Report of Independent Auditors and Consolidated Financial Statements. Kaweah Delta Health Care District

Report of Independent Auditors and Consolidated Financial Statements Kaweah Delta Health Care District June 30, 2014 and 2013

CONTENTS MANAGEMENT S DISCUSSION AND ANALYSIS 1 16 PAGE REPORT OF INDEPENDENT AUDITORS 17 18 CONSOLIDATED FINANCIAL STATEMENTS Consolidated statements of net position 20 21 Consolidated statements of revenues, expenses, and changes in net position 22 Consolidated statements of cash flows 24 25 Notes to consolidated financial statements 26 50 Supplementary pension information 52

MANAGEMENT S DISCUSSION AND ANALYSIS Kaweah Delta Health Care District s (the District ) discussion and analysis is designed to assist the reader in focusing on significant financial issues, provide an overview of the District s financial activity, identify changes in the District s financial position, and identify any material deviations from the financial plan (the approved budget). Unless otherwise noted, all discussion and analysis pertains to the District s financial condition, results of operations, and cash flows as of and for the year ended June 30, 2014. Please read it in conjunction with the financial statements in this report. FINANCIAL HIGHLIGHTS The District s net position increased by $21.2 million, or 5.9%, primarily attributable to the year s positive net income (income before contributions). Total assets increased by $23.7 million, or 3.8%. Cash and investments increased by $32.3 million, or 14.5%, primarily in board designated assets resulting from positive cash flow generated by operations as well as a decrease in the net days revenue in patient accounts receivable. Capital assets decreased $6.0 million to $264.2 million with $14.7 million in net additions to buildings, equipment, and construction in progress outpaced by a $20.7 million net increase in accumulated depreciation. For the year, the District s total operating revenues increased to $478.4 million, a 4.4% increase from the prior year, while total operating expenses increased to $458.6 million, an increase of 7.0%. The current year increase in total operating revenues is primarily due to a 5.4% increase in net patient service revenue. This increase in net patient service revenue is attributable to the overall increase in inpatient and outpatient volumes as well as the District s continuous efforts to improve clinical documentation, the result of which better reflects the acuity of patients and appropriately higher reimbursement rates. Capital contributions to the Foundation were $848,000, a slight increase from last year s contributions of $756,000. During the fiscal year, the District made the following significant capital expenditures: water line infrastructure for the original wing of the Medical Center purchase of land and building to be used as an outpatient clinic MRI equipment construction to expand ambulatory surgery area nursing unit remodels The source of funding for these projects was derived from operations, capital contributions, bond project funds, and funds reserved for capital acquisition. 1

MANAGEMENT S DISCUSSION AND ANALYSIS REQUIRED CONSOLIDATED FINANCIAL STATEMENTS The consolidated financial statements of the District include: (a) a statement of net position, (b) a statement of revenues, expenses, and changes in net position, and (c) a statement of cash flows. The consolidated statement of net position includes information about the nature of the District s assets and liabilities and classifies them as current or non current. It also provides the basis for evaluation of the capital structure of the District and for assessing the liquidity and financial flexibility of the District. The District s revenues and expenses are accounted for in the consolidated statement of revenues, expenses, and changes in net position. This statement measures the District s operations and can be used to determine whether the District has been able to recover all of its operating costs from patient services and other operating revenue sources. The primary purpose of the consolidated statement of cash flows is to provide information about the District s cash from operating, non capital financing, capital and related financing, and investing activities. It provides answers to such questions as what were the District s sources of cash, what was cash used for, and what was the change in cash balances during the reporting period. 2

MANAGEMENT S DISCUSSION AND ANALYSIS TABLE 1 Financial Analysis of the District Condensed Consolidated Statements of Net Position (in Thousands) A summary of the District s consolidated statements of net position is presented in Table 1 below: As restated June 30, June 30, Dollar Total % 2014 2013 Change Change Current and other assets $ 381,308 $ 351,538 $ 29,770 8.5% Capital assets 264,188 270,240 (6,052) 2.2% Total assets 645,496 621,778 23,718 3.8% Deferred outflows 3,190 2,782 408 14.7% Current and other liabilities 74,290 65,558 8,732 13.3% Long term debt outstanding 196,792 202,577 (5,785) 2.9% Total liabilities 271,082 268,135 2,947 1.1% Net investment in capital assets 71,185 80,298 (9,113) 11.3% Restricted 27,438 26,471 967 3.7% Unrestricted 278,981 249,656 29,325 11.7% Total net position $ 377,604 $ 356,425 $ 21,179 5.9% As reflected in Table 1, net position increased $21.2 million to $377.6 million for the year ended June 30, 2014, primarily attributable to the District s $20.3 million income before contributions. The GASB issued GASB Statement No. 65, Items Previously Reported as Assets and Liabilities ( GASB No. 65 ), which is effective for financial statements for periods beginning after December 15, 2012. GASB No. 65 establishes accounting and financial reporting standards that reclassify, as deferred outflows of resources or deferred inflows of resources, certain items that were previously reported as assets and liabilities and recognizes, as outflows of resources or inflows of resources, certain items that were previously reported as assets and liabilities. It also provides other financial reporting guidance related to the impact of the financial statement elements deferred outflows of resources and deferred inflows of resources, such as changes in the determination of the major fund calculations and limiting the use of the term deferred in financial statement presentations. The District has adopted this statement for the fiscal year ended June 30, 2014, and, consequently, restated information for previously reported periods. 3

MANAGEMENT S DISCUSSION AND ANALYSIS TABLE 2 Financial Analysis of the District (continued) Condensed Consolidated Statements of Net Position (in Thousands) A summary of the District s consolidated statements of net position is presented in Table 2 below: As restated June 30, June 30, Dollar Total % 2013 2012 Change Change Current and other assets $ 351,538 $ 320,829 $ 30,709 9.6% Capital assets 270,240 274,915 (4,675) 1.7% Total assets 621,778 595,744 26,034 4.4% Deferred outflows 2,782 917 1,865 203.4% Current and other liabilities 65,558 70,942 (5,384) 7.6% Long term debt outstanding 202,577 195,397 7,180 3.7% Total liabilities 268,135 266,339 1,796 0.7% Net investment in capital assets 80,298 81,901 (1,603) 2.0% Restricted 26,471 28,772 (2,301) 8.0% Unrestricted 249,656 219,649 30,007 13.7% Total net position $ 356,425 $ 330,322 $ 26,103 7.9% As reflected in Table 2, net position increased $26.1 million to $356.4 million for the year ended June 30, 2013, primarily attributable to the District s $25.3 million income before contributions. 4

MANAGEMENT S DISCUSSION AND ANALYSIS TABLE 3 Financial Analysis of the District (continued) Condensed Consolidated Statements of Revenues, Expenses, and Changes in Net Position (in Thousands) The following table presents a summary of the District s revenues, expenses, and changes in net position: Years ended As restated June 30, June 30, Dollar Total % 2014 2013 Change Change Net patient services revenue $ 445,837 $ 423,017 $ 22,820 5.4% Management services revenue 22,134 20,852 1,282 6.1% Other operating revenue 10,473 14,379 (3,906) 27.2% Total operating revenues 478,444 458,248 20,196 4.4% Salaries and benefits 248,698 227,602 21,096 9.3% Medical and other supplies 99,938 97,002 2,936 3.0% Medical and other fees and services 52,898 50,102 2,796 5.6% Maintenance, utilities, and rent 26,166 21,401 4,765 22.3% Depreciation and amortization 22,066 21,954 112 0.5% Other 8,831 10,571 (1,740) 16.5% Total operating expenses 458,597 428,632 29,965 7.0% Operating income 19,847 29,616 (9,769) 33.0% Non operating revenues net of non operating expenses 484 (4,269) 4,753 111.4% Income before contributions 20,331 25,347 (5,016) 19.8% Capital contributions 848 756 92 12.1% Change in net position 21,179 26,103 (4,924) 18.9% Net position beginning of year 356,425 330,322 26,103 7.9% Net position end of year $ 377,604 $ 356,425 $ 21,179 5.9% 5

MANAGEMENT S DISCUSSION AND ANALYSIS TABLE 4 Financial Analysis of the District (continued) Condensed Consolidated Statements of Revenues, Expenses, and Changes in Net Position (in Thousands) The following table presents a summary of the District s revenues, expenses, and changes in net position: Years ended As restated June 30, June 30, Dollar Total % 2013 2012 Change Change Net patient services revenue $ 423,017 $ 408,618 $ 14,399 3.5% Management services revenue 20,852 19,391 1,461 7.5% Other operating revenue 14,379 12,790 1,589 12.4% Total operating revenues 458,248 440,799 17,449 4.0% Salaries and benefits 227,602 224,197 3,405 1.5% Medical and other supplies 97,002 93,160 3,842 4.1% Medical and other fees and services 50,102 46,716 3,386 7.2% Maintenance, utilities, and rent 21,401 20,369 1,032 5.1% Depreciation and amortization 21,954 22,795 (841) 3.7% Other 10,571 8,389 2,182 26.0% Total operating expenses 428,632 415,626 13,006 3.1% Operating income 29,616 25,173 4,443 17.6% Non operating revenues net of non operating expenses (4,269) (3,466) (803) 23.2% Income before contributions 25,347 21,707 3,640 16.8% Capital contributions 756 5,932 (5,176) 87.3% Change in net position 26,103 27,639 (1,536) 5.6% Net position beginning of year 330,322 302,683 27,639 9.1% Net position end of year $ 356,425 $ 330,322 $ 26,103 7.9% 6

MANAGEMENT S DISCUSSION AND ANALYSIS SOURCES OF REVENUE Operating revenues For fiscal year 2014, the District derived 98.1% of its total revenues from operations. Operating revenues include, among other items, patient care revenue from Medicare, Medi Cal, and other federal, state, and local government programs, and commercial insurance payers and patients; management services revenue associated with the District s forty five percent (45%) ownership in SRCC Medical Oncology, LLC, a management services organization providing staff, facilities, and administrative services to a medical oncology physician group; cafeteria sales; membership sales and dues from a District owned health and fitness center; and minority ownership interests in a free standing ambulatory surgery center, an assisted living center, and a memory care facility. Non operating revenues For fiscal year 2014, the District derived 1.9% of its total revenues from investment income and property tax revenue including that associated with the general obligation bonds as well as an allocation of general property taxes assessed by the County of Tulare on properties residing within the District s geographical boundaries. OPERATING AND FINANCIAL PERFORMANCE The following summarizes the District s consolidated statements of revenues, expenses, and changes in net position between 2014 and 2013: Acute admissions decreased by 220, or 1.0%, to 21,734, while acute patient days increased by 4,340, or 4.0%, to 111,793. Skilled nursing and long term subacute patient days increased to 20,662 in 2014 from 20,478 in 2013. Outpatient procedures and emergency room visits were 26,308, or 2.0%, above 2013 levels. Significant increases in emergency department visits, urgent care and prompt care center visits, diagnostic laboratory tests, radiology procedures, and rural health clinic visits contributed to the overall increase in outpatient activity for 2014. Net patient services revenue increased $22.8 million, or 5.4%, in 2014. The increase in net patient services revenue can mainly be attributed to the overall increase in inpatient and outpatient volumes as well as the District s continuous efforts to improve clinical documentation, the result of which better reflects the acuity of patients and appropriately higher reimbursement rates. The California Hospital Fee Program (the Program ) was signed into law by the Governor of California and became effective on January 1, 2010. Amending legislation to conform to changes requested by the Centers for Medicare & Medicaid Services ( CMS ) during the approval process was signed into law on September 8, 2010 by the Governor of California. The Program requires a hospital fee or Quality Assurance Fee ( QA Fee ) to be paid by certain hospitals to a State fund established to accumulate the assessed QA Fees and receive matching federal funds. QA Fees and corresponding matching federal funds are then paid to participating hospitals in two supplemental payment methodologies: a fee for service methodology and a managed care plan methodology. 7

MANAGEMENT S DISCUSSION AND ANALYSIS OPERATING AND FINANCIAL PERFORMANCE (CONTINUED) The District, as a non designated public hospital in California, is not subject to the QA Fee according to the legislation, but does participate in the receipt of supplemental funding. The period covered by the Program included a substantial retroactive federal matching component, including all or a portion of the 2009 2010 and 2010 2011 federal fiscal years, but because final CMS approval required to enact the legislation was not received until fiscal year 2011, the revenue was recognized for retroactive periods in the period that final CMS approval of the Program was received. Legislation in March 2011 ( SB 90 ) extended the Program for the period from January 1, 2011 through June 30, 2011; however, the extension under SB 90 included only private hospitals and thus excluded the District. As an alternative, the Non designated Public Intergovernmental Transfer Program was established under AB 113 in 2011 to allow non designated public hospitals to access additional federal funds. In fiscal years 2014 and 2013, the District recognized net patient services revenue of $7.3 million and $6.8 million, respectively. Additional legislation ( SB335 ) extended the Program for the period from July 1, 2011 through December 31, 2013. Again, the Program extension included only private hospitals, but did allow for direct grants to non designated public hospitals. The District recognized net patient services revenue of $3.0 million and $4.2 million related to this grant program in fiscal years 2014 and 2013, respectively. Management services revenue increased $1.3 million, or 6.1%, from 2013. The increase in revenue is primarily associated with the increase in revenue generated by the SRCC Medical Oncology joint venture. Other operating revenue consists primarily of cafeteria sales, equity ownership in an ambulatory surgery center, assisted living center and memory care facility, contributions, and health and fitness center membership sales and dues. Other operating revenue decreased by $3.9 million, or 27.2%. Other operating income was positively impacted by the recognition of $3.8 million of Health Information Technology for Economic and Clinical Health ( HITECH ) Act funding recognized during 2013, while no HITECH funding was recognized during 2014. Salaries and benefits expense increased $21.1 million, or 9.3%. Salaries and wages increased $10.6 million, or 5.7%, and employee benefits expense increased $10.5 million, or 25.8%, from 2013. The increase in salaries and wages was mainly attributable to an increase in patient volumes, as discussed above, and wage related adjustments, while the increase in employee benefits was driven by an increase in claims and estimated reserves related to the District s self insured workers compensation and health insurance plans. Medical and other supplies increased $2.9 million, or 3.0%, from 2013 due to an increase in general medical supplies associated with the increase in patient volumes, as well as an increase in pharmaceutical costs associated with SRCC Medical Oncology volume. 8

MANAGEMENT S DISCUSSION AND ANALYSIS OPERATING AND FINANCIAL PERFORMANCE (CONTINUED) Medical and other fees and services increased $2.8 million, or 5.6%, due primarily to increases in physician fees related to the rural health and prompt care clinics, graduate medical education, emergency department calls, and hospitalist programs. Maintenance, utilities, and rent increased by $4.8 million, or 22.3%, during 2014 primarily due to an increase in the cost of maintenance contracts related to information systems. Depreciation and amortization expense increased $112,000, or 0.5%. Other expenses decreased by $1.7 million, or 16.5%, resulting mainly from a decrease in professional liability expense, as well as a decrease in physician recruitment cost. Total operating expenses increased by $30.0 million, or 7.0%. Non operating revenues of $9.3 million for fiscal year 2014 are comprised of $4.4 million of tax revenue received from the County of Tulare and $4.9 million in investment income on cash and investments. Tax revenue increased by $534,000, or 13.7%, in 2014. Investment income represents interest income and realized and unrealized gains and losses on District and the Foundation investments. District investments by law may only be invested in high grade, governmental and commercial fixed income securities, and money market funds. Investment income for 2014 increased $3.0 million, or 164.5%, from 2013 due to increases in realized and unrealized gains associated with governmental and commercial bonds and the Foundation s equity investments. Non operating expenses represent interest expense recognized during 2014 on the District s short and long term debt consisting of revenue bonds, a note payable, and capital leases, as well as the cost of issuance of general obligation refunding bonds recognized in 2014. Total interest expense of $8.5 million decreased by $260,000, or 3.0%, from 2013. For fiscal year 2014, capital contributions of $848,000 represent amounts received from the Foundation donors to support specific capital purposes. The Foundation exists to support the needs of the District and to help build support for the District and our community. The following summarizes the District s consolidated statements of revenues, expenses, and changes in net position between 2013 and 2012: Acute admissions decreased by 493, or 2.2%, to 21,954, while acute patient days decreased by 4,885, or 4.4%, to 107,453. Skilled nursing and long term subacute patient days increased to 20,478 in 2013 from 19,480 in 2012 primarily due to increased admissions to the subacute unit. Outpatient procedures and emergency room visits were 61,426, or 4.8%, above 2012 levels. Significant increases in emergency department visits, urgent care and prompt care center visits, diagnostic laboratory tests, radiology procedures, CT scan procedures, and rural health clinic visits contributed to the overall increase in outpatient activity for 2013. 9

MANAGEMENT S DISCUSSION AND ANALYSIS OPERATING AND FINANCIAL PERFORMANCE (CONTINUED) Net patient services revenue increased $14.4 million, or 3.5%, in 2013. The increase in net patient services revenue can mainly be attributed to the District s continuous efforts to improve clinical documentation, the result of which better reflects the acuity of patients and appropriately higher reimbursement rates, as well as the receipt of various supplemental Medicare and Medi Cal payments more fully described herein. The California Hospital Fee Program (the Program ) was signed into law by the Governor of California and became effective on January 1, 2010. Amending legislation to conform to changes requested by the Centers for Medicare & Medicaid Services ( CMS ) during the approval process was signed into law on September 8, 2010 by the Governor of California. The Program requires a hospital fee or Quality Assurance Fee ( QA Fee ) to be paid by certain hospitals to a State fund established to accumulate the assessed QA Fees and receive matching federal funds. QA Fees and corresponding matching federal funds are then paid to participating hospitals in two supplemental payment methodologies: a fee for service methodology and a managed care plan methodology. The District, as a non designated public hospital in California, is not subject to the QA Fee according to the legislation, but does participate in the receipt of supplemental funding. The period covered by the Program included a substantial retroactive federal matching component, including all or a portion of the 2009 2010 and 2010 2011 federal fiscal years, but because final CMS approval required to enact the legislation was not received until fiscal year 2011, the revenue was recognized for retroactive periods in the period that final CMS approval of the Program was received. Legislation in March 2011 ( SB 90 ) extended the Program for the period from January 1, 2011 through June 30, 2011; however, the extension under SB 90 included only private hospitals and thus excluded the District. As an alternative, the Non designated Public Intergovernmental Transfer Program was established under AB 113 in 2011 to allow non designated public hospitals to access additional federal funds. Due to this legislation, in fiscal year 2012 the District recognized net patient services revenue of $7.3 million including intergovernmental transfer funding of $4.3 million related to the year ended June 30, 2012 and $3.0 million related to the year ended June 30, 2011. In fiscal year 2013, the District recognized net patient services revenue of $6.8 million including intergovernmental transfer funding of $6.5 million related to the year ended June 30, 2013 and $343,000 related to the year ended June 30, 2012. Additional legislation ( SB335 ) extended the Program for the period from July 1, 2011 through December 31, 2013. Again, the Program extension included only private hospitals but did allow for direct grants to non designated public hospitals. The District recognized net patient services revenue of $4.2 million and $1.6 million related to this grant program in fiscal years 2013 and 2012, respectively. Without considering the direct grant revenue and the Intergovernmental Transfer revenue discussed above, the District s net patient services revenue increased $12.2 million, or 3.1%, in 2013. At the same time, net patient services revenue per adjusted patient day (the amount of net patient services revenue actually collected per equivalent patient encounter) increased from $1,763 to $1,789, or 1.5%, from 2012 to 2013. Management services revenue increased $1.5 million, or 7.5%, from 2012. The increase in revenue is primarily associated with the increase in revenue generated by the SRCC Medical Oncology joint venture. 10

MANAGEMENT S DISCUSSION AND ANALYSIS OPERATING AND FINANCIAL PERFORMANCE (CONTINUED) Other operating revenue consists primarily of cafeteria sales, equity ownership in an ambulatory surgery center and assisted living center, contributions, and health and fitness center membership sales and dues. Other operating revenue increased by $1.6 million, or 12.4%. Other operating income was positively impacted by the recognition of $3.8 million of Health Information Technology for Economic and Clinical Health ( HITECH ) Act funding earned during 2013, as compared to the $2.0 million of HITECH funding earned and recognized during 2012. Salaries and benefits expense increased $3.4 million, or 1.5%. Salaries and wages increased $3.0 million, or 1.6%, and employee benefits expense increased $435,000, or 1.1%, from 2012. The increase in salaries and wages was mainly attributable to an increase in the average hourly wage rate while the increase in employee benefits was driven by an increase in pension expense due to an increased 401(k) match. Medical and other supplies increased $3.8 million, or 4.1%, from 2012 due mainly to an increase in pharmaceutical cost associated with SRCC Medical Oncology volume, as well as an increase in the District s inpatient and employee pharmacy costs. Medical and other fees and services increased $3.4 million, or 7.2%, due to increases in rural health clinic physician fees, graduate medical education physician fees, contract labor, and staff recruitment fees. Maintenance, utilities, and rent increased by $1.0 million, or 5.1%, during 2013 primarily due to an increase in the cost of repairs and maintenance expense related to information systems. Depreciation and amortization expense decreased $841,000, or 3.7%. Other expenses increased by $2.2 million, or 26.0%, resulting mainly from an increase in professional liability expense. Total operating expenses increased by $13.0 million, or 3.1%. Non operating revenues of $5.7 million for fiscal year 2013 are comprised of $3.9 million of tax revenue received from the County of Tulare and $1.8 million in investment income on cash and investments. Tax revenue decreased by $126,000, or 3.1%, in 2013. Investment income represents interest income and realized and unrealized gains and losses on District and the Foundation investments. District investments by law may only be invested in high grade, governmental and commercial fixed income securities, and money market funds. Investment income for 2013 decreased $138,000, or 7.0%, from 2012 due to a $690,000 decrease in unrealized gains associated with governmental and commercial bonds and the Foundation s equity investments offset by an increase in investment yields. Non operating expenses represent interest expense recognized during 2013 on the District s short and long term debt consisting of revenue bonds, a note payable, and capital leases, as well as the cost of issuance of revenue bonds recognized in fiscal year 2013. Total interest expense of $8.7 million decreased by $756,000, or 8.0%, from 2012. For fiscal year 2013, capital contributions of $756,000 represent amounts received from the Foundation donors to support specific capital purposes. The Foundation exists to support the needs of the District and to help build support for the District and our community. 11

MANAGEMENT S DISCUSSION AND ANALYSIS BUDGET RESULTS The Board of Directors approves the annual operating budget of the District. The budget remains in effect the entire year, but is updated as needed for internal management use to reflect changes in activity and approved variances. A fiscal year 2014 budget comparison and analysis is presented below. TABLE 5 Actual vs. Budget (in Thousands) Years ended June 30, 2014 2014 Dollar Total % Actual Budget Change Change Net patient services revenue $ 445,837 $ 431,536 $ 14,301 3.3% Management services revenue 22,134 20,040 2,094 10.4% Other operating revenue 10,473 12,681 (2,208) 17.4% Total operating revenues 478,444 464,257 14,187 3.1% Salaries and benefits 248,698 241,068 7,630 3.2% Medical and other supplies 99,938 96,516 3,422 3.5% Medical and other fees and services 52,898 51,456 1,442 2.8% Maintenance, utilities, and rent 26,166 21,220 4,946 23.3% Depreciation and amortization 22,066 23,124 (1,058) 4.6% Other 8,831 11,565 (2,734) 23.6% Total operating expenses 458,597 444,949 13,648 3.1% Operating income 19,847 19,308 539 2.8% Non operating revenues net of non operating expenses 484 (2,381) 2,865 120.3% Income before contributions $ 20,331 $ 16,927 $ 3,404 20.1% 12

BUDGET RESULTS (CONTINUED) MANAGEMENT S DISCUSSION AND ANALYSIS In comparing actual versus budgeted 2014 results, the following is noted: The District completed its fiscal year 2014 $3.4 million, or 20.1%, in excess of budgeted income before contributions of $16.9 million. The excess of profitability compared to budget is primarily attributable to investment income. The District s operating income surpassed budget expectations by $539,000, or 2.8%. Net patient services revenue exceeded budget by $14.3 million, or 3.3%, mainly due to higher than expected patient volumes. Management services revenue and other operating revenue fell short of budget by $114,000, or 0.3%, in total. The District realized an unfavorable variance in total operating expenses of $13.6 million, or 3.1%, in fiscal year 2014. This unfavorable expense variance was primarily due to salaries and benefits; medical and other supplies; and maintenance, utilities, and rent expense, which were $7.6 million, or 3.2%; $3.4 million, or 3.5%; and $4.9 million, or 23.3%, higher than expected, respectively. The unfavorable variance in supplies and salaries expense is related to the patient volumes experienced in 2014, while the variance in benefits expense relates to unexpected increases in workers compensation and health insurance costs. The unfavorable variance in maintenance, utilities, and rent relates to maintenance contracts for information systems. 13

MANAGEMENT S DISCUSSION AND ANALYSIS CAPITAL ASSETS At June 30, 2014, the District had $264.2 million invested in a variety of capital assets, as reflected in the following schedule (in thousands), which represents a net decrease (additions less retirements and depreciation) of $6.1 million from the end of the prior year. June 30, June 30, Dollar Total % 2014 2013 Change Change Land $ 14,562 $ 13,832 $ 729 5.3% Buildings and improvements 304,757 300,498 4,259 1.4% Equipment 156,422 146,850 9,572 6.5% Construction in progress 7,876 6,851 1,025 15.0% 483,616 468,031 15,584 3.3% Less accumulated depreciation 232,299 214,276 18,023 8.4% 251,317 253,755 (2,439) 1.0% Property under capital leases less accumulated amortization 12,871 16,485 (3,614) 21.9% Capital assets, net $ 264,188 $ 270,240 $ (6,052) 2.2% Material additions during fiscal year 2014 included (in thousands): Construction and equipment costs related to: Nursing units remodel $ 750,593 Expansion of ambulatory surgery $ 1,072,527 MRI suite Acequia Wing $ 340,479 Mineral King Wing Radiology suite $ 326,609 Graduate medical education sleep rooms $ 337,594 Labor and delivery triage area $ 318,176 Replace water line infrastructure $ 638,686 Purchase of land and building for clinic $ 2,083,711 MRI equipment $ 1,390,948 Upgrade clinical documentation system $ 448,528 14

MANAGEMENT S DISCUSSION AND ANALYSIS LONG TERM DEBT At June 30, 2014, the District had approximately $200.4 million in capital lease obligations, notes payable, and revenue and general obligation bonds outstanding as described in Notes 7 and 8 of the consolidated financial statements. The general obligation bonds represent the general obligation of the District. The District has the power and is obligated to cause annual ad valorem taxes to be levied upon all property within the District, subject to taxation by the District, and collected by the County of Tulare for payment, when due, of the principal and interest on the bonds. The bond indenture agreements contain various restrictive covenants which include, among other things, minimum debt service coverage, maintenance of minimum liquidity, restrictions on certain additional indebtedness, and requirements to maintain certain financial ratios. In July 2012, the District issued $75.8 million of Kaweah Delta Health Care District Revenue Bonds, Series 2012. The 2012 bonds bear interest at rates of 2.0% to 5.0%. Approximately $9.8 million of the net proceeds of the bonds will be used by the District to expand its ambulatory surgery services and its endoscopy services, to complete capital improvements related to the graduate medical education program, and for other infrastructure improvements. Approximately $68.0 million of the net proceeds were used to prepay existing debt, including the 1999A, 2003B, and 2004 revenue bonds. The 2012 revenue bonds maturing on or after June 1, 2017 are subject to redemption at the option of the District prior to their respective stated maturities at amounts ranging from 100% to 102% of face value. The 2012 revenue bonds require the District to make minimum sinking fund payments beginning in June 2036. The current refunding of the 1999A, 2003B, and 2004 revenue bonds resulted in decreased debt service payments of approximately $8.7 million over the next 21 years and an economic gain (difference between the present value of the debt service payments on the old and new debt) of approximately $7.1 million. During January 2014, the District issued $48.9 million of Kaweah Delta Health Care District General Obligation Refunding Bonds, Series 2014, at rates of 3.6% to 4.1%, solely to advance refund $47.3 million of the outstanding 2004 General Obligation bonds, bearing interest rates of 5.0% to 5.5%. Mandatory sinking fund redemption payments on the bonds begin on August 1, 2015. The final maturity of the bonds is August 1, 2034. The advance refunding of the 2004 bonds resulted in decreased debt service payments of approximately $6.3 million over the next 21 years and an economic gain (difference between the present value of the debt service payments on the old and new debt) of approximately $4.3 million. 15

MANAGEMENT S DISCUSSION AND ANALYSIS ECONOMIC OUTLOOK The District s Board of Directors and management considered many factors when setting the fiscal year 2015 budget. Of primary importance in setting the 2015 budget is the status of the California economy, the fiscal policy of the state and federal governments, the availability and affordability of labor, the general rise of health care related costs, and local and regional competition for health care services. Specific factors and assumptions incorporated in the District s fiscal year 2015 budget include: Inpatient utilization is projected to increase by 1.6% from 2014 levels reflecting an average daily patient census of 386. Outpatient activity expressed in equivalent inpatient days is projected to increase 2.9% from 2014. A 1.2% increase in gross patient revenue due to volume, although no retail price increase was budgeted. A Medicare general acute care rate decrease (market basket update of 2.7% reduced by a cumulative 3.5% for numerous reductions mandated by the Affordable Care Act and the American Tax Relief Act) of approximately 0.8%, an increase of 1.7% for outpatient services, an increase of 2.0% for skilled nursing and subacute services, a decrease of 1.0% for home health services, an increase of 0.7% for rural health clinic services, and an increase of 2.2% for acute rehabilitation and acute psychiatric Medicare services. A 5.0% reduction in Medi Cal fee for service acute medical/surgical and rehabilitation services effective July 1, 2014 due to the transition to DRG based payment system, with no change in reimbursement anticipated for skilled nursing, subacute, psychiatric, home health, outpatient, and rural health clinic Medi Cal fee for service reimbursement. Includes $3.7 million in anticipated fee for service intergovernmental transfer revenue and $5.0 million provider fee grant revenue. Medi Cal managed care reimbursement rate increases of approximately 2.6% based on scheduled rate increases included in multi year contracts. Includes $3.5 million of Medi Cal managed care program intergovernmental transfer revenue. Annual scheduled rate increases for non government managed care payers for contracts negotiated in prior years as well as expected new negotiated increases with managed care plans averaging 3.7%. Overall expense per adjusted patient day is projected to decrease by 1.5% from the prior year. Through the first two months of fiscal year 2015, the District has posted an unaudited operating income of $3.4 million, a 4.2% operating margin, equal to the District s budgeted operating income for the period. Through August 31, 2014, the District experienced net income before contributions of $3.9 million, a 4.7% excess margin, representing a negative variance of $39,000 from its year to date budgeted income before contributions of $4.0 million. 16

Board of Directors Kaweah Delta Health Care District REPORT OF INDEPENDENT AUDITORS Report on Financial Statements We have audited the accompanying consolidated financial statements of Kaweah Delta Health Care District, which comprise the consolidated statements of net position as of June 30, 2014 and 2013, and the related consolidated statements of revenues, expenses and changes in net position, and cash flows for the years then ended, and the related notes to the consolidated financial statements. Management s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditor s Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor s judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Kaweah Delta Health Care District as of June 30, 2014 and 2013, and the results of its operations and its cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America. 17

Emphasis of Matter Effective July 1, 2013, Kaweah Delta Health Care District adopted GASB Statement No. 65, Items Previously Reported as Assets and Liabilities. The statement establishes accounting and financial reporting standards that reclassify, as deferred outflows of resources or deferred inflows of resources, certain items that were previously reported as assets and liabilities, and recognizes, as outflows of resources or inflows of resources, certain items that were previously reported as assets and liabilities. As more fully described in Note 1, the impact of this statement to Kaweah Delta Health Care District is the requirement of debt issuance costs to be expensed as incurred rather than capitalized and amortized as under previous guidance. In accordance with GASB Statement No. 65, Kaweah Delta Health Care District restated the Net Position as of July 1, 2012 to remove bond issuance costs. Other Matter Accounting principles generally accepted in the United States of America require that the Management s Discussion and Analysis on pages 1 through 16 and the supplemental pension benefit information on page 52 be presented to supplement the basic consolidated financial statements. Such information, although not a part of the basic consolidated financial statements, is required by the Governmental Accounting Standards Board who considers it to be an essential part of financial reporting for placing the basic consolidated financial statements in an appropriate operational, economic, or historical context. We have applied certain limited procedures to the required supplementary information in accordance with auditing standards generally accepted in the United States of America, which consisted of inquiries of management about the methods of preparing the information and comparing the information for consistency with management's responses to our inquiries, the basic consolidated financial statements, and other knowledge we obtained during our audit of the basic consolidated financial statements. We do not express an opinion or provide any assurance on the information because the limited procedures do not provide us with sufficient evidence to express an opinion or provide any assurance. Stockton, California October 30, 2014 18

CONSOLIDATED STATEMENTS OF NET POSITION

CONSOLIDATED STATEMENTS OF NET POSITION JUNE 30, 2014 2013 As restated CURRENT ASSETS Cash and cash equivalents $ 3,588,907 $ 2,095,399 Current portion of Board designated and trusteed assets 11,088,717 8,826,674 Accounts receivable Net patient accounts 77,320,637 86,700,477 Other 3,311,892 4,897,197 80,632,529 91,597,674 Inventories 5,468,858 5,277,167 Medicare and Medi Cal settlements 15,310,577 10,760,109 Prepaid expenses 5,633,204 4,250,289 Total current assets 121,722,792 122,807,312 NON CURRENT CASH AND INVESTMENTS less current portion Board designated assets 222,701,143 188,931,353 Bond and lease assets held in trust 10,366,641 14,405,794 Assets in self insurance trust fund 7,116,614 8,268,888 240,184,398 211,606,035 CAPITAL ASSETS Land 14,561,584 13,832,285 Buildings and improvements 304,757,203 300,498,099 Equipment 156,421,657 146,849,705 Construction in progress 7,875,821 6,851,478 483,616,265 468,031,567 Less accumulated depreciation 232,299,078 214,276,199 251,317,187 253,755,368 Property under capital leases less accumulated amortization 12,871,097 16,484,556 264,188,284 270,239,924 OTHER ASSETS Property not used in operations 3,391,007 3,052,444 Health related investments 3,030,314 3,077,574 Other 12,978,992 10,994,659 19,400,313 17,124,677 Total assets 645,495,787 621,777,948 20

CONSOLIDATED STATEMENTS OF NET POSITION (CONTINUED) JUNE 30, 2014 2013 As restated DEFERRED OUTFLOWS Unamortized loss on defeasance of debt 3,189,879 2,781,656 CURRENT LIABILITIES Accounts payable and accrued expenses 23,759,739 21,185,123 Accrued payroll and related liabilities 27,143,929 24,009,202 Long term debt current portion 6,588,463 5,919,248 Total current liabilities 57,492,131 51,113,573 LONG TERM DEBT less current portion Bonds payable 174,147,808 177,566,379 Notes payable 116,073 Capital leases 22,643,903 24,894,058 196,791,711 202,576,510 OTHER LONG TERM LIABILITIES 16,797,748 14,444,907 Total liabilities 271,081,590 268,134,990 NET POSITION Net investments in capital assets 71,185,277 80,297,940 Restricted: Expendable 19,745,613 19,957,021 Non expendable minority interest 1,941,803 1,611,450 Non expendable permanent endowments 5,750,932 4,902,742 Unrestricted 278,980,451 249,655,461 Total net position $ 377,604,076 $ 356,424,614 See accompanying notes 21

CONSOLIDATED STATEMENTS OF REVENUES, EXPENSES, AND CHANGES IN NET POSITION YEARS ENDED JUNE 30, 2014 2013 As restated OPERATING REVENUES Net patient services revenue $ 445,836,884 $ 423,017,013 Other revenues Management services revenue 22,133,824 20,852,576 Other 10,473,014 14,378,609 Total other revenues 32,606,838 35,231,185 Total operating revenues 478,443,722 458,248,198 OPERATING EXPENSES Salaries and wages 197,488,126 186,906,395 Employee benefits 51,210,111 40,695,791 Total employment expenses 248,698,237 227,602,186 Medical and other supplies 99,937,843 97,001,807 Medical and other fees 39,892,912 36,823,163 Purchased services 13,004,600 13,278,818 Repairs and maintenance 18,850,499 15,207,653 Utilities 5,643,486 4,881,110 Rents and leases 1,672,142 1,312,428 Depreciation and amortization 22,065,767 21,954,456 Other 8,831,349 10,570,989 Total operating expenses 458,596,835 428,632,610 OPERATING INCOME 19,846,887 29,615,588 NON OPERATING REVENUES (EXPENSES) Tax revenue 4,426,582 3,892,674 Investment income 4,892,458 1,849,767 Bond issuance expense (378,041) (1,295,696) Interest expense (8,456,273) (8,715,835) Total non operating revenues (expenses) 484,726 (4,269,090) INCOME BEFORE CAPITAL CONTRIBUTIONS 20,331,613 25,346,498 CAPITAL CONTRIBUTIONS 847,849 756,356 Change in net position 21,179,462 26,102,854 NET POSITION beginning of year 356,424,614 330,321,760 NET POSITION end of year $ 377,604,076 $ 356,424,614 22 See accompanying notes

CONSOLIDATED STATEMENTS OF CASH FLOWS

CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED JUNE 30, 2014 2013 As restated CASH FLOWS FROM OPERATING ACTIVITIES Cash received from patient services revenue $449,941,188 $ 419,133,119 Cash received from management services and other operating revenues 30,295,130 33,743,193 Cash payments for salaries, wages, and related benefits (243,970,850) (229,366,095) Cash payments for other operating expenses (183,840,935) (183,185,985) Net cash from operating activities 52,424,533 40,324,232 CASH FLOWS FROM NON CAPITAL FINANCING ACTIVITIES Tax revenue 1,060,342 1,084,283 CASH FLOWS FROM CAPITAL AND RELATED FINANCING ACTIVITIES Bond issuance costs (378,041) (1,295,696) Interest payments on bonds payable, capital leases, and notes payable (9,066,721) (10,081,680) Principal payments on bonds payable, capital leases, and notes payable (6,573,202) (8,067,993) Net proceeds from revenue and general obligation bonds, and municipal leases 48,906,000 80,355,399 Current refunding of revenue bonds and general obligation bonds (47,940,000) (69,489,800) Contributions received for capital expenditures 847,849 756,357 Tax revenue related to general obligation bonds 3,366,240 2,808,391 Purchase of capital assets (15,569,967) (15,053,816) Proceeds from disposal of capital assets 12,423 29,200 Net cash used for capital and related financing activities (26,395,419) (20,039,638) CASH FLOWS FROM INVESTING ACTIVITIES Interest income on investments 2,662,224 2,429,404 Purchase of investments (94,764,045) (160,248,503) Health related investment distributions 352,000 154,000 Proceeds from sales and maturities of investments 66,849,185 129,972,831 Net cash used for investing activities (24,900,636) (27,692,268) NET CHANGE IN CASH AND CASH EQUIVALENTS 2,188,820 (6,323,391) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 84,415,161 90,738,552 CASH AND CASH EQUIVALENTS AT END OF YEAR $ 86,603,981 $ 84,415,161 24

CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED JUNE 30, 2014 2013 As restated RECONCILIATION OF CASH AND CASH EQUIVALENTS TO THE STATEMENT OF NET POSITION Cash and cash equivalents in current assets $ 3,588,907 $ 2,095,399 Cash and cash equivalents in non current cash and investments Board designated cash and investments 65,998,617 63,914,924 Bond and lease assets held in trust 16,997,539 18,146,517 Assets in self insurance trust fund 18,918 258,321 $ 86,603,981 $ 84,415,161 RECONCILIATION OF OPERATING INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES Operating income $ 19,846,887 $ 29,615,588 Adjustments to reconcile operating income to net cash provided by operating activities: Depreciation and amortization 22,065,767 21,954,456 Provision for bad debts 12,601,562 12,605,170 Loss (gain) on disposal of capital assets 88,394 (18,607) Changes in: Increase in accounts receivable (1,636,417) (16,911,812) Increase in inventories, prepaid expenses, and other assets (8,543,621) (4,620,782) Decrease (increase) in accounts payable and accrued expenses, accrued payroll, and related liabilities, and other long term liabilities 8,001,961 (2,299,781) Net cash from operating activities $ 52,424,533 $ 40,324,232 See accompanying notes 25

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 BASIS OF PRESENTATION AND ACCOUNTING POLICIES A summary of significant accounting policies applied in the preparation of the accompanying consolidated financial statements follows: Reporting entity Kaweah Delta Health Care District (the District ) is a political subdivision of the state of California, organized and existing under the State of California Local Health Care District Law as set forth in the Health and Safety Code of the state of California. The District is governed by a separately elected Board of Directors. The accounting policies of the District conform to those recommended by the Health Care Committee of the American Institute of Certified Public Accountants. The District s consolidated financial statements are presented in accordance with the pronouncements of the Governmental Accounting Standards Board ( GASB ), and the Financial Accounting Standards Board ( FASB ) when applicable. The District is not generally subject to state and federal income taxes. The District provides health services to individuals who reside primarily in the local geographic area. Principles of consolidation The consolidated financial statements of the District include the accounts of the District, Kaweah Delta Hospital Foundation (the Foundation ), Sequoia Regional Cancer Center, LLC ( SRCC ), Sequoia Regional Cancer Center Medical Oncology, LLC ( SRCC MO ), and TKC Development, LLC ( TKC ). SRCC, SRCC MO, TKC, and the Foundation are component units that have been blended for presentation purposes. The District has a 75% interest in TKC, which leases real estate and equipment from the District and then subleases the real estate and equipment to SRCC and SRCC MO. The District has a 75% interest in SRCC and a 45% interest in SRCC MO, management services organizations providing staff, facilities, and administration services to the radiation oncology department of the District and a medical oncology physician group, respectively. The District provides key management, administrative, and support services to SRCC and SRCC MO, including all of their employees, leased buildings and equipment, accounting, human resources, information technology, housekeeping, risk management, and maintenance services. The Foundation was established in March 1980 as an exempt organization under Internal Revenue Code Section 501(c)(3) to raise funds to support the operation of the District. The Foundation s bylaws provide that all funds raised be distributed to or be held for the benefit of the District. The Foundation s general funds, which represent the Foundation s unrestricted resources, will be distributed to the District in amounts and in periods determined by the Foundation s Board of Trustees. All intercompany transactions have been eliminated in the District s consolidated financial statements. 26