SEATTLE CHILDREN S HOSPITAL. EIN No OMB Uniform Guidance. Supplementary Financial Report. Year ended September 30, 2017

Transcription

1 EIN No OMB Uniform Guidance Supplementary Financial Report Year ended September 30, 2017 (With Independent Auditors Report Thereon)

2 Table of Contents Independent Auditors Report 1 Balance Sheets 3 Statements of Operations and Changes in Net Assets 4 Statements of Cash Flows 6 Notes to Financial Statements 7 Independent Auditors Report on Internal Control over Financial Reporting and on Compliance and Other Matters Based on an Audit of Financial Statements Performed in Accordance with Government Auditing Standards 28 Report on Compliance for Each Major Federal Program; Report on Internal Control Over Compliance; and Report on Schedule of Expenditures of Federal Awards Required by the Uniform Guidance 30 Schedule of Expenditures of Federal Awards 32 Notes to Schedule of Expenditures of Federal Awards 50 Schedule of Findings and Questioned Costs 51 Page

3 KPMG LLP Suite Eighth Avenue Seattle, WA Independent Auditors Report The Board of Trustees Seattle Children s Hospital: Report on the Financial Statements We have audited the accompanying financial statements of Seattle Children s Hospital (a Washington not-forprofit corporation and a controlled affiliate of Seattle Children s Healthcare System) (the Hospital), which comprise the balance sheets as of September 30, 2017 and 2016, and the related statements of operations and changes in net assets and cash flows for the year then ended, and the related notes to the financial statements. Management s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with U.S. generally accepted accounting principles; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error. Auditors Responsibility Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditors judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Hospital as of September 30, 2017 and 2016, and the changes in its net assets and its cash flows for the year then ended in accordance with U.S. generally accepted accounting principles. KPMG LLP is a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity.

4 Other Matter Our audit was conducted for the purpose of forming an opinion on the financial statements as a whole. The accompanying schedule of expenditures of federal awards is presented for purposes of additional analysis, as required by Title 2 U.S. Code of Federal Regulations, Part 200, Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards, and is not a required part of the financial statements. Such information is the responsibility of management and was derived from and relates directly to the underlying accounting and other records used to prepare the financial statements. The information has been subjected to the auditing procedures applied in the audit of the financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the financial statements or to the financial statements themselves, and other additional procedures in accordance with auditing standards generally accepted in the United States of America. In our opinion, the schedule of expenditures of federal awards is fairly stated, in all material respects, in relation to the financial statements as a whole. Other Reporting Required by Government Auditing Standards In accordance with Government Auditing Standards, we have also issued our report dated December 21, 2017 on our consideration of the Hospital s internal control over financial reporting and on our tests of its compliance with certain provisions of laws, regulations, contracts, and grant agreements and other matters. The purpose of that report is solely to describe the scope of our testing of internal control over financial reporting and compliance and the results of that testing, and not to provide an opinion on the effectiveness of Example NFP s internal control over financial reporting or on compliance. That report is an integral part of an audit performed in accordance with Government Auditing Standards in considering the Hospital s internal control over financial reporting and compliance. December 21,

5 Balance Sheets September 30, 2017 and 2016 (In thousands of dollars) Assets Current assets: Cash and cash equivalents $ 60,168 43,520 Accounts receivable, net of allowance for uncollectible accounts of $1,606 in 2017 and $1,819 in , ,581 Other current assets 111,397 65,612 Current portion of assets whose use is limited 22,796 19,860 Total current assets 420, ,573 Assets whose use is limited: Investments 914, ,504 Pooled investments held at Seattle Children s Healthcare System (SCHS) 576, ,145 Investments under bond indentures and other agreements, noncurrent portion 69,701 2,264 1,560,483 1,387,913 Beneficial interest in SCHS 150, ,187 Land, buildings, and equipment, at cost, net 1,103,367 1,021,051 Other assets, net 23,521 30,088 Total assets $ 3,259,202 2,891,812 Liabilities and Net Assets Current liabilities: Current portion of long-term debt $ 9,345 8,955 Interest payable 13,518 10,905 Accounts payable 67,004 65,539 Accrued salaries, wages, and benefits 75,725 62,717 Due to brokers for securities purchased 48,084 48,267 Other payables 37,897 29,985 Total current liabilities 251, ,368 Long-term debt, net of current portion 715, ,566 Other long-term liabilities 32,477 40,559 Total liabilities 999, ,493 Net assets: Unrestricted 1,803,308 1,618,581 Temporarily restricted 182, ,915 Permanently restricted 273, ,823 Total net assets 2,259,363 2,022,319 Total liabilities and net assets $ 3,259,202 2,891,812 See accompanying notes to financial statements. 3

6 Statements of Operations and Changes in Net Assets Years ended September 30, 2017 and 2016 (In thousands of dollars) Operating revenues: Net patient service revenues (net of contractual allowances and discounts) $ 1,184,425 1,136,802 Provision for uncollectible accounts (1,168) (2,901) Net patient service revenues 1,183,257 1,133,901 Research revenues 92,251 80,962 Other operating revenues 118, ,978 Total operating revenues 1,394,408 1,328,841 Operating expenses: Salaries, wages, and benefits 651, ,778 Purchased services 281, ,619 Supplies and other expenses 259, ,213 Depreciation 80,068 73,439 Interest and amortization 25,062 25,179 Total operating expenses 1,298,030 1,163,228 Operating income 96, ,613 Nonoperating income (expense): Interest and dividend income 26,188 16,492 Realized gains on trading securities, net 13,231 1,687 Unrealized gains on trading securities, net 37,016 27,496 Change in valuation of interest rate swap agreements 8,252 (1,823) Gain on forgiveness of debt 19,740 Other nonoperating expense, net (499) (1,461) Net nonoperating income 84,188 62,131 Excess of revenues over expenses $ 180, ,744 4 (Continued)

7 Statements of Operations and Changes in Net Assets (continued) Years ended September 30, 2017 and 2016 (In thousands of dollars) Excess of revenues over expenses, brought forward $ 180, ,744 Other changes in unrestricted net assets: Net assets released from restriction for capital and other 3,865 1,304 Other ,596 Increase in unrestricted net assets 184, ,644 Changes in temporarily restricted net assets: Investment return, net 32,242 23,737 Restricted contributions 67,575 53,930 Net assets released from restriction (61,607) (55,297) Change in beneficial interest in SCHS 4,052 1,457 Increase in temporarily restricted net assets 42,262 23,827 Changes in permanently restricted net assets: Restricted contributions 1,435 4,562 Change in beneficial interest in SCHS 8,620 4,453 Increase in permanently restricted net assets 10,055 9,015 Increase in net assets 237, ,486 Net assets, beginning of year 2,022,319 1,734,833 Net assets, end of year $ 2,259,363 2,022,319 See accompanying notes to financial statements. 5

8 Statements of Cash Flows Years ended September 30, 2017 and 2016 (In thousands of dollars) Cash flows from operating activities: Increase in net assets $ 237, ,486 Adjustments to reconcile increase in net assets to net cash provided by operating activities: Depreciation 80,068 73,439 Transfer from SCHS (35,528) Provision for uncollectible accounts 1,168 2,901 Realized gains on investments, net (26,234) (14,124) Unrealized gains on investments, net (51,436) (33,755) Restricted contributions (1,435) (4,562) Equity earnings on investments in joint venture, net of cash distributions 222 Change in beneficial interest in SCHS (12,672) (5,910) Change in valuation of interest rate swap agreements (8,252) 1,823 Gain on forgiveness of debt (19,740) Changes in assets and liabilities: Accounts receivable and other assets (52,638) 113 Payables and other liabilities 15, Net cash provided by operating activities 181, ,209 Cash flows from investing activities: Capital expenditures (155,541) (91,596) Proceeds from sale of investments 1,562,110 1,551,197 Purchases of investments (1,688,907) (1,694,798) Net cash used in investing activities (282,338) (235,197) Cash flows from financing activities: Restricted contributions 1,435 4,562 Repayment of long-term debt (8,955) (8,575) Proceeds from long-term debt 126,646 Payment of deferred financing costs (1,696) Net cash provided by (used in) financing activities 117,430 (4,013) Net increase in cash and cash equivalents 16,648 13,999 Cash and cash equivalents, beginning of year 43,520 29,521 Cash and cash equivalents, end of year $ 60,168 43,520 Supplemental disclosure of cash flow information: Cash paid during the year for interest (net of capitalized interest) $ 29,141 27,266 Construction in process included in accounts payable 9,565 See accompanying notes to financial statements. 6

9 Notes to Financial Statements September 30, 2017 and 2016 (In thousands of dollars) (1) Organization and Summary of Significant Accounting Policies (a) Organization Seattle Children s Hospital (the Hospital) is a nonprofit regional pediatric medical center and research institute. The Hospital is a member of a group of controlled corporations that have common management and representation on certain boards of governance. The membership of the Board of Trustees (the Board) of the Hospital and Seattle Children s Healthcare System (SCHS) are identical. The following are affiliates of the Hospital, each of which is a 501(c)(3) and a Washington nonprofit corporation, with the exception of the Children s Clinically Integrated Network which is structured as a Washington limited liability corporation (LLC): Seattle Children s Healthcare System (SCHS) The parent corporation of the Hospital and affiliated-controlled corporate entities. Seattle Children s Hospital Foundation (the Foundation) A corporation established to support SCHS and its affiliates, primarily the Hospital, through fundraising activities. Seattle Children s Hospital Guild Association (the Guild Association) A corporation established to support SCHS and its affiliates, primarily the Hospital, through fundraising events and memberships. Seattle Children s Retail (Retail) A corporation established to support SCHS, through the operation of thrift stores. Children s Clinically Integrated Network A LLC established to develop, coordinate and administer a clinically integrated pediatric network to promote collaboration to enhance the quality and cost effectiveness of pediatric care. Substantially all the net fundraising revenues and support raised by the Foundation, the Guild Association and Retail are transferred to the Hospital or to SCHS on a discretionary basis. Contributions are distributed to the Hospital and are classified to comply with the purposes specified by donors. During 2017 and 2016, the Foundation, the Guild Association, and Retail transferred contributions of $80,268 and $70,386 to the Hospital, respectively. The 1915 Terry property was transferred from SCHS to the Hospital in This resulted in an intercompany equity transfer from SCHS to the Hospital of $35,528 reflected in unrestricted net assets in the line item other. (b) Tax Exemption The Internal Revenue Service has granted the Hospital, and each of the affiliated corporations listed above, exemption from federal income taxes under Section 501(a) of the Internal Revenue Code (IRC) as an organization described in Section 501(c)(3) of the IRC formed to operate a hospital for charitable, 7 (Continued)

10 Notes to Financial Statements September 30, 2017 and 2016 (In thousands of dollars) educational, scientific, and medical purposes. During 2017 and 2016, the Hospital did not record any liability for unrecognized tax benefits. (c) Use of Estimates The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (d) Cash and Cash Equivalents Cash and cash equivalents including highly liquid instruments that are readily convertible to known amounts of cash are recorded at cost, which approximates fair value. This includes money market funds and deposits held by creditworthy, high-quality financial institutions with original maturities of three months or less. (e) Assets Whose Use Is Limited and Investments Assets whose use is limited includes unrestricted assets designated by the Board of Trustees for future capital and various program purposes, over which the Board of Trustees retains control and may, at its discretion, subsequently use for other purposes. Assets whose use is limited also includes temporarily and permanently restricted assets, based on donor restriction, and assets held by trustees under bond indentures and other agreements. Investments under bond indentures and other agreements primarily include assets held by trustees under the terms of the revenue bonds. Amounts required to meet current liabilities of the Hospital have been classified as current assets in the accompanying balance sheets at September 30, 2017 and Investments are stated at fair value. The Hospital classifies its investment portfolio as a trading portfolio, and as such, all unrestricted net unrealized gains or losses are recorded in nonoperating income in the accompanying statements of operations and changes in net assets in the period in which they occur. Investment income (which includes interest and dividends and realized and unrealized gains and losses) is included in nonoperating income in the accompanying statements of operations and changes in net assets, unless the income or gain (loss) is restricted by donor. Restricted investment income is included in the increase (decrease) in temporarily restricted net assets in the accompanying statements of operations and changes in net assets. Investment securities, in general, are exposed to various risks, such as interest rate, credit, and overall market volatility. Due to the level of risks associated with certain investment securities, it is reasonably possible that changes in the value of investments could occur in the near term and that such changes could materially affect the amounts reported in the accompanying balance sheets. 8 (Continued)

11 Notes to Financial Statements September 30, 2017 and 2016 (In thousands of dollars) The Hospital accounts for its investments on a trade-date basis. Investment sales and purchases initiated prior to the balance sheet date and settled subsequent to the balance sheet date result in amounts due from and to brokers. Changes in these assets and liabilities represent noncash investing activities excluded from the statements of cash flows. The cost of investments sold is determined in accordance with the specific identification method, and realized gains and losses are included in investment income in the accompanying statements of operations and changes in net assets. As of September 30, 2017 and 2016, the Hospital recorded payables of $48,084 and $48,267, respectively, for investments purchased but not settled as due to brokers for securities purchased in the accompanying balance sheets. As of September 30, 2017 and 2016, the Hospital recorded a receivable of $28,778 and $0, for investments sold but not settled and interest receivable, included in other current assets in the accompanying balance sheet. Pooled Investments Held at SCHS Pooled investments held at SCHS represent the Hospital s interest in a pool of investments held and managed by SCHS, which are recorded at fair value. Investment income, net and unrealized gains or losses from the SCHS investment pool were allocated between SCHS and the Hospital based upon respective investment balances. The Hospital recognizes the changes in its interest in the SCHS investment pool using a method that approximates the equity method of accounting. (f) Pledges Receivable Pledges receivable consist of private gifts and grants promised from individuals, corporations, foundations or other organizations and are reported at fair value at the date the promise is received. Restricted promises are reported as either temporarily or permanently restricted net assets if they are received with donor stipulations that limit the use of the donated assets to a specific time period or purpose. The schedule of future pledge payments, which are included in other current assets and other assets, in the accompanying balance sheets were as follows at September 30: Receivable in: Less than one year $ 5,356 2,736 One to five years 13,950 3,574 Over five years ,606 6,310 Less discount and allowance (784) (374) $ 18,822 5,936 9 (Continued)

12 Notes to Financial Statements September 30, 2017 and 2016 (In thousands of dollars) (g) Land, Buildings, and Equipment Land, buildings, and equipment are stated at cost, less accumulated depreciation. Maintenance and repairs are expensed as incurred. Interest costs incurred during the time required to ready the asset for its intended use are capitalized. Interest costs of $4,418 and $2,412 were capitalized in 2017 and 2016, respectively. Depreciation is computed using the straight-line method, which allocates the cost of the asset ratably over its estimated useful life. An estimated life of up to 40 years is used for buildings and 8 to 15 years for building and land improvements. Various lives ranging from 3 to 20 years are used for furniture and equipment. Leasehold improvements are depreciated over the shorter of the remaining life of the lease or the useful life of the asset. (h) Other Current Assets Other current assets primarily include prepaid expenses, nonpatient accounts receivable, receivables for securities sold but not settled, and inventories. Inventories are measured at the lower of cost or market value. At September 30, 2017 and 2016, SCH had $12,843 and $12,551, respectively, in inventories. (i) Joint Ventures The equity method of accounting is used for joint ventures in which the Hospital has significant influence, but does not have control. Significant influence is deemed to exist when the ownership interest in the investee is at least 20% and not more than 50% of net assets, although other factors may be considered in determining whether the equity method of accounting is appropriate. (j) Deferred Financing Costs Deferred financing costs are included as a direct deduction from the carrying amount of the Hospital s long-term debt in the accompanying balance sheets and are amortized using the effective-interest method over the term of the related outstanding obligation. (k) Net Assets Contributions are reported at fair value at the date of donation. Such amounts are reported as unrestricted, temporarily restricted, or permanently restricted net assets, based on donor stipulations (if any) that limit the use of the donated assets. When a donor restriction expires, that is, when a stipulated time restriction ends or purpose restriction is accomplished, temporarily restricted net assets are reclassified as unrestricted net assets and reported in the accompanying statements of operations and changes in net assets as other operating revenues and net assets released from restriction. Endowment fund balances, including funds functioning as endowments, are classified and reported as permanently restricted, temporarily restricted, or unrestricted net assets in accordance with Board or donor specifications. Funds functioning as endowments include Board-designated named endowments and other Board-designated funds. 10 (Continued)

13 Notes to Financial Statements September 30, 2017 and 2016 (In thousands of dollars) (l) Net Patient Service Revenues and Patient Accounts Receivable Net patient service revenues are reported at the estimated net realizable amounts from patients and third-party payers. Retroactive adjustments, under reimbursement agreements with third-party payers, are estimated and accrued in the period in which the related services are rendered, and adjusted in future periods as final settlements are determined. Patient accounts receivable are recorded on an accrual basis at established billing rates. The allowances for contractual allowances and discounts and uncollectible accounts are recorded on an accrual basis, using established billing and contracted rates and historical experience. In evaluating the collectibility of patient accounts receivable, the Hospital estimates the allowance for uncollectible accounts by major payer type based on historical experience for each payer type. Primary collection risks relate to uninsured patients and the portion of the bill which is the patients responsibility, primarily copayments and deductibles. For uninsured patients who do not qualify for the Hospital s charity care, the Hospital provides a discount from its standard rates. The Hospital regularly reviews data about the major payer sources of revenues in evaluating the sufficiency of the allowance for contractual allowances and discounts and uncollectible accounts. (m) Other Operating Revenues Other operating revenues primarily include revenues from a federal graduate medical education grant, Hospital s equity earnings from its participation in a joint venture, amounts received from Children s University Medical Group (CUMG), net assets released from restriction for operations, and other. (n) Excess of Revenues over Expenses The accompanying statements of operations and changes in net assets include excess of revenues over expenses. Changes in unrestricted net assets, which are excluded from excess of revenues over expenses, are primarily net assets released from restriction for capital in 2017, and include the transfer of the 1915 Terry property in (o) Reclassifications Prior period financial statement amounts have been reclassified to conform to current period presentation. (p) Subsequent Events The Hospital has performed an evaluation of subsequent events through December 21, 2017, which is the date these financial statements were issued. (q) New and Pending Accounting Pronouncements In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No , Revenue from Contracts with Customers. ASU No provides for a single comprehensive principles-based standard for the recognition of revenue across all industries through the application of the following five-step process: Step 1: Identify the contract(s) with a customer. 11 (Continued)

14 Notes to Financial Statements September 30, 2017 and 2016 (In thousands of dollars) Step 2: Identify the performance obligations in the contract. Step 3: Determine the transaction price. Step 4: Allocate the transaction price to the performance obligations in the contract. Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation. Among other provisions and in addition to expanded disclosure about the nature, amount, timing, and uncertainty of revenue, as well as certain additional quantitative and qualitative disclosures, ASU No changes the health care industry s specific presentation guidance previously under ASU No , Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts for Certain Health Care Entities. ASU No is now effective for fiscal years beginning after December 15, 2017, and interim periods thereafter. Early application is permitted only for fiscal years beginning after December 15, 2016, including interim periods within that reporting period, but has now been delayed one year by ASU No , Revenue from Contracts with Customers (Topic 606). The Hospital is evaluating this guidance and the impact that the adoption of this ASU will have on its consolidated financial statements and related disclosures. In March 2015, the FASB issued ASU No , Simplifying the Presentation of Debt Issuance Costs. This ASU changes the presentation of debt issuance costs in the financial statements. Under the ASU, an entity presents such costs in the consolidated balance sheet as a direct deduction from the recognized liability rather than as an asset. Amortization of the costs is reported as interest expense. The ASU is effective for fiscal years beginning after December 15, The Hospital adopted the standard effective October 1, 2016 and the prior year debt issuance costs of $4,351 have been reclassified from other assets, net to long-term debt, net of current portion in the accompanying balance sheets. In February 2016, the FASB issued ASU No , Leases (Topic 842), which requires lessees to recognize a lease liability and a right of use asset for all lease obligations with exception to short-term leases. The lease liability will represent the lessee s obligation to make lease payments arising from the lease measured on a discounted basis and the right to use asset will represent the lessee s right to use or control the use of a specified asset for a lease term. The lease guidance also simplifies accounting for sale leaseback transactions. The guidance is effective for fiscal years beginning after December 15, The Hospital is evaluating this guidance and the impact that the adoption of this ASU will have on its financial statements and related disclosures. In August 2016, the FASB issued ASU No , Presentation of Financial Statements of Not-for-Profit Entities, to reduce diversity in reporting practice, reduce complexity, and enhance understandability of not-for-profit (NFP) financial statements. This ASU contains the following key aspects: (A) Reduces the number of net asset classes presented from three to two: with donor restrictions and without donor restrictions; (B) Requires all NFPs to present expenses by their functional and their natural classifications in one location in the financial statements; (C) Requires NFPs to provide quantitative and qualitative information about management of liquid resources and availability of financial assets to meet cash needs within one year of the balance sheet date; and (D) Retains the option to present operating cash flows in the statement of cash flows using either the 12 (Continued)

15 Notes to Financial Statements September 30, 2017 and 2016 (In thousands of dollars) direct or indirect method. The guidance is effective for fiscal years beginning after December 15, The Hospital is evaluating this guidance and the impact, including the methods of implementation, that the adoption of this ASU will have on its financial statements and related disclosures. In November 2016, the FASB issued ASU No , Statement of Cash Flows (Topic 230): Restricted Cash, which requires organizations to include cash and cash equivalents that have restrictions on withdrawal or use in total cash and cash equivalents on the statement of cash flows. The guidance is effective for fiscal years beginning after December 15, 2018 and early adoption is permitted. The Hospital is evaluating this guidance and the impact that the adoption of this ASU will have on its financial statements and related disclosures. (2) Uncompensated and Undercompensated Care The Hospital is committed to caring for all children in its service area irrespective of ability to pay. The estimated costs of that care were as follows for the years ended September 30: Medicaid payment shortfall $ 155, ,471 Charity care 9,168 10,212 Total uncompensated and undercompensated care $ 164, ,683 Medicaid is a government sponsored healthcare program for low income individuals. The Medicaid payment shortfall represents the estimated cost of providing services to patients covered under Medicaid in excess of payments received. The estimated cost of services provided to Medicaid patients is estimated based on the ratio of Hospital patient care costs to Hospital patient care charges applied to charges related to services provided to Medicaid patients. Funds received to offset or subsidize charity and Medicaid payment shortfalls were $14,113 and $15,612 for the years ended September 30, 2017 and 2016, respectively. Charity care represents the estimated cost of care provided to patients who are uninsured or underinsured and whose families cannot afford to pay for their medical care. The Hospital provides charity care in accordance with its charity care policy based on family need and maintains records to identify the level of charity it provides. The determination of family need is evaluated during a patient s course of care and can be updated after care is complete. Because the Hospital does not pursue collection of amounts determined to qualify as charity care, these amounts are not reported as revenue. The estimated cost of charity care provided is estimated based on the ratio of Hospital total patient care costs to Hospital total patient care charges applied to gross charges related to charity care services. 13 (Continued)

16 Notes to Financial Statements September 30, 2017 and 2016 (In thousands of dollars) (3) Assets Whose Use Is Limited As of September 30, the fair value of assets whose use is limited was as follows: Board-designated investments $ 504, ,363 Pooled investments held at SCHS 576, ,145 Board-designated endowments 221, ,915 Donor-restricted endowments 188, ,226 Investments held under bond indentures and other 92,497 22,124 $ 1,583,279 1,407,773 (4) Investments and Fair Value Measurements In determining the fair value of investments, the Hospital utilizes valuation techniques to maximize the use of observable market data and minimize the use of unobservable inputs. Inputs refer broadly to the assumptions that market participants would use in pricing the asset or liability, including assumptions about risk. Inputs may be observable or unobservable. Observable inputs are inputs that reflect the assumptions market participants would use in pricing the asset or liability developed based upon market data obtained from sources independent of the reporting entity. Unobservable inputs are inputs that reflect the Hospital s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available. Assets and liabilities that are recorded at fair value are grouped into three levels based on the markets in which assets and liabilities are traded and the observability of the inputs used to determine fair value. The three levels are as follows: Level 1 Quoted prices in active markets for identical assets or liabilities. An active market for the asset or liability is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis. Level 2 Pricing inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly, and the fair value is determined through the use of models or other valuation methodologies. Level 3 Significant unobservable inputs, including assets and liabilities that are traded infrequently. The level in the fair value hierarchy within which a fair value measurement in its entirety falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The fair value hierarchy does not necessarily correspond to a financial instrument s relative liquidity in the market or to its level of risk. 14 (Continued)

17 Notes to Financial Statements September 30, 2017 and 2016 (In thousands of dollars) The following tables present assets and liabilities that were measured at fair value on a recurring basis (including items that were required to be measured at fair value and items for which the fair value option was elected) at September 30: Fair value measurements at reporting date using 2017 Level 1 Level 2 Level 3 Assets: Investments: Money market and other $ 115,785 66,031 49,754 Commercial paper 17,444 17,444 U.S. equity securities 4,786 4,786 U.S. corporate fixed-income securities 294, , Foreign corporate fixed-income securities 161, ,941 Notes issued by the U.S. government and U.S. government agencies 54,834 54,834 Mutual funds: Global (U.S. and foreign) equity funds U.S. corporate fixed income funds 264, ,202 Other 2,391 2,391 Pooled investments 576, ,020 Trustee-held funds 90,178 90,178 Total assets $ 1,583, , , ,522 Liabilities: Interest rate swap agreements $ 17,789 17,789 Total liabilities $ 17,789 17, (Continued)

18 Notes to Financial Statements September 30, 2017 and 2016 (In thousands of dollars) Fair value measurements at reporting date using 2016 Level 1 Level 2 Level 3 Assets: Investments: Money market and other $ 120,430 95,704 24,726 Commercial paper 39,036 39,036 U.S. equity securities 4,822 4,822 U.S. corporate fixed-income securities 307, , Foreign corporate fixed-income securities 155, ,650 Notes issued by the U.S. government and U.S. government agencies 54,444 47,443 7,001 U.S. municipal securities 2,341 2,341 Mutual funds: Global (U.S. and foreign) equity funds U.S. corporate fixed income funds 210, ,249 Other 2,264 2,264 Pooled investments 490, ,145 Trustee-held funds 19,860 19,860 Total assets $ 1,407, , , ,649 Liabilities: Interest rate swap agreements $ 26,041 26,041 Total liabilities $ 26,041 26,041 There were no transfers between Level 1 and Level 2 during 2017 or Pooled investments held at SCHS are recorded at the Hospital s share of the fair value of the SCHS investment pool. The SCHS investment pool was invested as follows at September 30 (in percentages): Mutual funds: Global (U.S. and Foreign) equity 24% 20% U.S. corporate fixed income 8 9 Alternative investments % 100% 16 (Continued)

19 Notes to Financial Statements September 30, 2017 and 2016 (In thousands of dollars) Alternative investments included within pooled investments held at SCHS, include limited partnerships, limited liability corporations, investment trusts, institutional funds, and offshore investment funds. Included in these funds are certain types of financial instruments, including, among others, futures and forward contracts, options, swaps, and securities sold not yet purchased, intended to hedge against changes in the fair value of investments. These financial instruments involve varying degrees of risk. Because alternative investments are not readily marketable, their estimated value is subject to uncertainty and, therefore, may differ from the value that would have been used had a ready market for such investments existed. Such differences could be material. The following table presents the Hospital s activity for assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended September 30, 2017 and 2016: Pooled investments Other Total 2017 Beginning balance at September 30, 2016 $ 490, ,649 Investment income and unrealized gain, net 67,718 (2) 67,716 Additions 25,000 25,000 Other changes (6,843) (6,843) Ending balance at September 30, 2017 $ 576, ,522 Pooled investments Other Total 2016 Beginning balance at September 30, 2015 $ 423, ,445 Investment income and unrealized gain, net 38, ,958 Additions 32,000 32,000 Purchases Other changes (4,254) (4,254) Ending balance at September 30, 2016 $ 490, ,649 Net unrealized gains (losses) included in income, in the table above, relating to assets held at September 30, 2017, were $42,851 and ($2) for pooled investment and other, respectively. Net unrealized gains (losses) included income relating to assets held at September 30, 2016 were $15,498 and $4 for pooled investment and other, respectively. The carrying amounts reported on the accompanying balance sheets for cash and cash equivalents, patient accounts receivable, other current assets, accounts payable, and accrued expenses approximate the fair value because of their short-term nature. 17 (Continued)

20 Notes to Financial Statements September 30, 2017 and 2016 (In thousands of dollars) The fair value of long-term debt, estimated based on the quoted market prices for similar issues, considered a Level 2 measurement, was $741,870 and $646,000 at September 30, 2017 and 2016, respectively. (5) Beneficial Interest in Seattle Children s Healthcare System The Hospital recognizes an interest in a portion of the net assets of SCHS representing certain temporarily and permanently restricted funds that will ultimately benefit the Hospital. At September 30, 2017 and 2016, the Hospital recorded a beneficial interest in SCHS of $150,859 and $138,187, respectively, which corresponds to temporarily and permanently restricted net assets held by SCHS on the Hospital s behalf. The Hospital recognizes changes in this beneficial interest as a change in temporarily and permanently restricted net assets. (6) Land, Buildings, and Equipment Land, buildings, and equipment consist of the following at September 30: Land and improvements $ 232, ,239 Buildings and improvements 973, ,218 Furniture and equipment 492, ,190 Construction in progress 101,251 83,170 1,800,145 1,675,817 Less accumulated depreciation (696,778) (654,766) $ 1,103,367 1,021,051 The Hospital has commitments for construction contracts totaling $61,521 as of September 30, (7) Endowment Funds and Temporarily and Permanently Restricted Net Assets The endowment funds consist of numerous individual funds established for a variety of purposes. They include donor-restricted endowments and funds functioning as endowments, which include board-designated named endowments and other board-designated endowments. Net assets associated with these funds are classified and reported based on the existence or absence of donor-imposed restrictions. The Hospital has interpreted the Washington State Uniform Prudent Management of Institutional Funds Act (WA-UPMIFA) as requiring the preservation of the fair value of the original gift as of the gift date of the donor-restricted endowment funds absent explicit donor stipulations to the contrary. As a result of this interpretation, the Hospital classifies as permanently restricted net assets (a) the original value of gifts donated to the permanent endowment; (b) the original value of subsequent gifts donated to the permanent endowment; and (c) accumulations to the permanent endowment made in accordance with the direction of the applicable donor gift instrument at the time the accumulation is added to the fund. 18 (Continued)

21 Notes to Financial Statements September 30, 2017 and 2016 (In thousands of dollars) The remaining portion of the donor-restricted endowment funds that is not classified in permanently restricted net assets is classified as temporarily restricted net assets until those amounts are appropriated for expenditure by the Hospital in a manner consistent with the standards of prudence prescribed by WA-UPMIFA. In making a determination to appropriate or accumulate donor-restricted endowment funds, the Hospital considers (a) the duration and preservation of the fund, (b) the purposes of SCHS and the donor-restricted endowment, (c) general economic conditions, (d) the appreciation of endowment investments; (e) other resources of the Hospital, and (f) the investment policy of the Hospital. From time to time, the fair value of assets associated with individual donor-restricted endowment funds may fall below the level that the donor or WA-UPMIFA requires the Hospital to retain as a fund of perpetual duration. Deficiencies of this nature are reflected as a reduction in unrestricted net assets. The Hospital has adopted investment and spending policies for endowment assets that attempt to provide a predictable stream of funding to programs supported by its endowments while seeking to maintain the purchasing power of the endowment assets. To satisfy its long-term rate-of-return objectives, the Hospital relies on a total return strategy in which investment returns are achieved through both capital appreciation (realized and unrealized) and current yield (interest and dividends). The Hospital targets a diversified asset allocation intended to achieve its long term return objectives within prudent risk constraints. The Hospital has a spending policy of appropriating 5% of its endowment funds 12-quarter average market value of donor-restricted and board-designated named endowments. In establishing this policy, the Hospital considered the long-term expected return on its endowment funds. The endowment net assets composition by type as of September 30, 2017 and 2016 were as follows: Temporarily Permanently Unrestricted restricted restricted Total September 30, 2017: Donor-restricted $ (57) 47, , ,794 Board-designated: Named endowment funds 9,968 9,968 Other endowment funds 211, ,097 Total funds $ 221,008 47, , ,859 September 30, 2016: Donor-restricted $ (353) 33, , ,226 Board-designated: Named endowment funds 9,196 9,196 Other endowment funds 185, ,719 Total funds $ 194,562 33, , , (Continued)

22 Notes to Financial Statements September 30, 2017 and 2016 (In thousands of dollars) The changes in endowment net assets for 2017 and 2016 were as follows: September 30, 2017 Temporarily Permanently Unrestricted restricted restricted Total Endowment net assets, September 30, 2016 $ 194,562 33, , ,141 Investment return: Net interest and dividends 2,238 2,115 4,353 Net appreciation (realized and unrealized) 24,799 20,205 45,004 Total investment return 27,037 22,320 49,357 Contributions 2 1,522 1,524 Appropriation of endowment assets for expenditure: Donor-restricted (128) (8,530) (40) (8,698) Board-designated named (465) (465) Total appropriations (593) (8,530) (40) (9,163) Endowment net assets, September 30, 2017 $ 221,008 47, , , (Continued)

23 Notes to Financial Statements September 30, 2017 and 2016 (In thousands of dollars) September 30, 2016 Temporarily Permanently Unrestricted restricted restricted Total Endowment net assets, September 30, 2015 $ 179,154 28, , ,807 Investment return: Net interest and dividends 2,256 2,169 4,425 Net appreciation (realized and unrealized) 13,778 11,272 25,050 Total investment return 16,034 13,441 29,475 Contributions 4,574 4,574 Appropriation of endowment assets for expenditure: Donor-restricted (163) (8,089) (8,252) Board-designated named (463) (463) Total appropriations (626) (8,089) (8,715) Endowment net assets, September 30, 2016 $ 194,562 33, , ,141 Temporarily restricted net assets were available for the following purposes at September 30: Healthcare services: Purpose restrictions $ 60,321 38,647 Unappropriated endowment earnings 47,775 33,984 Research 71,604 65,948 Capital projects 2,477 1,336 $ 182, ,915 Permanently restricted net assets were restricted to investments in perpetuity, the income from which is expendable to support the following at September 30: Healthcare services $ 132, ,034 Research 141, ,789 $ 273, , (Continued)

24 Notes to Financial Statements September 30, 2017 and 2016 (In thousands of dollars) (8) Long-Term Debt Long-term debt obligation consisted of the following at September 30: Maturing Interest Unpaid principal through rates Revenue Bonds Fixed: Series % $ 3,095 4,025 Series 2010A % 75,000 75,000 Series 2010B % 23,075 26,305 Series 2012A % 46,335 46,335 Series 2012B % 27,895 27,935 Series 2015A % 100, ,000 Series 2015B % 167, ,350 Series 2017A % 114,080 Total fixed 556, ,950 Variable: Series 2012C % 60,370 62,045 Series 2012D % 61,915 64,960 Total variable 122, ,005 Unpaid principal, long-term debt 679, ,955 Unamortized premiums, discounts and debt issuance costs, net 46,054 37,566 Long-term debt, including premiums, discounts, and debt issuance costs 725, ,521 Less current portion 9,345 8,955 Long-term debt, net of current portion $ 715, ,566 The Revenue Bonds are collateralized by a pledge of gross revenues and secured by interests in certain bond funds. 22 (Continued)

25 Notes to Financial Statements September 30, 2017 and 2016 (In thousands of dollars) Scheduled principal repayments as of September 30, 2017 on the long-term debt are due as follows: 2018 $ 9, , , , ,465 Thereafter 622, ,080 Add unamortized premiums, discounts and debt issuance costs, net 46,054 $ 725,134 In 2017, the Hospital issued $114,080 of Series 2017A Bonds, refinanced $60,400 in Series 2012C Bonds, and $61,900 in Series 2012D Bonds. In 2008, SCHS entered into a New Markets Tax Credit financing to develop and construct a portion of the Hospital s research facility. The compliance period of the transaction ended As a result of the completion of the compliance period, the Hospital recorded $19,740 as a noncash gain on forgiveness of debt in 2016, in nonoperating income (expense) in the accompanying statements of operations and changes in net assets. The members of the Obligated Group established under the Master Indenture include the Hospital and SCHS. As of September 30, 2017, total assets, total liabilities, and total unrestricted net assets of the Obligated Group constituted approximately 100%, 100%, and 100%, respectively, of the respective SCHS s consolidated totals. For 2017, the total operating revenues, operating income, and excess of revenues over expenses, from all sources attributable to the Obligated Group were 99%, 100%, and 100%, respectively, of the respective SCHS s consolidated totals. Under the terms of the Revenue Bonds and related indenture agreements, the Obligated Group is required to comply with various covenants, including income available for debt service. Accounting for Derivative Instruments Interest rate swap contracts are used to manage the net exposure to interest rate changes in attempting to reduce the overall cost of borrowing over time. The Hospital records these derivative instruments on the accompanying balance sheet as an asset or liability measured at its individual fair market value the fair value of interest rate swap contracts is included in other long-term liabilities on the accompanying balance sheet. Changes in the derivative instrument s fair market value are recognized in earnings unless certain specific hedge accounting criteria are met. The Hospital has not designated its interest rate swap agreements as cash flow hedges, and all changes in the valuation of the interest rate swaps are recognized in other nonoperating expenses, net, in the accompanying consolidated statements of operations and changes in net assets. Interest rate swaps not designated as hedges represented liabilities of $17,789 and $26,041 as of September 30, 2017 and 2016, respectively. 23 (Continued)