Consolidated Financial Statements, Management s Discussion and Analysis and Other Interim Information. Palmetto Health and Subsidiaries

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1 Consolidated Financial Statements, Management s Discussion and Analysis and Other Interim Information Palmetto Health and Subsidiaries As of June 30, 2014 and September 30, 2013 and for the three months and nine months ended June 30, 2014 and 2013

2 Table of Contents Management s Discussion and Analysis Consolidated Financial Statements: Balance Sheets... 8 Statements of Operations... 9 Statements of Changes in Net Assets Statements of Cash Flows Other Interim Information

3 Management s Discussion and Analysis For the Nine Months ended June 30, 2014 RESULTS OF OPERATIONS Palmetto Health s earnings are reported in accordance with generally accepted accounting principles (GAAP). Management believes that earnings reported under GAAP provides a meaningful representation of its fundamental earnings power and can be used in performing period-over-period financial analysis and comparison with peer group data. This measure is also used by management in making resource allocation and other budgetary and operational decisions. Operating (Loss) Income Three Months Ended Nine Months Ended June 30, June 30, Change June 30, June 30, Change $ $ Operating (loss) income $ (9,684) $ 688 $ (10,372) $ (12,878) $ 15,025 $ (27,903) Third Quarter Operating (loss) income decreased $10,372 from the three months ended June 30, 2013 to June 30, This decrease is due to the increase in operating expenses of $24,513 or 9.0%, offset by the increase in the unrestricted revenue, gains, and other support of $14,141, or 5.2%. See further discussion of these variances on the following page. Year to Date Operating (loss) income decreased $27,903 from the nine months ended June 30, 2013 to June 30, This decrease is due to the increase in operating expenses of $43,650 or 5.4%, offset by the increase in the unrestricted revenue, gains, and other support of $15,747, or 1.9%. See further discussion of these variances on the following page. Page 1

4 Management s Discussion and Analysis For the Nine Months ended June 30, 2014 Unrestricted Revenue, Gains and Other Support Three Months Ended June 30, Nine Months Ended June 30, Change Change $ % $ % Revenue at established charges $ 1,048,274 $ 1,009,711 $ 38, % $ 3,056,288 $ 2,955,113 $ 101, % Contractual adjustments (678,658) (660,463) (18,195) -2.8% (1,980,334) (1,906,826) (73,508) -3.9% Charity care (46,108) (44,565) (1,543) -3.5% (134,249) (130,685) (3,564) -2.7% Disproportionate share funding Net patient service revenue 3,800 2,550 1, % 10,550 7,650 2, % 327, ,233 20, % 952, ,252 27, % Provision for uncollectible accounts (59,932) (57,254) (2,678) 4.7% (174,526) (167,657) (6,869) 4.1% Net patient service revenue less provision for uncollectible accounts 267, ,979 17, % 777, ,595 20, % Other revenue 21,083 24,339 (3,256) -13.4% 64,152 68,539 (4,387) -6.4% Total $ 288,459 $ 274,318 $ 14, % $ 841,881 $ 826,134 $ 15, % Third Quarter The increase in unrestricted revenue, gains and other support was due to the increases in negotiated managed care rates and an average 3.5% price increase at the beginning of October 2013 and the opening of the Palmetto Health Baptist Parkridge Hospital (Parkridge Hospital) in mid-march These increases were partially offset by 1) a reduction in commercially insured patient service volume likely attributable to the increased use of high deductible insurance plans, 2) a shift from inpatient surgery to outpatient based surgeries, and 3) the loss of several OBGYN physicians. In addition, the decrease in other revenue is primarily related to the reduction in meaningful use funding. Year to Date The increase in unrestricted revenue, gains and other support was a result of the increases in negotiated managed care rates and an average 3.5% price increase at the beginning of October 2013 and the opening of the Parkridge Hospital in mid-march There were offsetting decreases due to the following factors: 1) significant snow events that adversely impacted patient service volume in both January and February, 2) a reduction in commercially insured patient service volume likely attributable to the increased use of high deductible insurance Page 2

5 Management s Discussion and Analysis For the Nine Months ended June 30, 2014 plans, 3) a shift from inpatient surgery to outpatient based surgeries, and 4) the loss of several OBGYN physicians. In addition, the decrease in other revenue is primarily related to the reduction in meaningful use funding. Operating Expenses Three Months Ended June 30, Nine Months Ended June 30 Change Change $ % $ % Salaries and benefits $ 161,366 $ 151,089 $ 10, % $ 461,923 $ 441,719 $ 20, % Supplies and other expenses 113, ,969 11, % 329, ,785 24, % Depreciation and amortization 15,888 13,993 1, % 43,239 42, % Interest expense 7,014 6, % 20,287 22,305 (2,018) -9.0% Total expenses $ 298,143 $ 273,630 $ 24, % $ 854,759 $ 811,109 $ 43, % Third Quarter Operating expenses increased primarily due to salaries and benefits and supplies and other expenses. Salaries and benefits expense increased $10,277, or 6.8%, including 1) a 2.1% overall pay increase effective April 2014, 2) staffing of the Parkridge Hospital, and 3) an increase in overtime and agency staffing due to competitive labor pressures particularly in critical care units and the emergency department. As a result, Management has increased focus on controlling the use of overtime and agency staffing. Supplies and other expenses increased $11,906 or 11.7% primarily as a result of changes in utilization patterns in pharmacy and implants, as well as price increases and inflation. In continuance of Management cost saving initiatives, consultants are engaged to identify potentially unnecessary or non-value added expenses. Depreciation and amortization expense increased due to timing of projects placed into service, including the opening of the Parkridge Hospital. Interest expense increased primarily due to fluctuations in market conditions. Page 3

6 Management s Discussion and Analysis For the Nine Months ended June 30, 2014 Year to Date Operating expenses increased primarily due to salaries and benefits and supplies and other expenses. Salaries and benefits increased $20,204 or 4.6%, including 1) a 2.1% overall pay increase effective April 2014, 2) staffing of the Parkridge Hospital, and 3) an increase in overtime and agency staffing due to competitive labor pressures particularly in critical care units and the emergency department. As a result, Management has increased focus on controlling the use of overtime and agency staffing. Supplies and other expenses increased $24,525 or 8.1% primarily as a result of changes in utilization patterns in pharmacy and implants, as well as price increases and inflation. In continuance of Management cost saving initiatives, consultants are engaged to identify potentially unnecessary or non-value added expenses. Depreciation and amortization expense increased due to timing of projects placed into service, including the opening of the Parkridge Hospital. Interest expense decreased primarily due to fluctuations in market conditions and the swap redesign in April Revenue and gains (under) over expenses and losses Revenue and gains (under) over expenses and losses Three Months Ended June 30, Nine Months Ended June 30, Change Change $ % $ % $ (5,128) $ 1,873 $ (7,001) % $ 14,370 $ 46,521 $ (32,151) -69.1% Third Quarter Revenues and gains (under) over expenses and losses decreased $7,001 due primarily to the $10,372 decrease in operating (loss) income described above. In addition, there was a $17,827 decrease in net change in unrealized (loss) gain on derivative financial instruments from a gain of $9,192 for the three months ended June 30, 2013 to an $8,635 loss for the three months June 30, There was also an offsetting $8,716 increase in net investment income, as well as an $11,715 increase in net change in unrealized (loss) gain in trading investments, both due to changes in market conditions. Year to Date Revenues and gains over expenses and losses decreased $32,151 due to the $43,650 decrease in operating income described above, as well $4,434 of start-up costs incurred in relation to the mid-march 2014 opening of Parkridge Hospital. In addition, there was a $32,134 decrease in net change in unrealized (loss) gain on derivative financial instruments from a $17,977 gain for the nine months ended June 30, 2013 to a $14,157 loss for the nine months ended June 30, There was an offsetting $6,580 increase in net investment income, as well as a $22,338 increase in net unrealized gain in trading investments. Both of these variances are due to changes in market conditions. Page 4

7 Management s Discussion and Analysis For the Nine Months ended June 30, 2014 (Decrease) increase in unrestricted net assets Three Months Ended June 30, Nine Months Ended June 30, Change Change $ % $ % (Decrease) increase in unrestricted net assets $ (4,994) $ 2,481 $ (7,475) % $ 15,842 $ 48,175 $ (32,333) -67.1% Third Quarter The change in unrestricted net assets decreased primarily from the decrease in revenue and gains (under) over expenses of $7,001 described above. Year to Date The change in unrestricted net assets decreased primarily from the decrease in revenue and gains over expenses of $32,151 described above. LIQUIDITY, FINANCIAL RESOURCES, AND FINANCIAL POSITION June 30, September 30, Change $ % Total cash, cash equivalents and assets limited as to use $ 771,676 $ 783,717 $ (12,041) -1.5% Total assets 1,724,160 1,660,519 63, % Total liabilities 874, ,128 47, % Total net assets 850, ,391 16, % Palmetto Health's unrestricted cash and investments fair value were approximately $716,048 at June 30, 2014 and $749,327 at September 30, 2013, representing 241 and 264 days of cash operating expenses, respectively. The decrease is primarily due to the $19,600 purchase of a medical office building located on the Parkridge Hospital campus in March 2014, partially offset by the receipt of proceeds from the issuance of Series 2010 bonds that were used in funding routine equipment. Subsequently, in July 2014, Palmetto Health received over $30,000 in bond proceeds for both the purchased medical office building mentioned above, as well as the constructed ambulatory services building, both of which are located on the Parkridge Hospital campus. Palmetto Health's long-term debt balances (including current maturities) were $677,629 at June 30, 2014 and $629,286 at September 30, 2013, due primarily to the issuance of $48,734 in Series 2010 bonds in the nine months ended June 30, Palmetto Health's ratio of unrestricted cash and investments to long-term debt (excluding current maturities) was 105.7% at June 30, 2014, and 119.1% at September 30, Page 5

8 Management s Discussion and Analysis For the Nine Months ended June 30, 2014 Total assets increased $63,641 or 3.8% primarily due to several areas including net patient accounts receivable, property and equipment and other current assets. The increase in net patient accounts receivable of $7,063 or 24.3% is attributable to the 3.5% price increase that went into effect the beginning of October 2013 as well as negotiated managed care rates, as well as the opening of the Parkridge Hospital opening in mid-march In addition, there was also a $48,876 increase in net property and equipment largely as a result of the construction of the Parkridge Hospital. Lastly there was a $5,006 or 45.0% increase in other current assets due primarily to accrued interest caused by timing of payment due dates. These increases were partially offset by the decrease in total cash, cash equivalents, and assets limited as to use of $12,041 or 1.5% and a $5,518 decrease in other receivables from the reduction in meaningful use funding mentioned previously. Total liabilities increased $47,002 or 5.7% primarily due to the $48,343 increase in long term debt (including current portion). As discussed above, this was due primarily to the issuance of $48,734 in Series 2010 bonds in the nine months ended June 30, There was also a $12,838 decrease in accounts payable and a $5,966 decrease in other current liabilities as a result of timing. In addition, there was an offsetting $16,639 increase in other noncurrent liabilities primarily due to the $14,157 additional loss in net unrealized (loss) gain in derivative financial instruments. Net assets increased $16,639 or 2.0%, most of which relates to the increase in unrestricted net assets of $15,842 described previously. The status of Palmetto Health s various CON s follows: In August 2007, DHEC approved the CON for the Parkridge Hospital, a 76-bed, 186,000 square foot community-based facility. The hospital s construction is complete and the hospital opened mid-march In conjunction with the Parkridge Hospital opening discussed above, Palmetto Health is constructing an 80,000 square foot ambulatory services building that is designated for use by the hospital and Palmetto Health owned physician practices. The construction is complete and the ambulatory services building opened approximately one month before Parkridge Hospital. In December 2012, a CON was submitted to DHEC for the $3,559 Baptist imaging upgrade, which includes purchase and installation of two new CT scanners, in addition to related renovations and relocation of another CT scanner to the northeast outpatient imaging location. This CON application was submitted to DHEC for review. In December 2012, a CON was submitted to DHEC for the $4,608 hybrid operating room, which enables both open surgical and close endovascular procedures in the same place. This project includes angiography imaging equipment, space renovation, and the addition of a control room. This CON application was approved June 2013 and a CON was issued July 10, In February 2013, a CON was submitted to DHEC for the $2, T MRI unit at the Parkridge Hospital facility. This project includes equipment and space renovation. This CON application was submitted to DHEC for review. Other than those mentioned above, there are no other significant CON s or approval by Palmetto Health s Board of Directors for any other non-routine capital expenditures, which are approximately $60,000 annually. Although no other major capital expenditures have either an approved CON or have been approved by the Board as of the date of this statement, the Board continually considers strategic capital expenditures and could approve such expenditures at any time in the future. Page 6

9 Management s Discussion and Analysis For the Nine Months ended June 30, 2014 On June 25, 2013, the Governor of South Carolina issued a veto of funding for South Carolina s Certificate of Need ( CON ) program, which is the regulatory review process that requires hospitals and other health care facilities to obtain authorization from the State in order to construct new health care facilities, make major capital expenditures, purchase high cost medical equipment, or expand services. On June 26, 2013, the South Carolina House of Representatives failed to override the Governor's veto of CON program funding, allowing the veto to stand. However, the CON general statutory law (the CON Statute ) has not been repealed. On June 28, 2013, the DHEC Director issued a letter to the regulated community advising that DHEC intends to suspend operation of the CON program beginning July 1, 2013, and that therefore: (i) DHEC cannot review new or existing CON applications; (ii) DHEC cannot take any CON enforcement action; (iii) suspending the program has the practical effect of allowing new and expanding health care facilities to move forward without the CON process; and (iv) should the General Assembly restore the program in the future, DHEC will not be inclined to take enforcement actions under the CON Statute for activity that occurs during the program s suspension, unless instructed otherwise by the General Assembly. On July 1, 2013, DHEC filed a petition seeking permission to proceed in the original jurisdiction of the South Carolina Supreme Court and have the Court hear a declaratory judgment action requesting a determination that DHEC s duty to administer and enforce the CON Statute during Fiscal Year has been suspended by the General Assembly s failure to override the Governor s veto of the monies appropriated by the General Assembly in the State Budget to fund the CON program. DHEC further requested a declaration from the Court as to the effect of the CON program suspension on members of, among other entities, the South Carolina Hospital Association ( SCHA ). Respondents to DHEC s petition, including SCHA, filed a motion to dismiss the petition. On July 18, 2013, a group of twelve petitioners, including hospitals, nursing homes, South Carolina Health Care Association, and SCHA filed a petition and complaint seeking permission to proceed in the original jurisdiction of the South Carolina Supreme Court, and seeking a declaratory judgment that the South Carolina legislature s failure to override the Governor s veto of CON program funding does not operate as an express or implied repeal or suspension of the CON Statute and that DHEC must continue to administer and enforce the CON Statute. The complaint also seeks a declaratory judgment that DHEC has received, and will continue to receive, sufficient funds from certain fees, intra-agency transfers and other deficit resolving measures to fund DHEC s administration and enforcement of the CON Statute. DHEC has filed a motion to dismiss the complaint. On April 14, 2013 the South Carolina Supreme Court issued their opinion on the Certificate of Need (CON) case, ruling in favor of SCHA, SCHCA, and the members who filed the petition asking that the CON statute be upheld. They found no irreconcilable conflict between the CON Act and the absence of funding in the Appropriations Act and that the failure to fund the CON program does not negate the directive issued by the General Assembly (and detailed in the CON Act) mandating DHEC administer the CON program. In response to the CON ruling, Governor Haley and DHEC indicated that they will continue their opposition to CON and intend to file a motion for reconsideration. Until the Supreme Court rules on the reconsideration motion, it is unlikely that DHEC will enforce the statute. The legal implications of these events, as well as the risks that competitors may take to pursue projects without CON review and which may adversely affect the utilization and revenues of existing hospitals, is unclear at this time. In July 2014 the CON office has reopened but it is not yet clear if new applications are being accepted. The 1.5T MRI CON discussed previously is the only CON submitted by Palmetto Health that has not yet been approved. Page 7

10 Consolidated Balance Sheets June 30, 2014 (Unaudited) and September 30, 2013 (Audited) June 30, September 30, (Unaudited) (Audited) Assets Current assets: Cash and cash equivalents $ 19,268 $ 23,499 Assets limited as to use 36,155 29,092 Patient accounts receivable, net 226, ,651 Other receivables 25,894 31,412 Inventories 19,566 17,934 Other current assets 16,138 11,132 Total current assets 343, ,720 Assets limited as to use 716, ,126 Property and equipment, net 601, ,124 Other assets 62,925 59,549 $ 1,724,160 $ 1,660,519 Liabilities and Net Assets Current liabilities: Current portion of long-term debt $ 21,346 $ 21,485 Current portion of capital lease obligations Accounts payable 34,687 47,525 Accrued salaries and benefits 52,022 57,988 Other current liabilities 27,567 26,123 Total current liabilities 136, ,878 Long-term debt, net 656, ,801 Capital lease obligations, net 20,160 20,807 Other noncurrent liabilities 61,281 44,642 Total liabilities 874, ,128 Commitments and contingencies Net assets: Unrestricted 815, ,524 Temporarily restricted 26,920 26,133 Permanently restricted 7,744 7,734 Total net assets 850, ,391 $ 1,724,160 $ 1,660,519 The accompanying notes are an integral part of these consolidated financial statements. Page 8

11 Consolidated Statements of Operations For the Three and Nine Months Ended June 30, 2014 and 2013 (Unaudited) Three Months Ended Nine Months Ended June 30, June 30, June 30, June 30, (Unaudited) (Unaudited) (Unaudited) (Unaudited) Unrestricted revenue, gains and other support: Net patient service revenue $ 327,308 $ 307,233 $ 952,255 $ 925,252 Provision for uncollectible accounts (59,932) (57,254) (174,526) (167,657) Net patient service revenue less provision for uncollectible accounts 267, , , ,595 Other revenue 21,083 24,339 64,152 68,539 Total unrestricted revenue, gains and other support 288, , , ,134 Expenses: Salaries and benefits 161, , , ,719 Supplies and other expenses 113, , , ,785 Depreciation and amortization 15,888 13,993 43,239 42,300 Interest expense 7,014 6,579 20,287 22,305 Total expenses 298, , , ,109 Operating (loss) income (9,684) 688 (12,878) 15,025 Nonoperating (expenses) income: Interest expense - (125) - (375) Investment income, net 14,128 5,412 32,703 26,123 Swap termination costs - (543) - (543) Start-up costs - - (4,434) - COPA Community health improvement projects (444) (543) (1,539) (4,023) Revenue and gains (under) over expenses and losses before net change in unrealized (loss) gain on derivative financial instruments and trading investments 4,000 4,889 13,852 36,207 Net change in unrealized (loss) gain on derivative financial instruments (8,635) 9,192 (14,157) 17,977 Net change in unrealized (loss) gain on trading investments (493) (12,208) 14,675 (7,663) Revenue and gains (under) over expenses and losses (5,128) 1,873 14,370 46,521 (Decrease) increase in interest in Affiliated Foundations (96) (56) 780 (21) Capital contributions expended and received Net adjustment for defined benefit plans (Decrease) increase in unrestricted net assets $ (4,994) $ 2,481 $ 15,842 $ 48,175 The accompanying notes are an integral part of these consolidated financial statements. Page 9

12 Consolidated Statements of Changes in Net Assets For the Year Ended September 30, 2013 (Audited) and the Nine Months Ended June 30, 2014 (Unaudited) Unrestricted Temporarily Restricted Permanently Restricted Balance as of September 30, 2012 (Audited) $ 725,393 $ 24,395 $ 7,259 $ 757,047 Revenue and gains over expenses and losses 69, ,699 (Decrease) increase in interest in Affiliated Foundations (174) 1, ,322 Net adjustment for defined benefit plans 3, ,741 Subsidiary equity transaction Contributions and grants - 8,946-8,946 Net assets released from restrictions used for capital 707 (707) - - Net assets released from restrictions used for operations - (7,522) - (7,522) Increase in net assets 74,131 1, ,344 Balance as of September 30, 2013 (Audited) $ 799,524 $ 26,133 $ 7,734 $ 833,391 Revenue and gains over expenses and losses 14, ,370 Increase in interest in Affiliated Foundations 780 1, ,457 Net adjustment for defined benefit plans Contributions and grants - 4,621-4,621 Net assets released from restrictions used for operations - (5,501) (5,501) Increase in net assets 15, ,639 Balance as of June 30, 2014 (Unaudited) $ 815,366 $ 26,920 $ 7,744 $ 850,030 Total The accompanying notes are an integral part of these consolidated financial statements. Page 10

13 Consolidated Statements of Cash Flows June 30, June 30, (Unaudited) (Unaudited) Cash flows from operating activities: Increase in net assets $ 16,639 $ 50,289 Adjustments to reconcile increase in net assets to net cash provided by operating activities: Change in interest in Affiliated Foundations (2,457) (1,848) (Gain) loss on equity method investments (1,257) 1,267 Net change in unrealized loss (gains) on derivative financial instruments 14,157 (17,977) Depreciation and amortization 43,239 42,300 Provision for uncollectible accounts 174, ,657 Loss on the disposal of property and equipment Net adjustment for defined benefit plans (692) (811) Changes in operating assets and liabilities: Patient accounts receivable (196,836) (178,639) Other receivables 5,518 8,890 Accounts payable and accrued salaries and benefits (18,804) (1,986) Other assets 338 (353) Other liabilities 4,618 (19,572) Other, net (15,454) (5,440) Net cash provided by operating activities before trading investments 23,565 43,915 Trading investments 7,810 (14,590) Net cash provided by operating activities 31,375 29,325 Cash flows from investing activities: Additions to property and equipment (82,965) (82,968) Proceeds from sale of property and equipment Net cash used in investing activities (82,859) (82,967) Cash flows from financing activities: Proceeds from issuance of long term debt 48,734 50,718 Payments of long-term debt (861) (103) Payments on capital lease obligations (620) (423) Net cash provided by financing activities 47,253 50,192 Net decrease in cash and cash equivalents (4,231) (3,450) Cash and cash equivalents, beginning of year 23,499 24,937 Cash and cash equivalents, end of year $ 19,268 $ 21,487 The accompanying notes are an integral part of these consolidated financial statements. Page 11

14 Consolidated Statements of Cash Flows (continued) June 30, June 30, (Unaudited) (Unaudited) Supplemental information Cash paid during the year for interest $ 806 $ 578 Noncash investing and financing activities: Accrued capital expenditures $ 8,816 $ 10,294 The accompanying notes are an integral part of these consolidated financial statements. Page 12

15 Note 1 - Description of Organization and Summary of Significant Accounting Policies Organization and Business In 1998, Richland Memorial Hospital (Richland) and Baptist Healthcare System of South Carolina, Inc. (Baptist) formed Palmetto Health through the execution of a joint operating agreement. Palmetto Health is composed of substantially all of the assets and liabilities of Richland and Baptist. In mid-march 2014 Palmetto Health opened Palmetto Health Baptist Parkridge Hospital (Parkridge Hospital). Palmetto Health is organized as a South Carolina nonprofit public benefit corporation exempt from federal and state income taxes under Section 501(c)(3) of the Internal Revenue Code (IRC). The governance of Palmetto Health consists of a 16-member board of directors, with six directors appointed by Richland, six by Baptist, three by the board of Palmetto Health, and Palmetto Health s Chief Executive Officer who serves as an ex officio voting member of the Board. Both Richland and Baptist elect at least one director each that is a licensed physician or dentist, and Chair of the Board of Trustees of each is a director without term limit. Palmetto Health also includes its for-profit, wholly owned subsidiaries HealthSource, Inc., Premier Practice Management-Carolina, Inc. (PPM) and Parkridge Surgery Center, LLC (Parkridge LLC). Prior to May 2013, Parkridge LLC was majority owned (72.2% - owned at September 30, 2012). Effective July 1, 2014 Parkridge LLC ceased clinical operations and the clinical activities previously provided by Parkridge LLC are now included in the outpatient operations of Parkridge Hospital. Principles of Consolidation The consolidated financial statements include all accounts of Palmetto Health and its Subsidiaries (Palmetto Health). All significant intercompany balances and transactions have been eliminated in consolidation. Investments in affiliates which Palmetto Health does not control are accounted for either at cost or under the equity method. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires that management make estimates and assumptions affecting the reported amounts of assets, liabilities, revenues and expenses, as well as disclosure of contingent assets and liabilities. Actual results could differ from those estimates. Significant estimates include, but are not limited to, accounts receivable allowances, third-party payor receivables and payables, useful lives assigned to capital assets, professional liability and other self-insurance accruals, and pension and post-retirement plan assumptions. In particular, laws and regulations governing the Medicare and Medicaid programs are extremely complex and subject to interpretation. As a result, there is at least a possibility that recorded estimates associated with these programs will change by a material amount in the near term. Costs of Borrowing Deferred financing costs and bond discounts are amortized over the period related obligations are outstanding using the effective interest method. Interest costs incurred on borrowed funds during the period of construction of capital assets, net of investment earnings on related trusteed funds, are capitalized as a component of the cost of acquiring those assets. Page 13

16 Cash and Cash Equivalents Cash and cash equivalents include certain investments in highly liquid debt instruments with original maturities of three months or less. Palmetto Health maintains bank accounts at financial institutions, of which at June 30, 2014, $1,250 are covered by the Federal Depository Insurance Corporation (FDIC), while the remaining $18,018 is in excess of the federally insured limit of $250 per institution. Management selects high-quality financial institutions for deposit maintenance and Palmetto Health has never experienced a loss in its FDIC-uninsured deposits. Other Receivables Other receivables include amounts expected to be received and collected in connection with the settlement of Medicare and Medicaid cost report filings. Other receivables also include funds expected to be received from the State of South Carolina disproportionate share program, which enhances Medicaid funding to acute care hospitals. Palmetto Health recognizes revenue monthly based on the provisions of the program, which follows the state fiscal year of July 1 through June 30. Therefore, included in other receivables is an accrual for the funds earned from the program that have not yet been collected during the periods reported. Inventories Inventories, consisting principally of medical supplies and pharmaceuticals, are determined using the first-in, first-out (FIFO) method and are stated at the lower of cost or market. Assets Limited as to Use Assets limited as to use include assets held by trustees under indenture agreements and designated assets set aside by the Board of Directors, primarily for future capital improvements, over which the board retains control and may, at its discretion, subsequently use for other purposes. Amounts required to meet current liabilities have been reclassified as current assets. Assets limited as to use are comprised of cash and investments. Investments in equity securities with readily determinable fair values and all investments in debt securities are reported at fair value in the accompanying consolidated balance sheets. Interest and dividend income and realized gains and losses are reported as nonoperating gains or losses in the accompanying consolidated statements of operations, except for investment income on funds held by the trustee, which is included in other revenue. Investment income and realized gains or losses on investments of donor-restricted funds are also included in other revenue unless the income or loss is restricted by donors, in which case the investment income is recorded directly to temporarily or permanently restricted net assets in accordance with the donor s wishes. Palmetto Health has designated and reported its entire investment portfolio as a trading portfolio as defined by the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 320, Investments Debt and Equity Securities. All changes in unrealized gains and losses on investments are also included within revenue and gains over expenses and losses (the performance indicator). Page 14

17 Property and Equipment All property and equipment transferred from Richland and Baptist, either by long-term lease in the case of real property or by conveyance of title in the case of personal property, has been recorded at the historical book values of Richland and Baptist. Although the title to the real property noted above has been retained by Richland and Baptist, the operating rights of the real property and improvements thereon have been conveyed to Palmetto Health. In addition, under the leases of real property, improvements on or to leased real property are covered under the lease. Real property under the leases cannot be sold without the prior consent of Richland and Baptist. Should real property held under leases be sold, it is the opinion of Palmetto Health s management and legal counsel that the proceeds would be retained in Palmetto Health. Property and equipment is stated at cost or, if donated, at fair value at time of donation. Additions and improvements are capitalized and depreciated over the estimated remaining useful lives of the related assets, primarily using the straight-line method. A summary of estimated useful lives follows: Buildings and improvements Land improvements Equipment and furniture 5 to 40 years 3 to 8 years 3 to 20 years Other Noncurrent Liabilities Other noncurrent liabilities include the fair value of derivatives in a liability position with maturities due in more than one year (see Note 12), deferred revenue, certain compensation accruals, and professional and general liability accruals. Deferred revenue represents unearned revenue on certain health care programs. Deferred compensation represents the obligation on retirement compensation for certain executives. Medical malpractice and general liability accruals represent Palmetto Health s self-insured retention and tail obligations (see Note 14). Donor-restricted Gifts Unconditional promises to give cash and other assets are reported at estimated fair value at the date the promise is received. Conditional promises to give are recognized when the conditions are substantially met, and indications of intentions to give are reported at fair value at the date the gift is received. The gifts are reported as either temporarily or permanently restricted net assets if they are received with donor stipulations that limit the use of the donated assets. When a donor restriction expires (that is, when a stipulated time restriction ends or purpose restriction is accomplished), temporarily restricted net assets are classified as unrestricted net assets and reported as net assets released from restrictions. To the extent that restricted resources from multiple donors are available for the same purpose, Palmetto Health expends such gifts on a FIFO basis. Interest Expense Proceeds from issuance of long-term debt effectively provide Palmetto Health with capital planning flexibility in the deployment of assets whose use is limited. Management considers associated investing and financing decisions to be nonoperating in nature and, accordingly, a calculated portion of interest expense is classified as nonoperating in the accompanying consolidated statements of operations. Page 15

18 Operating (Loss) Income Consistent with relevant accounting principles and industry practice, the following items are excluded from operating (loss) income: nonoperating (expenses) income, net change in unrealized gain on derivative financial instruments and net change in unrealized gain on trading investments. Nonoperating (expenses) income includes interest expense on debt obtained for investment purposes, net investment income, start-up costs and the Certificate of Public Advantage (COPA) commitment. The change in unrestricted net assets includes increase (decrease) in interest in Affiliated Foundations, contributions received and expended for capital purposes, and net adjustment for defined benefit plans. Revenue and Gains (Under) Over Expenses and Losses Changes in unrestricted net assets are excluded from revenue and gains (under) over expenses and losses (the performance indicator) consistent with relevant accounting principles and industry practice (see Operating (Loss) Income above for description of items included in changes in unrestricted net assets). Unrestricted Revenue, Gains and Other Support Net patient service revenue is reported at the estimated net realizable amounts due from patients, third-party payors and others for services rendered, including estimated retroactive adjustments under reimbursement agreements with third-party payors. Retroactive adjustments are accrued on an estimated basis in the period the related services are rendered and adjusted in future periods as final settlements are determined. Other revenue includes certain capitated arrangements, contributions from donors (when conditions are substantially met), grants, rental income, rebates, equity investee income, Baptist Easley Hospital (BEH) service contract revenue (see Note 4), and certain investment income and other miscellaneous income. Charity Care Palmetto Health provides care to patients who meet certain criteria under its charity care policies without charge or at amounts less than its established rates. Because Palmetto Health does not pursue the collection of amounts determined to qualify as charity care, they are not reported as net patient service revenue. Palmetto Health determines the costs associated with providing charity care by aggregating the applicable direct and indirect costs, including salaries, wages and benefits, supplies and other operating expenses, based on data from its costing system. Palmetto Health maintains records to identify and monitor the level of charity care it provides. These records include the amount of charges foregone for services and supplies furnished under its charity care policies. Income Taxes Palmetto Health qualifies as an organization exempt from federal and state income taxes on related income under IRC section 501(c)(3). Palmetto Health has two taxable subsidiaries, HealthSource, Inc. and PPM. As of June 30, 2014, HealthSource, Inc. estimates taxable income of $320 for the year ended September 30, 2013 and has recorded a tax provision of $99 as of June 30, In addition, as of June 30, 2014, Palmetto Health has recorded a tax provision of $90 for estimated taxes associated with unrelated business income. The entire amount was paid in full as of September 30, 2013, and therefore, no additional liability has been recorded on the books. Palmetto Health continues to evaluate tax positions related to ASC 740, Income Taxes, which prescribes financial statement recognition threshold and measurement attributes for tax positions taken or expected to be taken in tax returns. Page 16

19 Derivative Instruments and Hedging Activities Palmetto Health selectively enters into interest rate protection agreements to mitigate changes in interest rates on variable rate borrowings. The notional amounts of such agreements are used to measure the interest to be paid or received and do not represent the amount of exposure to loss. None of these agreements are used for speculative or trading purposes. Palmetto Health recognizes all derivatives as either assets or liabilities in the consolidated balance sheets and measures those instruments at their fair value. The accounting for changes in the fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and further, the type of hedging relationship. Palmetto Health s derivative instruments are not designated as hedging instruments, requiring the net unrealized gains and losses arising from fair value changes to be recognized in the performance indicator. All of Palmetto Health s interest rate derivative instruments involve elements of credit and market risk in excess of the amounts recognized in the consolidated financial statements. The counterparty to the financial instruments is a major financial institution. The Swap counterparty was rated A- by Standard & Poor s and Baa2 by Moody s Investors Services as of June 30, In addition to limiting the amounts of the agreements and contracts it enters into with any one party, Palmetto Health routinely monitors its positions with and the credit quality of counterparties to such financial instruments. Palmetto Health does not anticipate nonperformance by its current counterparties. Impairment of Long-lived Assets Long-lived assets, such as property and equipment and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized to the extent the carrying amount of the asset exceeds the fair value of the asset. If applicable, assets to be disposed of are separately presented in the consolidated balance sheets and reported at the lower of the carrying amount or fair value less costs to sell, and no longer depreciated. The assets and liabilities of a disposal group classified as held-for-sale are presented separately in the appropriate asset and liability sections of the consolidated balance sheets. Based on management s assessment, no impairment of long-lived assets was considered necessary. Commitments and Contingencies Liabilities for loss contingencies, including costs arising from claims, assessments, litigation, fines and penalties and other sources, are recorded when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Temporarily and Permanently Restricted Net Assets Temporarily restricted net assets are those whose use by Palmetto Health has been limited by donors to a specific time period or purpose. Permanently restricted net assets, generally representing specified endowments, have been restricted by donors to be maintained by Palmetto Health in perpetuity. Temporarily restricted net assets are generally available to fund designated capital expenditures and specific health care programs of Palmetto Health which include the Children s Hospital, Cancer Programs, Hospice and Camp Kemo. Page 17

20 Asset Retirement Obligations The fair value of a liability for legal obligations associated with asset retirements is recorded in the period in which it is incurred, if a reasonable estimate of the fair value of the obligation can be made. When the liability is initially recorded, the cost of the asset retirement obligation is capitalized by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost associated with the retirement obligation is depreciated over the useful life of the related asset. Upon settlement of the obligation, any difference between the cost to settle the asset retirement obligation and the liability recorded is recognized as a gain or loss in the consolidated statements of operations (see Note 19). Fair Value of Financial Instruments The carrying amounts reported in the accompanying consolidated balance sheets for cash and cash equivalents, patient accounts receivable, other receivables, other current assets, accounts payable, accrued salaries and benefits, and other current liabilities, approximate fair value due to the relatively short maturity of the respective instruments. Recently Issued Accounting Standards Accounting Standards Update (ASU) amends ASC , Balance Sheet: Offsetting, to enhance disclosures about financial instruments and derivative instruments that are either offset in accordance with U.S. Generally Accepted Accounting Principles (GAAP) or are subject to an enforceable master netting arrangement or similar agreement. The additional disclosures will facilitate comparisons between financial statements prepared under International Financial Reporting Standards (IFRS) versus U.S. GAAP. The amended guidance is effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods and should be applied retrospectively to all comparative periods presented. Palmetto Health is continuing to evaluate this guidance and will adopt this guidance for fiscal year As ASU relates only to disclosures, adoption will not impact results of operations, cash flows or financial position. Note 2 - Joint Operating Agreement and Certificate of Public Advantage (COPA) The State of South Carolina issued a Certificate of Public Advantage (COPA) in connection with the Joint Operating Agreement arising from Palmetto Health s formation. Among other conditions, the COPA requires Palmetto Health to: Provide an annual report to the South Carolina Department of Health and Environmental Control (DHEC). Generally provide 10% of the excess of revenue and gains over expenses and losses to fund public health initiatives and community outreach programs. These terms will be re-evaluated should revenue and gains over expenses and losses as a percent of gross revenue escalate or decline to a point where Palmetto Health s commitment to public health and other community benefits becomes unbalanced as it relates to Palmetto Health s profitability or to a point where there is little or no commitment. Provide one level of care and continue to provide indigent/charity care. Provide access to competing facilities for those services not offered by such facilities. Maintain mission statements that are substantially similar to those of Baptist and Richland. Page 18

21 Unexpended funds in the amount of $4,965 and $6,242 at June 30, 2014 and September 30, 2013, respectively, were included in other current liabilities in the accompanying consolidated balance sheets pending expenditure in accordance with COPA requirements. Compliance with COPA restrictions is the responsibility of Palmetto Health management and is subject to monitoring by DHEC. At June 30, 2014 and September 30, 2013, respectively, Board designated funds of $8,815 and $9,657 were set aside by Palmetto Health in a separate bank account equal to accrued but unexpended funds disclosed above of $4,965 and $6,242 at June 30, 2014 and September 30, 2013, respectively, in addition to an estimate of one year s COPA obligation. Note 3 - Net Patient Service Revenue and Patient Accounts Receivable Palmetto Health has agreements with third-party payors that provide for payments to Palmetto Health at amounts different from its established rates. A summary of the payment arrangements with major third-party payors follows: Medicare Inpatient acute care and most outpatient services rendered to Medicare program beneficiaries are paid at prospectively determined rates. These rates vary according to patient classification systems that are based on clinical, diagnostic and other factors. Inpatient nonacute services, certain outpatient services, and certain defined capital and medical education costs related to Medicare beneficiaries are paid based on formula/cost reimbursement methodologies. Palmetto Health is reimbursed for cost-reimbursable items at a tentative rate with final settlement determined after the submission of annual cost reports by Palmetto Health and audits thereof by the Medicare fiscal intermediary. The Medicare cost reports of Palmetto Health have been audited and final settled by the Medicare fiscal intermediary through the fiscal years ended September 30, 2009 for Palmetto Richland Memorial Hospital, Baptist Medical Center Columbia, and Baptist Medical Center Easley. Net revenue from the Medicare program accounted for approximately 27% and 26% of Palmetto Health s net patient service revenue for the nine months ended June 30, 2014 and Medicaid Inpatient services rendered to Medicaid program beneficiaries through September 30, 2012 were reimbursed on an interim basis at either a prospectively determined rate per discharge or specific rate for each inpatient day and then final settled at cost. For the fiscal year ended September 30, 2013 and forward all inpatient reimbursements are made on a prospective basis. Outpatient services are paid on an interim basis based on prospectively determined rates and then final settled at cost. Net revenue from the Medicaid program accounted for approximately 17% and 18% of Palmetto Health s net patient service revenue for the nine months ended June 30, 2014 and 2013, respectively. State Medicaid funding is a vital source of health care service funding for Palmetto Health. Palmetto Health recognized reimbursement from its participation in the South Carolina Medicaid disproportionate share program totaling $3,800 and $2,550 for the three months ended June 30, 2014 and 2013, respectively, and $10,550 and $7,650 for the nine months ended June 30, 2014 and 2013, respectively, net of the Medically Indigent Assistance program tax. There can be no assurance that Palmetto Health will continue to qualify for future participation in this program or that the program will not ultimately be discontinued or materially modified. Any material reduction in such funding would have a correspondingly material adverse effect on Palmetto Health s financial position and results of operations. Page 19