Lucile Salter Packard Children s Hospital at Stanford Consolidated Financial Statements August 31, 2013 and 2012

Transcription

1 Lucile Salter Packard Children s Hospital at Stanford Consolidated Financial Statements

2 Index Page(s) Independent Auditor s Report... 1 Consolidated Financial Statements Consolidated Balance Sheets... 2 Consolidated Statements of Operations and Changes in Net Assets... 3 Consolidated Statements of Cash Flows Report of Independent Auditors on Accompanying Consolidating Information Consolidating Balance Sheets Consolidating Statements of Operations and Changes in Net Assets... 38

3 Independent Auditor s Report To Board of Directors Lucile Salter Packard Children s Hospital at Stanford We have audited the accompanying consolidated financial statements of Lucile Salter Packard Children s Hospital at Stanford ( LPCH ) and its entities, which comprise the consolidated balance sheets as of, and the related consolidated statements of operations and changes in net assets, and cash flows for the years then ended. Management's Responsibility for the Consolidated Financial Statements Management is responsible for the preparation and fair presentation of the 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 Our responsibility is to express an opinion on the consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 our 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, we consider internal control relevant to the organization'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 organization'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 LPCH and its entities at, and the changes in their net assets and their cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America. December 11, 2013 PricewaterhouseCoopers LLP, Three Embarcadero Center, San Francisco, CA T: (415) , F: (415) ,

4 Consolidated Balance Sheets Assets Current assets Cash and cash equivalents $ 188,409 $ 85,641 Short term investments in Stanford University ( University ) managed pools - 1,070 Patient accounts receivable, net of allowance for doubtful accounts of $17,100 and $16,000 in 2013 and 2012, respectively 210, ,889 Contributions receivable 12,471 24,675 Other receivable from California Health Facilities Financing Authority ("CHFFA") - 97,437 Other receivables 33,377 42,551 Prepaid expenses, inventory and other 13,036 10,093 Total current assets 457, ,356 Investments 67,407 66,907 Investments in University managed pools 618, ,558 Board designated funds in University managed pools 213, ,149 Assets limited as to use, held by trustee 199, ,717 Property and equipment, net 643, ,898 Beneficial interest in trusts, net 14,858 13,604 Contributions receivable, net of current portion 10,992 25,210 Other assets 40,414 22,345 Total assets $ 2,266,263 $ 2,031,744 Liabilities and Net Assets Current liabilities Accounts payable and accrued liabilities $ 70,225 $ 88,074 Accrued salaries and related benefits 53,853 47,182 Due to related parties 40,376 27,533 Third-party payor settlements 1,535 1,701 Current portion of long-term debt and capital leases 2,200 2,030 Self-insurance reserves and other liabilities 6,394 5,107 Total current liabilities 174, ,627 Self-insurance reserves and other liabilities, net of current portion 29,561 30,728 Long-term debt and capital leases, net of current portion 358, ,736 Total liabilities 562, ,091 Commitments and contingencies (Note 15) Net assets Unrestricted 1,164, ,921 Temporarily restricted 338, ,973 Permanently restricted 200, ,759 Total net assets 1,703,410 1,467,653 Total liabilities and net assets $ 2,266,263 $ 2,031,744 The accompanying notes are an integral part of these consolidated financial statements. 2

5 Consolidated Statements of Operations and Changes in Net Assets Years Ended Operating revenues Net patient service revenue before provision for doubtful accounts $ 1,090,999 $ 930,846 Provision for doubtful accounts, net (7,705) (9,150) Net patient service revenue after provision for doubtful accounts 1,083, ,696 Other revenue 51,610 38,832 Net assets released from restrictions used for operations 20,578 19,130 Total operating revenues 1,155, ,658 Operating expenses Salaries and benefits 425, ,541 Professional services 24,809 21,804 Supplies 77,604 66,166 Purchased services 343, ,983 Other 100, ,953 Depreciation and amortization 37,873 37,381 Total operating expenses 1,008, ,828 Income from operations 146,622 68,830 Interest income 2,142 2,154 Income and gains from University managed pools 60,827 17,599 Other - (3,658) Excess of revenues over expenses 209,591 84,925 Net assets released from restrictions used for purchases of property and equipment 213 2,843 Transfer of net investment loss on certain endowments Adjustment for minimum pension liability 2, Transfers to University and other (30,741) (7,880) Increase in unrestricted net assets 181,301 80,913 Changes in temporarily restricted net assets Contributions 44, ,726 Income and gains from University managed pools 29,063 8,763 Change in value of beneficial interest in remainder trusts 317 (492) Net assets released from restrictions for operations (20,585) (19,130) Purchase of property and equipment (213) (2,843) Transfers to University and other 639 1,198 Increase in temporarily restricted net assets 53, ,222 Changes in permanently restricted net assets Contributions and other Change in value of beneficial interest in remainder trusts 1, Transfers to University and other (1,140) - Increase in permanently restricted net assets Increase in net assets 235, ,036 Net assets Beginning of year 1,467,653 1,242,617 End of year $ 1,703,410 $ 1,467,653 The accompanying notes are an integral part of these consolidated financial statements. 3

6 Consolidated Statements of Cash Flows Years Ended Cash flows from operating activities Change in net assets $ 235,757 $ 225,036 Adjustments to reconcile change in net assets to net cash provided by operating activities Depreciation and amortization 36,917 37,295 Loss on extinguishment of debt - 3,658 Premium received related to bond issuance - 19,640 Net transfers to related parties and other 29,356 6,862 Provision for doubtful accounts 7,705 9,150 Income and gains from University managed pools (67,174) (5,131) Contributions and investment income restricted by donors (63,995) (112,400) Changes in operating assets and liabilities Patient accounts receivable, net (57,512) (31,284) Contributions receivable 26,853 (19,195) Due to/from related parties 5,636 (6,829) Other receivables, inventory, other assets, prepaid expenses and other (12,273) (42,514) Accounts payable and accrued liabilities (14,261) 17,828 Accrued salaries and related benefits 6,671 4,184 Third-party payor settlements (166) 176 Self-insurance and other liabilities 120 3,145 Cash provided by operating activities 133, ,621 Cash flows from investing activities Purchases of investments in University managed pools and other (3,601) (5,359) Purchase of investment for assets limited as to use (783) (209,471) Sales of investments - 10,754 Purchases of property and equipment (163,773) (92,056) Cash used in investing activities (168,157) (296,132) Cash flows from financing activities Extinguishment of long term and short tem debt - (148,450) Payment of capital leases - (13,871) Payment of long term debt (2,030) - Cost of issuance related to debt issuance - (3,478) Proceeds from issuance of long term debt - 344,495 Contributions and investment income restricted by donors 161,991 13,799 Transfers to related parties (22,670) (10,657) Cash provided by financing activities 137, ,838 Net increase (decrease) in cash and cash equivalents 102,768 (4,673) Cash and cash equivalents Beginning of year 85,641 90,314 End of year $ 188,409 $ 85,641 Supplemental disclosures of cash flow information Interest paid $ 13,723 $ 6,859 Noncash activities Accounts payable related to purchases of property and equipment (3,588) 6,498 Accrual of net assets transfer to related parties 13,451 3,144 The accompanying notes are an integral part of these consolidated financial statements. 4

7 1. Organization Lucile Salter Packard Children s Hospital at Stanford ( LPCH ) operates a licensed acute care pediatric and obstetric hospital on the Leland Stanford Junior University ( University ) campus in Palo Alto and operates several inpatient care units on its license in nearby community hospitals. LPCH also operates outpatient physician clinics in its facilities and other community settings. The Board of Trustees of the University is the sole corporate member of LPCH and Stanford Hospital and Clinics ( SHC ). LPCH, SHC, and the University engage in certain related party transactions as described further in Note 13. LPCH leases all its 3,032 full time and part time employees from SHC as of August 31, These consolidated financial statements for fiscal year 2013 include LPCH s interest in Packard Children s Health Alliance (PCHA). PCHA was incorporated in October 2011 as a not-for-profit physician practice management organization, which supports Stanford University Medical Center s (SoM) mission of delivering quality care to the community and conducting research and education. PCHA is developing a clinical delivery network of pediatric community physicians. The SoM and LPCH are the members of PCHA, and appoint directors to the governing board. The bylaws of PCHA afford control of PCHA to LPCH and therefore, the activities of PCHA have been included in the consolidated financial statements of LPCH. LPCH has recorded PCHA s 2013 results of operations as an investment in PCHA and it is eliminated in consolidation. In 2013, PCHA purchased eight physician practices for approximately $14,300 which were funded by LPCH through a capital contribution. Effective September 1, 2002, LPCH and SHC entered into an agreement whereby LPCH became a member of the Stanford University Medical Indemnity Trust ( SUMIT ), a not-for-profit, tax-exempt corporation that is a captive insurance carrier. SUMIT Holding International, LLC ( SHI ) is the sole owner of SUMIT Insurance Company Ltd. ( SUMIT ) and Stanford University Medical Network Risk Authority, LLC ( SRA ). SHC and LPCH are the owners of SHI. LPCH s share of SUMIT net assets was approximately 25.1% and 25.5% for the years ended, respectively. LPCH s ownership in SUMIT is accounted for using the equity method. As of, LPCH had an investment of $17,306 and $13,696 in SUMIT, respectively, which is reflected on the balance sheets as other assets. SRA was formed on September 19, 2012 and began operations on December 1, SRA provides risk management services to SHI, the owners of SHI and other affiliated and unaffiliated parties and serves as attorney-in-fact to Professional Exchange Insurance Company ( PEAC ). LPCH s ownership interest in SRA was 18% for the year ended August 31, LPCH s ownership in SRA is accounted for using the equity method. As of August 31, 2013, LPCH s investment in SRA was a loss of $11. Professional Exchange Insurance Company ( PEAC ), a captive insurance carrier that entered into business with SRA on October 18, 2012, provides professional liability insurance coverage for physicians and other licensed healthcare practitioners of PHCA, University Healthcare Alliance (a subsidiary of SHC) and other affiliated parties. PCHA s share of net assets in PEAC was 20.4% for the year ended August 31, PCHA s ownership in PEAC is accounted for using the equity method. As of August 31, 2013, PCHA had an investment of $130. 5

8 On September 1, 2006, LPCH and the University entered into a Professional Services Agreement ( PSA ) pursuant to which the University assigned to LPCH the right to bill and collect all revenue related to pediatric and obstetric practices on behalf of the University s School of Medicine ( SoM ) faculty as the LPCH Medical Group, a division of LPCH. 2. Summary of Significant Accounting Policies Basis of Presentation The accompanying financial statements are prepared on the accrual basis of accounting. Net assets of LPCH and changes therein have been classified and are reported as follows: Unrestricted net assets Unrestricted net assets represent those resources of LPCH that are not subject to donor-imposed stipulations. The only limits on unrestricted net assets are broad limits resulting from the nature of LPCH and the purposes specified in its articles of incorporation or by laws and limits resulting from contractual agreements, if any. Temporarily restricted net assets Temporarily restricted net assets represent contributions, which are subject to donor-imposed restrictions that can be fulfilled by actions of LPCH pursuant to those stipulations or by the passage of time. Permanently restricted net assets Permanently restricted net assets represent contributions that are subject to donor-imposed restrictions that they be maintained by LPCH in perpetuity. Generally, the donors of these assets permit LPCH to use all or part of the investment return on these assets. Expenses are generally reported as decreases in unrestricted net assets. Donor-imposed restrictions expire when the stipulated time period has elapsed, when the stipulated purpose for which the resource was restricted has been fulfilled, or both. Temporarily restricted contributions are recorded as restricted revenue when received and when the restriction expires, the net assets are shown as released from restriction in the Consolidated Statements of Operations and Changes in Net Assets. Income earned on temporarily restricted or permanently restricted net assets for which that income is restricted for a stipulated purpose is recorded in temporarily restricted net assets. When income is made available for release and when the restriction is deemed to have been met, those amounts are included in net assets released from restrictions in the Consolidated Statements of Operations and Changes in Net Assets. Transfers to Related Parties Certain amounts previously received from donors have been transferred to related parties. Cash and Cash Equivalents Cash and cash equivalents consist primarily of demand deposits and money market mutual funds with an original maturity of three months or less when purchased. These amounts are carried at cost which approximates fair value. Assets Limited as to Use, Held by Trustee Assets limited as to use primarily include assets held by trustees under bond indenture agreements. The bond indenture terms require that the trustee control the disbursement of bond proceeds for capital projects. Assets limited as to use consist of money market funds for the year 6

9 ended, respectively. Fair values are based on quoted market prices or broker or dealer price quotations on a specific identification basis. Contributions Receivable Contributions are recorded at fair value at the date the promise is received. Donations for specific purposes are reported as either temporary or permanently restricted net assets and are included as restricted contributions. Contributions to be received after one year are discounted at an appropriate discount rate commensurate with the risks involved and applicable to the years in which the promises are received, and recorded in their respective net asset category. The discount rates used during the year ended were determined using the risk free rate adjusted for the risk of donor default. Amortization of the discount is included in contribution revenue in the Consolidated Statements of Operations and Changes in Net Assets. Conditional promises to give are recognized when the condition is substantially met. Other Receivables Other receivables are comprised of nonpatient related receivables for medical services provided. Investments Investments held directly by LPCH consist primarily of mutual funds and are stated at fair value. Investment earnings (including realized gains and losses on investments, interest, dividends and impairment loss on investment securities) are included in investment income unless the income or loss is restricted by donor or law. Income on investments of donor restricted funds is added to or deducted from the appropriate net asset category based on the donor s restriction. Unrestricted unrealized gains and losses on other than trading securities are separately reported below the excess of revenues over expenses in the Consolidated Statement of Operations and Changes in Net Assets. Investments in University Managed Pools Investments in University managed pools consist of funds invested in the University s Merged Pool ( MP ). The value of its share of the MP is determined by the University, and is based upon the fair value of the underlying assets held in the MP. Earnings include distributions and increases or decreases in the value of LPCH s share of the pool. LPCH may deposit funds in the MP at its discretion; however, withdrawals require advance notice, with the exception of the Liquidity Agreement that was in effect from July 25, 2008 through March 21, The Liquidity Agreement provided for the liquidation of MP shares held by LPCH into immediately available funds for the purpose of funding tenders of the 2008 California Health Facilities Financing Authority Series A, B and C variable rate bonds. Funds that were available same day pursuant to the liquidity agreement and funds which would be disbursed to LPCH near the end of the fiscal year were both classified as short term investments. The agreement was cancelled on March 21, All investment gains and losses and the increases or decreases in the share value are treated as realized and included in the excess of revenues over expenses, unless the income is restricted by donor or law. Board Designated Funds in University Managed Pools LPCH s board of directors approved designating $213,102 for future investment in facilities, programs, and services over which the Board retains control and may at its discretion subsequently use for other purposes. These funds are primarily invested in the MP and were funded from cash and cash equivalents. In accordance with the instructions of the Board, investment returns earned 7

10 on board designated funds are treated as unrestricted income with the principal to remain intact until required for future investment in facilities, programs, and services. Beneficial Interest in Trusts LPCH is the remainder beneficiary of certain charitable remainder trusts where the trust assets are invested and administered by outside trustees. LPCH records its remainder interest in these trusts at fair value based on estimated future cash receipts discounted at rates ranging from 0.4% to 2.78% for the year ended August 31, 2013 and 0.23% to 1.85% for the year ended August 31, The fair value of these assets is based on the market value of the traded securities as of year end. Additionally, LPCH is the sole beneficiary of a perpetual trust that is carried at the fair market value of the trust. Income from the trust (interest, net of fees) is distributed to LPCH and included in interest income. Property and Equipment Property and equipment are stated at cost except for donated assets, which are recorded at fair market value at the date of donation. LPCH capitalizes certain internal costs of computer software developed or obtained for internal use. Depreciation of property and equipment is computed using the straight-line method over the estimated useful lives or the remaining expected useful life, which are as follows: Land improvements Buildings and improvements Equipment Ground leases 10 to 25 years 10 to 40 years 3 to 20 years 3 to 49 years Significant replacements and improvements are capitalized, while maintenance and repairs, which do not improve or extend the life of the respective assets, are charged to expense as incurred. Upon sale or disposal of property and equipment, the cost and accumulated depreciation are removed from the respective accounts, and any gain or loss is included in the Consolidated Statements of Operations and Changes in Net Assets. Assets under capital leases are recorded at the present value at the inception of the lease and are amortized on a straight-line basis over the shorter of the lease term or the estimated useful life of the asset. The amortization of assets recorded under capital leases is included in depreciation and amortization expense in the accompanying Consolidated Statements of Operations and Changes in Net Assets. LPCH holds several ground leases, also classified as property and equipment. These ground leases are amortized on a straight-line basis over the term of the leases and are reflected as depreciation and amortization in the Consolidated Statements of Operations and Changes in Net Assets. Interest costs incurred on borrowed funds during the period of construction of capital assets are capitalized, net of any interest earned, as a component of the cost of acquiring the asset. 8

11 Asset Retirement Obligations Asset retirement obligations, reported in accounts payable and accrued liabilities, are legal obligations associated with the retirement of long-lived assets. These liabilities are initially recorded at fair value and the related asset retirement costs are capitalized by increasing the carrying amount of the related assets by the same amount as the liability. Asset retirement costs are subsequently depreciated over the useful lives of the related assets. Subsequent to initial recognition, LPCH records changes in the liability resulting from the passage of time and revisions to either the timing or amount of the original estimate of undiscounted cash flows. LPCH reduces these liabilities when the related obligations are settled. Impairment and Disposition of Long-Lived Assets Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net undiscounted cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. There were no impairment losses for the years ended. Other Assets Other assets include LPCH s ownership interest in SUMIT, SRA and PEAC, investment in joint ventures and PCHA, deposits with vendors, goodwill and deferred debt issuance costs. LPCH performs impairment analysis at the reporting unit level when events occur that require an evaluation to be performed or at least annually. If the carrying value of goodwill or indefinite lived intangible assets are determined to be impaired, or if the carrying value of a business that is to be sold or otherwise disposed of exceeds its fair value, then the carrying value is reduced, including any allocated goodwill, to fair value. Estimates of fair value are based on appraisals, established market prices for comparative assets or internal estimates of future net cash flows based on projected performance, depending on circumstances. Impairment testing is performed annually to ascertain if events or changes in circumstances indicate that the asset might be impaired. No impairment of goodwill is included in the accompanying statement of operations and changes in net assets for the year ended August 31, Deferred debt issuance costs represent costs incurred in conjunction with the issuance of LPCH s long-term debt. These costs are amortized on a straight-line basis, which approximates the effective interest method, over the life of the debt. Compensated Absences In accordance with formal policies concerning vacation and other compensated absences, accruals of $31,006 and $30,772 were recorded as of, respectively, and are included in accrued salaries and related benefits. Premiums on Long-Term Debt Premiums arising from the original issuance of long-term debt are amortized on a straight-line basis, which approximates the effective interest method, over the life of the debt. The unamortized portion of these premiums is included in long-term debt. 9

12 Excess of Revenues Over Expenses The Consolidated Statements of Operations and Changes in Net Assets include excess of revenues over expenses. Changes in unrestricted net assets which are excluded from excess of revenues over expenses include permanent transfers of assets to and from affiliates for other than goods and services, contributions of long-lived assets (including assets acquired using contributions which by donor restriction were to be used for the purposes of acquiring such assets), adjustment for minimum pension liability, and transfer of funds related to underwater endowments. Net Patient Service Revenue Net patient service revenue is reported at the estimated net realizable amounts from patients, third-party payors including Medi-Cal and others for services rendered. The contractual commitments and laws and regulations governing the payment for services for government (Medi-Cal and Medicare) and commercial payors are extremely complex and subject to interpretation. As a result, there is at least a reasonable possibility that recorded estimates will change by a material amount in the near term. The process for estimating the ultimate collectibility of receivables involves historical collection experience, changes in contracts with payors, and significant assumptions and judgment. LPCH has implemented a standardized approach to this estimation based on the payor classification and age of outstanding receivables. Account balances are written off against the allowance when management believes it is probable the receivable will not be recovered. The use of historical collection experience is an integral part of the estimation of the reserve for doubtful accounts. Revisions in the reserve for doubtful accounts are recorded as adjustments to the provision for doubtful accounts. Charity Care and Community Benefits LPCH provides care to patients who meet certain criteria under its charity care policy without charge or at amounts less than its established rates. Amounts determined to qualify as charity care are not reported as net patient service revenue. LPCH also provides services to patients under Medi-Cal and other publicly sponsored programs, which reimburse at amounts less than the cost of the services provided to the recipients. Such amounts are considered community benefits. Self-Insurance Reserves and Other Liabilities LPCH self-insures for professional liability risks, postretirement medical benefits, health, dental and vision, and workers compensation. These liabilities are reflected as self-insurance reserves on the balance sheets. 10

13 Professional Liability LPCH is self insured through SUMIT (LPCH and SHC Captive Insurance Carrier) for medical malpractice and general liability losses under claims-made coverage. LPCH also maintains professional liability reserves for claims not covered by SUMIT which totals $735 and $1,118 for the years ended, respectively. For the policy year s September 1, 2012 to September 1, 2013, SUMIT retains 100% of the risk related to the first $15,000 per occurrence subject to $35,000 aggregate. The next $115,000 is transferred to various reinsurance companies rated A or better by AM Best rating agency. For the period from September 1, 2005 to September 1, 2012, LPCH maintained the same coverage limits as fiscal year Prior to September 1, 2005 LPCH maintained various coverage limits. Postretirement Medical Benefits Liabilities for post-retirement medical claims for current and retired employees are actuarially determined by SHC and allocated to LPCH. Health, Dental and Vision Liabilities for health, dental and vision claims for current employees are based on estimated costs. Workers Compensation LPCH purchases insurance for workers compensation claims with a $750 deductible per occurrence. Workers compensation insurance provides statutory limits for the State of California. An actuarial estimate of retained losses (or losses retained within the deductible) has been used to record a liability. Fair Value of Financial Instruments Due to the short-term nature of cash and cash equivalents, accounts payable and accrued liabilities, and accrued salaries and related benefits, their carrying value approximates their fair value. Transactions with the University LPCH enters into various transactions with the University. LPCH records expense transactions where direct and incremental economic benefits are received by LPCH. Certain expenses are allocated from the University to LPCH. Allocated expenses reported as operating expenses in the Consolidated Statements of Operations and Changes in Net Assets are management s best estimates of LPCH s arms-length payment of such amounts for its market specific circumstances. To the extent that payments to the University exceed an arms-length estimated amount relative to the benefit received by LPCH, they are recorded as transfers to the University. Concentration of Credit Risk Financial instruments, which potentially subject LPCH to concentrations of credit risk, consist principally of cash and cash equivalents, patient accounts receivable, and investments in University managed pools (Note 7). LPCH invests its cash and cash equivalents in highly rated financial instruments including insured deposits. As of August 31, 2013, LPCH has invested its cash and cash equivalents with a financial institution in excess of federal depository insurance limits. LPCH s concentration of credit risk relating to patient accounts receivable is limited by the diversity and number of the patients and payers. Patient accounts receivable consists of amounts due from governmental programs, commercial insurance companies, private pay patients, and other group insurance programs. 11

14 Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant estimates relate to patient accounts receivable allowances and self-insurance reserves. Actual results may differ from those estimates. Income Taxes LPCH is a California not-for-profit corporation and has been recognized as tax-exempt pursuant to Section 501(c)(3) of the Internal Revenue Code. PCHA is a not-for-profit corporation and has applied for recognition of tax-exempt status pursuant to Section 501(c)(3) of the Internal Revenue Code and is currently operating as though it has been recognized as tax-exempt. Management has no reason to believe that PCHA s tax-exempt status will not be recognized in due course. Adoption of New Standards The Financial Accounting Standards Board ( FASB ) Accounting Standards Codification ( ASC ) is the sole source of authoritative non-governmental U.S. generally accepted accounting principles ( U.S. GAAP ). In December 2011, the FASB issued an update to the ASC which expanded the required disclosures about offsetting and related arrangements of an entity s financial assets and liabilities. The disclosures are intended to provide additional information to assist financial statement users in understanding the effect of those arrangements on the entity s financial position. This guidance is effective for annual periods beginning on or after January 1, LPCH is currently evaluating the impact that this guidance will have on its consolidated financial statements. In July 2012, the FASB issued an update to the ASC that allows an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative impairment test on indefinite-lived intangible assets. This guidance is effective for fiscal periods beginning after September 15, LPCH is currently evaluating the impact that this guidance will have on its consolidated financial statements. During 2012, LPCH adopted guidance to disclose or record the impact of two updates to the ASC which require the cost to be used as the measurement for charity care disclosure purposes and eliminates the ability for health care entities to net insurance recoveries against related claim liabilities. In 2012, LPCH also adopted an update to the ASC which required reclassification of provision for doubtful accounts associated with patient service revenue from operating expense to a deduction from net patient revenue as a separate line item. This guidance was applied retrospectively. In May 2011, the FASB issued an update to the ASC to ensure a consistent definition of fair value, fair value measurements and disclosure requirements under both U.S. GAAP and International Financial Reporting Standards. This guidance is effective for annual periods beginning after December 15, Key provisions include (1) additional information about Level 3 fair value measurements, including quantitative information about unobservable inputs, a description of the valuation process used, and a description of the sensitivity of fair value measurement to changes in inputs; and (2) for public entities, disclosure of all transfers between investments classified in the 12

15 Level 1 and Level 2 fair value hierarchy. This guidance did not impact LPCH s financial statement disclosures. Reclassification of Prior Year Amounts Certain comparative figures such as Current portion of long term debt on the Consolidated Balance Sheets have been reclassified to conform with current year presentation. Comparative Information LPCH revised the 2012 statement of cash flows to properly present changes in accounts payable and accrued liabilities related to purchases of property, plant and equipment. Management revised such amounts by increasing the previously reported cash from operating activities by $15,146 and increasing the previously reported cash used in investing activities by $15,146. This error had no effect on the consolidated balance sheet of LPCH at August 31, 2012, the consolidated statement of operations and changes in net assets, and the net change in cash and cash equivalents within the consolidated statement of cash flows of LPCH for the year ended August 31, Management believes that the error was not material to the 2012 financial statements. 3. Net Patient Service Revenue LPCH has agreements with third-party payors that provide for payments at amounts different from LPCH s established rates. A summary of payment arrangements with major third-party payors are as follows: Medi-Cal Inpatient services rendered to State and Managed Medi-Cal program beneficiaries through June 30, 2013 were reimbursed under contracts negotiated per diem rates. On July 1, 2013, the State began reimbursing for Medi-Cal program beneficiaries using an All Patient Refined-Diagnosis Related Group (APR-DRG) methodology. Outpatient services are reimbursed based upon prospectively determined fee schedules. In addition, LPCH qualified for additional revenue under the Medi-Cal Disproportionate Share ( DSH ) program. DSH is a California program for the poor and when a hospital is considered by the State to have relatively more Medi-Cal utilization than the norm, it qualifies to receive DSH supplemental funding. LPCH must re-qualify for DSH annually. For the years ended August 31, 2013 and August 31, 2012, LPCH received $9.4 million and $0.4 million in DSH supplemental payments, respectively. HMO/PPO and Other Managed care contracts such as those with HMOs and PPOs reimburse LPCH at per diem rates or a percent of charges basis, which are less than full charges. Net patient service revenue by major payor before the provision for bad debt for the years ended August 31 is as follows: LPCH PCHA Total LPCH PCHA Total Medi-Cal $ 231,242 $ 3,807 $ 235,049 $ 169,558 $ - $ 169,558 HMO/PPO 770,031 25, , , ,570 Other 60, ,664 51, ,718 $ 1,061,445 $ 29,554 $ 1,090,999 $ 930,264 $ 582 $ 930,846 13

16 Included above in the Medi-Cal net patient services revenue is $82,958 and $67,994 for Medi-Cal Fee-For-Service and Managed Care payments for fiscal years 2013 and 2012, respectively, under the hospital provider fee program. Amounts due from Blue Cross and the State of California s Medi-Cal program represent 24% and 10%, and 25% and 14%, of LPCH net patient accounts receivable at, respectively. Amounts due from the State of California s Medi-Cal program and Blue Cross represent 37% and 21% of PCHA net patient accounts receivable at August 31, Amounts due from Blue Cross and Blue Shield, represent 27% and 15% of PCHA net patient accounts receivable at August 31, LPCH does not believe significant credit risks exist with these payors. Hospital Quality Assurance Fee Program The State of California enacted AB 1383 in 2009, as amended by AB 1653 in 2010, which established a Hospital Quality Assurance Fee Program ( QAF ) and a Hospital Fee Program. These programs imposed a provider fee on certain California general acute care hospitals that, combined with federal matching funds, would be used to provide supplemental payments to certain hospitals and support the State s effort to maintain health care coverage for children. The effective period of the Hospital Fee Program was April 1, 2009 through December 31, The State received final approval from the Centers for Medicare & Medicaid Services (CMS) in December of 2010 on the rates to pay Medi-Cal managed care plans. Subsequent legislation extended the QAF and Hospital Fee programs from January 1, 2011 through June 30, 2011, which was approved by CMS in December Additional legislation extended the QAF and Hospital Fee programs from July 1, 2011 through December 31, In June 2012, CMS approved the fee-for-service Medi- Cal supplement payments portion of this thirty month extension and, in May 2013, CMS approved the managed care supplemental payments portion of this thirty month program. For the years ended, respectively, LPCH recognized $82,958 and $67,994 in net patient service revenue for Medi-Cal Fee-For-Service ( FFS ) and Managed Care supplemental payments and $23,871 and $32,941, in other expense in the Consolidated Statement of Operations and Changes in Net Assets for QAF paid to California Department of Health Care Services ( DHCS ). 4. Charity Care and Community Benefits LPCH is committed to advocacy, outreach, education, and research to improve the health status of children and pregnant women. LPCH continually reaffirms its commitment to its community by developing innovative programs to enhance its own and the community s capacity to care for children and pregnant women. These programs include: Health Professions Education Graduate Medical Education Social Services Internships Community Programs Mobile Adolescent Health Services 14

17 Pediatric Weight Control Programs CareAVan Community Health Education Perinatal Outreach Programs Support to Ravenswood Family Health Center Child Safety & Inquiry Presentation Programs Family and Children Health Advocacy LPCH s direct charity care and uncompensated costs of medical services to government-covered patients for the years ended August 31 is as follows: Charity care at established rates $ 3,032 $ 4,160 Estimated cost of charity care 801 1,169 Estimated cost of medical services provided to government covered patients (not including Medicare) 168, ,838 $ 168,946 $ 230,007 The decrease in the estimated cost of medical services provided to government covered patients (not including Medicare) in 2013 was mainly due fewer MediCal patients in relation to the total census and higher MediCal charges in relation to the applicable costs. Additionally, LPCH invests in improving the health of children of San Mateo and Santa Clara counties primarily by providing health professional education and community health services. 5. Meaningful Use Funds LPCH is participating in the Medicare and Medicaid Electronic Health Records Incentive Programs (EHR), which provides payments to eligible professionals, eligible hospitals and critical access hospitals as they adopt, implement, upgrade or demonstrate meaningful use of certified Electronic Health Records technology. LPCH recognized $4,398 and $1,965 in other revenue in the Consolidated Statements of Operations and Changes in Net Assets under these programs for the year ended August 31, 2013 and August 31, 2012, respectively. 6. Contributions Receivable Contributions receivable and contribution revenue are included in the financial statements in the appropriate net asset category. Contributions are recorded at the discounted net present value of the future cash flows, adjusted for the risk of donor default, using discount rates ranging from 5.8% to 3.2% as of 2013 and

18 Contributions receivable at August 31 are expected to be realized in the following periods: In one year or less $ 13,213 $ 26,657 Between one year and five years 13,035 29,680 More than five years ,248 56,337 Less: Discount/allowance (2,785) (6,452) Total contributions receivable, net 23,463 49,885 Less: Current portion (12,471) (24,675) Contributions receivable, net of current portion $ 10,992 $ 25,210 Contributions receivable at August 31 are to be utilized for the following purposes: Plant replacement and expansion $ 14,855 $ 36,486 Clinical services 5,519 9,888 Indigent care and other 3,089 3,511 $ 23,463 $ 49,885 Conditional pledges, which depend on the occurrence of a specified future or uncertain event, were $119,602 and $136,550 at, respectively. The majority of these conditional pledges are related to construction or time defined milestones related to the Renewal Project. 16

19 7. Investments and Investments in University Managed Pools The composition of investments held directly by the organization at August 31 is as follows: Cost Fair Value Cost Fair Value Investments Mutual funds $ 67,803 $ 67,407 $ 66,889 $ 66,907 Board designated funds, short-term investments and other noncurrent investment funds are invested in University merged pools (MP), holding a variety of investments, which consist of cash and cash equivalents, government and corporate debt securities, equity securities and mutual funds, real estate, investment in partnerships, and other Cost Fair Value Cost Fair Value Beneficial interest in investments in University managed pools $ 397,365 $ 618,790 $ 395,838 $ 552,628 Board designated funds 210, , , ,149 $ 607,514 $ 831,892 $ 605,987 $ 762,777 Losses or gains on LPCH s beneficial interest in investments in University merged pools of $67,588 and $4,847 for the years ended, respectively, represent the change in the fair value of LPCH s share of the MP. The MP is the primary investment pool in which funds are invested. The MP is invested with the objective of maximizing long-term total return. It is a unitized pool in which the fund holders purchase investments and withdraw funds based on a monthly share value. The MP s investments at are as follows: Assets Cash and cash equivalents 5 % 4 % Fixed income 5 4 Public equities Real estate Natural resources 8 8 Absolute return Private equities Total 100 % 100 % 17

20 8. Fair Value Measurements U.S. GAAP defines fair value as the price received upon sale of an asset or paid upon transfer of a liability in an orderly transaction between market participants and establishes a hierarchy of valuation inputs based on the extent to which the inputs are observable in the marketplace. Observable inputs reflect market data obtained from independent sources. In contrast, unobservable inputs reflect the entity s assumptions about how market participants would value the financial instrument. Valuation techniques used under U.S. GAAP must maximize the use of observable inputs to the extent available. The following describes the hierarchy of inputs used to measure fair value and the primary valuation methodologies used for financial instruments measured at fair value on a recurring basis: Level 1 Level 2 Level 3 Quoted prices in active markets for identical assets or liabilities, at the reporting date, without adjustment. Market price data is generally obtained from relevant exchange or dealer markets. Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the same term of the assets or liabilities. Inputs are obtained from various sources including market participants, dealers and brokers. Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. A financial instrument s categorization within this hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The following table summarizes consolidated LPCH s assets and liabilities measured at fair value as of August 31, 2013, based on the inputs used to value them. Level 1 cash and cash equivalents include $3,619 for PCHA. Level 1 Level 2 Level 3 Total Assets Cash and cash equivalents $ 188,409 $ - $ - $ 188,409 Assets limited as to use, held by trustee 199, ,500 Investments (mutual funds) 67, ,407 Investments in Stanford University managed pools - 831, ,892 Beneficial interest in trusts ,858 14,858 Total assets $ 455,316 $ 831,892 $ 14,858 $ 1,302,066 There were no transfers of assets or liabilities between Level 1 and Level 2 during the year ended August 31,

21 The following table presents the 2013 activities of financial instruments of which fair value measurement is using Level 3 inputs: Balance at September 1, 2012 $ 13,604 Realized gains (losses) (427) Unrealized gains (losses) 1,681 Balance at August 31, 2013 $ 14,858 The following table summarizes consolidated LPCH s assets and liabilities measured at fair value as of August 31, 2012, based on the inputs used to value them: Level 1 Level 2 Level 3 Total Assets Cash and cash equivalents $ 85,641 $ - $ - $ 85,641 Assets limited as to use, held by trustee 198, ,717 Investments (mutual funds) 66, ,907 Investments in Stanford University managed pools 1, , ,777 Beneficial interest in trusts ,604 13,604 Total assets $ 352,335 $ 761,707 $ 13,604 $ 1,127,646 There were no transfers of assets or liabilities between Level 1 and Level 2 during the year ended August 31, The following table presents the 2012 activities of financial instruments of which fair value measurement is using Level 3 inputs: Balance at September 1, 2011 $ 13,972 Realized gains (losses) (357) Unrealized gains (losses) (11) Balance at August 31, 2012 $ 13,604 19

22 9. Property and Equipment Property and equipment consist of the following as of : LPCH PCHA Consolidated LPCH PCHA Consolidated Land improvements $ 6,899 $ - $ 6,899 $ 6,899 $ - $ 6,899 Buildings and improvements 357, , , ,110 Equipment 214,348 1, , , ,736 Ground leases 59,384-59,384 59,385-59, ,610 1, , , ,130 Less: Accumulated depreciation (313,992) (592) (314,584) (277,352) (2) (277,354) Construction-in-progress 315,553 2, , , ,122 Property and equipment, net $ 640,171 $ 3,040 $ 643,211 $ 520,812 $ 86 $ 520,898 Buildings under capital lease obligations were demolished in FY2012 as a result of the hospital expansion project. Ground lease accumulated amortization totals $8,226 and $7,039 for the years ended, respectively. Total depreciation and amortization expense for the years ended, is $37,873 and $37,381, respectively. During the year ended August 31, 2013, capitalized interest expense was $316. In fiscal year 2012, none of interest expense, net of interest income, was capitalized. 10. Long-Term Debt and Capital Leases LPCH s outstanding debt at August 31 is summarized below: Effective Year of Interest Outstanding Principal Maturity 2013/ California Health Facilities Financing Authority Variable rate bonds Series 2012B %/3.00% 49,015 51,045 Series 2012B Premium 7,570 8,111 Fixed rate bonds Series 2012A %/5.00% 200, ,000 Series 2012A Premium 10,874 11,160 Fixed rate put bonds Series 2008A %/1.45% 30,340 30,340 Series 2008B %/1.45% 30,340 30,340 Series 2008C %/1.45% 32,770 32, , ,766 Less: Current portion of long term debt (2,200) (2,030) Long term debt $ 358,709 $ 361,736 20

23 The fair value of the 2012 Series A and B bonds are estimated based on the current borrowing rates for similar issues, and amounted to approximately $192,100 and $53,600, respectively, at August 31, The fair value of the 2008 Series A, B and C fixed rate bonds is estimated based on the current borrowing rates for similar issues, and amounted to approximately $30,200, $30,200, and $32,600 at August 31, All bonds held at August 31, 2013 are considered to be level 2 fair value measurements. In 2003, LPCH entered into a master indenture of trust (the LPCH Master Indenture ) as the sole initial member of an obligated group ( LPCH Obligated Group ), the purpose of which is to provide for issuance of obligations under the LPCH Master Indenture securing indebtedness of the members of the LPCH Obligated Group on a joint and several basis. Obligations issued under the LPCH Master Indenture are collateralized by a lien on the gross revenues of LPCH. The LPCH Master Indenture also includes various covenants, the most restrictive of which include maintenance of a minimum annual debt service coverage ratio, limitations on additional indebtedness, restrictions on the disposition or transfer of assets, mergers and entry into and withdrawal from the LPCH Obligated Group. During the year ended August 31, 2013, LPCH was in compliance with its covenants. In March 2012, the California Health Facilities Financing Authority ( CHFFA ) issued, on behalf of LPCH under the LPCH Master Indenture, revenue bonds 2012 Series A Bonds and 2012 Series B Bonds in the aggregate par amount of $251,045 (the 2012 Bonds ). The 2012 bonds were collateralized under the provisions of an Indenture and loan agreement. The 2012 Series A, fixed rate bonds were issued at a $200 million principal amount and a premium of $11,288. Proceeds are to be primarily used for financing the acquisition, construction, and expansion of the hospital. The 2012 Series B bonds, variable rate bonds, were issued at a $51,045 principal amount with a premium of $8,351. The proceeds of the Series B bonds were to be used for redemption of 2003 Series C bond and costs of issuance. In March 2012, the full balance of the 2003 Series C bonds, or $55 million, were legally defeased using the proceeds of 2012 Series B bonds. As a result of the defeasance, LPCH recorded a loss on defeasance of $3,658. In July 2003, CHFFA issued, on behalf of LPCH under the LPCH Master Indenture, revenue bonds in the aggregate par amount of $115,000. The 2003 bonds were comprised of $60,000 of Series A and B auction rate revenue bonds and $55,000 of Series C fixed rate revenue bonds. The interest rates on the 2003 Series A and B bonds were reset every 7 days. The 2003 Series C fixed rate bonds were issued at a net premium of $3,113. The 2003 Bonds were a limited obligation of the CHFFA and were payable solely from payments made by LPCH. In August 2008, LPCH redeemed the 2003 Series A and B bonds. LPCH converted the 2008 Series Bonds from short term variable rate bonds into $93,450 of fiveyear fixed rate put bonds in March 2012 with no gain or loss. In August 2008, the California Health Facilities Financing Authority ( CHFFA ) issued, on behalf of LPCH under the LPCH Master Indenture, revenue bonds in the aggregate par amount of $93,450. The 2008 bonds were comprised of Series A, B and C variable rate revenue bonds that bore interest at a daily, weekly, commercial paper, long term or auction rate, as defined by the LPCH Master Indenture. The bonds of each Series initially bore interest at a weekly rate, which reset every 7 days. The 2008 Bonds were payable solely from payments made by LPCH. Holders of these certificates had the option to 21

24 tender these certificates weekly. In order to ensure the availability of funds to purchase any certificates tendered that the remarketing agent was unable to remarket, LPCH entered into a Liquidity Agreement with the University. The agreement allowed immediate availability of LPCH funds invested in the MPs for purpose of funding tenders. The entire 2008 CHFFA Series A, B, and C issue were classified as a current liability prior to March 21, 2012 when the bonds were converted. As a result of refinancing of the 2008 Series bonds, LPCH cancelled the liquidity agreement with the University, effective March 21, As of August 31, 2013, the 2008 bonds are classified as long-term and will be required to be remarketed in Scheduled principal payments on long-term debt are summarized below: Scheduled Principal Maturities Interest Year ending August 31, 2014 $ 2,200 $ 13, ,375 13, ,675 13, ,825 14, ,060 14,892 Thereafter 317, ,665 $ 342,465 $ 406, Retirement Plans LPCH provides retirement benefits through defined benefit and defined contribution retirement plans covering substantially all benefit eligible leased employees. Defined Contribution Pension Plan Employer contributions to the defined contribution retirement plan are based on a percentage of participant annual compensation. Employer contributions to this plan which are vested immediately to participants totaling $22,191 and $21,569 for the years ended, respectively, are included in salaries and benefits expense in the Consolidated Statements of Operations and Changes in Net Assets. Postretirement Medical Benefit Plan LPCH currently provides health insurance coverage for certain of its leased employees, through the SHC plan, upon retirement as early as age 55, with years of service as defined by specific criteria. The health insurance coverage for retirees who are under age 65 is the same as that provided to active employees. A Medicare supplement option is provided for retirees over age 65. LPCH has recorded a liability totaling $16,024 and $16,930 for the years ended August 31, 2013 and 2012, respectively, included in self insurance reserves on the Consolidated Balance Sheets. This represents the obligation for its leased employees. LPCH reimburses SHC for costs related to this plan on a periodic basis, and in 2013 has recorded expense of $593 and an increase of $1,499 to net assets to reduce the minimum benefit liability. 22

25 Defined Benefit Pension Plans Certain LPCH leased employees are covered by a noncontributory defined benefit pension plan held by SHC. SHC s defined benefit pension plan benefits are based on years of service and the employee s compensation. Contributions to the plans are based on actuarially determined amounts sufficient to meet the benefits to be paid to plan participants. SHC and LPCH have an arrangement whereby SHC assumes the pension liability of the employees leased to LPCH. However, LPCH is required to reimburse SHC for the annual expense incurred for these leased employees. LPCH paid $594 and $548 in cash for the years ended, respectively, which represented current year pension expenses related to LPCH leased employees. The remainder of certain other leased LPCH employee s not covered by the previously described plans are covered by a frozen noncontributory defined benefit pension plan (the LPCH Frozen Pension Plan ). Benefits are based on years of service and the employee s compensation. Contributions to the plan are based on actuarially determined amounts sufficient to meet the benefits to be paid to plan participants. The following tables present information on plan assets and obligations, costs, and actuarial assumptions for the LPCH Frozen Pension Plan for the years ended, respectively. 23

26 The change in pension assets and the related change in benefit obligations, using a measurement date as of and for the years ended are as follows: Change in plan assets Fair value of plan assets at beginning of year $ 5,593 $ 4,991 Actual return on plan assets (108) 873 Employer contributions Benefits paid (508) (446) Fair value of plan assets at end of year $ 5,017 $ 5,593 Change in benefit obligation Projected benefit obligation at beginning of year $ 7,874 $ 6,655 Interest cost Actuarial (gain) loss (646) 1,354 Benefits paid (508) (446) Projected benefit obligation at end of year $ 6,981 $ 7,874 Funded status at end of year and net amount recognized in balance sheet $ (1,964) $ (2,281) Net amount recognized in balance sheet $ (1,964) $ (2,281) Amounts not yet reflected in net periodic benefit cost and included in other changes in net assets Accumulated net (loss) (1,595) (2,130) Adjustment for minimum pension liability (1,595) (2,130) Cumulative employer contributions in excess of net periodic benefit cost (369) (151) Net amount recognized in balance sheet $ (1,964) $ (2,281) The estimated net loss that will be amortized from other changes in net assets into net periodic benefit cost over the next fiscal year is $256. Due to the LPCH pension plan being frozen, the accumulated benefit obligation is the same as the projected benefit obligation at the end of the year. The increase to net assets to adjust the minimum pension liability of $535 is included in the Consolidated Statements of Operations and Changes in Net Assets for the year ended August 31, The respective decrease to net assets for the year ended August 31, 2012 was $551. Net benefit expense related to the plan for the years ended August 31 includes the following components: 24

27 Interest cost $ 261 $ 311 Expected return on assets (335) (301) Amortization of net loss Total net periodic benefit cost $ 258 $ 241 Changes recognized in other changes in net assets for the years ended August 31 include the following components: Prior service cost (credit) arising during period $ - $ - Net loss (gain) arising during period (203) 782 Amortization of net (loss) (332) (231) Total recognized in unrestricted net assets $ (535) $ 551 Total recognized in net periodic benefit cost and unrestricted net assets $ (277) $ 792 Actuarial Assumptions The weighted-average assumptions used to determine benefit obligations are as follows for the years ended August 31: Weighted-average assumptions to determine benefit obligations Discount rate 4.37 % 3.42 % Rate of compensation increase N/A N/A The discount rate, expected rate of return on plan assets, and the projected covered payroll growth rates used in determining the above accrued benefit costs are as follows for the years ended August 31: Weighted average assumptions to determine net periodic benefit costs Discount rate 3.42 % 4.83 % Rate of compensation increase N/A N/A Expected return on assets 6.25 % 6.25 % LPCH utilizes an independent investment consulting firm to provide an estimate of the future expected returns for each asset class based on LPCH s asset allocation targets. The evaluation of 25

28 the future expected returns resulted in the use of 6.25% as the assumption for the expected return on plan assets. Plan Investments The investments of the LPCH Frozen Pension Plan have been invested to ensure stability of returns as well as to preserve the asset base of investments. Changing market cycles require flexibility in asset allocation to allow movement of capital within the asset classes for the purpose of increasing investment return and/or reducing risk. The plan asset allocation for the LPCH Frozen Pension Plan as of the measurement date August 31 is 69% fixed income, 30% equity, and 1% cash as of August 31, 2013 and 69% fixed income and 30% equity, and 1% other as of August 31, Fair Value of Plan Assets The plan assets measured at fair value are as follows for the year ended August 31, 2013: Level 1 Level 2 Level 3 Total Assets Cash and cash equivalents $ 38 $ - $ - $ 38 Public equities 1, ,508 Fixed income 3, ,471 Other Total plan assets $ 5,017 $ - $ - $ 5,017 The plan assets measured at fair value are as follows for the year ended August 31, 2012: Level 1 Level 2 Level 3 Total Assets Cash and cash equivalents $ 23 $ - $ - $ 23 Public equities 1, ,669 Fixed income 3, ,888 Other Total plan assets $ 5,593 $ - $ - $ 5,593 Concentration of Risk LPCH manages a variety of risks, including market, credit, and liquidity risks, across plan assets through our investment managers. Concentration of risk is defined as an undiversified exposure to one of the above mentioned risks that increases the exposure of the loss of plan assets unnecessarily. LPCH management minimizes risk by diversifying exposure to such risks across a variety of instruments, markets, and counterparties. Plan Contributions LPCH expects to contribute $200 to the LPCH Frozen Pension Plan during the fiscal year ending August 31,

29 Estimated Future Benefit Payments The following table presents the expected benefit payments: Year ending August 31, 2014 $ Next 5 Years 2, Temporarily and Permanently Restricted Net Assets The endowment is intended to generate investment income that can be used to support their current operating and strategic initiatives. LPCH invests the majority of the endowments in the University s MP. LPCH s Board of Directors has adopted the University s investment and spending policies for its permanently restricted assets that provide for annual amounts (payout) to be distributed to appropriate temporarily restricted funds supporting operating and strategic activities of LPCH. Through the combination of investment strategy and payout policy, the hospital is striving to provide a reasonably consistent payout from the endowment to support operations, while preserving the purchasing power of the endowment adjusted for inflation. Consistent with UPMIFA, when determining the appropriate payout, the Board considers the purposes of the endowment, the duration and preservation of the endowment, general economic conditions, the possible effect of inflation or deflation, the expected return from income and the appreciation of investments, and investment policy. The current University Board of Trustees approved targeted spending rate is 5.5%, which was adopted by the Board of Directors of LPCH. Normally, the payout amount is determined by applying a smoothing rule that limits payout in a given year to the sum of 70% of the previous year s actual rate and 30% of the long-term spending target rate applied to the projected per share value of the endowment. The smoothing rule and the diversification of the investment asset allocation attempt to mitigate the impact of short-term market volatility on the flow of funds to support LPCH s operations. The smoothing rule was not applied to the current target rate. LPCH classifies as permanently restricted net assets (a) the original value of gifts donated to the permanent endowment, (b) the original value of subsequent gifts to the permanent endowment, and (c) accumulations to the permanent endowment made in accordance with the direction of the applicable donor gift instrument at the time the accumulation is added to the fund. The remaining portion of the donor-restricted endowment fund that is not classified in permanently restricted net assets is classified as temporarily restricted net assets until those amounts are authorized for expenditure. Net unrealized losses on permanently restricted endowment funds are classified as a reduction to unrestricted net assets until such time as the fair value equals or exceeds historic value. The aggregate amount by which fair value was below historic value was approximately $12 and $216 as of, respectively. 27

30 Changes in LPCH s endowment, for the years ended, are as follows: 2013 Temporarily Permanently Unrestricted Restricted Restricted Total Endowment at beginning of year $ (216) $ 66,850 $ 199,759 $ 266,393 Investment returns Earned income - 14,242-14,242 Unrealized and realized gains ,687 1,364 15,255 Total investment returns ,929 1,364 29,497 Amounts distributed for operations - (13,365) - (13,365) Contributions received from donors - - 1,185 1,185 Other - (1,344) (1,567) (2,911) Net increase in endow ment , ,406 Endowment at end of year $ (12) $ 80,070 $ 200,741 $ 280, Temporarily Permanently Unrestricted Restricted Restricted Total Endowment at beginning of year $ (277) $ 71,780 $ 198,858 $ 270,361 Investment returns Earned income - 13,389-13,389 Unrealized and realized gains 61 (5,795) 481 (5,253) Total investment returns 61 7, ,136 Amounts distributed for operations - (12,058) - (12,058) Contributions received from donors Other - (511) (357) (868) Net increase (decrease) in endowment 61 (4,930) 901 (3,968) Endowment at end of year $ (216) $ 66,850 $ 199,759 $ 266,393 All of LPCH s endowments are classified as donor-restricted. Return Objectives and Risk Parameters LPCH has adopted endowment investment and spending policies that attempt to provide a predictable stream of funding to programs supported by its endowment while seeking to maintain the purchasing power of endowment assets. Under this policy, the return objective for the endowment assets is to generate optimal total return while maintaining an appropriate level of risk for LPCH. LPCH expects its endowment funds over time, to provide at least an average rate of return of approximately 5% annually. Actual returns in any given year may vary from this amount. Strategies Employed for Achieving Investment Objectives To achieve its long-term rate of return objectives, LPCH relies on a total return strategy in which investment returns are achieved through both capital appreciation (realized and unrealized gains) and current yield (interest and dividends). LPCH targets a diversified asset allocation that places greater emphasis on types of investments as described in Note 6 to achieve its long-term objectives within prudent risk constraints. Portfolio asset allocation targets as well as expected 28

31 risk, return and correlation amongst the asset classes are reevaluated annually by the asset manager and reported to the Board of Directors. Permanently restricted net assets consist of investments to be held in perpetuity and invested to generate income to support the following purposes at August 31: Permanently restricted Education $ 26,967 $ 24,611 Plant replacement and equipment 4,598 - Clinical services 160, ,008 Indigent care and other 8,773 8,140 $ 200,741 $ 199,759 Temporarily restricted net assets consist of the following at August 31: Temporarily restricted Education $ 10,518 $ 7,986 Plant replacement and equipment 147, ,039 Plant replacement and equipment - Prop 3 from CHFFA 98,000 98,000 Clinical services 73,590 69,422 Indigent care and other 8,381 7,526 $ 338,447 $ 284, Related-Party Transactions Transactions with SHC LPCH and SHC share certain functions, including various information systems, human resources, managed care contracting, and materials management. The costs for these shared services, which are included in purchased services in the Consolidated Statements of Operations and Changes in Net Assets, are allocated between SHC and LPCH based on management s best estimates. LPCH s total cost for shared services was $21,158 and $19,689 for the years ended, respectively. LPCH also purchases various services from SHC. These services include operating room, cardiac catheterization, interventional radiology, radiation oncology, and laboratory. The cost of these services, which is included in purchased services in the Consolidated Statements of Operations and Changes in Net Assets, is charged back to LPCH based on a percentage of charges intended to approximate costs or a cost per procedure. LPCH s total cost for services purchased from SHC was $42,353 and $43,394 for the years ended, respectively. 29

32 In addition to the services described above, LPCH purchases services from SHC that include services provided by interns and residents, maintenance and certain operating expenses, including utilities and capital projects. These services totaled $25,175 and $22,892 for the years ended, respectively, and are included in purchased services and other expenses in the Consolidated Statements of Operations and Changes in Net Assets or in property and equipment, net, in the Consolidated Balance Sheets. Transactions with the University LPCH records operating expense or equity transfers to account for transactions with the University. LPCH purchases services from the University including telecommunications, transportation, certain utilities, rent, legal, and internal audit. Costs incurred by LPCH for these services purchased from the University were approximately $24,600 and $22,600 for the fiscal years ended August 31, 2013 and August 31, 2012, respectively, and are recorded as professional services, purchased services, and other expenses in the Consolidated Statements of Operations and Changes in Net Assets for those fiscal years or as property and equipment, net, in the Consolidated Balance Sheets. The total recoveries from the University including rent and certain salary and benefits was $1,658 and $2,283 as of August 31, 2013 and August 31, 2012, respectively. 30

33 Transactions with Stanford School of Medicine (SoM) Services purchased from the University and specifically, the Stanford School of Medicine, include clinical services that benefit LPCH, including hospital based physicians, medical direction, blood products, and medical library services. Payment for these services is based on management s best estimate of market value. On September 1, 2006, LPCH and the University entered into a Professional Services Agreement ( PSA ) which assigned to LPCH the right to bill and collect all revenue related to pediatric and obstetric clinical services on behalf of the Stanford School of Medicine faculty. In return, LPCH reimburses the University for the services provided by the physician faculty. The PSA is revised periodically, most recently as of September 1, The expense recorded related to payments and accruals for all of these services amounted to approximately $149,600 and $131,400 for the fiscal years ended, respectively. The collections received from external parties by LPCH as agent on behalf of SoM was recorded in other revenue and purchased services. The amounts were $9,900 and $9,500 as of August 31, 2013 and August 31, 2012, respectively. Transactions with the Lucile Packard Foundation for Children s Health The Lucile Packard Foundation for Children s Health ( LPFCH ) is a private charity dedicated to promoting, protecting, and sustaining the physical, mental, emotional and behavioral health of children in the Bay Area. In addition to serving as a community grant maker, LPFCH is the primary community fundraising agent for LPCH and the pediatric faculty and programs at the University. Although these three entities share similar missions, LPFCH is governed by a separate board that is independent of LPCH and the University. LPCH purchases and records as expense fundraising services provided by LPFCH. All contributions raised by LPFCH through community fundraising that are specifically designated for LPCH are recorded by LPCH rather than LPFCH. Contributions recorded as a result of LPFCH fundraising efforts are as follows: Unrestricted gifts $ 5,154 $ 2,841 Temporarily restricted gifts 44, ,726 Permanently restricted gifts 1, Total gifts $ 50,592 $ 159,344 31

34 14. Operating Leases The organization leases various equipment and facilities under operating leases expiring at various dates. Total rental expense (included in other operating expenses in the Consolidated Statements of Operations and Changes in Net Assets) under these leases for the years ended August 31, 2013 and 2012 was $23,255 and $20,540, respectively. Net minimum future operating lease payments for periods subsequent to August 31, 2013 are as follows: Net Minimum Future Operating Leases Payments Year ending August 31, LPCH PCHA Total 2014 $ 18,530 $ 1,673 $ 20, ,647 1,143 15, , , , , , ,736 Thereafter 21, ,783 $ 90,173 $ 4,895 $ 95,068 LPCH leased space in its medical office buildings to others under noncancelable operating lease arrangements in FY2011. The previously leased space was demolished in FY2012 to make way for future hospital expansion. 15. Commitments and Contingencies LPCH is aware of certain asserted and unasserted legal claims. While the outcome cannot be determined at this time, management is of the opinion that the liability, if any, from these actions will not have a material effect on LPCH s financial position. As with many medical centers across the country, information security and privacy is a growing risk area based on developments in the law and expanding mobile technology practices. LPCH has policies, procedures, and training in place to safeguard protected information, but select incidents have occurred in the past and may occur in the future involving potential or actual disclosure of such information (including, for example, certain identifiable information relating to patients). In most cases, there has been no evidence of unauthorized access to, or use/disclosure of, such information, yet laws may require reporting to potentially affected individuals and federal and state governmental agencies. Governmental agencies have the authority to investigate and request further information about an incident or safeguards, to cite LPCH for a deficiency or regulatory violation, and/or require payment of fines, corrective action, or both. California law also allows a private right to sue for a breach of medical information. The cost of such possible consequences has not been material to date to LPCH, and LPCH management does not believe that any future consequences of these incidents will be material to its consolidated financial statements. The healthcare industry is subject to numerous laws and regulations of federal, state and local governments. Compliance with these laws and regulations can be subject to future government review and interpretation, as well as to regulatory actions unknown or unasserted at this time. 32

35 There is heightened government activity with respect to investigations and allegations concerning possible violations by healthcare providers of regulations that could result in the imposition of significant fines and penalties, as well as significant repayments for patient services previously billed. LPCH is subject to similar regulatory reviews, and while such reviews may result in repayments and/or civil remedies that could have a material effect on LPCH s financial results of operations in a given period, management is not aware of any repayments and/or civil remedies that would have a material effect on LPCH s financial position. In March 2010, the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 (the Acts) were signed into law. These Acts address a broad range of topics affecting the health care industry, including a significant expansion of healthcare coverage. The coverage expansion is accomplished primarily through incentives for individuals to obtain and employers to provide health care coverage and an expansion in Medicaid eligibility. These Acts also include incentives for medical research and the use of electronic health records, changes designed to curb fraud, waste and abuse, and creates new agencies and demonstration projects to promote the innovation and efficiency in the healthcare delivery system. Some provisions of the health care reform legislation were effective immediately; others will be phased in through The impact of these Acts will likely affect the Hospital; however, due to the number of changes involved, the ultimate impact of these Acts is uncertain at this time. Effective May 1, 2011, LPCH entered into a seven year agreement with Dell Marketing L.P., a Texas limited partnership ( Dell ), pursuant to which Perot will provide certain information technology services to LPCH. Under the terms of the agreement, LPCH will be charged a fixed annual service charge plus expenses, payable monthly, for core services, as defined, and additional fees plus expenses for special projects. The annual fixed service charges are subject to adjustment under certain conditions, but unless so adjusted, amount to approximately $7,000 for each year through to Adjustments are expected for variations in the number of devices, user demand, and project specific work that may increase the amount above the baseline in any given period. LPCH has signed several other information technology contracts in FY2012 and FY2013. The total commitment for these information technology contracts was approximately $63 million as of August 31, Effective March 1, 2009, LPCH entered into a 5 year agreement with PST Services, Inc. to provide billing functions related to the PSA. Under the terms of the agreement, LPCH will be charged 7.5% of monthly net collections. LPCH has certain rights to reduce the scope of service and to terminate the agreement early for a termination fee. The amount of the termination fee depends on when the right to terminate is exercised and reduces annually. Termination fees for the first month of the agreement range from $3,762 to $5,335 depending on the scope of services terminated. California s Hospital Seismic Safety Act requires licensed acute care functions to be conducted only in facilities that meet specified seismic safety standards. Facilities classified by the State of California as noncompliant in the event of an earthquake must be retrofitted, replaced or removed from acute-care service by applicable deadlines in 2013, 2020 or There are separate and distinct seismic safety standards for structural frame performance and for nonstructural element performance. LPCH complies with the structural frame requirements for the existing hospital building allowing its use past LPCH will be retrofitting discrete areas of the existing hospital for compliance to the nonstructural standards by the applicable deadlines. 33

36 LPCH relies upon services located in the SHC hospital facility. Through the construction of a New Stanford Hospital, as well as through planned retrofits of the existing SHC facility, SHC services that support LPCH will be compliant to seismic safety regulations within available deadlines. Amendments of the Hospital Seismic Safety Act via SB 90, permit OSHPD to extend the structural compliance deadline for SHC from 2013 until January 1, 2020 due to its status as a trauma center. In addition, SHC remains eligible for a separate extension via SB 608 until January 1, Management expects SHC to be eligible for such extensions under either SB 90 or SB 608. At this time, SHC has pending applications on file with OSHPD for extensions under SB 90 and SB 608. SHC currently has an administrative extension to 2015, and has received extensions on three buildings to July These extensions will allow sufficient time to construct the new hospital, and mitigate deficiencies of the existing facility. In June 2011, the Palo Alto City Council certified the Final Environmental Impact Report ( FEIR ), land use changes, permits and a Development Agreement with Stanford Hospital, LPCH and Stanford University as part of the Renewal Project. In July 2011, the Palo Alto City Council provided final approval for the Renewal Project at the second reading of the Development Agreement. The Renewal Project will rebuild Stanford Hospital and expand LPCH to assure adequate capacity, meet State-mandated earthquake safety standards, and provide modern, technologically-advanced hospital facilities. The Renewal Project also includes replacement of outdated laboratory facilities at the Stanford School of Medicine and remodeling of Hoover Pavilion. Total estimated cost of LPCH s portion of the Project Renewal is approximately $1.2 billion. LPCH has recorded $239,300 in construction in progress related to this project as of August 31, Based on current estimated schedules, management currently projects that the Renewal Project construction will be completed in At August 31, 2013, the remaining commitment on contracts for the construction and remodeling of LPCH facilities was approximately $482,173. In August of 2012, LPCH received final approval from the California Health Facilities Financing Authority (CHFFA) on its application for a maximum of $98,000 of grant funding from California State Proposition 3 for certain construction, expansion, renovation, furnishing and equipment costs for a children s hospital. As a result, in August of 2012, LPCH recorded a receivable of $97,437 (the grant amount less administrative costs paid to the State) with the offset recorded in temporarily restricted net assets. As of August 31, 2013, LPCH had received $97,437 from CHFFA. In December of 2011 and July of 2012, the LPCH hospital ground floor was flooded as a result of work being performed related to the new hospital construction. Included in other revenue is $2,513 and $2,892 of recoveries from insurance claims and included in other expense is $534 and $6,347 of costs related to repair and recovery from the floods as of, respectively. As of August 31, 2013, LPCH has received final claim reimbursement from their insurance company for the December 2011 flood. Currently, LPCH is in the process of finalizing insurance claims related to the July 2012 flood, so final insurance recoveries are not estimable as of the date that these financial statements were available for issuance. 34

37 LPCH is directly liable under irrevocable letters of credit totaling $13,792 at August 31, 2013, including $7,152 required as security for the workers compensation deductible plan as described in Note 2 and $6,640 for security for construction, operation and maintenance of certain utility facilities. No amounts have been drawn on these letters of credit as of August 31, LPCH also serves as guarantor for $1,000 loan of South County Community Health Center in East Palo Alto. Approximately 45% of LPCH employees are covered by collective bargaining arrangements. These employees are members of two unions; approximately 35% are covered by an agreement which expires in March 31, 2016; the other 10% are covered by an agreement which expires in August 26, In 2013, LPCH became the guarantor on a ten year building lease under which the total rent payments over the life of the lease will be approximately $9, Functional Expenses Expenses incurred comprise the following program services for the years ended August 31: LPCH PCHA Total LPCH PCHA Total Patient services $ 867,647 $ 33,604 $ 901,251 $ 834,180 $ 991 $ 835,171 Management and general 91,176 8,394 99,570 65,262 2,524 67,786 Fundraising 8,039 8,039 7,871-7,871 Total functional expenses $ 966,862 $ 41,998 $ 1,008,860 $ 907,313 $ 3,515 $ 910, Subsequent Events LPCH has evaluated subsequent events occurring between the end of the most recent fiscal year and December 11, 2013, the date the financial statements were available for issuance. Subsequent to year-end, LPCH completed the purchase of a building in Northern California for use as clinical offices by LPCH and PCHA with a total purchase price of $24,200. Also subsequent to year-end, LPCH entered into a letter of intent to purchase a second Northern California building also to be used for clinical offices and paid a deposit of $500. LPCH is performing due diligence on the property and the scheduled completion of the due diligence is January 21,

38 Report of Independent Auditors on Accompanying Consolidating Information To the Board of Directors Lucile Salter Packard Children s Hospital at Stanford We have audited the consolidated financial statements of Lucile Salter Packard Children s Hospital at Stanford ( LPCH ) as of for the year then ended and our report thereon appears on pages 1 of this document. That audit was conducted for the purpose of forming an opinion on the consolidated financial statements taken as a whole. The consolidating 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 consolidating information has been subjected to the auditing procedures applied in the audit of the financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the financial statements or to the financial statements themselves and other additional procedures, in accordance with auditing standards generally accepted in the United States of America. In our opinion, the consolidating information is fairly stated, in all material respects, in relation to the consolidated financial statements taken as a whole. The consolidating information is presented for purposes of additional analysis of the consolidated financial statements rather than to present the financial position, changes in net assets and cash flows of the individual entities and is not a required part of the consolidated financial statements. Accordingly, we do not express an opinion on the financial position, changes in net assets and cash flows of the individual entities. December 11, 2013 PricewaterhouseCoopers LLP, Three Embarcadero Center, San Francisco, CA T: (415) , F: (415) ,