Swedish Covenant Hospital. Consolidated Financial Report September 30, 2017

Transcription

1 Swedish Covenant Hospital Consolidated Financial Report September 30, 2017

2 Contents Independent auditor s report 1-2 Consolidated financial statements Consolidated statements of financial position 3-4 Consolidated statements of operations and other changes in unrestricted net assets 5 Consolidated statements of changes in total net assets 6 Consolidated statements of cash flows 7 Notes to consolidated financial statements 8-36

3 Independent Auditor s Report To the Board of Benevolence The Evangelical Covenant Church To the Board of Directors Swedish Covenant Hospital Report on the Financial Statements We have audited the accompanying consolidated financial statements of Swedish Covenant Hospital and subsidiaries (the Hospital) (an affiliate of The Evangelical Covenant Church) which comprise the consolidated statements of financial position as of September 30, 2017 and 2016, the related consolidated statements of operations and other changes in unrestricted net assets, changes in total net assets, and cash flows for the years then ended, and the related notes to the consolidated financial statements, (collectively, the financial statements). Management s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error. Auditor s Responsibility Our responsibility is to express an opinion on these 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 from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. 1

4 Opinion In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Swedish Covenant Hospital and subsidiaries as of September 30, 2017 and 2016, and the results of their operations, their changes in net assets and their cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America. Chicago, Illinois January 15,

5 Consolidated Statements of Financial Position September 30, 2017 and 2016 Assets Current assets: Cash and cash equivalents $ 5,650 $ 2,122 Assets whose use is limited (Notes 1, 2, and 3) 12,220 9,902 Patient accounts receivable - net of estimated uncollectibles of $11,631 in 2017 and $12,146 in 2016 (Note 6) 54,820 46,346 Inventories 4,948 4,445 Due from third-party payors 2,269 4,797 Other current assets 5,633 6,318 Total current assets 85,540 73,930 Assets whose use is limited and investments (Notes 1, 2, and 3): Board-designated funds 155, ,885 Donor restricted 21,752 19,071 SCIC restricted investments 39,527 36,710 Debt service reserve funds - 9, , ,983 Property and equipment (Notes 1 and 12): Land and land improvements 11,467 11,467 Buildings and building equipment 287, ,420 Fixed and movable equipment 201, ,966 Construction in progress 8,943 11, , ,158 Accumulated depreciation (322,626) (305,827) 186, ,331 Other assets: Pledges receivable (Note 11) Goodwill and other intangibles (Note 1) Note receivable (Note 4) 9,680 9,680 Insurance recoveries receivable, less current portion, and other assets (Notes 3 and 12) 8,196 4,925 19,227 15,883 Total assets $ 508,025 $ 478,127 3

6 Consolidated Statements of Financial Position (Continued) September 30, 2017 and 2016 Liabilities and Net Assets Current liabilities: Accounts payable $ 23,360 $ 18,044 Accrued liabilities 39,454 40,780 Note payable 11,900 - Current portion of long-term debt (Note 4) 5,445 5,008 Estimated third-party payor settlements (Note 6) 18,314 17,638 Total current liabilities 98,473 81,470 Long-term debt, excluding current portion (Note 4) 179, ,717 Professional liability, excluding current portion (Note 12) 33,339 28,167 Fair value of interest rate swaps (Notes 3 and 4) 15,218 22,174 Asset retirement obligation (Note 12) 1,933 1,815 Other long-term liabilities 754 1,004 Total liabilities 329, ,347 Commitments and Contingencies (Note 12) Net assets: Unrestricted 156, ,663 Temporarily restricted (Notes 1 and 5) 4,169 4,317 Permanently restricted (Notes 1 and 5) 17,800 17,800 Total net assets 178, ,780 Total liabilities and net assets $ 508,025 $ 478,127 See notes to consolidated financial statements. 4

7 . Consolidated Statements of Operations and Other Changes in Unrestricted Net Assets Years Ended September 30, 2017 and Revenue: Patient service revenue, net of contractual allowances and discounts (Notes 1 and 6) $ 271,780 $ 276,297 Provision for uncollectible accounts (Note 6) (15,299) (13,942) Public aid assessment tax revenues (Note 6) 23,317 23,314 Total net patient service revenue 279, ,669 Capitation revenue 16,678 3,777 Other revenue 20,052 22,791 Interest and dividend income 3,072 3,483 Net assets released from restrictions, operations (Note 5) Total revenue 320, ,658 Expenses: Salaries and wages 142, ,829 Employee benefits (Notes 1 and 8) 25,388 23,419 Professional fees 14,828 16,027 Medical fees 7,366 - Supplies 47,764 47,166 Utilities 4,226 4,247 Repairs and maintenance 4,412 4,867 Depreciation 17,306 17,857 Insurance 4,342 5,008 Interest and financing costs (Note 4) 6,510 8,522 Public aid assessment tax (Note 6) 14,496 12,855 Other 27,751 29,938 Total expenses (Note 10) 317, ,735 Income from operations 3,395 8,923 Nonoperating income (expense): Change in beneficial interest in investment pool (Note 2): Realized gains (losses) on investments, net 3,282 (4,532) Unrealized net gains 11,748 12,628 Alternative investment gain, including realized gains of $279 in 2017 and $1,474 in ,363 8,583 Change in fair value of swaps, net (Note 4) 6,956 (3,878) Contribution to pension plan (3,000) - Other nonoperating (expense) income (1,682) (651) Unrestricted contributions ,853 4,096 Excess of revenue over expenses before extinguishment of debt 21,248 13,019 Extinguishment of debt - loss on advance refunding (16,562) - Excess of revenue over expenses 4,686 13,019 Other changes in unrestricted net assets: Transfers from temporarily restricted net assets Net assets released from restriction, capital Net assets transferred to Covenant Ministries of Benevolence (Note 8) (660) (3,000) Other 5 24 Increase in unrestricted net assets $ 4,319 $ 10,771 See notes to consolidated financial statements. 5

8 Consolidated Statements of Changes in Total Net Assets Years Ended September 30, 2017 and Unrestricted net assets: Excess of revenue over expenses $ 4,686 $ 13,019 Transfers from temporarily restricted net assets Net assets released from restriction, capital Net assets transferred to Covenant Ministries of Benevolence (660) (3,000) Other 5 24 Increase in unrestricted net assets 4,319 10,771 Temporarily restricted net assets: Contributions and pledges 815 1,511 Transfers to unrestricted net assets - (698) Transfer from permanently restricted net assets Net assets released from restrictions (Note 5) (1,198) (968) Changes in fair value of temporarily restricted net assets Other - (15) (Decrease) increase in temporarily restricted net assets (148) 381 Permanently restricted net assets: Unrealized and realized gain on investments, net Transfer to temporarily restricted net assets - (493) Decrease in permanently restricted net assets - (324) Increase in net assets 4,171 10,828 Net assets: Beginning of year 174, ,952 End of year $ 178,951 $ 174,780 See notes to consolidated financial statements. 6

9 Consolidated Statements of Cash Flows Years Ended September 30, 2017 and Cash flows from operating activities: Change in net assets $ 4,171 $ 10,828 Adjustments to reconcile change in net assets to net cash provided by operating activities: Depreciation expense 17,306 17,857 Provision for uncollectible accounts 15,299 13,942 Net unrealized gains on investments (10,864) (6,333) Change in fair value of swaps, net (6,956) 3,878 Loss on extinguishment of debt 16,562 - Net gain on disposal of fixed assets (329) - Restricted endowment fund gain - (169) Net assets transferred to Covenant Ministries of Benevolence 660 3,000 Changes in assets and liabilities: Patient accounts receivable (23,773) (24,423) Inventories (503) (501) Other assets and liabilities (255) (908) Accounts payable 2,716 2,156 Accrued liabilities (1,326) 3,259 Estimated amounts due from/to third-party payors, net 3,204 (734) Net cash provided by operating activities 15,912 21,852 Cash flows from investing activities: Capital project expenditures (19,543) (10,667) Purchases of investments (77,530) (32,315) Sales of investments 84,359 24,374 Change in collateral posted under interest rate swaps 440 (4,940) Net activity from beneficial interest in pooled investments (5,743) 3,008 Net activity from trustee-held bond project fund investments (2,758) (4,108) Net change in other assets - 29 Net cash used in investing activities (20,775) (24,619) Cash flows from financing activities: Payments and funding of long-term debt (4,771) (4,807) Issuance of bonds - Series 2016A, 2016B and 2016C (155,003) - Refunding/repayment of bonds - Series 2008A, 2010A and 2010C 156,925 - Issuance of note payable 11,900 - Cash paid for net assets transferred to Covenant Ministries of Benevolence (660) (3,000) Net cash provided by (used in) financing activities 8,391 (7,807) Net increase (decrease) in cash and cash equivalents 3,528 (10,574) Cash and cash equivalents: Beginning of year 2,122 12,696 End of year $ 5,650 $ 2,122 Supplemental schedule of noncash investing and financing activities: Purchases of property and equipment in accrued liabilities $ 2,600 $ 2,945 See notes to consolidated financial statements. 7

10 Note 1. Nature of Organization and Significant Accounting Policies Organization and nature of business: Swedish Covenant Hospital, a not-for-profit corporation, and subsidiaries (the Hospital) are a part of Covenant Ministries of Benevolence, which includes EMC Health, Inc., Life Center on the Green, Inc., and all Covenant Retirement Communities and extended care facilities. These institutions operate under the direction of the Board of Benevolence of The Evangelical Covenant Church (ECC). Covenant Ministries of Benevolence is the sole corporate member of the Hospital. The Hospital provides health care services to the residents of the Northwest Chicago area. The Hospital purchased Managed Health Care Associates, Ltd. (MHCA) on January 1, 2017, for cash of $618 and changed the name of that corporation to Swedish Covenant Physician Partners, Ltd. On February 15, 2017, St. Francis Health Care, Ltd. (which was previously owned by Swedish Covenant Management Services, Inc.) was merged into Swedish Covenant Physician Partners, Ltd. Prior to January 1, 2017, the Hospital owned 50% of Swedish Covenant Managed Care Alliance, Inc. (SCMCA), its physician hospital organization (PHO), and MHCA owned the other 50% of the PHO. In connection with the purchase of MHCA, the Hospital acquired the remaining 50% of SCMCA. Effective September 25, 2017, SCMCA was dissolved after the managed care contracts had been assigned to Swedish Covenant Physician Partners, Ltd. The Hospital owns seven Class C units of CyberKnife Cancer Institute of Chicago, LLC (CKCI) and sixteen Class C units of CK Property Development, LCC (CKP). CKCI was formed to provide costefficient, highly specialized cancer care to patients residing in the Chicagoland area. CKP is a supporting real estate joint venture for CKCI. Additionally, the Hospital entered into a CK Program Lease and Services agreement. All activities for CKCI and CKP commenced operations in fiscal year The Hospital s investments in CKCI and CKP are accounted for using the equity method. The Hospital owns one Class B share of Upper Midwest Consolidated Services Center, LLC (UMCSC) for the purposes of pooling the Hospital s supply purchases with VHA Sponsored Patrons. This one share represents less than 5% of the total shares outstanding. The Hospital s investment in UMCSC is accounted for under the cost method. The Hospital made an initial investment of $30 in Accountable Care Chicago, LLC (ACC), to serve as an Accountable Care Entity (ACE) in accordance with the criteria set forth in the Illinois Department of Healthcare and Family Services (IDHFS) Solicitation for Accountable Care Entities. ACC was formed to develop a collaborative provider network that will be capable of providing the full range of health care services required by IDHFS across the care continuum, including having sufficient data analytics and a health information technology infrastructure to facilitate the coordination of care for the population and communities served. The Hospital s investment in ACC is accounted for using the equity method. Income from ACC totaled $311 and $2,119 in fiscal year 2017 and 2016, respectively, and is reported in other revenue in the consolidated statements of operations and other changes in unrestricted net assets. On July 15, 2015, Molina Healthcare of Illinois, Inc. entered into an asset purchase agreement with ACC (d/b/a MyCare Chicago) to acquire certain assets of the Medicaid business of ACC. ACC is in the process of liquidating. The Hospital s investments in UMCSC, CKCI, CKP, and PHO (in 2016) totaled $141 and $2,216 at September 30, 2017 and 2016, respectively, and are reported in other long-term assets in the consolidated statements of financial position. 8

11 Note 1. Nature of Organization and Significant Accounting Policies (Continued) During fiscal year 2015, the Hospital acquired several physician practices for cash of $197 in order to meet the primary service area s community needs for access to health care. Independent appraisals were obtained prior to negotiating the terms of the acquisition price. The excess of acquisition costs over the fair value of net assets acquired has been recorded as goodwill. At September 30, 2017 and 2016, the amount of goodwill recorded is $750. In addition to goodwill, at September 30, 2017 and 2016, the amount of intangible assets with finite lives is $74 and $0, respectively, net of accumulated amortization of $1,826 in both years. Intangible assets with finite lives are amortized over their useful lives, which is three years. The accompanying consolidated financial statements include Swedish Covenant Hospital (SCH) and its subsidiaries: Swedish Covenant Management Services, Inc. (SCMS) d/b/a Swedish Covenant Medical Group, a taxable not-for-profit corporation; Swedish Covenant Faculty Practice Group, a not-for-profit corporation; Swedish Covenant Hospital Foundation (the Foundation), a not-for-profit corporation; SC Insurance Company (SCIC), a not-for-profit captive insurance company; and Swedish Covenant Physician Partners, Ltd., a for-profit corporation. All significant intercompany accounts and transactions have been eliminated in consolidation. During fiscal year 2017, the Hospital changed its reporting of certain investment returns in the consolidated statements of operations and other changes in unrestricted net assets. Unrestricted interest and dividend income earned on the Hospital s investment portfolio was previously reported as nonoperating income. Because certain investment returns are used to directly support the Hospital's operations and further its mission, management believes it is more appropriate to report these amounts as a component of operating revenue. The comparative September 30, 2016 consolidated statement of operations and other changes in unrestricted net assets has been revised to apply this new classification retrospectively. Significant accounting policies are as follows: Use of estimates: Management has made estimates and assumptions that affect the reported amounts of certain assets, liabilities, revenue, and expenses. Actual results could differ from those estimates. The use of estimates and assumptions in the preparation of the accompanying consolidated financial statements is primarily related to the determination of the net patient accounts receivable, settlements with third-party payors, and the accrual for professional liability. Due to uncertainties inherent in the estimation and assumption process, it is at least reasonably possible that changes in these estimates and assumptions in the near-term could be material to the consolidated financial statements. Income taxes: The Hospital is a not-for-profit organization under the laws of Illinois. The Internal Revenue Service has determined that the Hospital is a not-for-profit organization described in Section 501(c)(3) of the Internal Revenue Code (the Code) and is exempt from federal income taxes on related income pursuant to Section 501(a) of the Code. Accordingly, the Hospital has not provided for income taxes in the accompanying consolidated financial statements. 9

12 Note 1. Nature of Organization and Significant Accounting Policies (Continued) For SCMS, deferred taxes are provided on a liability method, whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion of all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. SCMS had approximately $118,477 and $91,962 at September 30, 2017 and 2016, respectively, of net operating loss carryforwards; $0 and $1,033 expired in fiscal years 2017 and 2016, respectively. SCMS has recorded a full valuation allowance against the related deferred tax asset due to the uncertainty associated with its realizability. The Hospital and its not-for-profit subsidiaries each files Form 990 (Return of Organization Exempt from Income Tax), and the for-profit subsidiary files Form 1120 (U.S. Corporation Income Tax Return) annually. When these returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would ultimately be sustained. Examples of tax positions common to health systems include such matters as the tax-exempt status of each entity, the continued tax-exempt status of bonds, the nature, characterization and taxability of joint venture income and various positions relative to potential sources of unrelated business income (UBI). UBI is reported on Internal Revenue Service Form 990-T, as appropriate. The benefit of a tax position is recognized in the consolidated financial statements in the period during which, based on all available evidence, management believes that it is more likely than not that the tax position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions are not offset or aggregated with other positions. Tax positions that meet the more likely than not recognition threshold are measured as the largest amount of tax benefit that is more than 50% likely to be realized on settlement with the applicable taxing authority. The portion of the benefits reflected as a liability for unrecognized tax benefits in the consolidated statements of financial position includes any associated interest and penalties that would be payable to the taxing authorities upon examination. At September 30, 2017 and 2016, there were no unrecognized tax benefits identified or recorded as liabilities. The Forms 990, Forms 990-T and Forms 1120 filed by the Hospital are subject to examination for up to three years from the extended due date of each return. These returns are no longer subject to examination for tax years ended before September 30, Basis of presentation: The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). Excess of revenue over expenses: The consolidated statements of operations and other changes in unrestricted net assets report the excess of revenue over expenses for the Hospital. Changes in unrestricted net assets that are excluded from excess of revenue over expenses include net assets released from restrictions for capital purposes and net assets transferred to related organizations. Income from operations: The consolidated statements of operations and other changes in unrestricted net assets report income from operations. Activities directly related to meeting the Hospital s mission are considered operating activities. Other activities that result in gains and losses that are peripheral to the Hospital s mission are considered nonoperating. Nonoperating items include realized and unrealized gains and losses on the Hospital s investment portfolio, including all alternative investment returns, changes in the fair value of interest rate swaps, contributions to the ECC pension plan, and unrestricted contributions. 10

13 Note 1. Nature of Organization and Significant Accounting Policies (Continued) Cash and cash equivalents: Cash and cash equivalents consist principally of undesignated and unrestricted cash accounts, money market demand deposits, and commercial paper with maturities at date of purchase of three months or less. Assets whose use is limited: Certain board-designated assets are invested in a combined investment fund that aggregates investments of all Covenant Ministries of Benevolence institutions. While these funds are held and invested by Covenant Ministries of Benevolence, the Hospital retains the benefits of ownership of its proportional interest in the combined investment fund. Ownership interests in the combined investment fund are reported as beneficial interest in investment pool in the accompanying financial statements. Trustee-held funds are invested in qualified investments in accordance with the respective bond or loan agreements. Assets whose use is limited are classified as trading securities and are carried at fair value. See Note 3 for descriptions of the methods of determining fair value. Assets whose use is limited in the amount of $12,220 and $9,902 are classified as current assets as of September 30, 2017 and 2016, respectively, which includes project funds to be used to renovate the Hospital s emergency department and collateral postings under interest rate swap agreements. Realized gains and losses from sales of investments and unrealized gains and losses on investments are determined using the average cost method. Interest and dividends are reported as a component of operating revenue. Realized and unrealized gains and losses are reported as nonoperating income (loss). Inventories: Inventories are stated at the lower of cost or net realizable value. Property and equipment: Property and equipment are recorded at cost and are depreciated on the straight-line method over the estimated useful lives of the assets. Estimated useful lives of the assets are: Land improvements Buildings and building equipment Fixed and movable equipment 5-20 years years 3-20 years The Hospital continually evaluates whether circumstances have occurred that would indicate the remaining estimated useful lives of long-lived assets may warrant revision or that the remaining balance of such assets may not be recoverable. No such impairments were identified in fiscal years 2017 and Deferred debt issuance costs and debt premiums and discount: All costs relating to the procurement of debt, including underwriting fees, have been deferred and are amortized over the maturities of the bonds. Original debt premiums and discounts are amortized over the maturities of the related bonds. Temporarily restricted net assets: Temporarily restricted net assets are those whose use has been limited by donors to a specific time period or purpose. 11

14 Note 1. Nature of Organization and Significant Accounting Policies (Continued) Permanently restricted net assets: Permanently restricted net assets are those whose use is limited by donor stipulations that neither expire by the passage of time, nor can be fulfilled or otherwise removed. Investment income generated from permanently restricted assets, however, can be used to support Hospital-sponsored activities. Losses on investments that reduce permanently restricted net assets below their original donor gift fair value reduce unrestricted net assets by means of a transfer from unrestricted net assets to permanently restricted net assets. Subsequent investment gains that restore the fair value of the investments to the original donor gift fair value increase unrestricted net assets by means of a transfer from permanently restricted net assets. Net patient service revenue: Net patient service revenue is reported at the estimated net realizable amounts from patients, third-party payors, and others for services rendered, including estimated retroactive adjustments under certain 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. Total net patient service revenue also includes public aid assessment tax revenues (see Note 6). Capitation revenue: The Hospital has contracts with certain third-party payors under which it receives monthly capitation payments in exchange for providing designated services to enrolled participants. These per member per month payments are fixed, regardless of the extent of designated services provided to the enrolled participants. Capitation payments are recognized as revenue monthly, as the designated services are eligible to be provided. Other operating revenue: Other operating revenue includes revenue from the Hospital s parking garage, cafeteria and outpatient pharmacies, rental revenue from physician offices, and other patient-related revenue. Such revenue is recognized when services are provided. Contributions: Unrestricted contributions are included in contributions at the date of the gift. Restricted contributions received with donor stipulations that limit the use of the donated assets are reported as either temporarily or permanently restricted. Charity care: The Hospital provides care to patients who meet certain criteria under its charity care policy, in compliance with state law, without charge or at amounts less than its established rates. Accordingly, normal charges for these services are not recorded as revenue. See Note 7 for the estimated costs of the charity care. Medical fees expense: Medical fees expense represents amounts incurred, including a provision for incurred but not reported claims, by the Hospital for care provided by unaffiliated health care providers to patients covered under the Hospital s capitation arrangements with certain third-party payors. 12

15 Note 1. Nature of Organization and Significant Accounting Policies (Continued) Self-insured employee health care costs: The Hospital self-insures a significant portion of its employee health care costs, and limits its exposure through purchased stop-loss coverage. The Hospital accrues estimated incurred but not paid employee health costs based on analysis of historical payment lag patterns for such claims. The Hospital has implemented an Employer Provider Option (EPO) in which employees may elect coverage where a majority of their health care is provided by the Hospital and a network of Hospital-affiliated providers. Under the EPO, the third-party administrator (an insurance company) pays claims for services provided by the Hospital to the Hospital s employees at rates that approximate rates paid by the third-party administrator to other Chicago-area hospitals. The Hospital records patient service revenue for such services at the amount paid by the third-party administrator, with an equal amount recorded as employee benefits expense. For the years ended September 30, 2017 and 2016, the patient service revenue recognized for services provided by the Hospital to its employees approximated $6,891 and $5,589, respectively. Derivative financial instruments: The Hospital has entered into interest rate swap agreements in order to reduce the Hospital s exposure to variations in interest rates related to the Hospital s floating rate for long-term borrowings (see Note 4). Hedge accounting is not applied. The swap agreements are recorded in the consolidated statements of financial position at their fair values and changes in the fair values of the swap agreements are recorded in nonoperating income (expense). If debt is extinguished prior to its contractual maturity, the Hospital may conclude to either terminate the interest rate swap agreement or, if deemed economically disadvantageous to terminate, continue to operate under the agreement despite the extinguishment of the related debt. Newly adopted accounting pronouncement: In April 2015, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) , Interest Imputation of Interest (Subtopic ): Simplifying the Presentation of Debt Issuance Costs. This ASU requires that debt issuance costs related to a recognized debt liability be presented in the statement of financial position as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The Hospital adopted the provisions of ASU , which require retrospective application, in the accompanying consolidated financial statements. Accordingly, the September 30, 2016, consolidated statement of financial position has been restated to reclassify $2,259 of net deferred financing costs previously reported as other assets, as a reduction of long-term debt. Recent accounting pronouncements: In May 2014, the FASB issued ASU , Revenue from Contracts with Customers (Topic 606), requiring an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The updated standard will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective and permits the use of either a full retrospective or retrospective with cumulative effect transition method. The updated standard will be effective for the Hospital s fiscal year 2019 consolidated financial statements. The Hospital has not yet selected a transition method and is currently evaluating the effect that the updated standard will have on the consolidated financial statements. 13

16 Note 1. Nature of Organization and Significant Accounting Policies (Continued) In February 2016, the FASB issued ASU , Leases (Topic 842), which supersedes the leasing guidance in Topic 840, Leases. Under the new guidance, lessees are required to recognize lease assets and lease liabilities on the statement of financial position for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the statement of operations. The new standard will be effective for the Hospital s fiscal year 2020 consolidated financial statements. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Hospital is currently evaluating the effect of the new standard on the consolidated financial statements. In August 2016, the FASB issued ASU , Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities. Key elements of the ASU include a reduction in the number of net asset categories from three to two, conforming requirements on releases of capital restrictions, several new requirements related to expense presentation and disclosure (including investment expenses), and new required disclosures communicating information useful in assessing liquidity. The ASU will be effective for the Hospital s fiscal year 2019 consolidated financial statements. Early adoption is permitted. Retrospective application is required for many provisions of this guidance. The Hospital is currently evaluating the effect of the new standard on the consolidated financial statements. In August 2016, the FASB issued ASU , Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. ASU provides guidance on how certain cash receipts and cash payments should be presented and classified in the statement of cash flows with the objective of reducing existing diversity in practice with respect to these items. The new standard will be effective for the Hospital s fiscal year 2020 consolidated financial statements. Early adoption is permitted. ASU requires a retrospective transition method. However, if it is impracticable to apply the amendments retrospectively for some of the issues, the amendments for those issues would be applied prospectively as of the earliest date practicable. The Hospital is currently evaluating the effect the new standard on the consolidated financial statements. In November 2016, the FASB issued ASU , Statement of Cash Flows (Topic 230): Restricted Cash, which provides guidance on the presentation of restricted cash or restricted cash equivalents in the statement of cash flows. ASU will be effective for the Hospital s fiscal year 2020 consolidated financial statements. ASU must be applied using a retrospective transition method with early adoption permitted. The Hospital is currently evaluating the effect of the new standard on the consolidated financial statements. In March 2017, the FASB issued ASU , Compensation Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. The amendments in the ASU are intended to improve the presentation of net periodic pension cost and net periodic postretirement benefit cost by reporting the service cost component in the same line item as other compensation costs while the other components are presented separately from the service cost component and outside a subtotal of income from operations. ASU will be effective for the Hospital s fiscal year 2020 consolidated financial statements. Early adoption is permitted. The Hospital is currently evaluating the effect of the new standard on the consolidated financial statements. 14

17 Note 1. Nature of Organization and Significant Accounting Policies (Continued) Subsequent events: The Hospital recognizes, in the consolidated financial statements, the effects of all subsequent events that provide additional evidence about conditions that existed at the date of the consolidated statement of financial position, including the estimates inherent in the process of preparing the consolidated financial statements. The Hospital does not recognize subsequent events that provide evidence about conditions that did not exist at the date of the consolidated statement of financial position, but arose after the date of the consolidated statement of financial position, but before the consolidated financial statements are issued. For these purposes, the Hospital has evaluated events occurring subsequent to the date of the consolidated statement of financial position through January 15, 2018, the date the consolidated financial statements were issued. The Hospital has not evaluated events occurring after January 15, 2018, in these consolidated financial statements. Reclassifications: Certain prior-year amounts have been reclassified to conform to the current-year presentation, with no effect on excess of revenue over expenses and net assets. Note 2. Assets Whose Use Is Limited Assets whose use is limited include assets classified in the following seven categories: Board-Designated Funds Assets set aside by the Board of Directors (Board) for debt repayment, benevolent care, capital replacement, and certain future construction and capital projects over which the Board retains control and, which at its discretion, may use subsequently for other purposes. Such funds are not expected to be used in the next year. Debt Service Reserve Funds Assets held by trustees under the terms of the master indenture agreement, set aside to meet the maximum annual interest payments, principal payments, and sinking fund requirements during the term of the bond. The requirement to maintain debt service reserve funds was eliminated in conjunction with the Series 2016 Revenue Bond Issuance (see Note 4). Trustee-Held Bond-Sinking Funds Assets held by bond trustees under the terms of the master indenture agreement for either bond principal or bond interest payments. Trustee-Held Project Funds Bond proceeds held by trustees to be designated for project expenditures. Collateral Posted, Interest Rate Swap Agreements Assets held by banks under the terms of the swap agreements. SCIC Restricted Investments Assets held by SCIC for the Department of Arizona Insurance Regulations of capitalization and for the purposes of paying malpractice liability and general insurance claims. Donor-Restricted Funds Assets restricted by donors to be maintained by the Foundation in perpetuity. 15

18 Note 2. Assets Whose Use Is Limited (Continued) Assets whose use is limited, at fair value, as of September 30, 2017 and 2016, consisted of the following: Board-designated funds: Funded depreciation $ 91,745 $ 85,166 Long-term investment 64,395 56, , ,885 Donor-restricted funds 21,752 19,071 SCIC restricted investments 39,598 37,186 Trustee-held funds, bond-sinking funds 151 2,316 Trustee-held funds, debt service reserve funds - 9,317 Trustee-held funds, project fund 4,670 - Collateral posted, interest rate swap agreements (Note 4) 6,670 7,110 Total 228, ,885 Current portion (12,220) (9,902) Assets whose use is limited, noncurrent $ 216,761 $ 206,983 The Hospital s assets whose use is limited, at fair value, as of September 30, 2017 and 2016, consisted of the following: Interest in Covenant Ministries of Benevolence combined investment fund $ 142,428 $ 129,793 Alternative investment funds: Hedge funds 3,261 3,007 Cash and money market accounts 12,241 10,682 Equity securities: Equity mutual funds 38,086 30,767 Fixed income mutual funds 32,965 25,317 Common stock - 1,954 Fixed income securities - 15,365 $ 228,981 $ 216,885 16

19 Note 3. Fair Value Measurements Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value, the Hospital uses various methods including market, income and cost approaches. Based on these approaches, the Hospital often utilizes certain assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and or the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable inputs. The Hospital utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Based on the observability of the inputs used in the valuation techniques, the Hospital is required to provide the following information according to the fair value hierarchy. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values. Financial assets and liabilities carried at fair value will be classified and disclosed in one of the following three categories: The hierarchy is measured in three levels based on the reliability of inputs: Level 1: Valuations are based on quoted prices in active markets for identical assets or liabilities that the Hospital has the ability to access. Valuation adjustments and block discounts are not applied to Level 1 instruments. Level 2: Valuations are not based on quoted prices for identical assets or liabilities, but rather are based on significant observable inputs (including quoted prices for similar securities, interest rates, prepayment speeds, credit risk, etc.). Fair values are primarily obtained from third-party pricing services for comparable assets or liabilities. Level 3: Valuations are derived from other valuation methodologies and incorporate certain assumptions and projections that are not observable in the market and require significant professional judgment in determining the fair value assigned to such assets or liabilities. Management s estimates of the fair values of the alternative investments in hedge funds, limited partnerships, and private equity funds are based on net asset value information provided by the fund managers or general partners, which in turn, is based on the most recent information available to the fund manager for the underlying investments. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls, is based on the lowest level input that is significant to the fair value measurement in its entirety. 17

20 Note 3. Fair Value Measurements (Continued) Investment Securities The Hospital invests in a pooled fund (combined investment fund, or CIF) maintained by Covenant Ministries of Benevolence (CMB). The CMB pooled fund is comprised of various types of investments including: mutual funds, equity and debt securities, and alternative investments. The Hospital owns an interest in CMB s pooled fund; the Hospital does not own or have any interest in the underlying investments. As an investor in the pooled fund, the Hospital has the ability to withdraw up to $105,000 from its account with 30 days notice or less. Additionally, 90 days notice may be required for the Hospital to withdraw in excess of $105,000, up to the full balance, from its account. As a practical expedient, the fair value of the Hospital s interest in the CMB pooled fund is estimated based on the net asset value of the CIF reported by CMB. The Hospital reports investments in equity securities with readily determinable fair values and all investments in debt securities at fair value. Fair value of equity securities is determined primarily on the basis of quoted market prices in active markets. The Hospital s shares in mutual funds are stated at fair value based on quoted market prices, which represents the net asset value of shares held by the Hospital at year-end. The fair value of investments in fixed income securities, which primarily includes investments in corporate and other bonds, is primarily determined using techniques that are consistent with the market approach. Alternative Investments The fair value of alternative investments is $3,261 and $3,007 at September 30, 2017 and 2016, respectively. As of September 30, 2017 and 2016, these investments were invested in a fund of hedge funds with quarterly liquidity requiring one day notice for redemption. As a practical expedient, alternative investments with no market activity are valued using the net asset values reported by the investment funds, which in turn are based on the most recent information available to the fund manager for the underlying investments. Significant observable inputs include benchmark yields, reported trades, observable broker/dealer quotes, and issuer spreads. Investments in alternative investment funds consist of domestic equity, international equity, hedge funds, private equity, international real estate, puts and calls, and mortgages. In the case of large cap equity, small cap equity, international equity and hedge funds, the holdings are in offshore corporations that are valued monthly. The underlying fund holdings are primarily exchange traded, readily marketable securities both equities and bonds. A small percentage of holdings are in private investments and derivatives. All hedged equity, international hedged equity and absolute return funds have pricing policies that depend on outside pricing services to validate their pricing. Interest in Irrevocable Trusts Interest in irrevocable trusts is recorded as the Hospital s percentage of the fair value of the trusts net assets. Interest Rate Swaps The fair value of the interest rate swap agreements was determined using an industry standard valuation model, which is based on a market approach. The determination of fair value includes the consideration of any credit valuation adjustments necessary, giving consideration to the creditworthiness of the respective counterparties or the Hospital, as appropriate. 18

21 Note 3. Fair Value Measurements (Continued) Fair value of financial instruments carried at fair value: Categories of assets and liabilities measured at fair value on a recurring basis during the year ended September 30, 2017, using unadjusted quoted prices in active markets for identical assets (Level 1); significant other observable inputs (Level 2); and significant unobservable inputs (Level 3), are as follows: Fair Value as of September 30, 2017 Quoted Prices in Significant Investments Active Other Significant Valued Identical Observable Unobservable Using the Assets Inputs Inputs Practical Description Total (Level 1) (Level 2) (Level 3) Expedient Interest in CMB combined investment fund $ 142,428 $ - $ - $ - $ 142,428 Alternative investment funds: Hedge funds 3, ,261 Equities securities: Mutual funds: Domestic small cap 8,758 8, Domestic mid cap 6,678 6, Domestic large cap 13,314 13, International real estate 1,261 1, International small cap International large cap 7,412 7, Domestic bond 31,046 31, International bond 1,919 1, ,740 $ 71,051 $ - $ - $ 145,689 Cash and money market accounts 12,241 Total $ 228,981 Interest in irrevocable trusts $ 881 $ - $ - $ 881 $ - Derivatives - interest rate swaps (Note 4) $ (15,218) $ - $ (15,218) $ - $ - 19

22 Note 3. Fair Value Measurements (Continued) Categories of assets and liabilities measured at fair value on a recurring basis during the year ended September 30, 2016, are as follows: Fair Value as of September 30, 2016 Quoted Prices in Significant Investments Active Other Significant Valued Identical Observable Unobservable Using the Assets Inputs Inputs Practical Description Total (Level 1) (Level 2) (Level 3) Expedient Interest in CMB combined investment fund $ 129,793 $ - $ - $ - $ 129,793 Alternative investment funds: Hedge funds 3, ,007 Equities securities: Mutual funds: Domestic small cap 2,088 2, Domestic mid cap 3,958 3, Domestic large cap 9,531 9, Domestic real estate 2,342 2, International large cap 12,848 12, Domestic bond 19,691 19, International bond 5,626 5, Common stock: Energy 1,954 1, Fixed income securities: U.S. government obligations 2,042 1, Municipal bonds Federal agency mortgage-backed securities 1,949 1, Collateralized mortgage obligations and asset-backed securities 1, , Corporate and other obligations 9,521 5,469 4, ,203 $ 66,836 $ 6,567 $ - $ 132,800 Cash and money market accounts 10,682 Total $ 216,885 Interest in irrevocable trusts $ 840 $ - $ - $ 840 $ - Derivatives - interest rate swaps (Note 4) $ (22,174) $ - $ (22,174) $ - $ - 20

23 Note 3. Fair Value Measurements (Continued) A reconciliation of the beginning and ending balances for the assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the years ended September 30, 2017 and 2016, is as follows: Interest in Irrevocable Trusts Balance, October 1, 2015 $ 782 Unrealized gains 58 Balance, September 30, Unrealized gains 41 Balance, September 30, 2017 $ 881 For the years ended September 30, 2017 and 2016, the application of valuation techniques applied to similar assets has been consistent. The Hospital assesses levels of the investments at each measurement date, and transfers between levels are recognized on the actual date of the event or change in circumstances that caused the transfer. The Hospital invests a significant amount of funds in the CIF. In the event that CMB does not fulfill its obligations, the Hospital may be exposed to risk. The risk of default depends on the creditworthiness of the counterparty to those transactions. CMB attempts to minimize credit risk by monitoring the creditworthiness of counterparties. 21