Children s Healthcare of Atlanta, Inc. and Affiliates

Transcription

1 Children s Healthcare of Atlanta, Inc. and Affiliates Consolidated Financial Statements as of and for the Years Ended December 31, 2006 and 2005, and Independent Auditors Report

2 CHILDREN S HEALTHCARE OF ATLANTA, INC. AND AFFILIATES TABLE OF CONTENTS INDEPENDENT AUDITORS REPORT 1 CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005: Consolidated Balance Sheets 2 Consolidated Statements of Operations 3 Consolidated Statements of Changes in Net Assets 4 Consolidated Statements of Cash Flows 5 Page Notes to Consolidated Financial Statements 6 19

3 Deloitte & Touche LLP Suite Peachtree Street NE Atlanta, Georgia USA Tel: INDEPENDENT AUDITORS REPORT To the Board of Directors of Children s Healthcare of Atlanta, Inc. and Affiliates Atlanta, Georgia We have audited the accompanying consolidated balance sheets of Children s Healthcare of Atlanta, Inc. and Affiliates (a Georgia not-for-profit corporation) (the System ) as of December 31, 2006 and 2005, 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 System 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 of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes 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 System 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, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the System as of December 31, 2006 and 2005, and the results of its operations, the changes in its net assets, and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. May 14, 2007

4 CHILDREN S HEALTHCARE OF ATLANTA, INC. AND AFFILIATES CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2006 AND 2005 (In thousands) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 116,543 $ 35,431 Patient accounts receivable, less allowance for uncollectible accounts of $5,512 and $3,712 in 2006 and 2005, respectively 90,056 69,194 Contributions receivable net 19,523 17,752 Other receivables 5,895 2,982 Supplies and prepaid expenses 11,567 12,546 Total current assets 243, ,905 ASSETS WHOSE USE IS LIMITED 1,521,746 1,452,550 PROPERTY AND EQUIPMENT Net 458, ,806 OTHER NONCURRENT ASSETS: Bond issuance costs net 5,378 5,529 Deposits and other assets 10,098 9,751 Noncurrent contributions receivable net 17,750 20,069 Total other noncurrent assets 33,226 35,349 BENEFICIAL INTERESTS IN TRUSTS 82,180 77,502 TOTAL ASSETS $ 2,339,661 $ 2,044,112 LIABILITIES AND NET ASSETS CURRENT LIABILITIES: Current maturities of long-term debt $ 531 $ 531 Accounts payables and other 121, ,832 Salaries, related taxes, and benefits 30,450 25,304 Accrued interest Total current liabilities 152, ,128 LONG-TERM DEBT Net of current maturities 382, ,227 OTHER NONCURRENT LIABILITIES 37,900 47,073 COMMITMENTS AND CONTINGENCIES (Note 8) NET ASSETS: Unrestricted 1,437,813 1,197,022 Temporarily restricted 208, ,370 Permanently restricted 119, ,292 Total net assets 1,766,075 1,478,684 TOTAL LIABILITIES AND NET ASSETS $ 2,339,661 $ 2,044,112 See notes to consolidated financial statements

5 CHILDREN S HEALTHCARE OF ATLANTA, INC. AND AFFILIATES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005 (In thousands) OPERATING REVENUES AND SUPPORT: Net patient service revenue $ 691,973 $ 653,951 Other operating revenue 16,298 20,999 Unrestricted contributions 8,803 6,667 Net assets released from restriction for operations 11,134 5,543 Total operating revenues and support 728, ,160 OPERATING EXPENSES: Salaries and wages 341, ,962 Employee benefits 65,751 60,354 Supplies and other 200, ,752 Provision for bad debts 10,765 8,308 Interest expense 11,002 10,477 Depreciation and amortization 41,716 41,521 Total operating expenses 670, ,374 OPERATING INCOME 57,358 55,786 INVESTMENT INCOME AND OTHER 87, ,029 EQUITY IN INCOME OF UNCONSOLIDATED AFFILIATES AND INVESTMENTS MINORITY INTEREST IN EARNINGS OF SUBSIDIARY (4,691) (3,634) REVENUES IN EXCESS OF EXPENSES $ 140,900 $ 161,181 See notes to consolidated financial statements

6 CHILDREN S HEALTHCARE OF ATLANTA, INC. AND AFFILIATES CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005 (In thousands) Temporarily Permanently Unrestricted Restricted Restricted Total NET ASSETS December 31, 2004 $ 1,050,259 $ 113,954 $ 108,971 $ 1,273,184 Revenues in excess of expenses 161, ,181 Contributions and other - 61, ,397 Investment income Net assets released from restriction for operations - (5,543) - (5,543) Net assets released from restriction for property additions 2,207 (2,207) - - Net change in unrealized gains (losses) on investments (15,608) (15,212) Net change in fair value of interest rate swaps (1,017) - - (1,017) Increase in value of beneficial interest in trusts - - 4,627 4,627 Increase in net assets 146,763 53,416 5, ,500 NET ASSETS December 31, ,197, , ,292 1,478,684 Revenues in excess of expenses 140, ,900 Contributions and other 42 58, ,561 Investment income Net assets released from restriction for operations - (11,134) - (11,134) Net assets released from restriction for Hughes Spalding Children s Hospital (Note 1) - (3,701) - (3,701) Net assets released from restriction for property additions 2,688 (2,688) - - Net change in unrealized gains on investments 94, ,637 Net change in fair value of interest rate swaps 2, ,641 Increase in value of beneficial interest in trusts - - 4,678 4,678 Increase in net assets 240,791 40,948 5, ,391 NET ASSETS December 31, 2006 $ 1,437,813 $ 208,318 $ 119,944 $ 1,766,075 See notes to consolidated financial statements

7 CHILDREN S HEALTHCARE OF ATLANTA, INC. AND AFFILIATES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005 (In thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Increase in net assets $ 287,391 $ 205,500 Adjustments to reconcile increase in net assets to net cash provided by operating activities: Depreciation and amortization 41,716 41,521 Net change in unrealized gains on investments (94,637) 15,608 Net change in fair value of interest rate swaps 2,641 1,017 Equity in income of unconsolidated affiliates and investments (434) - Gain on sale of marketable securities (61,207) (83,499) Provision for bad debts 10,765 8,308 Minority interest in earnings of subsidiary 4,691 3,634 Restricted contributions and investment income (59,370) (61,464) Changes in assets and liabilities: Patient accounts receivable and other receivables (34,542) (28,269) Supplies and prepaid expenses 979 (486) Other noncurrent assets (4,476) (22,864) Accounts payable and accrued liabilities 11,709 17,057 Other noncurrent liabilities (11,762) (2,222) Total adjustments (193,927) (111,659) Net cash provided by operating activities 93,464 93,841 CASH FLOWS FROM INVESTING ACTIVITIES: Property additions (153,451) (96,623) Proceeds from disposal of (purchases of) assets whose use is limited net 86,648 (318,038) Net cash used in investing activities (66,803) (414,661) CASH FLOWS FROM FINANCING ACTIVITIES: Distributions to minority shareholders of subsidiary (4,310) (3,136) Proceeds from restricted contributions and investment income 59,370 61,464 Payment of bond issuance costs (78) (4,839) Issuance of long-term debt - 272,100 Principal payments under long-term debt (531) (2,831) Net cash provided by financing activities 54, ,758 NET INCREASE IN CASH AND CASH EQUIVALENTS 81,112 1,938 CASH AND CASH EQUIVALENTS Beginning of year 35,431 33,493 CASH AND CASH EQUIVALENTS End of year $ 116,543 $ 35,431 See notes to consolidated financial statements

8 CHILDREN S HEALTHCARE OF ATLANTA, INC. AND AFFILIATES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2006 AND ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES Organization ESR Children s Health Care System, Inc. ( ESR ) was established as a Georgia not-for-profit corporation on February 1, 1998, by the merger of Egleston Children s Health Care System, Inc. and Scottish Rite Children s Medical Center, Inc. (collectively the Hospitals ). ESR changed its name to Children s Healthcare of Atlanta, Inc. ( Children s ) in September Children s is organizationally comprised of Children s and affiliate organizations (collectively, the System ). Affiliate organizations controlled by Children s are the following corporations: a. Egleston Children s Hospital at Emory University, Inc. ( ECH ). b. Scottish Rite Children s Medical Center, Inc. ( SR ). c. Egleston Affiliated Services, Inc. ( EAS ), which operates Children s immediate care centers in the Atlanta area. d. TRE Properties, Inc. ( TRE ), a real estate company that owns, leases, and manages real estate for Children s and its affiliated companies. As of December 31, 2006, TRE has been merged into Children s. e. Egleston Pediatric Group, Inc. ( EPG ), the contract provider of physician services to the affiliates of Children s, such as the hospitals, primary care centers, and EAS. EPG is the sole member of two LLC entities that provide sedation services and anesthesiology services (Children s Anesthesia Services ( CAS ), and Children s Sedation Services, ( CSS )). f. Children s Healthcare of Atlanta, Inc. Foundation (the Foundation ) was established to promote and support Children s and its affiliates. The Foundation s primary purpose is to represent Children s in the community and to financially support the services and operations of Children s. g. Sibley Heart Center, Inc. ( Sibley Heart Center ), which employs pediatric cardiologists who provide services for the System. h. The Children s Health Network, a physician hospital organization. i. HSOC, Inc. ( HSOC ), which provides management, administrative and related services for pediatric acute care hospitals. In addition, SR owns a majority interest in Children s Healthcare of Atlanta Surgery Center at Meridian Mark Plaza, LLC (the Surgery Center ), a joint venture with physicians to operate an outpatient surgery center. This majority interest ownership percentage was approximately 51% at December 31, 2006 and The System also includes an affiliate corporation, Emory-Egleston Children s Research Center, - 6 -

9 Inc., which conducts pediatric health research, of which ECH is a member along with certain other parties. Effective February 1, 2006, HSOC assumed management of Hughes Spalding Children s Hospital ( Hughes Spalding ), a pediatric acute care hospital located in Atlanta, Georgia, pursuant to a management agreement dated December 15, The parties to the management agreement are HSOC, a subsidiary of ECH, and the Fulton-DeKalb Hospital Authority d/b/a Grady Health System, a hospital authority organized under the Georgia Hospital Authority Law. Under certain circumstances, HSOC may be required to provide minimum capital investments and other financial support, as defined in the agreement. Effective September 1, 2006, the System entered into a joint venture agreement with Emory Healthcare, Inc. ( Emory ) for the purpose of restructuring Emory Children Center Inc. ( ECC ), a pediatric physician faculty group practice of which Emory and the System are sole members. Emory and the System will own 51% and 49%, respectively, of the joint venture. Pursuant to a Financial Support Agreement, the System may make annual financial support payments to ECC to support the operation of and provision of health care services by the ECC clinical practices. The System accounts for this investment under the equity method of accounting in conformity with Accounting Principles Board Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. The accompanying consolidated statement of operations reflects equity losses related to the System s investment in this joint venture of approximately $2,757,000 for the year ended December 31, ECH and SR (collectively, the Hospitals ) are located in Atlanta, Georgia. The Hospitals were organized for the purposes of treating sick children, encouraging scientific investigation into the medical problems of children, and providing instruction in the diseases and care of children. Summary of Significant Accounting and Reporting Policies A summary of the significant accounting and reporting policies followed by the System in the preparation of its consolidated financial statements is presented below: Cash and Cash Equivalents Cash and cash equivalents include highly liquid instruments with original maturities of three months or less at the date of purchase and are recorded at cost, which approximates market value. The System invests cash, which is not required for immediate operating needs, in major financial institutions in amounts which exceed Federal Depository Insurance Corporation limits. These financial institutions have strong credit ratings, and management believes that the credit risk related to these deposits is minimal. Assets Whose Use is Limited Assets whose use is limited primarily include assets set aside by the Board of Trustees (the Board ) over which the Board retains control and may, at its discretion, subsequently use for other purposes, in addition to assets provided by donors for special purposes such as uncompensated child care. Investments in equity and other securities with readily determinable fair values and all investments in debt securities are measured at fair value in the balance sheets. Generally, investment income or loss (including realized gains and losses on investments, interest, and dividends) is included in the revenues in excess of expenses as investment income. Unrealized gains and losses on investments are included in the statements of changes in net assets as increases or decreases of net assets according to restrictions as to use. Investments in equity and other securities without readily determinable fair values are measured at cost or using the equity method of accounting, depending on the System s ownership percentage of - 7 -

10 the specific investment. The System s equity in income (losses) of these unconsolidated investments accounted for under the equity method is included in revenues in excess of expenses. Hedging Instruments The System uses derivative instruments, including interest rate swap agreements, to manage certain interest rate exposures. Derivative instruments are viewed as risk management tools by the System and are not used for trading or speculative purposes. Derivatives used for hedging purposes must be designated and effective as a hedge of the identified risk exposure at the inception of the contract. Derivatives used to hedge forecasted cash flows are accounted for as cash flow hedges. The System applies Statement of Financial Accounting Standard ( SFAS ) No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended, which establishes accounting and reporting standards for derivative instruments and hedging activities. SFAS No. 133 requires the System to recognize all derivatives as either assets or liabilities in the consolidated balance sheets and measure those instruments at fair value. Gains and losses on derivatives designated as cash flow hedges are recorded as a component of unrestricted net assets. Any ineffectiveness is recognized currently in operating income. Property and Equipment Property and equipment are recorded at cost. The System s policy is to capitalize major additions, including interest during construction and interest costs involving certain tax-exempt borrowings, and to remove retired items from the accounts. Depreciation is provided using the straight-line method over the estimated service lives of the depreciable property and equipment. The depreciable lives applied are generally 16 to 40 years for buildings and renovations, 15 years for fixed equipment, 10 years for movable equipment, and 3 to 5 years for computer software and hardware. A detail of property, equipment, and accumulated depreciation as of December 31, 2006 and 2005, is as follows (in thousands): Land and land improvements $ 43,141 $ 43,174 Buildings and fixed equipment 338, ,464 Movable equipment and computer software 302, ,437 Construction in progress Master Facility Plan 143,586 70,286 Construction in progress 17,885 11, , ,518 Less accumulated depreciation (386,470) (347,712) Property and equipment net $ 458,925 $ 340,806 Capitalized interest recorded in construction in progress during the years ended December 31, 2006 and 2005, is approximately $5,510,000 and $1,412,000, respectively. Bond Issuance Costs Costs incurred in issuing long-term debt are amortized based on the effective interest method over the life of the underlying debt. The gross amount of bond issuance costs totaled $6,200,000 and $6,122,000 as of December 31, 2006 and 2005, respectively, and the related accumulated amortization as of December 31, 2006 and 2005, totaled $822,000 and $593,000, respectively. Beneficial Interests in Trusts The System is the beneficiary of the proportional income from certain perpetual third-party trusts. The System has no access to the corpus of these trusts and has only limited input into the investment mix of the funds in the trusts, in some cases. The estimated present value of the future distributions to be received from these trusts has been recorded as an asset and as a component of - 8 -

11 permanently restricted net assets in the accompanying consolidated balance sheets. Management s estimate of the present value of the future distributions to be received is updated annually, the effect of which is included in the accompanying consolidated statements of changes in net assets. Net Patient Service Revenue, Patient Accounts Receivable, and Bad Debts Children s has agreements with third-party payors that provide for payments to Children s at amounts different from its established rates. Payment arrangements include prospectively determined rates per discharge, reimbursed costs, discounted charges, and per-diem payments. Net patient service revenue and patient accounts receivable are reported at the estimated net realizable amounts from patients, third-party payors, and others for services rendered, including estimated retroactive adjustments under reimbursement agreements with third-party payors. Retroactive adjustments are accrued on an estimated basis in the period that related services are rendered and adjusted in future periods as final settlements are determined. A summary of the payment arrangements with major third-party payors is as follows: Medicaid Programs Children s renders care to patients covered by the Medicaid program. Payments for inpatient services rendered under this program are based on prospectively determined rates per discharge. These rates vary according to a patient classification system that is based on clinical, diagnostic, and other factors. Payments for outpatient services rendered under this program are generally based on the reasonable cost of providing care. Net patient service revenue from the Medicaid program accounted for approximately 35% and 38% of Children s total net patient revenue for the years ended 2006 and 2005, respectively. Laws and regulations governing the Medicaid program 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. Net patient service revenue increased approximately $8,089,000 and $13,586,000, respectively, during 2006 and 2005 due to the removal of allowances previously estimated that are no longer necessary as a result of final settlements and years that are no longer subject to reviews, audits, and investigations. Children s recognizes that net patient service revenue and patient accounts receivable from government agencies are significant to its operations; however, management does not believe that there are any significant credit risks associated with these government agencies. Managed Care and Commercial Programs Children s has entered into payment arrangements with certain commercial insurance companies and managed care providers. The basis for payment to Children s under these agreements includes prospectively determined rates per discharge, discounts from established charges, and prospectively determined daily rates. Net revenue from managed care and commercial programs accounted for approximately 63% and 60% of Children s total net patient revenue for the years ended 2006 and 2005, respectively. Children s recognizes that net patient service revenue and patient accounts receivable from managed care and commercial programs are significant to its operations; however, management does not believe that there are any significant credit risks associated with these managed care and commercial programs. The provision for bad debts relating to patient service revenue is based on an evaluation of potentially uncollectible portions of accounts receivable. The provision considered necessary for such bad debts is based on an analysis of current and past-due accounts, collection experience in relation to amounts billed, and other relevant information. The allowance for uncollectible accounts represents the estimated uncollectible portion of patient accounts receivable

12 Contributions Contributions are recorded at fair value upon receipt of cash or other assets or when unconditional promises to contribute are received and are included in contributions receivables and noncurrent contributions receivable in the accompanying consolidated balance sheets. Conditional promises to give are reported at fair value at the date the gift is received or at the time the condition is substantially met. Promises to pay are discounted to their present values using an interest rate commensurate with the collection risk involved. Gifts, bequests, and promises to pay, which are restricted by donors as to use or to be received in excess of one year, are recorded as temporarily restricted net assets until used in the manner designated or upon expiration of the time period over which the assets are to be received. The assets released for their intended purposes are included in operating revenue in the accompanying consolidated statements of operations or as a transfer to unrestricted net assets if the use is for a capital item. Donated property and equipment are recorded as temporarily restricted net assets at fair market value on the date of receipt. When donated property and equipment are used for their intended purposes, the applicable amount is transferred to unrestricted net assets. At December 31, 2006, Children s had approximately $40,127,000 of unconditional promises to contribute, of which $20,418,000 are due in less than one year and $19,709,000 are due between one and five years. Children s has recorded an allowance for its estimate of uncollectible contributions receivables of approximately $2,855,000 at December 31, At December 31, 2005, Children s had approximately $39,649,000 of unconditional promises to contribute, of which $18,627,000 are due in less than one year and $21,022,000 are due between one and five years. Children s has recorded an allowance for its estimate of uncollectible contributions receivables of approximately $1,828,000 at December 31, Children s had no material outstanding conditional promises to contribute at December 31, 2006 and 2005, respectively. Minority Interest in Subsidiary At December 31, 2006 and 2005, SR owns a majority interest in the Surgery Center. This majority interest was approximately 51% at December 31, 2006 and The minority interest was approximately 49% at December 31, 2006 and Minority interest of $3,369,000 and $3,027,000 at December 31, 2006 and 2005, respectively, is included in other noncurrent liabilities in the accompanying consolidated balance sheets. In addition, a charge of $4,691,000 and $3,634,000 has been recorded in the 2006 and 2005 consolidated statement of operations to reflect the minority owners share of the Surgery Center s 2006 and 2005 net income. Revenue in Excess of Expenses The consolidated statements of operations include revenues in excess of expenses. Changes in unrestricted net assets, which are excluded from revenues in excess of expenses consistent with industry practice, include unrealized gains and losses on marketable securities (other than trading securities), gains (losses) on derivative instruments classified as cash flow hedges, and 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). Income Taxes The System is comprised primarily of organizations that have been recognized by the Internal Revenue Service as tax-exempt under Internal Revenue Code Section 501(c)(3). Accordingly, no provision for income taxes has been made in the accompanying statements of operations. Sibley Heart Center is a taxable not-for-profit entity, and the Sibley Heart Center s provision for income taxes was insignificant for the years ended December 31, 2006 and Statements of Cash Flows Cash payments for interest totaled approximately $9,964,000 and $9,986,000 for the years ended December 31, 2006 and 2005, respectively

13 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 as of the date of the financial statements. Estimates also affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Consolidation All significant intercompany amounts have been eliminated in the accompanying consolidated financial statements. Fair Values of Financial Instruments The following methods and assumptions were used by the System to estimate the fair value of each class of financial instrument for which it is practicable to estimate that value: Cash and Cash Equivalents, Patient Accounts Receivable, Accounts Payable, and Accrued Liabilities The carrying amount approximates fair value because of the short-term nature of these instruments. Assets Whose Use is Limited The fair values for investments are estimated based on quoted market prices for those or similar investments where a market price is available or an amount determined by external investment managers if quoted market prices are not available. Long-Term Debt The fair market value of long-term debt is based on the current rates offered for debt of the same remaining maturities. Industry 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 limited to, matters such as licensure, accreditation, government health care program participation requirements, reimbursement for patient services, the federal False Claims Act, and Medicare and Medicaid fraud and abuse. Government activity is ongoing with respect to investigations and allegations concerning possible violations of the False Claims Act and 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. Management believes that the System is in compliance with the False Claims Act and fraud and abuse statutes as well as other applicable government laws and regulations. While no regulatory inquiries have been made, compliance with such laws and regulations can be subject to future government review and interpretation, as well as regulatory actions unknown or unasserted at this time. Recent Accounting Pronouncements In January 2007, the Financial Accounting Standards Board issued SFAS No. 133 Implementation Issue No. G26, Cash Flow Hedges: Hedging Interest Cash Flows on Variable-Rate Assets and Liabilities That Are Not Based on a Benchmark Interest Rate ( DIG G26 ), which is effective the first day of the fiscal quarter that begins after January 8, DIG G26 clarifies the definition of benchmark interest rates, including situations where interest rates are reset through an auction process, and the requirements to qualify for hedge accounting. Specifically, DIG 26 indicates that in situations where an interest rate is reset through an auction process, an entity may hedge the variability in cash flows by designating the hedged risk as the risk of overall changes in cash flows, provided all of the other cash flow hedging criteria in SFAS No. 133 are met. The entity may not indicate that the risk being hedged is interest rate risk unless the cash flows of the hedged transaction are explicitly based on that same benchmark interest rate. The System is currently evaluating the impact of this recent accounting pronouncement on its consolidated financial statements

14 2. TEMPORARILY AND PERMANENTLY RESTRICTED NET ASSETS Temporarily restricted net assets are those net assets whose use has been limited by donors to a specific time or purpose. Temporarily restricted net assets of approximately $208,318,000 and $167,370,000 as of December 31, 2006 and 2005, respectively, are available for various System purposes, including charity care for children, investment in medical technology and facilities, and the expansion of medical services. Permanently restricted net assets have been restricted by donors to be maintained in perpetuity by the System. Investment income on permanently restricted net assets is generally available for unrestricted purposes. Permanently restricted net assets as of December 31, 2006 and 2005, were approximately $119,944,000 and $114,292,000, respectively. 3. MEDICAID PROGRAM AND OTHER COMMUNITY BENEFITS The System renders care to patients covered by the Medicaid program. Payments for inpatient services are based on prospectively determined rates per discharge. These rates vary according to a patient classification system that is based on clinical, diagnostic, and other factors. Payments for outpatient services under the program are generally based on discounted reasonable costs of providing care. In the opinion of management, adequate allowances have been recorded as of December 31, 2006 and 2005, to properly reflect accounts receivable from Medicaid. On June 1, 2006, Medicaid Managed Care was implemented by the state of Georgia. Three different care management organizations ( CMOs ) are contracted with Georgia Medicaid to coordinate care for Medicaid eligible patients that select or are assigned to the CMO. Children s is contracted with each of the CMOs for payment terms and rates similar to traditional Medicaid. Under the provisions of the Indigent Care Trust Fund ( ICTF ) Act, Medicaid disproportionate share hospitals may contribute funds which will be used by the state in the Medicaid program and be supplemented by federal funds. For the years ended December 31, 2006 and 2005, the Hospitals recorded $7,314,000 and $6,832,000, respectively, of ICTF funds which are included in net patient service revenue. Contributions were not required under the ICTF in either period. The ICTF for the state of Georgia s fiscal year 2007 is not finalized due to changes in funding and distribution mechanisms. While the System expects continued funding from the ICTF in the near term, there can be no assurances that any such funding will continue, or continue at the levels experienced in recent years. Additionally, Centers for Medicare and Medicaid Services has challenged the state of Georgia s funding mechanism for future state fiscal years. The implications of this are currently unknown. Prior to 2006, providers were obligated to commit 15% of total proceeds from the ICTF for state-approved primary care projects as well as an additional commitment to provide established levels of indigent care. The remaining liability for primary care programs, included in temporarily restricted net assets, was $247,000 and $768,000 as of December 31, 2006 and 2005, respectively. For the years ended December 31, 2006 and 2005, $501,000 and $904,000, respectively, were incurred and charged against these liabilities. The net amount of funds received and expended are included in contributions and other in the accompanying consolidated statements of changes in net assets. The purpose of the primary care projects is to expand the availability of services of primary care to the Medicaid and indigent populations. Providing and promoting immunizations, healthier communities, school outreach, and teenage counseling were the focus of the System s 2006 and 2005 primary care plans

15 Amounts received under the ICTF in excess of the 15% obligation and the original amounts advanced are recognized as increases in net patient service revenue to the extent the indigent care obligation has been met. The System provides assistance to patients who meet certain criteria under its charity care policy without charge or at amounts less than its established rates. Because the System does not pursue collection of amounts determined to qualify as charity care, they are not reported as revenue or accounts receivable in the accompanying financial statements. The System maintains records to identify and monitor the level of charity care it provides. These records include the cost of services and supplies furnished under its charity care policy. The System estimates that unreimbursed costs for charity care and Medicaid services, net of funding from the ICTF, the State of Georgia Neonatal Fund, and other funding provided to defray these costs, were approximately $81,131,000 and $77,894,000 in 2006 and 2005, respectively. Other Community Benefits (Unaudited) Children s efforts benefit the community not only through direct patient care but also through community outreach programs and health and safety education. The following unaudited information details some of the more significant programs Children s provides to benefit the communities it serves. In the community-at-large, Children s Community Health Development & Advocacy Department works to improve the lives of children through three strategies: injury prevention, obesity prevention, and illness prevention and management. The System has developed methods of communicating with and educating key populations in need through programs and partnerships throughout the community. Direct and pediatric advice line programs are physician-to-physician consultation services that enable a patient s primary care physician to access pediatric information resources that might otherwise be unavailable in that physician s community. In addition, Children s educates parents and care providers through specially designed programs by offering a variety of low-cost or free classes and programs related to fitness, nutrition, and wellness in early life as well as a program to promote the benefits of literacy on overall health to parents. Children s is the lead agency involved in SAFE KIDS of Georgia, which is dedicated to unintentional injury prevention. SAFE KIDS of Georgia and its 22 coalitions and chapters throughout the state distributed thousands of child passenger safety seats, booster seats, bike helmets, and smoke detectors in Other programs included safety seat training and safety seat check events. To address school health issues, Children s scoliosis screening program coordinated the primary screening of 79,910 children. Other school-based programs included workshops and conferences focusing on such topics as immunization, disease management, nutrition, infection control, asthma, and first aid. In addition, Children s nurse consultants had an impact on an estimated 791,000 children. A complement to these community outreach efforts is Children s 24-hour physician referral and health information line and Children s Web site. Staffed by registered nurses, the call center often eliminates unnecessary visits to the physician s office or emergency room. Parents can access more than 300 pediatric health information topics through the call center. Children s staff handled more than 285,000 calls from the community in The Web site, likewise, provides parents and others with health education, as well as information about upcoming classes and events

16 4. ASSETS WHOSE USE IS LIMITED The composition of assets limited as to use as of December 31, 2006 and 2005, is set forth in the following table (in thousands): Board-designated for asset acquisition and uncompensated child care: Cash and cash equivalents $ 11,810 $ 868 Equity securities 964, ,577 Debt securities 116, ,703 Investments in equity and other securities accounted for under the equity method 112,489 - Investments in equity and other securities carried at cost 129, ,384 1,335,092 1,159,532 Bond agreement designated for asset construction and acquisition: Cash and cash equivalents 20, ,500 Donor restricted for special purposes such as uncompensated child care: Cash and cash equivalents 1,657 16,476 Equity securities 145, ,449 Debt securities 18,226 12, , ,518 Total assets whose use is limited $ 1,521,746 $ 1,452,550 The following table shows the gross unrealized losses and fair values of the System s investments with unrealized losses that are not deemed to be other-than-temporarily impaired (in millions), aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2006 (in thousands). Less Than 12 Months 12 Months or Greater Total Fair Unrealized Fair Unrealized Fair Unrealized Value Losses Value Losses Value Losses Description of securities Equity securities $ 34,737 $ (3,376) $ 21,308 $ (4,142) $ 56,045 $ (7,518) Debt securities 5,974 (586) 127,515 (6,273) 133,489 (6,859) Investments in equity and other securities carried at cost 12,489 (879) ,489 (879) Total $ 53,200 $ (4,841) $ 148,823 $ (10,415) $ 202,023 $ (15,256) Equity Securities The System s investments in marketable equity securities are comprised of a diversified portfolio of holdings in various markets, sectors and industries. The System evaluated the near-term prospects of the issuers in relation to the severity and duration of the impairment. Based upon these evaluations and the System s ability and intent to hold those investments for a reasonable period of

17 time sufficient for a forecasted recovery of fair value, and as there is no concentration within a specific industry, the System does not consider those investments to be other-than-temporarily impaired as of December 31, Debt Securities The unrealized losses on the System s fixed income securities were caused by interest rate increases. Because the System has the ability and intent to hold these investments until a recovery of fair value, which may be maturity, the System does not consider those investments to be other-thantemporarily impaired at December 31, Investments in Equity and Other Securities Carried at Cost The System s investments in equity securities carried at cost consist primarily of partnerships created for the purpose of investing in privately held companies. Current asset values of the partnerships may be below amounts funded by the System due to partnership management fees incurred in the early years of the partnership before significant investments have been made by the partnerships. The System does not consider these investments to be other-than-temporarily impaired at December 31, Fair value for financial reporting purposes is based on quoted market prices or an amount determined by external investment managers if quoted market prices are not available. Management reviews and evaluates fair value provided by the external investment managers as well as the valuation methods and assessments used in determining the fair value of such investments. Such estimated fair values (amounting to $1,245,752,000 for investments with estimated fair values based on quoted market prices and $267,487,000 for investments with estimated fair values provided by external investment managers at December 31, 2006) may differ from the ultimate realizable value of the investments, and these differences may be material. For the years ended December 31, 2006 and 2005, investment income is comprised of the following (in thousands): Investment income: Interest and dividends net of fees $ 28,443 $ 24,919 Realized gains on sales of securities 61,207 84,239 Total $ 89,650 $ 109,158 The accompanying consolidated statement of operations reflect equity income related to the Systems investment in equity and other securities without readily determinable fair values and required to be accounted for under the equity method of accounting of approximately $3,191,000 for the year ended December 31, LONG-TERM DEBT ECH In November 1998, ECH issued $35 million of DeKalb Private Hospital Authority (the DeKalb Authority ) variable rate demand revenue anticipation certificates 1998A and 1998B Series (the 1998 Certificates ). In December 1995, ECH issued $20 million of DeKalb Authority variable rate demand revenue anticipation certificates 1995A and 1995B Series (the 1995 Certificates ). In March 1994, ECH issued $60 million of DeKalb Authority variable rate demand revenue anticipation certificates 1994A and 1994B Series (the 1994 Certificates ). The 1998, 1995, and 1994 Certificates bear an adjustable interest rate (3.9% and 3.5% as of December 31, 2006 and 2005, respectively) and are remarketed on a weekly basis. Interest is payable monthly. The 1994 Certificates mature on March 1,

18 2024 and are subject to mandatory sinking fund redemption beginning on March 1, The 1995 Certificates mature on December 1, 2017, and are subject to mandatory sinking fund redemption beginning on December 1, The 1998 Certificates mature on December 1, 2028, and are subject to mandatory sinking fund redemption beginning on December 1, The recorded amount of the debt approximates fair market value. ECH has obtained irrevocable letters of credit to serve as security for the payment of the 1994, 1995, and 1998 Certificates. There were no amounts outstanding under the letters of credit at December 31, 2006 and Under the terms of the agreement governing the 1998, 1995, and 1994 Certificates, the obligated group is subject to certain covenants, including limitations on the incurrence of additional indebtedness, maintenance of certain amounts of insurance, mergers, transfers of assets, and various other financial covenants and tests. The obligated group is comprised of ECH, TRE, EAS, and EPG (see Note 1). The obligated group is in compliance with all financial covenants as of December 31, Surgery Center In 2003, the Surgery Center entered into a loan agreement with SunTrust Bank, N.A. which provided for the issuance of a $5,305,000 term loan. Proceeds of the term loan were used to fund the initial expenditures and working capital requirements associated with the formation of the Surgery Center. The term loan and accrued interest are currently being paid in installments over a ten-year period. The term loan is secured by all of the assets of the Surgery Center. In addition, the term loan was guaranteed by Children s from inception through September 30, At September 30, 2006, the outstanding amount of the term loan was $3,227,000. Children s In February 2005, the DeKalb Authority issued $150,000,000 in tax-exempt revenue anticipation certificates, consisting of $110,000,000 of Series 2005A Notes and $40,000,000 of Series 2005B Notes (the DeKalb Series 2005 Certificates ) pursuant to a Trust Indenture for each of the respective series by and between the DeKalb Authority and various banks. The proceeds of the DeKalb Series 2005 Certificates were loaned to Children s, ECH, SR, EAS, TRE, EPG and the Foundation (see Note 1) (the Obligated Group ) pursuant to a loan agreement for each respective series between the DeKalb Authority and the Obligated Group. The DeKalb Series 2005 Certificates mature in July 2039 and bear an adjustable interest rate based on the BMA index plus an applicable spread as defined in the Trust Indenture (3.75% for Series 2005A and 2005B Notes at December 31, 2006 and 3.48% for Series 2005A Notes and 3.51% for Series 2005B Notes at December 31, 2005). Interest is payable weekly. Proceeds from the DeKalb Series 2005 Certificates are being used as part of the Master Facilities Plan under which the System is currently making substantial capital additions and renovations at its ECH and SR campuses and to pay certain costs of issuance relating to the DeKalb Series 2005 Certificates. In connection with the February 2005 issuance of tax-exempt revenue anticipation certificates, Children s entered into forward interest rate swap agreements with various banks effectively converting Children s interest rate exposure on a portion of this debt from a variable to a fixed rate. The interest rate swaps had an aggregate notional amount of $150,000,000 and have terms which closely mirror those of the underlying debt. The swap agreements were designated as cash flow hedges, and the changes in the fair value are recorded as a component of unrestricted net assets. Children s assesses, both at inception and at least quarterly thereafter, whether the interest rate swaps that are used in hedging transactions are effective at offsetting changes in cash flows of the related underlying debt. Any ineffectiveness is recognized currently in operating income. During the years ended December 31, 2006 and 2005, Children s recorded approximately $2,641,000 and $1,017,000, respectively, in net change in fair value of interest rate swaps related to the effective portion of the interest rate swaps. In 2006 and 2005, Children s recorded $0 of interest expense related to the ineffective portion of the interest rate swaps. At

19 December 31, 2006 and 2005, Children s had recorded a $572,000 asset and a $2,068,000 liability, respectively, related to the interest rate swaps in other noncurrent liabilities in the accompanying consolidated balance sheet. In February 2005, the Development Authority of Fulton County (the Development Authority ) issued $122,100,000 in tax-exempt revenue bonds, consisting of $46,865,000 of Series 2005A Notes, $50,000,000 of Series 2005B Notes, and $25,235,000 of Series 2005C Notes (the Development Authority Series 2005 Bonds ) pursuant to a Trust Indenture for each of the respective series by and between the Development Authority and various banks. The proceeds of the Development Authority 2005 Bonds were loaned to the Obligated Group pursuant to a loan agreement for each respective series between the Development Authority and the Obligated Group. The Development Authority Series 2005 Bonds mature in July 2039 and bear an adjustable interest rate based on the BMA index plus an applicable spread as defined in the Trust Indenture (3.91% for Series 2005A and 2005C Notes and 3.75% for Series 2005B Notes at December 31, 2006 and 3.93% for Series 2005A Notes, 3.40% for the Series 2005B Notes, and 3.51% for the Series 2005C Notes at December 31, 2005). Interest is payable weekly. Proceeds from the Development Authority Series 2005 Bonds are being used as part of the Master Facilities Plan under which the System is currently making substantial capital additions and renovations at its ECH and SR campuses and to pay certain costs of issuance relating to the DeKalb Series 2005 Certificates. The recorded amount of the debt approximates fair market value. Children s has a line of credit of $35 million at an interest rate of LIBOR plus 0.30%. The line of credit is unsecured. Interest is payable monthly, and the line of credit matures on May 31, At December 31, 2006, there were no amounts outstanding under the line of credit. Debt Maturities Future maturities of all long-term debt are as follows at December 31, 2006 (in thousands): Years Ending December $ , , ,130 Thereafter 373, RETIREMENT BENEFITS $ 383,228 Effective January 1, 1999, the System consolidated the retirement plans of the Hospitals into a single defined contribution retirement plan. Contributions to the consolidated plan were $15,605,000 and $14,036,000 for the years ended December 31, 2006 and 2005, respectively. The Sibley Heart Center maintains a defined contribution retirement plan covering most of its full-time employees. The Sibley Heart Center s expenses under this plan were approximately $2,338,000 and $2,047,000 in 2006 and 2005, respectively