AUDITED CONSOLIDATED FINANCIAL STATEMENTS ARNOT HEALTH, INC.

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1 AUDITED CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2017

2 CONTENTS Page Independent Auditor's Report... 1 Consolidated Financial Statements: Consolidated Balance Sheets... 2 Consolidated Statements of Operations... 3 Consolidated Statements of Changes in Net Assets... 4 Consolidated Statements of Cash Flows... 5 Notes to the Consolidated Financial Statements Supplementary Schedules: Schedules of Expenditure of Federal Awards Notes to Schedule of Expenditure of Federal Awards Independent Auditor s Report on Internal Control Over Financial Reporting and on Compliance and Other Matters Based on an Audit of the Financial Statements Performed in Accordance with Government Auditing Standards Independent Auditor s Report on Compliance For Each Major Federal Program, Report on Internal Control Over Compliance and Report on Schedule of Expenditures of Federal Rewards as Required by the Uniform Guidance Schedule of Findings and Questioned Costs... 34

3 INDEPENDENT AUDITOR S REPORT To the Board of Directors Arnot Health, Inc. Elmira, New York Report on the Financial Statements We have audited the accompanying consolidated financial statements of Arnot Health, Inc. and its subsidiaries ( the Organization ) which comprise the consolidated balance sheets as of December 31, 2017 and 2016, and the related consolidated statements of operations, changes in net assets and cash flows for the years then ended, and the related notes to the consolidated financial statements. Management s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditor s Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards issued by the Comptroller General of the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor s judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the 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 consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Arnot Health, Inc. and its subsidiaries as of December 31, 2017 and 2016 and the results of its operations and its cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America. Other Reporting Required by Government Auditing Standards In accordance with Government Auditing Standards, we have also issued our report dated August 9, 2018 on our consideration of Arnot Health, Inc.'s internal control over financial reporting and on our tests of its compliance with certain provisions of laws, regulations, contracts, and grant agreements and other matters. The purpose of that report is to describe the scope of our testing of internal control over financial reporting and compliance and the results of that testing, and not to provide an opinion on internal control over financial reporting or on compliance. That report is an integral part of an audit performed in accordance with Government Auditing Standards in considering Arnot Health, Inc.'s internal control over financial reporting and compliance. Buffalo, New York August 9,

4 CONSOLIDATED BALANCE SHEETS December 31, ASSETS Current assets: Cash and cash equivalents $ 12,928,628 $ 8,028,801 Current portion of investments 5,000,000 6,351,357 Accounts receivable, net of allowance for doubtful accounts of approximately $9,667,000 ($12,366, ) 36,522,002 41,354,182 Notes and other receivables 898, ,704 Inventories 2,112,573 2,113,951 Current portion of assets limited as to use 2,585,878 2,708,793 Current portion of estimated amounts due from third-party payors, net - 778,210 Prepaid expenses and other current assets 1,750,771 2,066,054 Total current assets 61,798,469 64,246,052 Investments 49,049,877 49,719,043 Assets limited as to use 33,565,368 28,448,036 Property, plant and equipment, net 132,661, ,723,377 Other noncurrent assets 1,249,386 1,768,410 Interest in net assets of charitable trusts 2,372,876 2,503,488 Total assets $ 280,697,961 $ 283,408,406 LIABILITIES AND NET ASSETS Current liabilities: Accounts payable and accrued liabilities $ 26,571,279 $ 27,039,886 Current portion of long-term debt 1,547,031 1,948,139 Current portion of capital lease obligations 526, ,295 Current portion of estimated amounts due to third-party payors, net 826, ,351 Total current liabilities 29,471,390 30,144,671 Long-term debt 28,617,422 30,148,225 Capital lease obligations 862,641 1,003,647 Estimated amounts due to third-party payors, net 5,079,036 4,439,250 Self-insurance reserves 14,295,595 14,651,939 Accrued pension liability 16,299,150 16,003,338 Other long-term liabilities 7,933,051 6,698,620 Total liabilities 102,558, ,089,690 Net assets: Unrestricted 164,727, ,144,662 Temporarily restricted 10,372,367 13,138,587 Permanently restricted 3,039,502 3,035,467 Total net assets 178,139, ,318,716 Total liabilities and net assets $ 280,697,961 $ 283,408,406 See accompanying notes. 2

5 CONSOLIDATED STATEMENTS OF OPERATIONS For the Years Ended December 31, Unrestricted operating revenues, gains and other support: Net patient service revenue $ 371,449,771 $ 362,628,171 Provision for bad debts (19,053,969) (18,775,932) Net patient service revenue less provision for bad debts 352,395, ,852,239 Other operating revenue 12,394,777 13,993,454 Net assets released from restrictions 558,738 1,136,969 Total unrestricted operating revenues, gains and other support 365,349, ,982,662 Operating expenses: Salary and wages 187,220, ,273,185 Fringe benefits 56,428,763 53,406,590 Drugs and supplies 57,203,664 52,557,458 Purchased services and professional fees 47,105,164 48,016,165 Depreciation 16,070,166 15,735,898 Interest expense 1,069,882 1,136,629 Other expenses 14,062,046 14,453,734 Total operating expenses 379,160, ,579,659 Loss from operations (13,811,197) (11,596,997) Other income: Investment income 4,041,453 5,071,182 Net gain on sale of business and related property 63,115 26,736 Grant and other revenue, net 74, ,197 Deficiency of unrestricted revenues, gains and other support over expenses $ (9,632,209) $ (6,139,882) See accompanying notes. 3

6 CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS For the Years Ended December 31, Unrestricted net assets: Deficiency of unrestricted revenues, gains and other support over expenses $ (9,632,209) $ (6,139,882) Net unrealized gain (loss) on investments 6,151,479 (465,234) Change in funded status of pension plans (366,861) 3,756,772 Contributions for capital acquisitions 4,273,017 1,045,332 Reclassification of net assets 29,144 - Change in charitable remainder trusts 128,575 (192,089) Increase (decrease) in unrestricted net assets 583,145 (1,995,101) Temporarily restricted net assets: Net investment loss (292,950) (39,866) Net realized gains on investments 135,808 72,973 Net unrealized gain on investments 387,518 76,430 Net assets released from restriction to support operations (558,738) (1,136,969) Contributions 1,188,728 2,015,560 Change in charitable remainder trusts (259,199) 228,403 Net assets released from restrictions for purchase of property and equipment (3,367,387) - (Decrease) increase in temporarily restricted net assets (2,766,220) 1,216,531 Permanently restricted net assets: Contributions 4,035 7,201 Increase in permanently restricted net assets 4,035 7,201 Decrease in net assets (2,179,040) (771,369) Net assets - beginning of year 180,318, ,090,085 Net assets - end of year $ 178,139,676 $ 180,318,716 See accompanying notes. 4

7 CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, Cash flows from operating activities: Change in net assets $ (2,179,040) $ (771,369) Adjustments to reconcile change in net assets to net cash flows provided by operating activities: Depreciation and amortization 16,070,166 15,735,898 Amortization of deferred financing fees 35,024 34,267 (Decrease) increase in provision for doubtful accounts (2,699,000) 2,118,000 Decrease (increase) in minimum pension liability 366,861 (3,756,772) Net unrealized (gains) losses on investments (6,538,997) 388,804 Realized gains on investments (3,231,549) (4,355,012) Gain on sale of property, plant, and equipment (63,115) (26,736) Change in charitable remainder trust interests (130,624) 36,291 Contributions received from financing activities (4,273,017) (1,045,332) (Increase) decrease in assets: Accounts receivable 7,531,180 (4,235,233) Inventories 1,378 (15,926) Prepaid expenses and other current assets 1,210,926 (48,389) Notes and other receivables (53,913) 1,153,467 Increase (decrease) in liabilities: Accounts payable and accrued liabilities (468,607) 3,072,016 Estimated amounts due to third-parties, net 81,874 (2,663,109) Self-insurance reserves (356,344) (1,676,824) Accrued pension liability 295,812 (1,779,893) Other long-term liabilities 1,874, ,551 Net cash and cash equivalents provided by operating activities 7,473,547 2,937,699 Cash flows from investing activities: Purchases of property, plant and equipment (12,075,223) (13,433,793) Proceeds from the sale of property, plant and equipment 15,000 88,311 (Increase) decrease in assets limited as to use (785,767) 289,743 Decrease in other noncurrent assets 114, ,893 Net decrease in investments 7,843,379 16,091,559 Net cash and cash equivalents (used for) provided by investing activities (4,888,380) 3,245,713 Cash flows from financing activities: Repayments on long-term debt and capital lease obligations (1,958,357) (4,071,866) Contributions received for the purchase of property, plant and equipment 4,273,017 1,045,332 Net cash and cash equivalents provided by (used for) financing activities 2,314,660 (3,026,534) Net increase in cash and cash equivalents 4,899,827 3,156,878 Cash and cash equivalents - beginning of year 8,028,801 4,871,923 Cash and cash equivalents - end of year $ 12,928,628 $ 8,028,801 Supplemental disclosure of cash flow information: Capital assets acquired by capital lease $ 570,665 $ 1,463,933 Cash paid during the year for interest $ 1,072,982 $ 1,136,629 See accompanying notes. 5

8 NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization: Arnot Health, Inc. (the Organization or Arnot Health) is an integrated healthcare delivery system providing patient care through community hospitals, specialized services and long-term care facilities in the Southern Tier of New York State and northern Pennsylvania. Arnot Health, Inc. is the parent organization of Arnot Ogden Medical Center and Affiliates, Ira Davenport Memorial Hospital, Inc. and Affiliate and St. Joseph s Hospital, Inc. Included in the accompanying consolidated financial statements of Arnot Health, Inc. are the following: Arnot Ogden Medical Center and Affiliates: Arnot Ogden Medical Center (AOMC): A not-for-profit acute care hospital located in Elmira, New York primarily serving the residents of southern New York and northern Pennsylvania. Included in the activity of AOMC are employees performing services for Chemung Medical Services PC, d/b/a Arnot Medical Services, (AMS). AMS provides multi-specialty physician services consistent with the mission of Arnot Health. Ivy Street Development Corporation (Ivy Street): A wholly-owned for profit subsidiary of AOMC. Ivy Street's principal business activities are the investment in and development of real estate. Arnot Health Foundation (AOMC Foundation): A not-for-profit organization established to raise funds to support AOMC. Arnot Ogden Medical Center Auxiliary (the Auxiliary): An unincorporated association operated as a nonprofit organization for the benefit of, and in connection with, AOMC. Ira Davenport Memorial Hospital, Inc. and Affiliate: Ira Davenport Memorial Hospital (Ira Davenport): A not-for-profit healthcare facility located in Bath, New York. Ira Davenport is licensed to operate 38 acute care beds, a 120-bed long-term care facility known as the Fred and Harriett Taylor Health Center and a 12-slot adult day care program. Keuka Health Care Foundation, Inc. (Keuka): A not-for-profit organization that was formed to solicit contributions on behalf of and solely for the benefit of Ira Davenport. St. Joseph s Hospital, Inc.: St. Joseph s Hospital (SJH): A not-for-profit acute care hospital and skilled nursing facility located in Elmira, New York was founded in 1908 by the Sisters of St. Joseph of Rochester, New York in cooperation with the physicians and citizens of southern New York and northern Pennsylvania to provide medical care for all in need in accordance with the teachings of the Roman Catholic Church. Principles of Consolidation: The accompanying consolidated financial statements include the accounts of the Organization. All material intercompany balances and transactions have been eliminated in the accompanying consolidated financial statements. Use of Estimates: The preparation of the consolidated 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 amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates and the differences in estimates from actual results could be significant. Significant estimates made by the Organization include, but are not limited to reserves for uncollectible accounts and contractual allowances, amounts due to and from third party payors, workers compensation, malpractice, selfinsurance benefit reserves and actuarial assumptions used in determining pension expense. Display of Net Assets by Class: The accompanying consolidated financial statements have been prepared in conformity with the disclosure and display requirements of accounting principles generally accepted in the United States of America (US GAAP). US GAAP requires that resources be classified for reporting purposes into three net asset categories (temporarily restricted, permanently restricted and unrestricted) according to the existence or absence of donor-imposed restrictions. 6

9 NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Cash and Cash Equivalents: The Organization considers all highly liquid investments with a maturity of three months or less to be cash equivalents. Cash equivalents exclude amounts that are classified as assets limited or restricted as to use. Investments and Investment Income: Investments in equity securities with readily determinable fair values and all investments in debt securities are presented in the consolidated financial statements at fair value. Investments include cash and cash equivalents held as part of the managed portfolios of the Organization and are recorded at cost. The cost of specific securities sold is used to compute realized gains and losses on sales. Investment income or loss (including realized gains and losses or investments and interest and dividends) is included in the deficiency of unrestricted revenues, gains and other support over expenses. Unrealized gains and losses on investments are excluded from deficiency of unrestricted revenues, gains and other support over expenses due to their non-trading nature. Fair Value: As defined in US GAAP, 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. Fair value provisions apply to all assets and liabilities that are being measured and reported on a fair value basis. US GAAP requires disclosures that establish a framework for measuring fair value and disclosure about fair value measurements. This enables the reader of the consolidated financial statements to assess the inputs used to develop those measurements by establishing a hierarchy for ranking the quality and reliability of the information used to determine fair values. US GAAP requires that assets and liabilities carried at fair value will be classified and disclosed in one of the following three categories: Level 1: Level 2: Level 3: Quoted market prices in active markets for identical assets or liabilities. Observable market based inputs or unobservable inputs that are corroborated by market data. Unobservable inputs that are not corroborated by market data. Accounts Receivable: The Organization carries its patient and resident accounts receivable at anticipated amounts due from private pay patients and third party payors. Accounts receivable are reduced by an allowance for doubtful accounts. In evaluating the collectability of accounts receivable, the Organization analyzes their past history and identifies trends for each of its major payor sources of revenue to estimate the appropriate allowance for doubtful accounts and provision for bad debts. Management regularly reviews data about these major payor sources of revenue in evaluating the sufficiency of the allowance for doubtful accounts. For receivables associated with services provided to patients who have third-party coverage, the Organization analyzes contractually due amounts and provides an allowance for doubtful accounts, if necessary, for receivables associated with self-pay patients (which includes both patients without insurance and patients with deductible and copayment balances due for which third-party coverage exists for part of the bill). The Organization records a provision for bad debts in the period of service on the basis of its past experience, which indicates that many patients are unable or unwilling to pay the portion of their bill for which they are financially responsible. The difference between the standard rates (or the discounted rates if negotiated) and the amounts actually collected after all reasonable collection efforts have been exhausted is charged off against the allowance for doubtful accounts. The Organization s allowance for doubtful accounts decreased from 13.5% of gross accounts receivable at December 31, 2016 to 10.1% of gross accounts receivable at December 31, In addition, the Organization s bad debt write-offs increased approximately $250,000 from approximately $18,800,000 for fiscal year end 2016 to approximately $19,050,000 for fiscal year end The Organization has not changed its charity care or uninsured discount policies during the fiscal year 2017 and The Organization does not maintain a material allowance for doubtful accounts from third-party payors, nor did it have significant writeoffs from third-party payors. Notes and Other Receivables: Notes and other receivables is made up primarily of amounts due to the Organization related to grant reimbursement and tuition repayment. Inventories: Inventories consist primarily of food, drugs and medical supplies. These inventories are valued at the lower of cost (first-in, first-out) or net realizable value. 7

10 NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Assets Limited as to Use: The Organization s assets limited as to use represent funds designated by the Organization s Board of Directors for funded depreciation as previously required by third-party payors, capital expenditures, self-insurance reserves, deferred compensation 457 plan funds and required amounts under the terms of financing agreements. The current portion of assets limited as to use consists of amounts set aside for the current portion of the workers' compensation liability and the current portion of debt service and accrued interest on Chemung County Industrial Development Agency Civic Facility Revenue Bonds Series A. Property, Plant and Equipment: Property, plant and equipment is carried at cost, except for donated items, which are recorded at fair market value at the date of donation. Cost includes interest incurred on related indebtedness during periods of construction. Routine maintenance and repairs are charged to expense as incurred. The Organization capitalizes assets that have a cost in excess of $1,000 and an estimated useful life of over one year. Depreciation is computed on the straight-line method over the estimated useful lives of the assets, which generally follow American Hospital Association guidelines. Equipment under capital lease obligations is amortized over the shorter of its lease term of the asset or its useful life. Impairment of Long-Lived Assets: Under the provisions of US GAAP the Organization evaluates its long-lived assets for financial impairment as events or changes in circumstances indicate that the carrying amount of such assets may not be fully recoverable. If such evaluations indicate that the future undiscounted cash flows of certain long-lived assets are not sufficient to recover the carrying value of such assets, the assets are adjusted to their fair values. During the years ended December 31, 2017 and 2016, there was no impairment charges for long lived assets. Self-Insurance Reserves: The Organization retains risk of expected losses up to certain retention limits relating to professional and general liability, workers' compensation, and employee health insurance. The provision for estimated self-insured professional claims is recorded based on the Organization's estimates, after consultation with an insurance advisor and preparation of an actuarial calculation of the ultimate costs for both reported claims and claims incurred but not reported. Performance Indicator: The performance indicator is deficiency of unrestricted revenues, gains and other support over expenses, which includes all changes in unrestricted net assets other than changes in unrealized gain or loss on investments of other-than-trading securities (excluding other-than-temporary declines in investments), changes in funded status of pension plans, permanent transfers of assets to and from affiliates for other than goods and services, changes in the net assets of charitable remainder trusts, and contributions of long-lived assets (including assets acquired using contributions which by donor restriction were to be used for the purpose of acquiring such assets). Concentrations of Credit Risk: The Organization grants credit without collateral to its patients, most of whom are local residents and are insured under third-party payor agreements. The mix of receivables from patients and thirdparty payors were as follows as of December 31: Medicare 34% 25% Medicaid Blue Cross Other third-party payors Self pay % 100% In addition, financial instruments that potentially subject the Organization to concentration of credit risk consist principally of cash and cash equivalent accounts in financial institutions. Although the cash accounts exceed the federally insured deposit amount, management does not anticipate nonperformance by the financial institutions. Management reviews the financial viability of these institutions on a periodic basis. 8

11 NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Contributions: Unconditional promises to give cash and other assets are reported at fair value on the date the promise is received. The gifts are reported as either permanently or temporarily restricted if they are received with donor stipulations that limit the use of the donated assets. Permanently restricted net assets are restricted by the donor to be maintained by the Organization in perpetuity. Temporarily restricted net assets are those whose use by the Organization has been limited by donors to a specific time period or purpose. Temporarily restricted assets held by the Organization are restricted for capital related projects, educations and scholarships and general department support. When a donor restriction expires, that is, when a stipulated time restriction ends or a purpose restriction is accomplished, temporarily restricted net assets are reclassified as unrestricted net assets and reported in the statement of operations and changes in net assets as net assets released from restriction. Donor restricted contributions whose restrictions are met within the same year as received are reported as unrestricted contributions in the accompanying consolidated financial statements. Gifts of long-lived assets such as land, buildings, or equipment are reported as unrestricted support unless explicit donor stipulations specify how the donated assets must be used. Gifts of long-lived assets with explicit restrictions that specify how the assets are to be used and gifts of cash or other assets that must be used to acquire longlived assets are reported as temporarily restricted support. Absent explicit donor stipulations about how long these long-lived assets must be maintained, expirations of donor restrictions are reported when the donated or acquired long-lived assets are placed in service. Grant Revenue: The Organization recorded support received under grant contracts as revenue when the related costs of the associated grants are incurred. Grant revenue primarily includes amounts received through the New York State Department of Health. Income Taxes: Arnot Ogden Medical Center, AOMC Foundation, the Auxiliary, Ira Davenport, Keuka and SJH are organized as not-for-profit corporations as described in Section 501(c)(3) of the Internal Revenue Code (the Code) and accordingly, are exempt from Federal income taxes on related income pursuant to Section 501(a) of the Code. Ivy Street is a C-Corporation and files corporate tax returns. The Organization accounts for uncertain tax positions in accordance with US GAAP, which requires the recognition and measurement of uncertain tax positions that the Organization has taken or expects to take in the Organization s tax returns. Management believes there are no significant uncertain tax positions not reflected in the accompanying consolidated financial statements as of December 31, 2017 and Charity Care: The Organization provides care to patients and residents who meet certain criteria under its charity care policy without charge or at amounts less than its established rates. The Organization s policy is not to pursue collection of amounts determined to qualify as charity care; therefore, these amounts are not reported in net operating revenues or in provisions for doubtful accounts. The estimated cost of providing charity care to patients was approximately $ 747,000 for the year ended December 31, 2017 ($507, ), as measured utilizing a calculated ratio of costs to charges. Reclassifications: Certain amounts as presented in the December 31, 2016 consolidated financial statements have been reclassified to match the presentation at December 31, There was no impact on net assets. NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS ASU , Revenue for Contracts with Customers 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. In August 2015, the FASB issued ASU which defers the effective date of ASU one year making it effective for annual reporting periods beginning after December 15, The Organization has not yet selected a transition method and is currently evaluating the effect that the standard will have on the consolidated financial statements. 9

12 NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS (CONTINUED) ASU , Not-for-Profit Entities: Presentation of Financial Statements of Not-for-Profit Entities In August 2016, the FASB issued ASU , Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities, which simplifies and improves how a not-for-profit organization classifies its net assets, as well as the information it presents in financial statements and notes about its liquidity, financial performance, and cash flows. Among other changes, the ASU replaces the three current classes of net assets with two new classes, net assets with donor restrictions and net assets without donor restrictions, and expands disclosures about the nature and amount of any donor restrictions. ASU is effective for annual periods beginning after December 15, 2017 and interim periods within fiscal years beginning after December 15, 2018, with early adoption permitted. The Organization is currently evaluating the impact the adoption of this guidance will have on its consolidated financial statements. NOTE 3. NET PATIENT SERVICE REVENUE The Organization has agreements with third-party payors that provide for payments to the Organization at amounts different from its established rates. A summary of inpatient and outpatient payment arrangements with major thirdparty payors is as follows: Medicare - Inpatient acute care services and outpatient services rendered to Medicare program beneficiaries are paid at prospectively determined rates. These rates vary according to a patient classification system that is based on clinical, diagnostic, and other factors. The Organization is reimbursed at a tentative rate with final settlement determined after submission of annual cost reports and audits thereof by the Medicare fiscal intermediary. Medicaid - Inpatient services rendered to Medicaid program beneficiaries are reimbursed under a cost reimbursement methodology using a base year for operating costs and actual costs for capital. The Organization is reimbursed at a tentative rate with final settlement determined after submission of annual cost reports. Outpatient services are paid at a fee schedule amounts determined by New York State. Commercial - The Organization has entered into payment agreements with certain commercial insurance carriers, health maintenance organizations, and preferred provider organizations. The basis for payment to the Organization under these agreements includes prospectively determined rates per discharge, discounts from established charges, and prospectively determined daily rates. Workers Compensation and No-Fault - Reimbursement rates for Workers Compensation and No-Fault patients are paid at prospectively determined rates per discharge, as determined by the New York Health Care Reform Act (NYHCRA). These rates vary according to a patient classification system defined by NYHCRA that is based on clinical, diagnostic and other factors. Additionally, the Organization provides long term care services for which they are reimbursed on a per diem rate by third party payors. The Medicaid program is governed by the New York State Department of Health (DOH). Effective January 1, 2012, DOH revised its reimbursement formula for the Medicaid rates paid to skilled nursing facilities. Skilled nursing facilities payments are based upon a statewide pricing model. Skilled nursing facilities are placed into one of two peer groups which is used to compute the operating component of the Medicaid rate. This new statewide pricing methodology was being phased in over five years at varying percentages. Full implementation was effective January 1, The Organization had accrued the estimated impact from this change in Medicaid reimbursement. The Organization is eligible to receive funds from several pools established under NYHCRA. Amounts received or to be received from the pools have been included as increases to net patient service revenue. Differences between amounts recorded and final distributions from the pools will be included as adjustments to net patient service revenue in the year that such distributions are received. 10

13 NOTE 3. NET PATIENT SERVICE REVENUE (CONTINUED) The Organization believes that it is in compliance with all applicable laws and regulations and is not aware of any pending or threatened investigations involving allegations of potential wrongdoing. While no such regulatory inquiries have been made, compliance with such laws and regulations can be subject to future government review and interpretations. Non-compliance with such laws and regulations could result in repayments of amounts improperly reimbursed, interest, substantial monetary fines, civil and criminal penalties, and exclusion from the Medicare and Medicaid programs. Revenue from Medicaid, Medicare and other third-party payors accounted for approximately 14%, 40%, and 41% respectively (16%, 37%, 42%, respectively 2016), of the Organization s net patient service revenue for the year ended December 31, The Organization recognizes patient service revenue associated with services provided to patients who have third-party payor coverage on the basis of contractual rates for the services rendered. For uninsured patients that do not qualify for charity care, the Organization recognizes revenue on the basis of its standard rates for services provided (or on the basis of discounted rates, if negotiated or provided by policy). Based upon historical experience, a significant portion of the Organization s uninsured patients will be unable or unwilling to pay for the services provided. Thus, the Organization records a significant provision for bad debts related to uninsured patients in the period the services are provided. Patient service revenue, net of contractual allowances and discounts (but before the provision for bad debts), recognized for the year ended December 31, 2017 and 2016 from these major payor sources, is as follows: 2017 Other Third Total Party Self All Medicaid Medicare Payors Pay Payors Patient service revenue (net of contractual allowances and discounts) $ 53,379,894 $ 146,885,307 $ 153,862,392 $ 17,332,178 $ 371,449, Other Third Total Party Self All Medicaid Medicare Payors Pay Payors Patient service revenue (net of contractual allowances and discounts) $ 59,368,393 $ 133,746,130 $ 150,608,198 $ 18,905,450 $ 362,628,171 11

14 NOTE 4. ASSETS LIMITED AS TO USE The composition of assets limited as to use is as follows at December 31: Under the 2015 Series A CCCRC revenue bonds, debt service reserve funds and bond payment funds are required for bond holders in the event of default by AOMC. $ 1,970,218 $ 539,465 As previously required by the New York State Department of Health, the Organization has deposited amounts into a funded depreciation account. These funds are to be used for future capital expenditures or long-term debt principal payments. 13,642,601 11,656,544 Deferred compensation 457 plan funds for key employees at AOMC are restricted for use under the discretion of the employees. The Organization has recognized the liability for the deferred compensation plans and that liability is included in other long-term liabilities. 6,698,136 5,565,027 Funds designated by the Organization to satisfy the various self-insurance related claims, if required. 13,840,291 13,395,793 36,151,246 31,156,829 Less: current portion 2,585,878 2,708,793 $ 33,565,368 $ 28,448,036 NOTE 5. INVESTMENTS AND ASSETS LIMITED AS TO USE Investments, including assets limited as to use and interest in net assets of charitable trusts, are carried at fair value. The fair value of investments and assets limited as to use is summarized as follows as of December 31: Fair market value $ 90,201,123 $ 87,227,229 Cost 65,511,840 69,076,943 Unrealized gains $ 24,689,283 $ 18,150,286 Investment income is summarized as follows for the years ended December 31: Interest and dividend income $ 985,815 $ 884,994 Realized gains on investments 3,231,549 4,355,012 Investment management fees (175,911) (168,824) Total $ 4,041,453 $ 5,071,182 12

15 NOTE 5. INVESTMENTS AND ASSETS LIMITED AS TO USE (CONTINUED) The Organization analyzes its investments for other than temporary impairment on an annual basis. Factors considered in evaluating whether or not a decline is other than temporary include: 1) the Organization's ability and intent to retain the investment for a period of time sufficient to allow for a recovery in value, 2) the severity and duration and extent to which the fair value has been less than cost and 3) the issuers financial condition and near-term prospects. The Organization did not recognize a charge during December 31, 2017 and 2016 related to other-than-temporary declines in estimated fair values of certain investments, as the Organization believes all declines to be temporary. NOTE 6. INTEREST IN NET ASSETS OF CHARITABLE TRUSTS Ira Davenport is an income beneficiary of the Davenport Hospital Children's Trust. At December 31, 2017 the market value of the trust assets were $1,745,063 ($1,881, ). Income distributed by this trust, up to $25,000 annually, is restricted for use in Ira Davenport's pediatric programs and any additional funds can be used at the discretion of the Governing Board. Distributions received were $425,263 in 2017, and were used in the renovation of the Emergency Department at Ira Davenport ($93, ). In addition, Ira Davenport is an income beneficiary of the Murray W. Walker Trust. At December 31, 2017 the market value of the trust assets was $253,221 ($247, ). There were distributions received for the year ended December 31, 2017 of $12,370 ($13, ). Arnot Health (AOMC) Foundation has recorded an interest in a charitable remainder unitrust held by an independent trustee established to benefit the Arnot Health Foundation of which the Arnot Health Foundation has a 20% interest ($346,857 at December 31, 2017 and 2016). Payments amounting to 20% of the fair market value of the trust assets are being remitted to specified beneficiaries until they are deceased, at which time the Arnot Health Foundation s interest in the remainder of the trust will be remitted to the Arnot Health Foundation. NOTE 7. FAIR VALUE OF FINANCIAL INVESTMENTS In determining fair value, the Organization uses various valuation approaches within the fair value measurement framework. The following is a description of the valuation methodologies used for assets measured at fair value and their classification within the hierarchy: Cash and cash equivalents: The carrying amounts reported in the consolidated balance sheets approximate their fair value. U.S. government & agency obligations, and common stock: Amounts are valued at the closing price reported on the active market on which the individual securities are traded, or are estimated using quoted market prices for similar securities. Corporate bonds: Bonds are valued at the closing price reported on the active market. Mutual funds: Valued at the net asset value (NAV) of shares held at year end. The NAV is the closing price reported on the active market on which the securities are traded. 13

16 NOTE 7. FAIR VALUE OF FINANCIAL INVESTMENTS (CONTINUED) Investments, including assets limited as to use, are measured at fair value on a recurring basis at December 31, 2017 and 2016 as follows: 2017 Level 1 Level 2 Level 3 Total Cash & cash equivalents $ 12,072,698 $ - $ - $ 12,072,698 Common stock 13,268, ,268,424 Mutual funds- equity 38,747, ,747,813 Mutual funds- balanced 1,729, ,729,514 Mutual funds- fixed income 14,370, ,370,277 $ 80,188,726 $ - $ - $ 80,188,726 Investments measured at net asset value 7,401,962 Investment in reciprocal risk retention group 2,610,435 Total $ 90,201, Level 1 Level 2 Level 3 Total Cash & cash equivalents $ 11,071,115 $ - $ - $ 11,071,115 Common stock 11,193, ,193,744 Mutual funds- equity 37,934, ,934,658 Mutual funds- balanced 370, ,315 Mutual funds- fixed income 18,633, ,633,497 Corporate bonds 408, ,437 $ 79,611,766 $ - $ - $ 79,611,766 Investments measured at net asset value 5,720,066 Investment in reciprocal risk retention group 1,895,397 Total $ 87,227,229 The following alternative investments are valued using net asset value at December 31, 2017 and 2016: 2017 Redemption Frequency if Redemption Fair Unfunded Currently Notice Value Commitments Eligible Period Silchester International Value Equity $ 7,401,962 None Monthly 6 business days 14

17 NOTE 7. FAIR VALUE OF FINANCIAL INVESTMENTS (CONTINUED) 2016 Redemption Frequency if Redemption Fair Unfunded Currently Notice Value Commitments Eligible Period Silchester International Value Equity $ 5,720,066 None Monthly 6 business days The Organization invests in the Silchester International Value Equity Fund (Silchester) to create a portfolio of international equity securities. Silchester invests in a diversified portfolio of equity securities of companies located in any country other than the United States. Silchester only invests in companies located in countries represented in the MSCI EAFE Index. The Organization also invests with the Organization s current malpractice provider, Chart, as part of a reciprocal risk retention group. The Organization recognizes earnings as well as unrealized gains and losses based upon the performance and the Organization s equity ownership in the risk retention group. NOTE 8. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consist of the following at December 31: Land $ 7,783,458 $ 7,836,727 Land improvements 5,503,487 5,515,914 Leasehold improvements 957,133 1,008,901 Buildings and improvements 170,181, ,167,282 Equipment and furnishings 227,290, ,447,494 Equipment under capital leases 16,363,452 19,083,479 Construction in progress 2,391,580 10,962, ,470, ,022,098 Less: accumulated depreciation 297,808, ,298,721 $ 132,661,985 $ 136,723,377 Depreciation expense for the year ended December 31, 2017 amounted to $ 16,070,166 ($15,735, ). Lease amortization is included within depreciation expense. NOTE 9. LINES OF CREDIT Arnot Ogden Medical Center has an annually renewable $2,000,000 bank line-of-credit bearing interest at 5%. There were no outstanding borrowings at December 31, 2017 and

18 NOTE 10. LONG-TERM DEBT Long-term debt consists of the following at December 31: Arnot Ogden Medical Center has 2015A IDA revenue bonds collateralized by the debt service reserve fund and related property, payable each May 1 and November 1 through 2040, with interest at % (a) $ 26,469,000 $ 27,645,400 Arnot Ogden Medical Center has a commercial installment loan collateralized by securities and property, paid in monthly payments of $15,951 through October 2027, including interest at 2.50%. 1,669,809 1,811,555 Arnot Ogden Medical Center has a mortgage payable to a bank that bears interest at 3.59% and is due in monthly installments of $28,820, including interest. The mortgage is secured by a building and matures in ,763,674 2,995,441 St. Joseph s Hospital has a promissory note payable to a bank due in monthly installments of $23,221 through January 2018, including interest at a fixed rate of 4.50% secured by equipment. 23, ,898 St. Joseph s Hospital has a promissory note payable to a bank which is unsecured, due in monthly installments of $29,559 through May 2017, including interest at a fixed rate of 4.25%. This note was paid in full in ,171 30,925,530 32,892,465 Less: current portion 1,547,031 1,948,139 Less: unamortized deferred financing costs 761, ,101 $ 28,617,422 $ 30,148,225 Annual maturities of long-term debt for the five years and thereafter subsequent to December 31, 2017 are as follows: Deferred Long-Term Financing Debt Costs Net 2018 $ 1,587,429 $ 40,398 $ 1,547, ,580,001 33,254 1,546, ,596,170 33,254 1,562, ,613,687 33,254 1,580, ,631,673 33,254 1,598,419 Thereafter 22,916, ,663 22,328,907 $ 30,925,530 $ 761,077 $30,164,453 (a) On June 25, 2015, $29,410,000 Chemung County Capital of Resource Corporation Tax Exempt Multi- Mode Revenue Bonds (Arnot Ogden Medical Center Project) Series 2015A were issued to Arnot Ogden Medical Center. These bonds are secured by a security interest in certain real and personal property of Arnot Ogden Medical Center and by debt service reserve funds. Proceeds from the issuance were primarily used to refinance and legally defease the 2004 Series (A) and (B) bond issuance and for the renovation and reconstruction of the energy infrastructure of Arnot. 16

19 NOTE 10. LONG-TERM DEBT (CONTINUED) In conjunction with the Chemung County Capital of Resource Corporation Tax Exempt Multi-Mode Revenue Bonds (Arnot Ogden Medical Center Project) Series 2015A Bonds, Arnot Ogden Medical Center is required to maintain certain financial covenants. For the years ended December 31, 2017 and 2016, the Organization was in compliance with these covenants. Deferred financing costs are presented as a reduction of the carrying amount of debt rather than an asset. Deferred financing costs consist of financing fees associated with various financing agreements. Amortization is being provided over a straight line method over the life of the financing agreements. Amortization expense for the year ended December 31, 2017 was $35,024 ($34, ). Total financing cost amounted to $845,211 less accumulated amortization of $84,211 ($855,340 and $59, ). NOTE 11. CAPITAL LEASE OBLIGATIONS Capital leases obligation payable in monthly installments of $9,820, including interest at 1.43% expiring October 2017, secured by the leased equipment. This lease was paid in full in $ - $ 97,561 Capital lease obligation, payable in monthly installments of $8,169, expiring February 2021, secured by the leased equipment. This lease is non-interest bearing. 333, ,655 Capital lease obligation, payable in monthly installments of $14,712, expiring September 2021, secured by the leased equipment. This lease is non-interest bearing. 559, ,598 Capital lease obligation, payable in monthly installments of $3,347, expiring November 2019, secured by the leased equipment. This lease is non-interest bearing. 73, ,128 Capital lease obligation, payable in monthly installments of $9,402, expiring March 2020, secured by the leased equipment. This lease is non-interest bearing. 253,847 - Capital lease obligation, payable in monthly installments of $1,873, expiring October 2019, secured by the leased equipment. This lease is non-interest bearing. 41,202 - Capital lease obligation, payable in monthly installments of $21,300, expiring May 2019, secured by the leased equipment. This lease is non-interest bearing. 127,800-1,389,496 1,415,942 Less: current portion 526, ,295 $ 862,641 $ 1,003,647 The following is a schedule of the future minimum payments under capital leases, together with the present value of minimum lease payments as of December 31, 2017: Total future minimum lease payments $ 1,389,496 Less: amount representing interest - Present value of net minimum lease payments $ 1,390,496 17

20 NOTE 11. CAPITAL LEASE OBLIGATIONS (CONTINUED) Aggregate maturities of long-term capital lease obligations for the years subsequent to 2018 are as follows: 2019 $ 473, , ,421 $ 862,641 NOTE 12. PENSION PLANS Arnot Ogden Medical Center has two defined benefit retirement plans; one covers substantially all full-time union employees and the other plan was for non-union employees where participation has ceased and plan benefits were frozen as of December 31, The defined benefit plan for non-union employees was replaced with a defined contribution plan effective January 1, Covered union employees are entitled to benefits based on number of years of credited service multiplied by the union contract rate in effect during the year of retirement. Covered non-union employees are entitled to benefits, which had accrued at December 31, 2006, based upon years of credited service and annual compensation. It is Arnot Ogden Medical Center's policy to fund the plans in accordance with Internal Revenue Code and Employee Retirement Income Security Act (ERISA). Effective January 1, 2013 the Plan was frozen to new covered union employees. Eligible covered union employees who met the eligibility requirements are able to participate in the defined contribution plan. Ira Davenport maintains a defined benefit pension plan; however, participation in this plan ceased and plan benefits were frozen effective August 1, It is IRA Davenport s policy to fund the plans in accordance with Internal Revenue Code and Employee Retirement Income Security Act (ERISA). St. Joseph s Hospital has a non-contributory defined benefit plan which covers certain employees. Benefits are based on years of service and other factors as defined under the plan document. This plan is a Church Plan, as defined in the ERISA of 1974, and therefore is exempt from the requirements under ERISA. St. Joseph s Hospital uses the accrued benefit (unit credit) actuarial method to determine its funding requirements and its policy is to fund at least an amount necessary to amortize the unfunded accrued liability over not less than 10 years, but not more than 30 years. On August 1, 2003, the Hospital discontinued eligibility to the plan for employees hired on or after that date. Employees enrolled in the plan as of that date will continue to accrue benefits under the benefit formula, or under the terms of a new defined contribution plan, whichever is greater. Obligations and Funded Status: The following tables set forth the Plans funded status and amounts recognized at the respective measurement dates in the consolidated financial statements at December 31, Arnot Ogden Medical Ira St. Joseph s Center Davenport Hospital Total Change in plan assets: Fair value of plan assets at beginning of year $ 109,318,400 $ 478,190 $ 12,794,974 $ 122,591,564 Actual return on plan assets 17,464,478 77,738 2,046,511 19,588,727 Employer contributions 76,924-38, ,386 Benefits paid (4,984,569) (44,484) (1,155,704) (6,184,757) Fair value of plan assets at end of year $ 121,875,233 $ 511,444 $ 13,724,243 $ 136,110,920 18