C ONSOLIDATED F INANCIAL S TATEMENTS AND O THER F INANCIAL I NFORMATION

Transcription

1 C ONSOLIDATED F INANCIAL S TATEMENTS AND O THER F INANCIAL I NFORMATION Years Ended June 30, 2007 and 2006 With Report of Independent Auditors BAL

2 Consolidated Financial Statements and Other Financial Information Years Ended June 30, 2007 and 2006 Contents Report of Independent Auditors...1 Audited Consolidated Financial Statements Consolidated Balance Sheets...2 Consolidated Statements of Operations...4 Consolidated Statements of Changes in Net Assets...5 Consolidated Statements of Cash Flows...6 Notes to Consolidated Financial Statements...8 Other Financial Information Report of Independent Auditors on Other Financial Information...29 Consolidating Balance Sheet...30 Consolidating Statement of Operations...32 Consolidating Balance Sheet...33 Consolidating Statement of Operations...35 Supplementary Description of Eliminating Entries BAL

3 r Ernst & Young LLP r Phone: (410) East Pratt Street Fax: (410) Baltimore, Maryland Board of Directors Nanticoke Health Services, Inc. Report of Independent Auditors We have audited the consolidated balance sheets of Nanticoke Health Services, Inc. (a Delaware not-for-profit corporation, also referred to as the Company) and Subsidiaries as of June 30, 2007 and 2006, and the related consolidated statements of operations, changes in net assets, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company s management. 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. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Nanticoke Health Services, Inc. and Subsidiaries as of June 30, 2007 and 2006 and the consolidated results of their operations, changes in net assets, and cash flows for the years then ended in conformity with accounting principles generally accepted in the United States. As described in Note 2 to the consolidated financial statements, the Company has restated its consolidated statements of operations, changes in net assets and cash flows for the year ended June 30, 2006 to correct the accounting for its investments. As discussed in Note 1 to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans, as of June 30, September 25, 2007 EY BAL 1 A member firm of Ernst & Young Global Limited

4 Consolidated Balance Sheets June 30 Assets Current assets: Cash and cash equivalents $ 5,140,000 $ 4,957,000 Accounts receivable, net of allowances for uncollectible accounts of $7,313,000 and $6,681,000, respectively 15,961,000 17,042,000 Inventories 1,723,000 2,014,000 Other trusteed funds 356, ,000 Prepaid expenses and other 1,770,000 2,601,000 Total current assets 24,950,000 27,004,000 Assets whose use is limited: Board-designated funds 29,184,000 27,712,000 Other investments 7,667,000 7,125,000 Debt service reserve fund 4,236,000 4,040,000 Principal sinking fund 212, ,000 Total assets whose use is limited 41,299,000 39,160,000 Property and equipment 126,553, ,942,000 Less accumulated depreciation and amortization (58,617,000) (51,986,000) Property and equipment, net 67,936,000 72,956,000 Other assets, net 5,190,000 4,118,000 Total assets $ 139,375,000 $ 143,238, BAL 2

5 Consolidated Balance Sheets (continued) June 30 Liabilities and net assets Current liabilities: Accounts payable and accrued expenses $ 5,724,000 $ 6,589,000 Accrued salaries and benefits 5,294,000 5,571,000 Accrued interest payable 486, ,000 Current portion of revenue bonds payable and capital lease obligations 1,596,000 1,661,000 Payables to third parties 656,000 Total current liabilities 13,756,000 14,211,000 Revenue bonds payable, net of current portion 52,837,000 54,109,000 Capital lease obligations, net of current portion 366, ,000 Accrued pension and other postretirement benefits 7,603,000 7,167,000 Other liabilities 6,946,000 6,123,000 Total liabilities 81,508,000 82,418,000 Net assets: Unrestricted, net 57,684,000 60,704,000 Temporarily restricted 67,000 Permanently restricted 116, ,000 Total net assets 57,867,000 60,820,000 Total liabilities and net assets $ 139,375,000 $ 143,238,000 See accompanying notes BAL 3

6 Consolidated Statements of Operations Year Ended June 30 (Restated) Unrestricted revenues Net patient service revenues $ 121,735,000 $ 119,037,000 Other revenues 2,184,000 2,053,000 Total unrestricted revenues 123,919, ,090,000 Expenses Salaries and employee benefits 65,578,000 64,461,000 Supplies, purchased services, and other 39,780,000 35,343,000 Professional fees 3,499,000 5,258,000 Bad debts 11,393,000 12,126,000 Depreciation and amortization 7,534,000 6,464,000 Interest 3,022,000 2,656,000 Total expenses 130,806, ,308,000 Operating loss (6,887,000) (5,218,000) Other income (loss) Investment income 3,262,000 3,214,000 Unrealized gains (losses) on trading portfolio 1,315,000 (1,499,000) Unrestricted contributions 580, ,000 Total other income, net 5,157,000 1,986,000 Deficit of revenues over expenses (1,730,000) (3,232,000) Changes in unrestricted net assets Changes in net unrealized gains and losses on available-forsale investments 197,000 (18,000) Net assets released from restrictions, used for capital purposes 540,000 Change in additional minimum pension liability 728,000 1,113,000 Other (136,000) (88,000) Decrease in unrestricted net assets before adoption of SFAS 158 transition adjustment (941,000) (1,685,000) SFAS 158 transition adjustment (2,079,000) Decrease in unrestricted net assets $ (3,020,000) $ (1,685,000) See accompanying notes BAL 4

7 Consolidated Statements of Changes in Net Assets Year Ended June 30 (Restated) Unrestricted net assets Deficit of revenues over expenses $ (1,730,000) $ (3,232,000) Changes in net unrealized gains and losses on available-forsale investments 197,000 (18,000) Net assets released from restrictions, used for capital purposes 540,000 Change in additional minimum pension liability 728,000 1,113,000 Other (136,000) (88,000) Decrease in unrestricted net assets before adoption of SFAS 158 transition adjustment (941,000) (1,685,000) SFAS 158 transition adjustment (2,079,000) Decrease in unrestricted net assets (3,020,000) (1,685,000) Temporarily restricted net assets Net assets released from restrictions, used for capital purposes (540,000) Contributions 67,000 Increase (decrease) in temporarily restricted net assets 67,000 (540,000) Decrease in net assets (2,953,000) (2,225,000) Net assets at beginning of year 60,820,000 63,045,000 Net assets at end of year $ 57,867,000 $ 60,820,000 See accompanying notes BAL 5

8 Consolidated Statements of Cash Flows Year Ended June 30 (Restated) Operating activities Decrease in net assets $ (2,953,000) $ (2,225,000) Adjustments to reconcile decrease in net assets to net cash flows from operating activities: Effect of adoption of recognition provisions of SFAS 158 2,079,000 Change in additional minimum pension liability (728,000) (1,113,000) Depreciation and amortization 7,534,000 6,464,000 Changes in net unrealized gains and losses on available-for-sale assets whose use is limited (197,000) 18,000 Changes in net unrealized gains and losses on trading portfolio (1,315,000) 1,499,000 (Increase) decrease in assets whose use is limited (282,000) 818,000 Amortization of deferred financing costs 64,000 89,000 Changes in operating assets and liabilities, net 683,000 (292,000) Net cash flows from operating activities 4,885,000 5,258,000 Investing activities Purchases of property and equipment, net (2,514,000) (8,198,000) Increase in available-for-sale assets whose use is limited (345,000) (2,773,000) Net cash flows from investing activities (2,859,000) (10,971,000) Financing activities Repayments of revenue bonds payable and capital lease obligations (1,843,000) (1,841,000) Net cash flows from financing activities (1,843,000) (1,841,000) Net increase (decrease) in cash and cash equivalents 183,000 (7,554,000) Cash and cash equivalents at beginning of year 4,957,000 12,511,000 Cash and cash equivalents at end of year $ 5,140,000 $ 4,957, BAL 6

9 Consolidated Statements of Cash Flows (continued) Year Ended June 30 (Restated) Changes in operating assets and liabilities, net Decrease (increase) in operating assets: Accounts receivable, net $ 1,081,000 $ (2,531,000) Receivable from third-party payors, net 101,000 Inventories 291,000 (593,000) Prepaid expenses and other assets (241,000) (1,599,000) Other trusteed funds 34, ,000 1,165,000 (4,517,000) (Decrease) increase in operating liabilities: Accounts payable and accrued expenses (865,000) 3,369,000 Accrued salaries and benefits (277,000) 1,011,000 Accrued interest payable 96,000 (105,000) Accrued pension and other postretirement benefits (915,000) (1,759,000) Payables to third parties 656,000 Other liabilities 823,000 1,709,000 (482,000) 4,225,000 Changes in operating assets and liabilities, net $ 683,000 $ (292,000) Supplemental disclosure of cash flow information Cash paid for interest $ 2,914,000 $ 3,073,000 See accompanying notes BAL 7

10 Notes to Consolidated Financial Statements June 30, Organization and Summary of Significant Accounting Policies Basis of Presentation Nanticoke Health Services, Inc. (Health Services) was formed in January 1986 as a Delaware not-for-profit corporation to be governed by its Board of Directors. Health Services is a membership corporation without capital stock and is exempt from federal income taxes under Section 501(c)(3) of the Internal Revenue Code (IRC). Health Services was formed under a plan of corporate reorganizations to hold the no par common stock of the following subsidiaries: Corporation Number of Authorized Shares Nanticoke Memorial Hospital, Inc. 10,000 Mid-Sussex Medical Center, Inc. 10,000 Dual Development Corporation 10,000 Proprietary Enterprises, Inc. 1,000 Nanticoke Insurance Corporation, Inc. 120,000 A brief description of the activities and operations of each of the entities follows: Nanticoke Health Services, Inc. Health Services coordinates and supports health care delivery by establishing system-wide policy and directing strategic planning for the subsidiaries. In addition, Health Services coordinates the community fundraising functions for the subsidiaries. Previously, fundraising activities were performed by Community Health Corporation which was dissolved and merged into Health Services. Nanticoke Memorial Hospital, Inc. (the Hospital) The Hospital provides acute care patient services on an inpatient and outpatient basis. It is the most significant operating entity of the consolidated group. The Hospital has a wholly owned subsidiary, Nanticoke Alternative Care, Inc., which operates a long-term care facility under the name Lifecare at Lofland Park (Lofland). The Hospital and its subsidiary are exempt from federal income taxes under Section 501(c)(3) of the IRC. Mid-Sussex Medical Center, Inc. (Mid-Sussex) Mid-Sussex provides outpatient medical care in clinics located in Millsboro, Georgetown, and Seaford, Delaware. Mid-Sussex is exempt from federal income taxes under Section 501(c)(3) of the IRC BAL 8

11 1. Organization and Summary of Significant Accounting Policies (continued) Basis of Presentation (continued) Dual Development Corporation (Dual) Dual s primary operational activities are property development and management for the related corporations. Dual is exempt from federal income taxes under Section 501(c)(3) of the IRC. Proprietary Enterprises, Inc. (Proprietary) Proprietary was formed to operate for-profit ventures such as occupational health services and a child day-care center. Due to operating losses incurred, income taxes have not been significant. Nanticoke Insurance Corporation, Ltd. (NIC) NIC is a captive insurance entity established in the Cayman Islands, which was created to provide professional and general liability insurance to Health Services and professional liability coverage to physicians in the community. The accompanying consolidated financial statements include the accounts of each of the aforementioned corporations. All significant intercompany accounts and transactions have been eliminated. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents Cash and cash equivalents include cash held in checking and savings accounts, money market accounts, and short-term certificates of deposit with original maturities of 90 days or less. Cash balances are principally uninsured and subject to normal credit risks. Assets Whose Use Is Limited In accordance with Statement of Financial Accounting Standards (SFAS) No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations, Health Services and subsidiaries account for all investments in debt and marketable equity securities (except those accounted for under the equity method of accounting) at fair value BAL 9

12 1. Organization and Summary of Significant Accounting Policies (continued) Assets Whose Use Is Limited (continued) Investment income (including realized gains and losses, unrealized gains and losses on trading securities, interest and dividends) is reported as other income (expense) unless the income is restricted by donor or law. Other investments consists of debt and marketable equity securities that are recorded at NIC. These investments have been designated as other than trading. NIC periodically evaluates whether any declines in the fair value of these investments are other-than-temporary. This evaluation consists of a review of several factors, including but not limited to: length of time and extent that a security has been in an unrealized loss position, the existence of an event that would impair the issuer s future earnings potential, the near-term prospects for recovery of the market value of a security, and the intent and ability of Health Services to hold the security until the market value recovers. Declines in fair value below cost that are deemed to be other-thantemporary are recorded as realized losses and are included in other-than-temporary impairment of investments in the accompanying consolidated statements of operations. Based on its evaluation, NIC has recorded no adjustment for other-than-temporary impairment of availablefor-sale investments for the years ended June 30, 2007 and Patient Receivables and Allowances Health Services policy is to write off patient accounts that have been identified as uncollectible. An allowance for doubtful accounts is recorded for accounts not yet written off that are anticipated to become uncollectible in future periods. Insurance coverage and credit information are obtained from patients when available. No collateral is obtained for accounts receivable. Accounts receivable from third-party payors have been adjusted to reflect the difference between charges and estimated reimbursable amounts. Inventories Inventories, which primarily consist of medical supplies and drugs, are carried at the lower of cost or market BAL 10

13 1. Organization and Summary of Significant Accounting Policies (continued) Property and Equipment Property and equipment are stated at cost. Improvements that materially extend the useful lives of the assets are capitalized, while routine maintenance, repairs, and minor replacement costs are charged to operations when incurred. Property and equipment are depreciated using the straight-line method, based on the following estimated useful lives: Buildings and improvements Fixed and movable equipment Clinical Information System (included within movable equipment) years 3 20 years 8 years Estimated Professional Liabilities The provision for estimated professional liability claims includes estimates of the ultimate costs for both reported claims and incurred but not reported claims. Due to uncertainties inherent in the claims estimation process, it is at least reasonably possible that actual claims paid could differ materially from the amounts accrued in the accompanying consolidated balance sheets. Contributions Contributions from donors are classified as unrestricted, temporarily restricted, or permanently restricted net assets. Unrestricted contributions are reflected in the accompanying consolidated statements of operations. Temporarily restricted contributions are those limited by donors for specific uses. Such contributions are reflected as increases in unrestricted net assets when qualifying expenditures are made, thus releasing the restriction. Permanently restricted net assets, which have been restricted by the donor to be maintained in perpetuity, are included in other assets in the accompanying consolidated balance sheets. The income from these funds is expendable to support health care services BAL 11

14 1. Organization and Summary of Significant Accounting Policies (continued) Charity Care and Bad Debts Health Services provides care without charge or at amounts less than its established rates to patients who meet certain criteria under its charity care policy. Because Health Services does not pursue collection of amounts determined to qualify as charity care, those amounts are not reported as revenues. For those patients who did not meet the charity care policy, Health Services must evaluate their ability to collect amounts due from patients that are past due. A provision for bad debts is recorded for amounts not yet written off which are expected to become uncollectible. The provision for bad debts and the amount of charity care provided were as follows: June 30 Provision for bad debts $ 11,393,000 $ 12,126,000 Charity care (measured at established rates) 4,256,000 3,290,000 Total $ 15,649,000 $ 15,416,000 Net Patient Service Revenues Net patient service revenues are reported at the estimated net realizable amounts from patients and third-party payors for services rendered, including estimated retroactive adjustments and regulatory discounts under reimbursement agreements with third-party payors. Retroactive adjustments are accrued on an estimated basis in the period the related services are rendered, and adjusted in future periods, as final settlements are determined. The following table sets forth the detail of net patient service revenue: Year Ended June 30 Gross patient service revenue $ 233,140,000 $ 207,511,000 Revenue deductions: Charity care 4,256,000 3,290,000 Contractual and other allowances 107,149,000 85,184,000 Net patient service revenue $ 121,735,000 $ 119,037, BAL 12

15 1. Organization and Summary of Significant Accounting Policies (continued) Net Patient Service Revenues (continued) Substantial portions of the Hospital s net patient service revenues are for services provided to patients participating in the Medicare and Medicaid programs. Under the Medicare Inpatient Prospective Payment System (PPS), the Hospital is reimbursed a fixed amount per inpatient discharge based on a national rate adjusted for regional variation in wages and the diagnosis of the patient. These rates are adjusted annually by the Medicare program. Outpatient services at the Hospital are reimbursed by Medicare under the outpatient PPS. Outpatient services are reimbursed based on a national rate per service adjusted for regional variations in wages. These rates are adjusted annually by Medicare. The Delaware Medicaid program utilizes the services of a Managed Care Organization (MCO) to administer the program for hospital services. Reimbursement from the MCO for inpatient services is based on a fixed reimbursement per case, and outpatient services are reimbursed either on a fixed-fee basis or a percentage of charges based on cost, depending on the nature of the service. The current contract with the Medicaid MCO calls for annual increases to the fixed rates. The difference between Medicare/Medicaid reimbursement and the Hospital s standard billing rates is recorded as a component of contractual allowances in determining net patient service revenues in the accompanying consolidated statements of operations. Additionally, a significant portion of the Hospital s net patient service revenues are for services provided to subscribers of Blue Cross Blue Shield of Delaware (Blue Cross) and other commercial insurers. The Hospital is reimbursed by Blue Cross and these other third-party payors based on approved rates, less contractual discounts. These discounts are recorded as a component of contractual allowances in determining net patient service revenues in the accompanying consolidated statements of operations. A significant portion of Lofland s net patient service revenues are for services provided to patients participating in the Medicare and Medicaid programs. Medicare reimbursement methodology for long-term care is also based on PPS. Lofland is reimbursed a prospectively approved amount for each case within a resource utilization group (RUG). Delaware Medicaid reimburses Lifecare at Lofland Park for residents enrolled in the program at a fixed amount per day based on the level of care provided. These rates are adjusted annually based on aggregated and specific costs BAL 13

16 1. Organization and Summary of Significant Accounting Policies (continued) Net Patient Service Revenues (continued) The difference between the Medicare/Medicaid reimbursement and the standard billing rates has been recorded as a component of contractual allowances in determining net patient service revenues in the accompanying consolidated statements of operations. Mid-Sussex is also a provider of health care services to Medicare and Medicaid patients. Mid- Sussex is reimbursed based on a fixed fee-for-service. Any difference between the payment amount and established rates is recorded as a component of contractual allowances in determining net patient service revenues. Deficit of Revenues over Expenses The consolidated statements of operations include deficit of revenues over expenses and changes in net assets. Changes in unrestricted net assets, which are excluded from deficit of revenues over expenses, consistent with industry practice, include changes in unrealized gains and losses on available-for-sale investments, changes in minimum pension liabilities prior to the adoption of Statement of Financial Accounting Standards No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans An Amendment of FASB Statements No. 87, 88, 106, and 132R (SFAS 158), and contributions received for additions to long-lived assets. Reclassifications Certain amounts from the prior-year financial statements have been reclassified in order to conform to the current-year presentation. Adoption of New Accounting Standards In September 2006, the FASB issued Statement of Financial Accounting Standards (SFAS) No SFAS 158 requires companies to (1) fully recognize, as an asset or liability, the overfunded or underfunded status of defined pension and other postretirement benefit plans; (2) recognize changes in the funded status through other changes in unrestricted net assets in the year in which the changes occur; (3) measure the funded status of defined pension and other postretirement benefit plans as of the date of the company s fiscal year-end; and (4) provide enhanced disclosures. SFAS 158 is required to be adopted as of the end of the fiscal year ending after June 15, Health Services has adopted all provisions of SFAS 158 as of June 30, The net effect of the adoption was an increase to the accrued benefit liability and a reduction to unrestricted net assets of $2,079,000 for the year ended June 30, There was no effect of adoption related to the measurement date as Health Service s measurement date was its fiscal year-end. See Notes 11 and 12 for additional information related to the adoption of SFAS BAL 14

17 2. Restatement of Consolidated Financial Statements Health Services determined its investment portfolio, excluding investments held at NIC, should have been designated as a trading portfolio in accordance with FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities and FASB Statement No. 124, Accounting for Certain Investments in Debt and Equity Securities by Not-for-Profit Organization, versus a nontrading portfolio. As a result, the net change in unrealized (depreciation) appreciation in the fair value of investments has been reclassified from below the performance indicator, deficit of revenues over expenses, to other income (loss). Accordingly, the consolidated statements of operations and the consolidated statements of changes in net assets have been restated to reflect this error. The following financial statement line items were impacted as a result of the restatement: Originally Reported Amount of Adjustment As Restated June 30, 2006 Consolidated Statements of Operations Unrealized losses on trading portfolio $ $ (1,499,000) $ (1,499,000) Total other income, net 3,485,000 (1,499,000) 1,986,000 Deficit of revenues over expenses (1,733,000) (1,499,000) (3,232,000) Changes in net unrealized gains and losses on investments (1,517,000) 1,499,000 (18,000) Consolidated Statements of Changes in Net Assets Deficit of revenues over expenses (1,733,000) (1,499,000) (3,232,000) Changes in net unrealized gains and losses on investments (1,517,000) 1,499,000 (18,000) Consolidated Statements of Cash Flows Operating activities Decrease in assets whose use is limited 818, ,000 Net cash flows from operating activities 4,440, ,000 5,258,000 Investing activities Increase in assets whose use is limited (1,955,000) (818,000) (2,773,000) Net cash flows from investing activities (10,153,000) (818,000) (10,971,000) BAL 15

18 3. Regulatory Environment The health care industry is subject to numerous laws and regulations of federal, state, and local governments. These laws and regulations include, but are not necessarily limited to, matters such as licensure, accreditation, government health care program participation requirements, and reimbursement for patient services. Recently, government activity has increased with respect to investigations and allegations concerning possible violations of fraud and abuse statutes and regulations by health care providers. Violations of these laws and regulations could result in expulsion from government health care programs, together with the imposition of significant fines and penalties, as well as significant repayments for patient services previously billed. Compliance with such laws and regulations can be subject to future government review and interpretation. Also, future changes in federal and state reimbursement funding mechanisms and related government budgetary constraints could have an adverse effect on Health Services. Health Services and its subsidiaries are currently reviewing various aspects of its compliance with laws and regulations which include transactions which occurred in prior periods. Based upon its review thus far, management has not identified any significant violations which would have a material adverse effect on the accompanying financial statements. However, the ultimate determination of whether any contingent liabilities exist will not be finalized until this review is completed. 4. Board-Designated Funds Board-designated funds represent investments designated by the Board of Directors (Board) for future capital replacements and other Board-identified purposes. These investments consisted of the following (at fair value): June 30 Cash and certificates of deposit $ 703,000 $ 897,000 Common stocks 16,336,000 15,124,000 U.S. government securities 2,780,000 4,515,000 Corporate bonds 9,365,000 7,176,000 Total $ 29,184,000 $ 27,712, BAL 16

19 5. Trusteed Funds and Other Investments Trusteed Funds Trusteed funds include the interest fund, principal sinking fund, debt service reserve fund, and regulatory deposit. These funds are available to reimburse or directly pay costs associated with certain Hospital projects. Debt service reserve funds represent investments to be segregated and held pursuant to the terms of the revenue bond indentures (discussed in Note 8). These funds will be utilized to fund debt service payments in the later years of the revenue bonds. These investments are stated at fair value and consist of the following: June 30 Cash and cash equivalents $ $ 1,000 U.S. government securities 4,804,000 4,712,000 Total $ 4,804,000 $ 4,713,000 Other Investments Other investments consist of funds held by NIC, which was formed to provide professional liability insurance as discussed in Note 10. June 30 Equity securities $ 1,895,000 $ 1,852,000 U.S. government securities 1,632,000 2,209,000 Corporate bonds 4,140,000 3,064,000 Total $ 7,667,000 $ 7,125,000 The amortized cost and estimated fair value of investments at June 30, 2007 and 2006 by contractual maturities are shown on the following page. Expected maturities may differ from contractual maturities because borrowers may have the right to call or repay obligations with or without prepayment penalties BAL 17

20 5. Trusteed Funds and Other Investments (continued) Other Investments (continued) June 30 Amortized Amortized Cost Fair Value Cost Fair Value Due within one to five years $ 1,939,000 $ 1,930,000 $ 2,468,000 $ 2,438,000 Due within five to ten years 1,085,000 1,076,000 1,018, ,000 After ten years 2,814,000 2,766,000 1,916,000 1,838,000 $ 5,838,000 $ 5,772,000 $ 5,402,000 $ 5,273, Investment Income/Unrealized Gains and Losses Investment income and net unrealized gains and losses for Board-designated funds, as well as other assets whose use is limited and cash and cash equivalents, comprised the following: Year Ended June 30 Income Interest and dividend income $ 1,432,000 $ 1,276,000 Unrealized gains (losses) on trading portfolio 1,315,000 (1,499,000) Realized gains 1,830,000 1,938,000 $ 4,577,000 $ 1,715,000 Other changes in unrestricted net assets Unrealized gains (losses) on available-for-sale investments, net $ 197,000 $ (18,000) 7. Property and Equipment Property and equipment consisted of the following: June 30 Land $ 2,576,000 $ 3,419,000 Buildings and improvements 75,481,000 75,476,000 Fixed and movable equipment 47,887,000 38,502,000 Construction-in-progress 609,000 7,545,000 $ 126,553,000 $ 124,942, BAL 18

21 7. Property and Equipment (continued) As of June 30, 2007, the construction-in-progress account principally includes a Hospital project related to implementation of a patient billing system. As of June 30, 2006, the construction-inprogress account principally includes a Hospital project related to implementation of a clinical information system. 8. Revenue Bonds Revenue bonds consisted of the following: June 30 Delaware Health Facilities Authority Revenue Bonds: Series 2002A serial bonds with effective interest rates ranging from 2.45% to 5.25% due in various annual amounts on May 1 of each year from 2005 to Interest due semiannually and principal due annually. $ 24,396,000 $ 25,614,000 Series 2002B term bonds with effective interest rate of 5.625% due in various annual amounts from May 1, 2023 to Interest due semiannually and principal due annually. 30,250,000 30,250,000 54,646,000 55,864,000 Less current portion of Series 2002A Revenue Bonds 1,180,000 1,101,000 53,466,000 54,763,000 Less unamortized original issue discount 629, ,000 Revenue bonds payable, less current portion $ 52,837,000 $ 54,109,000 Series 2002 In August 2002, the Delaware Health Facilities Authority (the Authority) issued $27,750,000 Revenue Bonds (Nanticoke Memorial Hospital Project) Series 2002A and $30,250,000 Revenue Bonds (Nanticoke Memorial Hospital Project) Series 2002B at a discount of $774,000. The proceeds of the issue, after the payment of deferred financing costs, together with other funds was issued for the purposes of (1) paying a portion of the costs of certain health care facilities and equipment of the Hospital (the 2002 Projects) including some or all of the interest on the Series 2002 Bonds during construction of the 2002 Projects, (2) refinancing existing indebtedness, (3) funding a deposit to the Debt Service Reserve Fund, and (4) paying a portion of the related transaction costs. The Hospital and Dual jointly and severally guarantee the obligations of the revenue bonds. For the purposes of the 2002 Revenue Bonds, the Hospital and Dual constitute the Obligated Group (the Group) BAL 19

22 8. Revenue Bonds (continued) Series 2002 (continued) Under the terms of the project and refunding revenue bonds, the Group is required to maintain certain deposits with a trustee. Such deposits are included within assets whose use is limited. The loan agreement also places limits on the incurrence of additional borrowings and requires that the Group satisfy certain measures of financial performance as long as the notes are outstanding. The Group is required to make monthly deposits to a trusteed account sufficient to meet the requirements of the serial bonds for Series 2002A and the sinking fund requirements of Series 2002B term bonds. Annual sinking fund installments for the term bonds range from $2,355,000 on May 1, 2023 to $3,820,000 at maturity. As security for the debt service requirements of the Series 2002 Bonds, the Hospital has granted to the Authority a mortgage lien on certain of its health care facilities in Seaford, Delaware, and a security interest in all of the Hospital s gross revenues. The terms of the loan agreement restrict the Hospital s ability to create additional indebtedness and its use of the facilities, and require the Hospital to maintain stipulated insurance coverage and a rate structure in each year sufficient to meet certain rate covenant requirements. Principal Repayment Schedule Future principal payments on the Series 2002 Bonds are as follows: 2008 $ 1,180, ,220, ,265, ,315, ,370, and thereafter 48,296,000 $ 54,646, BAL 20

23 9. Capitalized Lease Obligations The Health Services has entered into capital lease agreements for certain medical equipment. Future payments under these obligations are as follows: 2008 $ 416, , , ,000 Total payments 787,000 Less amount deemed to represent interest (5,000) $ 782, Professional Liability Insurance and Self-Insurance In May 2004, NIC was formed to provide professional liability insurance for Health Services and, if required, for qualifying medical practices in Health Services communities. NIC is a wholly owned subsidiary of Health Services. For the policy periods ended July 1, 2007 and July 1, 2006, the Hospital s coverage for Professional Liability and Non-Employed Physician Professional Liability was $2,000,000 per medical incident with a limit for selected physicians of $1,000,000 per medical incident with a $6,000,000 annual aggregate limit. Health Service s liability on the General Liability coverage was $2,000,000 per occurrence with a $6,000,000 annual aggregate limit. Effective February 1, 2005, an excess umbrella policy was also written with limits of $10,000,000 per occurrence with a $10,000,000 annual aggregate limit. Certain physicians are not insured under the excess umbrella policy. All risks covered by the excess umbrella policy are reinsured by a third party reinsurer. Primary coverage is insured under a retrospectively rated claims-made policy; premiums are accrued based upon an estimate of the ultimate cost of the experience to date of each participating member institution. The basis for loss accruals for unreported claims under the primary policy is an actuarial estimate of asserted and unasserted claims including reported and unreported incidents and includes costs associated with settling claims. As of June 30, 2007 and 2006, respectively, estimates of losses and loss assessment expenses were approximately $4,491,000 and $4,844,000 and are principally recorded within Other Liabilities in the accompanying consolidated balance sheets. Projected losses were discounted at 4% at June 30, 2007 and BAL 21

24 11. Retirement Plans The Hospital has a qualified noncontributory defined benefit plan (the Pension Plan) covering substantially all employees of the Hospital. The Pension Plan benefits are based on years of service. The Hospital s funding policy is to make sufficient contributions to the Pension Plan to comply with the minimum funding requirements of the Employee Retirement Income Security Act (ERISA). At June 30, 2007, the accrued pension liability is included in accrued retirement benefits in the accompanying consolidated balance sheets. At June 30, 2006, the prepaid benefit costs are included in prepaid expense for the current portion and other assets for the long-term portion in the accompanying consolidated balance sheets. The measurement date of the Pension Plan and Other Benefits is June 30. Health Services adopted SFAS 158 effective June 30, The impact of the adoption of SFAS 158 has been reflected in the consolidated financial statements as of June 30, The following table summarizes information about the Pension Plan at June 30, 2007 and 2006 and reflects the adoption of SFAS 158 effective June 30, 2007: Changes in benefit obligations Projected benefit obligation, beginning of year $ 15,676,000 $ 15,577,000 Service cost 749, ,000 Interest cost 980, ,000 Assumption change (81,000) Actuarial loss (gain) 237,000 (904,000) Benefits paid (465,000) (425,000) Projected benefit obligation, end of year $ 17,096,000 $ 15,676,000 Accumulated benefit obligation at end of year $ 14,728,000 $ 13,576,000 Changes in plan assets Fair value of plan assets, beginning of year 11,173,000 $ 9,856,000 Actual return on plan assets 1,736, ,000 Employer contributions 2,056, ,000 Benefits and expenses paid (465,000) (425,000) Fair value of plan assets, end of year $ 14,500,000 $ 11,173,000 Funded status $ (2,596,000) $ (4,503,000) Unrecognized prior service cost 298,000 Unrecognized net loss 3,511,000 Accrued benefit cost $ (2,596,000) $ (694,000) BAL 22

25 11. Retirement Plans (continued) Amounts recognized in the accompanying consolidated balance sheets at June 30, 2006, consist of: Accrued benefit liability $(2,403,000) Cumulative decrease in unrestricted net assets 1,709,000 Accrued benefit cost $ (694,000) The underfunded status of the Pension Plan of $2,596,000 at June 30, 2007 is recognized in the accompanying consolidated balance sheets as accrued pension and other postretirement benefits. Net amounts recognized in the consolidated balance sheets consist of After adoption of SFAS 158: Accrued pension liability $ (2,596,000) N/A Amounts recognized in accumulated unrestricted net assets consist of Net actuarial loss 2,778,000 N/A Prior service cost 274,000 N/A $ 3,052,000 N/A Change in accumulated unrestricted net assets due to adoption of SFAS 158 $ (2,369,000) N/A Change in additional minimum pension liability included in unrestricted net assets before the adoption of SFAS 158 $ 728,000 $ 1,113,000 Components of net periodic benefit cost Service cost $ 749,000 $ 632,000 Interest cost 980, ,000 Expected return on assets (1,018,000) (854,000) Amortization of prior service cost 24,000 24,000 Amortization of unrecognized net actuarial loss 171, ,000 Net periodic benefit cost $ 906,000 $ 825, BAL 23

26 11. Retirement Plans (continued) The estimated net actuarial loss and the prior service cost that are expected to be amortized from other changes in unrestricted net assets into net periodic benefit cost for the year ending June 30, 2008 are $85,000 and $24,000, respectively. The assumptions used to determine the benefit obligation and net periodic benefit cost for the Pension Plan are set forth below. Assumptions Weighted-average assumptions used to determine benefit obligations at June 30: Discount rate 6.25% 6.25% Rate of increase in future compensation levels 5.00% 5.00% Weighted-average assumptions used to determine net periodic benefit cost for the years ended June 30: Discount rate 6.25% 6.25% Rate of increase in future compensation levels 5.00% 5.00% Expected long-term rate of return on assets 8.50% 8.50% The Pension Plan weighted average asset allocation and the target allocation, by asset category, are as follows: Asset Allocation June 30 Target Asset category Equity securities 60.0% 78.7% 73.6% Debt securities Other % 100.0% Health Service s defined benefit plan invests in a diversified mix of traditional asset classes. Investments in U.S. equity securities and fixed income securities are made to maximize longterm results while recognizing the need for adequate liquidity to meet ongoing benefit and administrative obligations. Risk tolerance of unexpected investment and actuarial outcomes is continually evaluated by understanding the pension plan s liability characteristics. Equity investments are used primarily to increase overall plan returns. Debt securities provide diversification benefits and liability hedging attributes that are desirable, especially in falling interest rate environments BAL 24

27 11. Retirement Plans (continued) The overall rate of expected return on assets assumption was based on historical returns, with adjustments made to reflect expectations of future returns. The extent to which the future expectations were recognized included the target rates of return for the future, which have historically not changed. The Hospital does not have any regulatory contribution requirements for 2008; however, the Hospital currently intends to make voluntary contributions to the defined benefit pension plan of $1,894,000 in The following benefit payments, which reflect expected future service as appropriate, are expected to be paid: 2008 $ 471, , , , , ,361,000 The Hospital also sponsors a Tax-Sheltered Annuity Plan (the TSA Plan) to provide retirement benefits to employees. Under the TSA Plan, substantially all employees, after working at least one year and attaining age 21, become eligible to receive a contribution of 1.5% of salary. Employees may elect to contribute a minimum of 1% of compensation and a maximum as determined by Sections 403(b) and 415 of the IRC. The Hospital also provides matching contributions of 50% of every dollar contributed by the employee up to the first 4% of the employee s salary. Participants vest in Hospital contributions after five years. Hospital contributions to the TSA Plan for 2007 and 2006 were $636,000 and $903,000, respectively. In June 2004, the Board authorized an executive retirement program for a select group of management employees. As of June 30, 2007, the benefit obligation under this program was $776,000, which reflects credits for prior service of $532, Postretirement Benefits The Hospital maintains a postretirement health benefit plan for its qualified retirees, as defined. The plan provides for health care benefits prior to a retiree s eligibility for Medicare and supplemental fixed monthly contributions subsequent to Medicare eligibility BAL 25

28 12. Postretirement Benefits (continued) The Hospital pays its postretirement benefit obligation currently, as benefits are provided to participants. The following table sets forth the related amounts recognized in the accompanying consolidated financial statements: June 30 Expected postretirement benefit obligation $ (3,978,000) $ (3,403,000) Unrecognized net actuarial gain (406,000) Unrecognized prior service credit (307,000) Net amount recognized $ (3,978,000) $ (4,116,000) Benefits paid $ 243,000 $ 119,000 Assumptions: Discount rate 6.25% 6.25% Health care cost trend rate 10.00% 11.00% Components of net periodic benefit cost Service cost $ 220,000 $ 231,000 Interest cost 222, ,000 Amortization of prior service credit (47,000) (47,000) Net periodic benefit cost $ 395,000 $ 370,000 During 2007, the Hospital adopted the provisions of SFAS No. 158 which included the recognition of an actuarial gain and prior service credit. The impact of adoption was an increase of unrestricted net assets of $290, Commitments and Contingencies Health Services, including the Hospital, has been named as a defendant in various lawsuits arising from the performance of its normal activities. In the opinion of the Hospital s management, after discussion with legal counsel, the amount, if any, of the Hospital s ultimate liability under these lawsuits will not have a material adverse effect on the consolidated financial position of Health Services BAL 26

29 13. Commitments and Contingencies (continued) A portion of Health Services revenues is received from health maintenance organizations and other managed care payors. Managed care payors generally use case management activities to control utilization. These payors also have the ability to select providers offering the most costeffective care. Management does not believe that the organization has undue exposure to any one managed care payor. 14. Temporarily and Permanently Restricted Net Assets Temporarily restricted net assets were available for the following purpose: June 30 Emergency department $ 40,000 $ Health services and other 27,000 Total temporarily restricted net assets $ 67,000 $ Permanently restricted net assets were restricted to: June 30 Investments to be held in perpetuity, the income from which is expendable to support health care services $ 116,000 $ 116, Functional Expenses Health Services provides support and coordinates the delivery of general health care services to residents within its geographical location. Expenses related to providing these services were as follows: Year Ended June 30 Health care services $ 111,764,000 $ 108,625,000 General and administrative 19,042,000 17,683,000 Total expenses $ 130,806,000 $ 126,308, BAL 27

30 16. Concentration of Credit Risk Health Services grants credit without collateral to its patients, most of whom are local residents and are insured under third-party payor agreements. The mix of gross receivables from patients and third-party payors, prior to contractual allowances and bad debt reserves, was as follows: June 30 Medicare 30% 29% Blue Cross Commercial Medicaid (including MCOs) Other third party payors 4 4 Patients Total 100% 100% 17. Fair Value of Financial Instruments The carrying amounts of cash and cash equivalents, accounts receivable, other receivables, inventories, prepaid expenses and other, accounts payable and accrued expenses, and accrued salaries and benefits approximate fair value given the short-term nature of these financial instruments and/or their methods of valuation. Fair values of assets whose use is limited are based on quoted market prices, if available, or estimated using quoted market prices for similar securities. The fair value of revenue bonds payable as of June 30, 2007 and 2006 was approximately $56,078,000 and $57,316,000, respectively BAL 28

31 BAL Other Financial Information

32 r Ernst & Young LLP r Phone: (410) East Pratt Street Fax: (410) Baltimore, Maryland Report of Independent Auditors on Other Financial Information Board of Directors Nanticoke Health Services, Inc. Our audit was conducted for the purpose of forming an opinion on the consolidated financial statements taken as a whole. The accompanying consolidating schedules are presented for purposes of additional analysis and are not a required part of the consolidated financial statements. Such information has been subjected to the auditing procedures applied in our audit of the consolidated financial statements and, in our opinion, is fairly stated in all material respects in relation to the consolidated financial statements taken as whole. September 25, 2007 EY BAL 29 A member firm of Ernst & Young Global Limited