CHILDREN S HEALTH SYSTEM OF TEXAS AND AFFILIATES CONSOLIDATED FINANCIAL AND OPERATING INFORMATION FOR THE THREE MONTHS ENDED March 31, 2015

Transcription

1 CHILDREN S HEALTH SYSTEM OF TEXAS AND AFFILIATES CONSOLIDATED FINANCIAL AND OPERATING INFORMATION FOR THE THREE MONTHS ENDED March 31, 2015 This information should be read in conjunction with the Audited Financial Statements as of December 31, 2014 Contact Information: Bruce Bickham, Chief Accounting Officer Children s Health System of Texas 1935 Medical District Drive Dallas, Texas Bruce.Bickham@childrens.com

2 Table of Contents Consolidated Financial Statements: Consolidated Balance Sheets... 1 Consolidated Statements of Operations... 2 Consolidated Statements of Changes in Net Assets... 3 Consolidated Statements of Cash Flows... 4 Notes to Consolidated Financial Statements... 5 Supplementary Information: Children s Health System Consolidating Statements of Operations Children s Medical Center Obligated Group Combining Balance Sheets Children s Medical Center Obligated Group Combining Statements of Operations Note to Children s Medical Center Obligated Group Consolidating Financial Statements Management s Discussion and Analysis of Financial Condition and Results of Operations (Unaudited) 18

3 Children's Health System of Texas Consolidated Balance Sheets As of March 31, 2015 and December 31, 2014 (In Thousands) (Unaudited) (Audited) ASSETS Current Assets: Cash and cash equivalents $ 443,394 $ 400,660 Patient accounts receivable, net of allowances 160, ,197 Pledges receivable, net of allowances 5,158 8,411 Inventories 9,605 9,828 Other current assets 82,400 94,274 Investment in unrestricted funds 13,759 11,410 Total Current Assets 714, ,780 Pledges Rececivable, net of allowances 18,093 17,142 Receivables From Remainder Trusts 8,808 8,840 Property and Equipment, net 806, ,642 Assets Limited As To Use 1,050,269 1,023,171 Other Assets 26,604 25,275 Total Assets $ 2,624,505 $ 2,535,850 LIABILITIES AND NET ASSETS Current Liabilities: Accounts payable $ 126,555 $ 108,607 Accrued liabilities 84,129 75,433 Accrued interest 2,373 7,241 Current portion of long-term debt and capital lease obligations 2,727 2,677 Other current liabilities 3,019 2,405 Total Current Liabilities 218, ,363 Long-term Debt and Capital Lease Obligations, net of current portion 373, ,590 Other Noncurrent Liabilities 83,675 81,952 Net Assets: Unrestricted 1,758,480 1,699,208 Temporarily restricted 81,271 76,957 Permanently restricted 108, ,780 Total Net Assets 1,948,161 1,881,945 Total Liabilities and Net Assets $ 2,624,505 $ 2,535,850 See Notes to the financial statements 1

4 Children's Health System of Texas Consolidated Statements of Operations For the three months ended March 31, 2015 and 2014 (In Thousands) (Unaudited) (Unaudited) OPERATING REVENUE: Patient services revenue less contractual allowances and charity allowances $ 305,593 $ 293,351 Provision for doubtful accounts (5,265) (15,547) Net patient service revenue 300, ,804 Other operating revenue 17,574 9,506 Graduate medical education 1,199 1,299 Net assets released from restrictions for operations 1,767 1,590 Total operating revenue 320, ,199 OPERATING EXPENSES: Salaries and benefits 150, ,008 Professional services 25,358 25,608 Supplies and other 31,074 29,364 General support 57,350 53,249 Depreciation and amortization 14,369 15,045 Interest 4,410 4,549 Total operating expenses 282, ,823 OPERATING INCOME 38,118 20,376 NONOPERATING GAINS (LOSSES): Realized investment gains 7,554 8,542 Unrealized investment gains 12,040 7,441 Total nonoperating gains 19,594 15,983 NET INCOME $ 57,712 $ 36,359 See notes to the financial statements 2

5 Children's Health System of Texas Consolidated Statements of Net Assets For the three months ended March 31, 2015 and 2014 (In Thousands) (Unaudited) (Unaudited) CHANGES IN UNRESTRICTED NET ASSETS: Net income $ 57,712 $ 36,359 Net assets released from restrictions 2,121 2,400 Change in donor designation and other (561) (42) Increase in unrestricted net assets 59,272 38,717 CHANGES IN TEMPORARILY RESTRICTED NET ASSETS: Contributions 8,050 1,509 Change in split-interest agreements (31) 77 Realized investment (losses) gains (26) 51 Unrealized investment gains Net assets released from restrictions for operations (1,767) (1,590) Net assets released from restrictions for capital (2,121) (2,400) Grants for pediatric purposes (39) (5) Change in donor designation and other 80 (77) Increase (decrease) in temporarily restricted net assets 4,314 (2,391) CHANGES IN PERMANENTLY RESTRICTED NET ASSETS: Permanently restricted contributions Gain on sale of assets - 3,359 Realized investment gains Unrealized investment gains 1, Change in donor designation and other Increase in permanently restricted net assets 2,630 6,022 INCREASE IN NET ASSETS 66,216 42,348 NET ASSETS AT BEGINNING OF PERIOD 1,881,945 1,732,926 NET ASSETS AT END OF PERIOD $ 1,948,161 $ 1,775,274 See notes to the financial statements 3

6 Children's Health System of Texas Consolidated Statements of Cash Flows For the three months ended March 31, 2015 and 2014 (In Thousands) (Unaudited) (Unaudited) CASH FLOW FROM OPERATING AND NONOPERATING ACTIVITIES: Increase in net assets $ 66,216 $ 42,348 Adjustments to reconcile increase in net assets to net cash provided by operating and nonoperating activities: Provision for doubtful accounts 5,265 15,547 Depreciation and amortization 14,369 15,045 Amortization of financing cost and bond discounts 129 (9) Amortization of bond premium (492) (506) Change in unrealized investments (12,040) (4,194) Loss on the disposal of property and equipment 3 31 Change in pension liability - 1,650 Changes in operating assets and liabilities: Patient and other receivables (7,322) 20,907 Pledges receivable, net 2,302 4,770 Inventory and other current assets (5,794) (16,150) Other assets (1,398) (3,538) Receivables from remainder trusts Purchases of assets limited as to use and unrestricted investments (17,407) (17,526) Accounts payable and accrued liabilities 21,776 (22,737) Other current liabilities 614 1,093 Other noncurrent liabilities 1,140 (4,344) Net cash provided by operating and nonoperating activities 67,393 33,230 CASH FLOWS FROM INVESTING ACTIVITIES: Purchase and construction of property and equipment (25,242) (21,194) Net cash used by investing activities (25,242) (21,194) CASH FLOW FROM FINANCING ACTIVITIES: Payments of annuities and trust obligations, net 583 (39) Net cash used by financing activities 583 (39) INCREASE IN CASH AND CASH EQUIVALENTS 42,734 11,997 CASH AND CASH EQUIVALENTS, beginning of period 400, ,093 CASH AND CASH EQUIVALENTS, end of period $ 443,394 $ 509,090 Supplemental cash flow disclosures: Interest paid $ 9,452 $ 9,872 Capital lease obligation $ - $ 2,534 See notes to the financial statements 4

7 Note 1 Organization and Basis of Presentation Children s Health System of Texas and Affiliates Consolidated Financial and Operating Information For the Three Months Ended March 31, 2015 The accompanying consolidated financial statements of Children s Health System of Texas and Affiliates, d/b/a Children s Health System of Texas (Children s Health SM ) have been prepared in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2015, are not necessarily indicative of the results that may be expected for the year ending December 31, Children s Health was incorporated in 1985, as a nonprofit Texas corporation that is exempt from federal income taxes under Section 501(a) of the Internal Revenue Code (IRC) of 1986 as an organization described in Section 501(c)(3) of the IRC. Children s Health operates a 559-bed pediatric teaching hospital, 19 children s clinics, and a foundation. Children s Health is the parent company of the following affiliates: Children s Health SM Children s Medical Center (CMC) was incorporated in 1948 as a nonprofit Texas corporation, exempt from federal income taxation under Section 501(a) of the IRC of 1986, as an organization described in Section 501(c)(3). CMC is licensed to operate a 559-bed pediatric teaching hospital with campuses in Dallas, Texas; Plano, Texas (Plano); and Southlake, Texas (Southlake). CMC is the sole member of Children s Insurance Company (CIC). CIC is a for-profit Vermont captive insurance company formed in 1990 to underwrite professional liability insurance. Children s Health is the sole member of Physicians for Children (PFC), Anesthesiologists for Children (AFC), Dallas Physicians Medical Services for Children (DPMSC), Children s Medical Center Services (CMCS), Complex Care Medical Services Corporation (CCMS), Children s Health SM Pediatric Group (PPC), Specialists for Children (SFC) and Community Providers for Childrens (CPC). The nonprofit affiliates PFC, AFC, DPMSC, CMCS, CCMS, PPC, SFC and CPC are Texas nonprofit corporations and are exempt from federal income tax under Section 501(a) of the IRC of 1986 as organizations described in Section 501(c)(3). PFC, doing business as Children s Health Pediatric Group (CHPG), has 19 locations where it provides primary care to children in critically underserved areas of Dallas, Collin, and Tarrant Counties. AFC provides physician staffing for anesthesiology services. DPMSC provides physician staffing for urgent care and hospitalist services. CMCS provides underserved communities access to pediatric physicians through such avenues as telemedicine and outreach clinics. CCMS serves as the medical home for children with complex medical illnesses where a multi-disciplinary team of care givers oversee and coordinate their care. PPC works towards the formation of networks (clinical and financial) comprised of community based primary care physicians in order to improve outcomes across a spectrum of indicators. SFC works towards the formation of networks (clinical and financial) comprised of community based pediatric subspecialist in order to improve outcomes across a spectrum of indicators. Children s Health SM Children s Medical Center Foundation (the Foundation) is a nonprofit Texas corporation exempt from federal income taxes under Section 501(c)(3) of the IRC. The Foundation was incorporated in 1985 to administer and invest funds in support of CMC and its affiliates. Alternative Care Systems, Inc. (ACS) was incorporated in 1988 as a for-profit Texas corporation. ACS was formed to participate in ventures that have included investment in companies that brought new medical supplies and pharmaceuticals to market and participation in medical device consortium. 5

8 Children s Health System of Texas and Affiliates Consolidated Financial and Operating Information For the Three Months Ended March 31, 2015 Children s Medical Center Pediatric Research Institute at UT Southwestern (Research Institute) is a nonprofit Texas corporation exempt from federal income taxes under Section 501(a) of the IRC of 1986 as an organization described in Section 501(c)(3) of the IRC. The Research Institute was incorporated in 2009 to conduct pediatric research. The Health and Wellness Alliance for Children (H&W) is a nonprofit Texas corporation. H&W partners with communities, businesses, advocates and other nonprofits to improve the health and wellness of children in underserved areas. Children s Population Health (CPH) is a nonprofit Texas corporation. CPH strives to improve the health of children across the continuum of care. Physicians Quality Alliance of North Texas (PQA) is a nonprofit Texas corporation. PQA is a healthcare collaborative initiative. Children s Health SM Children s Medical Center Health Plan (CMCHP) is a nonprofit Texas corporation. CMCHP is involved in health maintenance organization activities. NTPSS, Inc. is a for-profit Texas corporation that will function as an aggregator and supplier of goods and back-office services to community physicians with the focus of making life better for children by providing practical business support solutions for our physician partners. Texas Bluebonnet Health Plan, Inc. is a for-profit Texas corporation that will provide commercial health maintenance organization activities. The following companies: CMCS, CCMS, PPC, SFC, CPC, H&W, CPH, PQA, and CMCHP, are all applying for exemption from federal income tax under Section 501(a) of the IRC of 1986 as an organization described in Section 501(c)(3) of the IRC. The consolidated balance sheet at December 31, 2014, has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. For further information, refer to the audited consolidated financial statements and footnotes thereto for the year ended December 31, 2014, which can be found online at All significant intercompany balances and transactions have been eliminated in consolidation. Note 2 Physician Income Guarantees Physician income guarantees are accounted for in accordance with ASC Topic 460, Guarantees. Children s Health records an asset and liability for the estimated payments to be made under physician income guarantees. The assets are amortized using the straight-line amortization method for the guarantee period, and the liabilities are released as payments are made. The unamortized portion of these physician guarantees, included in other assets, is $4.8 million, as of March 31, The current portion of the guarantees is included in current liabilities and the noncurrent portion of the guarantees is included in other noncurrent liabilities on the consolidated balance sheets. Total guarantees were $4.0 million as of March 31, 2015 and $3.4 million as of December 31, The maximum amount that could be paid under Children s Health s physician income guarantees was approximately $10.4 million as of March 31,

9 Note 3 Employee Retirement Benefit Plans Children s Health System of Texas and Affiliates Consolidated Financial and Operating Information For the Three Months Ended March 31, 2015 Children s Health has a defined benefit retirement plan that covers substantially all full-time employees hired before December 24, As of December 24, 2006, the defined benefit plan was frozen to new employees. Benefits are based on the employee s years of service and compensation during the years immediately preceding termination of employment. Employees do not make contributions to the plan. Children s Health s policy is to contribute funds sufficient to meet or exceed the minimum annual funding standards under Section 412 of the Employee Retirement Income Security Act of Plan assets are held in a separate trust under a custodial agreement, with investments directed by the investment committee. Plan assets consist of U.S. government securities, high-grade debt securities, mutual funds, alternative investments, and marketable equity securities. Benefit plans are accounted for in accordance with ASC Topic 715, Compensation Retirement Benefits. The Plan was amended generally effective January 1, 2012, to (1) offer a one-time, lump-sum cash out opportunity in 2012 to terminated vested participants; (2) provide an automatic rollover distribution for participants who terminate employment on or after July 1, 2012, with a Vested Accrued Benefit that exceeds $1,000 but is less than or equal to $5,000 and who do not elect to receive a lump-sum distribution upon termination; and (3) offer a lump-sum distribution upon termination for participants who terminate on or after July 1, 2012, with a Vested Retirement Benefit of more than $5,000. Effective December 31, 2013, the decision was made to curtail the accrual of benefits for all active participants of the defined benefit plan, freeze any future service benefits, and increase matching contributions under the Children s Medical Center 401(a) Employee Savings Plan (Savings Plan) beginning in The Savings Plan will become the primary retirement program for all employees. The Savings Plan offers a common matching scale for all participants and normalizes Children s Health s retirement contribution for all employees. Substantially all employees may participate in the Savings Plan. Children s Health matches a portion of an employee s contributions, up to 7.5% of pay. Children s level of fixed matching contributions to the plan depends on the employee s date of hire and cumulative years of service. Children s Health s fixed matching contributions to the plan were $5.3 million and $4.7 million in the first quarter of 2015 and 2014, respectively. Note 4 Fair Value of Financial Instruments Fair value is defined as 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 (i.e., an exit price). To measure fair value, a hierarchy has been established that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs. As such, the hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets and liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described below: Level 1: Unadjusted quoted prices in active markets that are accessible to the reporting entity at the measurement date for identical assets or liabilities. 7

10 Children s Health System of Texas and Affiliates Consolidated Financial and Operating Information For the Three Months Ended March 31, 2015 Level 2: Inputs other than quoted prices in active markets for identical assets and liabilities that are observable either directly or indirectly for substantially the full term of the asset or liability. Level 2 inputs include the following: quoted prices for similar assets and liabilities in active markets quoted prices for identical or similar assets or liabilities in markets that are not active observable inputs other than quoted prices that are used in the valuation of the asset or liabilities (e.g., interest rate and yield curve quotes at commonly quoted intervals) inputs that are derived principally from or corroborated by observable market data by correlation or other means Level 3: Unobservable inputs for the asset or liability (i.e., supported by little or no market activity). Level 3 inputs include management s own assumption about the assumptions that market participants would use in pricing the asset or liability (including assumptions about risk). The level in the fair value hierarchy within which the fair value measurement is classified is determined based on the lowest level input that is significant to the fair value measure in its entirety. Following is a description of the valuation techniques and inputs used for each major class of assets and liabilities measured at fair value. Cash and Cash Equivalents Cash and cash equivalents include all cash balances and highly liquid investments when purchased with initial maturities of three months or less. The carrying amount approximates fair value because of the short maturity of these instruments. U.S. Government Securities, Common Stocks, Mutual Funds, Common/Collective Trusts, and Debt Securities The fair values of the investments included in Level 1 were determined through quoted market prices, while the fair values of Level 2 investments were determined primarily using a market approach, with inputs such as evaluated bid prices provided by third-party pricing services where quoted market values are not available. The underlying investments of common/collective trusts and pooled investment funds consist of marketable debt and equity securities with readily determinable market values without any lock-up or gate provisions. Alternative Investments Children's Health s alternative investments have similar risks as traditional fixed income and equity securities, although there may be some additional risk. The alternative investment strategy is to invest in hedge funds in order to obtain attractive risk-adjusted returns that are uncorrelated with equities and fixed income. These funds are invested through limited partnerships that employ various investment strategies, including long-term and short-term equity, multi-strategy, and credit. Performance is driven by individual manager selection and their ability to obtain superior results. Certain alternative investments have lock-up periods and other liquidity limitations that are generally one year from the date of the original investment. Earlier redemptions are allowed with an early redemption penalty. 8

11 Children s Health System of Texas and Affiliates Consolidated Financial and Operating Information For the Three Months Ended March 31, 2015 The net asset values (NAV) of alternative investments are based on valuations provided by the managers of the specified funds. Children's Health accounts for its alternative investments held outside the Foundation and defined benefit plan using the equity method of accounting; accordingly, these investments are excluded from the fair value hierarchy in ASC 820. Estimated fair values of financial instruments were as follows at March 31, 2015 (in thousands): Assets at Fair Value Total Level 1 Level 2 Level 3 Investment portfolio: Cash and cash equivalents $ 99,439 $ 99,439 $ - $ - U.S. government securites 17,103 17, Common stocks 24,891 24, Debt securities: - - Corporate bonds 38,026-38,026 - Mortgage-backed securities 25,010-25,010 - Mutual funds: - - Registered: - - Domestic equity 104, , International equity 26,400 26, Fixed income 16,724 16, Common/collective trusts: - - Domestic equity 257, ,918 - International equity 263, ,209 - Fixed income 79,669-79,669 - Alternative investments 35, ,574 Total investments at fair value 988,407 $ 289,001 $ 663,832 $ 35,574 Alternative and other equity method investments 75,621 Total investment portfolio 1,064,028 Included in investments in unrestricted funds 13,759 Total assets limited to use $ 1,050,269 Receivable from remainder trusts $ 8,808 $ - $ 8,808 $ - 9

12 Children s Health System of Texas and Affiliates Consolidated Financial and Operating Information For the Three Months Ended March 31, 2015 Estimated fair values of financial instruments were as follows at December 31, 2014 (in thousands): Assets at Fair Value Total Level 1 Level 2 Level 3 Investment portfolio: Cash and cash equivalents $ 94,862 $ 94,862 $ - $ - U.S. government securites 15,601 15, Common stocks 23,408 23, Debt securities: Corporate bonds 39,075-39,075 - Mortgage-backed securities 22,072-22,072 - Mutual funds: Registered: Domestic equity 104, , International equity 20,848 20, Fixed income 16,544 16, Common/collective trusts: Domestic equity 267, ,192 - International equity 252, ,470 - Fixed income 79,457-79,457 - Alternative investments 30, ,379 Total investments at fair value 966,483 $ 275,838 $ 660,266 $ 30,379 Alternative and other equity method investments 68,097 Total investment portfolio 1,034,580 Included in investments in unrestricted funds 11,410 Total assets limited to use $ 1,023,171 Receivable from remainder trusts $ 8,840 $ - $ 8,840 $ - Long-Term Debt ASC Topic 825, Financial Instruments, requires disclosure of fair value information, whether or not recognized on the balance sheet, for which it is practicable to estimate that value. Certain financial instruments and all nonfinancial instruments are excluded from these disclosure requirements. Accordingly, the aggregate carrying value amounts presented do not represent the underlying value of the long-term debt. The fair value of long-term debt is $408.2 million at March 31, 2015, compared to $399.6 million at December 31, The carrying value of long-term debt was $376.6 million at March 31, 2015, compared to $378.3 million at December 31, Estimates are based on available market quotes, for comparably rated debt instruments, which constitute a Level 2 estimate. Note 5 Charity Care The value of charity care provided by Children s Health, based upon its established rates, was approximately $10.7 million for the three months ended March 31, 2015 and $13.9 million for the three months ended March 31, ASU , Healthcare Entities Measuring Charity Care for Disclosure, requires charity care to be disclosed on a cost basis. Children s Health utilizes the cost to 10

13 Children s Health System of Texas and Affiliates Consolidated Financial and Operating Information For the Three Months Ended March 31, 2015 charge ratios, as calculated based on its most recent cost reports filed with the Centers of Medicare and Medicaid Services, to determine the total cost. Children s Health s cost of providing charity care was $4.5 million and $5.9 million for the three months ended March 31, 2015 and 2014, respectively. Note 6 Professional Liability The net amount of Children s Health s professional liability was $5.1 million and $3.5 million as of March 31, 2015 and December 31, 2014, respectively. ASU , Healthcare Entities Presentation of Insurance Claims and Related Insurance Recoveries, requires professional liabilities to be reported at gross, without the consideration of insurance recoveries. Accordingly, Children s Health has recorded professional liabilities of $9.0 million and $7.4 million in the other noncurrent liabilities portion of the consolidated balance sheet and an asset representing insurance recoveries of $3.9 million and $3.9 million in the other assets section of the consolidated balance sheet at March 31, 2015 and 2014, respectively. Note 7 Provision for Doubtful Accounts Accounts receivable are reduced by an allowance for doubtful accounts. In evaluating the collectability of accounts receivable, Children s Health analyzes its past history and identifies trends for each of its major payer sources to estimate the appropriate allowance for doubtful accounts and provision for doubtful accounts. Management regularly reviews data for these major payer sources in evaluating the sufficiency of the allowance. For receivables associated with services provided to patients who have third-party coverage, Children s Health analyzes contractually due amounts and provides an allowance for doubtful accounts. For receivables associated with self-pay patients (which includes both patients without insurance and those patients with insurance where deductible and copayment balances exist), Children s Health records a provision for doubtful accounts in the period of service on the basis of its past experience. The difference between the standard rates (or the discounted rates if applicable) and the amounts actually collected after all reasonable collection efforts have been exhausted is charged off against the allowance for doubtful accounts. Children s Health s allowance for doubtful accounts decreased from $30.5 million or 11.2% of total gross accounts receivable at March 31, 2014 to $26.8 million or 9.3% of total gross accounts receivable as of March 31, In addition, Children s Health has not changed its charity care or uninsured discount policies during fiscal years 2015 or Children s Health does not maintain a material allowance for doubtful accounts from third-party payers, nor did it have significant write-offs from third-party payers during Children s Health recognizes patient service revenue associated with services provided to patients who have third-party payer coverage on the basis of contractual rates for the services rendered. For uninsured patients that do not qualify for charity care, Children s Health recognized revenue on the basis of its standard rates for services provided, or on the basis of discounted rates if negotiated, and as provided by policy. On the basis of historical experience, Children s Health records a provision for doubtful accounts related to uninsured patients in the period the services are provided. Patient service revenue, net of contractual allowances and charity care (but before the provision for doubtful accounts), recognized yearto-date from these major payer sources is as follows (in thousands): Patient service revenue less contractuals: Government Commercial Other Total All Payers Three Months Ended March 31, 2015 $ 154,200 $ 130,977 $ 20,415 $ 305,593 Three Months Ended March 31, , ,976 29, ,351 11

14 Note 8 Changes to Reimbursement Children s Health System of Texas and Affiliates Consolidated Financial and Operating Information For the Three Months Ended March 31, 2015 Children s Health and rural hospitals historically were reimbursed for their actual audited allowable cost of providing care to Medicaid enrollees using the Tax Equity and Fiscal Responsibility Act of 1982 cost principles. Beginning on September 1, 2013, children s hospitals are reimbursed for inpatient service under an All Patient Refined Diagnosis Related Groups (APR-DRG) methodology. The state of Texas secured a waiver from certain federal Medicaid requirements for the five-year period ending September 1, Under the terms of the waiver, the State implemented changes to the way in which it compensates CMC and other providers for care to patients covered by the Medicaid program. The waiver established two new pools of funds, UCP and DSRIP. Under the terms of the waiver, the UCP program provides funding for hospitals which have substantial uncompensated care costs or unreimbursed costs for Medicaid patients, reduced by DSH payments to the hospitals. The DSRIP program will provide funding incentives to hospitals and other providers to enhance access to care and the health of patients. Children s Health continues to monitor and evaluate the differences in payment methodologies and the potential effect they may have on its results of operations. Note 9 Land Sale On March 14, 2014, acres land in Sachse, TX were sold for proceeds of $3.7 million and included an option for the buyer to purchase an additional acres for $2.7 million, which the buyer had 11 months to exercise. This transaction resulted in a gain of $3.4 million which affected permanently restricted net assets, as the donor s intent was to establish an endowment fund from the proceeds. In consideration for the gift of the property in 1975, the Foundation agreed to distribute 10% of the net proceeds to Trinity Valley School which was chosen by donor. Due to this donor restriction, a liability of $368,000 was also recorded. In November 2014, the Foundation received notice that the buyer wished to terminate their option to purchase the additional acres. A $63,863 receivable was recorded which represents the buyer s outstanding option payments on the land. Note 10 Subsequent Events Children s Health evaluated events and transactions occurring subsequent to March 31, 2015 through May 20, 2015, the date the interim financial statements were made available to external parties. During this period, there were no subsequent events requiring recognition in the financial statements. 12

15 Supplementary Information

16 Children's Health System of Texas Consolidating Statement of Operations For the Three Months Ending March 31, 2015 (Thousands) Clinical Professional Population Corporate Services Services Health Services Foundation CRI Eliminations Consolidated OPERATING REVENUE Net patient revenue $ 292,580 $ 7,748 $ - $ - $ - $ - $ - $ 300,328 Other operating revenue 11,266 8,756 3,710 1, (5,415) 20,540 Total operating revenue 303,846 16,504 3,710 1, (5,415) 320,868 OPERATING EXPENSES Salaries and benefits 99,865 15,181 5,241 28,336 1, ,189 Professional services 563 7,884 (4) 20, (4,007) 25,358 Supplies and other 32, (1,538) ,074 General support 20,378 5,181 5,691 26, (1,407) 57,350 Depreciation 10, , ,369 Interest 4, ,410 Shared Services 86,841 (6,212) 2,153 (82,782) Total operating expenses 254,984 22,930 13,104 (5,929) 1,824 1,252 (5,415) 282,750 Operating Income 48,862 (6,425) (9,395) 7,032 (905) (1,052) - 38,117 Non Operating Income Investment income 12, , ,594 Total non operating income 12, , ,594 NET INCOME $ 60,912 $ (6,425) $ (9,395) $ 7,032 $ 6,638 $ (1,052) $ - $ 57,712 14

17 Children's Health System of Texas Children's Medical Center Obligated Group Consolidated Balance Sheets As of March 31, 2015 (In Thousands) Children's Health System of Texas Children's Medical Center Children's Medical Center Foundation Children's Medical Center Obligated Group Eliminations Children's Medical Center Obligated Group ASSETS Current Assets: Cash and cash equivalents $ 30 $ 380,670 $ 24,466 $ - $ 405,166 Patient accounts receivable, net of allowances - 158, ,200 Pledges receivable, net of allowances - - 5,158-5,158 Inventories 918 8, ,605 Other current assets 17,099 55, ,695 Investment in unrestricted funds ,759-13,759 Total Current Assets 18, ,648 43, ,583 Pledges Rececivable, net of allowances ,093-18,093 Receivables From Remainder Trusts - - 8,808-8,808 Property and Equipment, net 36, ,537 18,876 (130) 793,351 Assets Limited As To Use - 611, ,354-1,050,269 Interest in Net Assets of the Foundation - 522,748 - (522,748) - Other Assets 16,810 25,886 9,152-51,848 Total Assets $ 70,926 $ 2,501,734 $ 537,171 $ (522,879) $ 2,586,952 LIABILITIES AND NET ASSETS Current Liabilities: Accounts payable $ 48,782 $ 71,120 $ 120 $ - $ 120,022 Accrued liabilities 33,319 47, ,361 Accrued interest - 2, ,373 Current portion of long-term debt and capital lease obligations - 2, ,727 Other current liabilities 613 2, ,019 Total Current Liabilities 82, , ,502 Long-term Debt and Capital Lease Obligations, net of current portion - 373, ,866 Other Noncurrent Liabilities 717,567 (746,158) 14,111 65,493 51,014 Net Assets: Unrestricted (729,355) 2,224, ,095 (65,624) 1,762,889 Temporarily restricted - 414,366 81,244 (414,339) 81,271 Permanently restricted - 108, ,410 (108,410) 108,410 Total Net Assets (729,355) 2,747, ,748 (588,372) 1,952,570 Total Liabilities and Net Assets $ 70,926 $ 2,501,734 $ 537,171 $ (522,879) $ 2,586,952 15

18 Children's Health System of Texas Children's Medical Center Obligated Group Combining Statements of Operations For the Quarter Ended March 31, 2015 (Unaudited, In Thousands) Children's Health System of Texas Children's Medical Center Children's Medical Center Foundation Children's Medical Center Obligated Group Eliminations Children's Medical Center Obligated Group OPERATING REVENUE: Patient services revenue less contractual allowances and charity allowances $ - $ 297,538 $ - $ - $ 297,538 Provision for doubtful accounts - (4,958) - - (4,958) Net patient service revenue - 292, ,580 Other revenue 11, ,988 Net assets released from restrictions for operations ,136 Total operating revenue 12, , ,704 OPERATING EXPENSES: Salaries and benefits 33,807 99,864 1, ,883 Professional services 24, ,917 Supplies and other (1,537) 32, ,591 General support 26,611 20, ,597 Depreciation and amortization 3,038 10,824 4 (2) 13,864 Interest 26 4, ,410 Shared Services (91,385) 86, (4,544) Total operating expenses (5,086) 254,983 1,824 (2) 251,718 OPERATING INCOME (LOSS) 17,438 38,368 (1,824) 2 53,985 NONOPERATING GAINS (LOSSES): Realized investment gains - 4,502 3,052-7,554 Unrealized investment gains - 7,549 4,491-12,040 Total nonoperating gains - 12,051 7,543-19,594 NET INCOME $ 17,438 $ 50,419 $ 5,719 $ 2 $ 73,579 16

19 Children s Medical Center Obligated Group Notes to Combining Obligated Group Three Months Ended March 31, 2015 Note 1 Basis of Presentation Children s Health Obligated Group (Obligated Group), as defined in the Master Trust Indenture dated September 1, 1988, as supplemented, and further supplemented by Supplemental Indentures through Number 18, dated March 1, 2014, is comprised of Children s Health System of Texas, Children s Medical Center of Dallas and Children s Medical Center Foundation. 17

20 Management's Discussion and Analysis of Financial Condition and Results of Operations

21 Children s Health System of Texas and Affiliates Management s Discussion and Analysis of Financial Condition and Results of Operations Three Months Ended March 31, 2015 (Unaudited) The following discussion and analysis should be read in conjunction with the Children s Health System of Texas Consolidated Financial Statements and the Notes thereto. Summary of Utilization Quarters Ended March 31, 2015 and 2014 First Quarter Inpatient Discharges 4,208 4,798 Patient Days 27,955 25,431 - ICU Days 8,743 7,844 ED Visits 43,307 44,357 Ambulatory Visits 86,581 81,781 Professional Services 63,090 54,710 - CHPG Visits 50,715 43,437 Surgeries 6,875 6,524 Case Mix Index Payor Mix Commercial 33% 31% Managed Medicaid 36% 33% Medicaid 27% 32% Other 4% 4% Volumes Inpatient discharges decreased by 590 days (12%) for the quarter ended March 31, 2015, compared to the same period in the prior year. Patient days increased by 2,524 days (10%) for the quarter ended March 31, 2015, compared to the same period in the prior year. ICU days increased by 899 days (11%) for the quarter ended March 31, 2015, compared to the same period in the prior year. ED visits decreased by 1,050 (2%) for the quarter ended March 31, 2015, compared to the same period in Ambulatory visits increased by 4,800 (6%) for the quarter ended March 31, 2015, compared to the same period in the prior year. Professional services increased by 8,380 (15%) for the quarter ended March 31, 2015, compared to the same period in the prior year. CHPG clinic visits increased by 7,278 (17%) for the quarter ended March , compared to the same periods in CHPG operated 19 clinics in the first quarter of 2015 compared to 16 clinics for the first quarter of Surgeries increased by 351 (5%) for the quarter ended March 31, 2015, compared to the same period in the prior year. The case mix index increased by 0.3 (15%) for the quarter ended March 31, 2015, compared to the same period in the prior year. 19

22 Children s Health System of Texas and Affiliates Management s Discussion and Analysis of Financial Condition and Results of Operations Three Months Ended March 31, 2015 (Unaudited) For the quarter ended March 31, 2015, Commercial payors increased 2%, Managed Medicaid payors increased 3%, and Medicaid payors decreased 5% when compared to the same period in the prior year. Net Patient Service Revenue Patient service revenue is derived from charges for services provided to patients. Physicians order all services provided to patients such as inpatient care and ancillary services, lab tests, drugs, radiology procedures, and surgical procedures. Children s Health records charges as revenue at the time the service is provided. Children s Health has contractual agreements with third-party payers including managed care health plans, such as HMOs and PPOs, and government programs, such as Medicaid and the Children s Health Insurance Program (CHIP), which are both administered by the state of Texas. Payments from these payers are based on charges, fixed per diem rates, the costs of providing services, and discounts from established charges. Children s Health reports revenue at net realizable value after reflecting adjustments provided for in these contracts. Children s Health provides financial counseling to assist patients with no third-party coverage to qualify for government programs. Children s Health records revenue for these patients at net realizable value based on historical qualification rates. Charges for patients that do not qualify for government assistance, but fall within Children s Health s charity guidelines, are recorded as charity care and excluded from net patient service revenue. Accounts receivable on Children s Health s balance sheets is recorded net of allowances for contractual adjustments, doubtful accounts, and charity care. The volume of inpatient, outpatient and surgery patients, as well as the acuity or intensity of care required, drives the level of Children s Health s revenue. Volumes in the intensive care unit have a disproportionately large influence on the level of revenue due to the very high acuity and resource consumption of these patients and because contractual arrangements provide an adequate level of reimbursement for these cases. Expenses Healthcare is a very labor-intensive industry. Salaries and benefits expense, as a percentage of operating expenses were 53% for the quarters ended March 31, 2015 and The salaries and benefits expense category represents salaries for all employees and all employee benefits and payroll-related taxes. Professional services, which includes the costs associated with residents and the cost of contract labor including medical administrative and physician coverage fees, were 9% of the operating expenses for the quarters ended March 31, 2015 and Supplies and other expenses, the cost of supplies, pharmaceuticals, and services directly related to patient care, were 11% of the operating expenses for the quarters ended March 31, 2015 and The general support expense category represents non-clinical supply and service costs in areas such as information services, medical records, and billing and collections. For the quarters ended March 31, 2015 and 2014, general support expenses were 20% of operating expenses. The depreciation and amortization expense category represents the cost of property and equipment and capital leases recognized over the estimated useful lives of the assets and terms of the leases. Depreciation expense, as a percentage of operating expenses, for the quarters ended March 31, 2015 and 2014, were 5% and 6%, respectively. Depreciation and amortization is computed using the straight-line method over a period of 3 to 40 years based on the asset classification or terms of the leases. 20

23 Children s Health System of Texas and Affiliates Management s Discussion and Analysis of Financial Condition and Results of Operations Three Months Ended March 31, 2015 (Unaudited) The interest expense category represents the cost of financing the outstanding bond issues, capital leases, and the purchase of the Pavilion building. Interest expense for the quarters ended March 31, 2015 and 2014, was 2% of operating expenses. For the quarters ended March 31, 2015 and 2014 no interest was capitalized. Results of Operations Operating income of $38.1 million for the quarter ended March 31, 2015, represents a $17.7 million increase over the same period in Net patient service revenue increased $22.5 million (8%) for the quarter ended March 31, 2015, compared to the same period in These increases were due primarily to an increase in the number of patient days and visits for the corresponding periods. Additional components of net patient service revenue include provision for doubtful accounts, disproportionate share, and uncompensated care. The provision for doubtful accounts represents the charges for patient services that are not recovered from patients that are deemed able to pay (and therefore do not qualify under Children s Health charity). These amounts include account balances from uninsured patients and unpaid deductible and co-pay amounts from insured patients. The provision for doubtful accounts decreased $10.3 million for the quarter ended March 31, 2015, compared to the same periods in As a percentage of net patient service revenue, the provision for doubtful accounts was 2% for the quarter ended March 31, Children s Health portion of the DSH program administered by the Texas Department of Human Services increased $0.4 million (11%) for the quarter ended March 31, 2015, compared to the same period in Under the program, local, state, and federal funds are accessed and distributed to hospitals providing a high volume of services to Medicaid and indigent patients. Children s Health portion of the UCP program administered by the Texas Department of Human Services increased $2.7 million (40%) for the quarter ended March 31, 2015, compared to the same period in Children s Health provided charity care of $10.7 million, based on charges, in the quarter ended March 31, The Children s Hospital Graduate Medical Education (CHGME) program receipts decreased $0.1 million for the quarter ended March 31, 2015, compared to the same period in Other operating revenue is primarily derived from DSRIP funds, dietary revenue, user fees, retail pharmacy revenue and other miscellaneous revenue. Other operating revenue increased by $8.1 million (85%) for the quarter ended March 31, 2015, compared to the same time period in DSRIP revenue for the quarter ended March 31, 2015 was $7.8 million compared to none in the prior year. Salaries and benefits increased $8.2 million (6%) for the quarter ended March 31, 2015, compared to the same period in the prior year. Salaries and benefits as a percentage of net patient service revenue were 50% and 51% for the quarters ended March 31, 2015 and Professional services decreased $0.3 million (1%) for the quarter ended March 31, 2015, compared to the same period in As a percentage of net patient service revenue for the quarters ended March 31, 2015 and 2014, professional services were 8% and 9%, respectively. Supply costs increased $1.7 million (6%) for the quarter ended March 31, 2015, compared to the same period in Supply costs as a percentage of net patient service revenue were 10% and 11% for the quarters ended March 31, 2015 and 2014, respectively. 21

24 Children s Health System of Texas and Affiliates Management s Discussion and Analysis of Financial Condition and Results of Operations Three Months Ended March 31, 2015 (Unaudited) General support increased $4.1 million (8%) for the quarter ended March 31, 2015, compared to the same period in General support costs were 19% of net patient service revenue for the quarters ended March 31, 2015 and Depreciation and amortization expense decreased $0.7 million (4%) for the quarter ended March 31, 2015, compared to the same period in As a percentage of net patient service revenue, depreciation and amortization expense was 5% for the quarters ended March 31, 2015 and Interest expense decreased $0.1 million (3%) for the quarter ended March 31, 2015, compared to the same period in Investment income (realized and unrealized investment gains and losses) was a gain of $19.6 million for the quarter ended March 31, 2015, compared to a gain of $16.0 million for the quarter ended March 31, Market conditions drove the gains in 2015 as well as in Liquidity and Capital Resources Children s Health continues to enjoy strong financial liquidity, with unrestricted cash and investments of $1.5 billion or 474 days of cash expenses. Net cash provided by operating and nonoperating activities was $67.4 million for the three months ended March 31, 2015, compared to net cash provided by operating and nonoperating activities of $33.2 million for the same period in Net cash used in investing activities was $25.2 million for the three months ended March 31, 2015, compared to net cash used of $21.2 million for the three months ended March 31, Net cash provided by financing activities was $0.6 million for the three months ended March 31, 2015, compared to net cash used by financing activities of less than $0.1 million for the three months ended March 31, In 2014, Children s Health entered into a capital lease obligation for the purchase of patient beds for $2.5 million. Critical Accounting Policies and Estimates The consolidated financial statements of Children s Health have been prepared in accordance with accounting principles generally accepted in the United States. In preparing the financial statements, management makes estimates, judgments, and assumptions that affect the reported amounts of assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Management believes that, of the accounting policies that are most important to the portrayal of Children s Health s financial condition and results of operations, the following accounting policies require management s most difficult, subjective, or complex estimates and assessments. Allowance for Contractual Discounts and Third-Party Settlements Children s Health derives a significant portion of revenue from the Medicaid program, managed care organizations, and other governmental programs that receive discounts from standard charges. The Medicaid regulations and various managed care contracts under which these discounts must be calculated are complex and are subject to interpretation and adjustment. Children s Health estimates the allowance for contractual discounts on a payer-specific basis given its interpretation of the applicable regulations or contract terms. However, the services authorized and provided, and the resulting reimbursement, are often subject to interpretation and sometimes result in payments that differ from Children s Health s estimates. Children s Health is paid by the Medicare program according to a cost-based reimbursement methodology under which an annual cost report is filed to report the cost of providing services and to settle the difference between the interim payments Children s Health receives and the actual cost. The cost report is subject to 22