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SKAGIT COUNTY PUBLIC HOSPITAL DISTRICT NO. 2

DBA ISLAND HOSPITAL

FINANCIAL STATEMENTS

YEARS ENDED DECEMBER 31, 2011 AND 2010

SKAGIT COUNTY PUBLIC HOSPITAL DISTRICT NO. 2 DBA ISLAND HOSPITAL TABLE OF CONTENTS

YEARS ENDED DECEMBER 31, 2011 AND 2010

INDEPENDENT AUDITORS' REPORT 1

MANAGEMENT’S DISCUSSION AND ANALYSIS 3

FINANCIAL STATEMENTS

BALANCE SHEETS 10

STATEMENTS OF REVENUES, EXPENSES AND CHANGES IN NET ASSETS 12

STATEMENTS OF CASH FLOWS 13

NOTES TO FINANCIAL STATEMENTS 15

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INDEPENDENT AUDITORS’ REPORT

Board of Commissioners Skagit County Public Hospital District No. 2 dba Island Hospital Anacortes, Washington We have audited the accompanying balance sheets of Skagit County Public Hospital District No. 2 dba Island Hospital (the Hospital) as of December 31, 2011 and 2010, and the related statements of revenues, expenses and changes in net assets, and cash flows for the years then ended. These financial statements are the responsibility of the management of Skagit County Public Hospital District No. 2. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits 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 audits 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Skagit County Public Hospital District No. 2 as of December 31, 2011 and 2010, and the results of its operations, change in its net assets, and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.

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Accounting principles generally accepted in the United States of America require that the management’s discussion and analysis information on pages 3 through 9 be presented to supplement the basic financial statements. Such information, although not a part of the financial statements, is required by the Governmental Accounting Standards Board, who considers it to be an essential part of financial reporting for placing the financial statements in an appropriate operational, economic, or historical context. We have applied certain limited procedures to the required supplementary information in accordance with auditing standards generally accepted in the United States of America, which consisted of inquiries of management about the methods of preparing the information and comparing the information for consistency with management’s responses to our inquiries, the financial statements, and other knowledge we obtained during our audit of the financial statements. We do not express an opinion or provide any assurance on the information because the limited procedures do not provide us with sufficient evidence to express an opinion or provide any assurance.

CliftonLarsonAllen LLP

Bellevue, Washington April 9, 2012

SKAGIT COUNTY PUBLIC HOSPITAL DISTRICT NO. 2 DBA ISLAND HOSPITAL

MANAGEMENT’S DISCUSSION AND ANALYSIS DECEMBER 31, 2011 AND 2010

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Using this Annual Report

The Hospital’s financial statements consist of three statements – balance sheets; statements of revenues, expenses, and changes in net assets; and statements of cash flows. These financial statements and related notes provide information about the activities of the Skagit County Public Hospital District No. 2 doing business as Island Hospital (the Hospital) including resources held by the Hospital but restricted for specific purposes by contributors, grantors, or enabling legislation. Balance Sheets and Statements of Revenues, Expenses, and Changes in Net Assets

Our analysis of the Hospital’s finances begins on page 6. One of the most important questions asked about the Hospital’s finances is “Is the Hospital as a whole better or worse off as a result of the year’s activities?” The balance sheets and the statement of revenues, expenses, and changes in net assets report information about the Hospital’s resources and its activities in a way that helps answer this question. These statements include all restricted and unrestricted assets and all liabilities using the accrual basis of accounting. All of the current year’s revenues and expenses are taken into account regardless of when cash is received or paid. Those two statements report the Hospital’s net assets and changes in them. You can think of the Hospital’s net assets – the difference between assets and liabilities – as one way to measure the Hospital’s financial health or financial position. Over time the increases or decreases in the Hospital’s net assets are one indicator of whether the financial health is improving or deteriorating. You will need to consider other nonfinancial factors, however, such as changes in the Hospital’s patient base and measures of the quality of service it provides to the community, as well as local economic factors to assess the overall health of the Hospital. Statements of Cash Flows

The final required statement is the statements of cash flows. The statements report cash receipts, cash payments, and net changes in cash resulting from operations, investing, and financing activities. It also describes the sources and uses of cash during the reporting period. Introduction

The discussion and analysis of the Hospital financial performance provides an overview of the financial activities for the years ended December 31, 2011 and 2010. The financial statements and notes are to be read in conjunction with this section. The following narrative utilized approximate amounts unless otherwise specified. Financial Highlights

For the fiscal year ended December 31, 2011, the Hospital reported a net operating loss of $1.4 million and deficit of revenues over expenses before capital contributions of ($14,692), a margin of -.02%. This compares to respective amounts in 2010 of a net operating loss of $1.4 million, excess of revenues over expenses of $44,406 and .06%.



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Financial Highlights (Continued)

The following significant events had an impact on the operating results for the Hospital:

The Hospital entered into an agreement with Challenge Developments II, LLC in March 2006 to form the Island Medical Center Condominium Association for the purpose of purchasing the Island Medical Center medical office building, which is located adjacent to the Hospital. The condominium is structured such that Challenge Developments II, LLC owns the first floor, which houses four physician office practices. The Hospital owns the lower level, which houses several hospital departments. The costs associated with operating and maintaining the building are shared on the basis of square footage owned by each party. The Hospital purchased its share of the condominium using Hospital reserves. The Hospital’s share of operating costs in 2011 were $38,000 offset by $27,500 of rental income, and in 2010 were $43,000 offset by $27,000 of rental income, respectively.

In November 2008, the Hospital entered into an agreement with Skagit Valley Hospital and United General Hospital to form Medical Information Network - North Sound (MIN-NS) to develop, implement, and maintain an electronic health record system for healthcare providers in Skagit County. Initial funding for this corporation came from a $50,000 grant received from the Health Care Authority and subsequent funding will be shared by the three hospitals equally. In 2010, the Hospital received an additional grant of $85,000 for this project. In addition, the Hospital contributed $133,088 in 2011, and $230,333 in 2010 for its share of the operating costs. United General Hospital has informed the others of its intention to discontinue its membership in the entity in 2012.

In 2008, the Hospital acquired the Zap Tune property and in January 2009 acquired the old KLKI radio station property. In December 2010, the Hospital entered into a construction contract with Lydig Construction to build the Medical Arts Pavilion on these parcels as well as other land already owned by the Hospital. Construction commenced in January 2011 with a scheduled completion date of December 2011. In June 2011, a new entity, Island Hospital Medical Properties, was created by the Hospital to hold and own the building. In August 2011, Island Hospital Medical Properties completed financing arrangements for the Medical Arts Pavilion utilizing the federal New Market Tax Credit program. The Hospital has entered into an agreement to lease the land to Island Hospital Medical Properties. The Hospital has also entered into a lease agreement with Island Hospital Medical Properties to lease the building for $545,000 for 2012. Services that will be housed in this new building include an expanded Cancer Care Center, Physical Therapy and Wound Care. Construction was completed in December 2011 and the building opened for business January 2012.

In June 2011, the Hospital entered into an agreement with Restorix Medical Group, PLLC and Restorix Health LLP to provide advanced wound care services and hyperbaric medicine services in the new Medical Arts Pavilion. The Hospital will be providing the building space and billing the technical side while Restorix provides the staff, equipment and expertise and bills for the professional services. The service opened to see patients in January 2012.



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In June 2011, the Hospital entered into an agreement with Dr. David Slepyan, M.D. to provide plastic surgery services to patients at the Hospital and clinics. The Center for Aesthetic, Reconstructive and Hand Surgery opened in September 2011.

In August 2011, the Hospital entered into a lease and services agreement with Orcas Medical Foundation. The Hospital agreed to lease the 6,000 square foot facility and Orcas Medical Foundation contracted with Island Hospital to operate and manage the primary care medical facility with federal rural health clinic status. The Orcas Medical Foundation has committed to provide grant funding to support the operation of the clinic up to annual maximum amount of $200,000 for 2011.

In October 2011, the Hospital entered into a refundable grant agreement in support of professional urology services in Skagit County with Skagit Valley Hospital. The grant calls for an initial grant of $107,000, which was paid in 2011 and an additional $227,000 for the first year of the agreement defined as November 1, 2011 to October 31, 2012. Subsequent year grants are to be determined by a predetermined formula.

In November 2011, the Hospital entered into a collaboration interlocal agreement with Skagit Valley Hospital and Cascade Valley Hospital for the purpose of finding areas to collaborate on. One area identified to collaborate is managed care insurance contracts and they have engaged Coopersmith Health Law Group, Inc. to represent them in payor contract review, analysis and negotiation. For 2011 no costs were incurred.

The Hospital submitted an application to the Office of Management and Budget (OMB) of the United States of America requesting a reclassification from the Mount Vernon-Anacortes MSA to the Seattle-Tacoma-Olympia CSA for purposes of increasing reimbursement from the Medicare program. The application was approved by OMB in December 2006 and approved by the Medicare Geographic Review Board in February 2007. The reclassification was effective October 1, 2007, resulting in an increase in reimbursement from the Medicare program. The Hospital has applied for and was approved for an extension of the reclassification through September 30, 2013.

Fitch Ratings downgraded the rating for the outstanding 2005 Limited General Obligation Bonds on December 23, 2011 to A- from A+.

The Hospital negotiated a three year agreement with the Washington Nurses Association for October 1, 2011 through September 30, 2014. The Hospital negotiated a three year agreement with the Service-Support Employees Bargaining Unit for March 1, 2010 through February 28, 2013.



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The Hospital received $100,000 in 2011 and $500,000 in 2010 from the Island Hospital Foundation for the purpose of funding the Medical Arts Pavilion with a commitment to receive $100,000 per year through 2020. The Hospital also received $144,200 in 2011 and $135,655 in 2010 from the Foundation for other capital equipment, as well as $86,700 in 2011 and $90,900 in 2010 for other programs in the Hospital.

The Hospital had qualified for an additional five percent add-on for Medicare inpatients under

the “Low Volume Medicare Inpatient Criteria”. The add-on was effective beginning October 1, 2010 thru September 30, 2011. The Hospital did not qualify for the add-on as of October 1, 2011 as a result of achieving more than 1,600 Medicare admissions in 2010.

Statements of Revenues, Expenses, and Changes in Net Assets

The following table summarizes the operating results of the Hospital for the years ended December 31, 2011 and 2010:

2011 2010 $ %

Net Patient Service Revenue 70,938$ 67,909$ 3,029$ 4.5 %Other Operating Revenue 660 615 45 7.3 Total Operating Revenues 71,598 68,524 3,074 4.5

Salaries, Wages and Benefits 40,487 38,976 1,511 3.9Professional Fees 5,000 5,391 (391) (7.3)Supplies 13,925 12,345 1,580 12.8Purchased Services 6,260 5,744 516 9.0Depreciation 4,490 4,630 (140) (3.0)Other Expenses 2,866 2,848 18 0.6

Operating Expenses 73,028 69,934 3,094 4.4

Operating Loss (1,430) (1,410) (20) 1.4

Non-Operating Revenue and Expenses 1,416 1,454 (38) (2.6)

Excess (Deficit) of Revenues over Expenses (15) 44 (59) (134.1)

Contributions for Capital 253 645 (392) (60.8)

Total Net Assets, Beginning of Year 44,098 43,408 690 1.6

Total Net Assets, End of Year 44,336$ 44,098$ 238$ 0.5 %

December 31, Change

(Dollars in Thousands)



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Sources of Revenue

Net patient service revenue for 2011 increased $3 million or 4.5% from 2010. This was a result of increases in room rates and ancillary department prices. Patient service revenues are reported net of contractual adjustments with Medicare, Medicaid, and other third-party payors. The collection percentage for the Hospital decreased during the year due to decrease in commercial insurance payments, increase in bad debt and charity, lower inpatient and emergency room volumes and an increase in charge master prices at a higher rate than the payment increases by third party payors. The following table shows the percentage of revenue by payor class based upon total patient revenue for the years ended December 31, 2011 and 2010.

Description 2011 2010 Change

Medicare (including MGH) 47.0 % 46.4 % 0.6 %Medicaid (including H/OPT) 9.2 8.6 0.6Other Government 7.5 6.8 0.7Commercial Insurances 32.9 34.7 (1.8)Self-Pay 3.4 3.5 (0.1)

100.0 % 100.0 %

In 2011, Medicare, including Medicare managed care dollars, increased .6%; and Medicaid, including Healthy Options, increased .5%; Government payors increased .7% and Commercial payors decreased 1.8% compared to 2010. In 2010, the self-pay patient revenue dollars increased .3%; Medicare, including Medicare managed care dollars, increased 2.6%; and Medicaid, including Healthy Options, decreased 1.2% compared to 2009. In 2011, bad debt expense increased 1% and charity write-offs increased 46% over the 2010 amounts. In 2010, bad debt expense increased 48.4% and charity write-offs increased 20.1% over the 2009 amounts. Operating Expenses

Total operating expenses in 2011 increased by $3.1 million (4.4%) over 2010 compared to an increased of $3 million (5%) over 2009. The increase for 2011 was in supplies, purchased services and salaries and benefits.

Salaries, Wages, and Benefits increased by 3.9% compared to 2010 as a result of collective bargaining agreements and annual wage adjustments. Total FTE’s decreased by 1 to a total of 477 in 2011 even with the addition of the Orcas Medical Center in August 2011.



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Operating Expenses (Continued)

Professional fees expense decreased 7.3% in 2011 due to decrease volumes in surgery and diagnostic imaging as well as decreased legal and consulting fees. Professional fees expense decreased 2.5% in 2010 from 2009, due to decreased volumes in diagnostic imaging and oncology.

Supplies increased 12.8% in 2011 from increases in supply costs related to orthopedic surgery cases, spine surgery cases and oncology drugs. Supplies increased 12% in 2010 compared to 2009 from increases in supply costs related to orthopedic surgery cases as well as a more costly mix of oncology drugs.

Depreciation decreased 3% in 2011 and decreased 9% in 2010 compared to 2009.

Balance Sheets

The following table shows the balance sheets as of December 31, 2011 and 2010:

2011 2010 $ %

Current Assets:Cash and Cash Equivalents 10,242$ 9,745$ 497$ 5.1 %Patient Accounts Receivable, Net 9,557 9,736 (179) (1.8)Other Current Assets 3,516 2,264 1,252 55.3

Total Current Assets 23,314 21,745 1,569 7.2Capital Assets, Net 70,406 63,031 7,375 11.7Other Assets 10,497 8,602 1,895 22.0

Total Assets 104,217$ 93,378$ 10,839$ 11.6 %

Current Liabilities 8,441$ 7,095$ 1,346$ 19.0 %Long-Term Debt, Net 50,497 41,360 9,137 22.1Other Liabilities 944 825 119 14.4

Total Liabilities 59,882 49,280 10,602 21.5

Net Assets 44,336 44,098 238 0.5

Total Liabilities and Net Assets 104,217$ 93,378$ 10,839$ 11.6 %

December 31, Change

(Dollars in Thousands)

Total assets increased $10.8 million from 2010 and increased $1.3 million from 2009. Current liabilities increased $1.3 million from 2010 and increased $1.2 million from 2009.

Capital assets increased during 2011 from the addition of the Medical Arts building as well as other normal additions and dispositions. The decrease in capital assets during 2010 resulted from the decreased capital purchases along with the increased depreciation due to the Expansion and Renovation Project that was completed in 2008.

Long-term debt increased as a result of the New Market Tax Credit financing for the Medical Arts Pavilion.



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Currently Known Facts, Decisions, or Conditions

The State of Washington Auditor’s Office performed a financial and compliance audit for the year ended December 31, 2010. The Hospital was issued a report with no findings. In March 2010, the Hospital contracted with DNV Healthcare, Inc. to conduct the accreditation survey and was issued an accreditation certificate on March 19, 2010, which is good thru March 2013. The Medicare cost reports for 2010, 2009, 2008 and 2007 have been filed and are awaiting final review. The cost report for 2011 will be filed in May 2012. Contacting the Hospital’s Financial Management

This financial report is designed to provide our patients, suppliers, taxpayers, and creditors with a general overview of the Hospital’s finances and to show the Hospital’s accountability for the money it receives. If you have questions about this report or need additional financial information, contact Administration, Skagit County Public Hospital District No. 2, 1211 24th Street, Anacortes, Washington 98221.


BALANCE SHEETS DECEMBER 31, 2011 AND 2010

See accompanying Notes to Financial Statements. (10)

2011 2010

ASSETS

CURRENT ASSETSCash and Cash Equivalents 10,241,540$ 9,744,532$ Patient Accounts Receivables 9,556,845 9,735,664 Other Receivables 557,090 296,080 Inventories 1,311,198 1,088,446 Prepaid Expenses 1,019,352 810,003 Current Portion of Assets Limited as to Use 628,334 69,558

Total Current Assets 23,314,359 21,744,283

ASSETS LIMITED AS TO USE, LESS CURRENT PORTION 8,510,794 6,699,909

CAPITAL ASSETS, NETArt 178,913 172,876 Land 4,208,953 4,259,901 Depreciable Capital Assets, Net 56,081,580 57,117,862 Construction in Progress 9,936,491 1,480,027

Total Capital Assets, Net 70,405,937 63,030,666

OTHER ASSETSIntangible Assets, Net 598,703 598,703 Deferred Financing Costs, Net 983,152 601,873 Purchase Option 404,400 386,400 Investment in Joint Venture - 315,333

Total Other Assets 1,986,255 1,902,309

Total Assets 104,217,345$ 93,377,167$


2011 2010

LIABILITIES AND NET ASSETS

CURRENT LIABILITIESCurrent Portion of Long-Term Debt 1,494,215$ 1,250,516$ Accounts Payable 3,235,480 2,926,957 Construction Payables 407,958 - Accrued Payroll and Related Liabilities 2,680,934 2,305,690 Accrued Interest 159,648 162,964 Estimated Third-Party Payor Settlements 437,462 423,462 Deferred Revenue 25,584 24,985

Total Current Liabilities 8,441,281 7,094,574

LONG-TERM LIABILITIES Long-Term Debt, Less Current Portion 50,496,656 41,360,407 Deferred Compensation Payable 381,612 314,406 Professional Liability Claims Payable 562,257 510,117

Total Long-Term Liabilities 51,440,525 42,184,930

Total Liabilities 59,881,806 49,279,504

NET ASSETSInvested in Capital Assets, Net of Related Debt 18,679,039 20,385,884 Unrestricted 25,656,500 23,711,779

Total Net Assets 44,335,539 44,097,663

Total Liabilities and Net Assets 104,217,345$ 93,377,167$


STATEMENTS OF REVENUES, EXPENSES AND CHANGES IN NET ASSETS YEARS ENDED DECEMBER 31, 2011 AND 2010


2011 2010

OPERATING REVENUESNet Patient Service Revenue 70,938,456$ 67,909,269$ Other Operating Revenue 659,691 614,886

Total Operating Revenues 71,598,147 68,524,155

OPERATING EXPENSESSalaries and Wages 32,602,707 31,766,593 Employee Benefits 7,883,836 7,210,029 Professional and Physician Fees 5,000,370 5,390,724 Supplies 13,925,390 12,344,910 Purchased Services 6,260,175 5,743,951 Rents and Leases 827,066 886,445 Depreciation 4,490,327 4,630,044 Other Expenses 2,038,502 1,961,353

Total Operating Expenses 73,028,373 69,934,049

OPERATING LOSS (1,430,226) (1,409,894)

NONOPERATING REVENUE AND EXPENSESInvestment Income 53,009 80,998 Interest Expense (1,930,024) (1,992,823) Revenue from Tax Levy 3,064,848 2,997,368 Loss from Investment in Joint Venture (283,422) - Other Nonoperating Revenues 511,123 368,757

Total Nonoperating Revenue and Expenses 1,415,534 1,454,300

EXCESS (DEFICIT) OF REVENUES OVER EXPENSES (14,692) 44,406

Contributions for Capital 252,568 644,923

Net Assets - Beginning of Year 44,097,663 43,408,334

NET ASSETS - END OF YEAR 44,335,539$ 44,097,663$


STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2011 AND 2010


2011 2010

CASH FLOWS FROM OPERATING ACTIVITIESReceipts from and on Behalf of Patients 71,131,275$ 67,182,456$ Payments to Suppliers and Contractors (28,070,124) (26,017,697) Payments to Employees (40,043,494) (38,563,271) Other Receipts and Payments, Net 398,681 655,721

Net Cash Provided by Operating Activities 3,416,338 3,257,209

CASH FLOWS FROM NONCAPITAL FINANCING ACTIVITIESOther Nonoperating Receipts, including Donations 511,123 494,911 Receipts from Tax Levy - Operations 114,279 92,879

Net Cash Provided by Noncapital Financing Activities 625,402 587,790

CASH FLOWS FROM CAPITAL AND RELATED FINANCING ACTIVITIES

Capital Expenditures (10,668,119) (3,917,515) Receipts from Issuance of Debt 10,994,000 1,260,000 Cash Paid for Financing Costs (434,096) - Principal Payments on Long-Term Debt (2,331,469) (1,726,440) Interest Paid (2,005,444) (1,955,231) Receipts from Tax Levy - Debt Service 2,950,569 2,904,489 Contributions for Capital 252,568 644,923

Net Cash Used by Capital and Related Financing Activities (1,241,991) (2,789,774)

CASH FLOWS FROM INVESTING ACTIVITIESInterest and Dividends on Investments 35,009 80,998 Capital Contributions for Investment in Joint Venture 31,911 (221,089) Changes in Assets Limited as to Use (2,369,661) 22,102

Net Cash Used by Investing Activities (2,302,741) (117,989)

INCREASE IN CASH AND CASH EQUIVALENTS 497,008 937,236 Cash and Cash Equivalents - Beginning of Year 9,744,532 8,807,296

CASH AND CASH EQUIVALENTS - END OF YEAR 10,241,540$ 9,744,532$


2011 2010

RECONCILIATION OF OPERATING LOSS TO NET CASH PROVIDED BY OPERATING ACTIVITIES

Operating Loss (1,430,226)$ (1,409,894)$ Adjustments to Reconcile Operating Loss to Net Cash Provided by Operating Activities:

Amortization 52,817 40,835 Depreciation 4,490,327 4,630,044 Provision for Bad Debts 2,834,233 2,830,041 (Increase) Decrease in:

Patient Accounts Receivable (2,655,414) (3,751,149) Other Receivables (261,010) 189,000 Inventory (222,752) (91,123) Prepaid Expenses (209,349) 6,058 Other Assets - (221,089)

Increase (Decrease) in:Accounts Payable 308,523 500,995 Accrued Payroll and Payroll Related Expenses 442,450 356,343 Estimated Third-Party Payor Settlements 14,000 226,384 Deffered Compensation Payable 599 58,699 Professional Liability Claims Payable 52,140 (107,935)

Net Cash Provided by Operating Activities 3,416,338$ 3,257,209$

NONCASH INVESTING AND FINANCING ACTIVITIESEquipment Obtained under Capital Leases 789,521$ -$

Obligations Assumed under Capital Leases 789,521$ -$

Construction Payables 407,958$ -$


NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2011 AND 2010

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NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Reporting Entity

The financial statements include the accounts of Skagit County Public Hospital District No. 2 dba Island Hospital (the Hospital), located in Anacortes, Washington, and Island Hospital Medical Properties. Skagit County Public Hospital District No. 2 is organized as a municipal corporation pursuant to the laws of the state of Washington. As organized, the Hospital is exempt from federal income tax. The Hospital Board of Commissioners is comprised of five community members elected by local voters to six year terms. The Hospital is not considered to be a component unit of the County. The Hospital is an acute-care community hospital with 43 licensed beds that provides services for Anacortes and surrounding communities. Island Hospital Medical Properties is a Washington non-profit corporation organized and operated for the exclusive purpose within the meaning of Internal Revenue Code 501(c)(2) to hold title to property in support of its sole member, Skagit County Public Hospital District No. 2. An application for acquiring the 501(c)(2) status has been filed with the Internal Revenue Service. Island Hospital Medical Properties is a blended component unit of the Hospital. The Hospital operates four primary care clinics: Anacortes Family Medicine, Lopez Island Medical Center, Fidalgo Medical Associates at Island Hospital and as of August 16, 2011 Orcas Medical Clinic. The Hospital leases the clinic facilities for Lopez Island Medical Center through a management contract with the Catherine Washburn Memorial Association, the facilities for Fidalgo Medical Associates from Challenge Developments and the facilities for Orcas Medical Clinic from the Orcas Medical Foundation. Total clinic revenue represented approximately 13% of the Hospital’s net patient service revenues in 2011 and 12% in 2010. Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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. Estimates also affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.



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NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Accounting Standards

The Hospital’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America for governmental units as established by the Governmental Accounting Standards Board (GASB). The Hospital uses enterprise fund accounting. Based on GASB Statement No. 20, Accounting and Financial Reporting for Proprietary Funds and Other Governmental Entities That Use Proprietary Fund Accounting, as amended, the Hospital has elected to apply the provisions of all relevant pronouncements of the Financial Accounting Standards Board, including those issued after November 30, 1989, that do not conflict with or contradict GASB pronouncements. The Hospital’s statements are reported using the economic resources measurement focus and the accrual basis of accounting. Revenue is recorded when earned and expenses are recorded when a liability is incurred, regardless of the timing of related cash flows. Property taxes are recognized as revenue in the year for which they are levied. Grants and similar items are recognized as revenue as soon as all eligibility requirements imposed by the provider have been met. Cash and Cash Equivalents

For purposes of the statements of cash flows, cash and cash equivalents include investments in highly liquid debt instruments with an original maturity of three months or less. Patient Accounts Receivables, Net

The Hospital provides an allowance for uncollectible self-pay and miscellaneous commercial insurance accounts. Patients are not required to provide collateral for services rendered. Payment for services is required upon receipt of an invoice, after payment by insurance, if any. Self-pay accounts are analyzed for collectability based on the months past due and payment history. An allowance is estimated for these accounts based on the historical experience of the Hospital. Accounts that are determined to be uncollectible are sent to a collection agency and written off at that time. Inventories

Inventories consist of medical, surgical, and pharmaceutical supplies, and are stated at the lower of cost (last-in, first-out) or market. Investments

Investments in debt and equity securities are reported at fair value except for short-term highly liquid investments that have a remaining maturity at the time they are purchased of one year or less. These investments are carried at amortized cost. Interest, dividends, and gains and losses, both realized and unrealized, on investments in debt and equity securities are included in nonoperating revenues when earned.



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Assets Limited As To Use

Assets limited as to use include assets set aside for future capital improvements or other designated uses over which the Board of Commissioners retains control, and assets restricted by donors or by bond agreements for capital improvements or debt service. Capital Assets

The Hospital’s capital assets are stated at cost. Donated capital assets are recorded as capital contributions at fair value at the date of donation. Expenditures for maintenance and repairs are charged to operations as incurred; betterments and major renewals are capitalized. When assets are disposed, the related costs and accumulated depreciation or amortization are removed from the accounts and the resulting gain or loss is classified in nonoperating revenues or expenses. All capital assets, other than land and art, are being depreciated or amortized (in the case of capital leases), by the straight-line method of depreciation using these asset lives: Land Improvements 15 to 20 Years Buildings and Leasehold Improvements 13 to 60 Years Equipment 3 to 20 Years Intangible Assets

Intangible assets include goodwill and restrictive covenants related to the purchase of the Island Radiology practice in January 2004, the purchase of Fidalgo Medical Associates in 2008 and the purchase of Island Surgeons in 2009. Goodwill is reviewed annually for impairment. Goodwill is $598,703 as of December 31, 2011 and 2010. The value of the restrictive covenants had been fully amortized in prior fiscal years. Deferred Financing Costs

The costs of issuing long-term debt have been capitalized and are being amortized over the terms of the related bonds. (see note 5) Investment in Joint Venture

The Hospital has an investment in Medical Information Network - North Sound (MIN-NS) to develop, implement and maintain an electronic health record system for healthcare providers in Skagit County. The Hospital has a one-third interest in this joint venture at December 31, 2011 and 2010, which is accounted for using the equity method of accounting. As of December 31, 2011 and 2010 the Hospital had paid and reported payments to MIN-NS for future services as prepaid assets of $165,000 and $-0-, respectively. Compensated Absences

The Hospital’s employees earn paid time off for vacation, holidays, and short-term illnesses, at varying rates depending on years of service. The related liability is accrued during the period in which it is earned.



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Property Taxes

The Hospital is permitted to levy an annual expense fund levy upon the taxable property within the district without a vote of the taxpayers. In addition, taxes are levied annually upon the taxable property within the district to service bond principal and interest payments on the 2004 and 1996 Unlimited Tax General Obligation (UTGO) Bonds. Taxes to finance debt service on these bonds may be levied without limit as to rate and amount. The Hospital records property taxes on the accrual method. Tax Levy

The Hospital received approximately 4.3 % and 4.4% of its financial support from property taxes in 2011 and 2010, respectively. These funds were available for the following:

2011 2010Operations 114,279$ 92,879$ Debt Service 2,950,569 2,904,489

Total 3,064,848$ 2,997,368$

Property taxes are levied by the County on the Hospital’s behalf on January 1 and are intended to finance the Hospital’s activities of the same calendar year. Amounts levied are based on assessed property values as of the preceding May 31. The state assessed value base of the taxing district of approximately $4.7 billion with a maximum levy rate of .1724 and .1760 per $1,000 assessed value for the years ended December 31, 2011 and 2010, respectively. The property tax calendar includes these dates: Levy date January 1 Lien date January 1 Tax bill mailed February 14 First installment payment due April 30 Second installment payment due October 31 Property taxes are considered delinquent on the day following each payment due date and interest must be paid on delinquent taxes. No allowance for uncollectible taxes receivable is considered necessary at the balance sheet dates. Grants and Contributions

From time to time, the Hospital receives grants from Skagit County and the state of Washington as well as contributions from individuals and private organizations. Revenues from grants and contributions may be restricted for either specific operating purposes or for capital purposes. Amounts that are unrestricted or that are restricted for a specific operating purpose are reported as nonoperating revenues. Amounts restricted for capital acquisitions are reported after nonoperating revenues and expenses.



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Net Assets

Net assets of the Hospital are classified in three components. Net assets invested in capital assets net of related debt; consist of capital assets net of accumulated depreciation and amortization and reduced by the current balances of any outstanding borrowings used to finance the purchase or construction of those assets. Restricted net assets; (expendable and nonexpendable) are noncapital assets that must be used for a particular purpose, as specified by creditors, grantors, or contributors external to the Hospital. Unrestricted net assets; are remaining net assets that do not meet the definition of invested in capital assets net of related debt or restricted.

When both restricted and unrestricted resources are available for use, it is the Hospital’s policy to use restricted resources first, and then unrestricted resources, as they are needed.

Operating Revenues and Expenses

The Hospital’s statements of revenues, expenses, and changes in net assets distinguish between operating and non-operating revenues and expenses. Operating revenues result from exchange transactions associated with providing healthcare services – the Hospital’s principal activity. Exchange transactions are those in which each party to the transaction receives and gives up essentially equal values. Non-exchange revenues, including taxes, grants, and contributions received for purposes other than capital asset acquisition, are reported as non-operating revenues. Operating expenses are all expenses incurred to provide healthcare services, other than financing costs.

Net Patient Service Revenue

Such revenue is reported at the estimated net realizable amounts from patients, third-party payors, and others for services rendered, including estimated retroactive adjustments under reimbursement agreements with third-party payors. Retroactive adjustments are accrued on an estimated basis in the period the related services are rendered and adjusted in future periods as final settlements are determined.

Charity Care

The Hospital provides care to patients who meet certain criteria under its charity care policies without charge or at amounts less than its established rates. Because the Hospital does not pursue collection of amounts determined to qualify as charity care, they are not reported as net patient service revenue. Foregone revenue for charity care provided during fiscal year 2011 and 2010 measured by the Hospital’s standard charges was $1,796,029 and $1,235,854, respectively.

Subsequent Events

In preparing these financial statements, the Hospital has evaluated events and transactions for potential recognition or disclosure through April 9, 2012, the date the financial statements were available to be issued.



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NOTE 2 DEPOSITS AND INVESTMENTS

The Revised Code of Washington (RCW), Chapter 39, authorizes municipal governments to invest their funds in a variety of investments including federal, state, and local government certificates, notes, or bonds; the state of Washington Local Government Investment Pool; savings accounts in qualified public depositaries; and certain other investments. State law requires collateralization of all deposits with federal depository insurance or other acceptable collateral. The Hospital’s cash on deposit with banks is insured through the Federal Deposit Insurance Corporation up to $250,000 per financial institution. Cash on deposit with the Washington state Local Government Investment Pool and with qualified public depositaries is protected against loss by the state of Washington Public Deposit Protection Commission, as provided for by RCW 39.58, subject to certain limitations.

The Skagit County Treasurer acts as the treasurer for certain deposits and investments of the Hospital. Deposits that are not covered by depository insurance are collateralized in the name of the County, and uninsured investments are registered in the name of the County.

Cash and cash equivalents consisted of the following:

2011 2010

Cash on Hand 2,910$ 2,310$

Whidbey Island Bank, Depository Account 787,871 535,221 Bank of America, Payroll Account 13,985 8,412 Washington Federal, Depository Accounts 15,746 - Skagit County Treasurer's Office 585,207 970,464 Washington State Local Government Investment Pool 8,895,355 8,359,504

Bank Balances 10,301,074 9,875,911 Reconciling Items (59,534) (131,379)

Total Cash and Cash Equivalents per Balance Sheet 10,241,540$ 9,744,532$

December 31,

Assets limited as to use consisted of the following:

2011 2010Internally Designated by the Board for Future Capital Improvements:

Cash and Cash Equivalents 1,673,081$ 974,232$ Certificates of Deposit and Commercial Paper - 3,000,000 Accrued Interest 1,699 4,187 State of Washington Local Government Investment Pool 5,552,852 1,871,717

Total 7,227,632$ 5,850,136$

December 31,



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NOTE 2 DEPOSITS AND INVESTMENTS (CONTINUED)

Assets limited as to use consisted of the following (continued):

2011 2010Restricted, Proceeds of 2004 Unlimited Tax General Obligation and 2005 Limited Tax General Obligation Issues to be Used for Capital Improvements:

Cash and Cash Equivalents 157,396$ 1,014$ State of Washington Local Government Investment Pool 736 -

Total 158,132$ 1,014$

Restricted, for the Repayment of 1996 Unlimited Tax General Obligation Refunding Bonds:

Cash and Cash Equivalents 8,912$ 23,464$ State of Washington Local Government Investment Pool 113,128 232,863

Total 122,040$ 256,327$

Restricted, for the Repayment of 2005 Limited Tax General Obligation Refunding Bonds:

Cash and Cash Equivalents 61,992$ 9,229$ State of Washington Local Government Investment Pool 354,709 295,575

Total 416,701$ 304,804$

December 31,

Restricted, for the Repayment of 1996 Limited Tax General Obligation Refunding Bonds:

State of Washington Local Government Investment Pool 79,848$ 79,696$

Restricted for the Repayment of New Market Tax Credit Loans:

Cash and Cash Equivalents 778,527$ -$

Restricted, under Deferred Compensation Arrangements:Investments in Mutual Funds 356,248$ 277,490$

Total Asset Limited as to Use 9,139,128$ 6,769,467$ Less: Current Portion 628,334 69,558

Assets Limited as to Use, Less Current Portion 8,510,794$ 6,699,909$



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NOTE 2 DEPOSITS AND INVESTMENTS (CONTINUED)

Cash and cash equivalents included in assets limited as to use are not considered cash and cash equivalents for purposes of presenting cash flows.

NOTE 3 ACCOUNTS RECEIVABLE

The Hospital has a concentration of credit risk with respect to unsecured patient accounts receivable. The majority of the Hospital’s patients are local residents and are insured under third-party payor agreements. Patient accounts receivable at December 31, consisted of the following:

2011 2010Receivable from Patients and Their Insurance Carriers 6,262,943$ 6,971,657$ Receivable from Medicare 3,123,625 2,713,949 Receivable from Medicaid 803,277 817,058

Total Patient Accounts Receivable 10,189,845 10,502,664Less: Allowance for Doubtful Accounts 633,000 767,000

Patient Accounts Receivable, Net 9,556,845$ 9,735,664$



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NOTE 4 CAPITAL ASSETS

Capital asset additions, retirements, and balances for the years ended December 31, 2011 and 2010 were as follows:

Balance BalanceDecember 31, December 31,

2010 Additions Transfers Retirements 2011

Land 4,259,901$ 16,000$ (66,948)$ -$ 4,208,953$ Art 172,876 5,543 494 - 178,913

Land Improvements 1,806,238 7,642 2,556 - 1,816,436

Buildings and Leasehold

Improvements 57,209,536 195,871 615,174 (10,965) 58,009,616

Fixed Equipment 8,035,472 48,411 - - 8,083,883

Major Moveable Equipment 25,260,850 2,215,550 404,360 (4,736,692) 23,144,068

Construction in Progress 1,480,027 9,412,100 (955,636) - 9,936,491

Total Historical Cost 98,224,900 11,901,117 - (4,747,657) 105,378,360

Less: Accumulated Depreciation:Land Improvements (833,840) (133,282) - - (967,122) Buildings and Leasehold

Improvements (12,837,113) (1,454,099) - 10,423 (14,280,789)

Fixed Equipment (3,774,024) (486,240) - - (4,260,264)

Major Moveable Equipment (17,749,257) (2,416,707) - 4,701,715 (15,464,249)

Total Accumulated Depreciation (35,194,234) (4,490,327) - 4,712,138 (34,972,423)

Total Capital Assets, Net 63,030,666$ 7,410,790$ -$ (35,519)$ 70,405,937$

Balance BalanceDecember 31, December 31,

2009 Additions Transfers Retirements 2010Land 4,043,778$ 66,948$ 149,175$ -$ 4,259,901$ Art 171,159 1,717 - - 172,876 Land Improvements 1,792,972 13,266 - - 1,806,238 Buildings and Leasehold Improvements 56,274,980 - 1,064,920 (130,364) 57,209,536 Fixed Equipment 8,035,163 9,109 16,141 (24,941) 8,035,472 Major Moveable Equipment 23,624,491 1,794,118 115,416 (273,175) 25,260,850 Construction in Progress 806,874 2,018,805 (1,345,652) - 1,480,027

Total Historical Cost 94,749,417 3,903,963 - (428,480) 98,224,900

Less: Accumulated Depreciation:Land Improvements (692,735) (141,105) - - (833,840) Buildings and Leasehold Improvements (11,360,230) (1,607,247) - 130,364 (12,837,113) Fixed Equipment (3,306,717) (492,248) - 24,941 (3,774,024) Major Moveable Equipment (15,612,972) (2,389,444) - 253,159 (17,749,257)

Total Accumulated Depreciation (30,972,654) (4,630,044) - 410,175 (35,194,234)

Total Capital Assets, Net 63,776,763$ (727,792)$ -$ (18,305)$ 63,030,666$

Construction in progress at December 31, 2011 consisted of costs associated with the Medical Arts Pavilion, which was completed in early 2012 with minimal additional costs. During 2011, interest cost of $200,083 net of $622 of interest income was capitalized.



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NOTE 5 LONG-TERM DEBT AND OTHER NONCURRENT LIABILITIES

A schedule of changes in the Hospital’s noncurrent liabilities for the years ended December 31, 2011 and 2010 are as follows:

Balance BalanceDecember 31, December 31, Amounts Due

2010 Additions Reductions 2011 Within 1 Year

Bonds and Notes Payable:2005 LTGO Bonds $ 10,010,000 $ - $ (255,000) $ 9,755,000 $ 270,000

2010 Revenue Bond 1,163,190 - (1,163,190) - -

2004 UTGO Bonds 30,150,000 - (740,000) 29,410,000 815,000

2011 Revenue Bond - 1,000,000 (77,602) 922,398 237,685

NDC CDE Loan A - 5,373,200 - 5,373,200 -

NDC CDE Loan B - 1,770,800 - 1,770,800 - Kitsap CDE Loan C - 2,121,000 - 2,121,000 -

Kitsap CDE Loan D - 729,000 - 729,000 -

Capital Leases - 789,521 (97,297) 692,224 171,530

Subtotal 41,323,190 11,783,521 (2,333,089) 50,773,622 1,494,215

Less: Deferred Refunding and Premiums 1,287,733 - (70,484) 1,217,249 -

Total Long-Term Debt 42,610,923 11,783,521 (2,403,573) 51,990,871 1,494,215

Other Noncurrent Payables:Deferred Compensation 314,406 67,206 - 381,612 -

Professional Liability Claims 510,117 52,140 - 562,257 -

Total Other Noncurrent 824,523 119,346 - 943,869 -

Total Noncurrent Liabilities 43,435,446$ 11,902,867$ (2,403,573)$ 52,934,740$ 1,494,215$

Balance Balance

December 31, December 31, Amounts Due2009 Additions Reductions 2010 Within 1 Year

Bonds and Notes Payable:2005 LTGO Bonds $ 10,250,000 $ - $ (240,000) $ 10,010,000 $ 255,000

2010 Revenue Bond - 1,260,000 (96,810) 1,163,190 255,516

2004 UTGO Bonds 30,500,000 - (350,000) 30,150,000 740,000

1996 UTGO Bonds 320,000 - (320,000) - -

Note Payable 678,428 - (678,428) - -

Subtotal 41,748,428 1,260,000 (1,685,238) 41,323,190 1,250,516

Less: Deferred Refunding and Premiums 1,328,945 - (41,212) 1,287,733 -

Total Long-Term Debt 43,077,373 1,260,000 (1,726,450) 42,610,923 1,250,516

Other Noncurrent Payables:Deferred Compensation 255,707 58,699 - 314,406 -

Professional Liability Claims 618,052 - (107,935) 510,117 - Total Other Noncurrent 873,759 58,699 (107,935) 824,523 -

Total Noncurrent Liabilities 43,951,132$ 1,318,699$ (1,834,385)$ 43,435,446$ 1,250,516$



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NOTE 5 LONG-TERM DEBT AND OTHER NONCURRENT LIABILITIES (CONTINUED)

Long-Term Debt

The terms and due dates of the Hospital’s long-term debt at December 31, 2011 and 2010 follows:

Limited tax general obligation bonds of $10,995,000, dated November 15, 2005, were issued to pay for a portion of the costs of expanding the Hospital’s facilities and to advance refund of the 1996 limited tax general obligation bonds. Interest is payable semiannually on June 1 and December 1, beginning June 1, 2006, at rates that range from 3.5% to 5.75%. The bonds mature in principal installments ranging from $195,000 in 2007 to $825,000 in 2030. Scheduled maturities on and after December 1, 2016, will be subject to redemption at the option of the Hospital on and after December 1, 2015, in whole or in part, at par plus accrued interest to the date of redemption. The recorded balance at December 31, 2011 and 2010, includes an unamortized bond premium of $36,259 and $38,176, respectively. The limited tax general obligation bonds are general obligations of the Hospital and are secured by an irrevocable pledge of the Hospital that it will have sufficient funds available to pay the bond principal and interest due by levying each year an expense fund levy upon the taxable property within the Hospital district. A portion of the bond proceeds ($3,322,736) was transferred to Bank of New York to be held in escrow to pay the remaining principal balance and accrued interest related to the 1996 limited tax general obligation bonds on January 2, 2006.

Unlimited tax general obligation bonds of $30,500,000, dated October 15, 2004, were issued to pay for a portion of the costs of a $40,000,000 project to remodel and expand the Hospital’s emergency room; construct, furnish, and equip new flexible-use inpatient rooms; relocate and expand the Hospital’s ancillary services such as radiology and laboratory; and make other related capital improvements. Interest is payable semiannually on June 1 and December 1, at rates that range from 3.5% to 5.25%. The bonds mature in principal installments beginning at $350,000 in 2010 and ranging to $2,975,000 in 2028. Scheduled maturities on and after December 1, 2015, will be subject to redemption at the option of the Hospital on and after December 1, 2014, in whole or in part, at par plus accrued interest to the date of redemption. The recorded balance at December 31, 2011 and 2010, includes an unamortized bond premium of $1,187,335 and $1,257,523 respectively. The Hospital irrevocably pledged to levy and collect taxes annually in sufficient amounts to pay the bond principal and interest payments when due. Such collections are reported as assets limited as to use.



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Long-Term Debt

The Hospital issued a revenue bond dated June 16, 2010, for the purpose of financing the payoff of the Island Radiology note and the Kitchen/HVAC Remodel. The bond is payable over a five year period, in monthly payments of $25,000 commencing October 1, 2010, including interest at 4.2%, to Whidbey Island Bank, the bondholder. This bond was paid off in 2011.

The Hospital issued a revenue bond dated August 22, 2011 for the purpose of

financing the payoff of the Whidbey Island revenue bond. The bond is payable over a four year period, in monthly payments of $22,691 commencing September 1, 2011, including interest at 4.2%, to Washington Federal bank, the bondholder.

In August 2011 Island Hospital Medical Properties, a Washington non-profit

corporation of which the Hospital is the sole member, secured financing utilizing the New Market Tax Credit program. Washington Federal is the tax credit investor with NDC New Markets Investment LXIII, LLC and Kitsap County NMTC Subsidiary Allocatee Three, LLC. Interest only payments commenced September 1, 2011 at an interest rate of 4.829% and will continue for seven years. In August 2018 Loan A and C mature at which time all principal and interest is due in full. Loans B and D require a one-time principal payment of $114,000 and $30,000, respectively. Remaining principal outstanding for Loans B and D are expected to be forgiven at this time if terms of the agreement are met, otherwise monthly payments of principal and interest of $10,141 and $4,278 respectively will be due until maturity in August of 2041.

The Hospital has entered into several agreements for the lease of various pieces of

medical equipment. The agreements expire on various dates in 2014-2016. The interest rates vary from 4.25% to 6.9%. Depreciation of the assets recorded under capital leases is included in depreciation in the accompanying financial statements of operations.

Aggregate annual principal and interest payments related to long-term debt are as follows:

Year EndingDecember 31, Principal Interest Principal Interest

2012 1,322,685$ 2,440,072$ 171,530$ 28,051$ 2013 1,432,985 2,381,427 173,756 20,019 2014 1,553,732 2,315,892 176,930 11,610 2015 1,582,996 2,249,584 103,169 3,722 2016 1,530,000 2,178,576 66,839 522

2017-2021 19,744,000 8,026,219 - - 2022-2026 14,115,000 4,400,288 - - 2027-2031 8,800,000 806,176 - -

Total 50,081,398$ 24,798,235$ 692,224$ 63,924$

Long-Term Debt Capital Leases



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Long-Term Debt

Equipment under capital lease obligations as of December 31 is as follows:

2011 2010Historical Cost 789,521$ -$ Accumulated Amortization (50,018) -

Equipment Under Capital Lease Obligation, Net 739,503$ -$

NOTE 6 OPERATING LEASES

The Hospital has leased office space under a noncancelable operating lease. Effective March 15, 2006, the Hospital purchased an ownership interest in the building that includes this space for $1,500,000, and it will continue to occupy the space that has been leased. In 2007 the Hospital entered into an agreement with Challenge Development to lease space for the Sleep Lab. Construction of the facility was completed in 2008 with occupancy in November 2008. The lease is for a term of 10 years with the monthly base rent of $8,600, commencing January 2009. The following is a schedule of future minimum operating lease payments as of December 31, 2011:

Year Amount2012 103,200$ 2013 103,200 2014 103,200 2015 103,200 2016 103,200 Total 516,000$



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NOTE 7 NET PATIENT SERVICE REVENUE

The Hospital has agreements with third-party payors that provide for payments at amounts different from its established rates. A summary of the payment arrangements with major third-party payors follows:

Medicare

Inpatient and outpatient acute care services provided to Medicare program beneficiaries are paid at prospectively determined rates. These rates vary according to a patient classification system that is based on clinical, diagnostic, and other factors. The Hospital’s classification of patients under the Medicare program and the appropriateness of their admission are subject to an independent review by a peer review organization under contract with the Hospital.

Medicaid

Medicaid reimbursement for most outpatient hospital and clinic services is prospectively set based on the ratio of estimated aggregate costs to aggregate charges. Certain outpatient services and physician services are reimbursed based on predetermined fee schedules.

Other

The Hospital has entered into payment agreements with certain commercial insurance carriers and preferred provider organizations. The basis for payment to the Hospital under these agreements includes prospectively determined rates per discharge, discounts from established charges, and prospectively determined daily rates.

The Hospital has settled its Medicare cost reports through December 31, 2006. Third-party settlements are accrued on an estimated basis in the period the services are rendered and adjusted in future periods, as final settlements are received.

Net patient service revenue consisted of the following:

2011 2010Gross Patient Service Revenue 159,831,089$ 150,328,763$ Less: Charity Care 1,796,029 1,235,854

158,035,060 149,092,909

Contractual Adjustments:Medicare 44,519,635 41,154,605 Medicaid 7,074,146 6,627,845 Other 32,668,590 30,571,150

Total Adjustments 84,262,371 78,353,600

Provision for Bad Debts 2,834,233 2,830,040

Net Patient Service Revenue 70,938,456$ 67,909,269$

Years Ended December 31,



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NOTE 8 RETIREMENT PLAN AND DEFERRED COMPENSATION

The Hospital sponsors a qualified retirement plan under Internal Revenue Service Code Section 403(b)(7) which is available to employees who have attained the age of 21 and have completed 18 months of service. For eligible employees who defer at least 5% of their compensation, the Hospital makes contributions at rates ranging from 6.1% to 6.5%. Related Hospital contributions for the years ended December 31, 2011 and 2010 were approximately $1,388,862 and $1,180,982, respectively. The Hospital sponsors a Supplemental Executive Retirement Plan (SERP), which is a nonqualified defined contribution plan under Internal Revenue Service Code Section 403(f). Payments of accrued benefits are made based upon a vesting schedule for eligible employees. The accrued liabilities related to the SERP were $381,612 and $314,406 at December 31, 2011and 2010, respectively.

NOTE 9 RISK MANAGEMENT

The Hospital is involved in litigation and regulatory investigations arising in the course of business. After consultation with legal counsel, management estimates that these matters will be resolved without material adverse effect on the Hospital’s future financial position or results of operations. The Hospital is exposed to various risks of loss related to torts; theft of, damage to, and destruction of assets; business interruption, errors, and omissions; injuries to employees; and natural disasters. The Hospital carries commercial insurance for these risks of loss. The Hospital has professional liability insurance coverage with Hudson Specialty Insurance Company and Physicians Insurance. The policies provide protection on a “claims-made” basis whereby only claims reported to the insurance carrier during the policy year are covered by the current policy. If there are unreported incidents that result in a claim, they will only be covered in the year the claim is reported to the insurance carrier if the Hospital purchases claims-made insurance in that year or if the Hospital purchases insurance coverage for “prior acts.” The Hospital’s present coverage is $1,000,000 per claim with an annual aggregate limit of $3,000,000, and is subject to an excess liability policy with the same carrier that has limits, per claim and annual aggregate, of $10,000,000. The Hospital records a liability for potential claims that may have been incurred but not reported in the current or prior years. As of December 31, 2011 and 2010, the Hospital recorded a professional liabilities payable for $562,257 and $510,117, respectively. It is possible that claims may exceed coverage available in any given year.



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NOTE 9 RISK MANAGEMENT (CONTINUED)

During fiscal year 2010 the Hospital had a self-insured unemployment plan for its employees. Accordingly, the Hospital was part of the Public Hospital District (PHD) Unemployment Compensation Fund, which is a risk transfer pool administered by the Washington State Hospital Association. Under the plan the Hospital paid its share of actual unemployment claims, maintenance of reserves, and administrative expenses. In April 2010, the Hospital moved out of the PHD Compensation Trust for unemployment to a plan directly with the Employment Security Department. During fiscal year 2010 the Hospital had a self-insured workers’ compensation plan for its employees. Accordingly, the Hospital was part of the Public Hospital District Workers’ Compensation Trust, which is a risk transfer pool administered by the Washington state Hospital Association. Under the plan the Hospital paid its share of actual workers’ compensation claims, maintenance of reserves, and administrative expenses. At the end of 2010, the Hospital moved out of the PHD Workers Compensation Trust to a plan directly with the Department of Labor & Industry.

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