NANTICOKE HEALTH SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY INFORMATION YEARS ENDED
NANTICOKE HEALTH SERVICES, INC. AND SUBSIDIARIES TABLE OF CONTENTS YEARS ENDED INDEPENDENT AUDITORS' REPORT 1 CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATED BALANCE SHEETS 2 CONSOLIDATED STATEMENTS OF OPERATIONS 4 CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS 5 CONSOLIDATED STATEMENTS OF CASH FLOWS 6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 7 INDEPENDENT AUDITORS' REPORT ON SUPPLEMENTARY INFORMATION 30 SUPPLEMENTARY INFORMATION NANTICOKE HEALTH SERVICES, INC. AND SUBSIDIARIES CONSOLIDATING BALANCE SHEET 31 CONSOLIDATING STATEMENT OF OPERATIONS 33 NANTICOKE MEMORIAL HOSPITAL, INC. AND SUBSIDIARY CONSOLIDATING BALANCE SHEET 34 CONSOLIDATING STATEMENT OF OPERATIONS 36 SUPPLEMENTARY DESCRIPTION OF ELIMINATING ENTRIES 37
CliftonLarsonAllen LLP www.cliftonlarsonallen.com INDEPENDENT AUDITORS REPORT Board of Directors Nanticoke Health Services, Inc. and Subsidiaries Seaford, Delaware We have audited the consolidated balance sheets of Nanticoke Health Services, Inc. (a Delaware notfor-profit corporation) and Subsidiaries as of June 30, 2012 and 2011, and the related consolidated statements of operations, changes in net assets, and cash flows for the years then ended. These consolidated financial statements are the responsibility of Nanticoke Health Services, Inc. and Subsidiaries' management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We did not audit the financial statements of Nanticoke Insurance Company, Ltd., whose statements reflect total assets consisting of approximately 10% and 7% as of June 30, 2012 and 2011, respectively, and revenues of less than 1% for the years ended June 30, 2012 and 2011, of the consolidated totals. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Nanticoke Insurance Company, Ltd., is based solely on the report of the other auditors. We conducted our audits in accordance with the auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the report of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Nanticoke Health Services, Inc. and Subsidiaries as of June 30, 2012 and 2011, and the results of their operations, changes in their net assets and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. In July 2011, the Financial Accounting Standards Board (FASB) issued guidance regarding the Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts for Health Care Entities. In 2012, Nanticoke Health Services, Inc. adopted and retrospectively applied the standard to the 2011 consolidated financial statements. See Note 1 of the consolidated financial statements for further disclosure. Plymouth Meeting, Pennsylvania August 30, 2012 CliftonLarsonAllen LLP (1)
NANTICOKE HEALTH SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS CURRENT ASSETS Cash and Cash Equivalents $ 12,438,471 $ 2,058,531 Patient Accounts Receivable, Net 11,257,466 11,941,191 Inventories 1,560,415 1,624,950 Other Trustee Funds 429,162 442,529 Prepaid Expenses and Other 3,543,048 2,983,734 Assets from Discontinued Operations 1,020,938 1,301,929 Total Current Assets 30,249,500 20,352,864 ASSETS LIMITED AS TO USE Board-Designated Funds 29,086,808 28,449,887 Other Investments 10,672,795 9,353,723 Debt Service Reserve Fund 4,047,242 4,042,926 Principal Sinking Fund 244,122 230,032 Total Assets Limited as to Use 44,050,967 42,076,568 PROPERTY AND EQUIPMENT 117,744,738 120,867,185 Less: Accumulated Depreciation and Amortization (66,898,956) (66,781,113) Property and Equipment, Net 50,845,782 54,086,072 OTHER ASSETS Security Deposits 1,000 33,848 Deferred Financing Costs, Net 1,184,047 1,327,029 Deferred Compensation 589,651 698,124 Investment in Joint Venture 314,750 - Total Other Assets 2,089,448 2,059,001 Total Assets $ 127,235,697 $ 118,574,505 See accompanying Notes to Consolidated Financial Statements. (2)
LIABILITIES AND NET ASSETS CURRENT LIABILITIES Current Portion Long-Term Obligations $ 3,033,521 $ 2,533,299 Accounts Payable and Accrued Expenses 12,368,332 11,844,319 Accrued Salaries and Payroll Taxes 2,199,507 2,046,501 Accrued Vacation 1,926,447 1,690,534 Accrued Interest Payable 432,387 446,117 Estimated Third Party Payor Settlements 950,000 400,000 Liabilities from Discontinued Operations 1,845,126 697,637 Total Current Liabilities 22,755,320 19,658,407 LONG-TERM OBLIGATIONS Revenue Bonds Payable, Net of Current Portion 50,199,883 51,320,473 Capital Lease Obligation, Net of Current Portion 2,120,231 1,586,747 Total Long-Term Obligations 52,320,114 52,907,220 ACCRUED PENSION AND OTHER RETIREMENT BENEFITS 8,266,998 3,931,659 OTHER LIABILITIES 1,216,602 1,306,175 Total Liabilities 84,559,034 77,803,461 COMMITMENTS AND CONTINGENCIES NET ASSETS Unrestricted 42,278,147 40,030,615 Temporarily Restricted 398,516 740,429 Total Net Assets 42,676,663 40,771,044 Total Liabilities and Net Assets $ 127,235,697 $ 118,574,505 (3)
NANTICOKE HEALTH SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED UNRESTRICTED REVENUES Net Patient and Resident Service Revenues $ 130,983,586 $ 129,805,698 Provision for Bad Debts (11,723,364) (11,451,576) Net Patient and Resident Service Revenues, Less Provision for Bad Debts 119,260,222 118,354,122 Other Revenues 4,791,952 2,220,056 Interest Income 430,528 304,790 Net Assets Released from Restrictions, Used for Operations 656,781 43,210 Total Unrestricted Revenues 125,139,483 120,922,178 EXPENSES Salaries and Wages 40,984,938 40,193,021 Employee Benefits 14,905,565 15,680,548 Contract Labor 3,967,246 4,114,193 Physician Fees 9,950,623 7,898,822 Professional Fees 773,096 860,130 Purchased Services 15,830,575 15,484,262 Medical Supplies 12,836,582 13,256,173 Drugs 4,422,998 5,065,439 Repairs and Maintenance 2,023,324 1,675,234 Rental and Lease Expenses 1,443,260 778,736 Utilities 2,469,070 2,591,804 Insurance 613,961 389,776 Other Expenses 2,755,965 4,441,756 Depreciation 6,147,570 7,440,439 Interest and Amortization Expense 2,975,931 2,947,513 Total Expenses 122,100,704 122,817,846 OPERATING INCOME (LOSS) 3,038,779 (1,895,668) OTHER INCOME Investment Return 513,332 643,825 Unrealized Gain (Loss) on Investments (495,673) 3,097,135 Total Other Income 17,659 3,740,960 EXCESS OF REVENUES OVER EXPENSES 3,056,438 1,845,292 Discontinued Operations, Including a Gain on Disposal of $5,739,025 in 2012 4,131,446 (1,031,330) Pension and Postretirement Adjustment (4,940,352) 3,598,879 INCREASE IN UNRESTRICTED NET ASSETS $ 2,247,532 $ 4,412,841 See accompanying Notes to Consolidated Financial Statements. (4)
NANTICOKE HEALTH SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS YEARS ENDED UNRESTRICTED NET ASSETS Excess of Revenues over Expenses $ 3,056,438 $ 1,845,292 Discontinued Operations 4,131,446 (1,031,330) Pension and Postretirement Adjustment (4,940,352) 3,598,879 Increase in Unrestricted Net Assets 2,247,532 4,412,841 TEMPORARILY RESTRICTED NET ASSETS Net Assets Released from Restrictions, Used for Operations (656,781) (43,210) Contributions 314,868 460,455 Increase (Decrease) in Temporarily Restricted Net Assets (341,913) 417,245 INCREASE IN NET ASSETS 1,905,619 4,830,086 Net Assets - Beginning of Year 40,771,044 35,940,958 NET ASSETS - END OF YEAR $ 42,676,663 $ 40,771,044 See accompanying Notes to Consolidated Financial Statements. (5)
NANTICOKE HEALTH SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CASH FLOWS FROM OPERATING ACTIVITIES Increase in Net Assets $ 1,905,619 $ 4,830,086 Adjustments to Reconcile Increase (Decrease) in Net Assets to Net Cash Provided by Operating Activities: Pension and Postretirement Adjustment 4,940,352 (3,598,879) Depreciation and Amortization 6,147,570 7,542,989 Provision for Bad Debts 11,723,364 11,451,576 Investment in Joint Venture 2,250 - Gain on Sale of Property and Equipment (257,376) - Changes in Net Unrealized (Gain) Loss on Investments 495,673 (3,097,135) Change in Assets Whose Use is Limited (2,470,072) (3,280,439) Change in Deferred Compensation 108,473 (59,072) Amortization of Deferred Financing Costs 142,982 69,105 Changes in Operating Assets and Liabilities, Net (9,668,646) (9,884,112) Net Cash Provided by Operating Activities 13,070,189 3,974,119 CASH FLOWS FROM INVESTING ACTIVITIES Net Cash Used for the Purchases of Property and Equipment (1,246,002) (3,710,464) Proceeds from Sale of Property and Equipment 934,993 - Investment in Joint Venture (317,000) - Net Cash Used by Investing Activities (628,009) (3,710,464) CASH FLOWS FROM FINANCING ACTIVITIES Cash Used for Repayments of Revenue Bonds Payable and Lease Obligations (2,062,240) (2,433,409) NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 10,379,940 (2,169,754) Cash and Cash Equivalents - Beginning of Year 2,058,531 4,228,285 CASH AND CASH EQUIVALENTS - END OF YEAR $ 12,438,471 $ 2,058,531 CHANGES IN OPERATING ASSETS AND LIABILITIES, NET Change in Operating Assets: Patient Accounts Receivable, Net $ (11,124,703) $ (10,583,857) Inventories 70,385 (77,558) Prepaid Expenses and Other Assets (562,648) (541,106) Other Trustee Funds 46,215 332,202 Total Change in Operating Assets (11,570,751) (10,870,319) Change in Operating Liabilities: Accounts Payable and Accrued Expenses 1,823,840 672,236 Accrued Salaries and Payroll Taxes 206,045 413,496 Accrued Vacation 30,536 40,862 Accrued Interest Payable (13,730) (8,003) Accrued Pension and Other Postretirement Benefits (605,013) 367,657 Estimated Third Party Payor Settlements 550,000 (435,000) Other Liabilities (89,573) (65,041) Total Change in Operating Liabilities 1,902,105 986,207 CHANGES IN OPERATING ASSETS AND LIABILITIES, NET $ (9,668,646) $ (9,884,112) SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash Paid for Interest $ 2,846,679 $ 2,886,411 NONCASH FINANCING AND INVESTING ACTIVITIES Purchases of Property and Equipment $ 1,975,356 $ 1,319,093 Capital Lease Obligation 1,975,356 1,319,093 (6)
NANTICOKE HEALTH SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation Nanticoke Health Services, Inc. was formed in January 1986 as a Delaware not-for-profit corporation to be governed by its Board of Directors. Nanticoke Health Services, Inc. is a membership corporation without capital stock and is exempt from federal income taxes under Section 501(c)(3) of the Internal Revenue Code (IRC). A brief description of the activities and operations of Nanticoke Health Services, Inc. and Subsidiaries (collectively known as the Organization ) follows: Nanticoke Health Services, Inc. (Health Services) Nanticoke Health Services, Inc. coordinates and supports health care delivery by establishing system-wide policy and directing strategic planning for the subsidiaries. In addition, Health Services coordinates the community fundraising functions for the subsidiaries. Nanticoke Memorial Hospital, Inc. (the Hospital) The Hospital provides acute care patient services on an inpatient and outpatient basis. It is the most significant operating entity of the consolidated group. The Hospital has a whollyowned subsidiary, Nanticoke Alternative Care, Inc., which operated a long-term care facility under the name Lifecare at Lofland Park (Lofland). The Hospital and its subsidiary are exempt from federal income taxes under Section 501(c)(3) of the IRC. As of June 29, 2012, the assets and activities of Lofland were sold to an unrelated party. Management is in the process of winding down the entity and anticipates closing the entity during fiscal 2013 (see Note 16). Mid-Sussex Medical Center, Inc. d/b/a Nanticoke Physician Network (the Physician Network) The Physician Network provides outpatient medical care in clinics located in Millsboro, Georgetown, and Seaford, Delaware. The Physician Network is exempt from federal income taxes under Section 501(c)(3) of the IRC. Dual Development Corporation (Dual) Dual s primary operational activities are property development and management for the related corporations. Dual is exempt from federal income taxes under Section 501(c)(3) of the IRC. In July 2011 Dual was dissolved and the operations were absorbed by the Hospital and Lofland. Proprietary Enterprises, Inc. (Proprietary) Proprietary was formed to operate for-profit ventures such as occupational health services and a child day-care center. The child day-care center was closed in the fiscal year ended June 30, 2008, and the remaining operations of Proprietary were merged into the Hospital. There were no activities in Proprietary as of June 30, 2012 and 2011. Nanticoke Insurance Corporation, Ltd. (NIC) NIC is a captive insurance entity established in the Cayman Islands, which was created to provide professional and general liability insurance to Health Services and professional liability coverage to physicians in the community. (7)
NANTICOKE HEALTH SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) The accompanying consolidated financial statements include the accounts of each of the aforementioned corporations. All significant inter-company accounts and transactions have been eliminated through consolidation. Method of Accounting The Organization reports in accordance with Audit and Accounting Guide for Health Care Organizations published by the American Institute of Certified Public Accountants which prescribes accounting and reporting policies, some of which are unique to providers of health care services. Use of Estimates The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents Cash and cash equivalents include certain investments in highly liquid debt instruments with original maturities of three months or less. Patient and Resident Accounts Receivable, Net The Organization s policy is to perform in-house collections procedures for approximately 90 days. A determination is made at that time as to what additional collection efforts to pursue. An allowance for doubtful accounts is recorded for accounts not yet written off that are anticipated to become uncollectible in future periods. The allowance for doubtful accounts was approximately $8,472,000 and $8,805,000 as of June 30, 2012 and 2011, respectively. Insurance coverage and credit information are obtained from patients when available. No collateral is obtained for accounts receivable. Accounts receivable from third-party payors have been adjusted to reflect the difference between charges and estimated reimbursable amounts. Inventories Inventories, which primarily consist of medical supplies and drugs, are carried at the lower of cost or market. Cost is determined using the first-in, first-out method. Assets Limited as to Use In accordance with Accounting for Certain Investments Held by Not-for-Profit Organizations, the Organization accounts for all investments in debt and marketable equity securities (except those accounted for under the equity method of accounting) at fair value. The fair values of individual investments are based on quoted market prices of individual securities or investments or are estimated using quoted market prices of similar investments. (8)
NANTICOKE HEALTH SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Assets Limited as to Use (Continued) Investment income (including realized gains and losses, unrealized gains and losses and interest and dividends) is reported as other income (expense) unless the income is restricted by donor or law. The cost of securities sold is based on the specific identification method. All investment balances are principally uninsured and subject to normal credit and market risk. Other investments consists of debt and marketable equity securities that are held by NIC. The Organization has designated its investment portfolio as trading with unrealized gains and losses included in excess of revenues over expenses. All other assets limited as to use primarily include assets held by trustees under indenture agreements and designated assets set aside by the board of directors 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 of the Organization have been reclassified to current assets in the consolidated balance sheet as of June 30, 2012 and 2011. Property and Equipment Property and equipment acquisitions are recorded at cost. Improvements that materially extend the useful lives of the assets are capitalized, while routine maintenance, repairs, and minor replacement costs are charged to operations when incurred. Depreciation is provided over the estimated useful life of each class of depreciable asset and is computed using the straight-line method. Equipment under capital lease obligations is amortized on the straightline method over the shorter period of the lease term of the estimated useful life of the equipment. Such amortization is included in depreciation and amortization in the consolidated statement of operations. Interest costs incurred on borrowed funds during the period of construction of capital assets is 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 the deficit of revenues over expenses, unless explicit donor stipulations specify how the donated assets must be used. Gifts of long-lived assets with explicit restrictions that specify how the assets are to be used and gifts of cash or other assets that must be used to acquire long-lived assets are reported as restricted support. Absent explicit donor stipulations about how long those long-lived assets must be maintained, expirations of donor restrictions are reported when the donated or acquired long-lived assets are placed into service. (9)
NANTICOKE HEALTH SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Investment in Joint Venture On June 9, 2011 the Hospital entered into a joint venture agreement with two other organizations to form Peninsula Home Care at Nanticoke, LLC. The Hospital contributed $317,000 and $0 for the fiscal years ended June 30, 2012 and 2011, respectively. The Hospital owns 33 percent of the entity, and a 33 percent share in the income or losses according to the joint venture agreement. The investment in the joint venture is recorded on the equity method and the Hospital recorded a loss of $2,250 for the fiscal year ended June 30, 2012 and no income or loss for the fiscal year ended June 30, 2011. Estimated Professional Liabilities The provision for estimated professional liability claims includes estimates of the ultimate costs for both reported claims and incurred but not reported claims. Due to uncertainties inherent in the claims estimation process, it is at least reasonably possible that actual claims paid could differ materially from the amounts accrued in the accompanying consolidated balance sheets. Net Assets Unrestricted net assets consist of investments and otherwise unrestricted amounts that are available for use in carrying out the Organization s mission and include those expendable resources which have been designated for special use by the board of directors. Temporarily restricted net assets are those whose use has been limited by donors to a specific time period or purpose. Permanently restricted net assets have been restricted by donors to be maintained in perpetuity. The Organization did not have any permanently restricted net assets at June 30, 2012 and 2011. Net Patient and Resident Service Revenues The Organization has agreements with third-party payors that provide for payments to the Organization at amounts different from its established rates. Payment arrangements include prospectively determined rates per discharge, reimbursed costs, discounted charges, and per diem payments. Net patient and resident 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 thirdparty 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. Contributions Contributions from donors are classified as unrestricted, temporarily restricted, or permanently restricted net assets. Unrestricted contributions are reflected in the accompanying consolidated statements of operations. Temporarily restricted contributions are those limited by donors for specific uses. Such contributions are reflected as increases in unrestricted net assets when qualifying expenditures are made, thus releasing the restriction. (10)
NANTICOKE HEALTH SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Charity Care The Organization provides care without charge or at amounts less than its established rates to patients who meet certain criteria under its charity care policy. Because the Organization does not pursue collection of amounts determined to qualify as charity care, those amounts are not reported as revenues. The Organization provides care to patients who meet certain criteria under its financial assistance policy without charge. Key elements used to determine eligibility include a patient s demonstrated inability to pay based on family size and household income related to federal income poverty guidelines. The Organization s charity care guidelines are 175% of the Federal Poverty Guidelines as published. The Organization maintains records to identify and monitor the amount of charges foregone for services and supplies furnished under its charity care policy which amounted to approximately $2,761,000 and $3,169,000 for the years ended June 30, 2012 and 2011, respectively. Excess of Revenues over Expenses The consolidated statements of operations include excess of revenues over expenses and changes in net assets. Changes in unrestricted net assets, which are excluded from excess of revenues over expenses, consistent with industry practice, include the pension adjustment, the effect of discontinued operations and contributions received and used for additions to long-lived assets. Other Revenues Other revenues for the years ended June 30, 2012 and 2011 include gains on the sale of property previously owned by the Hospital of $257,376 and $0, respectively. In accordance with Accounting for Impairment or Disposal of Long-Lived Assets, as the property did not meet the definition of a component of an entity, the gain has been included in other revenue in the accompanying consolidated statements of operations. Workers' Compensation Insurance The Organization has Workers' Compensation Insurance that covers all employees. This insurance is backed by letters of credit totaling $1,246,702 as of June 30, 2012 and 2011, as required by the insurance administrator. Income Taxes The Organization follows the standard of accounting for uncertainty in income taxes recognized in an entity s financial statements. The standard prescribes recognition and measurement of tax provisions taken or expected to be taken on a tax return that are not certain to be realized. The application of the standard had no impact on the Organization s consolidated financial statements. The Organization s tax returns are subject to review and examination by federal and state authorities. The tax returns for the years 2009 to 2011 are open to examination by federal and state authorities. (11)
NANTICOKE HEALTH SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Reclassifications Certain items in the prior year consolidated financial statements have been reclassified to conform to the current year s presentation. These reclassifications had no effect on total assets, net assets of the Organization, or the increase in net assets. Recent Pronouncements In July 2011, the Financial Accounting Standards Board (FASB) issued guidance regarding the Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts for Health Care Entities. The Organization adopted this standard to these comparative consolidated financial statements and retrospectively applied the provisions of the accounting standard to the June 30, 2011 financial statements. The guidance requires certain health care entities to change the presentation of the statement of operations by reclassifying the provision for bad debts associated with patient and resident service revenues from an operating expense to a deduction from patient and resident service revenues, net of contractual allowances and discounts. The guidance also requires enhanced disclosures surrounding the Organization s policies for recognizing and assessing bad debts (see Note 2). Subsequent Events In preparing these consolidated financial statements, the Organization has evaluated events and transactions for potential recognition or disclosure through August 30, 2012, the date the consolidated financial statements were issued. The results of this evaluation indicated that there are no subsequent events or transactions that are required to be disclosed in these consolidated financial statements. NOTE 2 NET PATIENT AND RESIDENT SERVICE REVENUE The Organization has various agreements with third-party payors that provide for payments to the Organization at amounts different from its established rates. A summary of the payment arrangements with major third-party payors follows: Medicare Substantial portions of the Hospital s net patient and resident service revenues are for services provided to patients participating in the Medicare and Medicaid programs. Under the Medicare Inpatient Prospective Payment System (PPS), the Organization is reimbursed a fixed amount per inpatient discharge based on a national rate adjusted for regional variation in wages and the diagnosis of the patient. These rates are adjusted annually by the Medicare program. Outpatient services at the Hospital are reimbursed by Medicare under the outpatient PPS. Outpatient services are reimbursed based on a national rate per service adjusted for regional variations in wages. These rates are adjusted annually by Medicare. (12)
NANTICOKE HEALTH SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 2 NET PATIENT AND RESIDENT SERVICE REVENUE (CONTINUED) Medicaid The Delaware Medicaid program utilizes the services of a Managed Care Organization (MCO) to administer the program for hospital services. Reimbursement from the MCO for inpatient services is based on a fixed reimbursement per case, and outpatient services are reimbursed either on a fixed-fee basis or a percentage of charges based on cost, depending on the nature of the service. The difference between Medicare/Medicaid reimbursement and the Hospital s standard billing rates is recorded as a component of contractual allowances in determining net patient and resident service revenues in the accompanying consolidated statements of operations. Blue Cross Blue Shield A significant portion of the Hospital s net patient and resident service revenues are for services provided to subscribers of Blue Cross Blue Shield of Delaware (Blue Cross) and other commercial insurers. The Hospital is reimbursed by Blue Cross and these other third-party payors based on approved rates, less contractual discounts. These discounts are recorded as a component of contractual allowances in determining net patient and resident service revenues in the accompanying consolidated statements of operations. Long-Term Care Medicare/Medicaid A significant portion of Lofland s net patient and resident service revenues are for services provided to patients participating in the Medicare and Medicaid programs. Medicare reimbursement methodology for long-term care is also based on PPS. Lofland is reimbursed a prospectively approved amount for each case within a resource utilization group (RUG). Delaware Medicaid reimburses Lifecare at Lofland Park for residents enrolled in the program at a fixed amount per day based on the level of care provided. These rates are adjusted annually based on aggregated and specific costs. The difference between the Medicare/Medicaid reimbursement and the standard billing rates has been recorded as a component of contractual allowances in determining net patient and resident service revenues in the accompanying consolidated statements of operations. The Physician Network Medicare/Medicaid The Physician Network is also a provider of health care services to Medicare and Medicaid patients. The Physician Network is reimbursed based on a fixed fee-forservice. Any difference between the payment amount and established rates is recorded as a component of contractual allowances in determining net patient and resident service revenues. Net patient and resident service revenues are reported at the estimated net realizable amounts from patients and third-party payors for services rendered, including estimated retroactive adjustments and regulatory discounts under reimbursement agreements with third-party payors. (13)
NANTICOKE HEALTH SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 2 NET PATIENT AND RESIDENT SERVICE REVENUE (CONTINUED) 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. In evaluating the collectability of accounts receivable, the Organization analyzes past results and identifies trends for each major payor source of revenue for the purpose of estimating the appropriate amounts of the allowance for doubtful accounts and the provision for bad debts. Data in each major payor source are regularly reviewed to evaluate the adequacy of the allowance for doubtful accounts. Specifically, for receivables relating to services provided to patients having third-party coverage, an allowance for doubtful accounts and a corresponding provision for bad debts are established for amounts outstanding longer than 90 days and for third-party payors experiencing financial difficulties; for receivables relating to self-pay patients, a provision for bad debts is made in the period services are rendered based on experience indicating the inability or unwillingness of patients to pay amounts for which they are financially responsible. Actual write-offs are charged against the allowance for doubtful accounts. For the fiscal year ended June 30, 2012 net patient and resident service revenue decreased $550,000 due to the addition of allowances estimated for amounts due back to the Medicare program. For the fiscal year ended June 30, 2011 net patient and resident service revenue increased $435,000 due to removal of allowances previously estimated that were no longer considered necessary during the fiscal year. A summary of patient and resident service revenue and contractual adjustments for the fiscal years ended June 30, 2012 and 2011 is as follows: Gross Patient and Resident Service Revenues: Third Party Payors $ 259,731,757 $ 259,754,345 Self-Pay 17,072,273 17,669,831 Revenue Deductions: Charity Care 6,265,760 6,571,671 Provision for Bad Debts 11,723,364 11,451,576 Contractual and Other Allowances 139,554,684 141,046,807 Net Patient and Resident Service Revenues $ 119,260,222 $ 118,354,122 The Organization recognizes patient and resident service revenue associated with services provided to patients who have third-party payor coverage on the basis of contractual rates for the services rendered. For uninsured patients that do not qualify for charity care, the Organization recognizes revenue on the basis of its standard rates for services provided (or on the basis of discounted rates, if negotiated or provided by policy). On the basis of historical experience, a significant portion of the Organization s uninsured patients will be unable or unwilling to pay for the services provided. Thus, the Organization records a significant provision for bad debts related to uninsured patients in the period the services are provided. (14)
NANTICOKE HEALTH SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 3 REGULATORY ENVIRONMENT The health care industry is subject to numerous laws and regulations of federal, state, and local governments. These laws and regulations include, but are not necessarily limited to, matters such as licensure, accreditation, government health care program participation requirements, and reimbursement for patient services. Recently, government activity has increased with respect to investigations and allegations concerning possible violations of fraud and abuse statutes and regulations by health care providers. Violations of these laws and regulations could result in expulsion from government health care programs, together with the imposition of significant fines and penalties, as well as significant repayments for patient services previously billed. Compliance with such laws and regulations can be subject to future government review and interpretation. Also, future changes in federal and state reimbursement funding mechanisms and related government budgetary constraints could have an adverse effect on the Organization. The Organization is currently reviewing various aspects of its compliance with laws and regulations which include transactions which occurred in prior periods. Based upon its review thus far, management has not identified any significant violations which would have a material adverse effect on the accompanying consolidated financial statements. However, the ultimate determination of whether any contingent liabilities exist will not be finalized until this review is completed. NOTE 4 ASSETS LIMITED AS TO USE Assets limited as to use primarily include assets held by trustees under indenture agreements and designated assets set aside by the Board of Directors. Board-Designated Funds Board-designated funds represent investments designated by the Board of Directors for future capital replacements and other identified purposes. These investments consisted of the following as of June 30, 2012 and 2011: Cash and Certificates of Deposit $ 1,487,883 $ 1,031,665 Equity Securities 16,824,682 12,916,251 U.S. Government Securities 10,774,243 6,815,909 Corporate Bonds - 7,686,062 Board Designated Funds $ 29,086,808 $ 28,449,887 Trustee Funds Trustee funds include the interest fund, principal sinking fund, debt service reserve fund, and regulatory deposit. These funds are available to reimburse or directly pay costs associated with certain Hospital projects. Debt service reserve funds represent investments to be segregated and held pursuant to the terms of the revenue bond indentures (see Note 6). These funds will be utilized to fund debt service payments in the later years of the revenue bonds. (15)
NANTICOKE HEALTH SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 4 ASSETS LIMITED AS TO USE (CONTINUED) Trustee Funds (Continued) These investments are stated at fair value and consist of the following as of June 30, 2012 and 2011: Cash and Certificates of Deposit $ 4,720,526 $ 4,715,487 Debt Service Reserve Fund $ 4,047,242 $ 4,042,926 Principal Sinking Fund 244,122 230,032 Other Trustee Funds 429,162 442,529 Total $ 4,720,526 $ 4,715,487 Other Investments Other investments include funds held by NIC, which was formed to provide professional liability insurance (see Note 8) and consist of the following as of June 30, 2012 and 2011: Cash and Certificates of Deposit $ 574,694 $ 318,036 Equity Securities 2,723,380 2,231,481 U.S. Government Securities 7,374,721 6,750,797 Corporate Bonds - 53,409 Other Investments $ 10,672,795 $ 9,353,723 Investment Income Investment income and net unrealized gains (losses) for Board-designated funds, as well as assets limited as to use and cash and cash equivalents, consist of the following as of June 30, 2012 and 2011: Interest and Dividend Income $ 466,084 $ 316,859 Unrealized Gains (Losses) on Investments (495,673) 3,097,135 Realized Gains 477,776 631,756 Total $ 448,187 $ 4,045,750 Interest Income $ 430,528 $ 304,790 Investment Return 513,332 643,825 Unrealized Gains (Losses) on Investments (495,673) 3,097,135 Total $ 448,187 $ 4,045,750 (16)
NANTICOKE HEALTH SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 5 PROPERTY AND EQUIPMENT Property and equipment consist of the following as of June 30, 2012 and 2011: Land $ 2,076,110 $ 2,685,480 Buildings and Improvements 61,170,095 67,349,103 Fixed and Movable Equipment 54,498,533 50,832,602 Property and Equipment 117,744,738 120,867,185 Less: Accumulated Depreciation and Amortization (66,898,956) (66,781,113) Property and Equipment, Net $ 50,845,782 $ 54,086,072 NOTE 6 LONG-TERM OBLIGATIONS Long-term obligations consist of the following: Description Delaware Health Facilities Authority Revenue Bonds, Series 2002A, maturing in varying annual amounts, principal due annually on May 1st, through 2022, interest due semi-annually, effective interest rates ranging from 2.45% to 5.25% $ 18,065,000 $ 19,435,000 Delaware Health Facilities Authority Revenue Bonds, Series 2002B, maturing in varying annual amounts, principal due annually on May 1st, starting 2023 through 2032, interest due semi-annually, effective interest rate of 5.63% 30,250,000 30,250,000 Unamortized Portion of Bond Discount (471,229) (529,166) Sub-Total 47,843,771 49,155,834 Delaware Economic Development Authority Strategic Fund Loan, maturing in varying annual amounts through 2019, no stated interest rate 3,554,369 3,554,369 Various Capital Lease Obligations 3,955,495 2,730,316 Long-Term Obligations 55,353,635 55,440,519 Less: Current Portion of Long-Term Obligations 3,033,521 2,533,299 Long-Term Obligations, Net of Current Portion $ 52,320,114 $ 52,907,220 (17)
NANTICOKE HEALTH SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 6 LONG-TERM OBLIGATIONS (CONTINUED) Series 2002A and 2002B In August 2002, the Delaware Health Facilities Authority (the Authority) issued $27,750,000 Revenue Bonds (Nanticoke Memorial Hospital Project) Series 2002A and $30,250,000 Revenue Bonds (Nanticoke Memorial Hospital Project) Series 2002B at a discount of $774,000. The proceeds of the issue, after the payment of deferred financing costs, together with other funds was issued for the purposes of paying a portion of the costs of certain health care facilities and equipment of the Hospital (the 2002 Projects) including some or all of the interest on the Series 2002 Bonds during construction of the 2002 Projects, refinancing existing indebtedness, funding a deposit to the Debt Service Reserve Fund, and paying a portion of the related transaction costs. The Hospital and Dual jointly and severally guarantee the obligations of the revenue bonds. For the purposes of the 2002 Revenue Bonds, the Hospital and Dual constitute the Obligated Group (the Group). Under the terms of the project and refunding revenue bonds, the Group is required to maintain certain deposits with a trustee. Such deposits are included within assets limited as to use. The loan agreement also places limits on the incurrence of additional borrowings and requires that the Group satisfy certain measures of financial performance, including a liquidity covenant, as long as the notes are outstanding. The Group is required to make monthly deposits to a trustee account sufficient to meet the requirements of the serial bonds for Series 2002A and the sinking fund requirements of Series 2002B term bonds. Annual sinking fund installments for the term bonds range from $2,355,000 on May 1, 2023 to $3,820,000 at maturity. As security for the debt service requirements of the Series 2002 Bonds, the Hospital has granted to the Authority a mortgage lien on certain of its health care facilities in Seaford, Delaware, and a security interest in all of the Hospital s gross revenues. The terms of the loan agreement restrict the Hospital s ability to create additional indebtedness and its use of the facilities, and require the Hospital to maintain stipulated insurance coverage and a rate structure in each year sufficient to meet certain rate covenant requirements, including a debt service coverage requirement. Capital Lease Obligations The Organization has entered into various capital lease agreements for certain medical equipment. As of June 30, 2012 and 2011 the gross amount of the equipment and related accumulated amortization recorded under these leases is as follows: Equipment $ 6,327,418 $ 4,352,062 Less: Accumulated Amortization (2,783,223) (1,827,522) Leased Equipment, Net $ 3,544,195 $ 2,524,540 (18)
NANTICOKE HEALTH SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 6 LONG-TERM OBLIGATIONS (CONTINUED) Scheduled principal payments on all long-term obligations and payments on capital lease obligations at June 30, 2012 are as follows: Long-Term Capital Lease Year Ending June 30, Obligations Obligations 2013 $ 1,669,486 $ 1,508,079 2014 1,968,973 1,035,102 2015 2,033,973 829,616 2016 2,108,973 491,030 2017 2,193,973 394,136 Thereafter 41,893,991 - Total $ 51,869,369 4,257,963 Less: Amounts Representing Interest 302,468 Present Value of Net Minimum Lease Payments $ 3,955,495 NOTE 7 OPERATING LEASES The Organization leases medical equipment and office space under operating leases. These leases expire on various dates with renewal options on many of the leases. Scheduled lease payments for the next five years on operating lease obligations at June 30, 2012 are as follows: Year Ending June 30, Amount 2013 $ 989,154 2014 710,009 2015 408,134 2016 171,243 2017 68,304 Total $ 2,346,844 Rent expense for the years ended June 30, 2012 and 2011 for all operating leases was $1,626,662 and $1,678,465, respectively, and has been included within purchased services and other in the accompanying consolidated statements of operations. NOTE 8 PROFESSIONAL LIABILITY INSURANCE AND SELF-INSURANCE In May 2004, NIC was formed to provide professional liability insurance for the Organization and, if required, for qualifying medical practices in the Organization s communities. NIC is a wholly-owned subsidiary of Health Services. For the policy periods ended June 30, 2012 and 2011, the Hospital s coverage for Professional Liability was $2,000,000 per medical incident with a $6,000,000 annual aggregate limit. Health Services liability limit on the General Liability coverage was $2,000,000 per occurrence with a $6,000,000 annual aggregate limit. Effective February 1, 2005, an excess umbrella policy was also written with limits of $10,000,000 per occurrence with a $10,000,000 annual aggregate limit. All risks covered by the excess umbrella policy are reinsured by third-party reinsurers. (19)
NANTICOKE HEALTH SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 8 PROFESSIONAL LIABILITY INSURANCE AND SELF-INSURANCE (CONTINUED) Primary coverage is insured under a retrospectively rated claims-made policy; premiums are accrued based upon an estimate of the ultimate cost of the experience to date of each participating member institution. The basis for loss accruals for unreported claims under the primary policy is an actuarial estimate of asserted and unasserted claims including reported and unreported incidents and includes costs associated with settling claims. As of June 30, 2012 and 2011, estimates of losses and loss assessment expenses were approximately $5,603,000 and $5,951,000, respectively, and are principally recorded within accounts payable and accrued expenses in the accompanying consolidated balance sheets. Projected losses were discounted at 4% for both fiscal years ended June 30, 2012 and 2011. NOTE 9 RETIREMENT PLANS The Hospital has a qualified noncontributory defined benefit plan (Pension Plan) covering substantially all employees of the Hospital. The Hospital s funding policy is to make sufficient contributions to the Pension Plan to comply with the minimum funding requirements of the Employee Retirement Income Security Act (ERISA). At June 30, 2012 and 2011, the accrued pension liability is included in accrued retirement benefits in the accompanying consolidated balance sheets. The measurement date of the Pension Plan is June 30. Effective January 1, 2009, the Pension Plan was frozen and was replaced with augmentations to the Tax-Sheltered Annuity Plan described in the following pages. The following table summarizes information about the Pension Plan for the fiscal years ended June 30, 2012 and 2011: Changes in Benefit Obligations Projected Benefit Obligation - Beginning of Year $ 17,500,533 $ 18,986,306 Interest Cost 994,116 1,025,053 Actuarial (Gain) Loss- Assumption Changes and Plan Experience 4,364,712 (1,890,255) Benefits Paid (663,182) (620,571) Projected Benefit Obligation - End of Year $ 22,196,179 $ 17,500,533 Accumulated Benefit Obligation at End of Year $ 22,196,179 $ 17,500,533 Changes in Plan Assets Fair Value of Plan Assets - Beginning of Year $ 14,918,195 $ 13,295,754 Actual Return on Plan Assets 463,303 2,127,808 Employer Contributions 651,256 115,204 Benefits and Expenses Paid (663,182) (620,571) Fair Value of Plan Assets - End of Year $ 15,369,572 $ 14,918,195 Accrued Benefit Cost $ (6,826,607) $ (2,582,338) (20)
NANTICOKE HEALTH SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 9 RETIREMENT PLANS (CONTINUED) Employers are required to recognize the over-funded or under-funded status of a defined benefit postretirement plan as an asset or liability in its consolidated balance sheets and to recognize changes in that funded status in the year in which the change occurs through unrestricted net assets. The under-funded status of the Pension Plan of $6,826,607 and $2,582,338 at June 30, 2012 and 2011, respectively, is recognized in the accompanying consolidated balance sheets as accrued pension and other retirement benefits. For the fiscal years ended June 30, 2012 net assets decreased for Pension Plan related changes other than periodic costs of $4,764,657. For the fiscal years ended June 30, 2011 net assets increased for Pension Plan related changes other than periodic costs of $3,598,459. Net Amounts Recognized in the Consolidated Balance Sheets Consist of: Accrued Pension Liability $ 6,826,607 $ 2,582,338 Amounts Recognized in Accumulated Unrestricted Net Assets Consist of: Net Actuarial Loss $ 8,647,690 $ 3,883,033 Components of Net Periodic Benefit Cost: Interest Cost $ 994,116 $ 1,025,053 Expected Return on Assets (1,063,848) (909,514) Amortization of Unrecognized Net Actuarial Loss 200,600 489,908 Total Expense for Year $ 130,868 $ 605,447 The estimated net actuarial loss that is expected to be amortized from unrestricted net assets into net periodic benefit cost for the year ending June 30, 2013 is $592,794. The assumptions used to determine the benefit obligation and net periodic benefit cost for the Pension Plan are set forth below. Assumptions Weighted-Average Assumptions Used to Determine Benefit Obligations at June 30: Discount Rate 4.00% 5.75% Rate of Increase in Future Compensation Levels 0.00% 0.00% Weighted-Average Assumptions Used to Determine Net Periodic Benefit Cost for the Years Ended June 30: Discount Rate 5.75% 5.50% Rate of Increase in Future Compensation Levels 0.00% 0.00% Expected Long-Term Rate of Return on Assets 7.00% 7.00% (21)
NANTICOKE HEALTH SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 9 RETIREMENT PLANS (CONTINUED) The Pension Plan weighted average asset allocation and the target allocation, by asset category, are as follows: June 30, Asset Allocation Target Asset Category: Equity Securities 35.0% - 65.0% 53.0 % 53.0 % Debt Securities 35.0% - 65.0% 44.4 44.4 Other 0.0% - 20.0% 2.6 2.6 Total 100.0 % 100.0 % The Hospital s defined benefit plan invests in a diversified mix of traditional asset classes. Investment in U.S. equity securities and fixed income securities are made to maximize longterm results while recognizing the need for adequate liquidity to meet ongoing benefit and administrative obligations. Risk tolerance of unexpected investment and actuarial outcomes is continually evaluated by understanding the pension plan s liability characteristics. Equity investments are used primarily to increase overall plan returns. Debt securities provide diversification benefits and liability hedging attributes that are desirable, especially in falling interest rate environments. The following table presents the fair value hierarchy for the balances of the plan assets measured at fair value on a recurring basis as of June 30, 2012 and 2011: Level 1 Level 2 Level 3 Total 2012 Retirement Plan Assets Equity Securities $ 8,142,799 $ - $ - $ 8,142,799 Debt Securities 6,824,090 - - 6,824,090 Other - 402,683-402,683 Total $ 14,966,889 $ 402,683 $ - $ 15,369,572 2011 Retirement Plan Assets Equity Securities $ 7,903,660 $ - $ - $ 7,903,660 Debt Securities 6,623,679 - - 6,623,679 Other - 390,856-390,856 Total $ 14,527,339 $ 390,856 $ - $ 14,918,195 The overall rate of expected return on assets assumption was based on historical returns, with adjustments made to reflect expectations of future returns. The extent to which the future expectations were recognized included the target rates of return for the future, which has historically not changed. The Hospital does not have a regulatory contribution requirement for 2012; however, the Hospital currently intends to make voluntary contributions to the defined benefit pension plan of approximately $230,000 in fiscal 2013. (22)