Quarterly Report As of December 31, 2016 and for the three and six months ended December 31, 2016 and 2015 Information Concerning Catholic Health Initiatives and the CHI Reporting Group Table of Contents PART I: OVERVIEW ...................................................................................................................... 1 PART II: CHI LEADERSHIP CHANGES .............................................................................................. 2 PART III: STRATEGIC AFFILIATIONS/ACQUISITIONS ......................................................................... 2 PART IV: SELECTED FINANCIAL DATA (unaudited) ........................................................................... 5 1. Critical Accounting Policies ........................................................................................................................................8 PART V: MANAGEMENT'S DISCUSSION AND ANALYSIS .................................................................. 9 1. Summary of Operating Results for the Three Months ended December 31, 2016 and 2015 ............................... 12 2. Summary of Operating Results for the Six Months ended December 31, 2016 and 2015 ................................... 17 3. Summary of Balance Sheet as of December 31, 2016 and June 30, 2016 .............................................................. 23 4. Certain Contractual Obligations .............................................................................................................................. 24 5. Liquidity and Capital Resources .............................................................................................................................. 28 6. Liquidity Report....................................................................................................................................................... 29 PART VI: LEGAL PROCEEDINGS ...................................................................................................... 29 APPENDIX A: CATHOLIC HEALTH INITIATIVES CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED) AS OF DECEMBER 31, 2016 AND FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 2016 AND 2015 (i) This Quarterly Report should be reviewed in conjunction with the information contained in the Annual Report dated November 23, 2016 (the "Annual Report'), which can be found on http://emma.msrb.org. Certain of the discussions included in this Quarterly Report may include forward-looking statements. Such statements are generally identifiable by the terminology used such as “believes,” “anticipates,” “intends,” “scheduled,” “plans,” “expects,” “estimates,” “budget” or other similar words. Such forward-looking statements are primarily included in PARTS III, lV and V. These statements reflect the current views of management with respect to future events based on certain assumptions, and are subject to risks and uncertainties. Catholic Health Initiatives, a Colorado non-profit corporation (the “Corporation”), undertakes no obligation to publicly update or review any forward-looking statement as a result of new information or future events. References to “CHI” in this Quarterly Report are to the Corporation and all of the affiliates and subsidiaries ("Participants") consolidated with it pursuant to generally accepted accounting principles (“GAAP”). References to the Corporation are references only to the parent corporation, and should not be read to include any of the Participants. References to the “CHI Reporting Group” include CHI and Bethesda Hospital, Inc., which at December 31, 2016, was a Designated Affiliate. PART I: OVERVIEW The Corporation is the parent corporation of a group of non-profit and for-profit corporations and other organizations that comprise one of the nation’s largest Catholic health care systems. Together with its Participants (collectively, “CHI”), the Corporation serves more than four million people each year through operations and facilities that span the continuum of care, including acute care hospitals; physician practices; long-term care facilities; assisted-living and residentialliving facilities; community-based health services; home care; research and development; medical and nursing education; reference laboratory services; virtual health services; managed care programs; and insurance products. CHI was formed in 1996 through the consolidation of four national Catholic health care systems. The goal of the consolidation was to develop and nurture a national health ministry sponsored and governed by a religiouslay partnership to transform health care delivery and to build healthy communities through the creation of new ministries across the nation. In doing so, the Founders created a new model of sponsorship by engaging the laity as partners in bringing their shared mission of nurturing the healing ministry of the church. Today, CHI has operations in 17 states, with a service area that covers approximately 54 million people, or 17% of the U.S. population. CHI is currently comprised of ten regions that are operated as integrated health systems and include five joint operating agreements (“JOAs”), joint operating companies (“JOCs”) or joint ventures. Geographic diversity and financial metrics for the fiscal year ended June 30, 2016 are depicted in the accompanying map. This document is dated as of February 15, 2017 1 PART II: CHI LEADERSHIP CHANGES Anthony K. Jones, FACHE, has been named interim Executive Vice President of Operations, effective December 5, 2016, replacing Michael T. Rowan, President, Health System Delivery and Chief Operating Officer who departed CHI effective December 31, 2016. Mr. Jones currently serves as president and CEO of Alliance Partners, Los Angeles, CA, a health care management and consulting company specializing in operations management, strategic planning and financial management for hospitals and health care organizations. He has served as interim CEO for both SUNY University Hospital of Brooklyn, NY, and for Tulare Healthcare District and Regional Medical Center in Tulare, CA, during financial turnarounds. In addition, Mr. Jones has been an executive consultant with KPMG/Beacon Partners, Boston, MA, and has served as interim President/CEO leading several hospitals through financial and operational turnarounds PART III: STRATEGIC AFFILIATIONS/ACQUISITIONS CHI actively engages in ongoing monitoring and evaluation of potential facility expansion, relationships with academic health center partners, mergers, acquisitions, divestitures, and affiliation opportunities consistent with its strategic goal of creating, maintaining and/or strengthening its CINs in key existing markets and, in certain cases, new markets. CHI’s strategic vision is supported by targeted system growth in both existing and new markets, as evidenced by CHI’s recent acquisition activity and strategic divestitures, and realignments, certain of which are described below. Pending and Completed Affiliations/Acquisitions Texas Physician Practice. In November 2016, a subsidiary of CHI acquired the operations of a multispecialty group in the state of Texas. The operations include a general acute care hospital and emergency room, an ambulatory surgery center, a management company, and an independent physician association comprising of more than 80 health care providers. Dignity Health, (California, Arizona and Nevada) (“Dignity”). On October 24, 2016, CHI and Dignity signed a non-binding letter of intent to explore aligning their organizations and expanding their mission of service in communities across the nation. The boards and sponsors of the two health systems are evaluating the potential alignment to strengthen their leadership role in transforming health care through increased access and enhanced clinical excellence. The letter of intent follows the September 2016 announcement that the two systems formed a partnership called the Precision Medicine Alliance LLC, which will create the largest community-based precision medicine program in the country. The organizations complement one another in many other important ways. CHI brings a diverse geographic footprint with proven clinical service lines and home health capabilities, as well as successful partnerships in research and education. Dignity has an operating model that has scaled enterprise-wide initiatives to ensure consistent practices across the system, and is well known for its work with innovative, diversified care-delivery partnerships. There is no geographical overlap of acute care facilities of the two health systems. Dignity owns and operates health care facilities in California, Arizona and Nevada, including 39 hospitals. As of and for the fiscal year ended June 30, 2016, Dignity reported approximately $17.1 billion of total assets, $6.2 billion of net assets and $12.6 billion in total operating revenue. Any definitive agreement would need to be approved by Dignity’s governing body and both organizations’ Boards, and also requires the 2 This document is dated as of February 15, 2017 approval by the California Attorney General and other regulatory agencies as well as satisfaction of customary closing conditions. It is anticipated that discussions will continue through 2017. CHI can give no assurance that the transaction will occur. Mercy Health Network, Inc. (Iowa). Effective March 1, 2016, the Corporation and Trinity Health Corporation, based in Livonia, Michigan (“THC”), amended and restated their existing Mercy Health Network Inc. (“MHN”) joint operating agreement that governs certain of their respective legacy operations in Iowa (collectively, the “Iowa Operations”) to (a) strengthen MHN’s management responsibilities over the Iowa Operations; (b) jointly acquire health care systems in Iowa and contiguous markets; and (c) provide for greater financial, governance, and clinical integration among the parties. Each of the respective party’s wholly-owned Iowa assets will continue to be consolidated in their respective financial statements, and commencing in July 2016, combined free cash flow from the Iowa Operations will be allocated equally between CHI and THC. MHN’s financial results, however, are not and will not be consolidated with either CHI or THC. CHI’s ownership interest in MHN is reflected as an investment in equity of unconsolidated organizations in its consolidated financial statements. Effective May 1, 2016, MHN became the sole corporate member of Wheaton Franciscan Healthcare-Iowa, which Is a faith-based 511-bed non-profit, comprehensive medical/surgical health care provider offering acute levels of medical care at Covenant Medical Center, Waterloo; Sartori Memorial Hospital, Cedar Falls and Mercy Hospital, Oelwein. Brazosport (Texas). Effective February 1, 2016, Brazosport Regional Health System (“BRHS”), Lake Jackson, Texas and CHI St. Luke’s, Houston, Texas, signed an affiliation agreement for BRHS to become part of CHI. Pursuant to the affiliation agreement, CHI St. Luke’s became the sole corporate member of BRHS. BRHS is a non-profit health care organization that includes a 158-bed hospital that operates the only Level III trauma center in Brazoria County. As a result of the BRHS acquisition, CHI reported approximately $21.3 million in additional total unrestricted net assets in fiscal year 2016, as well as total long-term indebtedness outstanding of $38.5 million (the “BRHS Debt”). Neither the Corporation nor any of its affiliates (other than BRHS) is obligated on the BRHS Debt. Excluding business combination gains, the BRHS acquisition contributed operating revenues of $39.4 million and operating EBIDA before restructuring, impairment and other losses of $(0.9) million for the six months ended December 31, 2016, to the Texas region. Trinity Health System (Ohio). Effective February 1, 2016, the Corporation assumed control of Trinity Health System (“Trinity”) based in Steubenville, Ohio. Prior to that date, Trinity was controlled by its two corporate members, Sylvania Franciscan Health (“SFH”) and another entity unrelated to CHI and SFH. In February 2016, CHI replaced that unrelated entity and became a corporate member of Trinity. Trinity owns and operates Trinity Medical Center East, Trinity Medical Center West, Tony Teramana Cancer Center and numerous outpatient clinics located in eastern Ohio. As a result of the Trinity acquisition, CHI reported approximately $145.1 million in additional total unrestricted net assets in fiscal year 2016, as well as total long-term indebtedness outstanding of $40.1 million (the “Trinity Debt”). Neither the Corporation, SFH nor any their respective affiliates (other than Trinity and/or its affiliates) is obligated on the Trinity Debt as a result of the transaction. Excluding business combination gains, the Trinity acquisition contributed operating revenues of $116.7 million and operating EBIDA before restructuring, impairment and other losses of $6.9 million for the six months ended December 31, 2016 to the Ohio region. Longmont United Hospital (Colorado). Effective August 1, 2015, Longmont United Hospital, a Colorado non-profit corporation (“LUH”) became affiliated with CHI pursuant to a Joint Operating and Management Agreement, between the Corporation, LUH, Centura This document is dated as of February 15, 2017 3 Health and Catholic Health Initiatives Colorado. LUH owns and operates Longmont United Hospital, a general acute care hospital licensed for 186 acute care beds and 15 skilled nursing beds, and operates an integrated health care delivery system providing health care services to patients residing in Longmont, Colorado, as well as Boulder, Weld and Larimer Counties in Colorado. As a result of the LUH acquisition, CHI reported approximately $111.6 million in additional total unrestricted net assets in fiscal year 2016, as well as total long-term indebtedness outstanding of $97.8 million (the “LUH Debt”). In May 2016, CHI issued $34.0 million of commercial paper notes, the proceeds of which were used to defease $37.1 million of the LUH Debt. Neither the Corporation nor any of its affiliates (other than LUH) is obligated on the remaining LUH Debt. Excluding business combination gains, the LUH acquisition contributed operating revenues of $88.7 million and operating EBIDA before restructuring, impairment and other losses of $(3.7) million for the six months ended December 31, 2016, to the Colorado region. Pending and Completed Divestitures Bethesda Hospital, Inc. In 2001, Bethesda Hospital, Inc. (“Bethesda”) became a member of the CHI Credit Group as a Designated Affiliate. Bethesda and The Good Samaritan Hospital of Cincinnati, Ohio, an affiliate of the Corporation, are jointly operated pursuant to a JOA between Bethesda, Inc. and the Corporation. The Corporation has previously loaned funds to Bethesda pursuant to its loan program, and the proceeds of a portion of the Corporation’s existing debt was used to finance Bethesda’s assets. In February 2017, Bethesda provided $139.7 million to the Corporation as repayment for its loans, and as of the date of this Report, Bethesda is no longer a Designated Affiliate. Certain financial information for the period ending December 31, 2016 included in this Report includes Bethesda, which at that time was a Designated Affiliate. For the six months ended December 31, 2016, Bethesda reported total operating revenues of $280.2 million and excess of revenues over expenses of $20.2 million. The CHI Reporting Group combined balance sheets also included Bethesda total assets of $768.6 million as of December 31, 2016. The Corporation is in the process of redeeming, prepaying or defeasing, as applicable, approximately $130.1 million in principal amount of the outstanding debt that is allocable to Bethesda’s assets. The Good Samaritan Hospital of Cincinnati, Ohio remains a Participant under the Capital Obligation Document, and the JOA remains in effect. The Corporation’s interest in the JOA continues to be reflected as an investment in an unconsolidated organization. University of Louisville Medical Center and KentuckyOne Health Joint Operating Agreement and Academic Affiliation Agreement. In November 2012, KentuckyOne Health (“KentuckyOne”) entered into a Joint Operating Agreement (“KY JOA”) and an Academic Affiliation Agreement (“AAA”) (collectively “Agreements”) with the University of Louisville Medical Center (“UMC”), the University of Louisville, and other parties (collectively “University”). Under the KY JOA, KentuckyOne agreed to manage the University of Louisville Hospital (“ULH”) for a period of 20 years. Under the AAA, ULH, through KentuckyOne, entered into various support and services agreements with the University of Louisville Health Sciences Center (“HSC”) for the same 20-year period. The Agreements went into effect on March 1, 2013. Over the past three years, KentuckyOne has operated under the Agreements, including the provision of significant financial support to and for ULH, UMC, and HSC. In October 2016, University alleged various breaches of the Agreements with an unspecified claim for damages against KentuckyOne. Subsequent to the allegations, University and KentuckyOne entered into a dispute resolution This document is dated as of February 15, 2017 4 process as defined in the Agreements. After the dispute resolution, both University and KentuckyOne agreed to seek revision of the current agreements and to move toward a more beneficial relationship between the parties. In December 2016, KentuckyOne and UMC agreed to restructure their existing JOA. Under the terms of the agreement, the operations, management and control of UMC would be transferred back to the University effective July 1, 2017. Other provisions in the agreement call for a continued negotiation to restructure the AAA between HSC and KentuckyOne affiliates Jewish Medical Center and the Frazier Rehab Institute, the development of various transition services agreements, and fulfillment of ongoing capital commitments. For the six months ended December 31, 2016, UMC reported total operating revenues of $256.3 million and excess of revenues over expenses of $7.1 million. The CHI consolidated balance sheets also included UMC total assets of $605.9 million as of December 31, 2016. Upon disposition, CHI expects to incur a loss of approximately $272 million. QualChoice. As a part of the performance improvement efforts described in Part IV B, Transformative Change Sharpens Focus in the Annual Report, CHI approved, in May 2016, a plan to sell or otherwise dispose of certain entities of QualChoice, a consolidated CHI subsidiary, whose primary business is to develop, manage and market commercial and Medicare Advantage health insurance programs, as well as a wide range of products and administrative services (see Part IV A in the Annual Report for further information). QualChoice reported a deficiency of revenues over expenses of $(24.4) million for the six months ended December 31, 2016, which is reported in the accompanying CHI consolidated statements of changes in net assets. Real Estate Asset Sale. In April 2016, CHI entered into an agreement to sell approximately 50 real estate assets across the system as part of a long-term effort to improve the mix of owned and leased real estate. In conjunction with the sales, CHI entered into 10-year operating lease agreements with the buyer. The majority of the real estate portfolio totaling 46 properties closed in fiscal year 2016 for gross proceeds of $601.7 and a total net book value of $323.3 million. As a result of the real estate sale, CHI recognized a $59.4 million gain on sale (net of commission and closing costs) in the consolidated statements of operations for the year ended June 30, 2016, as well as $20.1 million in short-term deferred gains reported in accrued expenses and $180.6 million in long-term deferred gains reported in other long-term liabilities reflected on the consolidated balance sheet as of June 30, 2016. The deferred gains are being amortized as a reduction of lease expense over the life of the operating leases. During the six months ended December 31, 2016, CHI sold certain real estate assets in the Texas and Pacific Northwest markets and entered into 10-year operating lease agreements with the buyers. The assets were sold for gross proceeds of $195.9 million and had a total net book value of $176.8 million. The sale resulted in the recognition of a $14.2 million gain on sale reported in the consolidated statements of operations and $6.2 million in long-term deferred gains and $0.7 million in short-term deferred gains reported in other long-term liabilities and accrued expenses, respectively, on the consolidated balance sheet as of December 31, 2016. CHI is considering the sale of additional real estate assets in fiscal year 2017. PART IV: SELECTED FINANCIAL DATA The selected financial data that follows has been prepared by management, based on (i) CHI’s unaudited interim financial statements as of December 31, 2016 and for the three and six month periods ended December 31, 2016 and 2015, and (ii) Bethesda, Inc. and Subsidiaries unaudited interim financial statements as of December 31, 2016, and for the three and six month periods ended December 31, 2016 and 2015. Certain financial and operating information is presented based on the “CHI Reporting Group,” created This document is dated as of February 15, 2017 5 under the Capital Obligation Document. The CHI Reporting Group includes all entities that are consolidated with the Corporation under GAAP (as “Participants”) and any Designated Affiliate that the Corporation chooses to include in the CHI Reporting Group. Currently, Bethesda Hospital, Inc. (“Bethesda”) is the sole Designated Affiliate. Where indicated, selected financial and operating data is also presented based on CHI consolidated financial operating data, which does not include Bethesda. Bethesda accounted for 3.7% of the CHI Reporting Group’s total assets and 3.4% of the CHI Reporting Group’s total operating revenues as of December 31, 2016. The CHI Reporting Group and CHI consolidated financial information should be read in conjunction with the unaudited financial statements, related notes, and other financial information of CHI included in Appendix A of this Quarterly Report. As described above, as of the date of this Quarterly Report, Bethesda has repaid its loans and is no longer a Designated Affiliate, but is included in this Quarterly Report because it was a Designated Affiliate as of December 31, 2016. The results of operations for recently acquired entities that have been accounted for as acquisitions are included in the CHI Reporting Group and CHI consolidated financial and operating information from the respective dates of acquisition. CHI participates in JOAs with hospital-based organizations in Colorado, Iowa and Ohio. The agreements generally provide for, among other things, joint management of the combined operations of the local facilities included in the JOAs through JOCs. CHI retains ownership of the assets, liabilities, equity, revenues and expenses of the CHI facilities that participate in the JOAs. Transfers of assets from facilities owned by the JOA participants are generally restricted under the terms of the agreements. The financial statements of the CHI facilities managed under all JOAs are included in the CHI consolidated financial statements. As of December 31, 2016, CHI has investment interests of 65%, 50%, and 50% in JOCs based in Colorado, Iowa, and Ohio, respectively. CHI’s interests in the JOCs are included in investments in unconsolidated organizations and totaled $358.6 million at December 31, 2016. CHI recognizes its investment in all JOCs under the equity method of accounting. The JOCs provide various levels of services to the related JOA sponsors, and operating expenses of the JOCs are allocated to each sponsoring organization. This document is dated as of February 15, 2017 6 A. The following table provides condensed combined balance sheets for the CHI Reporting Group as of December 31, 2016 and June 30, 2016. December 31, 2016 (Unaudited) The CHI Reporting Group Condensed Combined Balance Sheets June 30, 2016 (Unaudited) (in Thousands) Assets Current assets: Cash and equivalents $ Net patient accounts receivable Assets held for sale 771,603 $ 1,305,307 2,304,523 192,869 2,226,704 223,285 921,593 833,079 4,190,588 4,588,375 Internally designated investments 5,684,557 5,594,578 Restricted investments 1,174,679 1,235,495 Total investments and assets limited as to use 6,859,236 6,830,073 Property and equipment, net 9,395,958 9,723,525 Other assets 2,253,823 2,197,617 $ 22,699,605 $ 23,339,590 $ 2,331,871 $ Other current assets Total current assets Investments and assets limited as to use: Total assets Liabilities and net assets Current liabilities: Accounts payable and accrued expenses Liabilities held for sale 2,727,904 102,926 131,814 Short-term and current portion of debt 2,084,428 1,866,090 Total current liabilities 4,519,225 4,725,808 Other liabilities 3,442,726 3,503,715 Long-term debt 6,939,518 7,254,468 Total liabilities 14,901,469 15,483,991 7,461,045 7,522,084 Temporarily restricted 241,547 238,584 Permanently restricted 95,544 94,931 7,798,136 7,855,599 $ 22,699,605 $ 23,339,590 Net assets: Unrestricted Total net assets Total liabilities and net assets This document is dated as of February 15, 2017 7 B. The following table presents condensed combined statements of operations for the CHI Reporting Group for the three and six months ended December 31, 2016 and 2015. CHI Reporting Group Condensed Combined Statements of Operations Three Months Ended December 31, 2016 2015 (Unaudited) (Unaudited) Revenues Six Months Ended December 31, 2016 2015 (Unaudited) (Unaudited) (in Thousands) Net patient services revenues $ 4,007,460 $ 3,806,509 $ 7,876,799 $ 7,483,256 - - - 141,668 224,151 225,458 463,391 441,256 4,231,611 4,031,967 8,340,190 8,066,180 Salaries and employee benefits 2,079,411 1,962,858 4,115,329 3,867,167 Supplies, purchased services and other 1,925,504 1,865,762 3,866,075 3,671,117 225,538 222,856 449,453 443,741 76,750 74,222 154,402 147,118 4,307,203 4,125,698 8,585,259 8,129,143 (75,592) (93,731) (245,069) (62,963) 78,319 18,334 126,616 41,293 (153,911) (112,065) (371,685) (104,256) 126,359 123,611 349,581 (228,689) $ (27,552) $ 11,546 $ (22,104) $ (332,945) Business combination gains Other Total operating revenues Expenses Depreciation and amortization Interest Total operating expenses before restructuring, impairment and other losses Loss from operations before restructuring, impairment and other losses Restructuring, impairment and other losses Loss from operations Nonoperating gains (losses) (Deficit) excess of revenues over expenses 1. CRITICAL ACCOUNTING POLICIES The preparation of financial statements in conformity with GAAP requires that management make assumptions, estimates and judgments affecting the amounts reported in the financial statements, including the notes thereto, and related disclosures of commitments and contingencies, if any. Management considers critical accounting policies to be those that require more significant judgments and estimates in the preparation of its financial statements, including the following: recognition of net patient service revenues, which includes contractual allowances, bad debt and charity care reserves; cost report settlements; impairment of goodwill, intangibles and long-lived assets; provisions for bad debt; valuations of investments; and reserves for losses and expenses related to health care professional and general liability risks. In making such judgments and estimates, management relies on historical experience and on other assumptions believed to be reasonable under the circumstances. Actual results could differ materially from the estimates. A description of CHI’s significant accounting policies can be found in Note 1 of the CHI unaudited interim financial statements included in Appendix A of this Quarterly Report. This document is dated as of February 15, 2017 8 PART V: MANAGEMENT’S DISCUSSION AND ANALYSIS The following table provides key balance sheet metrics for the CHI Reporting Group as of December 31, 2016 and June 30, 2016. December 31, 2016 (Unaudited) CHI Reporting Group Key Balance Sheet Metrics Combined Balance Sheet Summary Total assets Total liabilities Total net assets June 30, 2016 (Unaudited) $ 22.7 billion $ 14.9 billion $ 7.8 billion $ 23.3 billion $ 15.5 billion $ 7.8 billion $ 6.5 billion 146 $ 9.0 billion 54.7% $ 6.9 billion 160 $ 9.1 billion 54.8% Financial Position and Leverage Ratios Total cash and unrestricted investments Days of cash on hand1 Total debt Debt to capitalization2 (Cash and equivalents + Investments and assets limited as to use: Internally designated investments)/((Total operating expenses before restructuring, impairment and other losses last twelve months - Depreciation and amortization last twelve months)/365). For the days of cash on hand last twelve months calculation one day of operating expenses represented $44.2 million and $43.0 million at December 31 and June 30, 2016, respectively. 2 (Short-term and current portion of debt + Long-term debt)/(Short-term and current portion of debt + Long-term debt + Unrestricted net assets). 1 This document is dated as of February 15, 2017 9 The following table presents key operating metrics and utilization statistics for CHI and the CHI Reporting Group for the three and six months ended December 31, 2016 and 2015. CHI and the CHI Reporting Group Key Operating Metrics and Utilization Statistics Three Months Ended December 31, 2016 2015 (Unaudited) (Unaudited) Six Months Ended December 31, 2016 2015 (Unaudited) (Unaudited) The CHI Reporting Group – Combined Revenues, Expenses and Key Operating Metrics* Total net patient services revenues $ 4.0 billion $ 3.8 billion $ 7.9 billion $ 7.5 billion Total operating revenues Total operating expenses before restructuring, impairment and other losses $ 4.2 billion $ 4.0 billion $ 8.3 billion $ 8.1 billion $ 4.3 billion $ 4.1 billion $ 8.6 billion $ 8.1 billion $ 226.7 million $ 203.3 million $ 358.8 million $ 527.9 million 5.4% 5.0% 4.3% 6.5% $ (75.6) million $ (93.7) million $ (245.1) million $ (63.0) million (1.8)% (2.3)% (2.9)% (0.8)% $ 148.4 million 3.5% $ 185.0 million 4.6% $ 232.2 million 2.8% $ 486.6 million 6.0% $ (153.9) million $ (112.1) million $ (371.7) million $ (104.3) million (3.6)% (2.8)% (4.5)% (1.3)% Acute admissions Acute inpatient days 139,153 654,366 134,262 641,568 276,334 1,297,590 269,011 1,280,410 Acute average length of stay in days Long-term care days 4.7 123,024 4.8 123,963 4.7 246,650 4.8 250,299 1.8 1.8 1.8 1.8 293,528 275,106 584,284 552,129 73,376 67,937 144,249 137,666 41,830 521,281 41,523 501,487 82,944 1,063,574 82,080 1,033,984 1,527,122 71,689 2,768,843 1,423,479 67,067 2,538,415 3,076,043 139,277 5,442,813 2,857,942 128,861 4,971,203 Operating EBIDA before restructuring, impairment and other losses1 Operating EBIDA margin before restructuring, impairment and other losses2 Operating loss before restructuring, impairment and other losses Operating loss margin before restructuring, impairment and other losses3 Operating EBIDA4 Operating EBIDA margin5 Operating loss Operating loss margin6 The CHI Reporting Group – Utilization Statistics CHI - Utilization Statistics Medicare case-mix index Adjusted admissions7 Inpatient ER visits Inpatient surgeries Outpatient ER visits Outpatient non-ER visits Outpatient surgeries Physician visits * Includes business combination gains. 1 Income (loss) from operations before restructuring, impairment and other losses + depreciation and amortization + interest. 2 Income (loss) from operations before restructuring, impairment and other losses + depreciation and amortization + interest/total operating revenues. 3 Income (loss) from operations before restructuring, impairment and other losses/total operating revenues. 4 Income (loss) from operations + depreciation and amortization + interest. 5 Income (loss) from operations + depreciation and amortization + interest/total operating revenues. 6 Income (loss) from operations/total operating revenues. 7 (Total gross patient revenues/total gross inpatient revenues) x acute admissions. This document is dated as of February 15, 2017 10 The following charts represent the payer gross revenue mix and healthcare services gross revenue mix for CHI’s consolidated operations as of December 31, 2016. PAYER GROSS REVENUE MIX Self-pay Commercial 3% 8% HEALTHCARE SERVICES GROSS REVENUE MIX Other 4% Physician 12% Managed care 39% Medicaid 13% Other 3% Inpatient 44% Medicare 33% Outpatient 41% The following charts represent quarterly patient volume activity for CHI’s consolidated operations over the previous eight quarters and includes the effects of acquisitions. Quarterly Acute Admissions 140,000 134,495 130,000 127,398 128,922 126,894 133,043 128,774 131,561 133,374 120,000 FY15 Q3 2,300,000 2,200,000 2,100,000 2,000,000 1,900,000 1,800,000 1,700,000 FY15 Q4 FY16 Q1 FY16 Q2 FY16 Q3 FY16 Q4 FY17 Q1 FY17 Q2 Quarterly Outpatient Visits 1,895,603 1,966,960 2,025,672 2,102,958 2,091,214 2,048,403 1,924,966 1,789,324 FY15 Q3 FY15 Q4 FY16 Q1 FY16 Q2 FY16 Q3 This document is dated as of February 15, 2017 FY16 Q4 FY17 Q1 FY17 Q2 11 1. SUMMARY OF OPERATING RESULTS FOR THE THREE MONTHS ENDED DECEMBER 31, 2016 AND 2015 OPERATING EBIDA/LOSS FROM OPERATIONS CHI operating EBIDA before restructuring, impairment and other losses totaled $210.1 million and $195.0 million for the three months ended December 31, 2016 and 2015, respectively, equivalent to an operating EBIDA margin before restructuring, impairment and other losses percentage of 5.1% and 5.0%, respectively. Results included $(17.0) million of unfavorable net patient accounts receivable reserve adjustments for the three months ended December 31, 2016 within the Nebraska region due to revenue realization adjustments reflecting a more current collection history. CHI experienced increases in net patient services revenues as a result of strategic affiliation growth, as well as increases in patient volumes, which were offset somewhat by unfavorable shifts in payer mix. Overall revenue improvements were offset by increases in compensation, purchased services and supplies costs. CHI’s loss from operations before restructuring, impairment and other losses totaled $(84.9) million and $(96.3) million for the three months ended December 31, 2016 and 2015, respectively, or an operating loss margin before restructuring, impairment and other losses percentage of (2.1)% and (2.5)%, respectively. The strategic affiliations completed in fiscal years 2017 and 2016 contributed operating revenues of $150.0 million and $51.6 million, operating EBIDA before restructuring, impairment and other losses of $2.2 million and $(0.5) million, and loss from operations before restructuring, impairment and other losses of $(5.8) million and $(5.1) million, for the three months ended December 31, 2016 and 2015, respectively, all excluding business combination gains. CHI’s consolidated operations improved slightly period over period, with mixed results across the various regions. Operating results for the Nebraska, Texas, and Kentucky regions declined period over period, but were somewhat offset by improvements in the Pacific Northwest and Ohio regions. Overall operations were impacted by same store operating expense growth outpacing same store net patient services revenue growth, and unfavorable shifts in payer mix. As part of CHI’s on-going comprehensive expense reduction strategy, focused clinical and operational initiatives across the system continue to be implemented to include targeted initiatives at the regional levels, as well as at CHI’s Corporate office. This document is dated as of February 15, 2017 12 The table below presents total operating EBIDA before restructuring, impairment and other losses, total operating EBIDA margin before restructuring, impairment and other losses and total operating revenues of CHI by region for the three months ended December 31, 2016 and 2015. Further information on CHI’s regional operating results is discussed within the regional operating trends section below. Catholic Health Initiatives Operations Summary – Three Months Ended December 31, 2016 and 2015 Region Colorado QTD 12/31/2016 Operating EBIDA before restructuring, impairment and other losses (in Thousands) QTD 12/31/2015 Operating EBIDA before restructuring, impairment and other losses (in Thousands) QTD 12/31/2016 Operating EBIDA margin before restructuring, impairment and other losses QTD 12/31/2015 Operating EBIDA margin before restructuring, impairment and other losses QTD 12/31/2016 Operating revenues percentage of CHI consolidated QTD 12/31/2015 Operating revenues percentage of CHI consolidated $ 60,144 $ 59,460 10.4% 10.9% 14.1% 13.9% Pacific Northwest 74,884 57,849 11.0% 9.2% 16.6% 16.1% Nebraska 20,596 47,840 4.1% 9.4% 12.4% 13.1% Kentucky 17,072 30,495 2.8% 5.2% 14.7% 15.1% Texas 16,077 30,910 3.0% 6.1% 13.0% 12.9% Iowa 20,663 21,215 8.0% 8.6% 6.3% 6.3% Ohio 23,773 17,468 7.7% 7.0% 7.5% 6.4% 7,157 12,321 3.7% 6.4% 4.8% 4.9% Tennessee 15,800 13,993 9.7% 8.7% 4.0% 4.1% North Dakota/Minnesota 18,258 19,584 9.3% 9.8% 4.8% 5.1% Arkansas National business lines1 5,125 3,737 7.4% 5.8% 1.7% 1.7% Other2 (13,291) (24,192) N/A N/A (0.1)% (0.2)% Total Regional 266,258 290,680 6.5% 7.5% 99.8% 99.4% Corporate services and other business lines3 (56,205) (95,645) N/A N/A 0.2% 0.6% Total CHI Consolidated $ 210,053 $ 195,035 5.1% 5.0% 100.0% 100.0% 1Includes Home Care and Senior Living business lines. 2 Includes the operations of Albuquerque Health Ministries and Lancaster Health Ministries MBOs as well as regional eliminations. 3Includes CHI Corporate and First Initiatives Insurance, Ltd. (“FIIL”), CHI’s wholly-owned captive insurance company as well as CHI system eliminations. OPERATING REVENUE AND VOLUME TRENDS CHI total operating revenues increased 4.8%, or $186.9 million, for the three months ended December 31, 2016, compared to the corresponding period of the prior fiscal year. Excluding the impacts of current and prior year acquisitions (same store basis), CHI total operating revenues increased 2.3%, or $88.7 million, for the three months ended December 31, 2016, compared to the corresponding period of the prior fiscal year. CHI total net patient services revenues increased 5.2%, or $190.2 million, for the three months ended December 31, 2016, compared to the corresponding period of the prior fiscal year, of which $93.4 million was due to recently completed acquisitions. CHI same store net patient services revenues increased 2.7%, or $96.8 million, for the three months ended December 31, 2016 compared to the corresponding period of the prior fiscal year and were impacted by $(17.0) million of unfavorable net patient accounts receivable reserve adjustments for the three months ended December 31, 2016 within the Nebraska region due to revenue realization adjustments to reflect a more current collection history including a reduction in recoveries, as well as increased patient volumes, and $(59.4) million in unfavorable shifts in payer mix across several of CHI’s regions. This document is dated as of February 15, 2017 13 CHI same store patient volumes increases (decreases) were as follows for the three months ended December 31, 2016, as compared to the corresponding period of the prior fiscal year. Patient Volumes Adjusted Admissions Acute Admissions Acute Inpatient Days Inpatient ER Visits Inpatient Surgeries Outpatient ER Visits Outpatient Non-ER Visits Outpatient Surgeries Physician Visits Percentage Change Volume Change 2.8% 0.9% (0.6%) 5.1% (1.3%) (0.5%) 2.4% 5.3% 6.8% 7,549 1,081 (3,408) 3,351 (536) (2,622) 32,639 3,472 171 CHI total other operating revenues decreased (3.4)%, or $(3.4) million, for the three months ended December 31, 2016, compared to the corresponding period of the prior fiscal year. CHI same store total other operating revenues decreased (3.4)%, or $(8.1) million, for the three months ended December 31, 2016, compared to the corresponding period of the prior fiscal year. OPERATING EXPENSES CHI total operating expenses before restructuring, impairment and other losses increased 4.4%, or $175.5 million, for the three months ended December 31, 2016, as compared to the corresponding period of the prior fiscal year, of which $99 million was due to recently completed acquisitions. CHI same store total operating expenses before restructuring, impairment and other losses increased 1.9%, or $76.5 million, for the three months ended December 31, 2016, as compared to the corresponding period of the prior fiscal year, primarily due to increases in total labor costs and purchased services, combined with annual inflation increases in other operating expenses across CHI as described in more detail below. CHI same store total labor costs increased 3.6%, or $67.8 million, for the three months ended December 31, 2016, as compared to the corresponding period of the prior fiscal year, due to annual inflation increases as well as growth initiatives. CHI same store total labor costs represented 48.5% and 47.7% of total operating expenses for the three months ended December 31, 2016 and 2015, respectively. CHI same store total labor costs as a percentage of net patient services revenues increased to 52.5% for the three months ended December 31, 2016, compared to 52.1% for the corresponding period of the prior fiscal year, representing an unfavorable expense variance of $(14.8) million, due to challenges with labor productivity, most notably in the Kentucky and Texas regions, as well as growth initiatives in certain physician practices where labor costs have been added in anticipation of future increased patient volumes. CHI same store purchased services expenses increased 6.0% or $26.1 million, for the three months ended December 31, 2016, as compared to the corresponding period of the prior fiscal year, as a result of new market implementations of revenue cycle services with Conifer during the latter part of the prior fiscal year, outsourcing and expansion of IT services, and physician alignment. REGIONAL OPERATING TRENDS CHI periodically reviews its allocation methodology for Corporate support services and may adjust those allocations based on the strategic needs and resource consumption of the regions and CHI overall. These changes in allocation methodologies may increase or decrease a region’s operating results from year to year, but have no impact on the consolidated results of CHI. Operating results for the three months ended December 31, 2016 declined across several of CHI’s regions compared to the corresponding period of the This document is dated as of February 15, 2017 14 prior fiscal year, including the Nebraska, Texas, Kentucky, Arkansas, North Dakota/Minnesota, and Iowa regions, which were offset by improvements in the Pacific Northwest, Ohio, Tennessee and Colorado regions as well as improvements within CHI Corporate services. Several regions have experienced unfavorable shifts in payer mix which have resulted in decreased net patient revenue yields and increases in operating expenses outpacing overall net patient services revenue growth. Additional information for CHI’s five largest operating regions are discussed below. The Colorado, Pacific Northwest, Nebraska, Kentucky and Texas regions’ operating revenues for the three months ended December 31, 2016, represent 70.8% of CHI’s consolidated operating revenues. Colorado - the region’s operating EBIDA before restructuring, impairment and other losses totaled $60.1 million for the three months ended December 31, 2016, and increased $0.7 million compared to the corresponding period of the prior fiscal year, due to increased patient volumes. Net patient services revenue increased $31.2 million compared to the same period of the prior fiscal year, with $(4.5) million of unfavorable shifts in payer mix being offset by $1.6 million of greater acuity and $3.7 million of improved service mix. Operations were also impacted by a decrease in provider fee revenue totaling $12 million. Provider fee expenses were $2 million lower than prior year, resulting in an unfavorable $10 million impact to the Colorado region’s operating EBIDA before restructuring, impairment and other losses. The Colorado region is in the process of installing the Epic electronic health record system across its various hospitals, and for the three months ended December 31, 2016, Epic operating expenses and training costs were $2.7 million higher, compared to the same period of the prior fiscal year. Total net revenue per adjusted admission increased 0.4% compared to the same period of the prior fiscal year, while total operating expense per adjusted admission increased 0.5%. Total labor as a percent of net patient services revenue increased to 42.5% compared to 41.9% in the same period of the prior fiscal year, representing an unfavorable expense variance of $(3.3) million. Pacific Northwest - the region’s operating EBIDA before restructuring, impairment and other losses totaled $74.9 million for the three months ended December 31, 2016, an increase of $17 million compared to the corresponding period of the prior fiscal year, due to overall increased patient volumes combined with the implementation of expense management and productivity improvements. Net patient services revenue increased $53.7 million, including $45.3 million in patient volumes and $18.4 million in greater acuity, compared to the same period of the prior fiscal year. Operating expenses increased $30.0 million compared to the corresponding period of the prior fiscal year, primarily due to increased volumes. Total net revenue per adjusted admission increased 5.1% compared to the same period of the prior fiscal year, while total operating expense per adjusted admission increased 1.3%. Total labor as a percentage of net patient services revenue decreased to 50.6% compared to 53.7% in the same period of the prior fiscal year as a result of ongoing labor productivity improvements, representing a favorable expense variance of $20.5 million. Supply expense as a percentage of net patient services revenue declined to 14.2% compared to 14.9% in the prior fiscal year due to revenue growth and improved utilization. Nebraska - the region’s operating EBIDA before restructuring, impairment and other losses totaled $20.6 million for the three months ended December 31, 2016, and decreased $(27.2) million compared to the corresponding period of the prior fiscal year, due to the recognition of $(17.0) million of unfavorable net patient accounts receivable reserve adjustments during the three months ended December 31, 2016. Net patient services revenue also included volume growth of $11.8 million and favorable shifts in acuity of $10.0 million. The net patient accounts receivable reserve adjustments were due to revenue realization adjustments to reflect a more current collection history including a reduction in recoveries. Total net revenue per adjusted admission decreased (3.7)% compared to the same period of the prior fiscal year, while total operating expense per adjusted admission increased 1.6%. Total labor as a percent of net patient services revenue increased to 57.3% compared to 54.8% in the same period of the prior fiscal year, due to agency 15 This document is dated as of February 15, 2017 usage. Total operating expenses increased 4.5%, or $22.4 million in the Nebraska region for the three months ended December 31, 2016, primarily in the areas of total compensation, purchased services and supplies expenses, compared to the corresponding period of the prior fiscal year. Supply expense as a percentage of net patient service revenues increased to 19.6% compared to 17.8% in the prior fiscal year. Increases in utilization and cost are concentrated in pharmacy, cardiovascular and orthopedic/spine and is a continued focus and opportunity for reduction. Kentucky - the region’s operating EBIDA before restructuring, impairment and other losses totaled $17.1 million for the three months ended December 31, 2016, and decreased $(13.4) million compared to the corresponding period of the prior fiscal year. Net patient services revenues increased 0.8%, or $4.6 million, for the three months ended December 31, 2016, compared to the corresponding period of the prior fiscal year as a result of $(14.1) million in unfavorable shifts in payer mix offset by improved realization. Total labor as a percentage of net patient services revenue increased to 49.4% compared to 44.8% in the same period of the prior fiscal year, representing an unfavorable expense variance of $(26.2) million. The Kentucky region is continuing its efforts to address nursing and other staff shortages which have resulted in increases to overall labor costs, including contract labor costs, and overtime and premium pay. Operations for the three months ended December 31, 2016 were favorably impacted by an $8.2 million decrease in a contingent consideration liability as a result of changes in payment assumptions related to the University of Louisville affiliation with KentuckyOne Health. Texas - the region’s operating EBIDA before restructuring, impairment and other losses totaled $16.1 million for the three months ended December 31, 2016, and decreased $(14.8) million compared to the same period of the prior fiscal year, due to increased operating expenses outpacing net patient services revenue growth. Net patient services revenue increased $36.8 million, including $39.3 million from several recently completed affiliations which was somewhat offset by unfavorable shifts in payer mix of $(11.1) million. Total labor as a percentage of net patient services revenue increased to 49.6% compared to 49.0% in the same period of the prior fiscal year. Same store operating expenses increased 0.6%, or $2.9 million in the Texas region for the three months ended December 31, 2016. Management is implementing strategies to improve labor productivity and supply chain savings in the Texas region, and is continuing to expand its referral base for additional growth in the region through acquiring and expanding the Texas physician enterprise in the greater Houston area. Operations in Bryan, Texas, a component of the Texas region acquired in fiscal year 2015, continue to report a strong operating EBIDA before restructuring of $9.5 million and 9.7% for the three month period ended December 31, 2016. CHI Corporate services and other business lines operating EBIDA before restructuring, impairment and other losses totaled $(56.2) million, representing an improvement of $39.4 million for the three months ended December 31, 2016, compared to the corresponding period of the prior fiscal year. Changes in support services activities relates to a variety of factors, and include strategic transfers of certain activities from the markets and other National service lines to the Corporate office in order to build National support functions, and new implementations of system-wide services such as revenue cycle and food programs. Support services allocations to the regions consider the strategic needs and resource consumption of the regions and CHI overall. Increases for the three months ended December 31, 2016 include $19.4 million of revenue cycle implementations and services for new markets, and $6.1 million related to new market implementations for national food services. IT expenses declined $13.9 million compared to the corresponding period of the prior fiscal year due to decreased activity in system implementations, and market compensation declined $8.0 million due to personnel transfers of market executive leaders from the Corporate Office to the regions. This document is dated as of February 15, 2017 16 RESTRUCTURING, IMPAIRMENT AND OTHER LOSSES CHI restructuring, impairment and other losses totaled $78.3 million and $18.3 million for the three months ended December 31, 2016 and 2015, respectively. For the three months ended December 31, 2016 and 2015, restructuring, impairment and other losses expenses included $37.9 million of goodwill and long-lived asset impairment charges for the three months ended December 31, 2016, $22.6 million and $10.8 million of changes in business operations, respectively, and $17.8 million and $7.5 million of severance costs, respectively. CHI changes in business operations include contract termination costs, as well as ongoing reorganization efforts which include consulting costs related to revenue cycle, supply chain, and labor productivity. NON-OPERATING RESULTS CHI non-operating gains totaled $121.6 million and $117.2 million for the three months ended December 31, 2016 and 2015, respectively. CHI investment gains were $18.7 million and $110.5 million for the three months ended December 31, 2016 and 2015, respectively, and realized and unrealized gains on interest rate swaps were $105.3 and $11.7 million for the three months ended December 31, 2016 and 2015, respectively. 2. SUMMARY OF OPERATING RESULTS FOR THE SIX MONTHS ENDED DECEMBER 31, 2016 AND 2015 OPERATING EBIDA/LOSS FROM OPERATIONS CHI operating EBIDA before restructuring, impairment and other losses totaled $332.1 million and $514.4 million for the six months ended December 31, 2016 and 2015, respectively, equivalent to an operating EBIDA margin before restructuring, impairment and other losses percentage of 4.1% and 6.6%, respectively. Results included $16.8 million of gains on asset sales in the Texas region for the six months ended December 31, 2016 and $141.7 million of business combination gains for the six months ended December 31, 2015, offset by $(28.0) million of unfavorable net patient accounts receivable reserve adjustments for the six months ended December 31, 2016 in the Nebraska region, related to moving the accounts receivable reserve methodology for one facility to the CHI standard, revenue realization adjustments and to reflect more current collection experience including a reduction in recoveries. CHI experienced increases in net patient services revenues as a result of strategic affiliation growth, increased acuity and increases in patient volumes, offset somewhat by unfavorable shifts in payer mix. Overall revenue improvements were offset by increases in compensation, purchased services and supplies costs. CHI loss from operations before restructuring, impairment and other losses totaled $(257.1) million and $(65.1) million for the six months ended December 31, 2016 and 2015, respectively, or an operating loss margin before restructuring, impairment and other losses percentage of (3.2)% and (0.8)%, respectively. The strategic affiliations completed in fiscal years 2017 and 2016 contributed operating revenues of $285.0 million and $88.2 million, operating EBIDA before restructuring, impairment and other losses of $6.4 million and $1.1 million, and loss from operations before restructuring, impairment and other losses of $(9.6) million and $(6.9) million, for the six months ended December 31, 2016 and 2015, respectively, all excluding business combination gains. CHI’s regional operations declined period over period, driven by operations in the Kentucky, Texas, Nebraska, and Colorado regions, whose combined operating EBIDA before restructuring, impairment and other losses declined $(162.9) million for the six months This document is dated as of February 15, 2017 17 ended December 31, 2016, compared to the same period of the prior fiscal year. Overall operations were impacted by same store operating expense growth outpacing same store net patient services revenue growth, and unfavorable shifts in payer mix. Partially offsetting the declining regional results were improvements in the Pacific Northwest and Ohio regions whose combined operating EBIDA before restructuring, impairment and other losses improved $42.4 million, for the six months ended December 31, 2016, compared to the same period of the prior fiscal year. As part of CHI’s on-going comprehensive expense reduction strategy, focused clinical and operational initiatives across the system continue to be implemented to include targeted initiatives at the regional levels, as well as at CHI’s Corporate office. The table below presents the total operating EBIDA before restructuring, total operating EBIDA margin before restructuring and total operating revenues of CHI by region for the six months ended December 31, 2016 and 2015. Further information on CHI’s regional operating results is discussed within the regional operating trends section below. Catholic Health Initiatives Operations Summary – Six Months Ended December 31, 2016 and 2015 Region Colorado YTD 12/31/2016 Operating EBIDA before restructuring, impairment and other losses (in Thousands) YTD 12/31/2015 Operating EBIDA before restructuring, impairment and other losses (in Thousands) YTD 12/31/2016 Operating EBIDA margin before restructuring, impairment and other losses YTD 12/31/2015 Operating EBIDA margin before restructuring, impairment and other losses YTD 12/31/2016 Operating revenues percentage of CHI consolidated YTD 12/31/2015 Operating revenues percentage of CHI consolidated $ 107,093 $ 124,491 9.4% 11.5% 14.1% 13.9% 137,445 112,546 10.4% 9.1% 16.4% 15.8% Nebraska 39,695 86,927 3.9% 8.8% 12.5% 12.7% Kentucky 11,637 64,950 1.0% 5.5% 14.7% 15.1% Texas 22,829 67,751 2.1% 6.9% 13.2% 12.6% Iowa 37,370 40,111 7.3% 8.0% 6.3% 6.4% Ohio 45,674 28,215 7.5% 5.8% 7.6% 6.3% Arkansas 12,274 21,756 3.2% 5.7% 4.8% 4.9% Tennessee 28,889 25,785 8.9% 8.2% 4.0% 4.0% North Dakota/Minnesota 25,915 34,703 6.8% 8.9% 4.7% 5.0% 9,363 6,824 6.8% 5.3% 1.7% 1.6% Other2 (19,868) (38,757) N/A N/A (0.1)% (0.3)% Total Regional Corporate services and other business lines3 458,316 575,302 5.7% 7.5% 99.9% 98.0% (126,245) (202,619) N/A N/A 0.1% 0.2% 332,071 372,683 4.1% 4.9% 100.0% 98.2% - 141,668 N/A N/A - 1.8% $ 332,071 $ 514,351 4.1% 6.6% 100.0% 100.0% Pacific Northwest National business lines1 Total CHI Consolidated before business combination (losses) gains Business combination gains Total CHI Consolidated 1Includes Home Care and Senior Living business lines. 2 Includes the operations of Albuquerque Health Ministries and Lancaster Health Ministries MBOs as well as regional eliminations. 3Includes CHI Corporate and First Initiatives Insurance, Ltd. (“FIIL”), CHI’s wholly-owned captive insurance company as well as CHI system eliminations. OPERATING REVENUE AND VOLUME TRENDS CHI total operating revenues increased 3.2%, or $250.6 million, for the six months ended December 31, 2016, compared to the corresponding period of the prior fiscal year; excluding the $141.7 million of business combination gains reflected in the prior fiscal year, CHI total operating revenues increased 5.1%, or $392.3 This document is dated as of February 15, 2017 18 million. Excluding the impacts of current and prior year acquisitions (same store basis), CHI total operating revenues increased 2.6%, or $195.7 million, for the six months ended December 31, 2016, compared to the corresponding period of the prior fiscal year. CHI total net patient services revenues increased 5.2%, or $374.3 million, for the six months ended December 31, 2016, compared to the corresponding period of the prior fiscal year, of which $188.4 million was due to recently completed acquisitions. CHI same store net patient services revenues increased 2.6%, or $185.9 million, for the six months ended December 31, 2016 compared to the corresponding period of the prior fiscal year mostly due to overall increased patient volumes of $104.0 million, favorable shifts in acuity of $91.6 million, offset by unfavorable shifts in payer mix of $(67.4) million and a revenue realization adjustment in the Nebraska Region of ($28.0) million to reflect a more current collection experience. CHI same store patient volume increases (decreases) were as follows for the six months ended December 31, 2016, as compared to the corresponding period of the prior fiscal year. Patient Volumes Percentage Change Volume Change Adjusted Admissions Acute Admissions Acute Inpatient Days Inpatient ER Visits Inpatient Surgeries Outpatient ER Visits Outpatient Non-ER Visits Outpatient Surgeries Physician Visits 2.1% 0.1% (1.0%) 1.7% (0.8%) (1.2%) 1.9% 6.4% 7.4% 11,430 244 (12,160) 2,269 (683) (12,598) 51,992 8,118 364,346 CHI total other operating revenues decreased (20.1)%, or $(123.7) million, for the six months ended December 31, 2016, compared to the corresponding period of the prior fiscal year, primarily due to the recognition of $141.7 million in business combination gains for the six months ended December 31, 2015. CHI also recognized $16.8 million in gains on asset sales in the Texas region for the six months ended December 31, 2016. CHI same store total other operating revenues increased 2.1%, or $9.7 million, for the six months ended December 31, 2016, compared to the corresponding period of the prior fiscal year, primarily due to the gains on asset sales. OPERATING EXPENSES CHI total other operating revenues decreased (20.1)%, or $(123.7) million, for the six months ended December 31, 2016, compared to the corresponding period of the prior fiscal year, primarily due to the recognition of $141.7 million in business combination gains for the six months ended December 31, 2015. CHI also recognized $16.8 million in gains on asset sales in the Texas region for the six months ended December 31, 2016. CHI total operating expenses before restructuring, impairment and other losses increased 5.6%, or $442.6 million, for the six months ended December 31, 2016, as compared to the corresponding period of the prior fiscal year, of which $199.5 million was due to recently completed acquisitions. CHI same store total operating expenses before restructuring, impairment and other losses increased 3.1%, or $243.1 million, for the six months ended December 31, 2016, as compared to the corresponding period of the prior fiscal year, primarily due to increases in total labor costs and purchased services, combined with annual inflation increases in other operating expenses across CHI as described in more detail below. CHI same store total labor costs increased 4.0%, or $149.4 million, for the six months ended December 31, 2016, as compared to the corresponding period of the prior fiscal year, due to annual inflation increases as well as growth initiatives. CHI same store total labor costs represented 48.1% and 47.7% of same store total operating expenses for the six months ended December 31, 2016 and 2015, respectively. CHI same store total labor costs as a percentage of same store net patient services revenues increased to 52.9% for the six months ended December 31, 2016, compared to 52.2% for the corresponding period of the prior fiscal year, This document is dated as of February 15, 2017 19 representing an unfavorable expense variance of $(51.1) million, due to challenges with labor productivity, most notably in the Kentucky and Texas regions, as well as growth initiatives in certain physician practices where labor costs have been added in anticipation of future increased patient volumes. CHI same store purchased services expenses increased 11.7% or $97.4 million, for the six months ended December 31, 2016, as compared to the corresponding period of the prior fiscal year, as a result of new market implementations of revenue cycle services with Conifer during the latter part of the prior fiscal year, outsourcing and expansion of IT services, and physician alignment. REGIONAL OPERATING TRENDS CHI periodically reviews its allocation methodology for Corporate support services and may adjust those allocations based on the strategic needs and resource consumption of the regions and CHI overall. These changes in allocation methodologies may increase or decrease a region’s operating results from year to year, but have no impact on the consolidated results of CHI. Operating results for the six months ended December 31, 2016 declined across several of CHI’s regions compared to the corresponding period of the prior fiscal year, including the Kentucky, Nebraska, Texas, Colorado, Arkansas, North Dakota/Minnesota, and Iowa regions, which were offset by improvements in the Pacific Northwest, Ohio, and Tennessee regions as well as improvements within CHI Corporate services. Several regions have experienced decreases in patient volumes and unfavorable shifts in payer mix which have resulted in decreased net patient revenue yields and increases in operating expenses outpacing overall net patient services revenue growth. Additional information for CHI’s five largest operating regions are discussed below. The Colorado, Pacific Northwest, Nebraska, Kentucky and Texas regions’ operating revenues for the six months ended December 31, 2016, represent 70.9% of CHI’s consolidated operating revenues. Colorado - the region’s operating EBIDA before restructuring, impairment and other losses totaled $107.1 million for the six months ended December 31, 2016, and decreased $(17.4) million compared to the corresponding period of the prior fiscal year, due to unfavorable shifts in payer mix and reductions in net provider fee revenue. Net patient services revenue increased $54.3 million, including $15.8 million as a result of the Longmont acquisition, compared to the same period of the prior fiscal year. The positive impacts were offset by $(10.1) million in unfavorable shifts in payer mix and a $(40.0) million decrease in provider fee revenue. Provider fee expenses were $23 million lower than prior year, resulting in a negative $(17) million impact to the Colorado region operating EBIDA before restructuring, impairment and other losses impact. The Colorado region is in the process of installing the Epic electronic health record system across its various hospitals, and for the six months ended December 31, 2016, Epic operating expenses and training costs were $6 million higher, compared to the same period of the prior fiscal year. Total net revenue per adjusted admission increased 1.0% compared to the same period of the prior fiscal year, while total operating expense per adjusted admission increased 2.1%. Total labor as a percentage of net patient services revenue increased to 43.4% compared to 40.8% in the same period of the prior fiscal year, representing an unfavorable expense variance of $(28.0) million. Pacific Northwest - the region’s operating EBIDA before restructuring, impairment and other losses totaled $137.4 million for the six months ended December 31, 2016, and increased $24.9 million compared to the corresponding period of the prior fiscal year, due to overall increased patient volumes combined with the implementation of expense management and productivity improvements. Net patient services revenue increased $95.7 million, including $71.5 million in patient volumes and $30.9 million in greater acuity, compared to the same period of the prior fiscal year. The net patient services revenue increase exceeded the $60.7 million in increased operating expenses, including This document is dated as of February 15, 2017 20 total compensation, purchased services and supplies expenses, compared to the corresponding period of the prior fiscal year. Total net revenue per adjusted admission increased 5.4% compared to the same period of the prior fiscal year, while total operating expense per adjusted admission increased 2.5%. Total labor as a percentage of net patient services revenue decreased to 51.5% compared to 53.8% in the same period of the prior fiscal year as a result of ongoing labor productivity improvements, representing a favorable expense variance of $29.5 million. Supply expense as a percentage of net patient services revenue declined to 14.5% compared to 15.0% in the prior fiscal year due to revenue growth and improved utilization. Nebraska – the region’s operating EBIDA before restructuring, impairment and other losses totaled $39.7 million for the six months ended December 31, 2016, and decreased $(47.2) million compared to the corresponding period of the prior fiscal year, due primarily to $(28) million of unfavorable net patient accounts receivable reserve adjustments for the six months ended December 31, 2016. Net patient services revenue also included volume growth of $26 million and favorable shifts in payer mix of $6.4 million. The net patient accounts receivable reserve adjustments were due to moving the accounts receivable reserve methodology for one facility to the CHI standard, revenue realization adjustments and to reflect more current collection experience including a reduction in recoveries. Total net revenue per adjusted admission decreased (1.8)% compared to the same period of the prior fiscal year, while total operating expense per adjusted admission increased 2.5%. Total labor as a percentage of net patient services revenue increased to 57.4% compared to 55.5% in the same period of the prior fiscal year, due to agency usage. Total operating expenses increased 5.7%, or $55.1 million in the Nebraska region for the six months ended December 31, 2016, primarily in the areas of total compensation, purchased services and supplies expenses, compared to the corresponding period of the prior fiscal year. Supply expense as a percentage of net patient service revenues increased to 19.3% compared to 17.5% in the prior fiscal year. Increases in utilization and cost are concentrated in pharmacy, cardiovascular and orthopedic/spine and is a continued focus and opportunity for reduction. Kentucky - the region’s operating EBIDA before restructuring, impairment and other losses totaled $11.6 million for the six months ended December 31, 2016, and decreased $(53.3) million compared to the corresponding period of the prior fiscal year. Net patient services revenues decreased (0.6)%, or $(6.4) million, for the six months ended December 31, 2016, compared to the corresponding period of the prior fiscal year as a result of unfavorable shifts in payer mix of $(21.7) million somewhat offset by improved realization. Total labor as a percentage of net patient services revenue increased to 49.9% compared to 44.4% in the same period of the prior fiscal year, representing an unfavorable expense variance of $(61.5) million. The Kentucky region is continuing ongoing efforts to address nursing and other staff shortages which have resulted in increases to overall labor costs including an $18.9 million increase to contract labor costs as well as overtime and premium pay. Operations for the six months ended December 31, 2016 were favorably impacted by a $12.4 million decrease in a contingent consideration liability as a result of changes in payment assumptions related to the University of Louisville affiliation with KentuckyOne Health. Texas - the Texas region’s operating EBIDA before restructuring, impairment and other losses totaled $22.8 million for the six months ended December 31, 2016, and decreased $(44.9) million for the six months ended December 31, 2016, compared to the same period of the prior fiscal year, due to increased operating expenses outpacing net patient services revenue growth. Results for the current year included $16.8 million in gains from asset sales in the Texas region. Net patient services revenue increased $67.4 million, including $60.8 million from recently completed affiliations, and was impacted by favorable acuity increases of $8.0 million and Medicaid 1115 wavier reimbursement increases of $23.3 million, which were somewhat offset by unfavorable shift in payer mix of $(18.8) million. Total labor as a percentage of net patient services revenue increased to 50.1% compared to 49.0% in the same period of the prior fiscal year. Same store operating expenses increased 6%, or $60 This document is dated as of February 15, 2017 21 million in the Texas region for the six months ended December 31, 2016. Management is implementing strategies to improve labor productivity and supply chain savings in the Texas region, and is continuing to expand its referral base for additional growth in the region through acquiring and expanding the Texas physician enterprise in the greater Houston area. Operations in Bryan, Texas, a component of the Texas region acquired in fiscal year 2015, continues to report a strong operating EBIDA before restructuring of 9.7% for the six month period ended December 31, 2016. CHI Corporate services and other business lines operating EBIDA before restructuring, impairment and other losses totaled $(126.2) million, representing an improvement of $76.4 million for the six months ended December 31, 2016, compared to the corresponding period of the prior fiscal year. Changes in support services activities relates to a variety of factors, and include strategic transfers of certain activities from the markets and other National service lines to the Corporate office in order to build National support functions, and new implementations of system-wide services such as revenue cycle and food programs. Support services allocations to the regions consider the strategic needs and resource consumption of the regions and CHI overall. Increases for the six months ended December 31, 2016 include $42.2 million of revenue cycle implementations and services for new markets, and $10.3 million related to new market implementations for national food services. IT expenses declined $22.1 million compared to the corresponding period of the prior fiscal year due to decreased activity in system implementations, and market compensation declined $19 million due to personnel transfers of market executive leaders from the Corporate Office to the regions. RESTRUCTURING, IMPAIRMENT AND OTHER LOSSES CHI restructuring, impairment and other losses totaled $126.6 million and $41.3 million for the six months ended December 31, 2016 and 2015, respectively. For the six months ended December 31, 2016 and 2015, respectively, restructuring, impairment and other losses expenses included $65.1 million and $30.8 million of changes in business operations, respectively, $35.2 million of goodwill and long-lived asset impairment charges for the six months ended December 31, 2016, and $26.3 million and $10.5 million of severance costs, respectively. CHI changes in business operations include contract termination costs, as well as ongoing reorganization efforts which include consulting costs related to revenue cycle, supply chain, and labor productivity. NON-OPERATING RESULTS CHI non-operating gains (losses) totaled $341.4 million and $(226.3) million for the six months ended December 31, 2016 and 2015, respectively, primarily driven by CHI’s investment portfolio gains (losses), and realized and unrealized gains (losses) on interest rate swaps. CHI investment gains (losses) were $244.7 million and $(172.0) million for the six months ended December 31, 2016 and 2015, respectively, and realized and unrealized (losses) on interest rate swaps were $105.3 million and $(46.7) million for the six months ended December 31, 2016 and 2015, respectively. This document is dated as of February 15, 2017 22 3. SUMMARY OF BALANCE SHEET AS OF DECEMBER 31, 2016 AND JUNE 30, 2016 The CHI Reporting Group total combined assets were $22.7 billion and $23.3 billion at December 31 and June 30, 2016, respectively, representing a decrease of (2.7)%, or $(640.0) million, during the six months ended December 31, 2016. The CHI Reporting Group decrease was primarily attributable to a $(443.7) million decrease in cash and unrestricted investments, as described further below, as well as a $(327.6) million reduction in net property and equipment balances as a result of real estate asset sales, and decreased capital spending across the regions. The CHI Reporting Group total cash and equivalents and unrestricted investments were $6.5 billion and $6.9 billion at December 31 and June 30, 2016, respectively, representing a decrease of (6.4)%, or $(443.7) million during the six months ended December 31, 2016. For the six months ended December 31, 2016, CHI spent a net $(203.9) million in investing cash flow activities, including $(425.0) million of on-going capital investment activity, offset by the receipt of $197.9 million in proceeds from asset sales. CHI’s capital investment activity includes continued implementation costs for CHI’s OneCare program and IT infrastructure investments, as well as new hospital construction and facility renovations across the regions. CHI financing cash flow activities for the six months ended December 31, 2016, totaled $(8.6) million and include net debt, interest and swap collateral postings. CHI’s cash flows from operations, including investments and assets limited to use, and working capital changes, were $(231.2) million for the six months ended December 31, 2016. The CHI Reporting Group days of cash on hand decreased to 146 days at December 31, 2016, from 160 at June 30, 2016. This decrease is primarily attributable to reductions of cash flows from operations and working capital changes, as well as CHI cash spent on capital additions and debt payments. The CHI Reporting Group net patient accounts receivable were $2.3 billion and $2.2 billion at December 31 and June 30, 2016, respectively, representing an increase of 3.5%, or $77.8 million, during the six months ended December 31, 2016, primarily as a result of the increase in CHI net patient services revenues discussed above. The CHI Reporting Group total combined liabilities were $14.9 billion and $15.5 billion at December 31 and June 30, 2016, respectively, representing a decrease of (3.8)%, or $(582.5) million, during the six months ended December 31, 2016, primarily attributable to a $(306.8) million decrease in accounts payable and accrued expenses as a result of working capital changes, as well as decreases in overall other long-term liabilities and outstanding debt balances. CHI Reporting Group total debt was $9 billion and $9.1 billion at December 31 and June 30, 2016, respectively, representing a decrease of $(96.6) million, primarily due to $(299.1) million in CHI debt redemptions and $(56.2) million in scheduled debt service payments, offset by the $200 million CHI Series 2016 Taxable variable-rate bond issuance and $58.7 in increases in capital leases and other debt issued during the six months ended December 31, 2016. The CHI Reporting Group debt-to-capitalization ratio decreased to 54.7% at December 31, 2016 from 54.8% at June 30, 2016, primarily as a result of the $(96.6) million decrease in CHI Reporting Group debt during the six months ended December 31, 2016 and a $(61.0) million decrease to unrestricted net assets. The CHI Reporting Group total unrestricted net assets decrease during the six months ended December 31, 2016, was driven by CHI’s deficit of revenues over expenses of $(42.3) million and a $(24.3) million net loss from CHI’s discontinued operations for the six months ended December 31, 2016. This document is dated as of February 15, 2017 23 4. CERTAIN CONTRACTUAL OBLIGATIONS CAPITAL OBLIGATION DOCUMENT The obligations of the Corporation to pay amounts due on its commercial paper notes, revenue bonds, guarantees and certain swap agreements are evidenced by Obligations issued under the Capital Obligation Document (COD). Obligations also evidence the Corporation’s obligations to banks that provide funds for the purchase of indebtedness tendered for purchase or subject to mandatory tender for purchase and not remarketed under the Corporation’s self-liquidity program and for general purpose revolving lines of credit. At December 31, 2016, the Corporation’s outstanding indebtedness evidenced by Obligations issued under the COD totaled $8.1 billion. Payment obligations under the COD are limited to the Obligated Group (defined in the COD), which only includes the Corporation. Certain covenants under the COD are tested based on the combination of the Obligated Group, Participants and Designated Affiliates. However, holders of Obligations have no recourse to Participants or Designated Affiliates or their property for payment thereof. INDEBTEDNESS (in Millions) December 31, 2016 Capital Obligation Debt Fixed Rate Bonds1 $5,020 Variable Rate Bonds2 Long Term Rate Bonds3 Direct Purchase Bonds4 Commercial Paper Notes Short term bank loans Total Capital Obligation Debt 508 142 1,038 816 584 $ 8,108 Non-Capital Obligation Debt Other MBO Debt5 Capital Leases EHF Payable issued to Episcopal Health Foundation Total Non-Capital Obligation Debt Total CHI Debt $ 509 183 167 $ 859 $ 8,967 Excludes unamortized original issue premium, discount and issuance costs. bonds that bear interest at variable rates (currently determined weekly) and are subject to optional tender for purchase by their holders, FRNs that bear interest at variable rates (currently determined weekly and monthly), for a specified period and are subject to mandatory tender as set forth below and direct purchase debt of affiliates that is placed directly with holders, bears interest at variable rates determined monthly based upon a percentage of LIBOR or SIFMA plus a spread, and is subject to mandatory tender on certain dates. 3 Long-term rate bonds bear interest at a fixed rate for a specified period and are subject to mandatory tender at the end of such period as set forth below. 4 Direct purchase debt of the Corporation is placed directly with holders, bears interest at variable rates determined monthly based upon a percentage of LIBOR or SIFMA plus a spread, and is subject to mandatory tender on certain dates as set forth below. On December 2, 2016, the Corporation issued a $200 million taxable bond (the “2016A Taxable Bond”) that was purchased by Morgan Stanley & Co. LLC. The proceeds from the sale of the 2016A Taxable Bond retired in full the Morgan Stanley revolving line of credit. 5 Other debt is comprised mostly of $238.1 million of CHI St. Luke’s affiliate debt, $96.4 million of Centura affiliate debt and $58.7 million of SFH affiliate debt. 1 2 Includes This document is dated as of February 15, 2017 24 The required principal payments on the total CHI longterm debt during fiscal year 2017 is approximately $135.0 million. At December 31, 2016, the Corporation had one revolving line of credit with Mizuho Bank, LTD., in the amount of $250 million that was fully drawn and matures on June 29, 2017, unless the parties mutually agree to renew or extend the loan. On December 2, 2016, the Corporation issued a $200 million 2016A Taxable Bond that was purchased by Morgan Stanley & Co. LLC. The proceeds from the sale of the 2016A Taxable Bond retired in full the Morgan Stanley revolving line of credit. The 2016A Taxable Bond matures December 1, 2021, but may be tendered to the Corporation for purchase on December 1, 2017. On February 10, 2016, the Corporation borrowed $333.7 million from JPMorgan Chase Bank, National Association to provide for the defeasance of certain fixed rate bonds (the “JPMorgan Loan”). This loan matures on December 20, 2017, unless the parties mutually agree to renew or extend. The Corporation’s direct purchase agreements are publicly available, and can be accessed through the Digital Assurance Certification LLC website (“DAC”) at www.dacbond.com and the Municipal Securities Rulemaking Board (“MSRB”) through the Electronic Municipal Market Access (“EMMA”) website of the MSRB, which can be found at http://emma.msrb.org. A. Direct Purchase Debt The Corporation’s direct purchase debt is subject to mandatory tender on the dates set forth below. Prior to the mandatory tender of direct purchase debt, management expects that it would analyze the then current market conditions and availability and relative cost of refinancing or restructuring alternatives which could include without limitation, conversion to another interest mode, refinancing or repayment. Par Outstanding December 31, 2016 Mandatory Tender Date $200.0 million December 1, 2017 118.0 million November 10, 2018 119.5 million January 29, 2019 Colorado 2004B61 54.2 million September 15, 2020 Taxable 2013F 75.0 million December 18, 2020 Colorado 2015-1 38.4 million August 1, 2021 Colorado 2015-2 73.7 million August 1, 2021 Colorado 2013C 100.0 million December 18, 2023 Taxable 2013E 125.0 million December 18, 2023 Colorado 2015A 18.6 million August 1, 2024 Colorado 2015B 50.0 million August 1, 2024 Washington 2015A 49.5 million August 1, 2024 Series Taxable 2016A Colorado 2011C 1 Washington 2008A1 Total Direct Purchase Bonds2 1 2 $1,022 million Includes a “term out” provision that varies among agreements, which permits repayment after the mandatory tender date absent any defaults or events of default. As discussed above, on December 2, 2016, the Corporation issued 2016A Taxable Bond that was purchased by Morgan Stanley & Co. LLC. The proceeds from the sale of the 2016A Taxable Bond retired in full the Morgan Stanley revolving line of credit. The 2016A Taxable Bond may be tendered to the Corporation for purchase on December 1, 2017. This document is dated as of February 15, 2017 25 B. Long-Term Rate Bonds The Corporation’s long-term rate bonds are subject to mandatory tender on the dates set forth below. Prior to the mandatory tender of long-term rate bonds, management expects that it would analyze the then current market conditions and availability and relative cost of refinancing or restructuring alternatives, which could include without limitation, conversion to another interest mode, refinancing or repayment. Par Outstanding December 31, 2016 Mandatory Tender Date $40.0 million November 6, 2019 Kentucky 2009B 60.0 million November 10, 2021 Colorado 2008D-3 41.9 million November 12, 2021 Series Colorado 2009B-3 Total Long-Term Rate Bonds $141.9 million C. Floating Rate Notes (“FRNs”) Par Outstanding December 31, 2016 Mandatory Tender Date Kentucky 2011B-1 $ 52.7 million January 31, 2020 Kentucky 2011B-2 52.7 million January 31, 2020 Colorado 2008C-2 26.5 million November 12, 2020 Colorado 2008C-4 26.5 million November 12, 2020 Washington 2013B-1 100.0 million December 31, 2020 Washington 2013B-2 100.0 million December 31, 2024 52.7 million January 31, 2025 The Corporation’s FRNs are subject to mandatory tender on the dates set forth below. Kentucky 2011B-3 $411.1 million Total FRNs D. Variable Rate Bonds The Corporation’s variable rate demand bonds are subject to optional and mandatory tender. As of December 31, 2016, variable rate demand bonds outstanding in the amount of $96.7 million, are supported by the Corporation’s self-liquidity, and are not supported by a dedicated liquidity or credit facility. See “Liquidity Arrangements” in Part IV below. E. Taxable Commercial Paper The Corporation’s commercial paper note program permits the issuance of up to $881 million in aggregate principal amount outstanding, with maturities within a 270 day period. The Corporation has directed the dealers for its commercial paper to tranche the maturities so that no greater than approximately onethird of the outstanding balance matures in any one month, and no more than $100 million matures per dealer within any five business-day period. The Corporation has, from time to time, directed its dealers to deviate from such directions, and may do so again in the future. As of December 31, 2016, $815.5 million of commercial paper notes were outstanding. The commercial paper notes are supported by the Corporation’s self-liquidity, and are not supported by a dedicated liquidity or credit facility. See “Liquidity Arrangements” in Part IV below. This document is dated as of February 15, 2017 26 F. Swap Agreements The Corporation or its affiliates are currently party to 43 swap transactions that had an aggregate notional amount of approximately $1.7 billion at December 31, 2016. The 43 transactions have varying termination dates ranging from 2017 to 2047.The swap agreements require the Corporation (or with respect to certain swap agreements, CHI St. Luke’s or SFH) to provide collateral if its respective liability, determined on a mark-toObligated Party Type market basis, exceeds a specified threshold that varies based upon the rating on the Corporation’s long-term indebtedness. The swap agreements of Memorial East Texas and Centura do not require collateral postings. Total cash collateral balances were $214.4 million at December 31, 2016. The swap agreements, excluding the Centura Health swap, are secured by Obligations issued under the COD. Outstanding Notional December 31, 2016 Termination Date January 3, 2017-January 16,2020 CHI1 Total Return $ 119.0 million CHI Fixed Payer 150.9 million May 1, 2025 CHI Fixed Payer 246.8 million March 1, 2032 CHI Fixed Payer 98.8 million September 1, 2036 CHI Fixed Payer 128.5 million September 1, 2036 CHI Fixed Payer 19.8 million September 1, 2036 CHI Fixed Payer 100.0 million December 1, 2036 CHI CHI St. Luke’s CHI St. Luke’s CHI St. Luke’s CHI St. Luke’s Fixed Payer Fixed Payer Fixed Payer Fixed Payer Fixed Payer 149.1 million 129.5 million 109.4 million 100.0 million 100.0 million December 1, 2036 February 18, 2031 February 15, 2032 February 15, 2047 February 15, 2047 Centura Health2 Fixed Payer 15.6 million Madonna Manor 28.4 million Memorial East Texas Total Return Fixed Payer May 20, 2024 August 15, 2020 26.4 million February 15, 2035 Memorial East Texas Fixed Payer 18.7 million February 15, 2028 Fixed Payer 8.7 million March 1, 2017 Total Return 69.3 million April 4, 2018 - August 15, 2020 St. Joseph Regional Health Fixed Payer 46.4 million January 1, 2028 St. Joseph Regional Health Basis 30.0 million March 1, 2028 Providence St. Joseph Regional Health Total Notional Amount 3 $1,695.3 million 1Represents 20 Total Return Swaps. 2 Not secured by CHI COD obligations. 3 Represents 5 Total Return Swaps. This document is dated as of February 15, 2017 27 5. LIQUIDITY AND CAPITAL RESOURCES Cash Equivalents and Internally Designated Investments CHI holds highly liquid investments to enhance its ability to satisfy liquidity needs. Asset allocations are reviewed on a monthly basis and compared to investment allocation targets included within CHI’s investment policy. At December 31, 2016 and June 30, 2016, the CHI Reporting Group had cash and equivalents and internally designated investments (including net unrealized gains and losses) as described in the table below. The CHI Reporting Group (in Thousands) Cash and equivalents Internally designated investments Total CHI maintains an Operating Investment Program (the ”Program”) administered by the Corporation. The Program is structured as a limited partnership with the Corporation as the managing general partner. The Program contracts with investment advisers to manage the investments within the Program. Substantially all CHI long-term investments are held in the Program. The Corporation requires all Participants to invest in the Program. The Program consists of equity securities, fixed-income securities and alternative investments (e.g., private equity, hedge funds and real estate interests). The asset allocation is December 31, 2016 June 30, 2016 $ 771,603 $ 1,305,307 5,684,557 5,594,578 $ 6,456,160 $ 6,899,885 established by the Finance Committee of the Board of Stewardship Trustees. At December 31, 2016, the asset allocation was 40% equity securities, 40% fixed-income securities, 19% alternative investments (e.g., private equity, hedge funds and real estate interests) and 1% cash and equivalents. Alternative investments within the Program have limited liquidity. As of December 31, 2016, illiquid investments not available for redemption totaled $404.5 million, and investments available for redemption within 180 days at the request of the Program totaled $752.6 million. The Program’s return was 4.2% for the six months ended December 31, 2016. LIQUIDITY ARRANGEMENTS The Corporation maintains several liquidity facilities that are dedicated to funding optional or mandatory tenders of its variable rate debt and paying the maturing principal of the commercial paper notes in the event remarketing proceeds are unavailable for such purpose. The Corporation’s dedicated self-liquidity lines are set forth below and can be found at http://emma.msrb.org. CHI Dedicated Self-Liquidity Lines – December 31, 2016 Bank Committed Amount Expiration Bank of New York Mellon $ 60.0 million PNC Bank 125.0 million August 24, 2017 J.P. Morgan 50.0 million December 31, 2017 Bank of New York Mellon 50.0 million December 15, 2017 MUFG Union Bank 75.0 million September 28, 2018 Northern Trust 65.0 million June 28, 2019 $ 425.0 million Total Self-Liquidity Lines 1 February 28, 20171 The Corporation and Bank of New York Mellon are negotiating renewal terms. This document is dated as of February 15, 2017 28 6. LIQUIDITY REPORT CHI posts a liquidity report monthly, which can be found at www.catholichealth.net and http://emma.msrb.org. PART VI: LEGAL PROCEEDINGS PENDING LITIGATION/REGULATORY MATTERS CHI operates in a highly litigious industry. As a result, various lawsuits, claims and regulatory proceedings have been instituted or asserted against it from time to time. CHI has knowledge of certain pending suits against certain of its entities that have arisen in the ordinary course of business. In the opinion of management, CHI maintains adequate insurance and/or other financial reserves to cover the estimated potential liability for damages in these cases, or, to the extent such liability is uninsured, adverse decisions will not have a material adverse effect on the financial position or operations of CHI. General Observation Relating to Status as Health Care System. CHI, like all major health care systems, periodically may be subject to investigations or audits by federal, state and local agencies involving compliance with a variety of laws and regulations. These investigations seek to determine compliance with, among other things, laws and regulations relating to Medicare and Medicaid reimbursement, including billing practices for certain services. Violation of such laws could result in substantial monetary fines, civil and/or criminal penalties and exclusion from participation in Medicare, Medicaid or similar programs. St. Joseph–London. Following a voluntary disclosure of compliance-related issues concerning cardiac stent cases performed at a CHI direct affiliate, St. Joseph London (“SJHS”), by a single, independent/nonemployed interventional cardiologist, on January 22, 2014, SJHS entered into a settlement agreement with the federal government, the Commonwealth of Kentucky, and three relators and paid $16.5 million to resolve civil and administrative monetary claims raised in a qui tam lawsuit relating to certain diagnostic and therapeutic cardiac procedures performed at SJHS’s facility and the financial relationship with certain cardiac physicians and physician groups. In addition, SJHS entered into a five-year corporate integrity agreement (“CIA”) with the OIG that imposes certain compliance oversight obligations solely at SJHS’s facility. The CIA is approaching the end of its third year. In a separate matter, numerous civil lawsuits have been filed against the Corporation and SJHS claiming damages for alleged unnecessary cardiac stent placements and other cardiac procedures. Both CHI and SJHS are vigorously defending these lawsuits. The first case, Edward Marshall, et al. v. Catholic Health Initiatives et al., Case No. 11-CI-00972, was tried to a defense verdict in favor of both CHI and SJHS. Plaintiffs agreed to dismiss the second case to be tried, Blair Apgar and Mary Apgar, his wife v. Catholic Health Initiatives, et al., Case No. 12-CI-00445. CHI and SJHS were dismissed before trial from the third case to be tried, James Davis, part of Anthony Adams et al. v. Catholic Health Initiatives, et al., Case No. 12-CI-00802, which resulted in a defense verdict in favor of the remaining defendants. The fourth case, LeMaster v. Catholic Health Initiatives, et al., Case No. 12-CI-00975, which was originally scheduled for trial in April 2016, was dismissed by the court following a grant of summary judgment in favor of SJHS due to plaintiff’s failure to establish a causal link between the alleged negligence and plaintiff’s injuries. The fifth case, Dolly Wathen, also part of Anthony Adams, et al. v. Catholic Health Initiatives, et al., Case No. 12-CI-00802, was dismissed by plaintiffs prior to trial. The sixth case, Kevin Ray Wells, Sr. v. Catholic Health Initiatives, et. al., Case No. 12-CI-00090, was tried to verdict in August 2016. The jury found in favor of the plaintiff and awarded compensatory damages in an amount just under $1.3 million and punitive damages of $20.0 million. Post-trial motions have been filed and, while the trial court did not set aside the verdict, it did reduce the punitive damage award to $5.0 million. The rulings of the trial court are now being appealed. The E/O Vada Owens v. Catholic Health Initiatives, et al. Case No. 12CI-00405 commenced trial on January 9, 2017 in the Circuit Court of Laurel County with the Honorable Judge Lay presiding. Prior to the case going to the jury, a Settlement in Principle was reached with Plaintiffs on all This document is dated as of February 15, 2017 29 of the cardiac claims, including the E/O Owens, but excluding Kevin Wells which is on appeal. Management believes that adequate reserves have been established and that the outcome of the current litigation will not have a material adverse effect on the financial position or results of operations of CHI. Pension Plan Litigation. In May 2013, the Corporation and two employees were named as defendants in a class action lawsuit under the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), challenging the “church plan” status of one of CHI’s defined benefit plans. Medina v. Catholic Health Initiatives, et. al., Civil No 13-1249 (District of Colorado). Subsequently, the Complaint was amended to name additional CHI-related defendants. The Complaint alleges that CHI’s defined benefit plan (1) does not meet the definition of a “church plan” under ERISA; (ii) does not satisfy ERISA’s minimum funding standards; (iii) violates various other provisions of ERISA applicable to covered defined benefit plans; or (iv) alternatively, if CHI’s defined benefit plan qualifies for “church plan” status, the “church plan” exemption is nonetheless an unconstitutional accommodation under the Establishment Clause of the First Amendment. On December 8, 2015, the U.S. District Court for the District of Colorado entered summary judgment in favor of CHI and the individual defendants on all of plaintiff’s claims, dismissing the claims with prejudice, and awarding defendants their costs. Plaintiff filed a notice of appeal on January 6, 2016. The parties have filed their initial briefs with the Tenth Circuit Court of Appeals and oral argument on the appeal was scheduled for January 18, 2017. However, on December 13, 2016, following certain action taken by the United States Supreme Court in other non-CHI-related “church plan” litigation (described below), the Tenth Circuit vacated the hearing and stayed the appeal. The parties are to file a joint report with the Tenth Circuit on the status of the Supreme Court proceedings by March 15, 2017. While no assurance can be given as to the outcome of the appeal, management does not believe that this matter, if decided adversely to CHI, would have a material adverse effect on the financial position or results of operations of CHI. In other non-CHI-related “church plan” litigation (i.e., Advocate Health Care Network v. Stapleton, St. Peter’s Healthcare System v. Kaplan, and Dignity Health v. Rollins), the Supreme Court, on December 2, 2016, granted certiorari on the legal question of whether only a church can establish a “church plan” within the meaning of ERISA. It is not yet known what the outcome of the Supreme Court proceedings in the three cases will be or what impact they will ultimately have on the CHI litigation, but as noted, the appeal is stayed pending the Supreme Court proceedings. This document is dated as of February 15, 2017 30 APPENDIX A CATHOLIC HEALTH INITIATIVES CONSOLIDATED INTERIM FINANCIAL STATEMENTS (Unaudited) As of December 31, 2016 and for the Three and Six Months Ended December 31, 2016 and 2015 This document is dated as of February 15, 2017 31 CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED) Catholic Health Initiatives As of December 31, 2016 and for the Three and Six Months Ended December 31, 2016 and 2015 With Review Report of Independent Auditors Ernst & Young LLP Catholic Health Initiatives Consolidated Interim Financial Statements (Unaudited) As of December 31, 2016 and for the Three and Six Months Ended December 31, 2016 and 2015 Contents Review Report of Independent Auditors .........................................................................................1 Consolidated Interim Financial Statements (Unaudited) Consolidated Balance Sheets ...........................................................................................................2 Consolidated Statements of Operations ...........................................................................................4 Consolidated Statements of Changes in Net Assets ........................................................................5 Consolidated Statements of Cash Flows ..........................................................................................6 Notes to Consolidated Interim Financial Statements (Unaudited) ..................................................7 1702-2191482 Ernst & Young LLP Suite 3300 370 17th Street Denver, CO 80202 Tel: +1 720 931 4000 Fax: +1 720 931 4444 ey.com Review Report of Independent Auditors The Board of Stewardship Trustees Catholic Health Initiatives We have reviewed the consolidated financial information of Catholic Health Initiatives, which comprise the consolidated balance sheet as of December 31, 2016, and the related consolidated statements of operations for the three-month and six-month periods ended December 31, 2016, changes in net assets for the six-month period ended December 31, 2016 and cash flows for the six-month periods ended December 31, 2016 and 2015. Management’s Responsibility for the Financial Information Management is responsible for the preparation and fair presentation of the interim financial information in conformity with U.S. generally accepted accounting principles; this includes the design, implementation and maintenance of internal control sufficient to provide a reasonable basis for the preparation and fair presentation of interim financial information in conformity with U.S. generally accepted accounting principles. Auditor’s Responsibility Our responsibility is to conduct our review in accordance with auditing standards generally accepted in the United States applicable to reviews of interim financial information. A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States, the objective of which is the expression of an opinion regarding the financial information. Accordingly, we do not express such an opinion. Conclusion Based on our review, we are not aware of any material modifications that should be made to the consolidated financial information referred to above for it to be in conformity with U.S. generally accepted accounting principles. ey February 15, 2017 1702-2191482 A member firm of Ernst & Young Global Limited 1 Catholic Health Initiatives Consolidated Balance Sheets (In Thousands) Assets Current assets: Cash and equivalents Net patient accounts receivable, less allowances for bad debts of $986,237 and $968,147 at December and June, respectively Other accounts receivable Current portion of investments and assets limited as to use Inventories Assets held for sale Prepaid and other Total current assets December 31, 2016 (Unaudited) $ Investments and assets limited as to use: Internally designated for capital and other funds Mission and Ministry Fund Capital Resource Pool Held by trustees Held for insurance purposes Restricted by donors Total investments and assets limited as to use Property and equipment, net Investments in unconsolidated organizations Intangible assets and goodwill, net Notes receivable and other Total assets 2 $ 771,433 June 30, 2016 $ 1,305,242 2,228,769 261,557 2,161,237 274,432 121,176 306,461 192,869 183,387 4,065,652 63,146 296,647 223,285 152,230 4,476,219 5,026,824 132,957 272,331 76,993 813,725 267,470 6,590,300 4,952,065 125,166 261,572 113,235 841,048 264,949 6,558,035 9,131,508 1,311,590 472,973 434,292 22,006,315 9,452,010 1,263,506 462,838 446,522 22,659,130 $ 1702-2191482 Liabilities and net assets Current liabilities: Compensation and benefits Third-party liabilities, net Accounts payable and accrued expenses Liabilities held for sale Variable-rate debt with self-liquidity Commercial paper and current portion of debt Total current liabilities December 31, 2016 (Unaudited) $ Pension liability Self-insured reserves and claims Other liabilities Long-term debt Total liabilities Net assets: Net assets attributable to CHI Net assets attributable to noncontrolling interests Unrestricted Temporarily restricted Permanently restricted Total net assets Total liabilities and net assets $ 710,771 71,533 1,398,945 102,926 96,700 1,987,728 4,368,603 June 30, 2016 $ 717,638 110,284 1,750,402 131,814 96,700 1,769,390 4,576,228 1,511,024 637,894 1,237,070 6,877,869 14,632,460 1,535,840 646,714 1,262,068 7,191,184 15,212,034 6,647,798 403,596 7,051,394 226,917 95,544 7,373,855 6,704,217 423,424 7,127,641 224,524 94,931 7,447,096 22,006,315 $ 22,659,130 See accompanying notes. 1702-2191482 3 Catholic Health Initiatives Consolidated Statements of Operations (In Thousands) (Unaudited) Three Months Ended December 31, 2016 2015 Revenues Net patient services revenues before provision for doubtful accounts Provision for doubtful accounts Net patient services revenues Other operating revenues: Donations Changes in equity of unconsolidated organizations Gains on business combinations Hospital ancillary revenues Other Total other operating revenues Total operating revenues $ 4,092,920 $ 3,891,551 $ 8,020,715 $ 7,672,147 (229,263) (475,526) (240,392) (449,785) 3,662,288 7,196,621 3,852,528 7,570,930 Expenses Salaries and wages Employee benefits Purchased services, medical professional fees, medical claims and consulting Supplies Utilities Rentals, leases, maintenance and insurance Depreciation and amortization Interest Other Total operating expenses before restructuring, impairment and other losses Loss from operations before restructuring, impairment and other losses Restructuring, impairment and other losses Loss from operations Nonoperating gains Investment income (losses), net (Loss) gain on defeasance of bonds Realized and unrealized gains (losses) on interest rate swaps Other nonoperating losses Total nonoperating gains (losses) (Deficit) excess of revenues over expenses (Deficit) excess of revenues over expenses attributable to noncontrolling interest Deficit of revenues over expenses attributable to CHI Six Months Ended December 31, 2016 2015 $ 10,360 8,874 – 85,845 132,492 237,571 4,090,099 7,348 15,228 – 88,612 129,766 240,954 3,903,242 18,570 17,115 – 175,265 281,383 492,333 8,063,263 15,245 30,922 141,668 176,110 252,083 616,028 7,812,649 1,700,532 325,013 1,616,971 291,622 3,373,677 633,864 3,172,705 585,637 627,160 726,216 54,331 218,122 218,869 76,128 228,672 574,563 708,464 55,387 227,085 217,398 73,911 234,115 1,260,255 1,443,209 116,162 456,267 436,046 153,117 447,758 1,114,489 1,378,422 115,742 463,532 432,784 146,666 467,771 4,175,043 3,999,516 8,320,355 7,877,748 (84,944) 78,319 (163,263) (96,274) 18,334 (114,608) (257,092) 126,616 (383,708) (65,099) 41,293 (106,392) 18,715 – 110,544 – 244,737 (8,506) (172,015) 908 105,283 (2,349) 121,649 (41,614) (249) 11,741 (5,080) 117,205 2,597 3,386 105,322 (143) 341,410 (42,298) (1,081) (46,720) (8,494) (226,321) (332,713) 7,471 (41,217) $ (340,184) (41,365) $ (789) $ See accompanying notes. 1702-2191482 4 Catholic Health Initiatives Consolidated Statements of Changes in Net Assets (In Thousands) Unrestricted Net Assets Attributable to Attributable Noncontrolling to CHI Interests Total Balances, July 1, 2015 (Deficit) excess of revenues over expenses Net loss from discontinued operations Change in pension funded status Temporarily and permanently restricted contributions Net assets released from restriction for capital Net assets released from restriction for operations Investment income (losses) Temporarily and permanently restricted assets from acquisitons Temporarily and permanently restricted assets from dispositions Distributions to noncontrolling owners Noncontrolling ownership acquisitions Other changes in net assets Net decrease in net assets Balances, June 30, 2016 Deficit of revenues over expenses Net loss from discontinued operations Change in pension funded status Temporarily and permanently restricted contributions Net assets released from restriction for capital Net assets released from restriction for operations Investment (losses) income Distributions to noncontrolling owners Other changes in net assets Net (decrease) increase in net assets Balances, December 31, 2016 (unaudited) $ 8,150,235 $ (703,207) (30,667) (768,468) – 66,487 – 423 – – – – (10,586) (1,446,018) 6,704,217 (41,217) (24,257) (4,422) – 14,626 – – – (1,149) (56,419) $ 6,647,798 $ Temporarily Permanently Restricted Net Restricted Net Assets Assets 445,687 $ 8,595,922 $ 3,779 (699,428) – (30,667) (4,877) (773,345) – – – 66,487 – – – 423 – – – – (19,669) (19,669) 9,275 9,275 (10,771) (21,357) (22,263) (1,468,281) 423,424 7,127,641 (1,081) (42,298) – (24,257) – (4,422) – – – 14,626 – – – – (9,220) (9,220) (9,527) (10,676) (19,828) (76,247) 403,596 $ 7,051,394 $ 268,317 $ – – – 39,276 (66,487) (17,912) 27 11,672 (5,700) – – (4,669) (43,793) 224,524 – – – 22,750 (14,626) (6,889) 2,995 – (1,837) 2,393 226,917 $ Total Net Assets 97,776 $ 8,962,015 – (699,428) – (30,667) – (773,345) 3,487 42,763 – – – (17,912) (378) 72 2,531 14,203 (11,373) (17,073) – (19,669) – 9,275 2,888 (23,138) (2,845) (1,514,919) 94,931 7,447,096 – (42,298) – (24,257) – (4,422) 1,513 24,263 – – – (6,889) 59 3,054 – (9,220) (13,472) (959) 613 (73,241) 95,544 $ 7,373,855 See accompanying notes. 5 1702-2191482 Catholic Health Initiatives Consolidated Statements of Cash Flows (In Thousands) (Unaudited) Six Months Ended December 31, 2016 2015 Operating activities Decrease in net assets Adjustments to reconcile decrease in net assets to net cash (used in) provided by operating activities: Depreciation and amortization Provision for bad debts Changes in equity of unconsolidated organizations Net gains on business combinations Net gains on sales of facilities and investments in unconsolidated organizations Noncash operating expenses related to restructuring, impairment and other losses Losses (gains) on defeasance of bonds (Increase) decrease in fair value of interest rate swaps Decrease in unfunded pension liability Net changes in current assets and liabilities: Net patient and other accounts receivable Other current assets Current liabilities Other changes Net cash used in operating activities, before net change in investments and assets limited as to use Net (increase) decrease in investments and assets limited as to use Net cash (used in) provided by operating activities Investing activities Purchases of property, equipment, and other capital assets Investments in unconsolidated organizations Business acquisitions, net of cash acquired Proceeds from asset sales Distributions from investments in unconsolidated organizations Net repayments of notes receivable Other changes Net cash used in investing activities Financing activities Proceeds from issuance of debt and bank loans Repayment of debt Swap cash collateral received (posted) Net cash (used in) provided by financing activities Decrease in cash and equivalents Cash and equivalents at beginning of period Cash and equivalents at end of period $ $ (73,241) $ (391,720) 436,046 449,785 (17,115) – 432,784 475,526 (30,922) (141,668) (21,106) (319) 35,197 8,506 (123,756) (24,816) 34 (908) 25,864 (15,433) (461,969) (37,485) (344,232) (42,002) (686,254) (11,615) (187,097) 25,369 (216,188) (105,111) (321,299) (506,359) 784,200 277,841 (332,900) (29,736) (62,328) 197,873 19,766 5,237 (1,814) (203,902) (416,994) (20,949) 5,521 82,819 28,193 7,676 81 (313,653) 240,622 (375,972) 126,742 (8,608) 583,246 (524,830) (43,343) 15,073 (533,809) 1,305,242 771,433 $ (20,739) 948,369 927,630 See accompanying notes. 1702-2191482 6 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) December 31, 2016 1. Summary of Significant Accounting Policies Organization Catholic Health Initiatives (CHI), established in 1996, is a tax-exempt Colorado corporation and has been granted an exemption from federal income tax under Section 501(c)(3) of the Internal Revenue Code. CHI sponsors market-based organizations (MBOs) and other facilities operating in 17 states and includes 104 hospitals, including 4 academic medical centers, and 29 critical access facilities; community health service organizations; accredited nursing colleges; home health agencies; and other facilities that span the inpatient and outpatient continuum of care. CHI also has an offshore captive insurance company, First Initiatives Insurance, Ltd. (FIIL). The mission of CHI is to nurture the healing ministry of the Church, supported by education and research. Fidelity to the Gospel urges CHI to emphasize human dignity and social justice as CHI creates healthier communities. Basis of Presentation The consolidated interim financial statements of CHI as of December 31, 2016, and for the three and six months ended December 31, 2016 and 2015, reflect all adjustments, consisting only of normal recurring adjustments, which in the opinion of management are necessary to fairly state its financial position, results of operations and cash flows for the periods presented. The consolidated interim financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim reporting, and accordingly, certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to U.S. GAAP. However, CHI believes that the disclosures are adequate to make the information presented not misleading. These consolidated interim financial statements should be read in conjunction with the audited financial statements as of and for the year ended June 30, 2016. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Actual results could vary from the estimates. Operating results for the three and six months ended December 31, 2016 and 2015, are not necessarily indicative of the results that may be expected for any future period or for a full fiscal year as revenues, expenses, assets and liabilities can vary during each quarter of the year. 1702-2191482 7 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 1. Summary of Significant Accounting Policies (continued) Principles of Consolidation CHI consolidates all direct affiliates in which it has sole corporate membership or ownership (Direct Affiliates) and all entities in which it has greater than 50% equity interest with commensurate control. All significant intercompany accounts and transactions are eliminated in consolidation. Fair Value of Financial Instruments Financial instruments consist primarily of cash and equivalents, patient accounts receivable, investments and assets limited as to use, notes receivable and accounts payable. The carrying amounts reported in the consolidated balance sheets for these items, other than investments and assets limited as to use, approximate fair value. See Note 6, Fair Value of Assets and Liabilities, for a discussion of the fair value of investments and assets limited as to use. Cash and Equivalents Cash and equivalents include all deposits with banks and investments in interest-bearing securities with maturity dates of 90 days or less from the date of purchase. In addition, cash and equivalents include deposits in short-term funds held by professional managers. The funds generally invest in high-quality, short-term debt securities, including U.S. government securities, securities issued by domestic and foreign banks, such as certificates of deposit and bankers’ acceptances, repurchase agreements, asset-backed securities, high-grade commercial paper and corporate short-term obligations. Net Patient Accounts Receivable and Net Patient Services Revenues Net patient accounts receivable has been adjusted to the estimated amounts expected to be collected. These estimated amounts are subject to further adjustments upon review by third-party payors. The provision for bad debts is based upon management’s assessment of historical and expected net collections, taking into consideration historical business and economic conditions, trends in health care coverage and other collection indicators. Management routinely assesses the adequacy of the allowances for uncollectible accounts based upon historical write-off experience by payor category. The results of these reviews are used to modify, as necessary, the provision for bad debts 1702-2191482 8 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 1. Summary of Significant Accounting Policies (continued) and to establish appropriate allowances for uncollectible net patient accounts receivable. After satisfaction of amounts due from insurance, CHI follows established guidelines for placing certain patient balances with collection agencies, subject to the terms of certain restrictions on collection efforts as determined by each facility. The provision for bad debts is presented on the consolidated statement of operations as a deduction from patient services revenues (net of contractual allowances and discounts) since CHI accepts and treats all patients without the regard to the ability to pay. For the year ended June 30, 2016, CHI added approximately $93.3 million in net patient and other accounts receivable due to the acquisition of various new subsidiaries – see Note 3, Acquisitions, Affiliations and Divestitures. Details of CHI’s allowance activity are as follows (in thousands): Reserve for Contractual Allowance Balance at July 1, 2015 Additions Reductions Balance at June 30, 2016 Additions Reductions Balance at December 31, 2016 $ (3,712,688) $ (36,732,943) 36,469,175 (3,976,456) (19,189,425) 19,222,311 $ (3,943,570) $ Allowance for Bad Debt (903,127) $ (879,841) 814,821 (968,147) (449,785) 431,695 (986,237) $ Reserve for Charity Total Accounts Receivable Allowances (304,135) $ (4,919,950) (903,790) (38,516,574) 1,029,754 38,313,750 (178,171) (5,122,774) (551,968) (20,191,178) 505,866 20,159,872 (224,273) $ (5,154,080) CHI records net patient services revenues in the period in which services are performed. CHI has agreements with third-party payors that provide for payments at amounts different from its established rates. The basis for payment under these agreements includes prospectively determined rates, cost reimbursement and negotiated discounts from established rates, and per diem payments. Net patient services revenues are reported at the estimated net realizable amounts from patients, third-party payors and others for services rendered, including estimated retroactive adjustments due to future audits, reviews and investigations, and excluding estimated amounts considered uncollectible. The differences between the estimated and actual adjustments are recorded as part of net patient services revenues in future periods, as the amounts become known, or as years are no longer subject to such audits, reviews and investigations. 1702-2191482 9 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 1. Summary of Significant Accounting Policies (continued) Investments and Assets Limited as to Use Investments and assets limited as to use include assets set aside by CHI for future long-term purposes, including capital improvements and self-insurance. In addition, assets limited as to use include amounts held by trustees under bond indenture agreements, amounts contributed by donors with stipulated restrictions, and amounts held for Mission and Ministry programs. CHI has designated its investment portfolio as trading as the portfolio is actively managed to achieve investment returns. Accordingly, unrealized gains and losses on marketable securities are reported within excess of revenues over expenses. In addition, cash flows from the purchases and sales of marketable securities are reported as a component of operating activities in the accompanying consolidated statements of cash flows. Direct investments in equity securities with readily determinable fair values and all direct investments in debt securities have been measured at fair value in the accompanying consolidated balance sheets. Investment income or loss (including realized gains and losses on investments, interest and dividends) is included in excess of revenues over expenses unless the income or loss is restricted by donor or law. Investments in limited partnerships and limited liability companies are recorded using the equity method of accounting (which approximates fair value as determined by the net asset values of the related unitized interests) with the related changes in value in earnings reported as investment income in the accompanying consolidated financial statements. Inventories Inventories, primarily consisting of pharmacy drugs, and medical and surgical supplies, are stated at lower of cost (first-in, first-out method) or market. Assets and Liabilities Held for Sale A long-lived asset or disposal group of assets and liabilities that is expected to be sold within one year is classified as held for sale. For long-lived assets held for sale, an impairment charge is recorded if the carrying amount of the asset exceeds its fair value less costs to sell. Such valuations include estimates of fair values generally based upon firm offers, discounted cash flows and incremental direct costs to transact a sale (Level 2 and Level 3 inputs). 1702-2191482 10 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 1. Summary of Significant Accounting Policies (continued) Property and Equipment Property and equipment are stated at historical cost or, if donated or impaired, at fair value at the date of receipt or impairment. Depreciation is provided over the estimated useful life of each class of depreciable asset and is computed using the straight-line method. Buildings and improvements are depreciated over estimated useful lives of 5 to 84 years, equipment over 3 to 30 years, and land improvements over 2 to 25 years. For property and equipment under capital lease, amortization is determined over the shorter period of the lease term or the estimated useful life of the property and equipment. During the first quarter of fiscal year 2017, and as part of CHI’s long-term effort to improve the mix of owned and leased assets, CHI sold various real estate assets and entered into operating lease agreements with the buyers. The assets had a total net book value of $176.8 million, including $5.1 million of net intangible assets, and were sold for gross proceeds of $195.9 million, resulting in the recognition of a $14.2 million gain on sale reflected in the consolidated statements of operations for the six months ended December 31, 2016, as well as $6.2 million in long-term deferred gains and $0.7 million in short-term deferred gains reflected in other-long term liabilities and accrued expenses, respectively, on the consolidated balance sheet, which will be amortized over the lease term. Interest cost incurred during the period of construction of major capital projects is capitalized as a component of the cost of acquiring those assets. Capitalized interest of $3.1 million and $5.4 million was recorded in the three months ended December 31, 2016 and 2015, respectively, and $6.2 million and $10.5 million was recorded in the six months ended December 31, 2016 and 2015, respectively. Costs incurred in the development and installation of internal-use software are expensed if they are incurred in the preliminary project stage or post-implementation stage, while certain costs are capitalized if incurred during the application development stage. Internal-use software is amortized over its expected useful life, generally between 2 and 15 years, with amortization beginning when the project is completed and the software is placed in service. 1702-2191482 11 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 1. Summary of Significant Accounting Policies (continued) Investments in Unconsolidated Organizations Investments in unconsolidated organizations are accounted for under the cost or equity method of accounting, as appropriate, based on the relative percentage of ownership and degree of influence over that organization. The income or loss on equity method investments is recorded in the consolidated statements of operations as changes in equity of unconsolidated organizations. Intangible Assets and Goodwill Intangible assets are comprised primarily of trade names, which are amortized over the estimated useful lives ranging from 10 to 25 years using the straight-line method. The weighted average useful life of the trade names is 16 years. Amortization expense of $2.5 million and $3.1 million was recorded in the three months ended December 31, 2016 and 2015, respectively, and $6.6 million and $6.3 million was recorded in the six months ended December 31, 2016 and 2015, respectively. Goodwill is not amortized but is subject to annual impairment tests during the third quarter of the fiscal year, as well as more frequent reviews whenever circumstances indicate a possible impairment may exist; no such circumstances were identified at December 31, 2016, with the exception of the Houston MBO discussed below. Impairment testing of goodwill is done at the reporting unit level by comparing the fair value of the reporting unit’s net assets against the carrying value of the reporting unit’s net assets, including goodwill. Each MBO is defined as a reporting unit for purposes of impairment testing. The fair value of net assets is generally estimated based on quantitative analysis of discounted cash flows (Level 3 measurement). The fair value of goodwill is determined by assigning fair values to assets and liabilities, with the remaining fair value reported as the implied fair value of goodwill. Effective in November 2016, the Houston MBO acquired various physician and diagnostic operations in Texas which resulted in the recognition of $34.4 million of goodwill, calculated as the difference between the consideration paid and the fair value of assets acquired and liabilities assumed. Based upon the Houston MBO’s quantitative goodwill analysis performed as of June 30, 2016 which determined that all of the Houston MBO’s goodwill balances were impaired, and based on the Houston MBO’s continued underperformance in the current fiscal year-to-date, CHI performed a goodwill impairment review of the Houston MBO as of December 31, 2016. The goodwill impairment review indicated that the fair value of the Houston MBO’s net assets remained below its carrying value and could not support a goodwill balance. As a result, CHI 1702-2191482 12 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 1. Summary of Significant Accounting Policies (continued) determined that the $34.4 million of goodwill recorded in November 2016 was impaired, and an impairment charge was recorded in the consolidated statement of operations for the three months ended December 31, 2016. As of June 30, 2016, CHI determined that $111.2 million of goodwill attributable to the Houston MBO operations was impaired and an impairment charge was recorded in the consolidated statement of operations for the fourth quarter of fiscal year 2016. The changes in the carrying amount of goodwill and intangibles is as follows as of the beginning of each fiscal period presented (in thousands): December 31, 2016 Intangible assets, beginning of period Current year acquisitions Other adjustments Intangible assets, end of period June 30, 2016 251,776 $ 2,279 (11,325) 242,730 238,491 13,285 – 251,776 Accumulated amortization, beginning of period Intangible amortization expense Other adjustments Accumulated amortization, end of period Intangible assets, net (50,680) (6,636) 8,198 (49,118) 193,612 (38,140) (12,783) 243 (50,680) 201,096 Goodwill, beginning of period Current year acquisitions Impairments Other adjustments Goodwill, end of period Total intangible assets and goodwill, net 261,742 52,256 (34,419) (218) 279,361 472,973 $ 1702-2191482 $ $ 350,149 22,766 (111,173) – 261,742 462,838 13 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 1. Summary of Significant Accounting Policies (continued) Notes Receivable and Other Assets Other assets consist primarily of notes receivable, pledges receivable, deferred compensation assets, long-term prepaid service contracts, deposits and other long-term assets. Notes receivable from related entities at December 31, 2016, and June 30, 2016, include balances from Bethesda Hospital, Inc. (Bethesda), the non-CHI joint operating agreement (JOA) partner in the Cincinnati, Ohio JOA. A summary of notes receivable and other assets is as follows (in thousands): December 31, 2016 Notes receivable: From related entities Other Long-term pledge receivables Reinsurance recoverable on unpaid losses and loss adjustment expense Deferred compensation assets Other long-term assets Total notes receivable and other $ $ June 30, 2016 140,930 $ 29,506 39,184 148,289 36,384 36,324 32,226 80,989 111,457 434,292 $ 32,226 81,722 111,577 446,522 Bethesda is a Designated Affiliate in the CHI credit group under the Capital Obligation Document (COD). As conditions of joining the CHI credit group, Bethesda has agreed to certain covenants related to corporate existence, insurance coverage, exempt use of bond-financed facilities, maintenance of certain financial ratios and compliance with limitations on the incurrence of additional debt. Based upon management’s review of the creditworthiness of Bethesda and its compliance with the covenants and limitations, no allowances for uncollectible notes receivable were recorded at December 31, 2016, and June 30, 2016. Subsequent to December 31, 2016, Bethesda repaid their note receivable; after December 31, 2016, Bethesda was no longer a Designated Affiliate in the CHI credit group under the COD. 1702-2191482 14 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 1. Summary of Significant Accounting Policies (continued) Net Assets Temporarily restricted net assets are those whose use has been limited by donors to a specific time period or purpose. Permanently restricted net assets consist of gifts with corpus values that have been restricted by donors to be maintained in perpetuity, including endowment funds. Temporarily restricted net assets and earnings on permanently restricted net assets, including earnings on endowment funds, are used in accordance with the donor’s wishes primarily to purchase equipment, to provide charity care and to provide other health and educational programs and services. Unconditional promises to receive cash and other assets are reported at fair value at the date the promise is received. Conditional promises and indications of donors’ intentions to give are reported at fair value at the date the conditions are met or the gifts are received. All unrestricted contributions are included in the excess of revenue over expenses as donation revenues. Other gifts are reported as either temporarily or permanently restricted 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 donations revenue when restricted for operations or as unrestricted net assets when restricted for property and equipment. Performance Indicator The performance indicator is the excess of revenues over expenses, which includes all changes in unrestricted net assets other than changes in the pension liability funded status, net assets released from restrictions for property acquisitions, cumulative effect of changes in accounting principles, discontinued operations, contributions of property and equipment, and other changes not required to be included within the performance indicator under generally accepted accounting principles. 1702-2191482 15 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 1. Summary of Significant Accounting Policies (continued) Operating and Nonoperating Activities CHI’s primary mission is to meet the health care needs in its market areas through a broad range of general and specialized health care services, including inpatient acute care, outpatient services, physician services, long-term care and other health care services. Activities directly associated with the furtherance of this purpose are considered to be operating activities. Other activities that result in gains or losses peripheral to CHI’s primary mission are considered to be nonoperating. Nonoperating activities include investment earnings, gains or losses from bond defeasance, net interest cost and changes in fair value of interest rate swaps, and the nonoperating component of JOA income share adjustments. Any infrequent and nonreciprocal contribution that CHI makes to enter a new market community or to expand upon existing affiliations is also classified as nonoperating. Charity Care As an integral part of its mission, CHI accepts and provides medically necessary health care to all patients without regard to the patient’s financial ability to pay. Services to patients are classified as charity care in accordance with standards established across all MBOs. Charity care represents services rendered for which partial or no payment is expected, and includes the cost of providing services to persons who cannot afford health care due to inadequate resources and/or who are uninsured or underinsured. CHI determines the cost of charity care on the basis of an MBO’s total cost as a percentage of total charges, applied to the charges incurred by patients qualifying for charity care under CHI’s policy. This amount is not included in net patient services revenue in the accompanying consolidated statements of operations and changes in net assets. The estimated cost of charity care provided was $58.0 million and $53.7 million in the three months ended December 31, 2016 and 2015, respectively, and $114.8 million and $107.1 million in the six months ended December 31, 2016 and 2015, respectively. Other Operating Revenues Other operating revenues include services sold to external health care providers, gains on the acquisitions of subsidiaries, cafeteria sales, rental income, retail pharmacy and durable medical equipment sales, auxiliary and gift shop revenues, electronic health records incentive payments, gains and losses on the sales of assets, the operating portion of revenue-sharing income or expense associated with Direct Affiliates that are part of JOAs, premium revenues and revenues from other miscellaneous sources. 1702-2191482 16 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 1. Summary of Significant Accounting Policies (continued) Derivative and Hedging Instruments CHI uses derivative financial instruments (interest rate swaps) in managing its capital costs. These interest rate swaps are recognized at fair value on the consolidated balance sheets. CHI has not designated its interest rate swaps related to CHI’s long-term debt as hedges. The net interest cost and change in the fair value of such interest rate swaps is recognized as a component of nonoperating gains (losses) in the accompanying consolidated statements of operations. It is CHI’s policy to net the value of collateral on deposit with counterparties against the fair value of its interest rate swaps in other liabilities on the consolidated balance sheets. Functional Expenses CHI provides health care services, including inpatient, outpatient, ambulatory, long-term care and community-based services to individuals within the various geographic areas supported by its facilities. Support services include administration, finance and accounting, information technology, public relations, human resources, legal, mission services and other functions that are supported centrally for all of CHI. Support services expenses as a percent of total operating expenses were approximately 5.4% and 5.6% for the three months ended December 31, 2016 and 2015, respectively, and 5.6% for the six months ended December 31, 2016 and 2015. Restructuring, Impairment and Other Losses Restructuring, impairment and other losses include charges relating to changes in business operations, severance costs, EPIC go-live support costs, goodwill and long-lived asset impairments, acquisition-related costs, and pension settlement activity. Changes in business operations include costs incurred periodically to implement reorganization efforts within specific operations, in order to align CHI’s operations in the most strategic and cost-effective manner. 1702-2191482 17 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 1. Summary of Significant Accounting Policies (continued) Following is detail of restructuring, impairment and other losses (dollars in thousands): Three Months Ended December 31, 2016 2015 Impairment charges $ Changes in business operations Severance costs Total from continuing operations Discontinued operations Total restructuring, impairment and other losses $ Six Months Ended December 31, 2016 2015 37,933 $ 22,614 17,772 – $ 10,834 7,500 35,203 $ 65,123 26,290 34 30,803 10,456 78,319 418 18,334 – 126,616 1,107 41,293 (5) 78,737 $ 18,334 $ 127,723 $ 41,288 Discontinued operations are reported in the consolidated statements of changes in net assets. Income Taxes CHI is a tax-exempt Colorado corporation and has been granted an exemption from federal income tax under Section 501(c)(3) of the Internal Revenue Code. CHI owns certain taxable subsidiaries and engages in certain activities that are unrelated to its exempt purpose and therefore subject to income tax. Management reviews its tax positions quarterly and has determined that there are no material uncertain tax positions that require recognition in the accompanying consolidated financial statements. Use of Estimates The preparation of financial statements in conformity with U.S. generally accepted accounting principles (U.S. GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Actual results could vary from the estimates. 1702-2191482 18 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 1. Summary of Significant Accounting Policies (continued) New Accounting Pronouncements Presentation of Financial Statements of Not-for-Profit Entities – In August 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-14, Not-for Profit Entities (Topic 958), to change the way a not-for-profit entity (NFP) classifies and presents net assets on the face of the financial statements, and presents information in the financial statements and notes about the NFP’s liquidity, financial performance and cash flows. The amendment changes the way an NFP reports classes of net assets, from the currently required three classes to two, by eliminating the distinction between resources with permanent restrictions and those with temporary restrictions. The amendment also requires the NFP to provide enhanced disclosure about the nature, amounts and effects of the various types of donor-imposed restrictions, the NFP’s management of its liquidity to meet short-term demands for cash, and the types of resources used and how they are allocated to carrying out the NFP’s activities. ASU 2016-14 is effective for fiscal years beginning after December 15, 2017, and for interim periods within fiscal years beginning after December 15, 2018. Early application is permitted. Classification of Certain Cash Receipts and Cash Payments – In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230), to provide guidance on the presentation and classification of eight specific cash flow issues, which includes debt prepayment or debt extinguishment costs, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, distributions received from equity method investees, and separately identifiable cash flows and application of the predominance principle. The objective of the amendment is to reduce the existing diversity in practice. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted. Restricted Cash – In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230), to provide guidance on the presentation of restricted cash or restricted cash equivalents in the statement of cash flows. The amendments require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. ASU 2016-18 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted. 1702-2191482 19 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 2. Joint Operating Agreements and Investments in Unconsolidated Organizations Joint Operating Agreements CHI participates in JOAs with hospital-based organizations in three separate market areas. The agreements generally provide for, among other things, joint management of the combined operations of the local facilities included in the JOAs through Joint Operating Companies (JOC). CHI retains ownership of the assets, liabilities, equity, revenues and expenses of the CHI facilities that participate in the JOAs. The financial statements of the CHI facilities managed under all JOAs are included in the CHI consolidated financial statements. Transfers of assets from facilities owned by the JOA participants generally are restricted under the terms of the agreements. As of December 31, 2016, and June 30, 2016, CHI has investment interests of 65%, 50%, and 50% in JOCs based in Colorado, Iowa, and Ohio, respectively. CHI’s interests in the JOCs are included in investments in unconsolidated organizations and totaled $358.6 million and $351.9 million at December 31, 2016, and June 30, 2016, respectively. CHI recognizes its investment in all JOCs under the equity method of accounting. The JOCs provide varying levels of services to the related JOA sponsors, and operating expenses of the JOCs are allocated to each sponsoring organization. Investments in Unconsolidated Organizations CHI holds noncontrolling interests in various organizations, accounted for under the cost or equity method of accounting, as appropriate. Significant investments are described below. Conifer Health Solutions (Conifer) – As of December 31, 2016, and June 30, 2016, CHI holds a 23.8% equity method investment in Conifer totaling $593.9 million and $570.7 million, respectively. The investment in Conifer was acquired as part of a multiyear agreement with Conifer where Conifer provides revenue cycle services and health information management solutions for CHI acute care operations. Since CHI was granted incremental shares in Conifer in conjunction with the multiyear agreement with Conifer, CHI also has a deferred income balance related to the Conifer agreement of $445.0 million and $458.9 million as of December 31, 2016, and June 30, 2016, respectively, reported in other liabilities on the consolidated balance sheets. The deferred income balances are being amortized straight line over the remaining agreement term expiring in January 2033, offsetting revenue cycle services fees paid to Conifer which are reported in purchased services expense on the consolidated statements of operations. 1702-2191482 20 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 2. Joint Operating Agreements and Investments in Unconsolidated Organizations (continued) As a result of CHI recording its incremental equity ownership in Conifer at fair value, the carrying value of its equity method investment in Conifer was $256.5 million and $261.8 million greater than CHI’s equity interest in the underlying net assets of Conifer as of December 31, 2016, and June 30, 2016, respectively, due to basis differences in the carrying amounts of the tangible and intangible assets of $189.8 million and $195.1 million, respectively, and of goodwill of $66.7 million in both periods. Goodwill is not amortized but is subject to annual impairment tests during the third quarter of the fiscal year, as well as more frequent reviews whenever circumstances indicate a possible impairment may exist. No impairment of goodwill was identified as of December 31, 2016, and June 30, 2016. The basis differences of the tangible and intangible assets are being amortized over the average useful lives of the underlying assets, ranging from 8 to 25 years, as a reduction of CHI’s equity earnings in Conifer. 3. Acquisitions, Affiliations and Divestitures The following table is a summary of the business combinations and affiliations that occurred in fiscal year 2017 (in thousands): Fiscal year 2017 Purchase consideration: Cash Current liabilities Debt $ $ Purchase price allocation: Inventory Property and equipment Intangible assets Goodwill Current liabilities Debt $ $ 1702-2191482 53,328 723 27,755 81,806 3,041 38,023 11,180 34,419 (752) (4,105) 81,806 21 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 3. Acquisitions, Affiliations and Divestitures (continued) During fiscal year-to-date December 31, 2016, CHI entered into various business combinations and affiliations, including the acquisition by a subsidiary of CHI of the operations of a multi-specialty group in the state of Texas. The operations include a general acute care hospital and emergency room, an ambulatory surgery center, a management company, and an independent physician association comprising of more than 80 health care providers. The following table is a summary of the business combinations and affiliations that occurred in fiscal year 2016 (in thousands): Trinity Fiscal year 2016 Purchase consideration: Cash Noncontrolling interest Business combination gains $ Equity interest in Trinity $ – – 72,717 72,717 72,392 145,109 Brazosport $ $ Trinity Fiscal year 2016 Purchase price allocation: Cash and investments Patient and other A/R Other current assets Property and equipment Intangible assets Other assets Current liabilities Pension liability Other liabilities Debt Restricted assets $ $ 1702-2191482 133,349 $ 40,363 6,373 57,598 210 8,962 (26,246) (16,408) (9,818) (40,069) (9,205) 145,109 $ – – 21,293 21,293 – 21,293 LUH $ $ Brazosport 18,650 $ 22,191 3,200 36,292 – 144 (18,777) – (671) (38,450) (1,286) 21,293 $ – – 111,551 111,551 – 111,551 Other $ $ LUH 70,416 $ 25,346 9,775 111,609 – 13,276 (17,455) – – (97,765) (3,651) 111,551 $ 17,225 9,275 17,475 43,975 – 43,975 Total $ $ Other 5,420 $ 5,443 786 16,970 19,848 – (2,994) – – (1,437) (61) 43,975 $ 17,225 9,275 223,036 249,536 72,392 321,928 Total 227,835 93,343 20,134 222,469 20,058 22,382 (65,472) (16,408) (10,489) (177,721) (14,203) 321,928 22 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 3. Acquisitions, Affiliations and Divestitures (continued) Trinity Health System – Effective February 1, 2016, CHI became the sole owner of Trinity Health System (Trinity) based in Steubenville, Ohio, when it acquired the remaining 50% ownership in Trinity. The other 50% ownership in Trinity was held by Sylvania Franciscan Health (Sylvania), which CHI acquired in November 2014; the remeasurement of Sylvania’s investment in Trinity resulted in an immaterial gain on Sylvania’s 50% equity ownership. Trinity owns and operates Trinity Medical Center East, Trinity Medical Center West, Tony Teramana Cancer Center, and numerous outpatient clinics located in eastern Ohio. The transaction resulted in the recognition of a $72.7 million gain in the third quarter of fiscal year 2016, calculated as the fair value of identifiable assets acquired and liabilities assumed, determined based upon Level 3 inputs, including estimated future cash flows and probability-weighted performance assumptions. For the three months ended December 31, 2016, Trinity reported $56.2 million in operating revenues and $(0.6) million of deficit of revenues over expenses in the CHI consolidated results of operations. For the six months ended December 31, 2016, Trinity reported $116.7 million in operating revenues and $9.9 million of excess of revenues over expenses in the CHI consolidated results of operations. Brazosport Regional Health System – Effective February 1, 2016, a consolidated subsidiary of CHI signed an affiliation agreement with Brazosport Regional Health System (Brazosport) in Lake Jackson, Texas, to become part of CHI. Brazosport is a nonprofit health care organization that includes a 158-bed hospital that operates the only Level III trauma center in Brazoria County. The transaction resulted in the recognition of a $21.3 million gain in the third quarter of fiscal year 2016, calculated as the fair value of identifiable assets acquired and liabilities assumed, determined based upon Level 3 inputs, including estimated future cash flows and probability-weighted performance assumptions. For the three months ended December 31, 2016, Brazosport reported $20.4 million in operating revenues and $(2.5) million of deficit of revenues over expenses in the CHI consolidated results of operations. For the six months ended December 31, 2016, Brazosport reported $39.4 million in operating revenues and $(3.9) million of deficit of revenues over expenses in the CHI consolidated results of operations. 1702-2191482 23 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 3. Acquisitions, Affiliations and Divestitures (continued) Longmont United Hospital – Effective August 1, 2015, a direct affiliate of CHI entered into a Joint Operating and Management Agreement with Longmont United Hospital (LUH) to become the sole and exclusive agent to manage and operate the LUH business for a period of 99 years. The transaction resulted in the recognition of an estimated gain of $124.4 million for the six months ended December 31, 2015, and a total gain of $111.6 million gain for fiscal year 2016, calculated as the fair value of identifiable assets acquired and liabilities assumed, determined based upon Level 3 inputs including estimated future cash flows and probability-weighted performance assumptions. For the three months ended December 31, 2016 and 2015, LUH reported $44.2 million and $43.5 million in operating revenues, respectively, and $(5.4) million and $(4.3) million of deficit of revenues over expenses, respectively, in the CHI consolidated results of operations. For the six months ended December 31, 2016, and for the period from August 1, 2015 through December 31, 2015, LUH reported $88.7 million and $72.5 million in operating revenues, respectively, and $(9.5) million and $(5.5) million of deficit of revenues over expenses, respectively, in the CHI consolidated results of operations. Had CHI owned Trinity, Brazosport and LUH as of the beginning of the 2016 fiscal year, CHI’s unaudited pro forma results for the three and six months ended December 31, 2016 and 2015, would have been as presented below (in thousands): Three Months Ended December 31, 2016 2015 Pro Forma Pro Forma Total CHI Total CHI Operating revenues Operating loss before restructuring (Deficit) excess of revenues over expenses Six Months Ended December 31, 2016 2015 Pro Forma Pro Forma Total CHI Total CHI $ 4,099,086 $ 4,016,109 $ 8,098,922 $ 7,916,480 (99,834) (206,422) (84,287) (254,486) (40,958) 994 (39,692) (479,298) Unaudited pro forma information is not necessarily indicative of the historical results that would have been obtained had the transaction actually occurred on those dates, nor of future results. 1702-2191482 24 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 3. Acquisitions, Affiliations and Divestitures (continued) KentuckyOne/UMC JOA dissolution – In December 2016, KentuckyOne Health, a subsidiary of CHI, and University Medical Center (UMC) agreed to restructure their existing JOA, originally entered into in March 2013, which had given KentuckyOne Health control over substantially all of UMC’s operations, including University of Louisville Hospital and the James Graham Brown Cancer Center. Among the various capital investment and funding aspects of the new agreement, the new agreement also calls for UMC to take over the management of UMC operations effective on July 1, 2017, at which time CHI would cease consolidating the operations of UMC. For the three months ended December 31, 2016 and 2015, UMC reported total operating revenues of $130.9 million and $124.5 million, respectively, and excess of revenues over expenses of $6.9 million and $4.3 million, respectively. For the six months ended December 31, 2016 and 2015, UMC reported total operating revenues of $256.3 million and $253.8 million, respectively, and excess of revenues over expenses of $7.1 million and $9.1 million, respectively. The CHI consolidated balance sheets also included UMC total assets of $605.9 million and $516.9 million as of December 31, 2016, and June 30, 2016, respectively. Upon deconsolidation of UMC, CHI expects to incur a loss of approximately $271.6 million. Dignity Health – In October 2016, CHI signed a non-binding letter of intent with Dignity Health to explore aligning the organizations. It is anticipated that discussions will continue through early 2017. Discontinued Operations In May 2016, CHI approved a plan to sell or otherwise dispose of certain entities of QualChoice Health, Inc. (QualChoice Health), a consolidated CHI subsidiary, whose primary business is to develop, manage and market commercial and Medicare Advantage health insurance programs, as well as a wide range of products and administrative services. The sale of the operations is being actively marketed and is anticipated to close in fiscal year 2017. The QualChoice Health operations are reflected as discontinued operations and held for sale as of December 31, 2016, and June 30, 2016, in accordance with ASU No. 2014-08, Reporting Discontinued Operations and Disclosure of Disposals of Components of an Entity, as the operations held for sale are deemed to represent a strategic shift in CHI’s operations which will have a major effect on its financial results. 1702-2191482 25 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 3. Acquisitions, Affiliations and Divestitures (continued) Effective in fiscal year 2016, CHI sold the operations of the Reading, Pennsylvania, MBO and the Denville, New Jersey, MBO for gross proceeds of $206.0 million. The Denville MBO sale included $20.9 million of working capital settlements; as of December 31, 2015, CHI had received $62.0 million for the sale of the hospital operations of the Denville MBO plus $16.0 million in estimated working capital settlements net of closing costs. A final settlement of the Reading MBO working capital settlements is expected in fiscal year 2017. The Reading and Denville MBOs are reflected as discontinued operations in accordance with Accounting Standards Codification (ASC) 205-20, Discontinued Operations. The results of operations of QualChoice Health, the Reading MBO and the Denville MBO are reported in the consolidated statements of changes in net assets as discontinued operations. A reconciliation of major classes of assets and liabilities of the discontinued operations is presented below (in thousands): December 31, 2016 Net patient accounts receivable Other accounts receivable Investments held for insurance purposes Property and equipment, net Other assets Total major classes of assets of the discontinued operations Other assets classified as held for sale Total assets classified as held for sale Accounts payable and accrued expenses Self-insured reserves Other liabilities Total major classes of liabilities of the discontinued operations classified as held for sale 1702-2191482 June 30, 2016 85 $ 34,021 131,766 11,697 8,003 810 75,769 116,950 12,598 10,171 185,572 216,298 7,297 192,869 $ 6,987 223,285 $ 21,346 $ 62,776 18,804 37,995 74,629 19,190 $ 102,926 $ 131,814 $ $ 26 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 3. Acquisitions, Affiliations and Divestitures (continued) The $7.3 million and $7.0 million of other assets classified as held for sale as of December 31, 2016, and June 30, 2016, respectively, represent real estate assets which are scheduled to be sold in fiscal year 2017, measured at the lower of their carrying amount or fair value, less cost to sell. Operating results of discontinued operations are reported in the accompanying consolidated statements of changes in net assets and are summarized as follows for the three and six months ended December 31 (in thousands): Three Months Ended December 31, 2016 2015 Net patient service revenues Insurance premium revenues Other revenues Total operating revenues $ Salaries, wages and employee benefits Medical claims Depreciation and amortization Other expenses Total operating expenses Restructuring and other (losses) income Nonoperating (losses) income Deficit of revenues over expenses $ Six Months Ended December 31, 2016 2015 119 $ 159,336 870 160,325 5,928 $ 119,142 30,220 155,290 291 $ 312,685 3,648 316,624 76,036 234,583 66,193 376,812 9,881 149,670 738 13,281 173,570 46,677 107,818 1,041 29,713 185,249 20,771 286,858 1,285 29,962 338,876 125,717 207,057 2,682 79,507 414,963 (418) (1,155) – 745 (1,107) (898) (14,818) $ (29,214) $ (24,257) $ 5 736 (37,410) The discontinued operations reported $0.8 million and $(0.5) million in capital expenditures for the three months ended December 31, 2016 and 2015, respectively, and $0.8 million and $0.5 million for the six months ended December 31, 2016 and 2015, respectively. 1702-2191482 27 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 4. Net Patient Services Revenues Net patient services revenues are derived from services provided to patients who are either directly responsible for payment or are covered by various insurance or managed care programs. CHI receives payments from the federal government on behalf of patients covered by the Medicare program, from state governments for Medicaid and other state-sponsored programs, from certain private insurance companies and managed care programs and from patients themselves. A summary of payment arrangements with major third-party payors follows: Medicare – Inpatient acute care and certain outpatient services rendered to Medicare program beneficiaries are paid at prospectively determined rates per discharge or procedure. These rates vary according to patient classification systems based on clinical, diagnostic and other factors. Certain CHI facilities have been designated as critical access hospitals and, accordingly, are reimbursed their cost of providing services to Medicare beneficiaries. Professional services rendered by physicians are paid based on the Medicare allowable fee schedule. Medicaid – Inpatient services rendered to Medicaid program beneficiaries are primarily paid under the traditional Medicaid plan at prospectively determined rates per discharge. Certain outpatient services are reimbursed based on a cost reimbursement methodology, fee schedules or discounts from established charges. Other – CHI has also entered into payment agreements with certain managed care and commercial insurance carriers, health maintenance organizations and preferred provider organizations. The basis for payment to CHI under these agreements includes prospectively determined rates per discharge, discounts from established charges and prospectively determined daily rates. 1702-2191482 28 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 4. Net Patient Services Revenues (continued) CHI’s Medicare, Medicaid and other payor utilization percentages, based upon net patient services revenues before provision for doubtful accounts, are summarized as follows: Three Months Ended December 31, 2016 2015 Medicare Medicaid Managed care Self-pay Commercial and other 31% 13 43 2 11 100% 32% 13 39 4 12 100% Six Months Ended December 31, 2016 2015 33% 13 39 3 12 100% 32% 12 38 5 13 100% Laws and regulations governing the Medicare and Medicaid programs are extremely complex and subject to interpretation. As a result, there is at least a reasonable possibility that recorded estimates will change by a material amount in the near term. Estimated settlements related to Medicare and Medicaid of $71.9 million and $108.4 million at December 31, 2016, and June 30, 2016, respectively, are included in third-party liabilities. Net patient services revenues from continuing operations increased by $45.3 million and $38.5 million for the three months ended December 31, 2016 and 2015, respectively, and $53.3 million and $46.6 million for the six months ended December 31, 2016 and 2015, respectively, due to favorable changes in estimates related to prior year settlements. 1702-2191482 29 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 5. Investments and Assets Limited as to Use CHI’s investments and assets limited as to use are reported in the accompanying consolidated balance sheets as presented in the following table (in thousands): December 31, 2016 Cash and equivalents CHI Investment Program Marketable equity securities Marketable fixed-income securities Hedge funds and other investments Less current portion June 30, 2016 223,418 $ 185,325 5,266,787 5,480,912 342,327 334,020 802,382 646,477 24,360 26,649 6,621,181 6,711,476 (63,146) (121,176) $ 6,590,300 $ 6,558,035 $ Net unrealized gains in investments and assets limited as to use at December 31, 2016 and June 30, 2016, were $154.9 million and $120.1 million, respectively. CHI attempts to reduce its market risk by diversifying its investment portfolio using cash equivalents, marketable equity securities, fixed-income securities and alternative investments. Most of the U.S. Treasury, money market funds and corporate debt obligations as well as exchange-traded marketable securities held by CHI and the CHI Investment Program (the Program) have an actively traded market. However, CHI also invests in commercial paper, mortgage-backed or other asset-backed securities, alternative investments (hedge funds, private equity investments, real estate funds, funds of funds, etc.), collateralized debt obligations, municipal securities and other investments that have potential complexities in valuation based upon the current conditions in the credit markets. For some of these instruments, evidence supporting the determination of fair value may not come from trading in active primary or secondary markets. Because these investments may not be readily marketable, the estimated value is subject to uncertainty and, therefore, may differ from the value that would have been used had an active market for such investments existed. Such differences could be material. However, management reviews the CHI investment portfolio on a regular basis and seeks guidance from its professional portfolio managers related to U.S. and global market conditions to determine the fair value of its investments. CHI believes the carrying amount of these financial instruments in the consolidated financial statements is a reasonable estimate of fair value. 1702-2191482 30 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 5. Investments and Assets Limited as to Use (continued) The majority of all CHI long-term investments are held in the Program. The Program is structured under a Limited Partnership Agreement with CHI as managing general partner and numerous limited partners, most sponsored by CHI. The partnership provides a vehicle whereby virtually all entities associated with CHI, as well as certain other unrelated entities, can optimize investment returns while managing investment risk. Entities participating in the Program that are not consolidated in the accompanying financial statements have the ability to direct their invested amounts and liquidate and/or withdraw their interest without penalty as soon as practicable based on market conditions but within 180 days of notification. The Limited Partnership Agreement permits a simple-majority vote of the noncontrolling limited partners to terminate the partnership. Accordingly, CHI recognizes only the unitized portion of Program assets attributable to CHI and its direct affiliates. Program assets attributable to CHI and its direct affiliates represented 89% of total Program assets at December 31, 2016, and June 30, 2016, respectively. The Program asset allocation is as follows: Equity securities Fixed-income securities Alternative investments Cash and equivalents December 31, 2016 June 30, 2016 40% 40 19 1 100% 44% 32 23 1 100% The CHI Finance Committee (the Committee) of the Board of Stewardship Trustees is responsible for determining asset allocations among fixed-income, equity and alternative investments. At least annually, the Committee reviews targeted allocations and, if necessary, makes adjustments to targeted asset allocations. Given the diversity of the underlying securities in which the Program invests, management does not believe there is a significant concentration of credit risk. 1702-2191482 31 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 5. Investments and Assets Limited as to Use (continued) The Program allocation to alternative investments is based upon contractual commitment levels to various funds. These commitments are drawn by the fund managers as opportunities arise to invest the capital. As of December 31, 2016, the Program had committed to invest $805.0 million in 39 funds, of which $676.7 million had been invested. The remaining $128.3 million will be invested when, and if, requested by the funds. Alternative investments within the Program have limited liquidity. As of December 31, 2016, illiquid investments not available for redemption totaled $404.5 million, and investments available for redemption within 180 days at the request of the Program totaled $752.6 million. Investment income (losses) is comprised of the following (in thousands): Three Months Ended December 31, 2016 2015 Dividend and interest income $ Net realized gains Net unrealized (losses) gains Total investment income (loss) from continuing operations Total investment (loss) income from discontinued operations Total investment income (loss) $ 40,870 $ 82,358 (104,513) 39,335 $ 28,675 42,534 Six Months Ended December 31, 2016 2015 69,584 $ 141,369 33,784 74,022 41,818 (287,855) 18,715 110,544 244,737 (172,015) (1,155) 17,560 $ 745 111,289 $ (898) 243,839 $ 736 (171,279) Direct expenses of the Program are less than 0.4% of total assets during the prior fiscal year and are estimated to remain below this level in the current fiscal year. Fees paid to the alternative investment managers are not included in the total expense calculation as they are not a direct expense of the Program. 1702-2191482 32 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 6. Fair Value of Assets and Liabilities Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820, Fair Value Measurements and Disclosures, establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 inputs) and the lowest priority to unobservable inputs (Level 3 inputs). The three levels of the fair value hierarchy and a description of the valuation methodologies used for instruments measured at fair value are as follows: Level 1 – Valuation is based upon quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2 – Valuation is based upon quoted prices for similar assets and liabilities in active markets or other inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial asset or liability. Level 3 – Valuation is based upon other unobservable inputs that are significant to the fair value measurement. Certain of CHI’s alternative investments are made through limited liability companies (LLC) and limited liability partnerships (LLP). These LLCs and LLPs provide CHI with a proportionate share of the investment gains (losses). CHI accounts for its ownership in the LLCs and LLPs under the equity method. CHI also accounts for its ownership in the CHI Investment Program under the equity method. As such, these investments are excluded from the scope of ASC 820. Financial assets and liabilities measured at fair value on a recurring basis were determined using the market approach based upon the following inputs at December 31, 2016, and June 30, 2016 (in thousands). 1702-2191482 33 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 6. Fair Value of Assets and Liabilities (continued) December 31, 2016 Fair Value Measurements at Reporting Date Using (Level 1) (Level 2) (Level 3) Fair Value Quoted Prices Other as of in Active Observable Unobservable December 31 Markets Inputs Inputs Assets Assets limited as to use: Cash and short-term investments Equity securities Fixed-income securities Other investments $ Deferred compensation assets: Cash and short-term investments $ Liabilities Interest rate swaps Contingent consideration Deferred compensation liability $ $ 1702-2191482 223,418 $ 334,020 646,477 602 202,706 $ 334,020 129,089 – 20,712 $ – 517,388 – – – – 602 7,207 1,211,724 $ 7,207 673,022 $ – 538,100 $ – 602 292,039 $ 175,277 7,207 474,523 $ – $ – 7,207 7,207 $ 292,039 $ – – 292,039 $ – 175,277 – 175,277 34 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 6. Fair Value of Assets and Liabilities (continued) June 30, 2016 Fair Value Measurements at Reporting Date Using (Level 1) (Level 2) (Level 3) Quoted Prices Other in Active Observable Unobservable Fair Value Markets Inputs Inputs Assets Assets limited as to use: Cash and short-term investments Marketable equity securities Marketable fixed-income securities Other investments $ Deferred compensation assets: Cash and short-term investments $ Liabilities Interest rate swaps Contingent consideration Deferred compensation liability $ $ 185,325 $ 342,327 802,382 428 183,641 $ 342,327 143,263 – 1,684 $ – 659,119 – – – – 428 8,248 1,338,710 $ 8,248 677,479 $ – 660,803 $ – 428 416,277 $ 207,204 8,248 631,729 $ – $ – 8,248 8,248 $ 416,277 $ – – 416,277 $ – 207,204 – 207,204 The fair values of the securities included in Level 1 were determined through quoted market prices. Level 1 instruments include money market funds, mutual funds and marketable debt and equity securities. The fair values of Level 2 instruments were determined through evaluated bid prices based on recent trading activity and other relevant information, including market interest rate curves and referenced credit spreads; estimated prepayment rates, where applicable, are used for valuation purposes and are provided by third-party services where quoted market values are not available. Level 2 instruments include corporate fixed-income securities, government bonds, mortgage and asset-backed securities, and interest rate swaps. The fair values of Level 3 securities are determined primarily through information obtained from the relevant counterparties for such investments. Information on which these securities’ fair values are based is generally not readily available in the market. The fair value of the contingent consideration liability was determined based on estimated future cash flows and probability-weighted performance assumptions, discounted to net present value. The contingent consideration liability balance was adjusted to reflect $29.1 million of payments made since June 30, 2016, and to reflect a $2.8 million decrease for changes in payment assumptions. 1702-2191482 35 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 7. Debt Obligations The following is a summary of debt obligations (in thousands): Debt secured under the CHI COD Variable-rate bonds: CHI Series 2004B CHI Series 2004C CHI Series 2008A CHI Series 2008C CHI Series 2011B CHI Series 2011C CHI Series 2013B CHI Series 2013C CHI Series 2013E Taxable CHI Series 2013F Taxable CHI Series 2015-1 CHI Series 2015-2 CHI Series 2015A CHI Series 2015B CHI Series 2016 Taxable Commons of Providence Series 2009B Providence Care Center Series 2009C Providence Residential Community Series 2009A Fixed-rate bonds: CHI Series 2002A CHI Series 2004A CHI Series 2006A CHI Series 2008D CHI Series 2009A CHI Series 2009B CHI Series 2011A CHI Series 2012A CHI Series 2012 Taxable CHI Series 2013A CHI Series 2013D Taxable Madonna Manor Series 2010 St. Clare Commons Series 2012A St. Joseph Manor Series 1997B St. Joseph Regional Health Center Series 1993B St. Joseph Regional Health Center Series 1997A St. Joseph Regional Health Center Series 2014 1702-2191482 Maturity Date Interest Rates at December 31, 2016 2044 2039 2037 2040 2046 2046 2035 2046 2046 2046 2032 2027 2032 2042 2021 2034 2034 1.66% 0.93–1.0 1.16 1.67 1.32–2.12 1.51 1.72–2.12 2.18 2.12 1.99 1.32 1.32 1.42–1.48 1.42 2.12 2.42 2.42 2034 2.42 2017 2034 2042 2039 2040 2040 2041 2036 2043 2045 2024 2040 2042 2028 5.5 4.75–5.0 4.0–5.0 5.0–6.38 4.0–5.5 1.88–5.25 3.25–5.25 3.5–5.0 1.6–4.35 5.0–5.75 2.6–4.2 7.0 3.17 5.38 2019 December 31, 2016 $ 54,200 96,700 119,450 52,990 158,155 118,000 200,000 100,000 125,000 75,000 38,400 73,700 68,100 50,000 200,000 5,860 4,160 June 30, 2016 $ 54,200 96,700 120,175 52,990 158,155 118,000 200,000 100,000 125,000 75,000 38,400 73,700 69,500 50,000 – – – 6,770 – 920 140,985 268,015 445,220 653,280 217,720 451,270 199,670 1,500,000 600,600 540,000 27,510 31,335 13,895 920 140,985 270,635 452,065 672,050 217,720 451,270 264,170 1,500,000 600,600 540,000 27,990 31,720 13,895 6.0 8,760 8,760 2028 5.38 37,427 45,017 2032 2.84 25,255 25,255 36 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 7. Debt Obligations (continued) Debt secured under the CHI COD (continued) Bank line of credit Bank line of credit Bank loan Commercial paper Unamortized debt premium and discount, net Unamortized debt issuance costs Total debt secured under the CHI COD Other debt St. Leonard Master Trust Indenture Note payable issued to Episcopal Health Foundation Capital leases Other debt Total debt obligations Less amounts classified as current: Variable-rate debt with self-liquidity Commercial paper and current portion of debt Long-term debt Maturity Date Interest Rates at December 31, 2016 6/2017 – 12/2017 2017 1.62% – 2.43 1.05 December 31, 2016 $ 250,000 – 333,741 815,519 June 30, 2016 $ 25,726 (30,013) 8,103,320 2040 6.0–6.63 2020 4.0 31,580 (31,295) 8,194,417 41,585 41,892 167,053 183,439 466,900 8,962,297 167,053 177,771 476,141 9,057,274 (96,700) $ 250,000 200,000 333,741 815,519 (1,987,728) 6,877,869 $ (96,700) (1,769,390) 7,191,184 The fair value of debt obligations was approximately $9.0 billion at December 31, 2016. Management has determined the carrying values of the variable-rate bonds are representative of fair values as of December 31, 2016, as the interest rates are set by the market participants. The fair value of the fixed-rate tax-exempt bond obligations is determined by applying credit spreads for similar tax-exempt obligations in the marketplace, which are then used to calculate a price/yield for the outstanding obligations (Level 2 inputs). CHI issues the majority of its debt under the COD and is the sole obligor. Bondholder security resides both in the unsecured promise by CHI to pay its obligations and in its control of its Direct and Designated Affiliates. Covenants include a minimum CHI debt service coverage ratio and certain limitations on secured debt. The Direct Affiliates of CHI, defined as Participants under the COD, have agreed to certain covenants related to corporate existence, maintenance of insurance and exempt use of bond-financed facilities. Effective in September 2016, CHI issued obligations under the COD to support the repayment of three series of previously outstanding Providence, Ohio, bonds (the Ohio bonds); the Ohio bonds were classified as other debt as of June 30, 2016, in the table above. There were no modifications to the payment terms or holders of the Ohio bonds. 1702-2191482 37 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 7. Debt Obligations (continued) Debt issued under the St. Leonard Master Trust Indenture is secured by the property of St. Leonard in Centerville, Ohio, and a pledge of gross revenues. Debt Redemptions and Reissuances In September 2016, CHI redeemed $37.1 million of bonds that were originally acquired as part of the LUH business combination in fiscal year 2016. The bond redemption was funded by the issuance of $34.1 million of commercial paper and restricted investments. In August 2016, CHI redeemed $62.0 million of Series 2012A fixed-rate bonds in connection with the sale in the prior fiscal year of the underlying real estate assets. The bond redemption was funded from the real estate sale proceeds and resulted in a loss on redemption of $8.5 million for the three months ended September 30, 2016. In December 2016, CHI issued $200.0 million of Series 2016 Taxable variable-rate bonds. Proceeds were used to repay the $200.0 million bank line of credit which matured in November 2016. Liquidity Facilities, Credit Facilities and Other Lines of Credit CHI has two types of external liquidity facilities: those that are dedicated to specific series of variable-rate demand bonds (VRDBs) and those that are not dedicated to a particular series of VRDBs but may be used to support CHI’s obligations to fund tenders of VRDBs and pay the maturing principal of commercial paper. Liquidity facilities that are dedicated to specific series of bonds were $1.0 billion and $824.0 million at December 31, 2016, and June 30, 2016, respectively, of which $6.3 million and $5.8 million are classified as current at December 31, 2016, and June 30, 2016, respectively. The remaining $1.4 billion and $1.2 billion is reported as long-term debt at December 31, 2016, and June 30, 2016, respectively, due to the repayment terms on any associated drawings extending beyond one year under the terms of the specific agreements. Liquidity facilities not dedicated for specific series of VRDBs but used to support CHI’s obligations to fund tenders and to pay maturing principal of commercial paper were $425.0 million at December 31, 2016, and June 30, 2016. Commercial paper balances of $815.5 million at December 31, 2016, and June 30, 2016, were classified as current due to maturities of less than one year. 1702-2191482 38 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 7. Debt Obligations (continued) At both December 31, 2016, and June 30, 2016, $96.7 million of VRDBs were classified as current due to the holder’s ability to put such VRDBs back to CHI on a daily basis, after providing seven-day notice to tender, without liquidity facilities dedicated to these bonds. CHI had a credit facility with Bank of New York Mellon totaling $69.0 million at both December 31, 2016, and June 30, 2016, of which letters of credit totaling $63.8 million and $63.9 million have been designated for the benefit of third parties at December 31, 2016, and June 30, 2016, respectively, principally in support of the self-insurance programs administered by FIIL. No amounts were outstanding under this credit facility at December 31, 2016, and June 30, 2016. Interest Rate Swap Agreements CHI utilizes various interest rate swap contracts to manage the risk of increased interest rates payable of certain variable rate bonds. The fixed-payer swap agreements convert CHI’s variablerate debt to fixed-rate debt. Generally, it is CHI policy that all counterparties have an AA rating or better. The swap agreements generally require CHI to provide collateral if CHI’s liability, determined on a mark-to-market basis, exceeds a specified threshold that varies based upon the rating on CHI’s long-term indebtedness. Based upon the swap agreements in place as of December 31, 2016, a reduction in CHI’s credit rating to BBB+ or BBB would obligate CHI to post additional cash collateral of $38.0 million or $67.0 million, respectively. If CHI’s credit rating were to fall below BBB, the swap counterparties would have the option to require CHI to settle the swap liabilities at the recorded fair value, which was $77.7 million as of December 31, 2016. The fair value of the swaps is estimated based on the present value sum of anticipated future net cash settlements until the swaps’ maturities. Cash collateral balances are netted against the fair value of the swaps, and the net amount is reflected in other liabilities in the accompanying consolidated balance sheets. At December 31, 2016, and June 30, 2016, the net swap liability reflected in other liabilities was $77.7 million and $75.1 million, respectively, net of swap collateral posted of $214.4 million and $341.1 million, respectively. The change in the fair value of swap agreements was a net gain of $114.1 million and $22.1 million, for the three months ended December 31, 2016 and 2015, respectively, and a net gain of $123.8 million and a net loss of $(25.9) million for the six months ended December 31, 2016 and 2015, respectively, reflected in realized and unrealized gains (losses) on interest rate swaps in the accompanying consolidated statements of operations. 1702-2191482 39 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 7. Debt Obligations (continued) The following is a summary of interest rate swap contracts (in thousands): Swap Contracts Fair Value Outstanding Liability (Asset) Notional Amount Maturity December 31, June 30, December 31, June 30, December 31, June 30, Date 2016 2016 2016 2016 2016 2016 Basis swaps Fixed payer swaps Total return swaps 3/2028 2017–2047 2017–2020 1 16 26 43 1 16 29 46 (736) $ (211) $ 30,000 415,308 290,545 1,448,556 1,705 1,705 216,752 $ 292,039 $ 416,277 $ 1,695,308 $ $ 30,000 1,452,710 223,787 $ 1,706,497 8. Retirement Plans CHI Pension Plan CHI and its direct affiliates maintain a variety of noncontributory, defined benefit retirement plans (Retirement Plans) for its employees. Certain of these plans were frozen in previous fiscal years, and benefits earned by employees through that time period remain in the Retirement Plans, where employees continue to receive interest credits and vesting credits, if applicable. Vesting occurs over a five-year period. Benefits in the Retirement Plans are based on compensation, retirement age and years of service. Substantially all of the Retirement Plans are qualified as church plans and are exempt from certain provisions of both the Employee Retirement Income Security Act of 1974 and Pension Benefit Guaranty Corporation premiums and coverage. Funding requirements are determined through consultation with independent actuaries. CHI recognizes the funded status (that is, the difference between the fair value of plan assets and the projected benefit obligations) of its Plans in the consolidated balance sheets, with a corresponding adjustment to net assets. Actuarial gains and losses that arise and are not recognized as net periodic pension cost in the same periods are recognized as a component of changes in net assets. CHI has increased its expected fiscal year 2017 contribution to the Plans to $66.5 million from $8.2 million previously disclosed in the audited financial statements as of and for the year ended June 30, 2016. 1702-2191482 40 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 8. Retirement Plans (continued) Estimated amounts for the components of net periodic pension expense (income) are summarized in the table below. Amounts will be adjusted at year-end to reflect actual results, based on the final annual actuarial reports (in thousands): Three Months Ended December 31, 2016 2015 Components of net periodic pension (credit) expense: Service cost Interest cost Expected return on the plans’ assets Actuarial losses $ $ Six Months Ended December 31, 2016 2015 2,335 $ 37,915 3,880 $ 50,298 4,670 $ 75,831 (67,925) 16,187 (11,488) $ (68,680) 9,534 (4,968) $ (135,851) 32,374 (22,976) $ 7,759 100,596 (137,359) 19,067 (9,937) CHI 401(k) Retirement Savings Plan CHI sponsors the CHI 401(k) Retirement Savings Plan (401(k) Savings Plan) for its employees whereby CHI matches 100.0% of the first 1.0% of eligible pay an employee contributes to the plan, and 50.0% of the next 5.0% of eligible pay contributed to the plan, for a maximum employer matching rate of 3.5% of eligible pay. On an annual basis and regardless of whether or not an employee participates in the 401(k) Savings Plan, CHI will also contribute 2.5% of eligible pay to an employee’s 401(k) Savings Plan account. This contribution is made if an employee reaches 1,000 hours in the first year of employment or every calendar year thereafter, and is employed on the last day of the calendar year. An employee is fully vested in the plan for employer contributions after three years of service. CHI recorded 401(k) Savings Plan expense of $58.5 million and $47.4 million for the three months ended December 31, 2016 and 2015, respectively, and $118.7 million and $99.1 million for the six months ended December 31, 2016 and 2015, respectively. 1702-2191482 41 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 9. Concentrations of Credit Risk CHI grants credit without collateral to its patients, most of whom are insured under third-party payor agreements. CHI’s exposure to credit risk on patient accounts receivable is limited by the geographical diversity of its MBOs. The mix of receivables from patients and third-party payors approximated the following: Medicare Medicaid Managed care Self-pay Commercial and other December 31, 2016 June 30, 2016 26% 12 38 7 17 100% 27% 11 33 11 18 100% CHI maintains long-term investments with various financial institutions and investment management firms through its investment program, and its policy is designed to limit exposure to any one institution or investment. Management does not believe there are significant concentrations of credit risk at December 31, 2016, and June 30, 2016. 10. Commitments and Contingencies Litigation During the normal course of business, CHI may become involved in litigation. Management assesses the probable outcome of unresolved litigation and records estimated settlements. After consultation with legal counsel, management believes that any such matters will be resolved without material adverse impact to the consolidated financial position or results of operations of CHI. 1702-2191482 42 Catholic Health Initiatives Notes to Consolidated Interim Financial Statements (Unaudited) (continued) 10. Commitments and Contingencies (continued) Health Care Regulatory Environment The health care industry is subject to numerous laws and regulations of federal, state and local governments. These laws and regulations include, but are not limited to, matters such as licensure, accreditation, government health care program participation requirements, reimbursement for patient services, and Medicare and Medicaid fraud and abuse. Management believes CHI is in compliance with all applicable laws and regulations of the Medicare and Medicaid programs. Compliance with such laws and regulations is complex and can be subject to future governmental interpretation as well as significant regulatory action, including fines, penalties and exclusion from the Medicare and Medicaid programs. Certain CHI entities have been contacted by governmental agencies regarding alleged violations of Medicare practices for certain services. In the opinion of management after consultation with legal counsel, the ultimate outcome of these matters will not have a material adverse effect on CHI’s consolidated financial position. 11. Subsequent Events CHI’s management has evaluated events subsequent to December 31, 2016 through February 15, 2017, which is the date these consolidated financial statements were available to be issued. There have been no material events noted during this period that would either impact the results reflected herein or CHI’s results going forward, except as disclosed below. In February 2017, a subsidiary of CHI sold certain outpatient ambulatory business lines which will result in an estimated gain on sale of approximately $100 million. 1702-2191482 43 EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. 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