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Home My WebLink About16 - Consolidated Financial StatementsCONSOLIDATED FINANCIAL STATEMENTS AND OTHER FINANCIAL INFORMATION Hoag Memorial Hospital Presbyterian and Affiliates Thirteen -Month Period Ended September 30, 2008 and Year Ended August 31, 2007 Hoag Memorial Hospital Presbyterian and Affiliates Consolidated Financial Statements and Other Financial Information Thirteen -Month Period Ended September 30, 2008 and Year Ended August 31, 2007 Contents Audited Consolidated Financial Statements Report of Independent Auditors ......................................................................... ..............................1 Consolidated Balance Sheets ............................................................................. ..............................2 Consolidated Statements of Operations ............................................................. ..............................3 Consolidated Statements of Changes in Net Assets .......................................... ..............................4 Consolidated Statements of Cash Flows ............................................................ ..............................5 Notes to Consolidated Financial Statements ...................................................... ..............................6 Other Financial Information Report of Independent Auditors on Other Financial Information .................... .............................35 Consolidating Balance Sheet ............................................................................ .............................36 Consolidating Statement of Operations ............................................................ .............................38 11JERNST &YOUNG Report of Independent Auditors Board of Trustees Hoag Memorial Hospital Presbyterian and Affiliates Ernst & Young LLP Suite 1000 18111 Von Karmen Avenue Irvine, California 92612 -1007 Tel: +1 949 794 2300 Fax: +1 949 437 0590 www.ey.com We have audited the accompanying consolidated balance sheets of Hoag Memorial Hospital Presbyterian and Affiliates (the Organization) as of September 30, 2008 and August 31, 2007, and the related consolidated statements of operations, changes in net assets and cash flows for the thirteen -month period ended September 30, 2008 and the year ended August 31, 2007. These consolidated financial statements are the responsibility of the Organization's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Organization's internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Organization's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Hoag Memorial Hospital Presbyterian and Affiliates as of September 30, 2008 and August 31, 2007, and the consolidated results of their operations and their cash flows for the thirteen -month period ended September 30, 2008 and the year ended August 31, 2007 in conformity with accounting principles generally accepted in the United States. December 23, 2008 19 w -t "1 40 A member firm of Ernst B Young Global Limited Hoag Memorial Hospital Presbyterian and Affiliates Consolidated Balance Sheets (in thousands) Assets Current assets: Cash and equivalents Patient accounts receivable, net of allowance for doubtful accounts of $22,591 at September 30, 2008 and $16,000 at August 31, 2007 Investments Other receivables Other current assets Board designated for short-term cash needs Total current assets Assets limited as to use: Board designated for capital improvements For endowments Under indenture agreement held by trustee Under malpractice claims funding arrangement held by trustee Total assets limited as to use September 30 August 31 2008 2007 83,435 $ 103,463 77,633 65,392 30,985 8,203 5,699 7,825 9,692 11,035 219,159 - 426,603 195,918 658,568 937,885 83,727 73,329 117,583 131,485 12,592 18,830 872,470 1,161,529 Donations and bequests pledged, net of allowance for doubtful accounts and unamortized discount of $6,414 at September 30, 2008 and $5,888 at August 31, 2007 61,681 48,637 Property and equipment, net 721,159 660,178 Other assets 11,275 16,834 Total assets S 2.093.188 $ 2.083.096 Liabilities and net assets Current liabilities: Accounts payable Accrued expenses: Payroll and related taxes Employee benefits Other Accrued liabilities under capitated contracts Estimated third -party payer settlements Current portion of bonds payable Total current liabilities Estimated malpractice claims Bonds payable, less current portion Liability to annuitants and other beneficiaries Other long -term liabilities Total liabilities Net assets: Unrestricted Temporarily restricted Permanently restricted Total net assets Total liabilities and net assets See accompanying notes. 32,581 $ 24,396 11,665 8,659 39,691 35,419 5,721 2,483 11,903 11,119 511 918 202,080 - 304,152 82,994 10,984 11,269 422,950 622,950 1,764 2,083 19,634 5,955 759,484 725,251 1,202,609 1,249,369 90,554 81,167 40,541 27,309 1,333,704 1,357,845 $ 2.093.188 $ 2.083.096 Hoag Memorial Hospital Presbyterian and Affiliates Consolidated Statements of Operations (in thousands) Thirteen -Month $ 631,369 $ Period Ended Year Ended September 30 August 31 2008 2007 Unrestricted operating revenues Net patient service $ 631,369 $ 520,197 Capitation 73,952 80,267 Other 45,521 50,342 Total unrestricted operating revenues 750,842 650,806 Operating expenses: Salaries and employee benefits 331,097 298,271 Professional fees 10,413 8,080 Provision for doubtful accounts 26,229 18,973 Supplies 124,410 106,954 Utilities 9,390 8,328 Insurance 2,943 2,475 Lease rental 8,360 9,307 Other 38,827 27,891 Purchased services 80,752 74,824 Depreciation and amortization 50,453 41,997 Interest 31,280 24,385 Total operating expenses 714,154 621,485 Income from operations 36,688 29,321 Other (expense) income: Investment (loss) income, net - (52,757) 99,115 Change in fair value of interest rate swap (14,300) - Other nonoperating losses and expenses (32,483) (7,445) Other (expense) income, net (99,540) 91,670 (Deficiency) excess of revenues over expenses before minority interest (62,852) 120,991 Minority interest 269 (457) (Deficiency) excess of revenues over expenses (62,583) 120,534 Net assets released from restrictions used for purchase of property and equipment and specific program purposes 10,298 1 1,009 Net assets released due to passage of time restrictions 5,168 - Unrealized gain (loss) from interest rate swap 356 (356) (Decrease) increase in unrestricted net assets $ (46,761) $ 131,187 See accompanying notes Hoag Memorial Hospital Presbyterian and Affiliates Consolidated Statements of Changes in Net Assets (in thousands) Thirteen -Month (356) Period Ended Year Ended September 30 August 31 2008 2007 Unrestricted net assets: (Deficiency) excess of revenues over expenses $ (62,583) $ 120,534 Net assets released from restrictions used for purchase of property and equipment and specific program purposes Net assets released due to occurrence of other events Unrealized gain (loss) from interest rate swap (Decrease) increase in unrestricted net assets Temporarily restricted net assets: Contributions Investment (loss) income Change in value of split - interest agreements Annuity payments and other Net assets released from restrictions used for purchase of property and equipment and specific program purposes Net assets released due to passage of time restrictions Increase in temporarily restricted net assets Permanently restricted net assets: Contributions Change in value of split - interest agreements Investment (loss) income Annuity payments Increase in permanently restricted net assets (Decrease) increase in net assets Net assets, beginning of the year Net assets, end of the year See accompanying notes. 10,298 11,009 5,168 — 356 (356) (46,761) 131,187 31,501 26,313 (6,726) 3,731 267 710 (188) (236) (10,298) (11,009) (5,168) — 9,388 19,509 13,208 10,490 29 13 (2) 3 (3) (3)- 13,232 10,503 (24,141) 161,199 1,357,845 1,196,646 $ 11333,704 $ 1,357,845 Hoag Memorial Hospital Presbyterian and Affiliates Consolidated Statements of Cash Flows (in thousands) Cash flows from operating activities (Decrease) increase in net assets Adjustments to reconcile (decrease) increase in net assets to net cash provided by operating activities: Depreciation and amortization Provision for doubtful accounts Net loss on disposition of property and equipment Temporarily and permanently restricted contributions Unrealized loss (gain) from interest rate swap Changes in operating assets and liabilities: Patient accounts receivable Other receivables and other current assets Donations and bequests pledged Board designated assets and endowments Investments Accounts payable Accrued expenses Accrued liabilities under capitated contracts Estimated third -party payor settlements Estimated malpractice claims Liability to annuitants and other beneficiaries Net cash provided by operating activities Cash flows from investing activities Decrease (increase) in assets under indenture agreement held by trustee Decrease (increase) in assets under malpractice claims funding arrangement held by trustee Decrease (increase) in other assets Purchase of property and equipment, net Net cash used in investing activities Cash flows from financing activities Thirteen -Month Period Ended Year Ended September 30 August 31 2008 2007 (24,141) $ 161,199 50,453 41,997 26,229 18,973 25,717 6,969 (30,727) (20,871) (356) 356 (38,470) (22,059) 3,469 (457) (13,044) (13,538) 49,760 (84,077) (22,782) 7,586 8,185 675 10,516 (3,579) 784 (1,742) (407) (567) (285) (931) (319) 22 44,582 89,956 13,902 (80,679) 6,238 (1,334) 5,559 (7,969) (137,151) (71,723) (111,452) (161,705) Proceeds from bond issuance 452,080 422,950 Repayment of bonds (450,000) (316,000) Increase in other long -term liabilities 14,035 713 Proceeds from temporarily and permanently restricted contributions 30,727 20,871 Net cash provided by financing activities 46,842 128,534 Net (decrease) increase in cash and equivalents Cash and equivalents, beginning of the year Cash and equivalents, end of the year Supplemental disclosure of cash flow information Cash paid during the year for interest See accompanying notes. (20,028) 56,785 103,463 46,678 $ 83.435 $ 103.463 $ 29.281 $ 24,954 Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements September 30, 2008 1. Summary of Significant Accounting Policies Organization Hoag Memorial Hospital Presbyterian (the Hospital) is a not - for -profit corporation operating a general acute care hospital in Newport Beach, California. The Hospital provides inpatient, outpatient and emergency services for residents of Orange County, California. Hoag Hospital Foundation (the Foundation) is a not - for -profit corporation which raises funds to support the Hospital. The Hospital is the sole voting corporate member of the Foundation. Hoag Management Services Inc. (HMSI) (formerly Hoag Practice Management, Inc.) is a for - profit taxable California corporation that until December 31, 2007, provided management and billing services to medical offices that provided physician healthcare services to patients in the Hospital's service area. The majority of the assets of HMSI were sold on December 31, 2007 and since that date operations are limited to providing services to other members of the Organization. HMSI is wholly owned by the Hospital. Coastal Physicians Purchasing Group, Inc. (Coastal Physicians) is a taxable California non -profit corporation that primarily serves as a purchasing co- operative for physicians. The Hospital exerts significant influence over Coastal Physicians. Newport Healthcare Center LLC (NHC) is a wholly owned subsidiary of the Hospital that acquires, develops and manages property. The Hospital has a 99% ownership in a joint venture, Newport Imaging Center (NIC), over which it exerts significant influence. NIC operates imaging centers in Orange County, California. The Hospital has a 51% ownership interest in a joint venture, Newport Beach Lido Surgery Center LLC (Lido Surgery), over which it exerts significant influence. Lido Surgery operates an outpatient surgery center near the Hospital. The Hospital has a 54% ownership interest in a joint venture, Hoag Endoscopy Center LLC (HEC), over which it exerts significant influence. HEC is in development and has not commenced operations. The Hospital has entered into a long -term lease to operate a second hospital facility located in Irvine, California, which is located within the existing hospital's primary service area. Services are expected to begin at the Irvine facility in 2010. Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 1. Summary of Significant Accounting Policies (continued) Change in Fiscal Year The Organization changed its fiscal year to September 30 effective in 2008. As such, the accompanying statements of operations, changes in net assets and cash flows include transactions covering the thirteen -month period beginning September 1, 2007 and ending September 30, 2008. Activity reported for the year ended August 31, 2007 may not be comparable to the longer thirteen -month period. Basis of Consolidation The consolidated financial statements include the accounts of the Hospital, the Foundation, HMSI, Coastal Physicians, NHC, NIC, Lido Surgery, and HEC (collectively, the Organization). All significant intercompany accounts and transactions have been eliminated in consolidation. Use of Estimates The preparation of the Organization's consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Estimates also affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Reclassifications Losses on abandoned capital projects of $7.2 million are now reported within "Net loss on disposition of property and equipment," a component of cash flows from operations, in the consolidated statements of cash flows for the year ended August 31, 2007. This amount was reported as a component of "Purchases of property and equipment, net," a component of cash flows from financing activities, in the prior year consolidated financial statements. Cash and Equivalents All highly liquid investments with a maturity of three months or less are considered to be cash equivalents. The carrying amount approximates fair value because of the short maturity of the investments. 7 Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 1. Summary of Significant Accounting Policies (continued) Investments Investments in equity securities, mutual funds and equity commingled funds with readily determinable fair values and all investments in debt securities are measured at fair value in the balance sheets. Investment in partnerships, limited liability companies and similarly structured entities are accounted for using the equity method of accounting, under which the Organization records its proportionate share of income or loss reported by the underlying entity. Investment income or loss (including realized and unrealized gains and losses on investments, interest and dividends) is included in the change in unrestricted net assets unless the income or loss is restricted by donor or law. Accounts Receivable The Organization receives payment for services rendered to patients from the federal and state governments under the Medicare and Medi -Cal programs, privately sponsored managed care programs for which payment is made based on terms defined under formal contracts, and other payors. The following table summarizes the percentage of net accounts receivable from all payors at September 30, 2008 and August 31, 2007: 2008 2007 Government 14% 20% Contracted 75% 74% Other 11% 6% 100% 100% The Organization's management believes there is no material credit risk associated with receivables from government programs. Receivables from managed care programs and others are from various payors who are subject to differing economic conditions, and do not represent any concentrated risks to the Organization. Management continually monitors and adjusts the provision for contractual discounts and doubtful accounts associated with receivables based on historical experience. Assets Limited as to Use Assets limited as to use include assets that are held by trustees under indenture and malpractice trust agreements, Foundation endowment assets, or are set aside by the Organization's Board of Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 1. Summary of Significant Accounting Policies (continued) Directors (the Board) for future capital improvements or short-term cash needs over which the Board retains control and may, at its discretion, subsequently use for other purposes. Donations and Bequests Donations and bequests of private support are recorded as revenue upon the receipt of the unconditional promise to give. The Organization is the ultimate remainderman of certain trusts. Assets that relate to irrevocable, unconditional promises to give are included in the consolidated financial statements at fair market value in temporarily or permanently restricted net assets, depending on donor restrictions. The Organization believes that certain donations and bequests pledged may not be collected and has provided an allowance for such amounts based on historical experience. Property and Equipment Property and equipment acquisitions are recorded at cost. Depreciation is provided over the estimated useful life of each class of depreciable asset and is computed using the straight -line method. Lives range from three to 20 years for equipment and 10 to 40 years for buildings and improvements. Amortization of leasehold improvements is provided over the shorter of the estimated useful lives of the assets or the lease term and is computed using the straight -line method. Gifts of long -lived assets such as land, buildings or equipment are reported as unrestricted support, and are included in the excess 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 in service. Accounting for the Impairment or Disposal of Long -Lived Assets The Organization accounts for the impairment and disposition of long -lived assets in accordance with Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for the Impairment or Disposal of Long -Lived Assets. In accordance with SFAS No. 144, long -lived assets are reviewed for events or changes in circumstances that indicate that their carrying value may not be recoverable. C Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 1. Summary of Significant Accounting Policies (continued) Temporarily and Permanently Restricted Net Assets Temporarily restricted net assets are those whose use by the Organization has been limited by donors to a specific time period or purpose. Permanently restricted net assets have been restricted by donors to be maintained by the Organization in perpetuity. Deferred Financing Costs Costs incurred in obtaining long -term financing are amortized over the term of the related obligations using the interest method. Derivative and Hedging Instruments In accordance with Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities, and its amendments in SFAS Nos. 137 and 138, the Organization is required to recognize all derivatives on the consolidated balance sheets at fair value. Derivatives that are not hedges must be adjusted to fair value through the consolidated statements of operations. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair values of the derivatives are offset against either the change in fair value of assets, liabilities, or firm commitment through the consolidated statements of operations, or recognized as a change in unrestricted net assets until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value, if any, is immediately recognized in the consolidated statement of operations. Excess of Revenues over Expenses The consolidated statements of operations include excess of revenues over expenses. Changes in unrestricted net assets that are excluded from excess of revenues over expenses, consistent with industry practice, include equity distributions, effective portion of the change in unrealized gains and losses on the interest rate swap, and contributions of long -lived assets, and contributions towards specific programs (including assets acquired using contributions which by donor restriction were to be used for the purposes of acquiring such assets). 10 Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 1. Summary of Significant Accounting Policies (continued) Net Patient Service Revenues Net patient service revenues are reported at the net realizable amounts from patients, third -parry payers and others when services are rendered, including estimated settlements under reimbursement agreements with third -party payers. Settlements are accrued on an estimated basis in the period the related services are rendered and adjusted in future periods as final settlements are determined. It is reasonably possible that actual settlements in the near term will differ from the estimated accrued settlements, although such settlements are not expected to be material to the consolidated financial position or results of operations of the Organization. In the opinion of the Organization's management, adequate provision has been made for such adjustments, if any, that might arise. The Organization's net patient service revenues from Medicare and Medi -Cal approximated 22% and 1% of the consolidated net patient revenues in 2008 and 23% and 1% in 2007. Net patient service revenue includes $0.3 million in 2008 and $0.6 million in 2007 relating to favorable final settlement of prior years' reimbursement from Medicare, Medi -Cal and other programs. The Organization is reimbursed for services provided to patients under certain programs administered by governmental agencies. Laws and regulations governing the Medicare and Medi -Cal programs are complex and subject to interpretation. The Organization believes that it is in compliance with all applicable laws and regulations, and it is not aware of any significant pending or threatened investigations involving allegations of potential wrongdoing. While no such regulatory inquiries have been made, compliance with such laws and regulations can be subject to future government review and interpretation, as well as significant regulatory action including fines, penalties and exclusion from the Medicare and Medi -Cal programs. Revenue Earned on Prepaid Capitation Contracts The Hospital has agreements with various health plans to provide medical services to subscribing participants. Under these agreements, the Hospital receives monthly capitation payments based on the number of each plan's participants enrolled with participating medical groups that have designated the Hospital as their provider. The Hospital is responsible for certain hospital contracted services provided to these plan participants, including services rendered at other health care facilities. The agreements call for risk - sharing arrangements between the Hospital and the participating physician groups dependent primarily on utilization. The Hospital has accrued for estimated risk - sharing settlements and claims for services from outside providers within accrued liabilities under capitated contracts in the accompanying balance sheets. Accrued liabilities related to these services are generally based on historical claims lag analyses and are continually monitored and reviewed by management. 11 Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 1. Summary of Significant Accounting Policies (continued) Charity Care The Hospital provides care to patients who meet certain criteria under its charity care policy without charge or at amounts less than established rates. Because the Hospital does not pursue collection of amounts determined to qualify as charity care, they are not recognized as revenue. Donor - Restricted Gifts Unconditional promises to give cash and other assets to the Hospital are received by the Hospital and Foundation, and reported at fair value at the date the promise is received. Conditional promises to give and indications of intentions to give are reported at fair value at the date the gift is received or the conditions are met. The gifts are reported as either temporarily or permanently restricted support if they are received with donor stipulations that limit the use of the donated assets. When a donor restriction expires, that is, when a stipulated time restriction ends or purpose restriction is accomplished, temporarily restricted net assets are reclassified as unrestricted net assets and reported in the consolidated statements of operations as net assets released from restrictions. Donor - restricted contributions whose restrictions are met within the same year as received are reported as unrestricted contributions in the accompanying consolidated financial statements. Self- Insurance The Organization is self - insured with respect to professional liability and comprehensive general liability risks, subject to certain limitations. Professional and general liability risks in excess of $2.0 million per occurrence are reinsured with major independent insurance companies. Based on actuarially determined estimates, an accrual totaling $11.0 million and $11.3 million has been made in the accompanying consolidated balance sheets for estimated losses relating to all known claims and incurred but not reported incidents as of September 30, 2008 and August 31, 2007, respectively. The Organization is self - insured for workers' compensation claims, subject to certain limitations. The liability risks in excess of $1.0 million per occurrence are reinsured with major independent insurance companies. Based on actuarially determined estimates, an accrual totaling $10.0 million and $7.9 million has been made and is recorded within accrued expenses - employee benefits in the accompanying consolidated balance sheets for estimated losses relating to all known claims and incurred but not reported incidents as of September 30, 2008 and August 31, 2007, respectively. 12 Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 1. Summary of Significant Accounting Policies (continued) The Organization provides certain benefits to its employees and others under health and other insurance programs and is self - insured with respect to certain of the benefits under such programs. Employee heath risks in excess of $400,000 per occurrence are reinsured with major independent insurance companies. Based on actuarially determined estimates, an accrual totaling $1.7 million and $1.3 million has been made within accrued expenses - employee benefits in the accompanying consolidated balance sheets for estimated losses relating to all known claims and incurred but not reported incidents as of September 30, 2008 and August 31, 2007, respectively. Income Taxes The Hospital and the Foundation are exempt from federal and California state income and franchise taxes under Section 501(c)(3) of the Internal Revenue Code and California Revenue and Taxation Code Section 23701(d), respectively. The Hospital and Foundation are recognized as public charities (not private foundations) under Sections 509(a)(1) and 170(b)(1)(A)(iii) and (vi), respectively. Neither entity is a private foundation as defined by Section 509(a). Split- Interest Agreements Split- interest agreements include charitable remainder trusts that are arrangements in which a donor establishes and funds a trust with specified distributions to be made to a designated beneficiary or beneficiaries over the trust term. The Foundation serves as trustee of these arrangements and recognizes the contribution in the period in which the trust is established. The assets are recorded at fair value when received and the liability to the designated beneficiary is recorded at the present value of the estimated future payments to be distributed over the expected life of the beneficiary using a discount rate. The fair value of charitable remainder trusts where the Foundation serves as trustee is $1.5 million at September 30, 2008, and $2.8 million at August 31, 2007 and are recorded within donations and bequests pledged. The present value of the related liabilities is $0.6 million at September 30, 2008, and 50.9 million at August 31, 2007, and is recorded within liability to annuitants and other beneficiaries. The Organization is a beneficiary of assets contributed by donors under unconditional, irrevocable agreements held by independent trustees or other fiscal agents. Where possible, assets have been included at their estimated fair value in the accompanying financial statements. In some cases, the estimated fair value of such assets cannot be determined and, accordingly, such assets are not included in the accompanying financial statements. The Organization is also the beneficiary of various revocable trusts. The value of certain of these trusts has not been disclosed to the Foundation and cannot be reasonably estimated. Assets that 13 Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 1. Summary of Significant Accounting Policies (continued) relate to revocable trust or conditional promises to give, for which the Organization is not trustee, are not included in the accompanying financial statements. The Organization recognizes these donations as revenue when the amounts are received or when the promise to give becomes unconditional. Other Nonoperating Losses and Expenses Other non operating losses and expenses in the thirteen -month period ended September 30, 2008, and the year ended August 31, 2007, consist of (in thousands): Capital improvement projects that were abandoned due to other considerations Amortization of bond issuance costs in connection with bond redemption Other nonoperating (income) expense Adoption of New Accounting Pronouncements 2008 2007 $ 26,606 $ 7,227 7,465 — (1,588) 218 $ 32,483 $ 7,445 The Organization adopted Financial Accounting Standards Board (FASB) Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109 (FIN 48), in 2008. FIN 48 clarifies the accounting for uncertainty in income taxes and prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Based on guidance in FIN 48, management of the Organization believes that the outcome of these uncertainties should not have a material adverse effect on the financial condition, cash flows, or operating results of the Organization and, accordingly, the adoption of FIN 48 had no impact on the 2008 financial statements. No liability has been recorded at September 30, 2008. New Accounting Pronouncements In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157 (FAS 157), Fair Value Measurements. This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. FAS 157 applies under other accounting pronouncements that require or permit fair value measurements and, accordingly, FAS 157 does 14 Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 1. Summary of Significant Accounting Policies (continued) not require any new fair value measurements. FAS 157 is effective for fiscal years beginning after November 15, 2007. The Organization is currently evaluating the impact that adopting this standard will have on the financial statements. In February 2007, the FASB issued FAS No. 159 (FAS 159), The Fair Value Option for Financial Assets and Financial Liahilities. FAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. FAS No. 159 is effective for the fiscal years beginning after November 15, 2007. The Organization is currently evaluating the impact that adopting this standard will have on the financial statements. 2. Investments Board Designated for Short -Term Cash Needs The Hospital's Board of Directors has established a short-term investment pool that is set aside primarily for major capital expenditures expected to take place in the next one to three fiscal years. The composition of this short-term investment pool at September 30, 2008 is as follows: (in thousands) Cash and cash equivalents S 89;633 U.S. Government Agency and Treasury notes 92,195 Debt and equity securities 37,331 S 219,159 The Board re- designated these investments in 2008, allowing them to also be used for other short-term needs including the payment of tendered bonds in the event of a failed remarketing, resulting in current asset classification at September 30, 2008. As of August 31, 2007, the assets currently segregated into the short-term investment pool were classified as "Board designated for capital improvements." Board designated investments for short-term cash needs are limited as to use and are included when calculating component percentages of total assets limited as to use. Assets Limited as to Use Assets limited as to use are recorded at fair market value and include assets which have been designated by the Hospital's Board of Directors for major equipment purchases, the renovation and replacement of plant facilities, and payment of potential malpractice and general liability claims. 15 Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 2. Investments (continued) The Foundation's Board of Directors has designated $38.4 million at September 30, 2008, and $32.7 million at August 31, 2007, as Board - designated funds functioning as an endowment to be invested to provide income for a long but unspecified period of time. These assets have been classified under assets limited as to use for endowments. Funds held by trustee under indenture agreements are subject to qualified expenditure reimbursements by the trustee. On June 1, 2007, the Hospital entered into a Repurchase Agreement concerning the investment of certain project funds deposited with the trustee. As of September 30, 2008, the repurchase transaction amount totaled $110.8 million, with the remaining bond proceeds invested in cash and cash equivalents. The composition of assets limited as to use at September 30, 2008 and August 31, 2007 is as follows: For endowments Cash and cash equivalents 2008 2007 $ (in thousands) Board designated for capital improvements: 1,143 Cash and cash equivalents $ 9,632 $ 49,996 U.S. Government Agency and Treasury notes 8,730 82,053 Mutual funds 225,217 275,864 Equity commingled funds 136,395 137,994 Debt and equity securities 133,884 187,777 Hedge funds 138,142 201,245 Private equity 5,790 2,956 Real assets 778 - 4,064 $ 658,568 $ 937,885 For endowments Cash and cash equivalents $ 9,849 $ 684 U.S. Government Agency and Treasury notes 1,143 - Mutual funds 26,455 32,116 Equity commingled funds 17,159 25,655 Debt and equity securities 17,815 10,674 Hedge funds 7,164 1,244 Private equity 4,064 2,956 Real assets 78 - $ 83,727 $ 73,329 Under indenture agreement held by trustee: Cash and cash equivalents $ 6,822 $ 953 Repurchase agreement 110,761 130,532 $ 117,583 $ 131,485 16 Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 2. Investments (continued) 2008 2007 (in thousands) Under malpractice claims funding agreement held by trustee: Cash and short-term investments $ 250 $ 513 U.S. Government Agency and Treasury notes 3,053 5,159 Debt and equity securities 9,289 13,158 $ 12,592 $ 18,830 The Organization's classification of "Mutual funds" includes equity and fixed income mutual funds which may be non - diversified under federal securities laws and may concentrate assets in geographic regions or countries, sectors, and securities issuers. In addition, the Organization's classification of mutual funds also includes a mutual fund -of -funds which seeks a positive return regardless of market direction and which is not restricted with respect to its exposure to any particular asset class. At the investment manager's discretion, the fund may invest all or substantially all of its assets in a limited number of underlying funds that primarily invest in marketable equity and fixed income securities denominated in both U.S. and foreign currency with an exposure to both emerging markets and developed markets. This mutual fund -of -funds has monthly liquidity with a 14 -day notice requirement, provided redemptions may be subject to redemption fees. As of September 30, 2008 and August 31, 2007, this mutual fund -of -funds comprised approximately 5% of the Organization's investment assets limited as to use. The Organization's classification of "Equity commingled funds" includes investments in commingled fund vehicles, such as a tax - exempt common trust fund, a Delaware Statutory trust, and Delaware Limited Liability Companies, which invest primarily in marketable equity securities. In addition, the Organization's classification of "Equity commingled funds" includes an investment in an offshore fund, structured as a Cayman Islands exempted company, which invests in global emerging equity markets. This fund does not engage in shorting individual stocks but has the discretion to build a significant cash position and/or hedge the portfolio using index - linked securities to provide downside portfolio protection. In addition, this fund has a redemption provision which provides for monthly liquidity with 90 -days prior written notice and gives discretion to the fund to limit withdrawals or redemptions to 15% of the total value of the Organization's interest in the fund under certain circumstances. In addition, the Organization may be subject to a 3% redemption fee if it redeems from this fund prior to February 2009. As of September 30, 2008 and August 31, 2007, this offshore fund comprised approximately 3% and 0% of the Organization's investment assets limited as to use, respectively. The remaining Equity Commingled Funds, in the amount of $124.7 million and $163.7 million as of September 30, 2008 and August 31, 2007, respectively, have monthly liquidity subject to certain notice requirements. 17 Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 2. Investments (continued) The Organization's classification of "Private equity" includes two private equity buyout funds, one private equity venture capital fund, and one private equity venture capital fund -of- funds. Three of the Private equity funds have ten -year terms, subject to two one -year extensions. The term of one of the Private equity funds is eleven years, subject to two one -year extensions. The Organization may not withdraw or sell, assign or transfer its interests in the funds except in certain very limited circumstances, subject to consent by the General Partners of the funds. The Organization's classification of "Real assets" consists of-an offshore fund which invests in multiple asset classes including publicly traded and privately placed equity and debt securities, particularly those related to financial and real estate- related companies, as well as investments in whole loans and direct investments in real estate both within and outside the United States. The term of this Real asset fund is five years subject to two one -year extensions at the General Partner's discretion. The Organization may not withdraw or sell, assign or transfer its interests in the fund except in certain very limited circumstances, subject to consent by the General Partners of the fund. The Organization's investments in the Real asset and Private equity buyout and venture capital funds described in the preceding paragraphs are structured as "drawdown" funds, which means that the Organization has committed capital to the funds and the fund managers make capital calls as the investment opportunities develop over initial investment periods that could last between two and six years. The table below summarizes the Organization's commitments and uncalled capital as of September 30, 2008: (in thousands) Commitment Drawn Down Uncalled Private equity $ 36,000 $ 10,662 $ 25,338 Real assets 8,800 880 7,920 Total $ 44,800 $ 11,542 $ 33,258 The Organization's classification of "Hedge funds" consists of three offshore direct hedge funds investments which employ primarily long or short equity hedge fund strategies, and three offshore multi - manager fund -of -funds hedge funds which implement a range of alternative investment strategies including but not limited to long or short equity, credit, market neutral, diversified futures, commodities, emerging country debt, and currency hedge. In addition, the Organization's classification of "Hedge funds" includes offshore hedge fund positions which were transferred in -kind from a fund -of -funds hedge fund liquidated by the Organization in 1E Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 2. Investments (continued) 2008. Approximately $2.0 million of the hedge fund positions transferred in -kind by the fund -of- funds may be uncertain as to timing of ultimate recovery based upon characteristics of the underlying assets. The remaining positions transferred in -kind by the fund -of- funds, which had an aggregate market value of approximately $3.3 million as of September 30, 2008, employ a distressed sub -prime and special opportunities or event driven strategy. The Organization's investments in "Hedge funds" have limited liquidity since shares or interests in the Hedge funds are not freely transferable and are subject to various lock -up periods, redemption fee and notice requirements. In addition, the Hedge funds typically reserve the rights to reduce ( "gate ") or suspend redemptions and to satisfy redemptions by making distributions in -kind, under certain circumstances. Additionally, Hedge funds may hold directly or indirectly, side pocket investments where no redemptions are permitted until such investments are liquidated or deemed realized. Approximately $46.5 million of the Hedge funds investments are subject to rolling three -year lock -up provisions. Investments in equity securities with readily determinable fair values and all investments in debt securities are measured at fair value. Investment income or loss (including realized and unrealized gains and losses on investments, interest and dividends) is included in investment income unless the income or loss is restricted by donor or law. In addition, the Organization uses the fair market value method of accounting for most of its Equity commingled funds, except for the offshore Equity commingled fund which is accounted for under the equity method of accounting. The Organization also utilizes the equity method of accounting for its Hedge fund, Private equity, and Real asset investments. Other Investments The following is a summary of investments, other than assets limited as to use, held by the Organization at September 30, 2008 and August 31, 2007, stated at fair value. 2008 2007 (in thousands) Mutual funds $ 30,985 $ 8,203 19 Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 2. Investments (continued) Net investment (loss) income for the thirteen -month period ended September 30, 2008 and the year ended August 31, 2007 consists of: Interest and dividend income Net realized gains and losses on investments Net unrealized gains and losses on fair value of investments Less investment fees 3. Donations and Bequests Pledged 2008 2007 (in thousands) $ 45,295 $ 40,177 1,876 88,912 (92,801) (25,139) (7,127) (4,835) $ (522757) $ 99,115 The Organization has received contributions under various types of split- interest agreements including charitable remainder annuity trusts and charitable remainder gift unitrusts. Such unconditional irrevocable agreements are reported at fair value at the date the promise is received. In determining the fair value of such assets, the Organization uses the present value of estimated future cash flows using a discount rate commensurate with the risks involved ranging from 7% to 11 %. For unconditional irrevocable agreements where the assets, or a portion of the assets, are being held for the benefit of others, such as the donor or third parties designated by the donor, a liability, measured at the present value of the expected future payments to be made to other beneficiaries, has been recorded in the accompanying consolidated balance sheets. The Organization is a beneficiary to assets contributed by donors under unconditional irrevocable agreements which are held by independent trustees or other fiscal agents. Where possible, assets have been included at estimated fair value in the accompanying consolidated financial statements. In some cases, the estimated fair value of such assets cannot be determined and, accordingly, such assets are not included in the accompanying consolidated financial statements. 20 Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 3. Donations and Bequests Pledged (continued) The amounts of net donations pledged that are receivable at September 30, 2008 and August 31, 2007 consist of the following: Due in one year or less Due after one year through five years Due after five years Less amount representing interest Pledges receivable, net Split- interest agreements September 30, August 31, 2008 2007 (in thousands) $ 15,347 $ 10,778 24,006 17,952 7,526 7,702 46,879 36,432 (5,798) (5,306) 41,081 31,126 20,600 17,511 $ 61,681 $ 48,637 The Organization is also the beneficiary of various revocable trusts. The value of certain of these trusts has not been disclosed to the Organization and cannot be reasonably estimated. Assets that relate to revocable trusts or conditional promises to give, for which the Organization is not trustee, are not included in the accompanying consolidated financial statements. The Organization includes these donations as revenue when the amounts are received or when the promise to give becomes unconditional. The fair value of certain of these assets was determined by calculating the net present value of the estimated future cash flows using a discount rate at the time the pledge was made which ranges between 1% and 6 %. The Organization is the beneficiary of volunteers performing numerous non - clinical functions in all areas of the Organization. Management has not estimated the fair value of services provided and no revenue is recognized as a result of these donated services. 21 Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 4. Property and Equipment A summary of property and equipment at September 30, 2008 and August 31, 2007 follows: Land Buildings and improvements Equipment Construction -in- progress Less accumulated depreciation Property and equipment, net 2008 2007 (in thousands) $ 77,331 $ 64,973 657,497 629,685 327,479 294,040 75,815 46,767 1,138,122 1,035,465 (416,963) (375,287) $ 721,159 $ 660,178 The Organization has outstanding commitments to complete construction -in- progress projects totaling approximately $117.0 million at September 30, 2008. These projects relate primarily to the construction of new buildings and the renovation of the Hospital's existing buildings in connection with a hospital campus -wide master plan. 5. Bonds Payable Refunding Revenue Bonds Series 2008 On May 22, 2008, $452.1 million of tax - exempt City of Newport Beach Refunding Revenue Bonds (Hoag Memorial Hospital Presbyterian) Series 2008 A through F (the Series 2008 Bonds) were issued by the City of Newport Beach under a loan agreement with the Hospital and bond indenture agreements with the trustee (the 2008 Indentures), comprised of the following: Series 2008 A -B Serial Bond Interest Rate Bonds The Series 2008 A and B Bonds were issued at total par of $132.0 million and initially bear interest at a Serial Bond Interest Rate of 1.80 %. During the Serial Bond Interest Rate Period, interest is payable on each June 1 and December 1, commencing December 1, 2008. These bonds are not subject to optional tender for purchase during the initial Serial Bond Interest Rate Period but are subject to mandatory tender for purchase and remarketing in June 2009. At the end of the Serial Bond Interest Rate Period, the Hospital may convert these bonds to a different interest rate mode or a new term within the Serial Bond Interest Rate Period mode, in accordance with the 22 Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 5. Bonds Payable (continued) Bond Indentures. These bonds are currently supported by self liquidity and the Hospital has agreed to pay the purchase price of any bonds not covered with remarketing proceeds upon the mandatory tender at the end of the initial Serial Bond Interest Rate period. The Series 2008 A and B Bonds are classified as current liabilities in the accompanying consolidated balance sheets. These bonds mature in 2040 and are also subject to varying redemption payments prior to their stated maturity commencing on December 1, 2016. Series 2008 C Variable Rate Demand Revenue Bonds The Series 2008 C Bonds were issued at par of $70.1 million and bear interest at variable interest rates which are reset on a weekly basis depending on prevailing market conditions. Interest is payable on a monthly basis. The average interest rate for these bonds during the period beginning on May 22, 2008 and ending on September 30, 2008 was 1.93% and was 7.61% as of September 30, 2008. The Hospital's remarketing agents have the authority to remarket these bonds at rates of interest up to 12 %. These bonds mature in 2040. However, these bonds are subject to mandatory redemption prior to their stated maturity. In addition, these bonds are subject to optional redemption at the discretion of the Hospital with varying redemption payments on these bonds commencing on December 1, 2016. Holders of variable rate demand revenue bonds have the right to tender the bonds on a daily basis. To effect such tender while the bonds bear interest at a weekly rate, the holder or beneficial owner must deliver written notice of tender to the tender agent and the remarketing agent on a business day not fewer than seven days prior to the designated purchase date. These 2008 Series C Bonds are supported by self - liquidity and the Hospital has agreed to maintain, in the aggregate, sufficient long -term assets, primarily marketable fixed income and other liquidity support vehicles, to be used to repurchase the bonds in the event that tendered bonds are not resold in the open market. The Series 2008 C Bonds are classified as current liabilities in the accompanying consolidated balance sheets. 23 Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 5. Bonds Payable (continued) Series 2008 D through F Variable Rate Demand Bonds The Series 2008 D through F Bonds were issued at total par of $250.0 million and bear interest at variable interest rates which are reset on a weekly basis depending on prevailing market conditions. Interest is payable on a monthly basis. The average interest rate for these bonds during the period beginning on May 22, 2008 and ending on September 30, 2008 was 1.95% and was 7.65% as of September 30, 2008. The Hospital's remarketing agents have the authority to remarket these bonds at rates of interest up to 12 %. These bonds mature in 2040. However, these bonds are subject to mandatory redemption prior to their stated maturity, with varying redemption payments commencing on December 1, 2012. In addition, these bonds are subject to optional redemption at the discretion of the Hospital. Holders of variable rate demand revenue bonds have the right to tender the bonds on a daily basis. To effect such tender while the bonds bear interest at a weekly rate, the holder or beneficial owner must deliver written notice of tender to the tender agent and the remarketing agent on a business day not fewer than seven days prior to the designated purchase date. While the Series 2008 D through F Bonds are in the weekly interest rate period mode, payment of the principal and purchase price of, and interest on the bonds is supported initially by an irrevocable, direct -pay letter of credit (the Letter of Credit) issued by Bank of America, N.A. (the Bank), pursuant to and subject to the terms of the Letter of Credit Agreement dated as of May 22, 2008 (the Reimbursement Agreement), among the Hospital, the Bank and certain other lenders. The Letter of Credit will expire on May 22, 2013, unless extended or earlier terminated pursuant to its provisions, and may, under certain circumstances, be replaced by a substitute letter of credit. In such event, the bonds are subject to mandatory tender for purchase. The Series 2008 D through F Bonds are classified as long -term in the accompanying consolidated balance sheets. Insured Revenue Bonds (Auction -Rate Securities) Series 2007 On May 31, 2007, $423.0 million of tax - exempt City of Newport Beach Insured Revenue Bonds (Hoag Memorial Hospital Presbyterian) Series 2007 A through E (the Series 2007 Bonds) were issued as auction -rate securities by the City of Newport Beach under a loan agreement with the Hospital and a bond indenture agreement with the trustee (the 2007 Indenture). The Series 2007 A -C Bonds, with total par of $250.0 million, were paid in full on May 22, 2008, using proceeds from the Series 2008 Bonds. The 2007 Series D through E Bonds, with total par of $173.0 million, remain outstanding as of September 30, 2008. 24 Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 5. Bonds Payable (continued) The Series 2007 Bonds were initially issued as auction -rate securities and bear interest at auction -rates for generally successive seven -day auction periods. Interest is generally payable weekly on the business day following the end of each auction period. The average interest rate for these Bonds in 2008 was 3.88 %. At the option of the Hospital and subject to the provisions of the 2007 Bond Indenture, the auction period for any Series of auction -rate securities may be changed to 35 days, and the auction date for any Series of auction -rate securities may be changed to another day of the week. In addition, the interest on any Series of Bonds may be converted to a weekly rate, a term rate, or a serial bond interest rate mode. The scheduled payment of the principal of, and interest on, the Series 2007 Bonds when due is guaranteed under a municipal new issue insurance policy by Ambac Assurance Corporation (Ambac). The Organization has agreed to comply with additional financial and operating covenants which are for the sole benefit of the insurer and may be enforced, waived or modified at any time at the insurer's sole discretion, so long as the insurer is not in default of its payment obligations under the policy. The auction -rate securities are not supported by a liquidity facility. The beneficial owners of an auction -rate security may sell, transfer, or dispose of its auction -rate security only pursuant to a bid or sell order in accordance with established auction procedures or through a broker- dealer for the applicable Series of auction -rate securities. The final maturity date for the Series 2007 Bonds is December 1, 2040. The Series 2007 Bonds are subject to redemption, at the option of the Hospital, prior to their stated maturity. The Series 2007 Bonds are also subject to mandatory redemption with varying redemption payments commencing on December 1, 2012, and required to be made through December 1, 2040. The Series 2007 Bonds are classified as long -term in the accompanying consolidated balance sheets. Insured Revenue Bonds (Auction -Rate Securities) Series 2005 On August 24, 2005, $200.0 million of tax- exempt City of Newport Beach Insured Revenue Bonds (Hoag Memorial Hospital Presbyterian) Series 2005 A through C (the Series 2005 Bonds) were issued as auction -rate securities by the City of Newport Beach under a loan agreement with the Hospital and a bond indenture agreement with the trustee (the 2005 Bond Indenture). These bonds were paid in full on May 22, 2008, using proceeds from a short -term bridge loan that was later paid in August 2008, using proceeds from the Series 2008 Bonds. 25 Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 5. Bonds Payable (continued) Assets Pledged Under Master Trust Indenture Essentially all of the cash, investments, receivables, revenues and income of the Hospital and NHC are pledged as collateral under a Master Trust Indenture dated of May 1, 2007, as supplemented. Interest Rate Swap In 2007, the Hospital entered into a derivative financial instrument, specifically an interest rate swap agreement with an effective date of May 31, 2007, for the purpose of managing the Hospital's exposure to fluctuations in interest rates. The swap was initially designated, and qualified as, a cash flow hedge. Accordingly, the effective portion of the gain or loss on the derivative instrument was reported as a change in unrestricted net assets. The ineffective portion was reported in interest expense in the same period or periods during which the hedged transaction affected earnings. In May 2008, the interest rate swap agreement was amended to correspond to the Series 2008 D through F Bonds upon the refunding of a portion of the Series 2007 Bonds. Upon re- designation of the derivative instrument to the Series D through F 2008 Bonds, the Hospital discontinued the use of the cash flow hedge method of accounting, thereby recognizing any change in the fair value of the swap in the excess of revenue over expenses on a monthly basis. The interest rate swap converts a portion of the Hospital's Series 2008 Bonds to a fixed -rate basis for the term of the bonds. Under the swap agreement, the Hospital pays a fixed rate equal to 3.229% and receives a floating rate equal to 55.7% of the USD- LIBOR -BBA rate plus 0.23 %, based on a total notional amount of $250.0 million. Settlements are made monthly over the term of the agreement. As of September 30, 2008 and August 31, 2007, the Hospital's mark -to- market liability on the swap totaled $14.3 million and $0.4 million, respectively, and is recorded within other long -term liabilities in the accompanying consolidated balance sheets. The Hospital is required under certain circumstances to post collateral with the swap counterparty. 26 Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 6. Temporarily and Permanently Restricted Net Assets Restricted net assets are available for the following purposes or periods at September 30, 2008 and August 31, 2007: 2008 2007 Temporarily Permanently Temporarily Permanently Restricted Restricted Restricted Restricted (in thousands) Women's Pavilion $ 3,772 $ 6,535 $ 2,456 $ 6,466 Heart programs 28,528 5,225 20,652 4,009 Cancer programs 34,604 13,045 34,255 12,542 Other programs 13,258 15,516 14,607 4,095 Time - restricted assets 10,392 220 9,197 197 $ 90,554 $ 40,541 $ 81,167 $ 27,309 7. Net Assets Released from Restrictions Net assets were released from donor restrictions for the thirteen -month period ended September 30, 2008 and the year ended August 31, 2007 by incurring expenses satisfying the restricted purposes or by occurrence of other events specified by donors, as follows: Purpose restrictions accomplished: Women's Pavilion Heart programs Cancer programs Education programs Other programs Passage of time restrictions Total restrictions released 2008 2007 (in thousands) 1,175 $ 3,452 677 1,786 3,898 1,170 1,628 2,386 2,920 2,215 5,168 - $ 15,466 $ 11,009 27 Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 8. Retirement Plan The Organization has a sheltered savings plan in which substantially all full -time employees who meet certain criteria, as defined, are eligible. The plan provides for an automatic annual contribution by the Organization of 3% to 6.5% of gross wages based on years of service of eligible employees and a matching contribution by the Organization of 50 %, up to 4% of gross wages of eligible employee contributions. Total expense for the plan was $11.2 million for the tbirteen -month period ended September 31, 2008 and $10.0 million for the year ended August 31, 2007. It is the Organization's policy to make contributions to the plan equal to the amounts accrued as expense. 9. Health and Welfare Benefits The Organization maintains self - insured medical, unemployment and workers' compensation coverage for all active, regularly scheduled, full -time and part-time employees. The cost of such benefit plans is accrued for in the period services are rendered. Accruals for unpaid claims are based on estimated settlements for reported claims and on experience -based estimates for unreported claims. Claims are paid as received. 10. Charity Care The Hospital provides care to patients who meet certain criteria under its charity care policy without charge or at amounts less than its established rates. Generally, services are provided without charge to uninsured patients with family incomes at or below 200% of the Federal Poverty Level as published by the Department of Health and Human Services. Charges are discounted to the Medicare fee schedule rate to uninsured patients with family incomes above 200% up to 350% of the Federal Poverty Level. Charges are discounted to 125% of the Medicare fee schedule rate to uninsured patients with family income above 350% up to 400% of the Federal Poverty Level. The Hospital maintains records to identify and monitor the level of charity care it provides. The following is an estimate of the cost of providing charity care provided during the thirteen -month period ended September 30, 2008, and the year ended August 31, 2007: 2008 2007 (in thousands) Estimated costs and expenses incurred to provide charity and indigent care $ 7,451 $ 5,675 M Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 10. Charity Care (continued) In addition, the Hospital provides services to indigent individuals covered by governmental programs that reimburse healthcare providers at levels below the cost of providing such care (including Medi -Cal and MSI programs). The Hospital provides numerous other services free of charge to the community for which charges are not generated and revenues have not been accounted for in the accompanying consolidated financial statements. These services include referral services, healthcare screenings, community support groups and health education programs. Estimated unreimbursed costs of community benefit including charity care and care to indigent individuals approximated $30.3 million and $26.4 million for the thirteen -month period ended September 30, 2008 and the year ended August 31, 2007, respectively. The above amounts also do not include the cost of providing services to Medicare patients that exceed reimbursement from Medicare, volunteer services provided by Hospital staff to the community on their personal time, nor services provided that are funded as a result of the Hospital's fund- raising activities. 11. Disclosures About Fair Value of Financial Investments The following methods are used to estimate the fair value of each class of financial instruments: Short -Term Investments The fair value of short-term investments, such as mutual funds, is based upon quoted market prices. Long -Term Investments The fair value of investments not accounted for under the equity method are estimated based on quoted market prices of the underlying securities. Bonds Payable The fair value of the Hospital's bonds payable is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Hospital for debt of the same remaining maturities. The fair value of the Hospital's debt approximated its carrying value at September 30, 2008 and August 31, 2007. 29 Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 12. Functional Expenses The Organization provides general healthcare services to residents within its service areas. Expenses relating to providing these services are as follows for the thirteen -month period ended September 30, 2008 and the year ended August 31, 2007: Healthcare services General and administrative Fundraising Interest 13. Commitments and Contingencies Leases 2008 2007 (in thousands) $ 485,340 $ 416,681 187,304 174,075 10,230 6,344 31,280 24,385 $ 714,154 $ 621,485 The Organization is obligated under a noncancelable operating lease to operate an acute care hospital located in Irvine, California, that is expected to commence in February 2009 when the Organization takes possession of the facility and will expire in 2024. The initial fifteen -year term of the lease is subject to multiple renewal options as well as a purchase option ten years following commencement. The agreement allows for a period of rent abatement followed by reduced rent during the initial twelve months of the lease. The Organization also leases certain equipment and office space under noncancelable operating lease agreements which expire on various dates through the year 2011. Certain leases continue escalation clauses that are fixed or variable based on inflationary measurements as well as renewal options of varying terms. These leases, including the Irvine hospital lease, require minimum annual rental payments as follows: Fiscal year: 2009 2010 2011 2012 2013 Thereafter (in thousands) $ 5,143 11,896 15,184 13,598 13,361 146,860 $ 206,042 30 Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 13. Commitments and Contingencies (continued) Rental expense totaled $8.4 million for the thirteen -month period ended September 30, 2008, and $9.3 million for the year ended August 31, 2007. The Organization leases certain office space to others under noncancelable operating leases expiring on various dates. Certain leases contain escalation clauses that are fixed or variable based on inflationary measurements as well as renewal options of varying terms. Future minimum rental revenue due the Organization under these leases is as follows: Fiscal year: (in thousands) 2009 $ 6,007 2010 5,097 2011 3,792 2012 2,353 2013 1,286 Thereafter 2,324 $ 20,859 Rental income totaled $8.1 million for the thirteen -month period ended September 30, 2008, and $5.7 million for the year ended August 31, 2007, and is included in other unrestricted operating revenues in the accompanying consolidated statements of operations. Medical Malpractice The Organization maintains a self - insurance accrual for potential malpractice and general liability claims. The Organization is self - insured for the first $2.0 million per claim. Estimated losses from asserted and unasserted claims are accrued based on actuarial estimates that incorporate the Organization's past experience, as well as other considerations. Reinsurance policies have been negotiated for amounts in excess of $2.0 million. The Organization maintains an irrevocable trust to maintain assets set aside for potential medical malpractice and general liability claims. Liabilities of $11.0 million at September 30, 2008, and $11.3 million at August 31, 2007, have been accrued for claims and potential claims incurred but not reported to the Organization. 31 Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 13. Commitments and Contingencies (continued) Seismic Regulations The state of California has passed legislation requiring hospitals to perform structural evaluations of their buildings by 2001 and upgrade facilities to meet certain minimum seismic standards by 2013. The Organization has completed its initial evaluation of its seismic standards and has obtained approval by OSHPD of this evaluation. The Organization currently estimates the costs associated with these seismic improvements will range from $29.0 million to $60.0 million (unaudited). Legal Matters The Organization is involved in litigation arising in the ordinary course of business. After consultation with legal counsel, the Organization's management estimates that these matters will be resolved without material adverse effect on the Organization's future consolidated financial position or results of operations. Healthcare Reform The healthcare 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 healthcare program participation requirements, reimbursement for patient services, and Medicare and Medi -Cal fraud and abuse. Government activity has increased with respect to investigations and allegations concerning possible violations of fraud and abuse statutes and regulations by healthcare providers. Violations of these laws and regulations could result in expulsion of government healthcare programs together with the imposition of significant fines and penalties, as well as significant repayments for patient services previously billed. The Organization's management believes that the Organization is in compliance with fraud and abuse as well as other applicable government laws and regulations. While no material regulatory inquiries have been made, compliance with such laws and regulations can be subject to future government review and interpretation as well as regulatory actions unknown or unasserted at this time. 32 Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 14. Subsequent Events Valuation of Investments The market value of investments declined subsequent to September 30, 2008 due to market conditions. Unrealized losses on investments of the Organization totaled $144.6 million as of November 30, 2008, a $65.0 million increase over the unrealized loss position of $79.6 million at September 30, 2008. Interest Rate Swap The interest rate swap described in Note 5 experienced further deterioration in value subsequent to September 30, 2008 due to market conditions. As of November 30, 2008, the market value of the swap liability was $46.9 million, compared to $14.3 million as of September 30, 2008. On December 1, 2008, the Organization was required to post collateral in the amount of $26.9 million with the swap counterparty. - Bonds Holders of variable rate demand revenue bonds have the right to tender the bonds on a daily basis. Subsequent to September 30, 2008, a number of bond holders individually tendered a total of approximately $77.8 million of bonds, all of which were successfully remarketed in the ordinary course of business. On December 12, 2008, the Organization notified bond holders of its intention to exercise its option to redeem a portion of the outstanding principle amount of the Insured Revenue Bonds Series 2007 as follows: Series Amount to be Redeemed Redemution Date 2007D $22,525,000 January 8, 2009 2007E $86,475,000 January 8, 2009 The Organization may revoke the notice not less than five business days from the planned date of redemption. The trustee of the bond indenture agreement has been instructed to use unspent bond proceeds to redeem the Series 2007 Bonds. 33 Hoag Memorial Hospital Presbyterian and Affiliates Notes to Consolidated Financial Statements (continued) 14. Subsequent Events (continued) Acquisition The Hospital expects to purchase on December 31, 2008 for approximately $22.4 million a 51% controlling interest in Main Street Specialty Surgery Center LLC, an existing business located in the Hospital's service area. 34 Other Financial Information JERNST&YOUNC Ernst Young LLP Suite 1000 000 18111 Von Korman Avenue Irvine, California 92612 -1007 Tel: +1949 794 2300 Fax: +1 949 437 0590 www.ey.com Report of Independent Auditors on Other Financial Information Hoag Memorial Hospital Presbyterian and Affiliates Our audits were conducted for the purpose of forming an opinion on the consolidated financial statements taken as a whole. The following consolidating information is presented for purposes of additional analysis and is not a required part of the consolidated financial statements. Such information has been subjected to the auditing procedures applied in our audits of the consolidated financial statements and, in our opinion, is fairly stated in all material respects in relation to the consolidated financial statements taken as a whole. December 23, 2008 li � f � LLP A member firm of Ernsi & Young Global Limited 35 Hoag Memorial Hospital Presbyterian and Affiliates Consolidating Balance Sheet September 30, 2008 (A) To eliminate intercompany accounts, M Hospital and Other (A) NHC Entities Foundation Eliminations Consolidated (in thousands) Current assets: Cash and equivalents $ 74,380 $ 7,548 $ 1,507 $ - $ 83,435 Patient accounts receivable, net of allowance for doubtful accounts 74,648 2,985 - - 77,633 Investments 4,810 - 26,175 - 30,985 Other receivables 5,721 357 - (379) 5,699 Other 9,212 167 313 - 9,692 Board designated for short-term cash needs 219,159 - - - 219,159 Due from Hospital - 165 - (165) - Due from Foundation 563 - - (563) - Due from other entities 248 - - (248) Total current assets 388,741 11,222 27,995 (1,355) 426,603 Assets limited as to use: Board designated for capital improvements 658,568 - - - 658,568 For endowments - - 83,727 - 83,727 Under indenture agreement held by trustee 117,583 - - - 117,583 Under malpractice claims funding - agreement held by trustee 12,592 - - - 12,592 Total assets limited as to use 788,743 - 83,727 - 872,470 Donations and bequests pledged, net of allowance for doubtful accounts and - unamortized discount 9,802 - 51,879 - 61,681 Property and equipment, net 714,115 7,044 - - 721,159 Other assets 24,935 681 7 (14,348) 11,275 Total assets $ 1,926,336 $ 18,947 $ 163,608 $ (15,703) $ 2,093,188 (A) To eliminate intercompany accounts, M Hoag Memorial Hospital Presbyterian and Affiliates Consolidating Balance Sheet (continued) Current liabilities: Accounts payable Accrued expenses: Payroll and related taxes Employee benefits Other Accrued liabilities under capitated contracts Estimated third -party payor settlements Current portion of bonds payable Due to Hospital Total current liabilities Estimated malpractice claims Bonds payable, less current portion Liability to annuitants and other beneficiaries Other long -term liabilities Total liabilities Net assets: Unrestricted Temporarily restricted Permanently restricted Total net assets Total liabilities and net assets (A) To eliminate intercompany accounts. September 30, 2008 Hospital & Other (A) NHC Entities Foundation Eliminations Consolidated (in thousands) $ 31,715 $ 636 $ 257 $ (27) $ 32,581 11,558 107 - - 11,665 39,251 440 - - 39,691 4,527 1,336 - (142) 5,721 11,903 - - - 11,903 511 - - - 511 202,080 - - - 202,080 - 413 563 (976) - 301,545 2,932 820 (1,145) 304,152 10,984 - - - 10,984 422,950 - - - 422,950 - - 1,764 - 1,764 18,177 210 - 1,247 19,634 753,656 3,142 2,584 102 759,484 1,167,171 15,805 35,438 (15,805) 1,202,609 5,509 - 85,045 - 90,554 - 40,541 - 40,541 1,172,680 15,805 161,024 (15,805) 1,333,704 $ 1,926,336 $ 18,947 $ 163,608 $ (152703) $ 2,093,188 37 Hoag Memorial Hospital Presbyterian and Affiliates Consolidating Statement of Operations Period Ended September 30, 2008 Unrestricted operating revenues: Net patient service Capitation Other Total unrestricted operating revenues Operating expenses: Salaries and employee benefits Professional fees Provision for doubtful accounts Supplies Utilities Insurance Lease rental Other (A) Purchased services Depreciation and amortization Interest Total operating expenses Income (loss) from operations Other (expense) income: Investment Coss) income, net Change in fair value of interest rate swap Other non operating losses and expenses Other (expense) income, net (Deficiency) excess of revenues over expenses before minority interest Minority interest (Deficiency) excess of revenues over expenses Transfers from Hoag Hospital Foundation Net assets released from restrictions used for purchase of property and equipment and specific program purposes Net assets released due to occurrence of other events Equity contributions Change in unrealized gain on interest rate swap (Decrease) increase in unrestricted net assets Hospital and Other (A) (B) NHC Entities Foundation Eliminations Consolidated (in thousands) $ 617,765 $ 13,604 $ - $ - $ 631,369 73,952 - - - 73,952 29,309 12,686 13,193 (9,667) 45,521- 721,026 26,290 13,193 (9,667) 750,842 315,686 15,411 - - 331,097 10,397 16 - - 10,413 25,635 594 - - 26,229 122,255 2,155 - - 124,410 9,101 289 - - 9,390 2,753 190 - - 2,943 6,816 1,544 - - 8,360 30,987 1,060 (A) 14,606 (7,826) 38,827 79,493 3,100 - (1,841) 80,752 48,988 1,465 - - 50,453 31,214 66 31,280 683,325 25,890 14,606 (9,667) 714,154 37,701 400 (1,413) - 36,688 (50,107) 110 (2,760) - (52,757) (14,300) - - - (14,300) (31,704) 100 (879) (32,483) (96,111) 210 (2,760) (879) (99,540) (58,410) 610 (4,173) (879) (62,852) 269 269 (58,410) 610 (4,173) (610) (62,583) 7,177 - (7,177) - - - - 10,298 - 10,298 2,684 - 2,484 - 5,168 - 2,344 - (2,344) - $ (48,193) $ 2,954 $ 11432 $ (A) Program service transfers from the Foundation are classified as other expenses within the Foundation column on this consolidating statement of operations but we excluded from total expenses, and instead reported as transfers to Hoag Memorial Hospital Presbyterian for program purposes on the statement of activities and changes in net assets for the thirteen -month period ended September 30, 2008 within the stand -alone financial statements of Hoag Hospital Foundation. (B) To eliminate intercompany accounts. m