Avita Health System. Consolidated Financial Report with Additional Information June 30, 2016

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1 Consolidated Financial Report with Additional Information June 30, 2016

2 Contents Report Letter 1-2 Consolidated Financial Statements Balance Sheet 3 Statement of Operations 4 Statement of Changes in Net Assets 5 Statement of Cash Flows Additional Information 37 Consolidating Balance Sheet Consolidating Statement of Operations 40

3 Independent Auditor's Report To the Board of Directors Avita Health System Report on the Consolidated Financial Statements We have audited the accompanying consolidated financial statements of Avita Health System (the "System"), which comprise the consolidated balance sheet as of and the related consolidated statements of operations, changes in net assets, and cash flows for the years then ended, and the related notes to the consolidated financial statements. Management's Responsibility for the Consolidated Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditor's Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits, as of June 30, 2016 and for the year then ended, in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor's judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity's preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. 1

4 To the Board of Directors Avita Health System Opinion In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Avita Health System as of June 30, 2016 and 2015 and the results of its operations, changes in net assets, and its cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America. Other Matters Our audits were conducted for the purpose of forming an opinion on the consolidated financial statements that collectively comprise Avita Health System's consolidated financial statements. The additional information is presented for the purpose of additional analysis and is not a required part of the consolidated financial statements. Such information is the responsibility of management and was derived from and relates directly to the underlying accounting and other records used to prepare the consolidated financial statements. The information has been subjected to auditing procedures applied in the audit of the consolidated financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the consolidated financial statements or to the consolidated financial statements themselves, and other additional procedures in accordance with auditing standards generally accepted in the United States of America. In our opinion, the information is fairly stated in all material respects in relation to the consolidated financial statements as a whole. Other Reporting Required by Government Auditing Standards In accordance with Government Auditing Standards, we have also issued our report dated November 30, 2016 on our consideration of the Avita Health System's internal control over financial reporting and on our tests of its compliance with certain provisions of laws, regulations, contracts, and grant agreements and other matters. The purpose of that report is to describe the scope of our testing of internal control over financial reporting and compliance and the results of that testing, and not to provide an opinion on the internal control over financial reporting or on compliance. That report is an integral part of an audit performed in accordance with Government Auditing Standards in considering Avita Health System's internal control over financial reporting and compliance. November 30,

5 Consolidated Balance Sheet Assets June 30, 2016 June 30, 2015 Current Assets Cash and cash equivalents $ 20,425,729 $ 10,016,594 Accounts receivable (Note 2) 24,626,197 22,284,307 Estimated third-party payor settlements 458,627 2,289,083 Prepaid expenses 2,082,170 2,197,645 Other current assets 1,861,562 3,961,690 Total current assets 49,454,285 40,749,319 Assets Limited as to Use (Note 4) 36,572,966 9,913,424 Property and Equipment - Net (Note 5) 88,552,391 69,120,130 Other Assets Bond issue costs (Note 3) 1,653, ,009 Other noncurrent assets 2,666,802 2,402,906 Total assets $ 178,899,730 $ 122,651,788 Liabilities and Net Assets Current Liabilities Current portion of long-term debt (Note 6) $ 2,279,639 $ 2,944,934 Accounts payable 11,520,288 6,410,200 Estimated third-party payor settlements 712,725 42,520 Fair value of interest rate swap agreement (Note 7) - 202,642 Accrued liabilities and other: Accrued compensation 10,192,477 8,913,179 Deferred revenue (Note 1) 1,317,010 1,317,010 Other accrued liabilities 1,364,203 1,669,287 Total current liabilities 27,386,342 21,499,772 Long-term Debt - Net of current portion (Note 6) 91,905,277 45,339,834 Accrued Pension Liability (Note 8) 11,735,898 8,489,821 Deferred Revenue (Note 1) 395,894 1,712,906 Total liabilities 131,423,411 77,042,333 Net Assets Unrestricted 46,390,991 44,499,109 Temporarily restricted 822, ,346 Permanently restricted 263, ,000 Total net assets 47,476,319 45,609,455 Total liabilities and net assets $ 178,899,730 $ 122,651,788 See. 3

6 Consolidated Statement of Operations Year Ended June 30, 2016 June 30, 2015 Unrestricted Revenue, Gains, and Other Support Net patient service revenue $ 184,032,099 $ 168,837,706 Less provision for bad debts (9,497,551) (9,467,428) Net patient service revenue less provision for bad debts 174,534, ,370,278 Other operating revenue 4,615,825 4,064,308 Net assets released from restrictions 267, ,995 Total unrestricted revenue, gains, and other support 179,417, ,555,581 Expenses Salaries and wages 79,442,768 69,143,474 Employee benefits and payroll taxes 18,780,461 17,556,781 Medical supplies and drugs 28,350,519 25,186,300 Purchased services 22,084,803 21,585,707 Insurance 1,730,845 1,477,577 Utilities 2,696,402 2,814,928 Repairs and maintenance 5,879,271 4,892,248 Depreciation and amortization (Note 5) 9,236,834 7,351,030 Interest expense 1,048,366 1,378,291 Other 6,616,334 5,727,169 Total expenses (Note 10) 175,866, ,113,505 Operating Income 3,550,928 6,442,076 Nonoperating Income Investment income (Note 4) 258, ,546 Other income 577, ,200 Change in unrealized investment (loss) gain (Note 4) (236,577) 70,916 Change in fair value of interest swap agreements (Note 7) 124, ,723 Total nonoperating income 723, ,385 Excess of Revenue Over Expenses 4,274,674 7,229,461 Contributions from Noncontrolling Members 171,500 - Distributions to Noncontrolling Members (527,742) (728,103) Pension-related Changes Other than Net Periodic Pension Cost (Note 8) (2,026,550) (3,239,993) Increase in Unrestricted Net Assets $ 1,891,882 $ 3,261,365 See. 4

7 Consolidated Statement of Changes in Net Assets Year Ended Unrestricted Net Assets Excess of revenue over expenses $ 4,274,674 $ 7,229,461 Pension-related changes other than net periodic pension cost (2,026,550) (3,239,993) Distributions to noncontrolling members (527,742) (728,103) Contributions from noncontrolling members 171,500 - Increase in unrestricted net assets 1,891,882 3,261,365 Temporarily Restricted Net Assets Contributions 272, ,214 Investment income (30,519) 104 Net assets released from restriction (267,158) (120,995) (Decrease) increase in temporarily restricted net assets (25,018) 151,323 Increase in Net Assets 1,866,864 3,412,688 Net Assets - Beginning of year 45,609,455 42,196,767 Net Assets - End of year $ 47,476,319 $ 45,609,455 See. 5

8 Consolidated Statement of Cash Flows Year Ended June 30, 2016 June 30, 2015 Cash Flows from Operating Activities Increase in net assets $ 1,866,864 $ 3,412,688 Adjustments to reconcile increase in net assets to net cash from operating activities: Depreciation and amortization 9,236,834 7,351,030 Net change in unrealized investment losses (gains) 236,577 (70,916) Pension-related changes other than net periodic pension cost 2,026,550 3,239,993 Change in fair value of interest rate swaps (124,317) (270,723) Provision for bad debts 9,497,551 9,467,428 Changes in assets and liabilities which (used) provided cash: Accounts receivable (11,839,441) (12,147,593) Prepaid and other current assets 2,215,603 (2,774,359) Other assets (263,896) (311,754) Accounts payable and other accrued liabilities 7,303,829 (60,019) Deferred revenue (1,317,012) (1,130,350) Third-party payor settlements 2,500,661 (1,243,386) Net cash provided by operating activities 21,339,803 5,462,039 Cash Flows from Investing Activities Purchase of property and equipment (27,599,809) (18,004,428) Purchase of equity investment - (110,700) Net purchases of assets limited as to use (26,896,119) (194,332) Net cash used in investing activities (54,495,928) (18,309,460) Cash Flows from Financing Activities Proceeds from issuance of long-term debt 86,275,000 9,799,275 Principal payment on long-term debt (39,215,200) (1,456,966) Payments on capital lease obligations (2,191,759) (1,549,073) Payment of financing costs (1,680,497) - Write off of deferred financing costs 456,041 - Settlement of interest rate swaps (78,325) - Net payments on line of credit - (1,000,000) Net cash provided by financing activities 43,565,260 5,793,236 Net Increase (Decrease) in Cash and Cash Equivalents 10,409,135 (7,054,185) Cash and Cash Equivalents - Beginning of year 10,016,594 17,070,779 Cash and Cash Equivalents - End of year $ 20,425,729 $ 10,016,594 Supplemental Cash Flow Information Cash paid for interest - Net of amount capitalized $ 943,910 $ 1,481,877 Equipment obtained via capital lease 1,032,107 5,277,637 See. 6

9 Note 1 - Nature of Business and Significant Accounting Policies Basis of Presentation - The accompanying consolidated financial statements of Avita Health System (Avita) include the accounts of Galion Community Hospital (GCH), Community Health Associates, Inc. (CHA), North Central Ohio Family Care Center (NCOFCC), Avita Health Foundation (f/k/a Galion Health Foundation) (Foundation), Galion Community Pain Management, LLC (GCPM), Galion Community Vascular Services, LLC (GCVS), GCH Acquisition Sub, BCH Acquisition, LLC (d/b/a Bucyrus Community Hospital) (BCH), BCH Physician Co., LLC, Homecare Matters Home Health and Hospice (Homecare Matters), and Avita Ontario Hospital, LLC (Ontario) (collectively, the "System"). All significant intercompany transactions and balances have been eliminated in consolidation. Descriptions of the entities are as follows: Avita, an Ohio not-for-profit corporation, was established as the sole member of GCH and GCH Acquisition Sub. GCH, an Ohio not-for-profit corporation, operates a 25-bed critical access hospital located in Galion, Ohio. GCH offers inpatient and outpatient healthcare services to residents within its geographical location. CHA and NCOFCC are not-for-profit corporations that are physician practices and the operations are substantially controlled by GCH, based on an agreement. Foundation, a not-for-profit corporation with a sole member, GCH, promotes and supports Avita Health System and its charitable affiliates. GCPM was formed as an Ohio corporation that provides specialty services for management of acute and chronic pain. GCH and BCH own a 51 percent interest in GCPM, with the remaining interest owned by an unrelated party. GCVS was formed as an Ohio limited liabilty corporation that provides peripheral endovascular procedures and venous services. GCH and BCH own a 52 percent interest in GCVS, with the remaining interest owned by an unrelated party. GCH Acquisition Sub was formed as an Ohio not-for-profit corporation for the purpose of acquiring certain assets of the former Bucyrus Community Hospital, an unrelated party that filed for bankruptcy; however, the System subsequently determined and approved that the asset purchase would be consummated by BCH. As such, GCH Acquisition Sub had no activity during fiscal years 2016 and BCH was formed as an Ohio not-for-profit corporation for the purpose of acquiring, owning, and operating the assets of the former Bucyrus Community Hospital. BCH's sole member is GCH. 7

10 Note 1 - Nature of Business and Significant Accounting Policies (Continued) BCH Physician Co., LLC is a physician practice and was formed as an Ohio limited liability corporation whose sole member is BCH. Homecare Matters is located in Galion, Ohio and operates as a not-for-profit hospice and home health agency serving residents of Crawford County and the surrounding area. Homecare Matters is a membership organization, the members being BCH and GCH of Avita Health System and MedCentral Health System. Avita Ontario Hospital LLC (Ontario) was created to operate the future hospital facility, scheduled to open in fiscal year 2017, located in Ontario, Ohio at the Richland Mall location. Ontario currently provides various physician clinics, laboratory, and imaging services, including a retail pharmacy. The sole member of Avita Ontario Hospital, LLC is GCH. Cash and Cash Equivalents - Cash and cash equivalents include cash and investments in highly liquid investments purchased with an original maturity of three months or less, excluding those amounts included in assets limited as to use. Cash balances held in the bank exceed the federal depository insurance limit. The System's cash is only insured up to the federal depository insurance limit. Accounts Receivable - Accounts receivable for patients, insurance companies, and governmental agencies are based on gross charges. An allowance for uncollectible accounts is established on an aggregate basis by using historical loss rate factors applied to unpaid accounts based on aging. Loss rate factors are based on historical loss experience and adjusted for economic conditions and other trends affecting the System's ability to collect outstanding amounts. Uncollectible amounts are written off against the allowance for uncollectible accounts in the period they are determined to be uncollectible. The allowance for contractual adjustments and interim payment advances is based on expected payment rates from payors based on current reimbursement methodologies. This amount also includes amounts received as interim payments against unpaid claims by certain payors. For receivables associated with self-pay patients (which includes both patients without insurance and patients with deductible and copayment balances due for which thirdparty coverage exists for part of the bill), the System records a significant provision for bad debts in the period of service on the basis of its past experience, which indicates that many patients are unable or unwilling to pay the portion of their bill for which they are financially responsible. The difference between the standard rates (or the discounted rates, if negotiated) and the amounts actually collected after all reasonable collection efforts have been exhausted is charged off against the allowance for doubtful accounts in the period they are determined to be uncollectible. 8

11 Note 1 - Nature of Business and Significant Accounting Policies (Continued) Investments - Investments in equity securities with readily determinable fair values and all investments in debt securities are carried at fair value, as determined by quoted market sources, on the consolidated balance sheet. Investment income or loss (including unrealized gains and losses on trading securities and realized gains and losses on investments, interest, and dividends) is included in the excess of revenue over expenses unless the income or loss is restricted by donor or law. Substantially all investments are classified as trading securities. The System invests in various investment securities. Investment securities are exposed to various risks such as interest rate, market, and credit risks. Due to the level of risk associated with certain investment securities, it is at least reasonably possible that changes in the values of investment securities will occur in the near term and that such changes could materially affect the amounts reported in the consolidated balance sheet. Assets Limited as to Use - Assets limited as to use consist of funds internally designated by the board of directors for capital improvements, funds held by trustees under indenture and debt arrangements, funds held by trustees for the construction of Ontario, and funds limited by donor restriction. Inventories - Inventories, which consist of supplies, are stated at the lower of average cost, or market. Inventories are included within other current assets on the consolidated balance sheet. Property and Equipment - Property and equipment are recorded at cost. Depreciation is computed principally on the straight-line basis over the estimated useful lives of the assets. Costs of maintenance and repairs are charged to expense when incurred. Interest costs incurred on borrowed funds during the period of construction of capital assets are capitalized as a component of the cost of acquiring those assets. Gifts of long-lived assets such as land, buildings, or equipment are reported as unrestricted support and are excluded from excess of revenue over expenses, unless explicit donor stipulations specify how the donated assets must be used. Gifts of longlived assets with explicit restrictions that specify how the assets are to be used and gifts of cash or other assets that must be used to acquire long-lived assets are reported when the donated or acquired long-lived assets are placed in service. Unamortized Bond Issue Costs - Unamortized bond issue costs are amortized over the period the obligations are outstanding. Third-party Settlements - Contractual adjustments under third-party reimbursement programs represent the difference between the System's established rates for services and amounts reimbursed by third-party payors. Cost report settlements result from the adjustment of interim payments to final reimbursement under these obligations. 9

12 Note 1 - Nature of Business and Significant Accounting Policies (Continued) Consolidated Statements of Operations and Changes in Net Assets - For the purpose of reporting, transactions deemed by management to be directly related to the provision of healthcare services are reported as revenue and expenses from operations. The consolidated statement of operations includes excess of revenue over expenses. Changes in unrestricted net assets that are excluded from excess of revenue over expenses, consistent with industry practice, include permanent transfers of assets to and from affiliates, pension-related changes other than net periodic pension cost, contributions from and distributions to noncontrolling members, and net assets released from restriction for nonoperating purposes. Net Patient Service Revenue - Net patient service revenue is reported at the estimated net realizable amounts from patients, third-party payors, and others for services rendered, including estimated retroactive adjustments under reimbursement agreements with third-party payors. For uninsured patients that do not qualify for charity care, the System recognizes revenue on the basis of its standard rates for services provided (or on the basis of discounted rates, if negotiated or provided by policy). On the basis of historical experience, a significant portion of the System's uninsured patients will be unable or unwilling to pay for the services provided. Thus, the System records a significant provision for bad debts related to uninsured patients in the period the services are provided. The composition of patient service revenue (net of contractual allowances and discounts, but before the provision for bad debts) for the fiscal years ended is as follows: Third-party Payors Total All Payors Self-pay Patient service revenue - Net of contractual allowances and discounts (but before the provision for bad debts) $ 175,793,213 $ 8,238,886 $ 184,032,099 Patient service revenue - Net of contractual allowances and discounts (but before the provision for bad debts) $ 160,763,574 $ 8,074,132 $ 168,837,706 Retroactively calculated adjustments arising under reimbursement agreements with third-party payors are accrued on an estimated basis in the period the related services are rendered and adjusted in future periods as final settlements are determined. 10

13 Note 1 - Nature of Business and Significant Accounting Policies (Continued) Laws and regulations governing the Medicare and Medicaid programs are complex and subject to interpretation. Management believes that it is in compliance with all applicable laws and regulations. Final determination of compliance with such laws and regulations is subject to future government review and interpretation. Violations may result in significant regulatory action, including fines, penalties, and exclusions from the Medicare and Medicaid programs. Charity Care - The System provides care to patients who meet certain criteria under its charity care policy without charge or at amounts less than its established rates. Because the System does not pursue collection of amounts determined to qualify as charity care, they are not reported as revenue. Charity care is determined based on established policies, using patient income and assets to determine payment ability. The amount reflects the cost of free or discounted health services, net of contributions and other revenue received, as direct assistance for the provision of charity care. The estimated cost of providing charity services is based on a calculation which applies a ratio of cost to charges to the gross uncompensated charges associated with providing care to charity patients. The ratio of cost to charges is calculated based on the System's total operating costs divided by gross patient service revenue. The System estimates that it provided $1,993,000 and $1,176,000 of services at cost to indigent patients during 2016 and 2015, respectively. The System received approximately $2,934,000 and $1,922,000 in net distributions from the Hospital Care Assurance Program for the care of indigent patients during 2016 and 2015, respectively. Distributions from the Hospital Care Assurance Program are intended to help cover the costs of care provided to the individuals that qualify for the program with income below the poverty level, losses on services provided to Medicaid enrollees, and the cost of bad debt related to patients without insurance. 11

14 Note 1 - Nature of Business and Significant Accounting Policies (Continued) Contributions - Contributions of cash and other assets, including unconditional promises to give in the future, are reported as revenue when granted or received, measured at fair value. Contributions with donor-imposed time or purpose restrictions are reported as restricted support. Contributions without donor-imposed restrictions and contributions with donor-imposed time or purpose restrictions that are met in the same period as the gift are both reported as unrestricted support. Other restricted gifts are reported as restricted support and temporarily or permanently restricted net assets. Interest Rate Swap - The System entered into interest rate swap agreements to reduce economic risks associated with variability in cash outflows for interest required under provisions of variable rate revenue bonds. Interest rate swaps are recognized as assets or liabilities at fair value. Realized gains and losses on interest rate swaps are classified as a component of income from operations and are presented as part of interest expense in the consolidated statement of changes in net assets. Unrealized changes in the fair value of the interest rate swaps are recognized as other income or loss, separate from income from operations. In November 2015, the System paid $78,325 to terminate the swap agreement in conjunction with the refinancing of certain debt as described in Note 6. Classification of Net Assets - Net assets of the System are classified as permanently restricted, temporarily restricted, or unrestricted depending on the presence and characteristics of donor-imposed restrictions limiting the System's ability to use or dispose of contributed assets or the economic benefits embodied in those assets. Donor-imposed restrictions that expire with the passage of time or can be removed by meeting certain requirements result in temporarily restricted net assets. Permanently restricted net assets result from donor-imposed restrictions that limit the use of net assets in perpetuity. Earnings and gains and losses on restricted net assets are classified as unrestricted unless specifically restricted by the donor or by applicable state law. Federal Income Tax - The Internal Revenue Service has ruled that Avita, GCH, CHA, NCOFCC, BCH, Foundation, GCH Acquisition Sub, and Homecare Matters are taxexempt organizations as defined under Section 501(c)(3) of the Internal Revenue Code. Accordingly, no provision for federal income taxes has been made in the consolidated financial statements. GCPM, GCVS, Ontario, and BCH Physician Co., LLC are limited liability companies that have elected to be taxed as partnerships. Partnership income or loss is not taxed at the entity level, but flows through to the partners. The System's share of the taxable income may be subject to unrelated business income tax. There were no significant provisions for income tax for

15 Note 1 - Nature of Business and Significant Accounting Policies (Continued) Use of Estimates - The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts and disclosures in the consolidated financial statements. Actual results could differ from those estimates. Fair Value of Financial Instruments - The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value: Cash and Cash Equivalents - The carrying amount approximates fair value because of the short maturity of those instruments. Investments - Fair values, which are the amounts reported in the consolidated balance sheet, are based on quoted market prices. Accounts Receivable, Accounts Payable, and Accrued Liabilities - The carrying amounts reported in the consolidated balance sheet for accounts receivable, accounts payable, and accrued liabilities approximate their fair value. Estimated Third-party Payor Settlements - Net - The carrying amount reported in the consolidated balance sheet for estimated net third-party payor settlements approximates its fair value. Interest Rate Swaps - The carrying amount reported in the consolidated balance sheet for interest rate swaps approximates their fair value. The fair value of the System's interest rate swaps is determined by an independent party. Long-term Debt - The fair value of the System's long-term debt is based on current rates at which the System could borrow funds with similar remaining maturities. Electronic Health Records Incentive Payments - The American Recovery and Reinvestment Act of 2009 (ARRA) established funding in order to provide incentive payments to hospitals and physicians that implement the use of electronic health record (EHR) technology. The System may receive incentive payments for program years, provided that the System demonstrates meaningful use of certified EHR technology during the EHR reporting period. The System is recognizing revenue from the incentive payments ratably over the EHR technology useful life assigned for depreciating the asset. The incentive payments are based on estimated total hospital discharges and days, Medicare days, and total hospital charges less charity care. The amounts are recorded within other operating revenue as the incentive payments are related to the System's ongoing and central activities, yet not critical to the delivery of patient services. 13

16 Note 1 - Nature of Business and Significant Accounting Policies (Continued) Income of approximately $1,300,000 was recognized within other operating revenue in 2016 and Incentive payments received but not yet recognized as revenue are recorded as deferred revenue at. The System did not receive any incentive payments during The System received payments totaling $172,301 during the year ended June 30, Retroactively calculated adjustments to the incentive payments recorded may occur as incentive payments are based on management's best estimates and the amounts are subject to change until final settlement occurs on related Medicare cost reports. Changes to incentive payment revenue will be recorded within other operating income in the period in which the adjustments occur. Management believes that it is in compliance with all applicable meaningful use criteria as attested. Final determination of the System's attestation is subject to audit by the federal government or its designee. Upcoming Accounting Changes - In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update No , Revenue from Contracts with Customers (Topic 606), which will supersede the current revenue recognition requirements in Topic 605, Revenue Recognition. The ASU is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The ASU also requires additional disclosure about the nature, amount, timing, and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. The new guidance will be effective for the System s year ending June 30, The ASU permits application of the new revenue recognition guidance to be applied using one of two retrospective application methods. The System has not yet determined which application method it will use or the potential effects of the new standard on the consolidated financial statements, if any. In April 2015, the Financial Accounting Standards Board issued Accounting Standards Update (ASU) No , Interest - Imputation of Interest (Subtopic ): Simplifying the Presentation of Debt Issuance Costs (ASU ). ASU No requires debt issuance costs to be presented in the balance sheet as a direct deduction from the carrying value of the associated debt liability, consistent with the presentation of a debt discount. Additionally, amortization of debt issuance costs should be reported as interest expense. Under the current standards, debt issuance costs are required to be presented in the balance sheet as an asset and the amortization of the costs is reported as amortization expense. The standard is effective for the year ending June 30,

17 Note 1 - Nature of Business and Significant Accounting Policies (Continued) In February 2016, the Financial Accounting Standards Board issued Accounting Standards Update (ASU) No , Leases, which supersedes the current lease requirements in ASC 840. The ASU requires lessees to recognize a right-of-use asset and related lease liability for all leases, with a limited exception for short-term leases. Leases will be classified as either finance or operating, with the classification affecting the pattern of expense recognition in the statement of operations. Currently, leases are classified as either capital or operating, with only capital leases recognized on the balance sheet. The reporting of lease-related expenses in the statements of operations and cash flows will be generally consistent with the current guidance. The new lease guidance will be effective for the System s year ending June 30, The System has not yet assessed the effect of this accounting standards update on the consolidated financial statements and on its financial position and results of operations. The Financial Accounting Standards Board (FASB) issued Accounting Standards Update No , Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities in August ASU No requires significant changes to the financial reporting model of organizations that follow FASB not-for-profit rules, including changing from three classes of net assets to two classes, net assets with donor restrictions and net assets without donor restrictions. The ASU will also require changes in the way certain information is aggregated and reported by the System, including required disclosures about the liquidity and availability of resources. The new standard is effective for the Systems year ending June 30, 2019 and thereafter and must be applied on a retrospective basis. The System is currently evaluating the impact this standard will have on the consolidated financial statements. Subsequent Events - The consolidated financial statements and related disclosures include evaluation of events up through and including November 30, 2016, which is the date the consolidated financial statements were issued. 15

18 Note 2 - Patient Accounts Receivable The details of patient accounts receivable are as follows: Patient accounts receivable $ 56,696,849 $ 50,334,219 Less allowance for uncollectible accounts (6,381,347) (4,363,111) Less allowance for contractual adjustments (25,689,305) (23,686,801) Net patient accounts receivable $ 24,626,197 $ 22,284,307 The System grants credit without collateral to patients, most of whom are local residents and are insured by third-party payor agreements. The composition of receivables from patients and third-party payors was as follows: Medicare 23 % 20 % Medicaid Commercial and other Self-pay Total 100 % 100 % Note 3 - Unamortized Bond Issue Costs Unamortized bond issue costs consist of the following: Hospital Facilities Revenue Refunding Bonds, Series 2010A and 2010B $ 600,682 $ 600,682 Less accumulated amortization (144,641) (134,673) Less write-off of deferred financing costs (456,041) - Hospital Facilities Revenue Refunding and Improvement Notes, Series ,680,497 - Less accumulated amortization (27,211) - Net carrying amount $ 1,653,286 $ 466,009 Amortization expense relating to the Series 2010A and 2010B Bonds aggregated $9,968 and $29,904 during the years ended, respectively. Amortization expense relating to the Series 2015 notes was $27,211 in

19 Note 4 - Assets Limited as to Use Assets limited as to use, stated at market value, consist of the following: Funds limited by donor restrictions and board designations for capital improvements: Cash and cash equivalents $ 1,310,551 $ 1,326,297 Equity securities 6,247,561 6,214,430 Debt securities 2,904,785 1,799,907 Charitable perpetual trust 263, ,000 Real estate investment trust 278, ,571 Interest receivable 64,141 33,960 Total 11,068,283 9,913,165 Held by trustee under indenture agreement - Cash and cash equivalents 25,504, Total assets limited as to use $ 36,572,966 $ 9,913,424 Investment gains from unrestricted cash equivalents and investments consist of the following: Interest, dividends, and realized gains $ 258,053 $ 206,546 Net unrealized investment (losses) gains (236,577) 70,916 Net investment gains $ 21,476 $ 277,462 17

20 Note 5 - Property and Equipment The cost of property, plant, and equipment and depreciable lives are summarized as follows: Depreciable Life - Years Land $ 1,231,652 $ 733,702 - Land improvements 1,594,763 1,520, Buildings and improvements 65,904,943 64,386, Equipment 56,462,932 52,900, Construction in progress 22,852, ,320 - Total cost 148,046, ,467,270 Accumulated depreciation (59,494,152) (51,347,140) Net property and equipment $ 88,552,391 $ 69,120,130 Depreciation expense, including assets under capital lease, totaled $9,199,655 and $7,321,126 for the years ended, respectively. Construction in progress consists of costs associated with the renovation of Ontario, which is currently in phase two of a three-phase renovation. Total remaining payments on the construction contract entered into during fiscal year 2016 are approximately $10,750,000 at June 30,

21 Note 6 - Long-term Debt A summary of long-term debt and capital lease obligations is as follows: County of Crawford, Ohio Hospital Facilities Revenue Refunding and Improvement Notes, Series 2015 $ 86,275,000 $ - County of Crawford, Ohio Adjustable Rate Hospital Facilities Revenue Refunding and Improvement Bonds, Series 2010A - 14,280,000 County of Crawford, Ohio Adjustable Rate Hospital Facilities Revenue Refunding and Improvement Bonds, Series 2010B - 10,010,000 Homecare Matters term loan note 761, ,386 Construction loan agreement - 14,860,000 Capital lease obligations 7,148,730 8,308,382 Total 94,184,916 48,284,768 Less current portion 2,279,639 2,944,934 Long-term portion $ 91,905,277 $ 45,339,834 On November 19, 2015, the County of Crawford Ohio issued for the benefit of the System $86,275,000 of Ohio Hospital Facilities Revenue Refunding and Improvement Notes, Series 2015 (Series 2015 Notes). The proceeds of the Series 2015 Notes were used by Avita to finance the costs of: (i) the acquisition, construction, renovation, and equipping of "Hospital Facilities," in Ontario, Ohio, (ii) refunding and retiring the outstanding principal amount of the issuer's outstanding (a) Adjustable Rate Hospital Facilities Revenue Refunding and Improvement Bonds, Series 2010A and (b) Adjustable Rate Hospital Facilities Revenue Bonds, Series 2010B, (iii) refinancing the construction loan, (iv) paying interest on the notes, and (v) paying certain costs and expenses incurred in connection with the issuance of the notes and the refinancing of the construction loan and the refunding and retiring of the Series 2010 Bonds. The Series 2015 Notes mature November 1, 2017 and bear interest at 1.43 percent per annum with payments of interest only on May 1 and November 1. The Series 2015 Notes will be subject to the master trust indenture dated December 1, 2010 between Avita and the master trustee and will require compliance with certain financial and other covenants. 19

22 Note 6 - Long-term Debt (Continued) In order to secure the payment of the Series 2015 Notes when due on November 1, 2017, the System, pursuant to a pledge and assignment agreement dated as of November 1, 2015 (the "Pledge Agreement"), has pledged and assigned to the trustee, for the benefit of the noteholders, the proceeds of a direct loan in the principal amount of $91,400,000 to be loaned by the United States Department of Agriculture (USDA) through its community facilities loan program (the "USDA Loan") to the System upon completion of the Ontario project. As of November 1, 2015, Avita, GCH, CHA, NCOFCC, BCH, and Ontario, are the obligated group members established under the Master Trust Indenture Series 2010 Bonds (the "Obligated Group"). GCPM and CGVS are treated as departments of GCH for the purpose of the Obligated Group. The Master Indenture and the Credit Agreement from 2010 require the maintenance of certain covenants and restrictions, which the Series 2015 notes must comply with. In connection with the issuance of the Series 2015 Notes, the System and the County of Crawford, Ohio entered into lease arrangements whereby the System has leased its existing facilities to the County of Crawford. The lease is in effect beginning November 1, 2015 and ending November 1, The base lease requires the County of Crawford to pay a total sum of $1 and other valuable consideration for which its receipt has been acknowledged. Under the sublease agreement, rental payments are sufficient to pay the total amount due with respect to the principal and interest on the Series 2015 Notes. The Series 2015 Notes are collateralized by a mortgage on substantially all property. Accordingly, such premise, together with the bond proceeds and bond indebtedness, are included in the accompanying consolidated financial statements as assets and liabilities of the System. The estimated fair value of the Series 2015 Notes was approximately $345,000 higher than the carrying amounts at June 30, The fair value of the System's fixed rate taxexempt bond obligations is determined by applying the yield of openly marketed bonds that have substantially the same characteristics as the System's tax-exempt bonds. The determination of fair value of the tax-exempt bond obligations is consistent with Level 2 measurement under the fair value hierarchy. In December 2010, the County of Crawford, Ohio issued for the benefit of the System $16,130,000 of Adjustable Rate Hospital Facilities Revenue Refunding and Improvement Bonds, Series 2010A and $11,300,000 of Adjustable Rate Hospital Facilities Revenue Refunding and Improvement Bonds, Series 2010B (collectively, the "Series 2010 Bonds"). 20

23 Note 6 - Long-term Debt (Continued) The proceeds were made available to the System in order to finance the retirement of the 2003 and 2006 Hospital Facilities Revenue Refunding and Improvement Bonds and other outstanding debt held by GCH, and finance the acquisition, construction, renovation, and equipping of the hospital facilities, including the purchase of the former Bucyrus Community Hospital property and equipment and networking capital, and the payment of certain costs of issuance. The Series 2010 Bonds included annual principal payments beginning at approximately $93,000 in the first year and increasing on a fixed schedule annually, with the bonds maturing in February 2031, and provided for varying rates of interest based on 1.65 percent plus the product of 65 percent and the greater of the 30-day LIBOR or.25 percent. The interest rate on the Series 2010A and Series 2010B bonds was percent at June 30, The Series 2010 Bonds are subject to mandatory tender of the bonds on February 15, The Series 2010 Bonds were refinanced in November 2015 as described above. Prior to November 1, 2015, Avita, GCH, CHA, NCOFCC, BCH, GCH Acquisition Sub, and BCH Physician Co., LLC were the obligated group members established under the Master Trust Indenture Series 2010 Bonds (the "Obligated Group"). GCPM and CGVS are treated as departments of GCH for purposes of the Obligated Group. In connection with the issuance of the Series 2010A Bonds, GCH and the County of Crawford, Ohio entered into lease arrangements whereby GCH has leased its existing facilities to the County of Crawford. The leases, by their terms, will remain in effect at least until full provision has been made for the payment of the Series 2010A Bonds under the indenture. The base lease requires the County of Crawford to pay a total sum of $1 and other valuable consideration for which its receipt has been acknowledged. Under the sublease agreement, rental payments are sufficient to pay the total amount due with respect to the principal and interest on the Series 2010A Bonds. The Series 2010A Bonds are collateralized by a mortgage on substantially all property. Accordingly, such premise, together with the bond proceeds and bond indebtedness, are included in the accompanying consolidated financial statements as assets and liabilities of GCH. These lease agreements were terminated upon the payoff of the Series 2010A Bonds as described above. 21

24 Note 6 - Long-term Debt (Continued) In connection with the issuance of the Series 2010B Bonds, BCH and the County of Crawford, Ohio entered into lease arrangements whereby BCH has leased its existing facilities to the County of Crawford. The leases, by their terms, will remain in effect at least until full provision has been made for the payment of the Series 2010B Bonds under the indenture. The base lease requires the County of Crawford to pay a total sum of $1 and other valuable consideration for which its receipt has been acknowledged. Under the sublease agreement, rental payments are sufficient to pay the total amount due with respect to the principal and interest on the Series 2010B Bonds. The Series 2010B Bonds are collateralized by a mortgage on substantially all property. Accordingly, such premise, together with the bond proceeds and bond indebtedness, are included in the accompanying consolidated financial statements as assets and liabilities of BCH. These lease agreements were terminated upon the payoff of the Series 2010B Bonds as described above. The System obtained a secured line of credit with a bank for $1,000,000 as part of the 2010 financing transaction to support the System's working capital needs. Draws on the line of credit were available through December 31, 2011 (original maturity date). The line of credit matured on January 31, 2016 and was not renewed by the System. The Homecare Matters term loan requires monthly payments of $8,070 beginning in May 2007 and ending in May Through December 31, 2012, the monthly payment included interest at the Federal Home Loan Bank of Cincinnati 10-year fixed rate plus 2.5 percent multiplied by 65 percent plus.15 percent (not to exceed 7.22 percent). Effective January 1, 2013 through April 30, 2016, interest on the outstanding principal balance is payable at a rate per annum of percent. Effective May 1, 2016 through maturity, the interest terms on the loan revert back to the original terms of the agreement prior to January 1, This note is secured by all assets of Homecare Matters. The Obligated Group secured a loan in April 2014 under the construction loan agreement. The proceeds of the loan are to be no more than $15,000,000 and portions of the loan are available to the Obligated Group based on properly filed disbursement requests to Fifth Third Bank (the "Lender") for the purchase of property and completion of an approved construction plan. The construction loan called for monthly principal payments of $62,500 commencing on May 1, 2014, with the loan maturing January 31, 2016, and with rates of interest based on 2.22 percent plus the greater of the 30-day LIBOR or.25 percent, which was 2.47 percent at June 30, The construction loan required the maintenance of certain covenants and restrictions. The System used the proceeds from the 2015 Series Notes described above to pay off the construction loan in November

25 Note 6 - Long-term Debt (Continued) The System is the lessee of certain medical and other equipment under capital leases expiring in various years through Interest rates on capitalized leases are imputed at the beginning of the lease based on the lessor's implicit rate of return. The assets and liabilities under capital leases are recorded at the lower of the present value of the minimum lease payments or fair value of the assets. The assets are depreciated over the lesser of their related lease terms or their estimated productive lives. Depreciation of assets under capital leases is included in depreciation expense. The following is a schedule of future bond and loan principal payments and minimum payments on capital lease obligations: Years Ending June 30 Long-term Debt Capital Lease Obligations 2017 $ 61,207 $ 2,474, ,203,012 2,328, ,076,305 1,824, ,150, , ,226, ,195 Thereafter 79,318, ,544 Total 87,036,186 7,707,004 Less amount representing interest under capital lease obligations - (558,274) Net $ 87,036,186 $ 7,148,730 At, the carrying value of equipment under capital lease obligations is as follows: Cost of equipment under capital lease $ 14,326,950 $ 13,294,843 Accumulated amortization (7,009,442) (4,429,611) Net $ 7,317,508 $ 8,865,232 23

26 Note 7 - Derivative Financial Instruments Effective January 4, 2011, the System entered into interest rate swap agreements, which essentially fixed the interest rate for $8,702,500 of the Adjustable Rate Hospital Facilities Revenue Refunding and Improvement Bonds, Series 2010A and $6,047,500 of the Adjustable Rate Hospital Facilities Revenue Refunding and Improvement Bonds, Series 2010B at an interest rate of 1.05 percent through January 1, 2012, 1.50 percent through January 1, 2013, 1.85 percent through January 1, 2014, 2.04 percent through January 1, 2015, and 2.49 percent through February 1, 2016, when the interest rate swaps were due to expire. In November 2015, the System paid $78,325 to terminate the swap agreement in conjunction with the refinancing of the bonds as described in Note 6. The variable interest rate, which the System receives, is based on 65 percent of the USD- LIBOR-BBA, which was percent as of November 17, 2015, the date that the interest rate swaps were terminated. As of, the System had a liability for derivatives of $0 and $202,642, respectively, reported on the consolidated balance sheet as fair value of interest rate swap agreements. The gain (loss) recognized attributable to derivative instruments and their locations in the consolidated statement of operations are as follows: Reported in Consolidated Statement of Operations as Interest expense $ (61,933) $ (278,347) Interest expense Change in fair market value of interest rate swap agreements 124, ,723 Nonoperating income Total gain (loss) $ 62,384 $ (7,624) Note 8 - Pension and Other Postretirement Benefit Plans The System has a defined benefit pension plan covering substantially all of GCH's employees who have obtained certain length of service requirements. Benefits are based on years of service and the employee's compensation during the last five years of employment. As of January 1, 2010, the System froze the plan, whereas additional participation, benefit service, and benefit accruals will no longer continue under the plan, but eligible employees have the option to participate in a 403(b) plan. Effective January 28, 2011, the 403(b) plan was amended to cover substantially all employees under the System in addition to GCH employees previously covered. 24

27 Note 8 - Pension and Other Postretirement Benefit Plans (Continued) The Avita 403(b) plan provides for an employer-matching contribution of 50 percent of employee salary deferrals, not to exceed deferrals in excess of 2 percent of employee compensation and for an employer fixed, nonelective contribution of 3 percent of the employee compensation. The System made total contributions to the 403(b) plan of $1,966,399 and $1,646,818 for the years ended, respectively. The System's policy is to fund the minimum contribution for the defined benefit plans as required under ERISA. The following tables set forth the funded status of the plan and other information for the years ended. Obligations and Funded Status Change in Benefit Obligation Benefit obligation at beginning of year $ 34,888,909 $ 32,261,633 Service cost - 7,942 Interest cost 1,402,470 1,242,725 Settlement gain (658,710) - Actuarial gain 2,809,245 2,734,650 Lump-sum benefits paid (2,069,562) - Annuity benefits paid (1,438,923) (1,358,041) Benefit obligation at end of year 34,933,429 34,888,909 Change in Plan Assets Fair value of plan assets at beginning of year 26,399,088 26,320,815 Actual return on plan assets 306, ,371 Employer contributions - 549,943 Lump-sum benefits paid (2,069,562) - Annuity benefit (1,438,923) (1,358,041) Fair value of plan assets at end of year 23,197,531 26,399,088 Funded status at end of year $ (11,735,898) $ (8,489,821) Amounts not recognized as components of net periodic benefit cost consist of $12,602,268 and $10,575,718 of net loss for the years ended, respectively. The accumulated benefit obligation for the defined benefit pension plan was $34,725,135 and $32,034,911 at, respectively. 25

28 Note 8 - Pension and Other Postretirement Benefit Plans (Continued) Components of net periodic benefit cost and other amounts recognized in net assets are as follows: Net Periodic Benefit Expense Service cost $ - $ 7,942 Interest cost 1,402,470 1,242,725 Expected return on plan assets (1,788,549) (1,827,464) Amortization of net loss 859, ,750 Benefit cost at end of year $ 472,930 $ (141,047) The estimated net loss and prior service cost for the defined benefit pension plan that will be amortized from net assets into net periodic benefit cost over the next fiscal year are $1,134,362. Assumptions Weighted average assumptions used to determine benefit obligations at June 30, 2016 and 2015 are as follows: Discount rate 3.23 % 4.12 % Rate of compensation increase Weighted average assumptions used to determine net periodic benefit cost for the years ended are as follows: Discount rate 4.12 % 3.95 % Expected long-term return on plan assets The overall expected rate of return on plan assets represents a weighted average composite rate based on the historical rates of return of the respective asset classes adjusted for anticipated market movements. 26

29 Note 8 - Pension and Other Postretirement Benefit Plans (Continued) Pension Plan Assets The investment objective of the plan is to provide a rate of return to offset the impact of inflation and to provide for real growth commensurate with a moderate level of risk. Assets are to be invested in a manner consistent with the fiduciary standards of ERISA. The asset mix is determined by the investment manager within the guidelines as approved by the board. Those guidelines are: equities, 40 percent to 70 percent; fixedincome securities, 20 percent to 60 percent; real estate, 0 percent to 5 percent; and cash and cash equivalents, 0 percent to 10 percent. Equities will consist primarily of mutual funds. Investments in individual companies may not exceed 10 percent of the equity portfolio. Fixed-income investments will consist mostly of bond funds. Individual bonds must be limited to U.S. Treasury, federal government agencies, and corporate bonds within Moody's rating of A3 or equivalent. Bond holdings in a single company may not exceed 5 percent of the fixed-income portfolio. The fair values of the defined benefit pension plan assets at by major asset classes are as follows: Fair Value Measurements at June 30, 2016 Total Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Cash and cash equivalents $ 1 $ 1 $ - Money market fund 457, ,694 - Common stock - Basic materials 1,865,672 1,865,672 - Common stock - Services 2,224,551 2,224,551 - Common stock - Consumer goods 3,253,158 3,253,158 - Common stock - Financial 1,929,638 1,929,638 - Common stock - Healthcare 1,205,805 1,205,805 - Common stock - Technology 2,899,315 2,899,315 - Common stock - Miscellaneous 579, ,885 - Mutual funds - Equity 4,255,022 4,255,022 - Mutual funds - Debt securities 3,158,937 3,158,937 - Debt securities - Corporate (a) 834, ,475 Debt securities - U.S. (b) 533, ,378 Total $ 23,197,531 $ 21,829,678 $ 1,367,853 27

30 Note 8 - Pension and Other Postretirement Benefit Plans (Continued) Fair Value Measurements at June 30, 2015 Total Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Cash and cash equivalents $ 1 $ 1 $ - Money market fund 1,101,754 1,101,754 - Common stock - Basic materials 2,089,524 2,089,524 - Common stock - Services 2,755,701 2,755,701 - Common stock - Consumer goods 2,739,820 2,739,820 - Common stock - Financial 2,200,413 2,200,413 - Common stock - Healthcare 2,704,368 2,704,368 - Common stock - Technology 2,857,304 2,857,304 - Common stock - Miscellaneous 547, ,039 - Mutual funds - Equity 4,705,226 4,705,226 - Mutual funds - Debt securities 3,099,638 3,099,638 - Debt securities - Corporate (a) 1,073,880-1,073,880 Debt securities - U.S. (b) 524, ,420 Total $ 26,399,088 $ 24,800,788 $ 1,598,300 (a) This category represents investments in fixed-income securities, which include corporate bonds. Investments include a variety of taxable bonds to maximize returns. (b) This category represents investments in fixed-income securities, which include U.S. government obligations and U.S. government agency bonds. The above tables present information about the pension and postretirement benefit plan assets measured at fair value at and the valuation techniques used by the System to determine those fair values. In general, fair values determined by Level 1 inputs use quoted prices in active markets for identical assets that the System has the ability to access. Fair values determined by Level 2 inputs use other inputs that are observable, either directly or indirectly. These Level 2 inputs include quoted prices for similar assets in active markets and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs, including inputs that are available in situations where there is little, if any, market activity for the related asset. 28

31 Note 8 - Pension and Other Postretirement Benefit Plans (Continued) In instances whereby inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest level input that is significant to the valuation. The System's assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each plan asset. The System's policy is to recognize transfers in and transfers out of Level 1, 2, and 3 fair value classifications as of the end of the reporting period. There were no transfers between levels of fair value hierarchy during 2016 and Cash Flow Contributions - The System expects to contribute $0 to its defined benefit pension plan in Estimated Future Benefit Payments The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid: Note 9 - Third-party Settlements 2017 $ 1,636, ,700, ,771, ,857, ,886, ,972,059 Approximately 42 percent of the System's net patient service revenue is received from the Medicare, Medicare HMOs, Medicaid, and Medicaid HMOs programs. The System has agreements with these payors that provide for reimbursement to the System at an amount different from established rates. Medicare - Effective October 1, 2004, GCH received full accreditation from the Centers for Medicare and Medicaid Services for critical access hospital designation. In 2011, the System assumed the provider agreement as part of the asset purchase agreement with the former Bucyrus Community Hospital. As such, BCH was able to be established as a critical access hospital. As critical access hospitals, GCH and BCH will receive reasonable, cost-based reimbursement for both inpatient and outpatient services, including laboratory services provided to Medicare beneficiaries. Rehabilitation services are paid based on a cost reimbursement method subject to limits. 29

32 Note 9 - Third-party Settlements (Continued) Medicaid - Inpatient acute-care services rendered to Medicaid program beneficiaries and capital costs are paid at prospectively determined rates per discharge. The System is reimbursed for outpatient services on an established fee-for-service methodology. The Medicaid payment system in Ohio is a prospective one, whereby rates for the following state fiscal year beginning July 1 are based upon filed cost reports for the preceding calendar year. The continuity of this system is subject to the uncertainty of the fiscal health of the State of Ohio, which can directly impact future rates and the methodology currently in place. Any significant changes in rates or the payment system itself could have a material impact on future Medicaid funding to providers. Final reimbursement under these programs is subject to audit by fiscal intermediaries. Although these audits may result in some changes in these amounts, they are not expected to have a material effect on the accompanying consolidated financial statements. The effect of prior year settlements (decreased) increased net revenue by $12,000 in 2016 and by $1,557,000 in The Medicare program has initiated a recovery audit contractor (RAC) initiative, whereby claims subsequent to October 1, 2007 will be reviewed by contractors for validity, accuracy, and proper documentation. The RAC program began in the state of Ohio in The System has received some payback requests during fiscal year 2015 and 2016 and the net outcome was not significant to the financial statements. If selected for audit, the potential exists for significant overpayment or underpayment of claims at a future date. Note 10 - Functional Expenses The System operates three general acute-care facilities that provide inpatient and outpatient healthcare services to patients in the Galion, Bucyrus, and Ontario, Ohio vicinities. Expenses related to providing these services are as follows: Healthcare services $ 131,087,617 $ 117,109,415 General and administrative 44,778,986 40,004,090 Total $ 175,866,603 $ 157,113,505 30

33 Note 11 - Professional and General Liability Insurance Based on the nature of its operations, the System is at times subject to pending or threatened legal actions which arise in the normal course of its activities. For the years ended, the System has insurance policies for professional and general liability claims based on claims made during the year. The policies cover claims resulting from claims submitted during the policy terms, regardless of when the incidents occur. Under the terms of the policies, the System bears the risk of the ultimate costs of any individual claim exceeding $1,000,000 or aggregate claims exceeding $3,000,000 for claims paid in the policy year. In addition, the System maintains for all classes of liability coverage an additional "umbrella" excess liability insurance policy of $20,000,000 for each occurrence and in the aggregate. Should the claims-made policy not be renewed, any claims filed subsequent to the policy term are considered uninsured. The System is not aware of any such medical malpractice claims, asserted or unasserted, that would have losses that are considered probable and estimable. Accordingly, no amounts have been accrued for malpractice claims liability at. The System is exposed to various risks of loss related to property and general losses, as well as medical benefits provided to employees. The System has purchased commercial insurance for coverage of these claims. Note 12 - Self-insured Benefits The System is partially self-insured under a plan covering substantially all employees for health benefits. On January 1, 2014, the System's stop-loss coverage included claims over $100,000 per employee per annum and an unlimited lifetime reimbursement maximum per covered person. On January 1, 2015, the System's stop-loss coverage was increased to include claims over $150,000 per employee per annum and an unlimited lifetime reimbursement maximum per covered person. Total expenses charged to operations, including an estimate of incurred but unreported claims, totaled $10,229,186 and $10,070,110 for the years ended June 30, 2016 and 2015, respectively. Note 13 - Fair Value Measurements Accounting standards require certain assets and liabilities be reported at fair value in the consolidated financial statements and provide a framework for establishing that fair value. The framework for determining fair value is based on a hierarchy that prioritizes the inputs and valuation techniques used to measure fair value. 31

34 Note 13 - Fair Value Measurements (Continued) The following tables present information about the System's assets and liabilities measured at fair value as of and the valuation techniques used by the System to determine those fair values. In general, fair values determined by Level 1 inputs use quoted prices in active markets for identical assets or liabilities that the System has the ability to access. Fair values determined by Level 2 inputs use other inputs that are observable, either directly or indirectly. These Level 2 inputs include quoted prices for similar assets and liabilities in active markets and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs, including inputs that are available in situations where there is little, if any, market activity for the related asset or liability. These Level 3 fair value measurements are based primarily on management's own estimates using pricing models, discounted cash flow methodologies, or similar techniques taking into account the characteristics of the asset or liability. In instances whereby inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest level input that is significant to the valuation. The System's assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each asset or liability. 32

35 Note 13 - Fair Value Measurements (Continued) Assets Measured at Fair Value on a Recurring Basis at June 30, 2016 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Balance at June 30, 2016 Assets Limited as to Use Equity securities - Large cap $ 3,926,321 $ - $ - $ 3,926,321 Equity securities - Small and mid cap 1,140, ,140,384 Equity securities - Developed international 514, ,967 Equity securities - Emerging markets 144, ,312 Equity securities - Other 130, , ,577 Debt securities - Corporate - 1,046,361-1,046,361 Debt securities - U.S. - 1,812,408-1,812,408 Debt securities - Other - 46,016-46,016 Real estate investment trust 278, ,245 Charitable perpetual trust , ,000 Total assets limited as to use $ 6,134,477 $ 2,904,785 $ 654,329 $ 9,693,591 33

36 Note 13 - Fair Value Measurements (Continued) Assets and Liabilities Measured at Fair Value on a Recurring Basis at June 30, 2015 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Balance at June 30, 2015 Assets Limited as to Use Equity securities - Large cap $ 4,156,746 $ - $ - $ 4,156,746 Equity securities - Small and mid cap 779, ,805 Equity securities - Developed international 541, ,619 Equity securities - Emerging markets 179, ,228 Equity securities - Other 135, , ,032 Debt securities - Corporate - 1,163,075-1,163,075 Debt securities - U.S , ,296 Debt securities - Other - 49,536-49,536 Real estate investment trust 275, ,571 Charitable perpetual trust , ,000 Total assets limited as to use $ 6,068,041 $ 1,799,907 $ 684,960 $ 8,552,908 Liabilities - Fair value of interest rate swap agreements $ - $ 202,642 $ - $ 202,642 The Level 2 inputs used in estimating the fair value of the swap agreements include the notional amount, effective interest rate, and maturity date. Additionally, the Level 2 inputs of the debt securities include quoted prices for similar assets in active markets. 34

37 Note 13 - Fair Value Measurements (Continued) The change in Level 3 assets measured at fair value for the year ended June 30, 2016 is as follows: Equity Securities - Other Charitable Perpetual Trust Balance at July 1, 2015 $ 421,960 $ 263,000 Total unrealized losses (30,631) - Balance at June 30, 2016 $ 391,329 $ 263,000 The change in Level 3 assets measured at fair value for the year ended June 30, 2015 is as follows: Equity Securities - Other Charitable Perpetual Trust Balance at July 1, 2014 $ 429,310 $ 263,000 Total unrealized losses (7,350) - Balance at June 30, 2015 $ 421,960 $ 263,000 Of the Level 3 assets that were held by the System at, the unrealized losses for the years ended were $30,631 and $7,350, respectively, which are recognized within excess of revenue over expenses. Both observable and unobservable inputs may be used to determine the fair value of positions classified as Level 3 assets. As a result, the unrealized gains and losses for these assets presented in the tables above may include changes in fair value that were attributable to both observable and unobservable inputs. The equity securities categorized as Level 3 assets primarily consist of shares of nonpublic company stock. This estimate is based on information provided by the nonpublic company's financial statements. The System estimates the fair value of the company stock based on its proportionate share of the nonpublic company's equity. The System estimates the fair value of the charitable perpetual trust based upon the present value of the expected future cash flows using management's best estimates of key assumptions, including payment periods and a discount rate commensurate with the current market and other risk involved. The System's policy is to recognize transfers in and transfers out of Level 1, 2, and 3 fair value classifications as of the end of the reporting period. There were no transfers between levels of fair value hierarchy during 2016 and

38 Note 14 - Changes in Consolidated Unrestricted Net Assets Attributable to the System and the Noncontrolling Interest The changes in consolidated unrestricted net assets attributable to the System and the noncontrolling interest were as follows: Total Controlling Interest Noncontrolling Interest Balance at June 30, 2014 $ 41,237,744 $ 39,787,365 $ 1,450,379 Excess of revenue over expenses 7,229,461 6,604, ,463 Distributions to noncontrolling member (728,103) - (728,103) Pension-related changes other than net periodic cost (3,239,993) (3,239,993) - Balance at June 30, ,499,109 43,152,370 1,346,739 Excess of revenue over expenses 4,274,674 3,933, ,601 Capital contribution from noncontrolling member 171, ,500 Distributions to noncontrolling member (527,742) - (527,742) Pension-related changes other than net periodic cost (2,026,550) (2,026,550) - Balance at June 30, 2016 $ 46,390,991 $ 45,058,893 $ 1,332,098 Note 15 - Commitments On December 4, 2015, the System entered into a contract with Ohio State University Medical Center to implement contracted services for clinical and revenue electronic health systems. The contract specifies a seven-year implementation plan that includes total payments for equipment, software, and implementation of the system of $5,551,106, which will be paid as incurred through December 31, The contract also includes annual maintenance costs of $1,782,239 per year to be paid monthly starting 30 days after the EPIC system functioning, which is scheduled to go live in December

39 Additional Information 37

40 Consolidating Balance Sheet June 30, 2016 Obligated Group Avita Health Foundation Subtotal Homecare Matters Eliminating Entries Total Assets Current Assets Cash and cash equivalents $ 19,377,125 $ 246,860 $ 19,623,985 $ 801,744 $ - $ 20,425,729 Accounts receivable 23,891,730-23,891, ,467-24,626,197 Estimated third-party payor settlements 458, , ,627 Prepaid expenses 1,967,481-1,967, ,689-2,082,170 Other current assets 1,843,749-1,843,749 17,813-1,861,562 Total current assets 47,538, ,860 47,785,572 1,668,713-49,454,285 Assets Limited as to Use 35,831, ,213 36,572, ,572,966 Property and Equipment - Net 87,294,525-87,294,525 1,257,866-88,552,391 Other Assets Investment in joint venture 1,190,008-1,190,008 - (1,190,008) - Bond issue costs 1,653,286-1,653, ,653,286 Other noncurrent assets 2,666,802-2,666, ,666,802 Total assets $ 176,175,086 $ 988,073 $ 177,163,159 $ 2,926,579 $ (1,190,008) $ 178,899,730 38

41 Consolidating Balance Sheet (Continued) June 30, 2016 Obligated Group Avita Health Foundation Subtotal Homecare Matters Eliminating Entries Total Liabilities and Net Assets Current Liabilities Current portion of long-term debt $ 2,218,432 $ - $ 2,218,432 $ 61,207 $ - $ 2,279,639 Accounts payable 11,412,037 1,554 11,413, ,697-11,520,288 Estimated third-party payor settlements 712, , ,725 Accrued liabilities and other: Accrued compensation 9,923,482-9,923, ,995-10,192,477 Deferred revenue 1,317,010-1,317, ,317,010 Other accrued liabilities 1,361,584-1,361,584 2,619-1,364,203 Total current liabilities 26,945,270 1,554 26,946, ,518-27,386,342 Long-term Debt - Net of current portion 91,205,298-91,205, ,979-91,905,277 Accrued Pension Liability 11,735,898-11,735, ,735,898 Deferred Revenue 395, , ,894 Total liabilities 130,282,360 1, ,283,914 1,139, ,423,411 Net Assets Unrestricted 45,164, ,132 45,793,917 1,787,082 (1,190,008) 46,390,991 Temporarily restricted 464, , , ,328 Permanently restricted 263, , ,000 Total net assets 45,892, ,519 46,879,245 1,787,082 (1,190,008) 47,476,319 Total liabilities and net assets $ 176,175,086 $ 988,073 $ 177,163,159 $ 2,926,579 $ (1,190,008) $ 178,899,730 39

42 Consolidating Statement of Operations Year Ended June 30, 2016 Avita Health Homecare Obligated Group Foundation Subtotal Matters Eliminations Total Unrestricted Revenue, Gains, and Other Support Net patient service revenue $ 179,427,557 $ - $ 179,427,557 $ 4,604,542 $ - $ 184,032,099 Less provision for bad debts (9,497,551) - (9,497,551) - - (9,497,551) Net patient service revenue less provision for bad debts 169,930, ,930,006 4,604, ,534,548 Other operating revenue 4,540,262-4,540,262 75,563-4,615,825 Net assets released from restrictions , , ,158 Total unrestricted revenue, gains, and other support 174,470, , ,737,426 4,680, ,417,531 Expenses Salaries and wages 77,070, ,606 77,189,392 2,253,376-79,442,768 Employee benefits and payroll taxes 18,159,772-18,159, ,689-18,780,461 Medical supplies and drugs 28,119,546 9,806 28,129, ,167-28,350,519 Purchased services 21,126,531 72,383 21,198, ,889-22,084,803 Insurance 1,730,845-1,730, ,730,845 Utilities 2,609,816-2,609,816 86,586-2,696,402 Repairs and maintenance 5,878, ,879, ,879,271 Depreciation and amortization 9,133,995-9,133, ,839-9,236,834 Interest expense 1,017,710-1,017,710 30,656-1,048,366 Other 5,794,623 60,247 5,854, ,464-6,616,334 Total expenses 170,642, , ,903,937 4,962, ,866,603 Operating Income (Loss) 3,828,133 5,356 3,833,489 (282,561) - 3,550,928 Nonoperating Income (Loss) Investment income 275,769 (17,716) 258, ,053 Equity in losses of unconsolidated investees (188,372) - (188,372) - 188,372 - Other income (expense) 725,570 (147,617) 577, ,953 Change in unrealized investment loss (236,577) - (236,577) - - (236,577) Change in fair value of interest rate swap agreements 124, , ,317 Total nonoperating income (loss) 700,707 (165,333) 535, , ,746 Excess of Revenue Over (Under) Expenses 4,528,840 (159,977) 4,368,863 (282,561) 188,372 4,274,674 Contributions from Noncontrolling Members 171, , ,500 Distributions to Noncontrolling Members (527,742) - (527,742) - - (527,742) Transfer (to) from Parent (216,184) 216, Pension-related Changes Other than Net Periodic Pension Cost (2,026,550) - (2,026,550) - - (2,026,550) Increase (Decrease) in Unrestricted Net Assets $ 1,929,864 $ 56,207 $ 1,986,071 $ (282,561) $ 188,372 $ 1,891,882 40

43 Federal Awards Supplemental Information June 30, 2016

44 Contents Independent Auditor's Reports: Report on Schedule of Expenditures of Federal Awards Required by the Uniform Guidance 1 Report on Internal Control Over Financial Reporting and on Compliance and Other Matters Based on an Audit of Financial Statements Performed in Accordance with Government Auditing Standards 2-3 Report on Compliance for Each Major Federal Program; Report on Internal Control Over Compliance 4-5 Schedule of Expenditures of Federal Awards 6 Notes to Schedule of Expenditures of Federal Awards 7 Schedule of Findings and Questioned Costs 8-12 Summary Schedule of Prior Audit Findings 13

45 Report on Schedule of Expenditures of Federal Awards Required by the Uniform Guidance Independent Auditor's Report To the Board of Directors Avita Health System We have audited the consolidated financial statements of Avita Health System as of and for the year ended June 30, 2016 and have issued our report thereon dated November 30, 2016, which contained an unmodified opinion on those consolidated financial statements. Our audit was conducted for the purpose of forming an opinion on the consolidated financial statements as a whole. We have not performed any procedures with respect to the audited consolidated financial statements subsequent to November 30, The accompanying schedule of expenditures of federal awards is presented for the purpose of additional analysis as required by the Uniform Guidance, and is not a required part of the consolidated financial statements. Such information is the responsibility of management and was derived from and relates directly to the underlying accounting and other records used to prepare the consolidated financial statements. The information has been subjected to the auditing procedures applied in the audit of the consolidated financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the consolidated financial statements or to the consolidated financial statements themselves, and other additional procedures in accordance with auditing standards generally accepted in the United States of America. In our opinion, the information is fairly stated in all material respects in relation to the consolidated financial statements as a whole. November 30,

46 Report on Internal Control Over Financial Reporting and on Compliance and Other Matters Based on an Audit of Financial Statements Performed in Accordance with Government Auditing Standards Independent Auditor's Report To Management and the Board of Directors Avita Health System We have audited, in accordance with the auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards issued by the Comptroller General of the United States, the consolidated financial statements of Avita Health System (the "System"), which comprise the consolidated balance sheet as of June 30, 2016 and the related consolidated statements of operations, changes in net assets, and cash flows for the year then ended, and the related notes to the consolidated financial statements, and have issued our report thereon dated November 30, Internal Control Over Financial Reporting In planning and performing our audit of the consolidated financial statements, we considered Avita Health System's internal control over financial reporting (internal control) to determine the audit procedures that are appropriate in the circumstances for the purpose of expressing our opinion on the consolidated financial statements, but not for the purpose of expressing an opinion on the effectiveness of the System's internal control. Accordingly, we do not express an opinion on the effectiveness of the System's internal control. Our consideration of internal control was for the limited purpose described in the preceding paragraph and was not designed to identify all deficiencies in internal control that might be material weaknesses or significant deficiencies and therefore, material weaknesses or significant deficiencies may exist that were not identified. However, as described in the accompanying schedule of findings and questioned costs, we identified certain deficiencies in internal control that we consider to be material weaknesses and other deficiencies that we consider to be significant deficiencies. A deficiency in internal control exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent, or detect and correct, misstatements on a timely basis. A material weakness is a deficiency, or a combination of deficiencies, in internal control such that there is a reasonable possibility that a material misstatement of the System's consolidated financial statements will not be prevented, or detected and corrected, on a timely basis. We consider the deficiency described as Finding in the accompanying schedule of findings and questioned costs to be a material weakness. 2

47 To Management and the Board of Directors Avita Health System A significant deficiency is a deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness, yet important enough to merit attention by those charged with governance. We consider the deficiencies described as Findings , , and in the accompanying schedule of findings and questioned costs to be significant deficiencies. Compliance and Other Matters As part of obtaining reasonable assurance about whether Avita Health System's consolidated financial statements are free from material misstatement, we performed tests of its compliance with certain provisions of laws, regulations, contracts, and grant agreements, noncompliance with which could have a direct and material effect on the determination of consolidated financial statement amounts. However, providing an opinion on compliance with those provisions was not an objective of our audit and, accordingly, we do not express such an opinion. The results of our tests disclosed no instances of noncompliance or other matters that are required to be reported under Government Auditing Standards. Avita Health System's Response to Findings Avita Health System's response to the findings identified in our audit are described in the accompanying schedule of findings and questioned costs. Avita Health System's response was not subjected to the auditing procedures applied in the audit of the consolidated financial statements and, accordingly, we express no opinion on it. Purpose of this Report The purpose of this report is solely to describe the scope of our testing of internal control and compliance and the results of that testing, and not to provide an opinion on the effectiveness of the System's internal control or on compliance. This report is an integral part of an audit performed in accordance with Government Auditing Standards in considering the System's internal control and compliance. Accordingly, this communication is not suitable for any other purpose. November 30,

48 Report on Compliance for Each Major Federal Program; Report on Internal Control Over Compliance Independent Auditor's Report To the Board of Directors Avita Health System Report on Compliance for Each Major Federal Program We have audited Avita Health System's (the "System") compliance with the types of compliance requirements described in the U.S. Office of Management and Budget (OMB) Compliance Supplement that could have a direct and material effect on its major federal program for the year ended June 30, Avita Health System's major federal program is identified in the summary of auditor's results section of the accompanying schedule of findings and questioned costs. Management's Responsibility Management is responsible for compliance with the requirements of laws, regulations, contracts, and grants applicable to its federal program. Auditor's Responsibility Our responsibility is to express an opinion on compliance for each of Avita Health System's major federal programs based on our audit of the types of compliance requirements referred to above. We conducted our audit of compliance in accordance with auditing standards generally accepted in the United States of America; the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States; and the audit requirements of Title 2 U.S. Code of Federal Regulations Part 200, Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards (the "Uniform Guidance"). Those standards and the Uniform Guidance require that we plan and perform the audit to obtain reasonable assurance about whether noncompliance with the types of compliance requirements referred to above that could have a direct and material effect on a major federal program occurred. An audit includes examining, on a test basis, evidence about Avita Health System's compliance with those requirements and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion on compliance for each major federal program. However, our audit does not provide a legal determination of Avita Health System's compliance. 4

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