HISTORICAL COVERAGE OF PRO FORMA DEBT SERVICE The following table presents, for the fiscal years ended September 30, 2012, 2013 and 2014, the System s income available to pay debt service on the indebtedness of the System for such years. The table also presents for the same years the pro forma maximum annual debt service on the indebtedness of the System, including the Series 2015 Bonds and the Series 2014 Bonds, and the extent to which such income available to pay debt service would have provided coverage of the pro forma maximum annual debt service. DEBT SERVICE COVERAGE (1) (dollars in thousands) FISCAL YEAR ENDED SEPTEMBER 30, Excess of revenues over expenses $83,564 $95,784 $56,453 Plus: Unrealized investment (gain) loss (37,923) (21,781) 6,180 Plus: Loss on defeasance 2,811 - - Plus: Change in interest rate swap value 2,729 (11,202) 316 Plus: Depreciation and amortization 53,460 49,727 52,228 Plus: Interest 22,848 21,792 21,097 Net revenues payable for debt service $127,489 $134,320 $136,274 Maximum annual debt service requirement (2) $30,592 $30,592 $30,592 Debt service coverage ratio 4.17x 4.39x 4.45x Pro-forma maximum annual debt service requirement (2)(3) $27,215, $27,215, $27,215, Pro-forma debt service coverage ratio 4.68 4.94 5.01 (1) The calculations of maximum annual debt service requirement and pro-forma maximum annual debt service requirement set forth in this table include debt obligations of non-obligated Issuers in addition to the obligations of the Obligated Group and therefore are not in compliance with the requirements of the Master Indenture. However, the System believes the foregoing better represents the System s debt service obligations. (2) Maximum annual debt service requirement and pro-forma maximum annual debt service requirement include both outstanding Master Notes and capital lease obligations of the Obligated Group and non-obligated Group members. In addition, the net swap payments for the System s three fixed payor swaps, assuming a rate of 3.00% for the variable rate receipt portion of the swaps, are included. (3) The Series 2014 Bonds bear interest at variable rates. The Series 2014 Bonds are assumed to bear interest at a rate of 3.00% per annum. Actual debt service may differ from that assumed. This pro-forma maximum annual debt service requirement does not include any debt service on the Series 2005 Bonds, the Series 2008A Bonds and the Series 2008B Bonds (refinanced with the Series 2014 Bonds) or the Series 2009 Bond (refinanced with the Series 2015 Bonds).
Historical Financial Performance The following summary of the consolidated balance sheets and consolidated statement of operations of the Corporation and affiliates for the fiscal years ended September 30, 2012, 2013 and 2014, has been derived from the consolidated financial statements of the Corporation and affiliates which have been audited. This summary should be read in conjunction with the consolidated financial statements together with the independent auditors report thereon as of September 30, 2012, 2013 and 2014. The following summary financial information includes Health System, PHCMA, National Regency, the Foundation and PHHC, which are not Obligated Issuers. Health System, PHCMA, National Regency, the Foundation and PHHC represented 18.62% of the total unrestricted revenue, gains and other support of the Corporation and its affiliates for the fiscal year ended September 30, 2014. The total unrestricted revenue, gains and other support and the excess of (less than) revenue over expenses of the non-obligated Issuers (assuming National Regency was an Obligated Issuer as of October 1, 2013) approximated $130.5 million and ($15.8) million, respectively, for the fiscal year ended September 30, 2014. SUMMARY OF CONSOLIDATED BALANCE SHEETS (Dollars in Thousands) SEPTEMBER 30, Current Assets Cash and cash equivalents $46,608 $57,622 $76,079 Patient accounts receivable-net 78,824 81,072 77,351 Other Current Assets 34,217 38,410 34,631 TOTAL CURRENT ASSETS 159,649 177,104 188,061 Investments 19,785 24,202 11,850 Assets whose use is limited or restricted 446,564 492,114 526,256 Property and equipment-net 474,042 490,854 521,824 Other Assets 54,416 48,474 44,417 TOTAL ASSETS $1,154,456 $1,232,748 1,292,408 Current Liabilities $81,882 $81,447 $93,980 Long-Term Debt 400,359 390,208 379,547 Fair Value of Interest Rate Swap 35,054 23,695 23,855 Agreement Other Liabilities 129,683 80,614 96,126 TOTAL LIABILITIES 646,978 575,964 593,508 Net Assets Unrestricted net assets, including 483,095 637,524 678,475 noncontrolling interest Temporarily restricted 17,338 12,024 14,846 Permanently restricted 7,045 7,236 5,579 Total net assets 507,478 656,784 689,900 TOTAL LIABILITIES AND NET ASSETS $1,154,456 $1,232,748 1,292,408
SUMMARY OF CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in Thousands) FISCAL YEARS ENDED SEPTEMBER 30, Unrestricted Revenues, Gains and Other Support: Net patient service revenue $641,790 $634,412 $657,933 Provision for bad debts (23,596) (19,407) (17,613) Net patient service revenues less provision for bad debt 618,194 615,005 640,320 Other operating revenue 51,217 64,869 60,391 669,411 679,874 700,711 TOTAL UNRESTRICTED REVENUE, GAINS AND OTHER SUPPORT Expenses Salaries and wages 264,219 272,790 278,171 Employee benefits and payroll taxes 69,989 78,990 79,930 Operating supplies and expenses 103,559 106,031 106,522 Depreciation and amortization 53,460 49,727 52,228 Interest Contracted services and other 22,848 122,093 21,792 121,762 21,097 144,809 TOTAL EXPENSES 636,168 651,092 682,757 Operating Income $33,243 $28,782 $17,954 Other Income (loss) Investment income Contributions 16,613-37,743 377 45,881 788 Loss on defeasance (2,811) - - Unrealized investment (loss) gain 37,923 21,781 (6,180) Change in interest rate swap value (2,729) 11,202 (316) Other 1,325 (4,101) (1,674) TOTAL OTHER INCOME 50,321 67,002 38,499 EXCESS OF REVENUE OVER EXPENSES $83,564 $95,784 $56,453
CERTAIN FINANCIAL INFORMATION - SOURCES OF NET PATIENT SERVICE REVENUE The Hospitals receive payment for services from commercial insurers and other private payors, from the federal government under the Medicare program, from the State of Wisconsin under the Medicaid program, from health maintenance organizations ( HMOs ), preferred provider organizations ( PPOs ) and other managed care entities and directly from patients. The following table indicates the sources of the Hospitals net patient service revenue for the three fiscal years ended September 30, 2014: FISCAL YEAR ENDED SEPTEMBER 30, Medicare 21.4% 21.1% 19.5% Medicare Managed Care 7.8 8.8 8.9 Total Medicare 29.2% 29.9% 28.4% HMO/PPO and other managed care 59.3 59.7 63.7 Commercial Insurance 2.0 1.0 0.8 Medicaid 1.5 1.7 1.7 Medicaid Managed Care 6.0 5.2 4.1 Total Medicaid 7.5% 6.9% 5.8% Self-Pay 2.0 2.5 1.3 Total: 100.0% 100.0% 100.0% The Corporation, WMH and OMH have entered into agreements with certain HMOs and PPOs. Most of the HMOs and PPOs currently pay WMH and OMH at negotiated fixed rates. Approximately 63.7% of the Hospitals net patient service revenues for fiscal year 2014 were attributable to HMO, PPO or other managed care agreements. The two largest agreements were with United Health Care and Anthem representing 23.5% and 14.2%, respectively, of the Hospitals net patient service revenues for such fiscal year. These agreements expire October 31, 2016 and December 31, 2017, respectively. The Corporation has entered into several new contracts with insurance providers that are offering products on the State health insurance exchange
OPERATIONS SELECTED OPERATING STATISTICS The following table presents certain combined operating statistics of the Hospitals for the fiscal years ended September 30, 2012 through 2014. FISCAL YEAR ENDED SEPTEMBER 30, Inpatient Admissions (1) 19,084 17,929 16,983 Observation Visits 5,522 6,313 7,022 Total 24,606 24,242 24,005 Total Discharges 19,185 17,953 16,992 Patient Days 71,632 68,592 65,345 Average Length of Stay (Days) (1) 3.75 3.82 3.85 Average Inpatient Daily Census (1) 195.70 187.92 179.00 Case Mix Index (1) 1.47 1.50 1.43 Outpatient Visits 336,816 340,840 348,902 Emergency Room Visits 53,376 53,390 51,504 Total Clinic Visits 405,659 393,313 432,729 Occupancy of Staffed Beds (%) 56.19% 63.00% 61.63% Inpatient Surgeries 5,451 5,021 4,712 Hospital Outpatient Surgeries 6,719 6,500 6,657 ProHealth Aligned Surgeries 4,601 4,524 4,583 The Orthopedic Surgery Center Surgeries 3,563 3,553 3,649 Total Surgical Cases 20,334 19,598 19,601 Cath Lab Procedures 5,419 5,431 4,531 Medical Oncology Visits 27,171 26,329 28,620 Radiation Oncology Procedures 13,960 13,863 11,946 Cardio Vascular Procedures 52,376 52,166 50,051 Radiology Procedures 146,237 144,593 140,620 (1) Figures exclude neonatal intensive care unit and newborn activity NUMBER OF STAFFED BEDS As of September 30, 2014, the Hospitals had a total of 323 staffed acute care beds, which were classified as follows: NUMBER OF STAFFED BEDS SERVICE WMH OMH TOTAL General Medical/Surgical 133 35 168 Intensive, Coronary and Intermediate Care 61 11 72 Obstetrics 33 12 45 Psychiatric 22 0 22 Oncology 16 0 16 Total Staffed Beds 265 58 323
EMPLOYEES As of September 30, 2014, the System employed 4,516 persons. Of these, 2,747 were full-time and 1,769 were part-time, collectively representing 3,489 full-time equivalent positions. There are no unions representing the employees and management characterizes relations with its employees as very good. CAPITALIZATION The following table sets forth the long term indebtedness and capitalization of the System and affiliates as of September 30, 2012, 2013 and 2014, and on a pro forma basis after giving effect to the issuance of the Series 2014 and the Series 2015 Bonds and the application of the proceeds thereof. DEBT TO CAPITALIZATION (dollars in thousands) AS OF SEPTEMBER 30, 2014 (Pro-Forma) Series 2005 Bonds (1) $23,570 $22,515 $21,410 --- Series 2008A Bonds (1) 51,615 50,515 49,415 --- Series 2008B Bonds (1) 65,070 64,045 62,970 --- Series 2009 Bonds (2) 126,855 126,855 126,855 --- Series 2011 Bonds 28,030 23,600 18,950 $18,950 Series 2012 Bonds 44,285 43,650 43,005 43,005 Series 2014A Bonds --- --- --- 102,400 Series 2014B Bonds --- --- --- 102,400 Series 2015 Bonds --- --- --- 129,000 * Notes Payable 31,400 31,400 31,400 31,400 Capital Leases 40,996 39,656 38,090 38,090 Total debt $411,821 $402,236 $392,095 $465,245 * Unrestricted net assets (including controlling interest) 483,095 637,524 678,475 678,475 Total capitalization $894,916 $1,039,760 $1,070,570 $1,143,720 * Total debt to capitalization 46.0% 38.7% 36.6% 40.7% * * Preliminary, subject to change (1) The Series 2005 Bonds, the Series 2008A Bonds and the Series 2008B Bonds were refinanced with the proceeds of the Series 2014A Bonds and the Series 2014B Bonds. (2) The Series 2009 Bonds will be refinanced with the proceeds of the Series 2015 Bonds.
LIQUIDITY The following table sets forth the days cash on hand for the Corporation and affiliates as of September 30, 2012, 2013 and 2014. SUMMARY OF TOTAL CASH AND INVESTMENTS (dollars in thousands) AS OF SEPTEMBER 30, Cash and cash equivalents $90,431 $99,828 $108,375 Private equities and hedge funds 38,658 36,437 28,896 Corporate bonds 88,055 104,776 78,277 Common stock and equity securities 273,014 326,229 371,796 U.S. Treasury obligations 28,197 13,379 33,757 Other 1,913 881 881 Total Cash and Investments $520,268 $581,530 $621,982 Less: Excluded Investments Restricted by donors $12,362 $15,003 $17,178 Limited by trustee under bond indenture 12,327 12,331 12,332 Designated for the Foundation 8,340 12,842 11,583 Reserved for unemployment compensation and 105 198 181 other Excluded Investments 33,134 40,374 41,274 Total Unrestricted Cash and Investments $487,134 $541,156 $580,708 The following table sets forth the cash position and liquidity of the Corporation as of September 30, 2012, 2013 and 2014. Liquidity includes operating cash, investments and board designated funds. Excluded are temporarily and permanently restricted assets, trustee-held bond funds and self-insurance assets. SUMMARY LIQUIDITY (dollars in thousands) AS OF SEPTEMBER 30, Days Cash on Hand Total Unrestricted Cash and Investments $487,134 $541,156 $580,708 Average daily operating expense 1,596.5 1,647.6 1,727.5 Days cash on hand 305.1 328.5 336.2
INSURANCE The Hospitals and the Corporation each maintain a policy for professional and general liability claims covering up to $1,000,000 per incident and $3,000,000 in the annual aggregate. Under Wisconsin law, once a health care provider secures such primary professional liability coverage, the provider s maximum liability for professional liability is limited to $1,000,000 per occurrence and $3,000,000 in the annual aggregate. Any claim in excess of these limits is chargeable to the Wisconsin Injured Patients and Families Compensation Fund ( PCF ) established by statute. Each participating hospital s premium under the PCF is assessed based upon the hospital s size and other factors. In addition, the Corporation maintains an excess liability policy which covers the excess of the occurrence underlying the general liability and automobile liability coverage, with a limit of $30 million in the annual aggregate. HEDGE TRANSACTIONS Effective February 1, 2004, the Corporation entered into an interest rate swap matched to its WHEFA Series 2001B bonds. Under the terms of this interest rate swap, the Corporation pays a fixed rate of 4.00 percent and receives a variable rate of interest equal to the weighted average of the Bond Market Associated (BMA) Municipal Swap Index, adjustable monthly. Effective June 9, 2004, the Corporation terminated the above interest rate swap, which hedged cash flows on its 2001B bonds, and entered into a new interest rate swap agreement, designated a hedge of variable cash flows on its Series 2001B bonds, whereby the Corporation pays a fixed rate of 3.52 percent and receives a variable rate of interest equal to 70 percent of the one-month LIBOR index. In addition, effective June 9, 2004, the Corporation entered into an interest rate swap to hedge variable cash flows of its WHEFA, Series 2004A bonds. Under the terms of this interest rate swap, the Corporation pays a fixed rate of 4.15 percent and receives a variable rate of interest equal to 70 percent of the one-month LIBOR index. Effective May 11, 2005, the Corporation entered into an interest rate swap matched to its Series 2005 bonds. Under the terms of this interest rate swap, the Corporation pays a fixed rate of 3.6 percent and receives a variable rate of interest equal to 70 percent of the one-month LIBOR index, reset weekly. Activity related to these interest rate swaps was recorded using hedge accounting throughout 2008 and prior. The 2001B and 2004A interest rate swaps became ineffective during 2008 at which point all changes in fair value were recorded in nonoperating (losses) on the consolidated statement of operations and changes in net assets. In conjunction with the legal defeasance of the 2001B and 2004A bonds and the issuance of the Series 2008A and 2008B bonds on August 14, 2008, the 2001B and 2004A interest rate swaps were restructured, resulting in a non-cash loss. Under the terms of the restructured interest rate swap agreements related to the 2008A bonds, the Corporation pays a fixed rate of 3.52% and receives a variable rate of interest equal to 70% of the one-month LIBOR index, reset weekly. Under the terms of the restructured interest rate swap agreement related to the 2008B bonds, the Corporation pays a fixed rate of 4.12% and receives a variable rate of interest equal to 70% of the one-month LIBOR index, reset weekly. The Corporation does not record the 2008A and 2008B interest rate swaps using hedge accounting, therefore all changes in fair value are included in nonoperating losses, net in the consolidated statement of operations and changes in net assets. On December 17, 2014, the Series 2005, Series 2008A and Series 2008B bonds were refinanced under the Series 2014A and Series 2014B. The underlying interest rate swap agreements for the legally defeased bonds still exist as identified above. Management s Discussion of Recent Financial Performance Overview The System s reputation, history, programs and services contribute to its status as an important community resource, as evidenced by a leading market position of 41% of discharges in its total service area for the 12-month period ended June 2014. The System s significant physical resources, including land, facilities and equipment have also contributed to it being a leading medical services provider in the market. Offering technologically advanced medical services such as a level 3 neonatal ICU, open heart surgery, robotic surgery via davinci and Mako robotics, and CyberKnife radiation therapy sets the System apart from most other community-based health care facilities. In addition, the System enjoys strong relationships with the local medical providers. Most of the physicians that practice in the primary market area are members of PHS. PHS includes both employed and independent physicians, of which 92% are connected electronically through the System s electronic medical record system. The high level of electronic connectivity within the provider network resulted in the System achieving phase II meaningful use under the Patient Protection and Affordable Care Act for the quarter ended September 30, 2014. The System employs approximately 70% of the primary care physicians in the market. Based on its
programs, services, primary care physician distribution, support from the medical community, facilities, low charge structure and mission commitment, the System enjoys a favorable position with payors. Over the years, the System has received generous ongoing philanthropic support, as evidenced by key contributions towards capital projects (e.g., WMH s ambulatory D.N. Greenwald Center, davinci robot, and PHHC s AngelsGrace Hospice Pewaukee Ambulatory Center), along with contributions to the Foundation ($36.3 million in assets). Historically, the Hospitals have drawn most of their patient volume from their primary service area and have remained the provider of choice in the market. Given the relative affluence of the area s population, the Hospitals have a payor mix composed primarily of Medicare and managed care, with a relatively small percentage of Medicaid patients. Like other hospital providers, the System faces numerous challenges in today s healthcare environment, including downward pressure on reimbursement rates and competition. To meet these challenges, management of the System intends to maintain and continue to expand its market position through initiatives that strategically place services based on community need and strengthen its relationships with independent physician partners in the market. Management also recognized the need to operate effectively and efficiently. Prior to the beginning of fiscal year 2014, management embarked upon implementation of a consultant-led comprehensive review of all operations (the Transformation Project ). The Transformation Project stimulated a broad range of initiatives. Most initiatives were completed by the end of fiscal year 2014. Annual recurring benefits recognized in fiscal year 2014 were estimated by management to be approximately $23 million. One-time fees associated with the Transformation Project were $23.8 million, with $21.5 million recognized in fiscal year 2014 and the balance in fiscal year 2013. In fiscal year 2015 management is expecting annual recurring benefits of approximately $17 million in addition to the benefits recognized in fiscal year 2014. Fiscal Year Ended September 30, 2014 as Compared with Fiscal Year Ended September 30, 2013 Utilization Inpatient volumes for the Hospitals decreased between fiscal years 2013 and 2014. The Hospital experienced a decrease in inpatient admissions of 5.3% to 16,983 and a decrease in patient days of 4.7% to 65,345. Observation visits increased 11.2% over the prior period. Consistent with national trends, inpatient admissions to the Hospitals have seen declines over the past several years. The trend is at least partially the result of the implementation by the Centers for Medicare and Medicaid Services ( CMS ) of the two-midnight rule, which redefined which hospital admissions are treated as inpatient. Overall acuity of patients receiving care, as measured by the case mix index, decreased 4.7% over the prior fiscal year. Outpatient visits increased, however, to 348,902, an increase of 2.4%. Net Patient Service Revenue During the twelve months ended September 30, 2014, the System generated net patient service revenue (prior to the provision for bad debts) of $657.9 million, which represents a 3.7% or $23.5 million increase from the $634.4 million generated during the twelve months ended September 30, 2013. The growth in net revenue is the result of favorable shifts in payor mix and revenue cycle improvements implemented as part of the Transformation Project. Total Expenses Total operating expenses of $682.8 million for the twelve months ended September 30, 2014 is an increase of 4.9%, or $31.7 million, from the twelve months ended September 30, 2013. Salaries and wages increased 2.0% or $5.4 million with salaries and wages as a percent of net patient service revenue (prior to the provision for bad debts) for the twelve months ended September 30, 2014 equal to 42.3%, which is an improvement from the 43.0% for the twelve months ended September 30, 2013. The improvement in the labor metrics is the result of Transformation Project initiatives that focused on reducing FTEs and labor cost. Benefit costs increased 1.2% or $0.9 million from the prior year, resulting from the higher health and pension expense experience. Operating supplies and expense increased $.6 million, or.6%, from the prior year. As a result of the State s Medicaid Hospital Tax program, the Hospitals were assessed a $16.2 million Medicaid Hospital tax during the twelve month period ended September 30, 2014, which was offset by $12.5 million in additional Medicaid payments from the program, resulting in a net loss of $3.7 million for the period. In comparison, during the twelve months ending September 30, 2013, the System had a net loss of $4.6 million due to Medicaid Hospital taxes paid in excess of Medicaid program payments received. Depreciation and interest expenditures increased 2.5% in the twelve month period ending September 30, 2014 as compared to the twelve month period ended September 30, 2013. Income From Operations The System generated a $18.0 million income from operations, compared to $28.8 million during the twelve months ended September 30, 2013. The decrease in income from operations was associated primarily with the consulting fees associated with the Transformation Project. In fiscal year 2014, the System recognized one-time fees totaling $21.5 million for the Transformation Project. The System s operations generated net operating income of $39.5 million, or a 5.6% operating margin, when the one-time fees for the Transformation Project are excluded. The improved operating performance measured without the one-time fees is primarily attributed to the impact of annual recurring benefits from the Transformation Project that were realized in fiscal year 2014, specifically in revenue, labor and supplies. In addition, the System benefited from improvements in payor mix.
Other Income Other income during the twelve month period ended September 30, 2014 was $38.5 million, as compared to $67 million for the twelve month period ended September 30, 2013. The decline is primarily due to lower investment returns. Excess of Revenues Over Expenses For the twelve months ended September 30, 2014, the System recorded excess of revenues over expenses of $56.5 million, which represents a $39.3 million, or 41%, decrease from the $95.8 million revenues and gains in excess of expenses recorded in the prior year. Unrestricted Cash and Investments The Corporation had $580.7 million of unrestricted cash and investments as of September 30, 2014, which is a 7.3%, or $39.5 million, increase compared to the $541.2 million of unrestricted cash and investments as of September 30, 2013. This increase in unrestricted cash and investments is predominantly the result of lower than planned capital spending, investment returns and a decline in days in accounts receivable due to revenue cycle process improvements.