Lucile Salter Packard Children’s Hospital at Stanfordbondholder-information.stanford.edu/pdf/LPCH_2012_financ... · 2012. 12. 13. · Lucile Salter Packard Children’s Hospital

Lucile Salter PackardChildren’s Hospital at StanfordConsolidated Financial StatementsAugust 31, 2012 and 2011

Lucile Salter Packard Children’s Hospital at StanfordIndexAugust 31, 2012 and 2011

Page(s)

Report of Independent Auditors ...............................................................................................................1

Consolidated Financial Statements

Consolidated Balance Sheets ......................................................................................................................2

Consolidated Statements of Operations and Changes in Net Assets .........................................................3

Consolidated Statements of Cash Flows .....................................................................................................4

Notes to Consolidated Financial Statements .........................................................................................5–35

Report of Independent Auditors on Accompanying Consolidating Information ..............................36

Consolidating Balance Sheets ...................................................................................................................37

Consolidating Statements of Operations and Changes in Net Assets ......................................................38

Report of Independent Auditors

To the Board of Directors

Lucile Salter Packard Children’s Hospital at Stanford

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of

operations and changes in net assets and cash flows present fairly, in all material respects, the financial

position of Lucile Salter Packard Children’s Hospital at Stanford (“LPCH”) at August 31, 2012 and 2011

and the results of its operations and its cash flows for the years then ended in conformity with accounting

principles generally accepted in the United States of America. These financial statements are the

responsibility of LPCH’s management. Our responsibility is to express an opinion on these financial

statements based on our audits. We conducted our audits of these statements in accordance with

auditing standards generally accepted in the United States of America. Those standards require that we

plan and perform the audit to obtain reasonable assurance about whether the financial statements are

free of material misstatement. An audit includes examining, on a test basis, evidence supporting the

amounts and disclosures in the financial statements, assessing the accounting principles used and

significant estimates made by management, and evaluating the overall financial statement presentation.

We believe that our audits provide a reasonable basis for our opinion.

December 12, 2012

PricewaterhouseCoopers LLP, Three Embarcadero Center, San Francisco, CA 94111-4004T: (415) 498 5000, F: (415) 498 7100, www.pwc.com/us

Lucile Salter Packard Children’s Hospital at StanfordConsolidated Balance SheetsAugust 31, 2012 and 2011

(in thousands of dollars)

The accompanying notes are an integral part of these consolidated financial statements.

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2012 2011

Assets

Current assets

Cash and cash equivalents 85,641$ 90,314$

Short term investments in Stanford University (“University”)

managed pools 1,070 93,450

Patient accounts receivable, net of allowance for doubtful

accounts of $16,000 and $12,000 in 2012 and 2011, respectively 160,889 138,755

Contributions receivable 24,675 19,532

97,437 -

Other receivables 42,551 2,536

Prepaid expenses, inventory and other 10,093 14,304

Total current assets 422,356 358,891

Investments 66,907 65,262

Investments in University managed pools 551,558 453,883

Board designated funds in University managed pools 210,149 206,599

Assets limited as to use, held by trustee 198,717 -

Property and equipment, net 520,898 459,725

Beneficial interest in trusts, net 13,604 13,972

Contributions receivable, net of current portion 25,210 10,200

Other assets 22,345 15,824

Total assets 2,031,744$ 1,584,356$

Liabilities and Net Assets

Current liabilities

Accounts payable and accrued liabilities 88,074$ 62,190$

Accrued salaries and related benefits 47,182 42,998

Due to related parties 27,533 38,168

Third-party payor settlements 1,701 1,525

Current portion of long-term debt and capital leases - 107,093

Self-insurance reserves and other liabilities 5,107 4,433

Total current liabilities 169,597 256,407

Self-insurance reserves and other liabilities, net of current portion 30,728 28,257

Long-term debt and capital leases, net of current portion 363,766 57,075

Total liabilities 564,091 341,739

Commitments and contingencies

Net assets

Unrestricted 982,921 902,008

Temporarily restricted 284,973 141,751

Permanently restricted 199,759 198,858

Total net assets 1,467,653 1,242,617

Total liabilities and net assets 2,031,744$ 1,584,356$

Other receivable from California Health Facilities Financing

Authority ("CHFFA")

Lucile Salter Packard Children’s Hospital at StanfordConsolidated Statements of Operations and Changes in Net AssetsYears Ended August 31, 2012 and 2011



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2012 2011

Operating revenues

Net patient service revenue before provision for doubtful accounts 930,846$ 870,708$

Provision for doubtful accounts, net (9,150) (9,711)

Net patient service revenue after provision for doubtful accounts 921,696 860,997

Other revenue 38,832 34,867

Net assets released from restrictions used for operations 19,130 18,768

Total operating revenues 979,658 914,632

Operating expenses

Salaries and benefits 389,541 364,677

Professional services 21,804 16,458

Supplies 66,166 64,454

Purchased services 294,983 263,902

Other 100,953 75,080

Depreciation and amortization 37,381 37,913

Total operating expenses 910,828 822,484

Income from operations 68,830 92,148

Interest income 2,154 1,140

Income and gains from University managed pools 17,599 78,786

Other (3,658) (2,000)

Excess of revenues over expenses 84,925 170,074

Net assets released from restrictions used for purchases of

property and equipment 2,843 1,533

Transfer of net investment loss on certain endowments 61 (277)

Adjustment for minimum pension liability 964 1,924

Transfers to University and other (7,880) (29,282)

Increase in unrestricted net assets 80,913 143,972

Changes in temporarily restricted net assets

Contributions 155,726 18,669

Income and gains from University managed pools 8,763 40,396

Change in value of beneficial interest in remainder trusts (492) (372)

Net assets released from restrictions for operations (19,130) (18,768)

Purchase of property and equipment (2,843) (1,533)

Transfers to University and other 1,198 (1,390)

Increase in temporarily restricted net assets 143,222 37,002

Changes in permanently restricted net assets

Contributions and other 420 34

Change in value of beneficial interest in remainder trusts 481 929

Transfers to University and other - (27,136)

Increase (decrease) in permanently restricted net assets 901 (26,173)

Increase in net assets 225,036 154,801

Net assets

Beginning of year 1,242,617 1,087,816

End of year 1,467,653$ 1,242,617$

Lucile Salter Packard Children’s Hospital at StanfordConsolidated Statements of Cash FlowsYears Ended August 31, 2012 and 2011



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2012 2011

Cash flows from operating activities

Change in net assets 225,036$ 154,801$

Adjustments to reconcile change in net assets to

net cash provided by operating activities

Depreciation and amortization 37,295 38,570

Loss on extinguishment of debt 3,658 -

Premium received related to bond issuance 19,640 -

Net transfers to related parties and other 6,862 55,473

Provision for doubtful accounts 9,150 9,711

Income and gains from University managed pools (5,131) (99,968)

Contributions and investment income restricted by donors (112,400) (11,633)

Changes in operating assets and liabilities

Patient accounts receivable, net (31,284) (37,435)

Contributions receivable (19,195) (375)

Due to/from related parties (6,829) (22,280)

Other receivables, inventory, other assets, prepaid

expenses and other (42,514) (15,469)

Accounts payable and accrued liabilities 2,682 24,635

Accrued salaries and related benefits 4,184 (1,164)

Third-party payor settlements 176 1,272

Self-insurance and other liabilities 3,145 5,107

Cash provided by operating activities 94,475 101,245

Cash flows from investing activities

Purchases of investments in University managed pools and other (5,359) (142,391)

Purchase of investment for assets limited as to use (209,471) -

Sales of investments in University managed pools - -

Sales of investments 10,754 10,000

Decrease in assets limited as to use - 37

Purchases of property and equipment (76,910) (60,100)

Cash used in investing activities (280,986) (192,454)

Cash flows from financing activities

Extinguishment of long term and short tem debt (148,450) -

Payment of capital leases (13,871) (2,593)

Cost of issuance related to debt issuance (3,478) -

Proceeds from issuance of long term debt 344,495 -

Contributions and investment income restricted by donors 13,799 13,344

Transfers to related parties (10,657) (21,456)

Cash provided by (used in) financing activities 181,838 (10,705)

Net decrease in cash and cash equivalents (4,673) (101,914)

Cash and cash equivalents

Beginning of year 90,314 192,228

End of year 85,641$ 90,314$

Supplemental disclosures of cash flow information

Interest paid 6,859$ 3,692$

Noncash activities

Accounts payable related to purchases of property and equipment 21,644 15,146

Transfer of pledge receivable to related party - 26,989

Accrual of net assets transfer to related parties 3,144 7,281

Lucile Salter Packard Children’s Hospital at StanfordNotes to Consolidated Financial StatementsAugust 31, 2012 and 2011


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1. Organization

Lucile Salter Packard Children’s Hospital at Stanford (“LPCH”) operates a licensed acute carepediatric and obstetric hospital on the Leland Stanford Junior University (“University”) campus inPalo Alto and operates several inpatient care units on its license in nearby community hospitals.LPCH also operates outpatient physician clinics in its facilities and other community settings.

The Board of Trustees of the University is the sole corporate member of LPCH and StanfordHospital and Clinics (“SHC”). LPCH, SHC, and the University engage in certain related partytransactions as described further in Note 13. LPCH leases all its 3,017 full time and part timeemployees from SHC as of August 31, 2012.

These consolidated financial statements for fiscal year 2012 include LPCH’s interest in PackardChildren’s Health Alliance (PCHA). PCHA was incorporated in October 2011 as a not-for-profitphysician practice management organization, which supports Stanford University Medical Center’s(SoM) mission of delivering quality care to the community and conducting research and education.PCHA is developing a clinical delivery network of pediatric community physicians. The SoM andLPCH are the members of PCHA, and appoint directors to the governing board. The bylaws ofPCHA afford control of PCHA to LPCH and therefore, the activities of PCHA have been included inthe consolidated financial statements of LPCH. LPCH has recorded PCHA’s 2012 results ofoperations as an investment in PCHA and it is eliminated in consolidation.

Effective September 1, 2002, LPCH and SHC entered into an agreement whereby LPCH became amember of the Stanford University Medical Indemnity Trust (“SUMIT”), a not-for-profit, tax-exemptcorporation that is a captive insurance carrier. LPCH’s share of SUMIT was approximately 25.5%and 17.7% for the years ended August 31, 2012 and 2011, respectively. LPCH’s ownership inSUMIT is accounted for using the equity method. As of August 31, 2012 and 2011, LPCH had aninvestment of $13,696 and $9,539 in SUMIT, respectively, which is reflected on the balance sheetsas other assets.

On September 1, 2006, LPCH and the University entered into a Professional Services Agreement(“PSA”) pursuant to which the University assigned to LPCH the right to bill and collect all revenuerelated to pediatric and obstetric practices on behalf of the University’s School of Medicine (“SoM”)faculty as the LPCH Medical Group, a division of LPCH.

2. Summary of Significant Accounting Policies

Basis of PresentationThe accompanying financial statements are prepared on the accrual basis of accounting.

Net assets of LPCH and changes therein have been classified and are reported as follows:

Unrestricted net assets – Unrestricted net assets represent those resources of LPCH thatare not subject to donor-imposed stipulations. The only limits on unrestricted net assets arebroad limits resulting from the nature of LPCH and the purposes specified in its articles ofincorporation or by laws and limits resulting from contractual agreements, if any.



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Temporarily restricted net assets – Temporarily restricted net assets representcontributions, which are subject to donor-imposed restrictions that can be fulfilled by actions ofLPCH pursuant to those stipulations or by the passage of time.

Permanently restricted net assets – Permanently restricted net assets representcontributions that are subject to donor-imposed restrictions that they be maintained by LPCHin perpetuity. Generally, the donors of these assets permit LPCH to use all or part of theinvestment return on these assets.

Expenses are generally reported as decreases in unrestricted net assets. Donor-imposedrestrictions expire when the stipulated time period has elapsed, when the stipulated purpose forwhich the resource was restricted has been fulfilled, or both. Temporarily restricted contributionsare recorded as restricted revenue when received and when the restriction expires, the net assetsare shown as released from restriction in the Consolidated Statements of Operations and Changesin Net Assets. Income earned on temporarily restricted or permanently restricted net assets forwhich that income is restricted for a stipulated purpose is recorded in temporarily restricted netassets. When income is made available for release and when the restriction is deemed to havebeen met, those amounts are included in net assets released from restrictions in the ConsolidatedStatements of Operations and Changes in Net Assets.

Transfers to Related PartiesCertain amounts previously received from donors have been transferred to related parties.

Cash and Cash EquivalentsCash and cash equivalents consist primarily of demand deposits and money market mutual funds.These amounts are carried at cost which approximates fair value.

Assets Limited as to Use, Held by TrusteeAssets limited as to use primarily include assets held by trustees under bond indentureagreements. The bond indenture terms require that the trustee control the disbursement of bondproceeds for capital projects. Assets limited as to use consist of money market funds for the yearended August 31, 2012, and no remaining balance for the year ended August 31, 2011. Fairvalues are based on quoted market prices or broker or dealer price quotations on a specificidentification basis.

Contributions ReceivableContributions are recorded at fair value at the date the promise is received. Donations for specificpurposes are reported as either temporary or permanently restricted net assets and are included asrestricted contributions. Contributions to be received after one year are discounted at anappropriate discount rate commensurate with the risks involved and applicable to the years inwhich the promises are received, and recorded in their respective net asset category. The discountrates used during the year ended August 31, 2012 and 2011 were determined using the risk freerate adjusted for the risk of donor default. Amortization of the discount is included in contributionrevenue in the Consolidated Statements of Operations and Changes in Net Assets. Conditionalpromises to give are recognized when the condition is substantially met.

Other ReceivablesOther receivables are comprised of nonpatient related receivables for medical services provided.



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InvestmentsInvestments held directly by LPCH consist primarily of mutual funds and are stated at fair value.Investment earnings (including realized gains and losses on investments, interest, dividends andimpairment loss on investment securities) are included in investment income unless the income orloss is restricted by donor or law. Income on investments of donor restricted funds is added to ordeducted from the appropriate net asset category based on the donor’s restriction. Unrestrictedunrealized gains and losses on other than trading securities are separately reported below theexcess of revenues over expenses in the statement of operations and changes in net assets.

Investments in University Managed PoolsInvestments in University managed pools consist of funds invested in the University’s Merged Pool(“MP”). The value of its share of the MP is determined by the University, and is based upon the fairvalue of the underlying assets held in the MP. Earnings include distributions and increases ordecreases in the value of LPCH’s share of the pool. LPCH may deposit funds in the MP at itsdiscretion; however, withdrawals require advance notice, with the exception of the LiquidityAgreement that was in effect from July 25, 2008 through March 21, 2012. The Liquidity Agreementprovided for the liquidation of MP shares held by LPCH into immediately available funds for thepurpose of funding tenders of the 2008 California Health Facilities Financing Authority Series A, Band C variable rate bonds. Funds that were available same day pursuant to the liquidity agreementand funds which would be disbursed to LPCH near the end of the fiscal year were both classifiedas short term investments. The agreement was renewed on May 27, 2011 and was cancelled onMarch 21, 2012.

All investment gains and losses and the increases or decreases in the share value are treated asrealized and included in the excess of revenues over expenses, unless the income is restricted bydonor or law.

Board Designated Funds in University Managed PoolsIn prior years, LPCH’s board of directors approved designating $206,599 for future investment infacilities, programs, and services over which the Board retains control and may at its discretionsubsequently use for other purposes. These funds are primarily invested in the MP and werefunded from cash and cash equivalents. In accordance with the instructions of the Board,investment returns earned on board designated funds are treated as unrestricted income with theprincipal to remain intact until required for future investment in facilities, programs, and services.

Beneficial Interest in TrustsLPCH is the remainder beneficiary of certain charitable remainder trusts where the trust assets areinvested and administered by outside trustees. LPCH records its remainder interest in these trustsat fair value based on estimated future cash receipts discounted at rates ranging from 0.23% to1.85% for the year ended August 31, 2012 and 0.11% to 2.24% for the year ended August 31,2011. The fair value of these assets is based on the market value of the traded securities as ofyear end.

Additionally, LPCH is the sole beneficiary of a perpetual trust that is carried at the fair market valueof the trust. Income from the trust (interest, net of fees) is distributed to LPCH and included ininterest income.



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Property and EquipmentProperty and equipment are stated at cost except for donated assets, which are recorded at fairmarket value at the date of donation. LPCH capitalizes certain internal costs of computer softwaredeveloped or obtained for internal use. Depreciation of property and equipment is computed usingthe straight-line method over the estimated useful lives or the remaining expected useful life, whichare as follows:

Land improvements 10 to 25 years

Buildings and improvements 10 to 40 years

Equipment 3 to 20 years

Ground leases 3 to 49 years

Significant replacements and improvements are capitalized, while maintenance and repairs, whichdo not improve or extend the life of the respective assets, are charged to expense as incurred.Upon sale or disposal of property and equipment, the cost and accumulated depreciation areremoved from the respective accounts, and any gain or loss is included in the ConsolidatedStatements of Operations and Changes in Net Assets.

Assets under capital leases are recorded at the present value at the inception of the lease and areamortized on a straight-line basis over the shorter of the lease term or the estimated useful life ofthe asset. The amortization of assets recorded under capital leases is included in depreciation andamortization expense in the accompanying Consolidated Statements of Operations and Changesin Net Assets.

LPCH holds several ground leases, also classified as property and equipment. These groundleases are amortized on a straight-line basis over the term of the leases and are reflected asdepreciation and amortization in the Consolidated Statements of Operations and Changes in NetAssets.

Interest costs incurred on borrowed funds during the period of construction of capital assets arecapitalized, net of any interest earned, as a component of the cost of acquiring the asset.

Asset Retirement ObligationsAsset retirement obligations, reported in accounts payable and accrued liabilities, are legalobligations associated with the retirement of long-lived assets. These liabilities are initiallyrecorded at fair value and the related asset retirement costs are capitalized by increasing thecarrying amount of the related assets by the same amount as the liability. Asset retirement costsare subsequently depreciated over the useful lives of the related assets. Subsequent to initialrecognition, LPCH records changes in the liability resulting from the passage of time and revisionsto either the timing or amount of the original estimate of undiscounted cash flows. LPCH reducesthese liabilities when the related obligations are settled.



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Impairment and Disposition of Long-Lived AssetsLong-lived assets are reviewed for impairment whenever events or changes in circumstancesindicate that the carrying amount of an asset may not be recoverable. Recoverability of assets tobe held and used is measured by a comparison of the carrying amount of an asset to future netundiscounted cash flows expected to be generated by the asset. If such assets are considered tobe impaired, the impairment to be recognized is measured by the amount by which the carryingamount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported atthe lower of the carrying amount or fair value less costs to sell. There were no impairment lossesfor the years ended August 31, 2012 and 2011.

Other AssetsOther assets include LPCH’s ownership interest in SUMIT, investment in joint ventures and PCHA,deposits with vendors, and deferred debt issuance costs. Deferred debt issuance costs representcosts incurred in conjunction with the issuance of LPCH’s long-term debt. These costs areamortized on a straight-line basis, which approximates the effective interest method, over the life ofthe debt.

Compensated AbsencesIn accordance with formal policies concerning vacation and other compensated absences, accrualsof $30,772 and $28,904 were recorded as of August 31, 2012 and 2011, respectively, and areincluded in accrued salaries and related benefits.

Premiums on Long-Term DebtPremiums arising from the original issuance of long-term debt are amortized on a straight-linebasis, which approximates the effective interest method, over the life of the debt. The unamortizedportion of these premiums is included in long-term debt.

Excess of Revenues Over ExpensesThe Consolidated Statements of Operations include excess of revenues over expenses. Changesin unrestricted net assets which are excluded from excess of revenues over expenses includepermanent transfers of assets to and from affiliates for other than goods and services, contributionsof long-lived assets (including assets acquired using contributions which by donor restriction wereto be used for the purposes of acquiring such assets), adjustment for minimum pension liability,and transfer of funds related to underwater endowment.

Net Patient Service RevenueNet patient service revenue is reported at the estimated net realizable amounts from patients,third-party payors including Medi-Cal and others for services rendered. The contractualcommitments and laws and regulations governing the payment for services for government(Medi-Cal and Medicare) and commercial payors are extremely complex and subject tointerpretation. As a result, there is at least a reasonable possibility that recorded estimates willchange by a material amount in the near term.



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The process for estimating the ultimate collectibility of receivables involves historical collectionexperience, changes in contracts with payors, and significant assumptions and judgment. LPCHhas implemented a standardized approach to this estimation based on the payor classification andage of outstanding receivables. Account balances are written off against the allowance whenmanagement believes it is probable the receivable will not be recovered. The use of historicalcollection experience is an integral part of the estimation of the reserve for doubtful accounts.Revisions in the reserve for doubtful accounts are recorded as adjustments to the provision fordoubtful accounts.

Charity Care and Community BenefitsLPCH provides care to patients who meet certain criteria under its charity care policy withoutcharge or at amounts less than its established rates. Amounts determined to qualify as charitycare are not reported as net patient service revenue. LPCH also provides services to patientsunder Medi-Cal and other publicly sponsored programs, which reimburse at amounts less than thecost of the services provided to the recipients. Such amounts are considered community benefits.

Self-Insurance Reserves and Other LiabilitiesLPCH self-insures for professional liability risks, postretirement medical benefits, health, dental andvision, and workers’ compensation. These liabilities are reflected as self-insurance reserves on thebalance sheets.

Professional Liability – LPCH is self insured through SUMIT (LPCH and SHC CaptiveInsurance Carrier) for medical malpractice and general liability losses under claims-madecoverage. LPCH also maintains professional liability reserves for claims not covered bySUMIT which totals $1,118 and $1,162 for the years ended August 31, 2012 and 2011,respectively. For the policy year’s September 1, 2011 to September 1, 2012, SUMIT retains100% of the risk related to the first $15,000 per occurrence. The next $115,000 is transferredto various reinsurance companies. For the period from September 1, 2005 to September 1,2011, LPCH maintained the same coverage limits as fiscal year 2012. Prior to September 1,2005 LPCH maintained various coverage limits.

Postretirement Medical Benefits – Liabilities for post-retirement medical claims for currentand retired employees are actuarially determined by SHC and allocated to LPCH.

Health, Dental and Vision – Liabilities for health, dental and vision claims for currentemployees are based on estimated costs.

Workers’ Compensation – LPCH purchases insurance for workers’ compensation claimswith a $750 deductible per occurrence. Workers’ compensation insurance provides statutorylimits for the State of California. An actuarial estimate of retained losses (or losses retainedwithin the deductible) has been used to record a liability.

Fair Value of Financial InstrumentsDue to the short-term nature of cash and cash equivalents, accounts payable and accruedliabilities, and accrued salaries and related benefits, their carrying value approximates their fairvalue.



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Transactions with the UniversityLPCH enters into various transactions with the University. LPCH records expense transactionswhere direct and incremental economic benefits are received by LPCH. Certain expenses areallocated from the University to LPCH. Allocated expenses reported as operating expenses in theConsolidated Statements of Operations and Changes in Net Assets are management’s bestestimates of LPCH’s arms-length payment of such amounts for its market specific circumstances.To the extent that payments to the University exceed an arms-length estimated amount relative tothe benefit received by LPCH, they are recorded as transfers to the University.

Concentration of Credit RiskFinancial instruments, which potentially subject LPCH to concentrations of credit risk, consistprincipally of cash and cash equivalents, patient accounts receivable, and investments in Universitymanaged pools (Note 7).

LPCH invests its cash and cash equivalents in highly rated financial instruments including insureddeposits. As of August 31, 2012, LPCH has invested its cash and cash equivalents with a financialinstitution in excess of federal depository insurance limits.

LPCH’s concentration of credit risk relating to patient accounts receivable is limited by the diversityand number of the patients and payers. Patient accounts receivable consists of amounts due fromgovernmental programs, commercial insurance companies, private pay patients, and other groupinsurance programs.

Use of EstimatesThe preparation of financial statements in conformity with accounting principles generally acceptedin the United States of America requires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts of revenues andexpenses during the reporting period. The most significant estimates relate to patient accountsreceivable allowances and self insurance reserves. Actual results may differ from those estimates.

Income TaxesLPCH is a California not-for-profit corporation and has been recognized as tax-exempt pursuant toSection 501(c) (3) of the Internal Revenue Code.

Adoption of New StandardsThe Financial Accounting Standards Board (FASB) is the authoritative source of GenerallyAccepted Accounting Principles (GAAP) in the United States. The consolidated financialstatements as of and for the year ended August 31, 2012 reflect several pronouncements that wereissued by the FASB or became effective during the year.

During 2012, LPCH adopted guidance to disclose or record the impact of two updates to the FASBAccounting Standards Codification (ASC) which require the cost to be used as the measurementfor charity care disclosure purposes and eliminates the ability for health care entities to netinsurance recoveries against related claim liabilities. LPCH has early adopted an update to theASC which requires reclassification of provision for doubtful accounts associated with patientservice revenue from operating expense to a deduction from net patient revenue as a separate lineitem. This guidance is applied retrospectively.



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In January 2010, the FASB issued an update to the ASC which expanded the required disclosuresabout fair value measurements. In particular, this guidance requires: (1) separate disclosure of theamounts of significant transfers in and out of Level 1 and Level 2 fair value measurements alongwith the reasons for such transfers; (2) information about purchases, sales, issuances andsettlements to be presented separately in the reconciliation for Level 3 fair value measurements;(3) fair value measurement disclosures for each class of assets and liabilities; and (4) disclosuresabout the valuation techniques and inputs used to measure fair value for both recurring andnonrecurring fair value measurements that fall in either Level 2 or Level 3. This guidance iseffective for the fiscal year beginning September 1, 2010 except for (2) above which is effective forthe fiscal year beginning September 1, 2011. This guidance did not materially impact LPCH’sfinancial statement disclosures.

Reclassification of Prior Year AmountsCertain comparative figures such as Provision for doubtful accounts on the ConsolidatedStatements of Operations and Changes in Net Assets have been reclassified to conform withcurrent year presentation.

3. Net Patient Service Revenue

LPCH has agreements with third-party payors that provide for payments at amounts different fromLPCH’s established rates. A summary of payment arrangements with major third-party payors areas follows:

Medi-Cal – Inpatient services rendered to Medi-Cal program beneficiaries are reimbursedunder a contract at prospectively determined negotiated per diem rates. Outpatient servicesare reimbursed based upon prospectively determined fee schedules.

In addition, LPCH qualified for additional revenue under the Medi-Cal Disproportionate Share(“DSH”) program. DSH is a California program for the poor and when a hospital is consideredby the State to have relatively more Medi-Cal utilization than the norm, it qualifies to receiveDSH supplemental funding. LPCH must re-qualify for DSH annually. For the years endedAugust 31, 2012 and August 31, 2011, LPCH received $0.4 million and $8.4 million in DSHsupplemental payments, respectively.

HMO/PPO and Other – Managed care contracts such as those with HMOs and PPOsreimburse LPCH at per diem rates or a percent of charges basis, which are less than fullcharges. Net patient service revenue by major payor for the years ended August 31 is asfollows:

2011

LPCH PCHA Total LPCH

Medi-Cal 169,558$ -$ 169,558$ 165,011$

HMO/PPO 709,039 531 709,570 641,406

Other 51,667 51 51,718 64,291

930,264$ 582$ 930,846$ 870,708$

2012



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Included above in the Medi-Cal net patient services revenue is $67,994 and $51,205 for Medi-CalFee-For-Service and Managed Care payments for fiscal years 2012 and 2011, respectively, underthe hospital provider fee program.

Amounts due from Blue Cross and the State of California’s Medi-Cal program represent 25% and14%, and 24% and 15%, of LPCH net patient accounts receivable at August 31, 2012 and 2011,respectively. LPCH does not believe significant credit risks exist with these payors. Amounts duefrom Blue Cross and Blue Shield represent 42% of PCHA net patient accounts receivable atAugust 31, 2012.

Hospital Quality Assurance Fee ProgramThe State of California enacted AB 1383 in 2009, as amended by AB 1653 in 2010, whichestablished a Hospital Quality Assurance Fee Program (“QAF”) and a Hospital Fee Program.These programs imposed a provider fee on certain California general acute care hospitals that,combined with federal matching funds, would be used to provide supplemental payments to certainhospitals and support the State’s effort to maintain health care coverage for children. The effectiveperiod of the Hospital Fee Program was April 1, 2009 through December 31, 2010. The Statereceived final approval from the Centers for Medicare & Medicaid Services (CMS) in December of2010 on the rates to pay Medi-Cal managed care plans. Subsequent legislation extended the QAFand Hospital Fee programs from January 1, 2011 through June 30, 2011, which was approved byCMS in December 2011. Additional legislation extended the QAF and Hospital Fee programs fromJuly 1, 2011 through December 31, 2013. In June 2012, CMS approved only the fee-for-serviceMedi-Cal supplement payments portion of this thirty month extension. The managed caresupplemental payments portion of this thirty month extension is pending approval by CMS andtherefore, no amounts under this portion of the program have been accrued as of August 31, 2012.

For the years ended August 31, 2012 and 2011, respectively, LPCH recognized $67,994 and$51,205 in net patient service revenue for Medi-Cal Fee-For-Service (“FFS”) and Managed Caresupplemental payments and $32,941 and $18,268, in other expense in the Consolidated Statementof Operations and Changes in Net Assets for QAF paid to California Department of Health CareServices (“DHCS”).

4. Charity Care and Community Benefits

LPCH is committed to advocacy, outreach, education, and research to improve the health status ofchildren and pregnant women. LPCH continually reaffirms its commitment to its community bydeveloping innovative programs to enhance its own and the community’s capacity to care forchildren and pregnant women. These programs include:

Health Professions Education

Graduate Medical Education

Social Services Internships

Community Programs

Mobile Adolescent Health Services

Pediatric Weight Control Programs



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CareAVan

Community Health Education

Perinatal Outreach Programs

Support to Ravenswood Family Health Center

Child Safety & Inquiry Presentation Programs

Family and Children Health Advocacy

LPCH’s direct charity care and uncompensated costs of medical services to government-coveredpatients for the years ended August 31 is as follows:

2012 2011

Charity care at established rates 4,160$ 2,489$

Estimated cost of charity care 1,169 670

Estimated cost of medical services provided to

government covered patients (not including Medicare) 228,838 163,392

230,007$ 164,062$

The increase in the estimated cost of medical services provided to government covered patients(not including Medicare) in 2012 was mainly due to higher charges and lower reimbursement.Additionally, LPCH invests in improving the health of children of San Mateo and Santa Claracounties primarily by providing health professional education and community health services.

5. Meaningful Use Funds

LPCH is participating in the Medicare and Medicaid Electronic Health Records Incentive Programs(EHR), which provides payments to eligible professionals, eligible hospitals and critical accesshospitals as they adopt, implement, upgrade or demonstrate meaningful use of certified ElectronicHealth Records technology. LPCH recognized $1,965 in other revenue under these programs forthe year ended August 31, 2012.

6. Contributions Receivable

Contributions receivable and contribution revenue are included in the financial statements in theappropriate net asset category. Contributions are recorded at the discounted net present value ofthe future cash flows, adjusted for the risk of donor default, using discount rates ranging from 3.2%to 5.8% as of 2012 and 2011.



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Contributions receivable at August 31 are expected to be realized in the following periods:

2012 2011

In one year or less 26,657$ 20,439$

Between one year and five years 29,680 12,228

More than five years - 25

56,337 32,692

Less: Discount/allowance (6,452) (2,960)

Total contributions receivable, net 49,885 29,732

Less: Current portion (24,675) (19,532)

Contributions receivable, net of current portion 25,210$ 10,200$

Contributions receivable at August 31 are to be utilized for the following purposes:

2012 2011

Education -$ 138$

Plant replacement and expansion 36,486 16,665

Clinical services 9,888 8,934

Indigent care and other 3,511 3,995

49,885$ 29,732$

Conditional pledges, which depend on the occurrence of a specified future or uncertain event, were$136,550 and $77,034 at August 31, 2012 and 2011, respectively.

7. Investments and Investments in University Managed Pools

The composition of investments held directly by the organization at August 31 is as follows:

Cost Fair Value Cost Fair Value

Investments

Mutual funds 66,889$ 66,907$ 65,000$ 65,262$

2012 2011



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Board designated funds, short-term investments and other noncurrent investment funds areinvested in University merged pools (MP), holding a variety of investments, which consist of cashand cash equivalents, government and corporate debt securities, equity securities and mutualfunds, real estate, investment in partnerships, and other.

Cost Fair Value Cost Fair Value

Beneficial interest in investments in

University managed pools 395,838$ 552,628$ 395,391$ 547,333$

Board designated funds 210,149 210,149 206,599 206,599

605,987$ 762,777$ 601,990$ 753,932$

2012 2011

Losses or income and gains on LPCH’s beneficial interest in investments in University mergedpools of $4,847 and $99,968 for the years ended August 31, 2012 and 2011, respectively,represent the change in the fair value of LPCH’s share of the MP.

The MP is the primary investment pool in which funds are invested. The MP is invested with theobjective of maximizing long-term total return. It is a unitized pool in which the fund holderspurchase investments and withdraw funds based on a monthly share value. The MP’s investmentsat August 31, 2012 and 2011 are as follows:

2012 2011

Assets

Cash and cash equivalents 4 % 1 %

Fixed income 4 3

Public equities 21 22

Real estate 11 11

Natural resources 8 9

Absolute return 26 27

Private equities 26 27

Total 100 % 100 %

8. Fair Value Measurements

U.S. GAAP defines fair value as the price received upon sale of an asset or paid upon transfer of aliability in an orderly transaction between market participants and establishes a hierarchy ofvaluation inputs based on the extent to which the inputs are observable in the marketplace.Observable inputs reflect market data obtained from independent sources. In contrast,unobservable inputs reflect the entity’s assumptions about how market participants would value thefinancial instrument. Valuation techniques used under U.S. GAAP must maximize the use ofobservable inputs to the extent available.



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The following describes the hierarchy of inputs used to measure fair value and the primaryvaluation methodologies used for financial instruments measured at fair value on a recurring basis:

Level 1 Quoted prices in active markets for identical assets or liabilities, at the reporting date,without adjustment. Market price data is generally obtained from relevant exchange ordealer markets.

Level 2 Inputs other than Level 1 that are observable, either directly or indirectly, such asquoted prices for similar assets or liabilities, quoted prices in markets that are notactive, or other inputs that are observable or can be corroborated by observable marketdata for substantially the same term of the assets or liabilities. Inputs are obtained fromvarious sources including market participants, dealers and brokers.

Level 3 Unobservable inputs that are supported by little or no market activity and that aresignificant to the fair value of the assets or liabilities.

A financial instrument’s categorization within this hierarchy is based upon the lowest level of inputthat is significant to the fair value measurement.

The following table summarizes LPCH’s and PCHA’s assets and liabilities measured at fair valueas of August 31, 2012, based on the inputs used to value them. Level 1 cash and cash equivalentsinclude $256 for PCHA.

Level 1 Level 2 Level 3 Total

Assets

Cash and cash equivalents 85,641$ -$ -$ 85,641$

Assets limited as to use, held by trustee 198,717 - - 198,717

Investments 66,907 - - 66,907

Investments in Stanford University

managed pools 1,070 761,707 - 762,777

Beneficial interest in trusts - - 13,604 13,604

Total assets 352,335$ 761,707$ 13,604$ 1,127,646$

The following table presents the 2012 activities of financial instruments of which fair valuemeasurement is using Level 3 inputs:

Balance at September 1, 2011 13,972$

Realized gains (losses) (357)

Unrealized gains (losses) (11)

Balance at August 31, 2012 13,604$



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The following table summarizes LPCH’s assets and liabilities measured at fair value as ofAugust 31, 2011, based on the inputs used to value them:


Assets

Cash and cash equivalents 90,314$ -$ -$ 90,314$

Assets limited as to use, held by trustee - - - -

Investments 65,262 - - 65,262

Investments in Stanford University

managed pools - 753,932 - 753,932

Beneficial interest in trusts - - 13,972 13,972

Total assets 155,576$ 753,932$ 13,972$ 923,480$

The following table presents the 2011 activities of financial instruments of which fair valuemeasurement is using Level 3 inputs:

Balance at September 1, 2010 13,628$

Realized gains (losses) (213)

Unrealized gains (losses) 557

Balance at August 31, 2011 13,972$

9. Property and Equipment

Property and equipment consist of the following as of August 31, 2012 and 2011:

2011

LPCH PCHA Consolidated LPCH

Land improvements 6,899$ -$ 6,899$ 6,899$

Buildings and improvements 339,101 9 339,110 332,233

Equipment 197,672 64 197,736 186,260

Ground leases 59,385 - 59,385 59,385

603,057 73 603,130 584,777

Less: Accumulated depreciation (277,352) (2) (277,354) (249,817)

Construction-in-progress 195,107 15 195,122 124,765

Property and equipment, net 520,812$ 86$ 520,898$ 459,725$

2012

Buildings under capital lease obligations and related accumulated amortization are $7,552 and$7,552 and are fully amortized as of August 31, 2012. Ground lease accumulated amortizationtotals $7,039 and $5,852 for the years ended August 31, 2012 and 2011, respectively.

Total depreciation and amortization expense for the years ended August 31, 2012 and 2011, is$37,381 and $37,913, respectively.

During the year ended August 31, 2012, capitalized interest expense was $183. In fiscal year2011, none of interest expense, net of interest income, was capitalized.



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10. Long-Term Debt and Capital Leases

LPCH’s outstanding debt at August 31 is summarized below:

Effective

Year of Interest

Maturity 2012/2011 2012 2011

California Health Facilities

Financing Authority

Variable rate bonds

Series 2008A 2027-2033 0.00%/0.13% -$ 30,340$

Series 2008B 2027-2033 0.00%/0.16% - 30,340

Series 2008C 2015-2023 0.00%/0.16% - 32,770

Series 2012B 2013-2027 3.00%/0.00% 51,045 -

Series 2012B Premium 8,111 -

Fixed rate bonds

Series 2003C 2013-2027 0%/3.25% - 55,000

Series 2003C Premium - 2,075

Series 2012A 2044-2051 5.00%/0.00% 200,000 -

Series 2012A Premium 11,160 -

Fixed rate put bonds

Series 2008A 2027-2033 1.45%/0.00% 30,340 -

Series 2008B 2027-2033 1.45%/0.00% 30,340 -

Series 2008C 2015-2023 1.45%/0.00% 32,770 -

Capital lease obligations - 13,643

363,766 164,168

Less: Current portion of long term debt

and capital lease obligations - (107,093)

Long term debt and capital leases 363,766$ 57,075$

Outstanding Principal

The fair value of the 2012 Series A and B bonds are estimated based on the current borrowingrates for similar issues, and amounted to approximately $218,200 and $59,500 respectively atAugust 31, 2012. The fair value of the 2008 Series A, B and C fixed rate bonds is estimated basedon the current borrowing rates for similar issues, and amounted to approximately $30,700,$30,700, and $33,200 at August 31, 2012. Carrying value approximated the fair value of the 2008A, B and C bonds due to the variable nature of the interest rate at August 31, 2011. The fair valueof the 2003 Series C bonds was estimated based on current borrowing rates for similar issues atAugust 31, 2011 at an approximate value of $56,700.

In 2003, LPCH entered into a master indenture of trust (the “LPCH Master Indenture”) as the soleinitial member of an obligated group (“LPCH Obligated Group”), the purpose of which is to providefor issuance of obligations under the LPCH Master Indenture securing indebtedness of themembers of the LPCH Obligated Group on a joint and several basis.



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Obligations issued under the LPCH Master Indenture are collateralized by a lien on the grossrevenues of LPCH. The LPCH Master Indenture also includes various covenants, the mostrestrictive of which include maintenance of a minimum annual debt service coverage ratio,limitations on additional indebtedness, restrictions on the disposition or transfer of assets, mergersand entry into and withdrawal from the LPCH Obligated Group. During the year ended August 31,2012, LPCH was in compliance with its covenants.

In March 2012, the California Health Facilities Financing Authority (“CHFFA”) issued, on behalf ofLPCH under the LPCH Master Indenture, revenue bonds 2012 Series A Bonds and 2012 Series BBonds in the aggregate par amount of $251,045 (the “2012 Bonds’). The 2012 bonds werecollateralized under the provisions of an Indenture and loan agreement. The 2012 Series A, fixedrate bonds were issued at a $200 million principal amount and a premium of $11,288. Proceedsare to be primarily used for financing the acquisition, construction, and expansion of the hospital.The 2012 Series B bonds, variable rate bonds, were issued at a $51,045 principal amount with apremium of $8,351. The proceeds of the Series B bonds were to be used for redemption of 2003Series C bond and costs of issuance.

In March 2012, the full balance of the 2003 Series C bonds, or $55 million, were legally defeasedusing the proceeds of 2012 Series B bonds. As a result of the defeasance, LPCH recorded a losson defeasance of $3,658.

In July 2003, CHFFA issued, on behalf of LPCH under the LPCH Master Indenture, revenue bondsin the aggregate par amount of $115,000. The 2003 bonds were comprised of $60,000 of Series Aand B auction rate revenue bonds and $55,000 of Series C fixed rate revenue bonds. The interestrates on the 2003 Series A and B bonds were reset every 7 days. The 2003 Series C fixed ratebonds were issued at a net premium of $3,113. The 2003 Bonds were a limited obligation of theCHFFA and were payable solely from payments made by LPCH. In August 2008, LPCH redeemedthe 2003 Series A and B bonds.

LPCH converted the 2008 Series Bonds from short term variable rate bonds into $93,450 of five-year fixed rate put bonds in March 2012 with no gain or loss. In August 2008, the California HealthFacilities Financing Authority (“CHFFA”) issued, on behalf of LPCH under the LPCH MasterIndenture, revenue bonds in the aggregate par amount of $93,450. The 2008 bonds werecomprised of Series A, B and C variable rate revenue bonds that bore interest at a daily, weekly,commercial paper, long term or auction rate, as defined by the LPCH Master Indenture. The bondsof each Series initially bore interest at a weekly rate, which reset every 7 days. The 2008 Bondswere payable solely from payments made by LPCH. Holders of these certificates had the option totender these certificates weekly. In order to ensure the availability of funds to purchase anycertificates tendered that the remarketing agent was unable to remarket, LPCH entered into aLiquidity Agreement with the University. The agreement allowed immediate availability of LPCHfunds invested in the MPs for purpose of funding tenders. The entire 2008 CHFFA Series A, B,and C issue were classified as a current liability prior to March 21, 2012 when the bonds wereconverted. As result of refinancing of 2008 Series bonds, LPCH cancelled the liquidity agreementwith the University, effective March 21, 2012. As of August 31, 2012, the 2008 bonds are classifiedas long-term and will be required to be remarketed in 2017.



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Scheduled principal payments on long-term debt are summarized below:

Scheduled

Principal

Maturities Interest

Year ending August 31,

2013 2,030$ 13,723$

2014 2,200 13,662

2015 5,375 13,572

2016 5,675 13,438

2017 5,825 14,049

Thereafter 323,390 351,557

344,495$ 420,001$

11. Retirement Plans

LPCH provides retirement benefits through defined benefit and defined contribution retirementplans covering substantially all benefit eligible leased employees.

Defined Contribution Pension PlanEmployer contributions to the defined contribution retirement plan are based on a percentage ofparticipant annual compensation. Employer contributions to this plan which are vested immediatelyto participants totaling $21,567 and $20,393 for the years ended August 31, 2012 and 2011,respectively, are included in salaries and benefits expense in the Consolidated Statements ofOperations and Changes in Net Assets.

Postretirement Medical Benefit PlanLPCH currently provides health insurance coverage for certain of its leased employees, through theSHC plan, upon retirement as early as age 55, with years of service as defined by specific criteria.The health insurance coverage for retirees who are under age 65 is the same as that provided toactive employees. A Medicare supplement option is provided for retirees over age 65.

LPCH has recorded a liability totaling $16,930 and $17,545 for the years ended August 31, 2012and 2011, respectively, included in self insurance reserves on the balance sheets. This representsthe obligation for its leased employees. LPCH reimburses SHC for costs related to this plan on aperiodic basis, and in 2012 has recorded expense of $900 and an increase of $1,515 to net assetsto reduce the minimum benefit liability.



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Defined Benefit Pension PlansCertain LPCH leased employees are covered by a noncontributory defined benefit pension planheld by SHC. SHC’s defined benefit pension plan benefits are based on years of service and theemployee’s compensation. Contributions to the plans are based on actuarially determinedamounts sufficient to meet the benefits to be paid to plan participants.

SHC and LPCH have an arrangement whereby SHC assumes the pension liability of theemployees leased to LPCH. However, LPCH is required to reimburse SHC for the annual expenseincurred for these leased employees. LPCH paid $548 and $505 in cash for the years endedAugust 31, 2012 and 2011, respectively, which represented current year pension expenses relatedto LPCH leased employees.

The remainder of certain other leased LPCH employee’s not covered by the previously describedplans are covered by a frozen noncontributory defined benefit pension plan (the “LPCH FrozenPension Plan”). Benefits are based on years of service and the employee’s compensation.Contributions to the plan are based on actuarially determined amounts sufficient to meet thebenefits to be paid to plan participants.

The following tables present information on plan assets and obligations, costs, and actuarialassumptions for the LPCH Frozen Pension Plan for the years ended August 31, 2012 and 2011,respectively.



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The change in pension assets and the related change in benefit obligations, using a measurementdate as of and for the years ended August 31, 2012 and 2011 are as follows:

2012 2011

Change in plan assets

Fair value of plan assets at beginning of year 4,991$ 4,845$

Adjustment due to change in measurement date - -

pursuant to FAS 158

Changes due to gap period benefit payments - -

Actual return on plan assets 873 457

Employer contributions 175 -

Benefits paid (446) (311)

Fair value of plan assets at end of year 5,593$ 4,991$

Change in benefit obligation

Projected benefit obligation at beginning of year 6,655$ 6,693$

Interest cost 311 311

Actuarial (gain) loss 1,354 (38)

Benefits paid (446) (311)

Adjustment due to change in measurement date - -

pursuant to FAS 158

Service cost and interest cost during gap period - -

Changes due to gap period benefit payments - -

Projected benefit obligation at end of year 7,874$ 6,655$

Funded status at end of year and

net amount recognized in balance sheet (2,281)$ (1,664)$

Net amount recognized in balance sheet (2,281)$ (1,664)$

Amounts not yet reflected in net periodic benefit cost

and included in other changes in net assets

Prior service credit (cost) -$ -$

Accumulated net gain (loss) (2,130) (1,579)

Adjustment for minimum pension liability (2,130) (1,579)

Cumulative employer contributions in excess of net

periodic benefit cost (151) (85)

Net amount recognized in balance sheet (2,281)$ (1,664)$

The estimated net loss that will be amortized from other changes in net assets into net periodicbenefit cost over the next fiscal year is $332.

Due to the LPCH pension plan being frozen, the accumulated benefit obligation is the same as theprojected benefit obligation at the end of the year.



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The decrease to net assets to adjust the minimum pension liability of $551 is included in theConsolidated Statements of Operations and Changes in Net Assets for the year ended August 31,2012. The respective increase to net assets for the year ended August 31, 2011 was $485.

Net benefit expense related to the plan for the years ended August 31 includes the followingcomponents:

2012 2011

Interest cost 311$ 311$

Expected return on assets (301) (291)

Recognized net actuarial loss 231 281

Total net periodic benefit cost 241$ 301$

Changes recognized in other changes in net assets for the years ended August 31 include thefollowing components:

2012 2011

Prior service cost (credit) arising during period -$ -$

Net loss (gain) arising during period 782 (204)

Amortizations

Gain (loss) (231) (281)

Total recognized in unrestricted net assets 551$ (485)$

Total recognized in net periodic benefit cost and

unrestricted net assets 792$ (184)$

Actuarial AssumptionsThe weighted-average assumptions used to determine benefit obligations are as follows for theyears ended August 31:

2012 2011

Weighted-average assumptions

to determine benefit obligations

Discount rate 3.42 % 4.83 %

Rate of compensation increase N/A N/A



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The discount rate, expected rate of return on plan assets, and the projected covered payroll growthrates used in determining the above accrued benefit costs are as follows for the years endedAugust 31:

2012 2011

Weighted average assumptions

to determine net periodic benefit costs

Discount rate 4.83 % 4.79 %

Rate of compensation increase N/A N/A

Expected return on assets 6.25 % 6.25 %

LPCH utilizes an independent investment consulting firm to provide an estimate of the futureexpected returns for each asset class based on LPCH’s asset allocation targets. The evaluation ofthe future expected returns resulted in the use of 6.25% as the assumption for the expected returnon plan assets.

Plan InvestmentsThe investments of the LPCH Frozen Pension Plan have been invested to ensure stability ofreturns as well as to preserve the asset base of investments. Changing market cycles requireflexibility in asset allocation to allow movement of capital within the asset classes for the purpose ofincreasing investment return and/or reducing risk. The plan asset allocation for the LPCH FrozenPension Plan as of the measurement date August 31 is 69% fixed income, 30% equity, and 1%other as of August 31, 2012 and 72% fixed income and 27% equity, and 1% other as of August 31,2011.

Fair Value of Plan AssetsThe plan assets measured at fair value are as follows for the year ended August 31, 2012:


Assets

Cash and cash equivalents 23$ -$ -$ 23$

Public equities 1,669 - - 1,669

Fixed income 3,888 - - 3,888

Other 13 - - 13

Total plan assets 5,593$ -$ -$ 5,593$



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The plan assets measured at fair value are as follows for the year ended August 31, 2011:


Assets

Cash and cash equivalents 26$ -$ -$ 26$

Public equities 1,358 - - 1,358

Fixed income 3,607 - - 3,607

Other - - - -

Total plan assets 4,991$ -$ -$ 4,991$

Concentration of RiskLPCH manages a variety of risks, including market, credit, and liquidity risks, across plan assetsthrough our investment managers. Concentration of risk is defined as an undiversified exposure toone of the above–mentioned risks that increases the exposure of the loss of plan assetsunnecessarily. LPCH management minimizes risk by diversifying exposure to such risks across avariety of instruments, markets, and counterparties.

Plan ContributionsLPCH expects to contribute $212 to the LPCH Frozen Pension Plan during the fiscal year endingAugust 31, 2013.

Estimated Future Benefit PaymentsThe following table presents the expected benefit payments:

Year ending August 31,

2013 481$

2014 484

2015 504

2016 533

2017 535

Next 5 Years 2,501



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12. Temporarily and Permanently Restricted Net Assets

The endowment is intended to generate investment income that can be used to support theircurrent operating and strategic initiatives. LPCH invests the majority of the endowments in theUniversity’s MP.

LPCH’s Board of Directors has adopted the University’s investment and spending policies for itspermanently restricted assets that provide for annual amounts (payout) to be distributed toappropriate temporarily restricted funds supporting operating and strategic activities of LPCH.Through the combination of investment strategy and payout policy, the hospital is striving toprovide a reasonably consistent payout from the endowment to support operations, whilepreserving the purchasing power of the endowment adjusted for inflation. Consistent with UPMIFA,when determining the appropriate payout, the Board considers the purposes of the endowment, theduration and preservation of the endowment, general economic conditions, the possible effect ofinflation or deflation, the expected return from income and the appreciation of investments, andinvestment policy.

The current University Board of Trustees approved targeted spending rate is 5.5%, which wasadopted by the Board of Directors of LPCH. Normally, the payout amount is determined byapplying a smoothing rule that limits payout in a given year to the sum of 70% of the previousyear’s actual rate and 30% of the long-term spending target rate applied to the projected per sharevalue of the endowment. The smoothing rule and the diversification of the investment assetallocation attempt to mitigate the impact of short-term market volatility on the flow of funds tosupport LPCH’s operations. The smoothing rule was not applied to the current target rate.

LPCH classifies as permanently restricted net assets (a) the original value of gifts donated to thepermanent endowment, (b) the original value of subsequent gifts to the permanent endowment,and (c) accumulations to the permanent endowment made in accordance with the direction of theapplicable donor gift instrument at the time the accumulation is added to the fund. The remainingportion of the donor-restricted endowment fund that is not classified in permanently restricted netassets is classified as temporarily restricted net assets until those amounts are authorized forexpenditure.

Net unrealized losses on permanently restricted endowment funds are classified as a reduction tounrestricted net assets until such time as the fair value equals or exceeds historic value. Theaggregate amount by which fair value was below historic value was approximately $216 and $277as of August 31, 2012 and 2011, respectively.



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Changes in LPCH’s endowment, for the years ended August 31, 2012 and 2011, are as follows:

Temporarily Permanently

Unrestricted Restricted Restricted Total

Endowment at beginning of year (277)$ 71,780$ 198,858$ 270,361$

Investment returns

Earned income - 13,389 - 13,389

Unrealized and realized gains 61 (5,795) 481 (5,253)

Total investment returns 61 7,594 481 8,136

Amounts distributed for operations - (12,058) - (12,058)

Contributions received from donors - 45 777 822

Other - (511) (357) (868)

Net increase (decrease) in endowment 61 (4,930) 901 (3,968)

Endowment at end of year (216)$ 66,850$ 199,759$ 266,393$

2012

Temporarily Permanently

Unrestricted Restricted Restricted Total

Endowment at beginning of year (2,285)$ 47,726$ 225,031$ 270,472$

Investment returns

Earned income - 12,986 - 12,986

Unrealized and realized gains 2,008 25,678 929 28,615

Total investment returns 2,008 38,664 929 41,601

Amounts distributed for operations - (13,724) - (13,724)

Contributions received from donors - - 34 34

Redesignation and transfer to University and other - (886) (27,136) (28,022)

Net increase (decrease) in endowment 2,008 24,054 (26,173) (111)

Endowment at end of year (277)$ 71,780$ 198,858$ 270,361$

2011

All of LPCH’s endowments are classified as donor-restricted.

Return Objectives and Risk ParametersLPCH has adopted endowment investment and spending policies that attempt to provide apredictable stream of funding to programs supported by its endowment while seeking to maintainthe purchasing power of endowment assets. Under this policy, the return objective for theendowment assets is to generate optimal total return while maintaining an appropriate level of riskfor LPCH. LPCH expects its endowment funds over time, to provide at least an average rate ofreturn of approximately 5% annually. Actual returns in any given year may vary from this amount.

Strategies Employed for Achieving Investment ObjectivesTo achieve its long-term rate of return objectives, LPCH relies on a total return strategy in whichinvestment returns are achieved through both capital appreciation (realized and unrealized gains)and current yield (interest and dividends). LPCH targets a diversified asset allocation that placesgreater emphasis on types of investments as described in Note 6 to achieve its long-termobjectives within prudent risk constraints. Portfolio asset allocation targets as well as expected



29

risk, return and correlation amongst the asset classes are reevaluated annually by the assetmanager and reported to the Board of Directors.

Permanently restricted net assets consist of investments to be held in perpetuity and invested togenerate income to support the following purposes at August 31:

2012 2011

Permanently restricted

Education 24,611$ 24,197$



199,759$ 198,858$

Temporarily restricted net assets consist of the following at August 31:

2012 2011

Temporarily restricted

Education 7,986$ 8,417$

Plant replacement and equipment 102,039 53,456

Plant replacement and equipment - Prop 3 from CHFFA 98,000 -



284,973$ 141,751$



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13. Related-Party Transactions

Transactions with SHCLPCH and SHC share certain functions, including various information systems, human resources,managed care contracting, and materials management. The costs for these shared services,which are included in purchased services in the Consolidated Statements of Operations andChanges in Net Assets, are allocated between SHC and LPCH based on management’s bestestimates. LPCH’s total cost for shared services was $19,689 and $17,959 for the years endedAugust 31, 2012 and 2011, respectively.

LPCH also purchases various services from SHC. These services include operating room, cardiaccatheterization, interventional radiology, radiation oncology, and laboratory. The cost of theseservices, which is included in purchased services in the Consolidated Statements of Operationsand Changes in Net Assets, is charged back to LPCH based on a percentage of charges intendedto approximate costs or a cost per procedure. LPCH’s total cost for services purchased from SHCwas $43,394 and $42,278 for the years ended August 31, 2012 and 2011, respectively.

In addition to the services described above, LPCH purchases services from SHC that includeservices provided by interns and residents, maintenance and certain operating expenses, includingutilities. These services totaled $20,821 and $20,615 for the years ended August 31, 2012 and2011, respectively, and is included in purchased services in the Consolidated Statements ofOperations and Changes in Net Assets.

Transactions with the UniversityLPCH records operating expense or equity transfers to account for transactions with the University.LPCH purchases services from the University including telecommunications, transportation, certainutilities, legal, and internal audit. Costs incurred by LPCH for these services purchased from theUniversity were approximately $22.6 million and $19.4 million for the fiscal years ended August 31,2012 and August 31, 2011, respectively, and are recorded as professional services, purchasedservices, and other expenses in the Consolidated Statements of Operations and Changes in NetAssets for those fiscal years.



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Transactions with Stanford School of Medicine (SoM)Services purchased from the University and specifically, the Stanford School of Medicine, includeclinical services that benefit LPCH, including hospital based physicians, medical direction, bloodproducts, and medical library services. Payment for these services is based on management’sbest estimate of market value. On September 1, 2006, LPCH and the University entered into aProfessional Services Agreement (“PSA”) which assigned to LPCH the right to bill and collect allrevenue related to pediatric and obstetric clinical services on behalf of the Stanford School ofMedicine faculty. In return, LPCH reimburses the University for the services provided by thephysician faculty. The PSA is revised periodically, most recently as of September 1, 2010.The expense recorded related to payments and accruals for all of these services amounted toapproximately $131.4 million and $115.6 million for the fiscal years ended August 31, 2012 and2011, respectively. The collections received from external parties by LPCH as agent on behalf ofSoM was recorded in other revenue and purchased services. The amounts were $9.5 million and$6.9 million as of August 31, 2012 and August 31, 2011, respectively.

Transactions with the Lucile Packard Foundation for Children’s HealthThe Lucile Packard Foundation for Children’s Health (“LPFCH”) is a private charity dedicated topromoting, protecting, and sustaining the physical, mental, emotional and behavioral health ofchildren in the Bay Area. In addition to serving as a community grant maker, LPFCH is the primarycommunity fundraising agent for LPCH and the pediatric faculty and programs at the University.Although these three entities share similar missions, LPFCH is governed by a separate board thatis independent of LPCH and the University. LPCH purchases and records as expense fundraisingservices provided by LPFCH. All contributions raised by LPFCH through community fundraisingthat are specifically designated for LPCH are reported as revenues of LPCH rather than LPFCH.Revenue recorded as a result of LPFCH fundraising efforts are as follows:

2012 2011

Unrestricted gifts 2,841$ 3,619$

Temporarily restricted gifts 155,726 18,669

Permanently restricted gifts 777 34

Total gifts 159,344$ 22,322$



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14. Operating Leases

The organization leases various equipment and facilities under operating leases expiring at variousdates. Total rental expense (included in other operating expenses in the Consolidated Statementsof Operations and Changes in Net Assets) under these leases for the years ended August 31, 2012and 2011 was $20,530 and $18,837, respectively. Net minimum future operating lease paymentsfor periods subsequent to August 31, 2012 are as follows:

Noncancelable

Operating

Leases -

Expense

Year ending August 31, LPCH PCHA Total

2013 15,014$ 280$ 15,294$

2014 13,420 53 13,473

2015 10,439 - 10,439

2016 8,676 - 8,676

2017 8,149 - 8,149

Thereafter 29,909 - 29,909

85,607$ 333$ 85,940$

LPCH leased space in its medical office buildings to others under noncancelable operating leasearrangements in FY2011. The previously leased space was demolished in FY2012 to make wayfor future hospital expansion.

15. Commitments and Contingencies

LPCH is aware of certain asserted and unasserted legal claims. While the outcome cannot bedetermined at this time, management is of the opinion that the liability, if any, from these actionswill not have a material effect on LPCH’s financial position.

The healthcare industry is subject to numerous laws and regulations of federal, state and localgovernments. Compliance with these laws and regulations can be subject to future governmentreview and interpretation, as well as to regulatory actions unknown or unasserted at this time.There is heightened government activity with respect to investigations and allegations concerningpossible violations by healthcare providers of regulations that could result in the imposition ofsignificant fines and penalties, as well as significant repayments for patient services previouslybilled. LPCH is subject to similar regulatory reviews, and while such reviews may result inrepayments and/or civil remedies that could have a material effect on LPCH’s financial results ofoperations in a given period, management is not aware of any repayments and/or civil remediesthat would have a material effect on LPCH’s financial position.



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In March 2010, the Patient Protection and Affordable Care Act and the Health Care and EducationReconciliation Act of 2010 (the Acts) were signed into law. These Acts address a broad range oftopics affecting the health care industry, including a significant expansion of healthcarecoverage. The coverage expansion is accomplished primarily through incentives for individuals toobtain and employers to provide health care coverage and an expansion in Medicaid eligibility.These Acts also include incentives for medical research and the use of electronic health records,changes designed to curb fraud, waste and abuse, and creates new agencies and demonstrationprojects to promote the innovation and efficiency in the healthcare delivery system. Someprovisions of the health care reform legislation were effective immediately; others will be phased inthrough 2014. The impact of these Acts will likely affect the Hospital; however, due to the numberof changes involved, the ultimate impact of these Acts is uncertain at this time.

Effective February 1, 2011, LPCH entered into a seven year agreement with Perot Systems HealthCare Services LLC ("Perot"), pursuant to which Perot will provide certain information technologyservices to LPCH. Under the terms of the agreement, LPCH will be charged a fixed annual servicecharge plus expenses, payable monthly, for core services, as defined, and additional fees plusexpenses for special projects. The annual fixed service charges are subject to adjustment undercertain conditions, but unless so adjusted, amount to approximately $9,000 for each year throughto 2017. Adjustments are expected for variations in the number of devices, user demand, andproject specific work that may increase the amount above the baseline in any given period. LPCHhas signed several other information technology contracts in FY2012. The total commitment forthese information technology contracts was approximately $27,787 as of August 31, 2012.

Effective March 1, 2008, LPCH entered into a 5 year agreement with PST Services, Inc. to providebilling functions related to the PSA. Under the terms of the agreement, LPCH will be charged 7.5%of monthly net collections. LPCH has certain rights to reduce the scope of service and to terminatethe agreement early for a termination fee. The amount of the termination fee depends on when theright to terminate is exercised and reduces annually. Termination fees for the first month of theagreement range from $3,762 to $5,335 depending on the scope of services terminated.

California's Hospital Seismic Safety Act requires licensed acute care functions to be conductedonly in facilities that meet specified seismic safety standards. Facilities classified by the State ofCalifornia as noncompliant in the event of an earthquake must be retrofitted, replaced or removedfrom acute-care service by applicable deadlines in 2013, 2015, 2020 or 2030. There are separateand distinct seismic safety standards for structural frame performance and for nonstructuralelement performance. LPCH complies with the structural frame requirements for the existinghospital building allowing its use past 2030. LPCH will be retrofitting discrete areas of the existinghospital for compliance to the nonstructural standards by the applicable deadlines.



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LPCH relies upon services located in the SHC hospital facility. Through the construction of a NewStanford Hospital, as well as through planned retrofits of the existing SHC facility, SHC servicesthat support LPCH will be compliant to seismic safety regulations within available deadlines.Amendments of the Hospital Seismic Safety Act, through SB 608, permit OSHPD to extend thestructural compliance deadline for SHC from 2013 until January 1, 2016 due to local planningdelays. In addition, such legislation authorizes OSHPD to grant two additional one-yearextensions, until January 1, 2018, if SHC is able to demonstrate that it meets certaincriteria. Separately, SB 90, approved earlier in 2011, allows an extension to January 1, 2020 toSHC if it can demonstrate that it meets certain eligibility requirements. Management expects SHCto be eligible for such extensions under both SB 90 and SB 608. At this time, SHC has pendingapplications on file with OSHPD for extensions under SB 608 and SB 90. An administrativeextension of up to two years is expected to be received while a final determination is maderegarding the actual extension for which SHC will qualify.

In June 2011, the Palo Alto City Council certified the Final Environmental Impact Report (“FEIR”),land use changes, permits and a Development Agreement with Stanford Hospital, LPCH andStanford University as part of the Renewal Project. In July 2011, the Palo Alto City Councilprovided final approval for the Renewal Project at the second reading of the DevelopmentAgreement. The Renewal Project will rebuild Stanford Hospital and expand LPCH to assureadequate capacity, meet State-mandated earthquake safety standards, and provide modern,technologically-advanced hospital facilities. The Renewal Project also includes replacement ofoutdated laboratory facilities at the Stanford School of Medicine and remodeling of Hoover Pavilion.Total estimated cost of LPCH’s portion of the Project Renewal is approximately $1.2 billion. LPCHhas recorded $162,000 in construction in progress related to this project as of August 31, 2012.

In August of 2012, LPCH received final approval from the California Health Facilities FinancingAuthority (CHFFA) on its application a maximum of $98,000 of grant funding from California StateProposition 3 for certain construction, expansion, renovation, furnishing and equipment costs for achildren’s hospital. As a result, in August of 2012, LPCH recorded a receivable of $97,437 (thegrant amount less administrative costs paid to the State) with the offset recorded in temporarilyrestricted net assets. LPCH had already applied for some reimbursement under the grant and inSeptember of 2012, received $56,000 from CHFFA. LPCH intends to apply for the remaining$41,400 as additional costs are incurred on the project.

In December of 2011 and July of 2012, the LPCH hospital ground floor was flooded as a result ofwork being performed related to the new hospital construction. Included in other revenue is $2,892of recoveries from insurance claims and included in other expense is $6,347 of costs related torepair and recovery from the floods. LPCH is in the process of finalizing both insurance claims, sofinal insurance recoveries are not estimable as of the date that these financial statements wereavailable for issuance.

Based on current estimated schedules, management currently projects that the Renewal Projectconstruction will be complete by 2016.

At August 31, 2012, the remaining commitment on contracts for the construction and remodeling ofLPCH facilities was approximately $554,045.



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LPCH is directly liable under irrevocable letters of credit totaling $13,359 at August 31, 2012,including $6,719 required as security for the workers’ compensation deductible plan as described inNote 2 and $6,640 for security for construction, operation and maintenance of certain utilityfacilities. No amounts have been drawn on these letters of credit as of August 31, 2012. LPCHalso serves as guarantor for $1,000 loan of South County Community Health Center in East PaloAlto.

Approximately 45% of LPCH employees are covered by collective bargaining arrangements.These employees are members of two unions; approximately 35% are covered by an agreementwhich expires in March 31, 2013; the other 10% are covered by an agreement which expires inAugust 26, 2014.

16. Functional Expenses

Expenses incurred comprise the following program services for the years ended August 31:

2011

LPCH PCHA Total LPCH

Patient services 834,180$ 991$ 835,171$ 761,385$

Management and general 65,262 2,524 67,786 53,441

Fundraising 7,871 - 7,871 7,658

Total functional expenses 907,313$ 3,515$ 910,828$ 822,484$

2012

17. Subsequent Events

LPCH has evaluated subsequent events occurring between the end of the most recent fiscal yearand December 12, 2012, the date the financial statements were available for issuance.

Subsequent to August 31, 2012, PCHA entered into an agreement with the intent to purchase theassets of a medical group for approximately $10,000. The purchase had not closed as of the datethat these financial statements were available for issuance.

Report of Independent Auditors

on Accompanying Consolidating Information

To the Board

Documents

Lucile Salter Packard Children’s Hospital at Stanfordbondholder-information.stanford.edu/pdf/LPCH_2012_financ... · 2012. 12. 13. · Lucile Salter Packard Children’s Hospital