Audited Consolidated Financial Statements with Consolidating Information CHILDREN S HOSPITAL ASSOCIATION. December 31, 2016 and 2015

Transcription

1 Audited Consolidated Financial Statements with Consolidating Information CHILDREN S HOSPITAL ASSOCIATION December 31, 2016 and 2015

2 Contents Independent Auditor s Report on the Consolidated Financial Statements 1-2 Consolidated Financial Statements Consolidated statements of financial position 3 Consolidated statements of activities 4 Consolidated statements of cash flows 5 Notes to the consolidated financial statements 6-23 Consolidating Information Independent auditor s report on the consolidating information 24 Consolidating statement of financial position 25 Consolidating statement of activities 26 Consolidating statement of cash flows 27

3 Independent Auditor s Report on the Consolidated Financial Statements To the Board of Trustees Children s Hospital Association We have audited the accompanying consolidated financial statements of National Association of Children s Hospitals, Inc. and Affiliates (collectively, Children s Hospital Association), which comprise the consolidated statements of financial position as of December 31, 2016 and 2015, and the related consolidated statements of activities and cash flows for the years then ended, and the related notes to the consolidated financial statements. Management s Responsibility for the Consolidated Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditor s Responsibility L S t r e e t, N W S u i t e 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, with respect to National Association of Children s Hospitals and Related Institutions, Inc. (NACHRI) only, 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 audits to obtain reasonable assurance about whether the 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 auditor s 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 Children s Hospital Association 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 Children s Hospital Association 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 financial position of Children s Hospital Association as of December 31, 2016 and 2015, and the changes in their net assets and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. 1

4 To the Board of Trustees May 31, 2017 Page 2 of 2 Other Reporting Required by Government Auditing Standards In accordance with Government Auditing Standards, we have also issued our report dated May 31, 2017 on our consideration of NACHRI s internal control over financial reporting and on our tests of its compliance with certain provisions of laws, regulations, contracts, and grant agreements and other matters. The purpose of that report is to describe the scope of our testing of internal control over financial reporting and compliance and the results of that testing, and not to provide an opinion on 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 NACHRI s internal control over financial reporting and compliance. Washington, DC May 31,

5 Consolidated Statements of Financial Position December 31, Assets Cash and cash equivalents - Note B $ 60,349,649 $ 53,187,770 Investments - Notes B and C 39,939,423 36,992,996 Accounts receivable - Note D 19,060,566 16,570,754 Prepaid expenses and deposits 831, ,964 Investment in VPS - Note F 643, ,567 Investment in CHIC II - Note G 112, ,849 Investments designated for employee benefits - Notes C & H 797,785 2,133,100 Property and equipment - Note E 7,188,123 4,303,417 Total assets $ 128,922,708 $ 114,574,417 Liabilities, Net Assets, and Stockholders' Equity Liabilities Accounts payable and accrued expenses $ 8,894,892 $ 7,280,952 Patronage dividends payable - Note I 44,614,806 38,610,645 Deferred revenue - Note J 893,251 1,327,935 Capital lease obligation - Note K 363, ,783 Deferred rent and lease incentive - Note O 5,124,372 3,494,311 Employee benefit obligations - Note H 1,130,733 2,453,466 Total liabilities 61,021,337 53,460,092 Commitments and contingencies - Note O - - Net assets and stockholders' equity Net assets - Note L Unrestricted 56,578,038 50,196,694 Temporarily restricted 5,519,389 5,014,034 Total net assets 62,097,427 55,210,728 Stockholders' equity - Note I Common stock Additional paid-in capital 1,379,530 1,379,530 Retained earnings 4,424,199 4,523,852 Total stockholders' equity 5,803,944 5,903,597 Total net assets and stockholders' equity 67,901,371 61,114,325 Total liabilities, net assets, and stockholders' equity $ 128,922,708 $ 114,574,417 See notes to the consolidated financial statements. 3

6 Consolidated Statements of Activities Year Ended December 31, Unrestricted activities Revenue and support Administrative fees - Note B $ 40,119,539 $ 36,720,570 Program fees 25,043,999 23,196,743 Membership dues 14,895,768 14,254,135 Insurance commissions 10,856,827 9,243,819 Federal award 8,170,519 6,139,416 Royalties 1,451,181 1,900,182 Contracts for services and other income 1,051, ,914 Dividend income - Note C 769, ,631 Sponsorships 190, ,823 In-kind contributions 147,840 2,637, ,696,690 96,041,423 Net assets released from restrictions - Note L 1,093, ,464 Total revenue and support 103,790,170 96,999,887 Expense - Note N Personnel and benefits 27,981,914 27,852,336 Program services 16,593,936 14,227,264 General support 3,075,342 3,854,664 Occupancy 2,365,380 1,955,561 Depreciation and amortization 1,480,807 1,367,318 Travel and meetings 1,192,037 1,217,991 Strategic redevelopment 1,119, ,137 Professional services 997,863 1,523,736 In-kind contributions 147,840 2,637,190 Information technology development 70, ,904 Total expense 55,025,082 56,428,101 Change in unrestricted net assets from operations 48,765,088 40,571,786 Net gain (loss) on investments - Note C 2,247,667 (1,152,172) Equity in gain (loss) of VPS - Note F (1,130) 189,942 Equity in gain (loss) of CHIC II - Note G (372) 10,007 Change in gain share liability - Note H 372 (10,007) Loss on sublease - Note O - (428,889) Benefit plan changes other than net periodic cost - Note H (15,476) 49,944 Change in unrestricted net assets 50,996,149 39,230,611 Temporarily restricted activities Contributions 1,579,800 5,165,200 Investment income - Note C 19,035 2,246 Net assets released from restrictions - Note L (1,093,480) (958,464) Change in temporarily restricted net assets 505,355 4,208,982 Change in net assets 51,501,504 43,439,593 Net assets and stockholders' equity, beginning of year 61,114,325 56,230,501 Patronage dividends - Note I (44,714,458) (38,555,769) Net assets and stockholders' equity, end of year $ 67,901,371 $ 61,114,325 See notes to the consolidated financial statements. 4

7 Consolidated Statements of Cash Flows Year Ended December 31, Cash flows from operating activities Change in net assets $ 51,501,504 $ 43,439,593 Adjustments to reconcile change in net assets to net cash provided by operating activities: Net (gain) loss on investments (2,247,667) 1,152,172 Depreciation and amortization 1,480,807 1,367,318 Loss on disposal of property and equipment 163,266 - Equity in (gain) loss of VPS 1,130 (189,942) Equity in (gain) loss of CHIC II 372 (10,007) Changes in assets and liabilities: Accounts receivable (2,489,812) (3,368,723) Prepaid expenses and deposits (202,284) (407,940) Accounts payable and accrued expenses 1,613, ,902 Deferred revenue (434,684) 955,098 Deferred rent and lease incentive 1,630, ,367 Employee benefit obligations 12,582 (230,173) Total adjustments (472,289) 714,072 Net cash provided by operating activities 51,029,215 44,153,665 Cash flows from investing activities Proceeds from sales of investments 3,824,268 1,927,652 Purchases of investments (4,523,028) (3,079,082) Purchases of property and equipment (4,149,649) (332,762) Proceeds from CHIC II cash distribution - 83,068 Net cash used in investing activities (4,848,409) (1,401,124) Cash flows from financing activities Forgiveness of obligation under old capital lease (183,904) - Principal payments on capital lease obligation (124,726) (124,818) Payments of patronage dividends in cash (38,710,297) (31,315,599) Payments of patronage dividends in QWNA - (3,665,000) Net cash used in financing activities (39,018,927) (35,105,417) Net increase in cash and cash equivalents 7,161,879 7,647,124 Cash and cash equivalents, beginning of year 53,187,770 45,540,646 Cash and cash equivalents, end of year $ 60,349,649 $ 53,187,770 Supplemental disclosures of cash flow information: Patronage dividends payable $ 44,614,806 $ 38,610,645 Interest expense for capital lease obligation $ 12,100 $ 18,276 Schedule of noncash investing and financing activites: Property and equipment related to new capital lease obligation $ 379,129 $ - Forgiveness of obligation under old capital lease $ (183,904) $ - See notes to the consolidated financial statements. 5

8 Notes to the Consolidated Financial Statements A. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization: National Association of Children's Hospitals, Inc. (N.A.C.H) was organized as a business league providing assistance to organizations engaged in the delivery of medical and hospital care for children in the United States. N.A.C.H is characterized as the parent company within the consolidated group. National Association of Children's Hospitals and Related Institutions, Inc. (NACHRI) was organized to create an association of hospitals and other institutions which specialize in medical care for children, with the objective of improving such care through the dissemination of information and the promotion of research and education programs related to such care; to foster and encourage those hospitals and institutions which are voluntarily organized to provide hospital based services for children; to undertake activities to enhance and increase public understanding of and support for hospitals so organized; and to participate in charitable, scientific, or educational endeavors. N.A.C.H is the sole voting member of NACHRI. Child Health Corporation of America (CHCA) was organized for the purpose of developing support services for its members throughout North America and developing successful business projects primarily unique to children and child health providers. N.A.C.H owns 100% of CHCA s common stock. However, CHCA s members have retained their voting and economic rights. Child Health Patient Safety Organization, Inc. (PSO) was organized to improve the safety and quality of child health care delivery by creating a secure environment to analyze data that will enable the reduction of risks and hazards associated with patient care. N.A.C.H is the sole voting member of PSO. Principles of consolidation: The consolidated financial statements include accounts of N.A.C.H, NACHRI, CHCA, and PSO, which are collectively referred to as Children s Hospital Association. Significant intra-entity accounts and transactions have been eliminated in consolidation. The entities included in the consolidated financial statements signed a consolidation agreement (the Consolidation Agreement) that has aligned the entities over time (the Alignment). One key feature of the Alignment was the election of a common governing body for the entities. The Board of Trustees for the entities are composed of the same individuals. As a result, the entities operate under a coordinated governance structure and benefit from a variety of efficiencies. The restructuring and consolidation of the entities under a single parent company (N.A.C.H) facilitates aligned governance, consolidated operational leadership, and a single nationwide advocacy voice for children's health care providers. Income taxes: N.A.C.H is exempt from the payment of income taxes on its exempt activities under Section 501(c)(6) of the Internal Revenue Code. NACHRI is exempt from the payment of income taxes on its exempt activities under Section 501(c)(3) of the Internal Revenue Code and is classified as other than a private foundation within the meaning of Section 509(a)(2) of the Internal Revenue Code. However, NACHRI is subject to income tax on its unrelated business activities, such as advertising income from print and online sources. In determining the liability for income taxes, NACHRI includes allowable deductions against its unrelated business income. As a result, NACHRI has no provision for income tax expense. 6

9 Notes to the Consolidated Financial Statements A. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED Income taxes - continued: CHCA is a for-profit cooperative, which is taxable under Subchapter T (Sections ) of the Internal Revenue Code. As a nonexempt cooperative, CHCA is granted a patronage dividend deduction for business transactions with its members. Accordingly, the provision for income taxes is based on CHCA s net income or loss as a result of transactions with nonmembers when that income or loss has not been allocated to its members. As a result, CHCA has no provision for income tax expense. PSO is exempt from the payment of income taxes on its exempt activities under Section 501(c)(3) of the Internal Revenue Code and is classified as other than a private foundation within the meaning of Section 509(a)(2) of the Internal Revenue Code. Basis of accounting: The accompanying consolidated financial statements have been prepared on the accrual basis of accounting. Revenue is recognized when earned and expense when the obligation is incurred. Use of estimates: The preparation of consolidated financial statements in conformity with U.S. Generally Accepted Accounting Principles (GAAP) requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual results could differ from estimates. Cash and cash equivalents: For financial statement purposes, Children s Hospital Association considers demand deposits and money market funds to be cash and cash equivalents. Administrative fees: Administrative fees and other revenues associated with purchasing agreements are recognized when the members, to which the agreements relate, pay the associated vendors. Program fees: Program fees are recognized over the term of the participation agreement. Federal award: Federal award revenue is recognized as costs qualified under the grant are incurred. Government funds received in advance of costs incurred are recorded as deferred revenue until expended for the purposes of the grant. Government costs incurred in excess of funds received are recorded as accounts receivable. In-kind contributions: A donor provided an in-kind contribution of approximately 1,200 and 22,200 dolls during the years ended December 31, 2016 and 2015, respectively, in relation to a holiday giving campaign. Children s Hospital Association distributed the dolls to certain participating hospitals which provided the dolls, free of charge, to individual children who were receiving medical care at the hospitals during the December 2016 and 2015 holiday seasons. The estimated fair value of the dolls provided by the donor has been recorded as revenue and expense in equal amounts for each year presented in the consolidated statements of activities. Contributions: Contributions are recorded as unrestricted or temporarily restricted support depending upon the existence and/or nature of any donor imposed restrictions. When a stipulated purpose restriction is accomplished or when a time limitation expires, temporarily restricted net assets are reclassified to unrestricted net assets and reported in the consolidated statements of activities as net assets released from restrictions. Measure of operations: Children s Hospital Association classifies net gain (loss) on investments, equity gain (loss) in VPS, equity in gain (loss) of CHIC II, change in the gain share liability, loss on sublease and benefit plan changes other than net periodic pension cost as non-operating items. 7

10 Notes to the Consolidated Financial Statements A. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED Reclassifications: Certain 2015 amounts have been reclassified for comparative purposes with no effect on previously reported consolidated change in net assets. B. CONCENTRATIONS Credit risk: Children s Hospital Association maintains demand deposits at commercial banks and money market funds at financial institutions. At times, certain balances held within these accounts may not be fully guaranteed or insured by the U.S. Government. The uninsured portions of cash and money market accounts are backed solely by the assets of the underlying institution. Therefore, the failure of an underlying institution could result in financial loss to Children s Hospital Association. However, Children s Hospital Association has not experienced losses on these accounts in the past, and management believes the risk of loss, if any, to be minimal. Market risk: Children s Hospital Association invests in a professionally managed portfolio, which primarily consists of mutual funds but also includes an alternative investment fund. Such investments are exposed to market and credit risks. Therefore, Children s Hospital Association s investments may be subject to significant fluctuations in fair value. As a result, the investment balances reported in the accompanying consolidated financial statements may not be reflective of the portfolio's value during subsequent periods. Revenue: CHCA has an agreement, which expires in 2024, for group purchasing services with a group purchasing organization (GPO). Under the group purchasing agreement, CHCA receives administrative fees associated with purchases made by its owner-member hospitals, net of service fees charged by the GPO. Net revenue earned under this agreement represented 38% and 37% of total consolidated revenues for the years ended December 31, 2016 and 2015, respectively. C. INVESTMENTS In accordance with U.S. GAAP, Children s Hospital Association uses the following prioritized input levels to measure the fair value of investments. The input levels used in valuing investments are not necessarily an indication of risk. Level 1 Observable inputs that reflect quoted prices for identical assets or liabilities in active markets, such as stock quotes. Level 2 Includes inputs other than Level 1 inputs that are directly or indirectly observable in the marketplace, such as yield curves or other market data. Level 3 Unobservable inputs which reflect the fund manager s assessment of the assumptions that market participants would use in pricing the asset or liability, including assumptions about risk, such as bid/ask spreads and liquidity discounts. Investments classified within Level 1 include various types of mutual funds, which were valued based on quoted prices for identical assets in active markets. 8

11 Notes to the Consolidated Financial Statements C. INVESTMENTS - CONTINUED Investments classified within Level 3 include an alternative investment (Hatteras Multi-Strategy TEI Institutional), which was valued at its estimated net asset value as reported by the fund manager. In particular, the fund manager values its respective interest in the fund based on the net asset value of a Master Fund. The Master Fund s portfolio securities are valued based on its interests in certain advisor funds, separate account holdings, or direct investments. In valuing the Master Fund s portfolio securities, the Master Fund s investment adviser considers all reasonably available information. NACHRI is currently in the process of liquidating its interest in the fund. Management believes the estimated fair value of investments to be a reasonable approximation of the exit price for its investments. Investments recorded at cost include money market funds. Investments at cost are not required to be classified in one of the levels prescribed by the fair value hierarchy. The following is a summary of the input levels used to determine the fair value of investments, which are measured on a recurring basis, at December 31,: 2016 Total Level 1 Level 2 Level 3 Investments, at fair value Mutual funds - equities $ 20,317,790 $ 20,317,790 $ - $ - Mutual funds - fixed income 10,373,408 10,373,408 Mutual funds - balanced 8,976,598 8,976,598 Alternative investment 269, ,942 Investments, at cost Money market funds 1,685 39,937,738 $ 39,667,796 $ - $ 269,942 $ 39,939, Total Level 1 Level 2 Level 3 Investments, at fair value Mutual funds - equities $ 17,419,214 $ 17,419,214 $ - $ - Mutual funds - fixed income 10,330,689 10,330,689 Mutual funds - balanced 7,901,244 7,901,244 Exchange traded fund 821, ,243 Alternative investment 421, ,516 Investments, at cost Money market funds 99,090 36,893,906 $ 36,472,390 $ - $ 421,516 $ 36,992,996 9

12 Notes to the Consolidated Financial Statements C. INVESTMENTS CONTINUED Level 3 investments included the following activity as of and for the years ended December 31,: Balance, beginning of year $ 421,516 $ 774,447 Withdrawals (135,583) (360,685) Net (loss) gain on investments (15,991) 7,754 Balance, end of year $ 269,942 $ 421,516 Level 3 investments provide limited liquidity and are not transferable. Liquidity will be provided only through repurchase offers made from time to time, generally on a quarterly basis upon prior written notice. Furthermore, Level 3 investments will generally be restricted securities that are subject to substantial holding periods or are not traded in public markets so that the Master Fund may not be able to resell some of its holdings for extended periods, which may be several years. Advanced notice of intent to redeem the Master Fund s total or partial interest must generally be provided and redemptions may be delayed or denied depending on the underlying governing agreements. Beginning in 2013, NACHRI began to redeem its alternative investment and plans to continue the redemptions in future years until fully liquidated, subject to the terms of the Master Fund. Investment income: Investment income consisted of the following for the years ended December 31,: Dividend income Dividends $ 859,449 $ 700,248 Management fees (70,593) (66,371) $ 788,856 $ 633,877 Net gain (loss) on investments Realized gain on investments $ 1,388,853 $ 921,899 Unrealized gain (loss) on investments 858,814 (2,074,071) $ 2,247,667 $ (1,152,172) 10

13 Notes to the Consolidated Financial Statements C. INVESTMENTS CONTINUED Investments designated for deferred compensation: The investments designated for employee benefits are held to fund obligations related to certain employee benefit plans, which are described in Note H, and are participant-directed to various mutual fund options. The following is a summary of the investments designated for employee benefits, which are measured on a recurring basis, at December 31,: Investments at fair value - Level Mutual funds - balanced $ 493,995 $ 919,361 Mutual funds - equities 241, ,551 Mutual funds - fixed income 61,935 54,580 Investments, at cost Money market funds 44 1,003,608 $ 797,785 $ 2,133,100 D. ACCOUNTS RECEIVABLE Accounts receivable are presented at the gross, or face, amount due to Children s Hospital Association. Management periodically reviews the status of all accounts receivable balances for collectability. Each receivable balance is assessed based on management's knowledge of and relationship with the member and the age of the receivable balance. As a result of these reviews, account balances deemed to be uncollectible are charged directly to bad debt expense. Management believes that the use of the direct write-off method approximates the results that would be presented if an allowance for bad debts had been recorded. Accounts receivable consisted of the following at December 31,: Administrative fees $ 10,030,061 $ 9,077,876 Federal awards 4,915,159 3,287,045 Program fees 2,134,228 2,167,457 Insurance commissions 1,029, ,040 Deferred rent receivable from sublease 335, ,865 Other receivables 325, ,713 Royalties 289, ,758 $ 19,060,566 $ 16,570,754 11

14 Notes to the Consolidated Financial Statements E. PROPERTY AND EQUIPMENT Property and equipment is recorded at cost and acquisitions greater than $2,500 are depreciated or amortized using the straight-line method over the following useful lives: furniture, fixtures, and equipment, 2-10 years; and leasehold improvements, the lesser of the useful life of the assets or the remaining term of the lease. Property and equipment consisted of the following at December 31,: Furniture, fixtures, and equipment $ 7,225,793 $ 11,982,093 Leasehold improvements 4,486,493 2,093,744 11,712,286 14,075,837 Less accumulated depreciation and amortization (4,524,163) (9,772,420) $ 7,188,123 $ 4,303,417 F. VIRTUAL PICU SYSTEMS, LLC Virtual PICU Systems, LLC (VPS) was organized for the purpose of providing an integrated line of services including data collection, user meetings, networking, research, comparative reports, and data analysis and application, designed to create a network of children's hospitals and other facilities offering PICU care to improve the quality of critical care for children worldwide. VPS is a limited liability company which was originally owned equally (33 1/3% each) by National Association of Children's Hospitals and Related Institutions, Inc. (NACHRI), Children s Hospital Los Angeles (CHLA), and Children s Hospital and Health System (CHHS). On January 26, 2015, CHLA purchased CHHS s 33 1/3% ownership share of VPS. Accordingly, at December 31, 2016 and 2015, VPS was owned 66 2/3% by CHLA and 33 1/3% by NACHRI. The following summarized financial information for VPS was obtained from the audited financial statements for 2015 and The audited financial statements for 2015 were issued in final form during December 2016 and were used to record the 2016 investment in VPS. The audited financial statements for 2014 were issued in final form during October 2015 and were used to record the 2015 investment in VPS. Management expects the audited financial statements for 2016 to be issued during a similar time frame in Management reviews the current year unaudited financial statements of VPS for significant losses to determine whether the investment in VPS should be written down. The investment in VPS was written down by $60,000 in 2016 in response to losses reported on the unaudited financial statements for the year ended December 31,

15 Notes to the Consolidated Financial Statements F. VIRTUAL PICU SYSTEMS, LLC - CONTINUED Summarized financial information for VPS is as follows as of and for the years ended December 31,: Assets $ 2,344,055 $ 2,179,921 Liabilites (233,744) (246,221) Partners' equity $ 2,110,311 $ 1,933,700 Revenue $ 3,040,700 $ 2,834,564 Expense 2,864,089 2,264,737 Net income $ 176,611 $ 569,827 The following is a rollforward of NACHRI s equity method investment in VPS as of and for the years ended December 31,: Investment in VPS, beginning of year $ 644,567 $ 454,624 Equity in gain (loss) of VPS 58, ,943 Additional equity in gain (loss) of VPS (60,000) - Investment in VPS, end of year $ 643,437 $ 644,567 NACHRI's equity method cumulative investment in VPS consisted of the following as of December 31,: Cash contribution $ 573,333 $ 573,333 Software contribution 342, ,000 Accumulated deficit (271,896) (270,766) $ 643,437 $ 644,567 The software contribution represents the fair value of the portion of the PICU system developed by NACHRI, as determined by a third-party appraisal. NACHRI s portion of the software contribution primarily consisted of salaries and benefits resulting from employee time spent on developing the PICU database as well as development meetings. 13

16 Notes to the Consolidated Financial Statements G. CHILD HEALTH INVESTMENT II, LLC Child Health Investment II, LLC (CHIC II) is a venture capital investment company that invests primarily in seed-stage and early-stage health care technology companies which benefit children and child health providers. CHCA owns approximately 28% of CHIC II for the benefit of former CHCA employees in satisfaction of its obligation under a gain share program described in Note H. During the year ended December 31, 2016, the members of CHIC II sold its portfolio investments to a third-party buyer according to the terms of the Purchase and Sale agreement between both parties. Prior to sale, portfolio investments were recorded at fair value determined by management in accordance with a valuation methodology approved by the members of CHIC II. All accumulated unrealized appreciation or depreciation on investments were realized upon the sale of the investments. The following table provides summarized financial information for CHIC II as of and for the years ended December 31,: Assets $ 402,534 $ 403,527 Members' capital $ 402,534 $ 403,527 Investment income $ 10,877 $ 49,598 Operating expense (11,870) (11,766) Net increase in members' capital $ (993) $ 37,832 The following is a rollforward of CHCA s equity method investment in CHIC II as of and for the years ended December 31,: Investment in CHIC II, beginning of year $ 112,849 $ 185,910 Proceeds from CHIC II cash distribution - (83,068) Equity in gain of CHIC II (372) 10,007 Investment in CHIC II, end of year $ 112,477 $ 112,849 CHCA s equity method cumulative investment in CHIC II consisted of the following as of December 31,: Cash contribution $ 2,155,218 $ 2,155,218 Proceeds from CHIC II cash distributions (2,422,807) (2,422,807) Accumulated earnings 380, ,438 $ 112,477 $ 112,849 14

17 Notes to the Consolidated Financial Statements H. EMPLOYEE BENEFIT PLANS Employee benefit obligations include various employee benefit plans. A summary of the obligations under each type of plan consisted of the following at December 31,: Deferred compensation (NACHRI) $ 797,785 $ 1,130,537 Post-retirement medical benefit (NACHRI) 220, ,517 Gain share program (CHCA) 112, ,849 Supplemental executive retirement plan (CHCA) - 1,002,563 $ 1,130,733 $ 2,453,466 Deferred compensation (NACHRI): NACHRI established deferred compensation plans under Sections 457(b) and 457(f) of the Internal Revenue Code for a group of key employees. The assets of the plans are held in participant-directed investments in mutual funds, which are detailed in Note C, totaling $797,785 and $1,130,537 at December 31, 2016 and 2015, respectively. During the year ended December 31, 2016, NACHRI paid compensation previously deferred under the 457(f) plan in accordance with deferred compensation agreements. NACHRI s contributions to the plans totaled $308,595 and $226,678 for the years ended December 31, 2016 and 2015, respectively. Post-retirement medical benefit (NACHRI): NACHRI established a post-retirement medical benefit plan for a retired executive and his spouse. Medical benefits are based on the statistically determined life expectancies of the beneficiaries. In accordance with U.S. GAAP, the cost of providing retiree health care benefits is recognized on an actuarially determined basis and have been discounted at a rate of 3.77% for 2016 and 4.35% for 2015 over the years the beneficiaries become eligible for benefits. Benefit plan changes other than net periodic cost are not included in the change in net assets from operations and the post-retirement medical benefit obligation totaled $220,471 and $207,517 at December 31, 2016 and 2015, respectively. Gain share program (CHCA): During 1998, CHCA established a gain share program for its employees. However, during 2003, the Board of Directors approved a resolution to discontinue providing contributions to the gain share program. Vesting in the gain share program occurred after three years and unvested benefits for employees terminated prior to full vesting were reallocated to vesting employees on a proportionate basis such that the total liability under the program remained the same. CHCA s investment in CHIC II was made in order to fund its obligation to employees under the gain share program which totaled $112,477 and $112,849 at December 31, 2016 and 2015, respectively. Supplemental executive retirement plan (CHCA): CHCA had a supplemental executive retirement plan (SERP) for certain employees. Beginning January 1, 2012, CHCA discontinued its contributions to the SERP. The SERP was funded by participant-directed investments, which are detailed in Note C, totaling $0 and $1,002,563 at December 31, 2016 and 2015, respectively. The final SERP payout occurred during the year ended December 31, Defined contribution plan (NACHRI): NACHRI sponsors a defined contribution plan and a tax deferred annuity plan (together, the Plans are referred to as the 403(b) plan). The 403(b) plan covers all eligible employees who meet age and length of service requirements. NACHRI s contributions equal 100% of participant elective deferrals, up to 5% of annual compensation. Additionally, NACHRI also makes discretionary contributions for employees equal to 4% of annual compensation. NACHRI s contributions to the 403(b) plan totaled $1,453,894 and $1,418,384 for the years ended December 31, 2016 and 2015, respectively. 15

18 Notes to the Consolidated Financial Statements I. STOCKHOLDERS EQUITY CHCA s bylaws provide for distribution of patronage dividends to its members. Net tax basis income is allocated to members as patronage dividends without regard to class of ownership. This allocation is based on CHCA s volume of business done with or for each member. Allocations to members may be in cash, property, or any combination thereof. The actual form of the patronage dividend is at the discretion of the Board of Directors, as long as cash distributions are at least 20% of net tax basis income. However, historically, patronage dividends have been paid 100% in cash. As a result, CHCA records the patronage dividend payable based on 100% of the estimated net tax basis income. The patronage dividend is distributed within the first eight and one-half months of the subsequent year. Patronage dividends payable totaled $44,614,806 and $38,610,645 at December 31, 2016 and 2015, respectively. Stockholders equity consisted of the following as of and for the years ended December 31,: Retained earnings Accumulated Additional other Common paid-in comprehensive Retained 2016 stock capital income earnings Total Balance, January 1, 2016 $ 215 $ 1,379,530 $ 9,390 $ 4,514,462 $ 5,903,597 Patronage dividends for 2015 paid in cash (38,710,297) (38,710,297) Change in patronage dividends payable (6,004,161) (6,004,161) Comprehensive income Net income 44,618,478 44,618,478 Unrealized depreciation of investments (3,673) (3,673) Total comprehensive income - - (3,673) 44,618,478 44,614,805 Balance, December 31, 2016 $ 215 $ 1,379,530 $ 5,717 $ 4,418,482 $ 5,803,944 Retained earnings Accumulated Additional other Common paid-in comprehensive Retained 2015 stock capital income earnings Total Balance, January 1, 2015 $ 215 $ 1,379,530 $ 72,172 $ 4,396,805 $ 5,848,722 Patronage dividends for 2014 paid in cash (31,315,599) (31,315,599) Change in patronage dividends payable (3,575,170) (3,575,170) QWNA payable (3,665,000) (3,665,000) Comprehensive income Net income 38,673,426 38,673,426 Unrealized depreciation of investments (62,782) (62,782) Total comprehensive income - - (62,782) 38,673,426 38,610,644 Balance, December 31, 2015 $ 215 $ 1,379,530 $ 9,390 $ 4,514,462 $ 5,903,597 16

19 Notes to the Consolidated Financial Statements J. DEFERRED REVENUE Revenue received in advance of the period in which it will be earned is reported as deferred revenue. Deferred revenue, listed by component in the consolidated group of entities, primarily consisted of member program fees at December 31,: NACH $ 356,300 $ 106,800 NACHRI 507,926 1,110,200 CHCA 13,625 58,435 PSO 15,400 52,500 $ 893,251 $ 1,327,935 K. CAPITAL LEASE OBLIGATION CHCA had a five-year master equipment lease agreement which was originally scheduled to expire on March 3, 2018 and was considered to be equivalent to an installment sale purchase. Assets acquired under the master equipment lease were capitalized and the related obligation was determined using interest rates appropriate at the inception of the lease. The equipment assets were amortized using the straight-line method over the term of the lease. The capital lease was payable in monthly installments of $11,905, and the obligation was determined using an assumed interest rate of 5.0%. During the year ended December 2016, and related to a new NACHRI lease agreement, CHCA s obligation under the lease totaling $183,904 was forgiven, and the lease was terminated. The cost of the assets recorded under the original lease totaled $516,963 and the related accumulated depreciation totaled $355,412 at date of disposal in December The net book value of the capitalized assets was written off and a loss on disposal of property and equipment totaling $161,551 was recorded during the year ended December 31, NACHRI signed a new lease agreement for similar equipment with the same vendor effective November 1, The new lease is scheduled to expire November 1, 2020 and is also considered to be equivalent to an installment sale purchase that is subject to the same accounting treatment and estimation methods used for the original lease. The capital lease is payable in monthly installments of $8,695, and the obligation was determined using an assumed interest rate of 5.0%. The cost of the assets recorded under the new capital lease totaled $379,129 and the related accumulated depreciation totaled $15,797 at December 31, The capitalized assets have been included in property and equipment. 17

20 Notes to the Consolidated Financial Statements K. CAPITAL LEASE OBLIGATION - CONTINUED Future minimum lease payments under the new capital lease are as follows: Year Ending December 31, Amount 2017 $ 104, , , ,949 $ 399,963 The new capital lease obligation consisted of the following components at December 31, 2016: Future minimum lease payments $ 399,963 Less amount representing interest (36,680) Present value of minimum lease payments $ 363,283 L. NET ASSETS Unrestricted: Unrestricted net assets include those net assets whose use is not restricted by donors, even though their use may be limited in other respects, such as by board designation. Unrestricted net assets consisted of the following as of December 31,: Undesignated $ 56,342,907 $ 49,965,598 Designated The Don Black Memorial Lecture 235, ,096 $ 56,578,038 $ 50,196,694 18

21 Notes to the Consolidated Financial Statements L. NET ASSETS - CONTINUED Temporarily restricted: Temporarily restricted net assets include those net assets whose use by Children s Hospital Association has been donor restricted for a specific purpose. Temporarily restricted net assets consisted of the following at December 31,: Contribution of QWNA $ 3,665,000 $ 3,665,000 Graduate Medical Education 1,585,468 1,117,938 The Don Black Memorial Lecture 235, ,096 Mattel 33,790 - $ 5,519,389 $ 5,014,034 Net assets are released from restrictions as a result of the satisfaction of a purpose restriction. Net assets are released from restrictions consisted of the following during the years ended December 31,: Graduate Medical Education $ 1,062,270 $ 944,464 Mattel 16,210 - The Don Black Memorial Lecture 15,000 14,000 $ 1,093,480 $ 958,464 M. RELATED PARTY TRANSACTIONS Program transfer: Effective December 31, 2014, CHCA agreed to transfer to NACHRI certain data programs that are similar to programs already operated by NACHRI, thus leaving CHCA to focus on its core cooperative activity of group purchasing and insurance services. The purchase price of $3,665,000 was determined in accordance with a valuation done by an independent third party and the sale was closed and final on January 1, As a result of the program transfer, CHCA recorded a gain of $3,665,000 and NACHRI recorded an expense of $3,665,000 which is equal to the purchase price and which was eliminated in consolidation. During January 2015, the members of CHCA promised to give a portion of their patronage dividends to NACHRI. CHCA s members signed Qualified Written Notices of Allocation (QWNA) in relation to their promise to allocate $3,665,000 to NACHRI. The amount due from CHCA has been included in NACHRI s QWNA receivable and the amount due to NACHRI has been included in CHCA s QWNA payable which have been eliminated in consolidation. Venture capital investment companies: CHCA provides management services to CHIC II. As specified in the operating agreement, CHIC II was scheduled to terminate on December 31, However, during 2014 the terms of CHIC II were extended until December 31, 2017 by the consent of the members holding a majority of the voting percentages. Furthermore, CHCA agreed to waive the management fees for CHIC II. 19

22 Notes to the Consolidated Financial Statements N. FUNCTIONAL EXPENSES The consolidated statement of activities presents expense using natural categories; for example, personnel and benefits or depreciation. Functional expenses related to providing program and supporting services have been summarized below. Therefore, certain natural expenses have been allocated among the program and supporting services benefited. Functional expenses consisted of the following for the year ended December 31, 2016: N.A.C.H NACHRI CHCA PSO Eliminations Total Program services Quality and performance improvement $ - $ 10,904,499 $ - $ 482,652 $ - $ 11,387,151 Comparative data 7,502,327 7,502,327 Education 5,701,335 5,701,335 Public policy 4,353,879 4,353,879 Insurance services 2,290,907 2,290,907 Supply chain services 2,282,994 2,282,994 External relations & child health 1,986,183 1,986,183 Strategic redevelopment 75, , ,294 1,119,673 Management services 4,984,782 (4,984,782) - Total program services expense 4,428,879 32,002,505 4,695, ,652 (4,984,782) 36,624,449 Supporting services Management and general 1,789,212 10,332,913 2,370, ,550 (5,153,576) 9,578,950 Information technology 518,415 4,907, , ,591 6,350,591 Communication and conference services 1,874,699 1,874,699 Membership services 596, ,393 Total supporting services expense 2,307,627 17,711,753 3,188, ,141 (5,153,576) 18,400,633 Total expense $ 6,736,506 $ 49,714,258 $ 7,883,883 $ 828,793 $ (10,138,358) $ 55,025,082 Functional expenses consisted of the following for the year ended December 31, 2015: N.A.C.H NACHRI CHCA PSO Eliminations Total Program services Quality and performance improvement $ - $ 8,775,882 $ - $ 672,415 $ - $ 9,448,297 Comparative data 7,152,596 7,152,596 Education 5,474,886 5,474,886 Public policy 4,453,636 4,453,636 Insurance services 2,611,307 2,611,307 Supply chain services 2,203,289 2,203,289 External relations & child health 4,451,248 4,451,248 Strategic redevelopment 776,604 19, ,137 Management services 4,584,698 (4,584,698) - Total program services expense 4,453,636 31,215,914 4,834, ,415 (4,584,698) 36,591,396 Supporting services Management and general 1,481,455 11,434,388 2,805, ,485 (5,124,108) 10,703,451 Information technology 693,731 4,925,349 1,002,617 38,701 6,660,398 Communication and conference services 1,939,280 1,939,280 Membership services 533, ,576 Total supporting services expense 2,175,186 18,832,593 3,807, ,186 (5,124,108) 19,836,705 Total expense $ 6,628,822 $ 50,048,507 $ 8,641,977 $ 817,601 $ (9,708,806) $ 56,428,101 20

23 Notes to the Consolidated Financial Statements O. COMMITMENTS AND CONTINGENCIES Office leases: During November 2013, NACHRI signed an operating lease for office space in Washington, DC. The lease commenced May 12, 2014 and expires May 31, The lease requires that NACHRI hold an irrevocable letter of credit in the amount of $377,129, which has no collateral requirement other than maintaining custodial investments at the bank. Under the terms of the lease, the letter of credit is scheduled to decline in two annual increments of $125,709 over the term of the lease such that it will eventually decline to a balance of $125,710. The lease contains an abatement of the first twelve month s base rent, including related pass through operating and real estate costs. The lease also contains an escalation clause that adjusts the annual base rentals. As an incentive to lease the office space, the landlord provided a tenant build-out allowance totaling $2,263,000. U.S. GAAP requires the cost of the build-out to be capitalized within property and equipment and amortized over the term of the lease. U.S. GAAP also requires that the lease incentive along with the rent abatement and the scheduled rent increases resulting from the escalation of base rentals be recorded as a liability and amortized ratably over the term of the lease so as to record rent expense on a straight-line basis over the term of the agreement. The liability for deferred rent and lease incentive totaled $2,827,007 and $3,016,426 at December 31, 2016 and 2015, respectively. Rent expense under the Washington, DC office lease totaled $881,379 for each of the years ended December 31, 2016 and Future minimum cash basis lease payments for the Washington, DC office lease are as follows: Year Ending December 31, Amount 2017 $ 1,097, ,125, ,163, ,199, ,229,000 Thereafter 4,431,700 $ 10,245,300 In January 2016, N.A.C.H signed an operating lease for office space in Lenexa, KS. The lease commenced July 1, 2016 and expires December 31, The lease required that a security deposit in the amount of $111,000 that is refundable within 45 days of the termination of the lease. The lease contains an abatement of the first six month s base rent, including related pass through operating and real estate costs. The lease also contains an escalation clause that adjusts the annual base rentals. As an incentive to lease the office space, the landlord provided a tenant build-out allowance totaling $1,663,728. The liability for deferred rent and lease liability totaled $1,939,366 at December 31,

24 Notes to the Consolidated Financial Statements O. COMMITMENTS AND CONTINGENCIES - CONTINUED Rent expense under the Lenexa, KS lease totaled $275,637 for the year ended December 31, Future minimum cash basis lease payments for the Lenexa, KS office lease are as follows: Year Ending December 31, Amount 2017 $ 675, , , , ,400 Thereafter 3,921,000 $ 7,452,000 The operating lease for office space in Overland Park, Kansas expired on December 31, Rent expense under the Overland Park, Kansas office lease totaled $588,929 and $669,650 for the years ended December 31, 2016 and 2015, respectively. Sublease: In March 2015, NACHRI signed a sublease agreement with a tenant of the Washington, DC office. The sublease commenced May 1, 2015 and terminates May 26, The sublease requires a deposit $189,996 in either cash or in the form of an irrevocable letter of credit. Under the terms of the sublease, the deposit is scheduled to decline to $94,998 on the third anniversary and to $31,666 on the fourth anniversary of the sublease either by reducing the cash paid or by amending the letter of credit. The sublease provides an abatement of the base rent and related pass through operating and real estate costs for the first twelve months of the lease. The sublease also includes an escalation clause that adjusts the annual base rentals. In addition, the base rentals stipulated in the sublease are lower than the base rentals in NACHRI s office lease. As a result, NACHRI accrued a liability for the loss on sublease totaling $428,889 for the year ended December 31, The liability related to the accrued loss on sublease will be amortized on a straight-line basis over the term of the sublease as an increase in sublease rental income. Future minimum cash basis rental receipts related to the sublease are as follows: Year Ending December 31, Amount 2017 $ 342, , , , ,300 Thereafter 999,800 $ 2,415,100 22