00% to 5.00% serial and term bonds, payable in varying installments to 2024; interest payable semiannually Fixed Rate Insured Revenue Bonds, Series 2016B 5.00% term bond, sinking fund payments due beginning in 2024 and maturing in 2028; interest payable semiannually Other: Medical office building mortgage payable due in monthly installments to 2017; interest payable at a fixed rate of 6.32% Plus: Premium, net of accumulated amortization Less: Current portion of long-term debt Deferred issuance costs Long-term debt ,575 95,265 28,900 28,900 23,060 23,060 3,586 4, , ,994 8,039 9,480 (9,701) (2,066) (3,093) (2,331) 372, ,050 Based on the borrowing rates currently available to RCHHC for financing with similar terms and average maturities, the estimated fair value of long-term debt was 390,343 and 403,610 as of June 30, 2017 and 2016, respectively. The Obligated Group members, RCHHC and RCHSD, are subject to certain debt covenants, including restrictions on additional indebtedness under the master trust indenture, supplemental indentures, bank reimbursement agreements, and line of credit agreements. The debt issued under the master trust indenture is secured by Obligated Group gross revenues as defined in the master trust indenture. The Obligated Group constituted approximately 95% and 96% of the consolidated RCHHC total revenues for the fiscal years ended. The Obligated Group constituted 94% of the consolidated RCHHC total assets as of. In July 2008, RCHHC issued 230,000 of variable rate revenue bonds (Series 2008A, 2008B, 2008C, and 2008D) with various maturities through A portion of the bond proceeds was placed in an irrevocable trust and, pursuant to an escrow agreement, was used to purchase government securities to advance refund outstanding bond obligations totaling 225,659, to finance bond issuance costs of 2,109, and to finance a portion of certain total return swap termination payments. 25

28 The Series 2008A, 2008B, 2008C, and 2008D bond indentures allow the bondholders to put the bonds back to RCHHC. In April 2012, RCHHC elected to execute early extensions of the 2008A and 2008C letters of credit and to replace the 2008B and 2008D letters of credit with direct purchase agreements. In September 2013, RCHHC elected to replace the 2008A letter of credit with a direct purchase agreement. Under the direct purchase agreements, mandatory tenders of the 2008A, 2008B and 2008D bonds were required, pursuant to provisions for a purchase in lieu of redemption in the bond indentures. The tenders allowed for the bonds to be obtained from the existing bondholders and sold to the direct purchase banks. The direct purchase agreements expire in September 2018 for the 2008A and 2008B debt series, and August 2021 for the 2008D debt series. There was no material financial statement impact due to these transactions. As of June 30, 2017, under the letter of credit related to the 2008C bonds, to the extent that amounts are drawn on the letter of credit, the outstanding balance commences amortization on the earlier of 367 days after the advance is made, if the advance has not been repaid in those 367 days, or the termination date of the letter of credit. Quarterly payments on the advance, along with accrued interest, are then due through three years after the advance, or when a substitute letter of credit or other liquidity facility is put in place, or if the bonds are converted. Additionally, amounts become due in the event of default. The 2008C letter of credit expires July In November 2011, Rady Children s issued 100,000 of fixed rate revenue bonds with various maturities through A portion of the bond proceeds is to finance and refinance the costs of acquisition, construction, improvement and/or equipping of certain health facilities owned and/or operated by RCHHC, and a portion was used to finance bond issuance costs of 1,611. In May 2016, RCHHC issued 51,960 of fixed rate revenue bonds (Series 2016A and 2016B) with various maturities through A portion of the bond proceeds was placed in an irrevocable trust and, pursuant to an escrow agreement, was used to purchase government securities to advance refund the Series 2006A and 2006B fixed rate bonds, and a portion was used to finance bond issuance costs of 993. Based on the terms of the trust and escrow agreements, the advance refunded debt is considered to have been legally defeased, and accordingly, the previously outstanding bonds and trust assets were removed from the consolidated balance sheet. RCHHC recorded a loss on early extinguishment of debt of 1,

29 The scheduled repayment of principal for all long-term debt according to the original bond amortization schedule and the scheduled repayments should the bond credit facility be utilized, as of June 30, 2017, is as follows: Bond amortization schedule Fiscal year ending June 30: Thereafter Total Credit facility terms 9,701 6,795 7,030 7,270 7, ,985 9, ,635 6,100 56,890 56, , , ,901 RCHHC utilizes derivative financial instruments, specifically interest rate swaps, to manage the fixed and variable interest rate mix and the related interest rate risk on the overall cost of long-term debt. RCHHC does not use financial instruments for trading purposes. In March 2015 and April 2016, RCHHC novated and restructured swap agreements totaling 127,285 and 100,000, increasing collateral threshold limits with no change to the notional value of the interest rate swaps. As of, RCHHC was party to eight total return swap agreements, with notional amounts totaling 225,625 and 226,480, respectively. RCHHC pays interest to the swap counterparties at an average fixed rate of 3.49% and 3.48%, respectively, as of and, in return, receives interest at a variable rate equal to a percentage of one-month LIBOR. Both RCHHC and the counterparty have the right to terminate the agreements prior to maturity. The net amount paid (received) under the swap agreements is recorded as interest expense (or a reduction thereof) in the consolidated statements of operations and changes in net assets. Net cash payments under the swaps totaled 6,820 and 7,375 for the years ended June 30, 2017 and 2016, respectively. The estimated fair value of the total return swap agreements is determined using available market information and valuation methodologies, considering both discounted cash flows and the current market value of the variable interest rate bonds. These instruments have not been designated as a cash flow hedge and, therefore, the change in fair value for the years ended is included in the excess of revenues over expenses in the accompanying consolidated statements of operations and changes in net assets. The fair value of the total return swap instruments was recorded in the consolidated balance sheets as a liability of 66,799 and 97,192 at, respectively. As of, RCHHC is required to collateralize the fair value of the interest rate swap agreements when the aggregate liability exceeds 15,000 for counterparty A. As of June 30, 2017 and 27

30 2016, RCHHC is required to collateralize the fair value of the interest rate swap agreements when the aggregate liability exceeds and 30,000 for counterparty B. Counterparty A is required to collateralize the fair value of the interest rate swap agreements when RCHHC is in an aggregate receivable position, counterparty B is required to collateralize the amount over 30,000 when RCHHC is an aggregate receivable position. The collateral posting thresholds are determined based on each counterparty s current credit rating. At, a swap collateral fund held by counterparty A of 43,630 and 65,192, respectively, was recorded as an asset limited as to use in the consolidated balance sheets. As of, RCHHC had a 20 million line of credit with a bank, pursuant to which revolving working capital loans could be obtained. Included as part of this credit facility were standby letters of credit, to guarantee payment of workers compensation claims, totaling and 9,075 as of June 30, 2017 and 2016, respectively. As of June 30, 2017, there were no amounts outstanding on this line of credit. RCHHC had a second credit facility pursuant to which revolving working capital loans could be obtained (allowing for a line of credit and letters of credit), with a second bank, for an additional 30 million as of June 30, As of June 30, 2017, there were no amounts outstanding on this working capital line of credit and there were no draws on the letters of credit. (9) Temporarily and Permanently Restricted Net Assets As of, temporarily restricted net assets are available for the following purposes: 2017 Specified health care services and education Capital projects Total ,952 3,929 41,963 3,864 55,881 45,827 During the years ended, temporarily restricted net assets were released from restrictions for the following purposes: 2017 Specified health care services and education Capital projects Total , , ,495 8,068 Permanently restricted net assets of 31,237 and 30,096 at, respectively, represent funds to be held in perpetuity. The income from such net assets is restricted for the care of indigent patients or to support health care services. (10) Endowments As of June 30, 2017, RCHHC s endowment consists of approximately 50 separate endowment funds, established for a variety of purposes, which are included in investments on the consolidated balance 28

31 sheets. The endowment includes both donor-restricted endowment funds and funds designated by the Board to function as endowments. Net assets associated with endowment funds, including funds designated by the Board to function as endowments, are classified and reported based on the existence or absence of donor-imposed restrictions. RCHHC has interpreted the California Uniform Prudent Management of Institutional Funds Act (UPMIFA) as requiring the preservation of the fair value of the original gift as of the gift date of the donor-restricted endowment funds absent explicit donor stipulations to the contrary. As a result of this interpretation, RCHHC classifies as permanently restricted net assets: (a) the original value of gifts donated to the permanent endowment and (b) the original value of subsequent gifts to the permanent endowment. The remaining portion of the donor-restricted endowment fund that is not classified in permanently restricted net assets is classified as temporarily restricted net assets until those amounts are allocated for expenditure by the organization in a manner consistent with the standard of prudence prescribed by the UPMIFA. RCHHC has investment and spending policies for endowment assets designed to provide a predictable stream of funding to programs supported by its endowment while seeking to maintain the purchasing power of the endowment assets. RCHHC targets a diversified asset allocation to achieve its long-term investment return objectives within prudent risk constraints. Investment policies, spending policies, and target asset allocations are reviewed annually. Changes in donor-restricted and board-designated endowment net assets for the years ended June 30, 2017 and 2016 are as follows: Temporarily restricted Permanently restricted 33,028 (649) (1,281) 3,507 (362) (621) 17,286 12,810 53,821 (1,011) 12,810 (1,902) Endowment net assets at June 30, ,098 2,524 30,096 63,718 Investment income, net Contributions Reclass for donor intent Releases for expenditures 3,267 (1,567) 2,577 (321) (436) 32,798 4,344 Unrestricted Endowment net assets at June 30, 2015 Investment income, net Contributions Releases for expenditures Endowment net assets at June 30, ,237 Total 5, (2,003) 68,379

32 (11) Employee Benefit Plans (a) Defined Benefit Pension Plan RCHHC has a noncontributory defined benefit pension plan (the Plan) covering substantially all employees hired prior to July 1, A participating employee s annual postretirement pension benefit is based on compensation, years of service, and social security benefits. RCHHC s funding policy is to contribute annually at least the required minimum amount as actuarially determined. RCHHC uses a June 30 measurement date for its defined benefit plan. The change in plan assets and the related change in benefit obligation as of and for the years ended are presented as follows: 2017 Change in benefit obligation: Projected benefit obligation, beginning of year Service cost Interest cost Actuarial (gain) loss Benefits paid Administrative expenses paid Plan change ,799 14,732 10,710 (5,236) (3,736) (689) 2, ,596 12,220 10,186 43,882 (2,434) (651) Projected benefit obligation, end of year 290, ,799 Change in plan assets: Fair value of plan assets, beginning of year Actual return on plan assets Employer contributions Benefits paid Administrative expenses paid 183,165 23,714 20,000 (3,736) (689) 186,356 (106) (2,434) (651) 222, ,165 (67,929) (88,634) (67,929) 88,276 (88,634) 111,648 20,347 23,014 Fair value of plan assets, end of year Net accrued benefit cost at end of year Amounts recognized in the consolidated balance sheets consist of: Other long-term liabilities Accumulated charge to unrestricted net assets Net amount recognized 30

33 The accumulated charge to unrestricted net assets as of June 30, 2017 represents charges arising from the defined benefit plan but not yet recognized as a component of net periodic benefit cost. The accumulated charge to unrestricted net assets of 88,276 at June 30, 2017 comprises 86,474 of unrecognized net actuarial losses and 1,802 of unrecognized prior service credit. During fiscal year 2018, approximately 6,414 is expected to be reclassified from the accumulated charge to unrestricted net assets to pension benefit cost. The accumulated benefit obligation for the Plan was 254,773 and 231,846 at June 30, 2017 and 2016, respectively. RCHHC implemented changes to the Plan effective July 1, Plan participants as of June 30, 2014 will continue to accrue benefits in the Plan and new employees as of July 1, 2014 will not be eligible to participate in the Plan but will, instead, participate in a 403(b) plan as described in note 11c. For the years ended, the actuarially computed net periodic benefit cost includes the following components: 2017 Service cost Interest cost Expected return on plan assets Net prior service cost amortization Net loss amortization Net periodic benefit cost ,732 10,710 (11,280) (64) 8,568 12,220 10,186 (11,090) (127) 5,135 22,666 16,324 The Plan s assumptions used to determine benefit obligations as of were as follows: 2017 Discount rate Rate of compensation increase 3.99 % % 3.50 The Plan s assumptions used to determine net periodic pension cost for the years ended June 30, 2017 and 2016 were as follows: 2017 Discount rate Expected long-term return on plan assets Rate of compensation increase 3.88 % %

34 The Plan s expected future benefit payments as of June 30, 2017 were as follows: Fiscal year ending June 30: through ,988 5,989 7,122 8,529 9,954 72,971 The basis used to determine the Plan s overall expected long-term rate of return on assets has been the historical results of a balanced portfolio. The Plan s investment strategy has been to diversify its portfolio and to have its assets managed by third-party professionals. The target and actual allocations for the Plan s assets by category are as follows as of June 30, 2017: Target Equity securities Debt securities Real assets Other 32 Actual 57 % % % 100 %

35 The fair value of RCHHC s pension investments as of June 30, 2017 consists of the following: Quoted prices in active markets for identical assets (Level 1) Investments: Cash and cash equivalents Domestic equity funds International equity funds Fixed income funds Investments measured at NAV: Cash and cash equivalents Domestic equity funds International equity funds Fixed income funds Alternative investments Total investments Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Total balance at June 30, ,075 30,583 28,850 25,412 37,996 34,819 3,075 25,412 68,579 63,669 23,829 16,380 21,510 62,508 98, ,454 The fair value of RCHHC s pension investments as of June 30, 2016 consists of the following: Quoted prices in active markets for identical assets (Level 1) Investments: Cash and cash equivalents Domestic equity funds International equity funds Fixed income funds Alternative investments Investments measured at NAV: Cash and cash equivalents Domestic equity funds International equity funds Fixed income funds Alternative investments Total investments Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Total balance at June 30, ,360 24,507 32,406 14,147 27,402 19, ,507 51,909 51,972 22,681 15,231 17,057 67,081 61, ,165 33

36 For a description of the levels used for valuation, information about the valuation techniques and inputs used to measure the fair value of plan assets, see discussion regarding fair value measurements in note 5. (b) Deferred Compensation and Savings Plans RCHHC has a deferred compensation plan established for senior management and a voluntary savings plan for certain management employees, whereby RCHHC contributes a percentage of eligible employees earnings. At, a liability related to these plans of 2,409 and 1,875, respectively, is included in accrued salaries and related benefits and other long-term liabilities. Included in assets limited as to use at are 1,439 and 1,024, respectively, of investments that have been placed in a trust to fund a portion of this liability (note 6). During the years ended, RCHHC recorded expenses for these plans of 1,135 and 859, respectively, which are included in salaries and employee benefits within the consolidated statements of operations and changes in net assets. (c) Retirement Savings Plan RCHHC has a voluntary 401(k) and 403(b) savings and investment plan. The 401(k) savings and investment plan is for RCPMS employees. Effective January 1, 2012, any employee who has completed 6 months of service and is 21 years of age is eligible to participate in the plan. RCPMS contributes 100% of the first 3% of base compensation that a participant contributed to the plan plus 50% of the next 2% of base compensation contributed by the participant. The 403(b) savings and investment plan is for substantially all RCHSD employees. For employees hired or rehired on or before June 30, 2014 who work more than 1,000 hours in a given year, RCHSD matches from 25% to 65% (based upon years of service) of the employee s 403(b) contributed amount, up to 8% of each participant s salary. For employees hired or rehired after June 30, 2014 who work more than 1,000 hours and are employed by RCHSD for at least 12 consecutive months and on the last day of the plan year, which is December 31, RCHSD will match 100% of the amount contributed by employees to their 403(b) accounts up to 3% of each participant s salary. Additionally, RCHSD may provide a discretionary nonelective contribution of not less than one percent. Employer contributions are subject to a three-year cliff vesting period and the employee must work 1,000 hours in each plan year to receive a year of service credit. For the years ended, RCHHC recorded expenses of 8,195 and 7,411 related to the match as well as other plan-related contributions in salaries and employee benefits within the consolidated statements of operations and changes in net assets. (12) Pledges Receivable Pledges that represent unconditional promises from donors to give cash and other assets to RCHHC are recorded at fair value as of the date the promise is received. RCHHC discounts pledges with expected payment terms of greater than one year, using interest rates ranging from 1.5% to 7.0%, as applicable at the time of the contribution. 34

37 Pledges receivable, net are included in other receivables (4,521 and 4,316, respectively), and in other assets (30,787 and 27,076, respectively), as of. Total unconditional pledges included in other receivables and other assets as of June 30, 2017 are as follows: Thereafter Less present value discount 4,415 3,825 3,670 2,904 1,771 36,103 (17,380) 35,308 (13) Conditional Pledge In July 2014, RCHHC received a pledge of 120,000 to advance its research program. The pledge includes 20,000 to be paid in five equal annual installments commencing in the fiscal year ended June 30, 2015, an estate gift of 50,000 to support research efforts and an estate gift of 50,000 to fund an endowment to support the research program. The pledge is subject to the organization achieving certain goals. RCHHC records the contributions when the gifts have been received and the conditions have been satisfied. During the fiscal years ended of, RCHHC received 4,000 and 8,000, and recognized 8,035 and 2,015 as contributions, respectively. As of June 30, 2017, 5,396 is reflected as a deferred contribution, which is included in deferred revenue on the consolidated balance sheets. (14) Functional Expenses RCHHC categorizes unrestricted operating expenses into two categories: health care services and general and administrative. Health care services include all expenses in departments that generate patient revenue. All other costs are referred to as general and administrative. For the years ended June 30, 2017 and 2016, the functional grouping of expenses is as follows: 2017 Health care services General and administrative Total , , , ,037 1,049, ,354

38 (15) Income Taxes Components of income tax expense (benefit) consist of the following: 2017 Current Deferred Total (51) 459 (936) 280 (477) RCHHC s effective income tax rate is lower than what would be expected if the federal statutory rate were applied to income before income taxes primarily because of certain expenses deductible for tax return purposes that are not deductible for financial reporting purposes, including permanent differences, changes in the valuation allowance, and other items. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The major temporary differences that give rise to the deferred tax assets and liabilities as of June 30, 2017 and 2016 are as follows: 2017 Depreciation Deferred lease costs Deferred revenue Vacation Compensation Net operating losses Valuation allowance Deferred tax asset , ,903 2,981 2,915 (1,857) (1,857) 1,124 1,058 In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets depends on the generation of future taxable income during the periods in which those temporary differences are deductible. Management considers the scheduled reversal of deferred tax liabilities (including the impact of available carryback and carryforward amounts), projected taxable income, and tax-planning strategies in making this assessment. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Realization of the gross deferred tax asset is dependent on generating taxable income in future years. 36

39 (16) Commitments and Contingencies (a) General, Employment Practices, Professional Liability Coverage and Workers Compensation RCHHC retained the first 1,500 liability per claim for hospital professional liability, the first 1,000 for general liability and the first 250 for employment practices liability in 2017 and 2016 (retention). RCHHC s retention for 2017 and 2016 was limited by an annual policy-year combined aggregate of 6,000 for general and hospital professional liability. RCHHC purchases reinsurance for losses in excess of the RCHHC retention, on a claims made per-claim and aggregate basis, for hospital and professional liability. Reinsurance contracts do not relieve RCHHC from its obligations to claimants. Failure of reinsurers to honor their obligations could result in losses to RCHHC; consequently, allowances are established for amounts deemed uncollectible. RCHHC evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. As of, 9,825 and 850 was included in other receivables related to losses recoverable from reinsurers, respectively. The reserve for estimated general, employment practices, and professional claims of 19,593 and 20,274 recorded in other long-term liabilities as of, respectively, includes estimates of the ultimate costs for both reported claims and for claims incurred but not reported, in accordance with actuarial projections or paid claims lag models based on past experience. RCHHC has a high dollar deductible workers compensation program. Annual workers compensation expense under this program is based on historical claims experience and projected losses. The actuarial estimates of incurred losses, including claims incurred but not reported, are recorded in other long-term liabilities of 11,483 and 11,173 as of, respectively. Other assets include the receivables associated with excess professional liability and workers compensation insurance recoveries of 6,503 and 5,960 as of, respectively. (b) Leases RCHHC leases real property and equipment under noncancelable operating leases expiring at various dates through Minimum future rental payments required by these leases as of June 30, 2017 are as follows: Fiscal year ending June 30: Thereafter Total 37 10,330 8,957 8,681 7,904 4,821 5,877 46,570

40 RCHHC s leases generally include annual escalation clauses and renewal options at the end of the lease term. Rental expense was 10,597 and 9,653 for the years ended, respectively, and is included in other expenses within the consolidated statements of operations and changes in net assets. (c) State Funding for Property and Equipment In 2008, the State enacted the Children s Hospitals Bond Act of 2008 (the 2008 Bond Act), whereby 980,000 is provided to improve and expand California children s hospitals, as well as to purchase new medical equipment for these hospitals. RCHSD is entitled to approximately 97,000 from the 2008 Bond Act, which is to be recognized and reported as third-party funding for property and equipment in the accompanying consolidated statements of operations and changes in net assets and cash flows when qualifying expenditures are reimbursed. RCHSD has been paid 5,348 and 6,444 for the years ended, respectively, and are included within the consolidated statements of operations and changes in net assets. As of June 30, 2017, approximately 19,487 remained available to RCHSD. (d) Legal RCHHC is a party to certain legal actions arising in the ordinary course of business. In the opinion of management, based upon current facts and circumstances known by RCHHC, resolution of these matters should not have a material adverse effect on RCHHC s consolidated financial statements. The health care industry is subject to numerous laws and regulations of federal, state, and local governments. Compliance with these laws and regulations can be subject to government review and interpretation, as well as regulatory actions unknown and unasserted at this time. Government activity has continued with respect to investigations and allegations concerning possible violations of regulations by health care providers that could result in the imposition of significant fines and penalties, as well as significant repayment of previously billed and collected revenues for patient services. Management believes that RCHHC is in compliance with applicable fraud and abuse regulations, as well as other applicable government laws and regulations. Compliance with such laws and regulations can be subject to future government review and interpretation, as well as regulatory actions unknown or unasserted at this time. (17) Subsequent Events RCHHC completed its evaluation for subsequent events through September 25, 2017, the date the consolidated financial statements were available to be issued. 38

41 KPMG LLP Suite Executive Drive San Diego, CA Independent Auditors 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 The Board of Trustees Rady Children s Hospital and Health Center: 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 Rady Children s Hospital and Health Center and subsidiaries (RCHHC), which comprise the consolidated balance sheet as of June 30, 2017, and the related consolidated statements of operations, changes in net assets, and cash flows for the year then ended, and the related notes to the consolidated financial statements, and have issued our report thereon dated September 25, Internal Control Over Financial Reporting In planning and performing our audit of the consolidated financial statements, we considered RCHHC 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 RCHHC s internal control. Accordingly, we do not express an opinion on the effectiveness of RCHHC 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 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. Compliance and Other Matters As part of obtaining reasonable assurance about whether RCHHC s consolidated 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. 39 KPMG LLP is a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity.

42 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 RCHHC s internal control or on compliance. This report is an integral part of an audit performed in accordance with Government Auditing Standards in considering RCHHC s internal control and compliance. Accordingly, this communication is not suitable for any other purpose. San Diego, California September 25,

43 KPMG LLP Suite Executive Drive San Diego, CA Independent Auditors Report on Compliance for Each Major Federal Program; Report on Internal Control over Compliance; and Report on Schedule of Expenditures of Federal Awards Required by the Uniform Guidance The Board of Trustees Rady Children s Hospital and Health Center: Report on Compliance for Each Major Federal Program We have audited Rady Children s Hospital and Health Center and subsidiaries (RCHHC) compliance with the types of compliance requirements described in the OMB Compliance Supplement that could have a direct and material effect on each of RCHHC s major federal programs for the year ended June 30, RCHHC s major federal programs are identified in the summary of auditors results section of the accompanying schedule of findings and questioned costs. Management s Responsibility Management is responsible for compliance with federal statutes, regulations, and the terms and conditions of its federal awards applicable to its federal programs. Auditors Responsibility Our responsibility is to express an opinion on compliance for each of RCHHC s major federal programs 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 RCHHC 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 each major federal program. However, our audit does not provide a legal determination of RCHHC s compliance. Opinion on Each Major Federal Program In our opinion, Rady Children s Hospital and Health Center complied, in all material respects, with the types of compliance requirements referred to above that could have a direct and material effect on each of its major federal programs for the year ended June 30, Other Matters The results of our auditing procedures disclosed an instance of noncompliance, which is required to be reported in accordance with the Uniform Guidance and which is described in the accompanying schedule of findings and questioned costs as item, Our opinion on each major federal program is not modified with respect to this matter. 41 KPMG LLP is a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity.

44 RCHHC s response to the noncompliance finding identified in our audit is described in the accompanying schedule of findings and questioned costs. RCHHC s response was not subjected to the auditing procedures applied in the audit of compliance, and accordingly, we express no opinion on the response. Report on Internal Control over Compliance Management of RCHHC 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 RCHHC s internal control over compliance with the types of requirements that could have a direct and material effect on each major federal program to determine the auditing procedures that are appropriate in the circumstances for the purpose of expressing an opinion on compliance for each 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 RCHHC 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 a 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 a 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 and therefore, material weaknesses or significant deficiencies may exist that have not been identified. We did not identify any deficiencies in internal control over compliance that we consider to be material weaknesses. However, we identified a deficiency in internal control over compliance, as described in the accompanying schedule of findings and questioned costs as item , that we consider to be a significant deficiency. RCHHC s response to the internal control over compliance findings identified in our audit is described in the accompanying schedule of findings and questioned costs. RCHHC s response was not subjected to the auditing procedures applied in the audit of compliance, and accordingly, we express no opinion on the response. 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. 42

45 Report on Schedule of Expenditures of Federal Awards Required by the Uniform Guidance We have audited the consolidated financial statements of RCHHC as of and for the year ended June 30, 2017, and have issued our report thereon dated September 25, 2017, which contained an unmodified opinion on those 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. San Diego, California October 9,

46 Schedule of Expenditures of Federal Awards Year ended June 30, 2017 Catalog of federal Amounts domestic provided assistance Pass-through Federal to Federal grantor/pass-through agency/program title (CFDA) number entity identifying number expenditures subrecipients Research and Development Cluster: U.S. Department of Health and Human Services: Passed through University of California, San Diego: The Role of Germline Mutation & Parental Age in ASD R01 MH ,007 Effectiveness and Implementation of a Mental Health Intervention for ASD R01 MH ,619 Passed through University of Missouri, Columbia: The Autism Impact Measure R01 MH ,241 Direct program: High School SUCCESS: Vocational Soft Skills Program for Transition-Age ASD RMH ,183 Supported Employment, Cognitive Enhancement, Social Skills Program for ASD Adult R34 MH ,050 46,865 Subtotal CFDA ,100 46,865 Passed through University of California, San Diego: Specialized Cancer Center Support Grant P30 CA ,434 Passed through University of California, San Diego: Approaches and Decisions for Acute Pediatric TBI (ADAPT) Trial U01NS A1 23,709 Direct program: Clinical and Social Implications of 2-day Genome Results in Acutely Ill Newborns U19HD ,881,296 43,808 Clinical and Social Implications of 2-day Genome Results in Acutely Ill Newborns U19HD S1 142 Passed through University of California, San Diego: Rare Disease CRC for New Therapies and New Diagnostics Angelman Syndrome Natural History Study U54 HD Passed through Boston Children s Hospital: Brainstem Maturation in the Sudden Infant Death Syndrome R01 HD ,906 Subtotal CFDA ,995,008 43,808 Total U.S. Department of Health and Human Services 2,480,251 90,673 Total Research and Development Cluster 2,480,251 90,673 U.S. Department of Justice: Passed through California Governor s Office of Emergency Services: Child Abuse Treatment Program AT ,023 Child Abuse Treatment Program AT ,743 Unserved/Underserved Victims Advocacy XV ,050 Passed through County of San Diego: Victim Services XC Program ,173 Subtotal CFDA ,989 Passed through California Network of Child Advocacy Centers: NCA Conference Grant SAND-CA-SA2016 9,000 Direct program: Western Regional Children s Advocacy Center CI-FX-K , ,221 Subtotal CFDA , ,221 Total U.S. Department of Justice 932, ,221 44

47 Schedule of Expenditures of Federal Awards Year ended June 30, 2017 Catalog of federal Amounts domestic provided assistance Pass-through Federal to Federal grantor/pass-through agency/program title (CFDA) number entity identifying number expenditures subrecipients U.S. Department of Transportation: Passed through City of San Diego: Linda Vista Safe Routes to School (ATP) Cycle ATP S 102,990 Passed through City of El Cajon: Cajon Valley Union School District Pedestrian Safety Improvements (ATP) Cycle ATP S 129,273 Subtotal CFDA ,263 Total U.S. Department of Transportation 232,263 U.S. Department of Health and Human Services: Passed through the County of San Diego: Disaster Preparedness Grant ,268 Passed through Center for Comprehensive Care and Diagnosis of Inherited Blood Disorders: Community Counts: Public Health Surveillance for Bleeding Disorders CIBDIX2015CDC-RCHSD-X 22,899 Western States Regional Hemophilia Network CIDBIX2012HRSA-RCHSD-5 7,120 Direct program: Chadwick Trauma Informed Systems Dissemination and Implementation Project SM /03 188,524 Center for Child Welfare Trauma Informed Practice and Systems Change U79SM ,951 7,443 Subtotal CFDA ,475 7,443 Passed through Children s Hospital of Orange County: Transforming Clinical Practice Initiative (TCPI) L1CMS ,028,381 Direct program: The California Screening, Assessment and Treatment (CASAT) Initiative Project C /03 615,494 Passed through State of California Department of Social Services: The California Evidence-Based Clearinghouse EBC 30001/00-A2 609,233 Total U.S. Department of Health and Human Services 2,847,870 7,443 Total expenditures of federal awards 6,493, ,337 See accompanying notes to schedule of expenditures of federal awards and independent auditors report on compliance for each major federal program; report on internal control over compliance; and report on schedule of expenditures of federal awards required by the Uniform Guidance. 45

48 Notes to Schedule of Expenditures of Federal Awards Year ended June 30, 2017 (18) General The accompanying schedule of expenditures of federal awards (the Schedule) presents the activity of all federal financial award programs of Rady Children s Hospital and Health Center (RCHHC). RCHHC s reporting entity is identified in note 1 to the consolidated financial statements. For purposes of the Schedule, federal awards include all grants and contracts entered into directly between RCHHC and agencies and departments of the federal government and pass-through agencies. The awards are classified into major program categories in accordance with the provisions of Office of Management and Budget (OMB) Uniform Guidance. (19) Basis of Accounting The accompanying Schedule is presented on the accrual basis of accounting. Because the Schedule presents only a selected portion of the activities of RCHHC, it is not intended to and does not present either the financial position or changes in net assets of RCHHC. (20) Relationship to Federal Financial Reports Amounts reported in the accompanying Schedule agree in all material respects with the amounts reported in related federal financial reports. (21) Indirect Cost Rate RCHHC has not elected to use the 10% de minimus indirect cost rate as allowed by the Uniform Guidance. 46

49 Schedule of Findings and Questioned Costs Year ended June 30, 2017 (1) Summary of Auditors Results (a) Type of report issued on whether the consolidated financial statements were prepared in accordance with generally accepted accounting principles: Unmodified (b) Internal control deficiencies over financial reporting disclosed by the audit of the consolidated financial statements: Material weaknesses: No Significant deficiencies: None reported (c) Noncompliance material to the consolidated financial statements: No (d) Internal control deficiencies over major programs disclosed by the audit: Material weaknesses: No Significant deficiencies: Yes (e) Type of report issued on compliance for major programs: Unmodified (f) Audit findings that are required to be reported in accordance with 2 CFR (a): Yes (g) Major programs: Transforming Clinical Practice Initiative (TCPI) CFDA The California Screening, Assessment and Treatment (CASAT) Initiative Project CFDA (h) Dollar threshold used to distinguish between Type A and Type B programs: 750,000 (i) Auditee qualified as a low-risk auditee: Yes (2) Findings Relating to the Financial Statements Reported in Accordance with Government Auditing Standards None (3) Findings and Questioned Costs Relating to Federal Awards Cash Management Federal Program: Transforming Clinical Practice Initiative (TCPI) CFDA Number Federal Agency: U.S. Department of Health and Human Services Pass-through Entity: Children s Hospital of Orange County 47

50 Schedule of Findings and Questioned Costs Year ended June 30, 2017 Federal Award Years: September 29, 2015 to September 28, 2017 Condition Found During 2017, in our performance of cash management control and compliance testwork, a sample of reimbursement requests were selected and traced to supporting documentation showing the costs for which reimbursement was requested were paid to prior to the date of the reimbursement request. Of the 25 selections under the Transforming Clinical Practice Initiative program, 4 selections were found to have been requested for reimbursement prior to payment. The selections were not intended to be, and was not, a statistically valid sample. Criteria As a condition of receiving federal awards, nonfederal entities agree to comply with laws, regulations, and the provisions of grant agreements and contracts, and to maintain internal control to provide reasonable assurance of compliance with these requirements. As such, nonfederal entities must have controls in place to help ensure compliance with 2 CFR Section (b)(3), whereby program costs must be paid by nonfederal entity funds before submitting a payment request (2 CFR Section (b)(3)), i.e., the nonfederal entity must disburse funds for program purposes before requesting payment from the federal awarding agency or pass-through entity. Cause and Effect Although the costs were considered allowable costs, management s review of the expenditures submitted for reimbursement did not include a reconciliation to RCHHC s cash disbursements. Lack of review and reconciliation could result in more than inconsequential impact on noncompliance due to the reimbursement being requested prior to RCHHC payment of the expenditure. This is not a repeat finding relating to the prior period. Question Costs None noted. Recommendation RCHHC should implement a process to perform a reconciliation of expenditures accrued and/or not paid prior to requesting reimbursement. Additionally, RCHHC should revise its written policies over cash management to incorporate specific requirements per the Uniform Guidance. Management Response Management has updated its drawdown procedures to confirm vendors are paid prior to requesting a federal drawdown. Additionally, management is expected to have formal written policies for grants and contracts, which will include written policies over cash management, within the next fiscal year. 48

51 Correctiv ve Action Plan (UG section (c), AG ) For the fiscal year ending June 30, 2017 Finding Cash Management Conditionn Found During 2017, in our performance of cash management control and compliance testwork, a sample of reimbursement requests were selected and traced to supporting documentation showing the costss for which reimbursement was requested were paid to prior to the date of the reimbursement request. Of the 25 selections under the Transforming Clinical Practice Initiative program, 4 selections were found to have been requested for reimbursement prior to payment. These selections were considered allowable costs; however, these selections resulted in a cash management deficiency. 1. Contact person: Carla Reyes, Accounting Manager 2. Corrective action planned: Management has updated its drawdown procedures to confirm vendors are paid prior to requesting a federal drawdown. Additionally, management is expected to have formal written policies for grants and contracts, which will include written policies over cash management, within the next fiscal year. 3. Anticipated completion date: Drawdown proceduress were updated as of September 30, 2017 and written policies will be completed by June 30, Children s Way, San Diego, CA 92123