This document is dated February 15, 2017 _________________________________ UNAUDITED QUARTERLY REPORT For the period ended December 31, 2016 _________________________________ Dignity Health The information in this report has been provided by Dignity Health DIGNITY HEALTH AND SUBORDINATE CORPORATIONS TABLE OF CONTENTS Page QUARTERLY FINANCIAL STATEMENTS Independent Auditors’ Review Report 1 Condensed Consolidated Balance Sheets (unaudited) as of December 31, 2016 and June 30, 2016 2 Condensed Consolidated Statements of Operations and Changes in Net Assets (unaudited) for the Three and Six-Month Periods Ended December 31, 2016 and 2015 4 Condensed Consolidated Statements of Cash Flows (unaudited) for the Six-Month Periods Ended December 31, 2016 and 2015 6 Notes to Unaudited Condensed Consolidated Financial Statements 8 MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 23 ANNUAL AUDITED FINANCIAL STATEMENTS 29 INDEPENDENT AUDITORS’ REVIEW REPORT To the Board of Directors of Dignity Health San Francisco, California We have reviewed the accompanying condensed consolidated balance sheet of Dignity Health and Subordinate Corporations (“Dignity Health”) as of December 31, 2016, and the related condensed consolidated statements of operations and changes in net assets for the three and six-month periods ended December 31, 2016 and 2015 and cash flows for the six-month periods ended December 31, 2016 and 2015 (the “interim financial information”). Management's Responsibility for the Interim Financial Information Dignity Health’s management is responsible for the preparation and fair presentation of the interim financial information in accordance with accounting principles generally accepted in the United States of America; this responsibility 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 accordance with accounting principles generally accepted in the United States of America. Auditors' Responsibility Our responsibility is to conduct our reviews in accordance with auditing standards generally accepted in the United States of America 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 of America, 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 reviews, we are not aware of any material modifications that should be made to the interim financial information referred to above for it to be in accordance with accounting principles generally accepted in the United States of America. Report on Condensed Consolidated Balance Sheet as of June 30, 2016 We have previously audited, in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheet of Dignity Health as of June 30, 2016, and the related consolidated statements of operations and changes in net assets and cash flows for the year then ended; and in our report dated September 21, 2016, we expressed an unqualified opinion on those audited consolidated financial statements and included a disclaimer of opinion on the unsponsored community benefit expense information in Note 24. In our opinion, the accompanying condensed consolidated balance sheet of Dignity Health as of June 30, 2016, is consistent, in all material respects, with the audited consolidated financial statements from which it has been derived. February 15, 2017 DIGNITY HEALTH AND SUBORDINATE CORPORATIONS UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2016 AND JUNE 30, 2016 (In thousands) As of December 31, 2016 As of June 30, 2016 Assets Current assets: Cash and cash equivalents Short-term investments Collateral held under securities lending program Assets limited as to use Patient accounts receivable, net of allowance for doubtful accounts of $669,303 and $631,628 at December 31, 2016 and June 30, 2016, respectively Broker receivables for unsettled investment trades Provider fee receivable Other current assets Total current assets 436,365 $ 2,131,750 77,413 1,083,611 569,473 2,047,997 162,239 1,014,919 1,922,056 56,951 1,338,915 661,570 7,708,631 1,816,529 82,487 1,088,686 607,454 7,389,784 2,293,704 394,940 329,113 2,266,976 400,022 291,415 13,390 26,791 469,069 63,972 (1,083,611) 2,507,368 45,591 95,551 445,212 66,009 (1,014,919) 2,595,857 Property and equipment, net 4,915,709 4,909,980 Ownership interests in health-related activities 1,389,843 1,324,540 Goodwill 587,537 574,355 Intangible assets, net 215,466 213,185 Assets limited as to use: Board-designated assets (including $204,438 and $325,011 of assets loaned under securities lending program at December 31, 2016 and June 30, 2016, respectively) for: Capital projects Workers' compensation Professional and general liability Under bond indenture agreements for: Capital projects Debt service Donor-restricted Other Less amount required to meet current obligations Net assets limited as to use Other long-term assets, net Total assets $ 73,279 74,961 $ 17,397,833 $ 17,082,662 (Continued) 2 DIGNITY HEALTH AND SUBORDINATE CORPORATIONS UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2016 AND JUNE 30, 2016 (In thousands) As of December 31, 2016 As of June 30, 2016 Liabilities and Net Assets Current liabilities: Current portion of long-term debt Demand bonds subject to short-term liquidity arrangements, excluding current maturities Accounts payable Payable under securities lending program Accrued salaries and benefits Accrued workers' compensation Accrued professional and general liability Pension and other postretirement benefit liabilities Broker payables for unsettled investment trades Derivative instruments Provider fee and CHFT grant payables Other accrued liabilities Total current liabilities $ 207,002 $ 112,283 753,500 620,020 77,414 604,367 46,149 68,813 354,581 4,981 175,650 354,993 323,800 3,591,270 761,800 659,536 162,241 681,835 47,042 68,417 356,217 14,930 248,913 355,857 343,757 3,812,828 Other liabilities: Workers' compensation Professional and general liability Pension and other postretirement benefit liabilities Deferred tax liabilities Other Total other liabilities 343,905 274,642 1,644,272 111,738 117,011 2,491,568 344,927 266,278 1,604,163 108,534 112,725 2,436,627 Long-term debt, net of current portion 4,710,301 4,605,283 10,793,139 10,854,738 Total liabilities Net assets: Unrestricted - attributable to Dignity Health Unrestricted - noncontrolling interest Temporarily restricted Permanently restricted Total net assets Total liabilities and net assets 5,892,712 5,550,726 242,174 231,337 354,887 331,128 114,733 114,921 6,604,694 6,227,924 $ 17,397,833 $ 17,082,662 (Concluded) See notes to consolidated financial statements. 3 DIGNITY HEALTH AND SUBORDINATE CORPORATIONS UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND CHANGES IN NET ASSETS FOR THE THREE AND SIX-MONTH PERIODS ENDED DECEMBER 31, 2016 AND 2015 (In thousands) Three-Month Periods Ended December 31, 2016 2015 Unrestricted revenues and other support: Patient revenue, net of contractual allowances and discounts $ Provision for bad debts Net patient revenue Premium revenue Revenue from health-related activities, net Other operating revenue Contributions Total unrestricted revenues and other support Expenses: Salaries and benefits Supplies Purchased services and other Depreciation and amortization Interest expense, net Total expenses Operating income (loss) Other income (loss): Investment income (loss), net Loss on early extinguishment of debt Income tax expense Total other income (loss), net Excess (deficit) of revenues over expenses Less excess of revenues over expenses attributable to noncontrolling interests Excess (deficit) of revenues over expenses attributable to Dignity Health $ $ 3,172,483 $ (129,515) 3,042,968 195,764 23,948 84,052 5,629 3,352,361 3,002,421 (143,960) 2,858,461 160,247 25,581 79,795 4,215 3,128,299 1,688,994 467,585 927,383 152,438 (18,152) Six-Month Periods Ended December 31, 2016 2015 6,316,800 $ (293,555) 6,023,245 359,998 51,587 162,715 8,221 6,605,766 6,003,083 (300,705) 5,702,378 308,731 23,456 163,291 7,111 6,204,967 1,645,579 443,370 848,621 146,224 42,371 3,369,638 916,918 1,817,807 303,548 32,973 3,255,841 878,875 1,702,193 290,260 123,203 3,218,248 3,126,165 6,440,884 6,250,372 134,113 2,134 164,882 (45,405) 21,806 89,105 240,047 (169,659) (45,672) (992) (24,858) (3,755) 85,350 (45,672) (4,893) 189,482 (9,608) (179,267) 109,255 $ 87,484 354,364 $ (224,672) 9,806 9,045 99,449 $ 78,439 $ $ 21,845 $ 332,519 $ 17,011 (241,683) (Continued) 4 DIGNITY HEALTH AND SUBORDINATE CORPORATIONS UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND CHANGES IN NET ASSETS FOR THE THREE AND SIX-MONTH PERIODS ENDED DECEMBER 31, 2016 AND 2015 (In thousands) Three-Month Periods Ended December 31, 2016 2015 Unrestricted net assets attributable to Dignity Health: Excess (deficit) of revenues over expenses attributable to Dignity Health Net assets released from restrictions used for purchase of property and equipment Gain (loss) from discontinued operations, net Change in net assets of unconsolidated equity investments Change in ownership interests held by controlled subsidiaries Change in accumulated unrealized derivative gains, net Funds donated from unconsolidated sources for purchase of property and equipment Other Increase (decrease) in unrestricted net assets attributable to Dignity Health $ Unrestricted net assets attributable to noncontrolling interests: Excess of revenues over expenses attributable to to noncontrolling interests Change in ownership interest and other, net Increase in unrestricted net assets attributable to noncontrolling interests Temporarily restricted net assets: Contributions Net realized and unrealized gains (losses) on investments Net assets released from restrictions Change in interest in net assets of unconsolidated foundations Other Increase in temporarily restricted net assets Permanently restricted net assets: Contributions Net realized and unrealized gains on investments Change in interest in net assets of unconsolidated foundations Other Increase in permanently restricted net assets Increase (decrease) in net assets Net assets, beginning of period $ Net assets, end of period 99,449 $ 78,439 $ Six-Month Periods Ended December 31, 2016 2015 332,519 $ (241,683) 3,048 (28) 709 (868) 671 2,746 (329) 8,583 1,055 671 3,901 69 1,458 (714) 1,341 5,682 (370) 6,512 553 1,341 2,173 32 3,482 (90) 3,408 4 3,905 (255) 94,557 341,986 (224,315) 9,806 (6,683) 9,045 (5,983) 21,845 (11,008) 17,011 (12,646) 3,123 3,062 10,837 4,365 11,554 674 (7,014) 3,406 (42) 8,578 10,872 1,668 (6,688) 6,716 154 12,722 21,522 3,349 (10,978) 10,003 (137) 23,759 24,000 (2,358) (12,480) (2,595) 310 6,877 480 18 72 (290) 280 2,956 5 4 (15) 2,950 455 78 19 (364) 3,041 5 (1,038) (15) 188 1,993 105,186 117,167 6,487,527 6,604,694 $ 113,291 6,966,447 7,079,738 $ 376,770 6,227,924 (211,080) 7,290,818 6,604,694 $ 7,079,738 (Concluded) See notes to consolidated financial statements. 5 DIGNITY HEALTH AND SUBORDINATE CORPORATIONS UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX-MONTH PERIODS ENDED DECEMBER 31, 2016 AND 2015 (In thousands) Six-Month Periods Ended December 31, 2016 2015 Cash flows from operating activities: Change in net assets Adjustments to reconcile change in net assets to cash used in operating activities: Loss on early extinguishment of debt Depreciation and amortization Health-related activities: Changes in equity of unconsolidated entities Changes in ownership of consolidated entities Loss (gain), net, on disposal of assets Change in deferred taxes Restricted contributions Undistributed portion of change in net assets of unconsolidated foundations Net realized and unrealized losses (gains) on investments Change in fair value of swaps Changes in certain assets and liabilities: Accounts receivable, net Accounts payable Workers' compensation and professional and general liabilities Accrued salaries and benefits Pension and other postretirement liabilities Provider fee assets and liabilities Estimated receivables from/payables to third-party payors, net Other accrued liabilities Prepaid and other current assets Other, net Cash used in operating activities $ 376,770 $ (211,080) 45,672 306,669 291,548 (52,019) (920) 91 3,204 (21,516) (31,837) 122 (810) 4,017 (23,231) (10,023) (220,273) (73,263) 3,634 200,069 18,469 (105,527) (29,344) 9,736 (77,468) 38,473 (251,093) (6,985) (8,458) (48,432) (3,346) (128,052) (82,842) 53,252 (12,487) (127,216) (14,575) (84,605) (13,549) 31,717 (26,270) (1,783) (27,457) (Continued) 6 DIGNITY HEALTH AND SUBORDINATE CORPORATIONS UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX-MONTH PERIODS ENDED DECEMBER 31, 2016 AND 2015 (In thousands) Six-Month Periods Ended December 31, 2016 2015 Cash flows from investing activities: Net sales of investments Cash proceeds on disposal of assets Investments in health-related activities Cash distributions from health-related activities Additions to operating property and equipment Decrease in securities lending collateral Other, net Cash provided by (used in) investing activities Cash flows from financing activities: Borrowings Repayments Decrease in payable under securities lending program Deferred financing costs Restricted contributions Debt extinguishment costs Cash provided by (used in) financing activities Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of the year Cash and cash equivalents at end of the year Components of cash and cash equivalents and investments at end of period: Cash and cash equivalents Short-term investments Board-designated assets for capital projects Total Supplemental disclosures of cash flow information: Cash paid for interest, net of capitalized interest Supplemental schedule of noncash investing and financing activities: Property and equipment acquired through capital lease or note payable Accrued purchases of property and equipment Broker receivables for unsettled investment trades Broker payables for unsettled investment trades 186,866 (32,915) 2,779 (315,841) 84,827 (5,628) (79,912) 578,049 1,173 (47,927) 1,626 (341,597) 105,878 (11,505) 285,697 1,020,289 (835,418) (84,827) (1,032) 21,516 (45,672) 74,856 590 (79,681) (105,878) 23,231 (161,738) $ (133,108) 569,473 436,365 $ 96,502 285,568 382,070 $ 436,365 2,131,750 2,293,704 4,861,819 $ 382,070 1,617,953 2,926,225 4,926,248 $ 126,834 $ 103,792 $ $ $ $ 5,092 93,032 56,951 4,981 $ $ $ $ 9,982 78,990 18,261 2,624 (Concluded) See notes to consolidated financial statements. 7 Dignity Health and Subordinate Corporations Notes to Unaudited Condensed Consolidated Financial Statements 1. BASIS OF PRESENTATION The condensed consolidated financial statements of Dignity Health and Subordinate Corporations (“Dignity Health”) as of December 31, 2016, and for the three and six-month periods ended December 31, 2016 and 2015, should be read in conjunction with the audited financial statements as of and for the year ended June 30, 2016. Certain footnotes and disclosures that are required in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted as they substantially duplicate the disclosures contained in the annual financial statements. Dignity Health management is responsible for the accompanying condensed consolidated financial statements. These condensed consolidated financial statements include all normal and recurring adjustments that are considered necessary for the fair presentation of financial position and operating results in accordance with GAAP. Certain estimates and assumptions are made that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the balance sheet dates and the reported amounts of revenue and expenses for the periods presented. Actual results could differ from estimates. Operating results for the three and six-month periods ended December 31, 2016, 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. Certain reclassifications and changes in presentation were made in the condensed consolidated financial statements for the periods ended December 31, 2015 and June 30, 2016, to conform to the presentation for the six-month period ended December 31, 2016. In preparing the accompanying condensed consolidated financial statements, management of Dignity Health has evaluated subsequent events occurring between the end of the most recent fiscal quarter and February 15, 2017, the date the condensed consolidated financial statements were issued. See Note 10. 2. ACQUISITIONS, DIVESTITURES AND SIGNIFICANT INVESTMENTS In October 2016, Dignity Health and Catholic Health Initiatives 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. 3. RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS In April 2015, the FASB issued ASU No. 2015-07, Fair Value Measurement (Topic 820): Disclosures for Investments in Certain Entities that Calculate Net Asset Value per Share (or its Equivalent), (“ASU 2015-07”), which removes the requirement to categorize, within the fair value hierarchy, investments for which fair value is measured using the net asset value per share practical expedient. It also limits disclosures related to investments for which the entity has elected to measure the fair value using that practical expedient. The guidance of ASU 2015-07 was adopted by Dignity Health effective July 1, 2016. The guidance is applied retrospectively, as required by ASU 2015-07, by removing from the fair value hierarchy any investments for which fair value is measured using the net asset value (“NAV”) per share practical expedient. See Note 7. 8 4. NET PATIENT REVENUE The percentage of inpatient and outpatient services, calculated on the basis of usual and customary charges, is as follows: Three-Month Periods Ended December 31, Six-Month Periods Ended December 31, 2016 2015 2016 2015 Inpatient services 58% 58% 57% 58% Outpatient services 42% 42% 43% 42% Patient revenue, net of contractual allowances and discounts (before provision for bad debts) is comprised of the following (in thousands): Three-Month Periods Ended December 31, 2016 Government $ Contracted Self-pay and other 1,716,759 2015 $ 1,214,428 241,296 $ 3,172,483 Six-Month Periods Ended December 31, 1,624,083 2016 $ 1,183,839 194,499 $ 3,002,421 3,395,759 2015 $ 2,420,942 500,099 $ 6,316,800 3,200,039 2,370,741 432,303 $ 6,003,083 Government payor type includes fee for service, capitated, and managed care fee for service arrangements for both Medicare and Medicaid. Contracted payor type includes contracted rate payors and commercial capitated patient accounts. 5. REVENUE FROM GOVERNMENT PROGRAMS The following revenues, which enhance or adjust the per case, per diem, per procedure or per visit amounts received, have been recognized for patient services: Medicaid Supplemental Reimbursement Programs – Net patient revenue includes $310.1 million and $254.3 million related to supplemental Medi-Cal payments provided under the California provider fee programs during the three-month periods ended December 31, 2016 and 2015, respectively, and $592.8 million and $508.7 million for the six-month periods ended December 31, 2016 and 2015, respectively. These programs are funded by quality assurance fees paid by participating hospitals and matching federal funds. Dignity Health recorded $151.2 million and $134.3 million in such fees in purchased services and other expense during the three-month periods ended December 31, 2016 and 2015, respectively, and $302.3 million and $268.6 million for the six-month periods ended December 31, 2016 and 2015, respectively. Grant payments related to the California Health Foundation and Trust (“CHFT”) were recognized in connection with the California provider fee programs resulting in net expense of $4.8 million and $4.4 million recorded in purchased services and other expense during the three-month periods ended December 31, 2016 and 2015, respectively, and $9.6 million and $8.8 million for the six-month periods ended December 31, 2016 and 2015, respectively. Total net income recognized during the three-month periods ended December 31, 2016 and 2015, was $154.1 million and $115.6 million, respectively, and $280.9 million and $231.3 million for the six-month periods ended December 31, 2016 and 2015, respectively. California’s participation in a provider fee program, as authorized under federal regulations, has been made permanent by the passage of Proposition 52, an initiative on the November 2016 ballot. “Meaningful Use” Incentives – During the three-month periods ended December 31, 2016 and 2015, Dignity Health recorded meaningful use incentive revenue of $4.7 million and $6.0 million, respectively, related to Medicare and Medicaid programs. During the six-month periods ended December 31, 2016 and 2015, Dignity Health recorded meaningful use incentive revenue of $6.5 million and $11.2 million, respectively. Amounts are recognized in other operating revenue and represent management’s best estimates for payments ultimately expected to be received based on estimated discharges, charity care, and other input data. 9 Cost Reports and Other Settlements – During the three-month periods ended December 31, 2016 and 2015, net patient revenue includes $5.3 million and $2.5 million, respectively, in favorable net prior years’ reimbursement settlements from Medicare, Medicaid and other programs. During the six-month periods ended December 31, 2016 and 2015, net patient revenue includes $8.0 million and $4.5 million, respectively, in favorable net prior years’ reimbursement settlements from Medicare, Medicaid and other programs. In addition, Dignity Health recorded $0.0 million and $2.4 million in recovery audit contractor settlements and recoveries, net of take-backs, related to prior year claims, during the three-month periods ended December 31, 2016 and 2015, respectively, and $0.1 million in audit contractor takebacks, net of recoveries and $11.7 million in recovery audit contractor settlements and recoveries, net of take-backs, related to prior year claims, during the six-month periods ended December 31, 2016 and 2015, respectively. At December 31, 2016 and June 30, 2016, estimated receivables for third-party payor settlements recorded in other current assets were $69.4 million and $63.7 million, respectively, and estimated payables for third-party payor settlements recorded in other accrued liabilities were $33.1 million and $34.4 million, respectively. 6. SELF-INSURANCE PLANS Dignity Health maintains self-insurance programs for workers’ compensation benefits for employees and for hospital professional and general liability risks. Self-insurance expense decreased $33.8 million and $14.9 million during the three-month periods ended December 31, 2016 and 2015, respectively, and decreased $38.8 million and $27.1 million for the six-month periods ended December 31, 2016 and 2015, respectively, related to revisions to prior years’ actuarially estimated liabilities. The expenses and related adjustments are recorded in salaries and benefits for workers’ compensation benefits and in purchased services and other for professional and general liability risks in the accompanying consolidated statements of operations and changes in net assets. 7. FAIR VALUE MEASUREMENTS Dignity Health accounts for certain assets and liabilities at fair value or on a basis that approximates fair value. A fair value hierarchy for valuation inputs prioritizes the inputs into three levels based on the extent to which inputs used in measuring fair value are observable in the market. Each fair value measurement is reported in one of the three levels and is determined by the lowest level input that is significant to the fair value measurement in its entirety. These levels are: Level 1: Quoted prices are available in active markets for identical assets or liabilities as of the measurement date. Financial assets and liabilities in this category include U.S. Treasury securities and listed equities. Level 2: Pricing inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Financial assets and liabilities in this category generally include asset-backed securities, corporate bonds and loans, municipal bonds, and interest rate swaps. Level 3: Pricing inputs are generally unobservable for the assets or liabilities and include situations where there is little, if any, market activity for the investment. The inputs into the determination of fair value require management’s judgment or estimation of assumptions that market participants would use in pricing the assets or liabilities. The fair values are therefore determined using model-based techniques that include option pricing models, discounted cash flow models, and similar techniques. Financial assets in this category include alternative investments and contingent consideration. 10 The following represents assets and liabilities measured at fair value on a recurring basis and certain assets accounted for under the equity method as of December 31, 2016 and June 30, 2016 (in thousands): December 31, 2016 Quoted Prices in Active Significant Markets for Other Significant Identical Observable Unobservable NAV Instruments Inputs Inputs Practical (Level 1) (Level 2) (Level 3) Expedient Assets Cash and cash equivalents $ 437,912 U.S. government securities 206,854 U.S. corporate bonds 88,681 U.S. equity securities 757,236 Foreign government securities 3,312 Foreign corporate bonds 881 Foreign equity securities 426,167 Asset-backed securities 179 Structured debt 530 Private equity Multi-strategy hedge funds Real estate 13,955 Collateral held under securities lending program 9,583 Other fund investments $ 1,945,290 Total assets Liabilities Contingent consideration Derivative instruments Total liabilities $ 25,426 254,948 1,932 9,082 5,003 92 9,606 58,256 - $ 77,413 - 30,791 - $ Total Balance 427,205 354,903 91,653 612,235 344,348 912,870 181,114 $ 437,912 232,280 770,834 1,114,071 12,394 97,537 1,038,494 9,785 58,786 375,139 912,870 195,069 - - 77,413 9,583 $ 2,924,328 $ 5,342,167 $ 441,758 $ 30,791 $ - $ 175,650 $ 3,985 - $ - $ 3,985 175,650 $ - $ 175,650 $ 3,985 $ - $ 179,635 11 June 30, 2016 Quoted Prices in Active Significant Markets for Other Significant Identical Observable Unobservable Instruments Inputs Inputs (Level 1) (Level 2) (Level 3) Assets Cash and cash equivalents $ 350,377 U.S. government securities 285,502 U.S. corporate bonds 71,467 U.S. equity securities 774,511 Foreign government securities 7 Foreign corporate bonds 508 Foreign equity securities 352,470 Asset-backed securities Structured debt 627 Private equity Multi-strategy hedge funds Real estate 18,322 Collateral held under securities lending program 6,022 Other fund investments $ 1,859,813 Total assets Liabilities Contingent consideration Derivative instruments $ - $ - Total liabilities $ - $ 27,106 235,230 2,856 10,080 7,316 131 10,756 67,402 - $ 162,239 - 30,961 - NAV Practical Expedient $ Total Balance 413,707 455,345 94,438 594,479 326,119 879,451 191,708 $ 350,377 312,608 720,404 1,232,712 10,087 102,262 947,080 10,756 68,029 357,080 879,451 210,030 - - 162,239 6,022 $ 2,955,247 $ 5,369,137 $ 523,116 $ 30,961 248,913 $ 2,190 - $ - $ 2,190 248,913 $ 248,913 $ 2,190 $ - $ 251,103 Assets and liabilities measured at fair value on a recurring basis and certain assets accounted for under the equity method are reported in short-term investments, assets limited as to use, and other accrued liabilities in the consolidated balance sheets. Such amounts do not include certain donor-restricted funds and receivables or interests in unconsolidated foundations. There were no transfers among any of the levels of fair value hierarchy during the periods presented. The Level 2 and 3 instruments listed in the fair value hierarchy tables above use the following valuation techniques and inputs: For marketable securities such as U.S. and foreign government securities, U.S. and foreign corporate bonds, U.S. and foreign equity securities, asset-backed securities, and structured debt, in the instances where identical quoted market prices are not readily available, fair value is determined using quoted market prices and/or other market data for comparable instruments and transactions in establishing prices, discounted cash flow models and other pricing models. These inputs to fair value are included in industry-standard valuation techniques such as the income or market approach. Dignity Health classifies all such investments as Level 2. For private equity investments where no fair value is readily available, the fair value is determined using models that take into account relevant information considered material. Due to the significant unobservable inputs present in these valuations, Dignity Health classifies all such investments as Level 3. The fair value of collateral held under securities lending program classified as Level 2 is determined using the calculated NAV. The collateral held under this program is placed in commingled funds whose underlying investments are valued using techniques similar to those used for the marketable securities noted above. Amounts reported do not include non-cash collateral of $137.9 million and $169.7 million as of December 31, 2016 and June 30, 2016, respectively. 12 The fair value of liabilities for derivative instruments such as interest rate swaps classified as Level 2 is determined using an industry standard valuation model, which is based on a market approach. A credit risk spread (in basis points) is added as a flat spread to the discount curve used in the valuation model. Each leg is discounted and the difference between the present value of each leg’s cash flows equals the market value of the swap. The fair value of liabilities for derivative instruments such as risk participation agreements classified as Level 3 is determined using the market value of the referenced securities in the agreements, which factors in the credit risk of the issuer. Investments that are measured using the calculated NAV per share (or its equivalent) practical expedient (see Note 3) have not been classified in the fair value hierarchy. The NAV amounts presented in the table above are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the balance sheet. Related to investments valued using the NAV practical expedient, management also performs, on a regular basis when information is made available, various validations and testing of the NAV provided and determines that the investment managers’ valuation techniques are compliant with fair value measurement accounting standards. The following table presents the change in the balance of private equity investments using significant unobservable inputs (Level 3) measured on a recurring basis for the three and six-month periods ended December 31, 2016 and 2015 (in thousands): Three-Month Periods Ended December 31, 2016 Balance at beginning of period Total realized losses, net, included in excess (deficit) of revenues over expenses Total unrealized gains (losses), net, included in excess (deficit) of revenues over expenses Purchases Balance at end of period $ 2015 28,744 $ - $ Six-Month Periods Ended December 31, 548 1,499 30,791 $ 2016 31,897 $ (42) 1,406 33,261 30,961 $ 2015 29,478 (14,311) $ 12,642 1,499 30,791 $ (117) 3,900 33,261 Amounts included in financial liabilities representing contingent consideration relate to acquisitions made by USHW. 13 Included within the net assets above are investments in certain entities that report fair value using a calculated NAV or its equivalent. The following table and explanations identify attributes relating to the nature and risk of such investments as of December 31, 2016 and June 30, 2016 (in thousands): Fair Value NAV Practical Expedient Private equity (1) $ 344,348 Multi-strategy hedge funds (2) 912,870 - Real estate fund (3) 181,114 15,827 Commingled funds - debt securities (4) 518,858 29,705 Commingled funds - equity securities (5) 967,138 - Total NAV Practical Expedient $ 2,924,328 Fair Value $ $ 215,682 (1) $ 326,119 Multi-strategy hedge funds (2) 879,451 - Real estate fund (3) 191,708 15,899 Commingled funds - debt securities (4) 508,145 28,754 Commingled funds - equity securities (5) 1,049,824 - $ 2,955,247 Monthly, Quarterly, Semi-Annually, 5 - 120 days Annually Quarterly 90 days Daily, Monthly, 1 - 90 days Quarterly Daily, Semi-Monthly, 1 - 120 days Monthly, Quarterly As of June 30, 2016 Redemption Unfunded Frequency (If Commitments Currently Eligible) $ $ Redemption Notice Period 261,214 NAV Practical Expedient Private equity Total NAV Practical Expedient (1) As of December 31, 2016 Redemption Unfunded Frequency (If Commitments Currently Eligible) 213,281 Redemption Notice Period Monthly, Quarterly, Semi-Annually, 5 - 120 days Annually Quarterly 90 days Daily, Monthly, 1 - 90 days Quarterly Daily, Semi-Monthly, 1 - 120 days Monthly, Quarterly 257,934 This category includes several private equity funds that specialize in providing capital to a variety of investment groups, including but not limited to venture capital, leveraged buyout, mezzanine debt, distressed debt, and other situations. There are no provisions for redemptions during the life of these funds. Distributions from each fund will be received as the underlying investments of the funds are liquidated, estimated at December 31, 2016, to be over the next 11 years. 14 (2) This category includes investments in hedge funds that pursue diversification of both domestic and foreign fixed income and equity securities through multiple investment strategies. The primary objective for these funds is to seek attractive long-term risk-adjusted absolute returns. Under certain circumstances, an otherwise redeemable investment or portion thereof could become restricted. The following table reflects the various redemption frequencies, notice periods, and any applicable lock-up periods or gates to redemption as of December 31, 2016: Percentage of the Value of Category (2) Total Subtotal 22.3% 7.0% 45.8% 24.9% Redemption Frequency Redemption Notice Period Redemption Redemption Locked Up Until Gate % of Account (if applicable) (if applicable) 11.4% Annually 45 days 5.1% Annually 60 days - up to 50.0% 5.8% Annually 75 - 90 days - up to 10.0% 0.2% Semi-Annually 75 days - - 6.8% Semi-Annually 90 days - - 6.4% Quarterly 30 days - - 27.1% Quarterly 60 - 65 days 9/30/2017 up to 25.0% - 97.0% 12.3% Quarterly 90 days - up to 25.0% - 33.3% 12.2% Monthly 5 - 20 days - - 3.1% Monthly 30 - 45 days - up to 16.7% 9.6% Monthly 60 - 120 days - up to 25.0% - - (3) This category includes investments in real estate funds that invest primarily in institutional quality commercial and residential real estate assets within the U.S. and investments in publicly traded real estate investment trusts. Investments representing approximately 18.5 percent of the value of investments in this category do not have provisions for redemptions during the life of these funds. Distributions will be received as the underlying investments of the funds are liquidated, estimated at December 31, 2016, to be over the next 7 years. (4) This category includes investments in commingled funds that invest primarily in domestic and foreign debt and fixed income securities, the majority of which are traded in over-the-counter markets. Also included in this category are commingled fixed income funds that provide capital in a variety of mezzanine debt, distressed debt and other special debt securities situations. Investments representing approximately 8.8 percent of the value of investments in this category do not have provisions for redemptions during the life of these funds. Distributions will be received as the underlying investments of the funds are liquidated, estimated at December 31, 2016, to be over the next 4 years. (5) This category includes investments in commingled funds that invest primarily in domestic or foreign equity securities with multiple investment strategies. A majority of the funds attempt to match or exceed the returns of specific equity indices. The investments included above are not expected to be sold at amounts that are different from NAV. 15 Fair Value of Debt - The fair value of Dignity Health’s debt is estimated based on the quoted market prices and/or other market data for the same or similar issues and transactions in active markets or on the current rates offered to Dignity Health for debt of the same remaining maturities, discounted cash flow models and other pricing models. These inputs to fair value are included in industry-standard valuation techniques. Based on the inputs and valuation techniques, the fair value of long-term debt is classified as Level 2 within the fair value hierarchy. The carrying value of Dignity Health’s debt is reported within the current portion of long-term debt, demand bonds subject to short-term liquidity arrangements and long-term debt, net of current portion, on the consolidated balance sheets. The estimated fair value of Dignity Health’s long-term debt instruments as of December 31, 2016, is as follows (in thousands): Carrying Value Debt issued under Master Trust Indenture: Fixed rate revenue bonds Taxable bonds Senior secured notes payable Taxable direct placement loans Variable rate demand bonds Auction rate certificates Notes payable to banks under credit agreements Total debt under Master Trust Indenture Other Total debt Fair Value $ 1,607,242 1,473,417 179,836 360,842 761,077 270,340 897,821 5,550,575 120,228 $ 1,658,934 1,453,665 191,644 361,000 761,800 270,400 898,050 5,595,493 120,228 $ 5,670,803 $ 5,715,721 The fair value amounts do not represent the amount Dignity Health would be required to expend to retire the indebtedness. 8. INTANGIBLE ASSETS, NET Intangible assets reported in the consolidated balance sheets consist primarily of amounts for the trade name of U.S. HealthWorks (“USHW”), customer relationships, developed technology, favorable leasehold interests, noncompete agreements, licensing fees, and management fee contracts related to certain business combinations accounted for under the acquisition method. Information related to intangible assets at December 31, 2016, and June 30, 2016, is as follows (in thousands): As of December 31, 2016 Gross Carrying Accumulated Net Balance at Amount Amortization End of Period Trademark Customer relationships Noncompete agreements Management agreements Other $ 153,279 $ 65,830 9,556 2,633 35,237 - $ (17,955) (5,147) (27,967) $ 266,535 $ (51,069) $ Amortization period 153,279 Indefinite 47,875 5 - 15 years 4,409 60 months 2,633 Indefinite 7,270 36 - 80 months 215,466 16 As of June 30, 2016 Gross Carrying Accumulated Net Balance at Amount Amortization End of Period Trademark Customer relationships Noncompete agreements Management agreements Other $ 152,700 $ 60,800 9,142 2,633 33,420 - $ (15,520) (4,212) (25,778) $ 258,695 $ (45,510) $ Amortization period 152,700 Indefinite 45,280 10 - 15 years 4,930 60 months 2,633 Indefinite 7,642 36 - 80 months 213,185 The aggregate amount of amortization expense related to intangible assets subject to amortization is $2.8 million and $2.0 million for the three-month periods ended December 31, 2016 and 2015, respectively, and $5.5 million and $4.7 million for the six-month periods ended December 31, 2016 and 2015, respectively. Amortization expense on intangible assets is estimated to be $5.6 million for the remainder of 2017, $8.3 million in 2018, $7.2 million in 2019, $6.1 million in 2020, $5.7 million in 2021, and $26.6 million thereafter. 9. GOODWILL Goodwill is measured as of the effective date of a business combination as the excess of the aggregate of the fair value of consideration transferred over the fair value of the tangible and intangible assets acquired and liabilities assumed. The changes in the carrying amount of goodwill are as follows (in thousands): As of December 31, 2016 Balance at beginning of period Addition from acquisitions Acquisition and other accounting adjustments Balance at end of period As of June 30, 2016 $ 574,355 $ 14,203 (1,021) 572,957 23,823 (22,425) $ 587,537 574,355 $ 10. DEBT In July 2016, Dignity Health drew $100.0 million on its syndicated line of credit for general working capital purposes. In July 2016, Dignity Health provided for the redemption of $24.1 million of tax-exempt fixed rate bonds. The redemptions were financed with draws on the syndicated line of credit. In July 2016, the letters of credit issued in July 2009 to support variable rate demand bonds (“VRDBs”) of $37.8 million was extended to July 2018. This did not change the terms, provisions or classification of the VRDBs subject to short-term liquidity arrangements. In October 2016, Dignity Health drew an additional $100.0 million on its syndicated line of credit for general working capital purposes. In December 2016, Dignity Health issued $270.1 million of tax-exempt fixed rate bonds in a private placement. The proceeds were used to advance refund $256.8 million of outstanding tax-exempt fixed rate bonds. Proceeds were placed in an irrevocable trust and the bonds were legally defeased. The bonds will mature in March 2042. In December 2016, Dignity Health entered into two taxable lines of credit of $400.0 million and $250.0 million with two separate banks that mature in June 2018 and December 2017, respectively. Proceeds were used to advance refund $474.9 million of outstanding tax-exempt fixed rate bonds. The $400.0 million taxable line of credit was fully drawn and $124.0 million was drawn on the $250.0 million line of credit. Proceeds from both taxable lines of credit were placed in an irrevocable trust and the bonds were legally defeased. 17 Dignity Health recorded $45.7 million in loss on early extinguishment of debt related to the December transactions. In January 2017, Dignity Health drew $124.8 million on the $250.0 million taxable line of credit. Proceeds were used to advance refund $122.0 million of outstanding tax-exempt fixed rate bonds. Proceeds from the taxable line of credit were placed in an irrevocable trust and the bonds were legally defeased. Dignity Health recorded $2.3 million in loss on early extinguishment of debt upon the date of this transaction. In September 2015, the letter of credit issued in October 2012 to support VRDBs of $140.4 million was extended to October 2018. This did not change the terms, provisions or classification of the VRDBs subject to short-term liquidity arrangements. In October 2015, the letters of credit issued in October 2012 to support VRDBs of $76.0 million, $60.0 million and $59.6 million were extended to October 2019. This did not change the terms, provisions or classifications of the VRDBs subject to short-term liquidity arrangements. In December 2015, an arrangement was made with a substitute bank to take over as the credit facility provider for a letter of credit issued in October 2012 to support VRDBs of $57.0 million. Under the terms of the new arrangement, the letter of credit will expire in December 2019. The substitution did not change the terms, provisions or classification of the VRDBs subject to short-term liquidity arrangements. During the six-month period ending December 31, 2015, $0.7 million was repaid on the syndicated line of credit. 11. DERIVATIVE INSTRUMENTS The following table shows the outstanding notional amount of derivative instruments measured at fair value, net of credit value adjustments, as reported in other accrued liabilities in the consolidated balance sheets as of December 31, 2016 and June 30, 2016 (in thousands): Maturity Date of Derivatives Interest Rate Notional Amount Outstanding Fair Value December 31, 2016 Derivatives not designated as hedges Interest rate swaps 2026 - 2042 Risk participation agreements Total return swap 3.2% - 3.4% $ 922,600 $ 2017 - 2025, with extension SIFMA plus options spread $ 509,510 $ - SIFMA plus spread $ 270,095 $ 2,461 2024 (178,111) June 30, 2016 Derivatives not designated as hedges Interest rate swaps 2026 - 2042 Risk participation agreements 3.2% - 3.4% $ 937,750 $ 2017 - 2025, with extension SIFMA plus options spread $ 509,510 $ (248,913) - 18 Changes in fair value of derivative instruments have been recorded for the three and six-month periods ended December 31, 2016 and 2015, as follows (in thousands): Three-Month Periods Ended December 31, 2016 2015 Loss reclassified from unrestricted net assets into interest expense, net, related to derivatives in cash flow hedging relationships: Interest rate swaps - amortization $ (671) $ (671) Gain (loss) recognized in interest expense, net: Changes in fair value of non-hedged derivatives Amortization of amounts in unrestricted net assets - interest rate swaps Total $ 71,421 9,731 (671) 70,750 $ (671) 9,060 Six-Month Periods Ended December 31, 2016 2015 Loss reclassified from unrestricted net assets into interest expense, net, related to derivatives in cash flow hedging relationships: Interest rate swaps - amortization $ (1,341) $ (1,341) Loss recognized in interest expense, net: Changes in fair value of non-hedged derivatives Amortization of amounts in unrestricted net assets - interest rate swaps Total 73,263 (1,341) $ (18,469) (1,341) 71,922 $ (19,810) Of the amounts classified in unrestricted net assets as of December 31, 2016, Dignity Health anticipates reclassifying approximately $2.7 million of additional non-cash losses from unrestricted net assets into interest expense, net, in the next twelve months. Amounts in unrestricted net assets will be amortized into earnings as the interest payments being economically hedged are made. Of the $922.6 million notional amount of fixed pay interest rate swaps held by Dignity Health at December 31, 2016, $160.0 million are insured and have a negative fair value of $44.8 million. In the event the insurer, Assured Guaranty, is downgraded below A2/A or A3/A- (Moody’s/Standard and Poor’s), the counterparties have the right to terminate the swaps if Dignity Health does not provide alternative credit support acceptable to them within 30 days of being notified of the downgrade. If the insurer is downgraded below the thresholds noted above and Dignity Health is downgraded below Baa3/BBB- (Moody’s/Standard and Poor’s), the counterparties have the right to terminate the swaps. The remaining $762.6 million of interest rate swaps held as of December 31, 2016, are uninsured. Dignity Health has the right to terminate the insured interest rate swaps prior to maturity for any reason, while counterparties have various rights to terminate, including swaps in the outstanding notional amount of $100.0 million at each five-year anniversary date commencing in March 2018 and swaps in the notional amount of $209.8 million at each two-year anniversary commencing in May 2017. Swaps in the notional amount of $60.0 million and swaps in the notional amount of $67.7 million have mandatory puts in March 2021 and March 2023, respectively. The termination value would be the fair market value or the replacement cost of the swaps, depending on the circumstances. These interest rate swaps have a negative fair value of $79.4 million at December 31, 2016. The remaining uninsured interest rate swaps in the notional amount of $325.1 million have a negative fair value of $53.9 million as of December 31, 2016. Dignity Health had floating rate derivatives in the notional amount of $779.6 million as of December 31, 2016. Risk participation agreements in the notional amount of $509.5 million have a fair market value deemed immaterial as of December 31, 2016. In December 2016, Dignity Health entered into a total return swap in the notional 19 amount of $270.1 million to reduce interest expense associated with fixed rate debt. Dignity Health receives a fixed rate and pays a variable rate of SIFMA plus a spread. Dignity Health has the right to terminate the swap for any reason after December 2017, prior to its maturity in December 2023. The total return swap has a positive fair value of $2.5 million at December 31, 2016. All of the derivative agreements have certain early termination triggers caused by an event of default or a termination event. The events of default include failure to make payments when due, failure to give notice of a termination event, failure to comply with or perform obligations under the agreements, bankruptcy or insolvency, and defaults under other agreements (cross-default provision). Other than the insured swaps described above, the termination events include credit ratings dropping below Baa1/BBB+ (Moody’s/Standard & Poor’s) by either party on a notional amount of $714.9 million of swaps and below Baa2/BBB on a notional amount of $827.3 million and Dignity Health’s cash on hand dropping below 85 days. Dignity Health, under the terms of its Master Trust Indenture, is prohibited from posting collateral on derivative instruments. 12. INTEREST EXPENSE, NET The components of interest expense, net, include the following (in thousands): Three-Month Periods Ended December 31, 2016 2015 Interest and fees on debt and swap cash settlements $ 53,515 $ Six-Month Periods Ended December 31, 2016 2015 53,900 $ 107,335 $ 108,381 Market adjustment on swaps and amortization of amounts in unrestricted net assets Total interest expense Capitalized interest expense Interest expense, net 13. $ (70,750) (9,060) (71,922) 19,810 (17,235) (917) 44,840 (2,469) 35,413 (2,440) 128,191 (4,988) (18,152) $ 42,371 $ 32,973 $ 123,203 INVESTMENT INCOME (LOSS), NET Investment income (loss), net, on assets limited as to use, cash equivalents, collateral held under securities lending program, notes receivable, and investments are comprised of the following (in thousands): Three-Month Periods Ended December 31, 2016 Interest and dividend income $ 19,241 32,877 Net unrealized gains (losses) on securities Other, net of capitalized investment income Investment income (loss), net 14. 2015 16,251 $ Net realized gains on sales of securities $ Six-Month Periods Ended December 31, 2016 $ 2015 35,055 $ 39,623 16,697 59,892 81,632 (20,392) 60,025 156,416 (278,168) (6,930) (6,858) (11,316) (12,746) 21,806 $ 89,105 $ 240,047 $ (169,659) RETIREMENT PROGRAMS Total expense for all Dignity Health retirement and postretirement plans was $109.1 million and $79.9 million for the three-month periods ended December 31, 2016 and 2015, respectively, and $217.5 million and $160.9 million for the six-month periods ended December 31, 2016 and 2015, respectively. Such amounts are included in salaries and benefits expense in the condensed consolidated statements of operations and changes in net assets. 20 15. COMMITMENTS AND CONTINGENT LIABILITIES The following summary encompasses matters previously disclosed in Dignity Health’s audited financial statements, as well as additional developments since the date of those financial statements, related to litigation, regulatory and compliance matters. Litigation, Regulatory and Compliance Matters - General – The health care industry is subject to voluminous and complex laws and regulations of federal, state and local governments. Compliance with such laws and regulations can be subject to future government review and interpretation as well as regulatory actions unknown or unasserted at this time. These laws and regulations include, but are not necessarily limited to, the rules governing licensure, accreditation, controlled substances, privacy, government program participation, government reimbursement, antitrust, anti-kickback, prohibited referrals by physicians, false claims, and in the case of tax-exempt organizations, the requirements of tax exemption. In recent years, government activity has increased with respect to investigations and allegations of wrongdoing. In addition, during the course of business, Dignity Health becomes involved in civil litigation. Management assesses the probable outcome of unresolved litigation and investigations and records contingent liabilities reflecting estimated liability exposure. Following is a discussion of matters of note. U.S. Department of Justice and OIG Investigations – Dignity Health and/or its facilities periodically receive notices from governmental agencies, such as the U.S. Department of Justice (“DOJ”) or the Office of Inspector General (“OIG”), requesting information regarding billing, payment, or other reimbursement matters, or initiating investigations, or indicating the existence of whistleblower litigation. The health care industry in general is experiencing an increase in these activities, as the federal government increases enforcement activities and institutes new programs designed to identify potential irregularities in reimbursement or quality of patient care. Resolution of such matters can result in civil and/or criminal charges, cash payments and/or administrative measures by the entity subject to such investigations. Dignity Health does not presently have information indicating that pending matters or their resolution will have a material effect on Dignity Health’s financial statements, taken as a whole. Nevertheless, there can be no assurance that the resolution of matters of these types will not affect the financial condition or operations of Dignity Health, taken as a whole. Within this category of activities, in October 2014, Dignity Health completed a civil settlement and entered into a Corporate Integrity Agreement (“CIA”) with the OIG to resolve an investigation into government reimbursement of hospital inpatient stays. The CIA requires, for a five-year period, enhanced compliance program obligations, education and training, and that Dignity Health retain an independent review organization to review the accuracy of certain claims for hospital services furnished to federal health care program beneficiaries. Medicare Certification – From time to time, Dignity Health and/or its facilities receive notices from CMS indicating that steps to terminate the provider agreements of certain hospital facilities will be taken unless specific corrective actions related to qualification for Medicare participation are pursued. The process of responding to these notices involves plan(s) of correction submitted by the facility and resurvey by CMS or its designee. Currently, Sierra Nevada Memorial-Miners Hospital is in the process of addressing such a notice. While Dignity Health does not expect a loss of Medicare qualification by any facility, there can be no assurance that the loss of Medicare qualification by a facility or facilities will not occur and have a material effect on the financial condition or operations of Dignity Health, taken as a whole. Pension Plan Litigation – In April 2013, Dignity Health was served with a class action lawsuit filed in the United States District Court for the Northern District of California by a former employee alleging breaches of fiduciary duty and other claims under ERISA in connection with the Dignity Health Pension Plan (“DHPP”). Among other things, the complaint alleges that, because Dignity Health is not a church or an association of churches, the DHPP does not qualify as a “church plan”. The complaint also challenges the constitutionality of ERISA’s church plan exemption. Dignity Health and the sponsoring religious orders established the DHPP and determined the DHPP was a church plan that should be exempt from ERISA, including ERISA’s funding requirements, and received private letter rulings from the Internal Revenue Service that confirmed its church plan status. The plaintiff seeks to represent a class comprised of participants and beneficiaries of the DHPP as of April 2013, when the complaint was filed. In July 2014, the District Court ruled that only a church or an association of churches may establish a church plan, the DHPP does not qualify as a church plan since Dignity Health was not a church when the plan was established, and, therefore, DHPP is not exempt from ERISA. In November 2014, the District Court granted Dignity Health’s motion for certification of a partial summary judgment order, which allowed Dignity Health to request an appeal of the District Court’s order. In December 2014, Dignity Health filed a petition with the Ninth Circuit Court of Appeals seeking permission to appeal the District Court’s order. In February 2015, the Ninth Circuit granted 21 permission for Dignity Health to appeal the District Court’s ruling. In July 2016, the Ninth Circuit Court of Appeals issued its opinion, which affirmed the District Court’s order and held that a church plan must be established by a church or by an association of churches and must be maintained either by a church or by a churchcontrolled or church-affiliated organization whose principal purpose or function is to provide benefits to church employees. The Ninth Circuit remanded the case to the District Court for further proceedings. In August 2016, Dignity Health filed a petition with the United States Supreme Court requesting it to review the Ninth Circuit’s decision. In addition, Dignity Health filed a motion to suspend any further proceedings in the District Court until the disposition of the petition, which was denied by the Ninth Circuit, but subsequently granted by the Supreme Court. In December 2016, the Supreme Court granted Dignity Health’s petition together with the petitions of two other faith-based health systems facing similar challenges to church plan status. Briefing by the parties is in process and oral argument before the Supreme Court is scheduled to occur in late March 2017. Dignity Health disagrees with the conclusion reached by the District Court and the Ninth Circuit, and continues to vigorously defend its position in its briefs filed with the Supreme Court. While Dignity Health believes its position will ultimately prevail, there can be no assurance about the final resolution of this matter and, under certain circumstances, a negative final and non-appealable ruling against Dignity Health may have a material adverse effect on the financial condition or operations of Dignity Health, taken as a whole. 22 Dignity Health and Subordinate Corporations Management Discussion and Analysis of Financial Condition and Results of Operations Overview Dignity Health is a California not-for-profit corporation exempt from federal and state income taxes. Dignity Health operates 39 hospitals in California, Arizona and Nevada and provides a variety of health care, education and other benefits to the communities in which it operates. Health care services include inpatient, outpatient, sub-acute and home health care services, as well as physician services through a medical foundation and affiliated medical groups. Additionally, USHW, a wholly-owned for-profit subsidiary, operates 247 occupational health and urgent care centers in 19 additional states. Results of Operations Three Months Ended December 31, 2016 and 2015 For the three-month period ended December 31, 2016, Dignity Health recorded an operating gain of $134.1 million compared to $2.1 million for the same period in the prior year. The results of operations for the three-month period ended December 31, 2016, are primarily related to the following: • Dignity Health recognized $310.1 million in net patient revenue, which included a $27.4 million true-up of prior year provider fee revenues, and $156.0 million in purchased services and other for a net favorable impact of $154.1 million related to the California provider fee programs, compared to $115.6 million recognized during the same period in the prior year. • Net patient and premium revenues increased $220.0 million, or 7.3%, over the same period in the prior year. Excluding provider fee program revenues, net patient and premium revenues increased $164.3 million, or 5.9%, primarily due to higher volumes associated with acute care activities, physician organizations and consolidated joint ventures, and rate increases. Provision for bad debts on uncollectible accounts decreased $14.4 million, or 10.0%, with provision for bad debts on uncollectible accounts as a percentage of gross revenues decreasing to 1.0% from 1.1% for the three-month periods ended December 31, 2016 and 2015, respectively. • Hospital-only net patient and premium revenue per adjusted admission, excluding the impact of the provider fee programs, increased 3.2% compared to the same period in the prior year. The increase is primarily related to rate increases, improved collections, and service mix. Adjusted admissions increased 2.5% compared to the same period in the prior year. • Revenue from health-related activities, net, decreased $1.6 million over the same period in the prior year. • Salaries and benefits increased $43.4 million, or 2.6%, over the same period in the prior year primarily due to staffing for higher volumes, wage increases and pension cost increases, partially offset by decreases in contract labor. • Supplies increased $24.2 million, or 5.5%, compared to the same period in the prior year, with supply costs per adjusted admission increasing 2.9%, primarily related to pharmacy costs. • Purchased services and other increased $78.8 million, or 9.3%, compared to the same period in the prior year. Excluding the provider fee program costs, purchased services and other increased $61.5 million, or 8.7%, primarily due to increased out of network costs, medical fees, and repairs and maintenance costs incurred in connection with upgrades to facilities. • Non-cash market adjustments on swaps, recorded in interest expense, net, were $70.8 million favorable compared to $9.1 million favorable in the same period in the prior year. • Investment income, net, was $21.8 million in the current year compared to $89.1 million during the same period in the prior year. Net realized gains of $32.9 million in the current year were higher than net realized gains of $16.7 million in the same period in the prior year. Net unrealized losses were $20.4 million in the current year, compared to net unrealized gains of $60.0 million in the same period in the prior year. • A $45.7 million loss on early extinguishment of debt was recognized in December 2016 related to refinancing activities. 23 Six Months Ended December 31, 2016 and 2015 For the six-month period ended December 31, 2016, Dignity Health recorded an operating gain of $164.9 million compared to an operating loss of $45.4 million for the same period in the prior year. The results of operations for the sixmonth period ended December 31, 2016, are primarily related to the following: • Dignity Health recognized $592.8 million in net patient revenue, which included a $27.4 million true-up of prior year provider fee revenues, and $311.9 million in purchased services and other for a net favorable impact of $280.9 million related to the California provider fee programs, compared to $231.3 million recognized during the same period in the prior year. • Net patient and premium revenues increased $372.1 million, or 6.2%, over the same period in the prior year. Excluding provider fee program revenues, net patient and premium revenues increased $288.0 million, or 5.2%, primarily due to higher volumes associated with acute care activities, physician organizations and consolidated joint ventures, and rate increases, offset by $23.0 million in supplemental Medicaid payments received in Arizona in the prior year which have not yet been approved in the current year. Provision for bad debts on uncollectible accounts decreased $7.2 million, or 2.4%, with provision for bad debts on uncollectible accounts as a percentage of gross revenues decreasing to 1.1% from 1.2% for the six-month periods ended December 31, 2016 and 2015, respectively. • Hospital-only net patient and premium revenue per adjusted admission, excluding the impact of the provider fee programs, increased 1.7% compared to the same period in the prior year. The increase is primarily due to rate increases offset by the timing of supplemental Medicaid payments in Arizona and recovery audit contractor settlements year over year. Adjusted admissions increased 3.0% compared to the same period in the prior year. • Revenue from health-related activities, net, increased $28.1 million over the same period in the prior year, primarily due to a gain of $32.4 million recorded during the period related to the investment in Scripps Health compared to a loss of $5.5 million during the same period in the prior year. • Salaries and benefits increased $113.8 million, or 3.5%, over the same period in the prior year primarily due to staffing for higher volumes, wage increases and pension cost increases, partially offset by decreases in contract labor. • Supplies increased $38.0 million, or 4.3%, compared to the same period in the prior year, with supply costs per adjusted admission increasing 1.3%, primarily in the areas of pharmacy and surgery. • Purchased services and other increased $115.6 million, or 6.8%, compared to the same period in the prior year. Excluding the provider fee program costs, purchased services and other increased $81.1 million, or 5.7%, primarily due to increased out of network costs, medical fees, and repairs and maintenance costs incurred in connection with upgrades to facilities. • Non-cash market adjustments on swaps, recorded in interest expense, net, were $71.9 million favorable compared to $19.8 million unfavorable in the same period in the prior year. • Investment income was $240.0 million in the current year compared to a net loss of $169.7 million during the same period in the prior year. Net realized gains of $59.9 million in the current year were lower than net realized gains of $81.6 million in the same period in the prior year. Net unrealized gains were $156.4 million in the current year, compared to net unrealized losses of $278.2 million in the same period in the prior year. • A $45.7 million loss on early extinguishment of debt was recognized in December 2016 related to refinancing activities. Capital Resources Cash used in operating activities totaled $128.1 million for the six-month period ended December 31, 2016, compared to $27.5 million for the same period in the prior year. Significant activity for the three-month period ended December 31, 2016, includes the following: • Provider fee assets and liabilities, net, used cash of $251.1 million during the six-month period ended December 31, 2016, compared to $84.6 million during the same period in the prior year due to the longer lag between recognizing revenues and expenses for the program versus paying and receiving payments related to the program. 24 • Accounts receivable increased $105.5 million during the six-month period ended December 31, 2016, compared to $82.8 million during the same period in the prior year. • Accounts payable decreased $29.3 million during the six-month period ended December 31, 2016, compared to an increase of $53.3 million during the same period in the prior year. • Accrued salaries and benefits decreased $77.5 million during the six-month period ended December 31, 2016, compared to a decrease of $127.2 million during the same period in the prior year. Cash used in investing activities totaled $79.9 million for the six-month period ended December 31, 2016, compared to cash provided by investing activities of $285.7 million for the same period in the prior year, primarily due to the following: • Net sales of investments were $186.9 million during the six-month period ended December 31, 2016, compared to $578.0 million during the same period in the prior year. • Capital expenditures were $315.8 million during the six-month period ended December 31, 2016, compared to $341.6 million during the same period in the prior year. Such capital expenditures primarily relate to expansion and renovation of existing facilities, equipment and systems additions and replacements, and various other capital improvements. • Investments in health-related activities were $32.9 million during the six-month period ended December 31, 2016, compared to $47.9 million during the same period in the prior year. Cash provided by financing activities totaled $74.9 million for the six-month period ended December 31, 2016, compared to cash used in financing activities of $161.7 million for the same period in the prior year, primarily due to the following: • Net debt borrowings of $184.9 million during the six-month period ended December 31, 2016, compared to net repayments of $79.1 million during the same period in the prior year. • Debt extinguishment costs of $45.7 million in connection with the December 2016 refinancing activities. Dignity Health’s debt-to-capitalization ratio was 49.0% as of December 31, 2016, and 49.7% as of June 30, 2016. The decrease is due primarily to investment gains and operating income during the six-month period ended December 31, 2016. Dignity Health's EBITDA (earnings before interest expense, net, depreciation and amortization, loss on early extinguishment of debt, tax expense, investment earnings (losses), and special charges) increased to $501.4 million during the six-month period ended December 31, 2016, from $368.1 million for the same period in the prior year. The EBITDA margin percentage increased to 7.6% from 5.9% for the same period in the prior year. Business Strategy Dignity Health’s “Horizon 2020” strategy, which was launched in September 2010, envisioned the transition to a consumer-focused, value-based operating model, and described six core strategies to achieve Dignity Health’s vision: Quality, Cost, Growth, Integration, Connectivity, and Leadership. In addition to business model transformation, Dignity Health is focused on adjusting its cost structure to ensure sustainable long-term financial performance. Dignity Health has a range of initiatives underway to help the organization succeed in the current environment as well as in the future. Progress on selected key initiatives through December 31, 2016, is highlighted below: Brand Identity and Experience —Dignity Health’s Hello humankindness campaign is an integrated effort to articulate the patient and employee experience, and the organization has been focused on consumer awareness, brand identity and delivering the patient experience, since the launch of the new name and brand in 2012. Dignity Health’s clinical systems, workforce, and marketing strategies are aligned toward delivering an experience of healing through human connection and respect for patients, providers, and employees, consistent with Dignity Health’s mission and values and evolving consumer expectations. Consumer awareness is at 70% as of December 2016, based on brand strength monitoring surveys conducted by Berry Strategy LLC. 25 Building the Clinical Enterprise — Dignity Health is focused on expanding quality, patient experience and integration in its service areas through clinical integration and other physician alignment and implementation of new payment models. Selected recent accomplishments in these areas include: 1. Quality and Patient Experience – Similar to the approach taken in fiscal 2016, Dignity Health is using a service line framework to identify and achieve improvement opportunities in fiscal 2017. The aggregate composite includes nine measures (plus one continuing measure) as a focus. Early results for fiscal 2017 are positive. Individual measures including early mobility in the critical care area, improved palliative care screening and consultation, optimal use of blood therapeutics, and better continuum of care management for orthopedic patients, are all showing strong improvement during the first part of the fiscal year. The Dignity Health three-year goal is focused on creating an exceptional patient experience, using the national standard survey, HCAHPS, as the basis of the measurement. Preliminary results through December 31, 2016 for this three-year effort indicate a 7% improvement in the aggregate percentile rating across the ten survey composites that assess patient experience with nurse and physician communication, pain management, patient education, caregiver responsiveness, environment of care and care transitions, and other factors. 2. Physician Alignment – Dignity Health engages with physicians in a range of models to achieve alignment and integration. Overall, Dignity Health continues to expand its physician relationships, further growing the number of aligned physicians through December 31, 2016. Total aligned physicians, including Dignity Health’s Clinical Integration (“CI”) network, its medical foundation model in California, direct employment in Arizona and Nevada, community clinic models and aligned partnerships, grew to nearly 7,700 through December 31, 2016, an increase of over 16% since June 2016. The CI strategy aligns physicians and hospitals around a common set of clinical and quality metrics and information sharing through common technology, provider compliance and peer review, and payor contracting, enabling the transition to a value-based care framework. 3. New Payment Models - Economic models that support coordinated care are essential to Dignity Health’s success in population health management. Dignity Health has focused on participating in new payment models such as the Medicare Shared Savings Program, professional and/or hospital capitation, CMS demonstration projects, bundled payments, narrow networks and risk sharing. As of December 31, 2016, Dignity Health had 119 value-based agreements with over 911,000 attributable lives. This represents nearly 5% growth since June 2016. Value based agreements are contracts with health care payors and purchasers which include financial risk beyond routine pay-for-performance, negotiated narrow provider networks, and/or direct-to-employer arrangements. Many of these contracts include arrangements with Dignity Health’s seven CI networks. To date, these contracts represent a modest percentage of Dignity Health’s revenue, but management believes this will increase over time. Grow, Diversify and Expand the Continuum — Dignity Health’s growth strategy has focused on building out integrated delivery networks (“IDNs”) in existing service areas through expansion of the continuum of care and limited in-market consolidation, as well as growth in diversified services, defined as non-acute business lines with accretive economics. Dignity Health has a philosophy of partnering with best-in-class companies to bring expertise to the organization that will facilitate and accelerate the transition to population health management. Joint ventures such as those with One Medical Group (primary care) and Adeptus (micro-hospital and free standing emergency departments) are performing well. During fiscal year 2016 and through December 2016, eight new freestanding emergency department sites opened in Arizona, and construction has begun on a second micro-hospital, which is scheduled to open in 2017. Dignity Health’s joint venture with Emerus, a micro-hospital company, is also progressing, with four sites planned in the Las Vegas, Nevada area, with the first location scheduled to open in 2017. In the San Francisco Bay Area, the joint venture with Go Health has opened seven urgent care centers since August 2016, with five more planned to open over the next 12 months. Dignity Health has broadened its growth efforts to include potential partnerships with other integrated delivery networks outside its current geographic footprint. Dignity Health has been engaged in discussions with Catholic Health Initiatives (“CHI”) regarding a potential alignment of health care ministries, and announced the signing of a non-binding letter of intent in October 2016. A potential alignment could allow the organization to play a greater role in shaping the transformation of health care for the future, including expanding access to health care services and improving coordination of care and clinical excellence. Dignity Health and CHI are aligned in mission, vision, and values, share a similar heritage of multiple congregations of women religious coming together to build a strong health ministry, and share a commitment to expand access and improve clinical quality for all, including people who are poor and underserved. The Dignity Health Board of Directors, executive leaders and sponsors, together with counterparts at CHI, 26 are continuing the work to evaluate whether an alignment would enable Dignity Health to strengthen Catholic health care and expand its ability to impact the health needs of the people and communities it serves. Horizon 2020 Acceleration — Dignity Health is engaged at every level of the organization to build on the performance improvement initiatives of fiscal year 2016, and has developed a broad, multi-year effort to further improve operating performance. This work is called “Horizon 2020 Acceleration”, as it is critical to realizing the goals set forth in the Horizon 2020 strategic plan. Areas of focus include: 1. 2. 3. 4. 5. Clinical resource management, including continued improvement in length-of-stay, pharmacy standardization, and enhancements to clinical governance to further reduce clinical variation; Further optimization of the hospital revenue cycle function, particularly related to improving clinical documentation and reducing denials and bad debt; Revenue growth, through enhancement of overall revenue mix and growth in specific service lines and geographies; Physician organization performance, including standardizing staffing models and improving the physician revenue cycle function; and Initiatives within supply chain, productivity and corporate services. Senior executives and leadership across a wide range of functions within Dignity Health are aligned and accountable to achieve these operating improvement goals. Forward Looking Statements Certain of the discussions in this document may include “forward-looking statements” which involve known and unknown risks and uncertainties inherent in the operation of health care facilities. Actual actions or results may differ materially from those discussed above, and past or current trends may not continue. Specific factors that might cause such differences include competition from other health care facilities in the service areas of Dignity Health, federal and state regulation of health care providers, staffing shortages, organized labor initiatives and reimbursement policies of the state and federal governments and managed care organizations. In particular, statements preceded by, followed by or that include the word “believes,” “estimates,” “expects,” “anticipates,” “plans,” “intends,” “scheduled,” or other similar expressions are or may constitute forward-looking statements. 27 Dignity Health and Subordinate Corporations Consolidated Operating Statistics Three-Month Periods Ended December 31, 2016 2015 ($ in thousands) Financial Performance: Operating income (loss) Margin % EBITDA (earnings before interest expense, net, depreciation and amortization, tax expense, loss on early extinguishment of debt, investment earnings (losses), and special charges) Margin % Excess (deficit) of revenues over expenses attributable to Dignity Health Margin % Uncompensated Care: Charity care, at customary charges Charity care, at cost Charity care, at cost, as a percentage of total expenses Bad debt at customary charges Productivity: Salaries, wages and benefits as a % of net patient and premium revenue Supply expense as a % of net patient and premium revenue Purchased services as a % of net patient and premium revenue Capital expense as a % of net patient and premium revenue Operations: Acute admissions* Adjusted admissions* Acute inpatient days* Adjusted patient days * (1) Acute average length of stay* Outpatient revenue as a % of total patient services revenue Number of FTEs FTEs per adjusted occupied bed * (1) Six-Month Periods Ended December 31, 2016 2015 $ 134,113 $ 4.0% 2,134 0.1% $ 164,882 $ 2.5% (45,405) (0.7%) $ 268,399 $ 8.0% 190,729 6.1% $ 501,403 $ 7.6% 368,058 5.9% $ 99,449 $ 2.9% 78,439 2.4% $ 332,519 $ 4.9% (241,683) (4.0%) $ $ 117,451 $ 28,426 $ 0.9% 129,515 $ 109,623 27,225 0.9% 143,960 $ $ 228,161 $ 55,664 $ 0.9% 293,555 $ 198,440 49,763 0.8% 300,705 $ $ 52.1% 14.4% 28.6% 4.1% 54.5% 14.7% 28.1% 6.2% 52.8% 14.4% 28.5% 5.3% 54.2% 14.6% 28.3% 6.9% 94,483 156,541 415,878 694,641 4.40 42.3% 55,166 5.67 93,196 152,761 420,608 692,627 4.51 42.0% 55,240 5.76 189,261 315,747 824,166 1,386,370 4.35 42.7% 54,851 5.64 186,323 306,451 833,257 1,379,679 4.47 42.3% 54,452 5.71 *Hospital only (1) Adjusted patient days weigh skilled subacute days by 0.4 of an acute day and skilled nursing days by 0.2 of an acute day. 28