Frederick Memorial Healthcare System Financial Report and Management Discussion For the Three Months Ended September 30, 2009 This report is presented in accordance with the continuing disclosure requirements of the First and Second Supplemental Loan Agreements between Maryland Health and Higher Educational Facilities and Frederick Memorial Hospital, Inc. (Article II section 2.03) dated August 6, 2002 and May 1, 2006 respectively and the continuing disclosure requirements of the Third Supplemental Loan Agreement between Maryland Health and Higher Educational Facilities and Frederick Memorial Hospital Inc. dated July 1, 2008. This report is prepared with a focus on the financial results for the Three Months Ended September 30, 2009. A comprehensive overview of fiscal year ended June 30, 2009 and comparisons of fiscal year ended June 30, 2009 to Budget FY 2009 can be found in the June 30, 2009 Annual Report that is posted on the DAC website (www.dacbond.com). The following presentation may include forward-looking information including budget information and discussions about future expectations and events. Actual results could differ materially from what is presented or said. ALL OF THE CURRENT FINANCIAL AND STATISTICAL INFORMATION CONTAINED HEREIN IS UNAUDITED Management Overview The results of operations for Frederick Memorial Healthcare System (FMHS) for the Three Months Ended September 30, 2009 (the period) resulted in consolidated operating income of $771 thousand versus a budgeted loss of $372 thousand. The consolidated operating EBIDA of $7.1 million (9.3%) for the period was better than the budget of $6.0 million (7.9%). Net inpatient revenues were under budget by $167 thousand (0.4%). Regulated campus-based outpatient net revenue exceeded budget by $459 thousand (2.0%). Outpatient unregulated and Transitional Care Unit (TCU) net revenue approximated budget for the period. Total net patient services revenue exceeded budget by $336 thousand (0.5%). FMHS inpatient admissions (adult & pediatric) were above budget for the period by 183 (4.1%), nursery discharges exceeded budget by 63 (11.8%) and TCU admissions were 4 better than budget (2.5%). Hospital EIPA s for the period were 9,554, 5.6% over budget and 4.9% higher than last year. The average length of stay (adult & pediatric) for the period was 4.03 versus a budget of 3.93. Days Cash On Hand on September 30, 2009 was 124 days, 6 days higher than June 30, 2009 due mostly to unrealized gains on investments partially offset by capital spending and debt payments. (See the Statement of Cash Flows overview to follow). Days Net Revenue in Accounts Receivable increased 0.6 days to 50.6 days during the period. MADS coverage rose to 2.3 times from 2.0 and debt-to-capitalization decreased to 50.1% from 51.9% during the period.
Further discussion of the operating results for the period is provided in conjunction with the financial and statistical tables presented below. The following table illustrates the consolidated results for fiscal years ended June 30, 2008 and 2009 and the consolidated operating budget for fiscal year ending June 30, 2010: FMH and Subsidiaries Statement of Operations* (000 s) Audit Audit Budget FY 2008 FY 2009 2010 Revenues: Net patient service revenues $ 267,045 $ 286,829 $ 300,429 Other operating revenues 13,384 11,776 9,801 Total Revenue 280,429 298,605 310,230 Non-Capital Expenses: 253,543 271,245 282,201 Operating EBIDA 26,886 27,360 28,029 Capital Expenses: Depreciation/Amortization 16,384 18,196 18,439 Interest Expense 8,798 7,221 7,430 Operating Income (Loss) 1,704 1,943 2,160 Other income(expense) (9,360) (14,517) 4,771 Excess of Revenues over Expenses $ (7,656) $ (12,574) $ 6,932 *Minor reclassifications were made to FY08 figures to conform to FY09 reporting. 2
The following tables compare the consolidated results to prior year and current year budget and the variances to budget for the period (prior year contains some reclasses from audited figures to conform with current year reporting which do not impact operating income or the change in unrestricted net assets): FMH and Subsidiaries Statement of Operations For the three months ended September 30, 2009 (000's) Prior Current Budget Variance Revenues: Net patient service revenues $ 69,888 $ 74,125 $ 73,789 $ 336 Other operating revenues 2,627 2,330 2,453 (123) Total Operating Revenue 72,515 76,455 76,242 213 Non-Capital Expenses 65,754 69,370 70,226 (856) Operating EBIDA 6,761 7,085 6,016 1,069 Capital Expenses: Depreciation/Amortization 4,358 4,571 4,562 9 Interest Expense 1,823 1,743 1,826 (83) Operating Income 580 771 (372) 1,143 Other income(expense): Nonoperating revenue (2,268) 305 1,186 (881) Net unrealized appreciation (depreciation) on investments (4,075) 5,269-5,269 Mark-to-market adjustment - interest rate swap (1,612) (1,498) - (1,498) Excess of Revenues over Expenses (7,375) 4,847 814 4,033 Other changes in unrestricted net assets: Net assets released from restriction 68 18-18 Other - - - - Increase (decrease) in unrestricted net assets $ (7,307) $ 4,865 $ 814 $ 4,051 Operating EBIDA By Entity For the three months ended September 30, 2009 (000's) Prior Current Budget Variance FMH $ 6,737 $ 6,844 $ 5,917 $ 927 Subsidiaries FHSC 66 169 130 39 Emmitsburg - - - - Hospice (42) 72 (31) 103 Total Subsidiaries 24 241 99 142 Operating EBIDA $ 6,761 $ 7,085 $ 6,016 $ 1,069 * See Subsidiary Results section for FHSC discussion. 3
Hospital Revenue and Other Changes in Net Assets Total net patient service revenue for the period was above budget by $336 thousand. The components of that variance are described below: Frederick Memorial Hospital Net Patient Services Revenue - Variance to Budget For the three months ended September 30, 2009 (000's) Inpatient - Regulated $ (167) Outpatient - Regulated 459 Outpatient - Unregulated (14) TCU 24 Hospice 35 FHSC (1) Net Patient Services Revenue - variance to Budget $ 336 Inpatient cases totaled 4,632; 183 cases above budget and 170 cases above prior year. At the budgeted rate for the period of $8,625 average gross revenue per case, the positive inpatient volume variance was $1.6 million. This volume shortfall was offset by an unfavorable case mix variance of approximately $1.8 million. TCU inpatient admissions were 4 above budget for the period. TCU ALOS of 9.96 was 6.3% unfavorable to budget. TCU patient days were under budget by 3.9%. Net regulated outpatient revenue exceeded budget by $459 thousand (2.0%). Higher than expected volumes in cath lab, emergency department, radiation therapy and interventional radiology were partially offset by shortfalls in general surgery, IV therapy and cyberknife volumes. Net unregulated outpatient revenues were below budget by $14 thousand for the period. Better than expected results in Rosehill and Crestwood locations were offset by shortfalls in Hospice and Physician Practices. The combined deductions from revenue and provision for uncollectible accounts expense as a percent of gross revenues was 22.0%, unfavorable to budget by 1.0%. Self-pay write-offs have increased from the previous year. Other operating revenue, consisting primarily of cafeteria, rental income, transcription services and contributions revenue was unfavorable to budget by $122 thousand for the period mostly attributable to a shortfall in contributions. Other income (non-operating revenue) consists primarily of realized and unrealized investment income and the mark-to-market adjustment related to the interest rate swap. Other income exceeded budget by $2.9 million for the period primarily resulting from $5.3 million in unrealized gains on investments partially offset by lower investment income and interest rate swap mark-to-market adjustments. The FY 2010 budget does not include estimates for the markto-market adjustment or unrealized gains (losses) on investments. Other changes in unrestricted net assets consist of net assets released from temporarily restricted for capital purposes of $18 thousand. 4
Hospital Volumes and EIPA s The following tables compare the Hospital volumes to prior year and current year budget and the variances to budget for the period: FMH Hospital Only For the three months ended September 30, 2009 Prior Current Budget Variance Var % Utilization Statistics: Inpatient Admissions - Acute* 4,462 4,632 4,449 183 4.1% Patient Days - Acute* 18,001 18,653 17,488 1,165 6.7% Average Length of Stay 4.03 4.03 3.93 0.10 2.4% Nursery Discharges* 553 595 532 63 11.8% Inpatient Admissions - TCU 145 161 157 4 2.5% Average Length of Stay - TCU 11.53 9.96 10.63 (0.67) -6.3% Emergency Dept. Visits (inc. Inpatient) 17,836 19,316 17,650 1,666 9.4% Immediate Care Visits 4,554 4,352 4,691 (339) -7.2% Inpatient Surgery Cases 1,317 1,421 1,314 107 8.2% Outpatient Surgery Visits 1,997 1,779 1,904 (125) -6.6% Equivalent Admissions (EIPA's) 9,111 9,554 9,049 504 5.6% HSCRC Case Mix Index 0.905 0.918 0.966 (0.049) -5.0% Payor Mix: Medicare 39.7% 42.1% xx Medicaid 5.9% 7.6% xx United MAMSI 13.0% 13.3% xx CareFirst 17.3% 17.2% xx HMO's 12.3% 10.8% xx Commercial 2.8% 2.6% xx Self Pay/Other 9.1% 6.4% xx 100.0% 100.0% * NICU activity is included in Acute for all periods, previously NICU was included in Nursery. Acute inpatient admissions (adult & pediatric) were above budget for the period by 183 (4.1%), nursery discharges were ahead of budget by 63 (11.8%) and TCU admissions were 4 over budget (2.5%). Average length of stay (adult & pediatric) of 4.03 days was above budget by 2.4%. Immediate care visits were down 7.2% to budget and 4.4% below prior year. Inpatient surgery cases were 8.2% above budget and outpatient surgery cases were 6.6% below budget for the period. One measure of relative utilization performance is the equivalent inpatient admission (EIPA). EIPA is an industry standard measure that gives effect to the relative value of outpatient activity to arrive at a blended statistical unit for the Hospital inpatient and outpatient operations. The table below shows the calculation of EIPA s for the periods presented. EIPA s were favorable to budget by 5.6% and 4.9% higher than last year. 5
FMH Hospital Only EIPA's For the three months ended September 30, 2009 Prior Current Budget Variance Inpatient Revenue (000's) $ 43,120 $ 44,958 $ 45,162 $ (204) IP Admissions 4,607 4,793 4,606 187 IP Revenue per admission $ 9,360 $ 9,380 $ 9,805 $ (425) Outpatient Revenue (000's) $ 42,156 $ 44,655 $ 43,567 1,088 IP Revenue per admission $ 9,360 $ 9,380 $ 9,805 $ (425) IP Equivalent admissions 4,504 4,761 4,443 317 EIPA's 9,111 9,554 9,049 504 Hospital Only Non-Capital Expenses The following tables compare the Hospital Only Non-Capital expenses to prior year and current year budget and the variances to budget for the period: FMH Hospital Only Non-Capital Expenses For the three months ended September 30, 2009 (000's) Prior Current Budget Variance Salaries and Benefits $ 37,566 $ 38,408 $ 39,250 $ (842) Services and Fees 7,893 9,207 9,309 (102) Supplies, Drugs & Other 18,595 19,940 19,765 175 Total Non-Capital Expenses $ 64,054 $ 67,555 $ 68,324 $ (769) The following table shows the non-capital expenses per EIPA: FMH Hospital Only Non-Capital Expenses per EIPA For the three months ended September 30, 2009 (000's) Prior Current Budget Variance Salaries and Benefits $ 4,123 $ 4,020 $ 4,337 $ (317) Services and Fees 866 964 1,029 (65) Supplies, Drugs & Other 2,041 2,087 2,184 (97) Total Non-Capital Expenses $ 7,030 $ 7,071 $ 7,550 $ (479) Salaries and benefits were favorable to budget by $842 thousand (2.1%). On a per EIPA basis they were favorable 7.3%. Services and Fees were below budget by $102 thousand for the period. Supplies, drugs & other were negative to budget by $175 thousand for the period but 4.4% favorable on a per EIPA basis. Negative variances were experienced in supplies expense associated with surgeries and bad debt write-offs associated with higher self-pay volumes partially offset by cost control in travel, training and other discretionary spending. For the period, interest expense was $82 thousand favorable to the budget (4.5%). 6
Subsidiary Results The results of operations for Frederick Health Services Corporation (FHSC) include Corp OHS, Frederick Surgical Services and real estate entities. The operating gain for FHSC for the period was $10 thousand versus a budgeted loss of $38 thousand. Hospice of Frederick County (HOFC) posted an operating gain of $53 thousand for the period versus a budgeted operating loss of $31 thousand. Consolidated Balance Sheets and Statement of Cash Flows The Balance Sheets for FMH and subsidiaries as of June 30, 2009 and June 30, 2008 and the Statement of Changes in Cash and Investments for the period are shown in the tables below. A $5.8 million increase in combined unrestricted cash, short-term and long-term investments was experienced during the period. Cash generated by operating activities was $2.0 million. Cash generated by investing activities was $4.9 million; $2.9 million was used for capital expenditures and rebounding financial markets created $5.7 million increase in investments, trading. Net cash used in financing activities was $1.2 million, primarily used for the repayment of debt. 7
Frederick Memorial Hospital, Inc. and Subsidiaries Balance Sheet unaudited audited 30-Sep-09 30-Jun-09 Change Assets: Cash and Short Term Investments $ 32,587 $ 36,196 $ (3,609) Patient Receivables, net 40,745 39,328 1,417 Property and Equipment, net 177,465 179,611 (2,146) Assets Limited As To Use 12,222 13,806 (1,584) Other Assets 18,670 16,967 1,703 Long Term Investments 63,339 53,962 9,377 Donor Restricted Assets 7,140 7,163 (23) Total Assets 352,168 347,033 5,135 Liabilities: Accounts Payable/Accrued Expenses 53,324 53,371 (47) Advances from Third Party Payors 7,205 7,205 - Current Portion of LTD & Capital Lease Obligations 2,412 2,307 105 Interest Rate Swap Contract 9,544 8,046 1,498 Long Term Debt & Capital Lease Obligations 140,377 141,679 (1,302) Total Liabilities 212,862 212,608 254 Net Assets: Unrestricted 132,166 127,301 4,865 Temporarily Restricted 6,164 6,148 16 Permanently Restricted 976 976 - Total Net Assets 139,306 134,425 4,881 Total Liabilities and Net Assets $ 352,168 $ 347,033 $ 5,135 8
Frederick Memorial Hospital, Inc. and Subsidiaries Consolidated Statement of Change in Cash and Investments For the three months ended September 30, 2009 unaudited - in thousands of dollars Cash flows from operating activities Change in net assets $ 4,881 Adjustments to reconcile change in net assets to net cash provided by (used in) operating activities: Depreciation of property and equipment 4,558 Amortization of original issue discount and bond issue costs 52 Equity in earnings of joint ventures 174 Change in intangible assets 13 (Gain) loss on sale of property and equipment (17) Change in unrealized (gains) losses on trading securities, net (5,269) Proceeds from realized gains on investments-trading 114 (Increase) decrease in investments-trading (606) Proceeds from restricted contributions (54) Change in pledges receivable 40 Change in fair value of interest rate swap contract 1,498 Change in operating assets and liabilities: Receivables, patient and other (1,437) Inventories and other assets (1,895) Accounts payable 808 Accrued expenses (2,560) Accrued pension expense 625 Other short-term liabilities 467 Other long-term liabilities 613 Net cash provided by (used in) operating activities 2,005 Cash flows from investing activities Purchases of property and equipment (2,919) (Increase) decrease in assets limited as to use, non-trading, net 1,584 Net proceeds from sale of assets 523 Change in investments, trading 5,743 Net cash used in investing activities 4,931 Cash flows from fundraising and financing activities Proceeds from restricted contributions 54 Repayments of long-term debt (1,222) Net cash (used in) provided by fundraising and financing activities (1,168) Net increase (decrease) in cash and investments 5,768 Cash and investments at the beginning of the year 90,158 Cash and investments at the end of the period $ 95,926 9
Notes to Consolidated Financial Statements September 30, 2009 Organization and Mission Frederick Memorial Hospital, Inc. (the Hospital ) is a not-for-profit hospital, exempt from Federal income taxes under Section 501(c)(3) of the Internal Revenue Code, located in Frederick, Maryland. The Hospital provides health care services primarily to residents of Frederick County. The Hospital and Hospice of Frederick County have received determination letters from the Internal Revenue Service (IRS) stating that they are exempt from federal income taxes under Section 501(c) of the Internal Revenue Code. Frederick Health Services Corporation (FHSC) is subject to federal and state income taxes. No provision for income taxes has been recorded for 2009 and 2008 as FHSC does not have taxable income or current tax liabilities. Principles of Consolidation The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included and are of a normal and recurring nature. Operating results for the three-month period ended September 30, 2009 are not necessarily indicative of the results to be expected for the year ending June 30, 2010. For further information, refer to the audited consolidated financial statements and notes thereto for the year ended June 30, 2009. The accompanying unaudited consolidated financial statements include the accounts and transactions of the Hospital, its for-profit, wholly-owned subsidiary, Frederick Health Services Corporation (FHSC); Emmitsburg Properties, LLC; Hospice of Frederick County, Inc.; and Frederick Memorial Hospital Self-Insurance Trust. Hospice of Frederick County, Inc. (HFC) is an independent 501(c)(3) organization. HFC remains a separate entity, controlled by the Hospital, and operates as a fundraising organization for the benefit of hospice services and operates the Kline Hospice House. FHSC has three wholly-owned subsidiaries: Rosehill of Frederick, LLC,, and Corporate Occupational Health Solutions, LLC, which are for-profit limited liability companies, and Frederick Surgical Services Corporation(FSSC), all of which have been consolidated into FHSC in the accompanying financial statements. In 2006, FHSC owned a 100% interest in Frederick Surgical Center, LLC (FSC). In April 2007, FHSC contributed 100% of the assets of FSC for a 39% interest in a newly formed entity which now is accounted for under the equity method. 10
The accompanying unaudited consolidated financial statements include the accounts of the Hospital and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Recent Accounting Pronouncements In February 2007, the FASB issued FASB Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, Including an Amendment of FASB Statement No. 115 (Statement 159), which, among other things, permits entities to choose to measure many financial instruments and certain other items at fair value. Statement 159 was issued to improve financial reporting by providing entities the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply the complex hedge accounting provisions of FASB Statement No. 133. Statement 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Hospital has not adopted any provisions of FAS 159. On February 12, 2008 the FASB issued FASB Staff Position SFAS 157-2, Effective Date of FASB Statement No. 157 (FSP 157) which delayed for one year, the effective date of SFAS 157 for all non-financial assets and liabilities, except those that are recognized or disclosed in the financial statements on at least an annual basis. The Hospital adopted SFAS 157 as of July 1, 2008, except for those provisions deferred under FSP 157. The Hospital does not expect the adoption of the deferred portions of SFAS 157 to have a material impact on consolidated financial statements. In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities. SFAS No. 161 requires expanded disclosures regarding the location and amounts of derivative instruments in an entity s financial statements, how derivative instruments and related hedged items are accounted for under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and how derivative instruments and related hedged items affect an entity s financial position, operating results and cash flows. The Hospital adopted SFAS No. 161 on January 1, 2009. The adoption of SFAS No. 161 did not have an impact on our consolidated financial position and results of operations. In August 2008, the FASB issued FASB Staff Position No. 117-1, Endowments of Not-for-Profit Organizations: Net Asset Classification of Funds Subject to an Enacted Version of the Uniform Prudent Management of Institutional Funds Act, and Enhanced Disclosures for All Endowment Funds (FSP FAS 117-1). FSP FAS 117-1 provides guidance on the net asset classification of donor-restricted endowment funds for a not-for-profit organization that is subject to an enacted version of the Uniform Prudent Management of Institutional Funds Act of 2006 (UPMIFA), and also requires enhanced disclosures for all endowment funds, including funds designated as endowments by the Hospital. The Hospital s endowments, which are permanently restricted donor endowments, are not material. The Hospital adopted FSP FAS 117-1 on July 1, 2008. The adoption of FSP FAS 117-1 did not have a material effect on the Hospital s financial position as of June 30, 2009 or on the statement of operations and changes in net assets or cash flows for the year then ended. In May 2009, the FASB issued SFAS No. 165, Subsequent Events, which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. SFAS No. 165 is effective for financial statements issued for interim and annual reporting periods ending after June 15, 2009 11
(the year ending June 30, 2009 for the Hospital). The adoption of SFAS No. 165 did not have an impact on the Hospital s results of operations or financial condition. In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS No. 157).SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 was originally effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. On February 12, 2008, the FASB issued FASB Staff Position (FSP) No. Financial Accounting Standards (FAS) 157-2, Effective Date of FASB Statement No. 157 (FSP 157-2). FSP 157-2 was effective upon issuance and delayed the effective date of SFAS No. 157 for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis or at least once a year, to fiscal years beginning after November 15, 2008. Under U.S. generally accepted accounting principles, the Hospital adopted the provisions of SFAS No. 157 for its financial assets and liabilities on July 1, 2008. SFAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability (i.e., the exit price ) in an orderly transaction between market participants at the measurement date. SFAS 157 emphasizes that fair value is market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, SFAS 157 establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Level 1 and 2 of the hierarchy) and the reporting entity s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy). The fair value levels are as follows: Level 1: Level 2: Level 3: Inputs utilize unadjusted quoted prices in active markets for identical assets or liabilities that the Hospital has the ability to access at the measurement date. Inputs are inputs other than quoted prices included in Level 1 that are observable for the assets or liabilities, either directly or indirectly. Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the assets or liabilities (other than quoted prices), such as interest rates, foreign exchange rates and yield curves that are observable at commonly quoted intervals. Inputs are unobservable inputs for the assets or liabilities, which are typically based on an entity s own assumptions, as there is little, if any, related market activity. The determination of the fair value level within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Hospital s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the assets or liabilities. The following table presents the Hospital s assets and liabilities measured at fair value on a recurring 12
basis, aggregated by the level in the fair value hierarchy within which those measurements fall, as of September 30, 2009: Sept. 30, Identical Assets Inputs Inputs 2009 (Level 1) (Level 2) (Level 3) Assets: Cash and equivalents $ 52,157 $ 52,157 $ - $ - Equity securities 13,608 $ 13,608 $ - $ - U.S. government securities 10,857-10,857 - Corporate and other bonds 3,258-3,258 - Mutual Funds 26,069 26,069 - - Mortgage-backed securities 4,684-4,684 - Contributions receivable 4,655 - - 4,655 Total assets $ 115,288 $ 91,834 $ 18,799 $ 4,655 Liabilities: Interest rate swap liability $ (9,544) $ - $ (9,544) $ - Total liabilities $ (9,544) $ - $ (9,544) $ - The fair value of the Hospital s trading securities is determined by third-party service providers utilizing various methods dependent upon the specific type of investment. Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Where significant inputs, including benchmark yields, broker-dealer quotes, issuer spreads, bids, offers, the LIBOR curve and measures of volatility, are used by these third-party dealers or independent pricing services to determine fair values the securities are classified within Level 2. Assets utilizing Level 1 inputs include exchange-traded equity securities and equity and fixed income mutual funds. Assets and liabilities utilizing Level 2 inputs include U.S. government securities, corporate bonds, mortgage-backed securities and interest rate swaps. Assets utilizing Level 3 inputs are contributions receivable. Contributions receivable are recorded net of allowance for uncollectible pledges and discounted to net present value. The present value of estimated future cash flows using a discount rate commensurate with the risks involved is an appropriate measure of fair value for unconditional promises to give cash and is considered Level 3. 13
The following table provides a reconciliation of the beginning and ending balances of items measured at fair value on a recurring basis in the table above that used significant unobservable inputs (Level 3): in thousands of dollars Equities Contributions receivable Balance at June 30, 2009 $ - $ 4,695 $ 4,695 Purchases, issuances and settlements - (40) (40) Balance at September 30, 2009 $ - $ 4,655 $ 4,655 The Hospital entered into an interest rate swap agreement in conjunction with the issuance of variable rate bonds. The swap contract is valued using models based on readily observable market parameters for all substantial terms of the contract. The fair market value of the swap agreement is included as interest rate swap contract in the accompanying balance sheets. The fair market value calculation at September 30, 2009 includes a credit valuation adjustment (CVA) as required by SFAS 157. At September 30, 2009, the valuation of the interest rate swap agreement liability position was reduced by $1,364 when applying the CVA. The change in the fair market value of the swap agreement is included in excess (deficiency) of unrestricted revenue and other support over expenses, as the swap is not designated as an effective hedge. Credit exposure associated with non-performance by the counterparty to the derivative instrument is generally limited to the uncollateralized fair value of the asset related to instruments recognized in the balance sheets. In conjunction with the issuance of the Series 2008 Bonds, the Hospital modified it s interest rate swap contract with a third party to a notional amount of $72,160 until July 1, 2010, at which point the notional amount amortizes over the term of the underlying Series 2008 Bonds, with a final maturity of July 1, 2035. The Hospital is exposed to credit loss in the event of nonperformance by the counterparty to the interest rate swap contract. However, the Hospital does not anticipate nonperformance by the counterparty. Under the swap contract, the Hospital pays interest at a fixed rate of 3.804% and receives interest at a variable rate equal to 67% of the one-month London Interbank Offered Rate (LIBOR) (2.4625% as of September 30, 2009). The swap contract requires payments to be made or received monthly. The fair value of the swap contract was a liability of $9,544 and $8,046 at September 30, 2009 and June 30, 2009, respectively. In accordance with FAS 133, the Hospital records their derivatives as assets or liabilities at fair value. A derivative is typically defined as an instrument whose value is derived from an underlying instrument, index or rate, has a notional amount, requires little or no initial investment and can be net settled. The Hospital participates in an interest rate swap contract that is considered a derivative financial instrument. The interest rate swap contract is not designated as an effective cash flow hedge under SFAS No. 133. The Hospital s objectives of entering into the interest rate swap contract include limiting or hedging variable interest rate payments, to achieve lower overall borrowing costs than a comparable unhedged fixed rate borrowing, to alter the pattern of debt service payments and to improve asset/liability matching. Changes in the fair value of the derivative financial instrument are recognized in the consolidated statement of operations as a component of other loss. The carrying value of the Hospital s derivative financial instrument approximates fair value. The interest rate swap contract is valued using models based on readily observable market parameters for all substantial terms of the contract. Total 14
Credit exposure associated with non-performance by the counterparties to derivative instruments is generally limited to the uncollateralized fair value of the asset related to instruments recognized in the consolidated balance sheets. The Hospital attempts to mitigate the risk of nonperformance by selecting counterparties with high credit ratings and monitoring their creditworthiness. Our derivative agreements do not contain any credit support provisions that require us to post collateral if there are declines in the derivative value or our credit rating. in thousands of dollars Fair Value of Derivative Instruments Asset Derivatives Liability Derivatives September 30, 2009 June 30, 2009 September 30, 2009 June 30, 2009 Balance Sheet Location Fair Value Balance Sheet Location Fair Value Balance Sheet Location Fair Value Balance Sheet Location Fair Value Derivatives not designated as hedging instruments under Statement 133 Interest rate contracts $ - $ - Long-Term Liabilities $ 9,544 Long-Term Liabilities $ 8,046 Total derivatives not designated as hedging instruments under Statement 133 $ - $ - $ 9,544 $ 8,046 A summary of the effect of the non-hedging derivatives on the Hospital s income statement for the three months ended September 30, 2009 is as follows: in thousand of dollars Income Statement Type of Non-Hedging Derivatives Location of Loss Recognized Derivative Loss Recognized Interest rate swap contract Other loss $ (1,498) Total $ (1,498) 15
Long-term Debt in thousands of dollars Sept. 30, 2009 June 30, 2009 MHHEFA Series 2002 Bonds $ 67,666 $ 68,458 MHHEFA Series 2008 Bonds 72,027 72,025 Equipment note payable 637 894 Note payable - Emmitsburg 523 543 Capital lease obligations 1,936 2,066 142,789 143,986 Less current maturities 2,411 2,307 $ 140,378 $ 141,679 Series 2008 MHHEFA Revenue Bonds In July 2008, the Hospital advance refunded its Series 2006 MHHEFA Revenue Bonds (auction rate securities) totaling $75,000 in part through the issuance of Series 2008 MHHEFA Revenue Bonds (Series 2008 Bonds) in the amount of $72,160. The Series 2008 Bonds are variable rate demand bonds. The bond insurance securing the Series 2006 Bonds was terminated. The general terms of the original $75,000 interest rate swap contract remained in place. However, due to the lower principal amount on the new issuance, a portion of the swap was terminated ($2,840) and a partial termination fee was incurred of approximately $218. A loss on extinguishment of debt of $2,370 was recognized as a result of the write-off of unamortized deferred financing cost and original issue discounts. In conjunction with the issuance of the Series 2008 Bonds, the Hospital secured a three year letter of credit with a bank covering the entire bond issue. The letter of credit terms for tender advances are Libor +2.75% for the first 90 days, Libor +3.25% for days 91-366. Tender advances are due 366 days after initial draw. The Series 2008 MHHEFA Revenue Bonds are net of original issue discounts of $144 which are being amortized over the life of the bonds using the yield method. Accumulated amortization was $11 at September 30, 2009. During the year ended June 30, 2009 the interest rate on these variable rate demand bonds has varied from 0.27% to 8.0%. Interest is payable monthly through July 1, 2035. Under the provisions of the bond agreement, the Hospital has granted to the Authority a security interest in all receipts now owned and hereafter acquired. The Series 2008 Bonds are secured ratably with the Series 2002 Bonds. The bond agreement contains certain financial covenants. Series 2006A MHHEFA Revenue Bonds and Series 2006B MHHEFA Revenue Bonds In June 2006, the Hospital obtained two loans totaling $75,000 in MHHEFA Revenue Bonds, Frederick Memorial Hospital Issue, Series 2006A ($37,325) and Series 2006B ($37,675). The MHHEFA Series 2006 Bonds were issued to finance and refinance costs of construction, renovation and equipping certain Hospital facilities, as well as refunding the Series 1993 Bonds. On July 9, 2008 the Hospital advance refunded all of the Series 2006 MHHEFA Revenue Bonds. The bonds accrued interest at a variable rate (7.50% and 5.74% for the Series A and Series B respectively, as of July 8, 2008) based on auction rate procedures set forth in the loan agreement. 16
Interest was payable semiannually on each January 1 and July 1, through July 1, 2028 for the Series A bonds and through July 1, 2035 for the Series B bonds. Under the provisions of the bond agreement, the Hospital had granted to the Authority a security interest in all receipts then owned and thereafter acquired. The Series 2006A and 2006B Bonds were secured ratably with the Series 1993 and Series 2002 Bonds. The bond agreement contained certain financial covenants. Series 2002 MHHEFA Revenue Bonds In August 2002, the Hospital obtained a loan of $71,715 in MHHEFA Revenue Bonds, Frederick Memorial Hospital Issue, Series 2002. The MHHEFA Series 2002 Bonds were issued to finance and refinance costs of construction, renovation and equipping certain Hospital facilities. The Series 2002 Bonds are net of an original issue discount of $2,361 which is being amortized over the life of the bonds using the yield method. Accumulated amortization was $667 and $644 at September 30, 2009 and June 30, 2009, respectively. The annual interest rate on the bond loan ranges between 3.25% and 5.125%. Interest is payable semiannually on each January 1 and July 1, through July 1, 2035. In connection with the bond issuance, the Hospital was required to deposit as collateral, in a trusteed Debt Service Reserve Fund, an amount equal to the maximum annual debt service on the Series 2002 Bonds of $4,058. Series 2002 Bonds maturing on or after July 1, 2012 are subject to redemption or purchase prior to maturity, beginning on July 1, 2012 at the option of the Authority at the principal amount of the Series 2002 Bonds to be redeemed plus accrued interest thereon to the date set for redemption. Under the provisions of the bond agreement, the Hospital has granted to the Authority a security interest in all receipts now owned and hereafter acquired. The Series 2002 Bonds are secured ratably with the 2008 Bonds. Equipment Note Payable In June 2004, the Hospital obtained a $5,367 loan from GE Capital Public Finance, Inc. to finance the acquisition of certain equipment. The Hospital was required to place the loan proceeds into a trustee-held escrow account until all equipment was purchased. The Hospital expended all remaining loan proceeds in 2007. The note is payable in monthly installments of principal and interest of $88 and is due on July 1, 2010. The note bears interest at 4.83% and is collateralized by certain property and equipment. Note Payable Emmitsburg In December 1994, the Hospital acquired a 100% interest in Emmitsburg Properties, LLC and subsequently conveyed a 1% interest in the limited liability company to FHSC. In accordance with the terms of the purchase agreement, the Hospital executed two notes payable to the former owners aggregating $1,219. The notes are payable in monthly installments of principal and interest of $10, bear interest at 8%, and are due December 31, 2014. 17
Future debt service requirements on long-term debt and capital lease obligations, excluding the original issue discounts on the MHHEFA Bonds at September 30, 2009 of $1,827, are as follows: in thousands of dollars Years ending June 30: 2010 $ 1,185 2011 2,468 2012 2,525 2013 2,398 2014 4,056 Thereafter $ 131,984 144,616 Capital Lease Obligations The Hospital has entered into certain capital lease obligations to secure major medical diagnostic equipment. Future payments under these obligations are as follows: in thousands of dollars Years ending June 30: 2010 $ 435 2011 585 2012 535 2013 302 2014 205 Total payments 2,062 Less: interest payments 126 Total lease obligations, principal 1,936 Less: current portion 435 Long term obligations under capital leases $ 1,501 18
Contingencies The Hospital has been named as a defendant in various legal proceedings arising from the performance of their normal activities. In the opinion of management, after consultation with legal counsel and after consideration of applicable insurance, the amount of the Hospital s ultimate liability under all current legal proceedings will not have a material adverse effect on their consolidated financial position or results of operations. The Hospital was insured for professional liability under an occurrence basis policy through June 30, 2005. Effective July 1, 2005, the Hospital established a new irrevocable self-insurance trust to set aside funds to cover future professional liability claims. The initial funding to the trust was $1,500. Total disbursements from the fund for a covered loss by one or more persons as a result of any one occurrence shall not exceed $1,000 and $3,000 in the aggregate in any one fiscal year. Concurrently, the Hospital purchased excess umbrella coverage through a commercial carrier with a per-occurrence and aggregate limit of $10,000 per policy period. The funded balance of the trust was $4,128 and $4,128 at September 30, 2009 and June 30, 2009, respectively and is included as assets limited as to use on the consolidated balance sheets. There are known claims and incidents that could result in the assertion of additional claims, as well as claims from unknown incidents that could be asserted arising from services provided to patients. The Hospital maintains reserves, in the amount of $4,269 and $3,969, respectively, to cover estimated costs incurred within the self-insured period. The Hospital employs an independent actuary to estimate the ultimate settlement of such claims. These reserves are recorded at a discounted interest rate of 5%. In management s opinion the amounts recorded provide an adequate reserve for loss contingencies. However, changes in circumstances affecting professional liability claims could cause these estimates to change by material amounts in the short term. 19
Pension Plans The Hospital has a trusteed, defined benefit pension plan that covers substantially all employees. The Hospital s funding policy is to make a minimum annual contribution equal to net periodic pension cost for the Plan year as determined by its actuary. Effective June 30, 2007 the Hospital curtailed the Plan. The curtailment is such that participants will no longer accrue benefits under the Plan and no new participants will be accepted. Current participant accounts will not receive any service credits beyond June 30, 2007, however the Hospital will make annual contributions to the plan in accordance with actuarially determined amounts to meet future accumulated benefit obligations under the frozen plan. Expense recognized for the three months ended September 30, 2009 and 2008 was $625 and $128, respectively. As of June 30, 2007, the Hospital adopted FASB Statement No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132R) (SFAS 158 ). SFAS 158 requires plan sponsors of defined benefit pension and other postretirement benefit plans (collectively, postretirement benefit plans ) to recognize the funded status of their postretirement benefit plans in the statement of financial position, measure the fair value of plan assets and benefit obligations as of the date of the fiscal year-end statement of financial position, and provide additional disclosures. The Hospital has adopted the provisions of Statement 158 as of June 30, 2007. Effective June 30, 2007, the Hospital terminated accruals under the defined benefit pension plan. As a result, there was no net effect on accrued benefit liabilities or unrestricted net assets related to the adoption. For fiscal years ending after December 15, 2008, SFAS No. 158 also requires the adoption of a valuation date that is consistent with the fiscal year-end date. Therefore, FMH adopted a June 30 valuation date beginning in the fiscal year ending June 30, 2009. FAS 158 only requires the updating of the pension liability as of the fiscal year end (June 30, 2009). In conjunction with the curtailment of the defined benefit pension plan, the Hospital modified the 403b plan effective July 1, 2007. Available to substantially all employees, the Hospital provides a 50% match of employee deferrals up to 4% of gross earnings. Under the terms of the modified plan, every eligible employee receives a base contribution of 2.5% of earnings. The Hospital will match 50 70% on employee contributions up to 5% of employee earnings depending on years of service. In addition, certain employees are eligible for transition credits based on age and years of service to the Hospital. The expense recognized for both the base matching and transitional credits for the three months ended September 30, 2009 and 2008 was $1,312 and $1,269, respectively. In December, 2005, the Hospital adopted two non-qualified deferred compensation plans with an effective date of December 15, 2004, for certain members of executive management. Under the plans, participating employees may contribute amounts from their compensation to the plan and may receive a discretionary employer contribution. Employees are fully vested in all employee contributions to the plans. Vesting in employer contributions occurs in accordance with the underlying plan documents. All assets of the plans are held in separate trusts. Total Hospital contributions to the plans were $110 and $0 for the three months ended September 30, 2009 and 2008, respectively. 20