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THE METHODIST HOSPITAL SYSTEM

AUDITED 2013 RESULTS

Table of Contents

I. 2013 Audited Financial Statements II. 2013 Key Hospital Volume Indicators and Payor Mix Information

AUDITED CONSOLIDATED FINANCIAL STATEMENTS

Houston Methodist

December 31, 2013 and 2012

AUDITED CONSOLIDATED FINANCIAL STATEMENTS

HOUSTON METHODIST


Contents

Independent Auditors’ Report ............................................................................................. 1

Consolidated Balance Sheets ............................................................................................. 3

Consolidated Statements of Operations and Changes in Net Assets ............................... .4

Consolidated Statements of Cash Flows ............................................................................ 6

Notes to Consolidated Financial Statements ...................................................................... 8

Member of

Deloitte Touche Tohmatsu Limited

INDEPENDENT AUDITORS’ REPORT

To the Board of Directors of

Houston Methodist

Houston, Texas

We have audited the accompanying consolidated financial statements of Houston Methodist (Methodist),

which comprise the consolidated balance sheets as of December 31, 2013 and 2012, and the related

consolidated statements of operations and changes in net assets and cash flows for the years then ended,

and the related notes to the consolidated financial statements.

Management’s Responsibility for the Consolidated Financial Statements

Management is responsible for the preparation and fair presentation of these consolidated financial

statements in accordance with accounting principles generally accepted in the United States of America;

this includes the design, implementation, and maintenance of internal control relevant to the preparation

and fair presentation of consolidated financial statements that are free from material misstatement, whether

due to fraud or error.

Auditors’ Responsibility

Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits 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 consolidated financial statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the

consolidated financial statements. The procedures selected depend on the auditor’s judgment, including the

assessment of the risks of material misstatement of the consolidated financial statements, whether due to

fraud or error. In making those risk assessments, the auditor considers internal control relevant to

Methodist’s preparation and fair presentation of the consolidated financial statements in order to design

audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion

on the effectiveness of Methodist’s internal control. Accordingly, we express no such opinion. An audit

also includes evaluating the appropriateness of accounting policies used and the reasonableness of

significant accounting estimates made by management, as well as evaluating the overall presentation of the

consolidated financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our

audit opinion.

Deloitte & Touche LLP

1111 Bagby Street Suite 4500 Houston, TX 77002-4196 USA Tel: +1 713 982 2000 Fax: +1 713 982 2001 www.deloitte.com

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Opinion

In our opinion, the consolidated financial statements referred to above present fairly, in all material

respects, the financial position of Methodist as of December 31, 2013 and 2012, and the results of its

operations and its cash flows for the years then ended in accordance with accounting principles generally

accepted in the United States of America.

March 31, 2014

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CONSOLIDATED BALANCE SHEETS

HOUSTON METHODIST

(In Thousands)

December 31, 2013 2012

Assets

Current Assets

Cash and cash equivalents $ 71,457 $ 55,147 Assets limited as to use 1,434,466 1,474,265 Patient accounts receivable, net 368,757 349,075 Inventory and other current assets 69,850 72,730

Total Current Assets 1,944,530 1,951,217 Assets limited as to use, net of amounts required to meet current obligations 2,195,842

1,466,690

Property and equipment, net 2,402,478 2,435,958 Other assets 39,658 40,635

Total Assets $6,582,508 $5,894,500

Liabilities and Net Assets Current Liabilities

Accounts payable and accrued expense $ 395,745 $ 349,720 Estimated third-party settlements 31,499 18,856 Short-term bond debt 1,393,749 1,438,143

Total Current Liabilities 1,820,993 1,806,719 Long-term debt 148,544 203,442 Other long-term obligations, primarily

related to self-insurance 58,686

62,635 Total Liabilities 2,028,223 2,072,796

Net Assets

Unrestricted 4,309,723 3,628,220 Temporarily restricted 118,823 79,815 Permanently restricted 125,739 113,669

Total Net Assets 4,554,285 3,821,704 Total Liabilities and Net Assets $6,582,508 $5,894,500

See notes to consolidated financial statements.

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CONSOLIDATED STATEMENTS OF OPERATIONS AND CHANGES IN NET ASSETS HOUSTON METHODIST (In Thousands)

For the Years Ended

December 31,

2013 2012

Revenue

Net patient revenue (net of program and policy

based free, uncompensated care) $ 2,546,985

$ 2,292,516

Uncollectible, uncompensated care (127,793) (137,497)

Net patient revenue (net of uncollectible,

uncompensated care) 2,419,192

2,155,019

Other revenue 196,977 176,022

Total Revenue 2,616,169 2,331,041

Expense

Salaries, wages, and related personnel costs 1,281,589 1,184,255

Supplies and pharmaceuticals 474,507 430,741

Services and other expense 477,497 362,181

2,233,593 1,977,177

Earnings Before Interest, Depreciation and

Amortization 382,576

353,864

Depreciation and amortization 195,660 190,547

Interest 15,508 19,231

211,168 209,778

Operating Income 171,408 144,086

Other income, primarily investment earnings, net 512,117 242,478

Excess of Revenue Over Expense $ 683,525 $ 386,564

See notes to consolidated financial statements. (continued)

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CONSOLIDATED STATEMENTS OF OPERATIONS AND CHANGES IN NET ASSETS – Continued

HOUSTON METHODIST

(In Thousands)

For the Years Ended

December 31,

2013 2012

Unrestricted Net Assets

Excess of revenue over expense $ 683,525 $ 386,564

Transfer of matching funds to temporarily or

permanently restricted net assets (2,998)

(1,260)

Transfer from temporarily restricted net assets 976 73

Increase in Unrestricted Net Assets 681,503

385,377

Temporarily Restricted Net Assets

Investment earnings, net 32,022 13,454

Contributions 16,098 13,468

Transfer from (to) permanently restricted net

assets 1,575

(76)

Transfer from unrestricted net assets 565 627

Other, primarily assets released from restrictions (11,252) (8,826)

Increase in Temporarily Restricted

Net Assets 39,008

18,647

Permanently Restricted Net Assets

Contributions 11,212 10,699

Transfer (to) from temporarily restricted net assets (1,575) 76

Transfer from unrestricted net assets 2,433 633

Increase in Permanently Restricted Net Assets 12,070

11,408

Increase in Net Assets 732,581

415,432

Net Assets, Beginning of Year 3,821,704 3,406,272

Net Assets, End of Year $ 4,554,285

$ 3,821,704

See notes to consolidated financial statements (concluded)

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CONSOLIDATED STATEMENTS OF CASH FLOWS

HOUSTON METHODIST

(In Thousands) For the Years Ended

December 31,

2013 2012

Operating Activities

Cash received from patient services $ 2,406,516 $ 2,148,124

Other receipts from operations 207,220 183,250

Interest income, dividends and other income

received 25,448

34,079

Cash paid to or on behalf of employees (1,263,665) (1,177,703)

Cash paid for supplies and services (934,129) (819,016)

Interest paid (17,088) (22,571)

Net Cash Provided by Operating Activities 424,302 346,163

Investing Activities

Purchase of property and equipment (163,238) (174,633)

Purchases of investments (2,294,116) (2,313,134)

Sales of investments 2,135,639 2,228,463

Net Cash Used in Investing Activities (321,715)

(259,304)

Financing Activities

Principal payments on bond debt (97,025) (92,455)

Contributions to permanently restricted net assets 10,748 11,392

Net Cash Used in Financing Activities (86,277)

(81,063)

Net Increase in Cash and Cash Equivalents 16,310

5,796

Cash and Cash Equivalents, Beginning of Year 55,147 49,351

Cash and Cash Equivalents, End of Year $ 71,457

$ 55,147

See notes to consolidated financial statements (continued)

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CONSOLIDATED STATEMENTS OF CASH FLOWS – Continued

HOUSTON METHODIST

(In Thousands)

For the Years Ended

December 31,

2013 2012

Reconciliation of Increase in Net Assets to Net

Cash Provided by Operating Activities

Increase in Net Assets $ 732,581 $ 415,432 Adjustments to reconcile increase in net assets to

net cash provided by operating activities: Net gains on investments in net assets (502,493) (225,130) Permanently and temporarily restricted

activities not related to operations (41,152) (27,888) Loss on impaired asset 3,261 1,114 Depreciation and amortization 195,660 190,547 Uncollectible, uncompensated care 127,793 137,497 Other noncash items 617 (1,693) Increase in patient accounts receivable (147,475) (182,744) Decrease in inventory and other current

assets 2,880 9,131 Decrease (increase) in other assets 289 (4,770) Increase in accounts payable and accrued

expense 43,204 13,366 Increase in estimated third-party settlements 12,643 23,014 Decrease in other long-term obligations (3,506) (1,713)

Net Cash Provided by Operating Activities $ 424,302 $ 346,163

See notes to consolidated financial statements (concluded)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HOUSTON METHODIST


NOTE A – MISSION AND ORGANIZATION

The mission of Houston Methodist (Methodist) is to provide high-quality, cost-effective health care that delivers the best value to the people it serves in a spiritual environment of caring in association with internationally recognized teaching and research. Methodist operates a large academic medical center hospital, a research institute, a physician organization, four community hospitals, and various medical office buildings in Houston, Texas, and the surrounding area.

Methodist is a not-for-profit, nonmember corporation organized and existing under the

laws of the State of Texas. It is exempt from federal income taxes. The consolidated

financial statements include the accounts of Methodist and its wholly owned and/or controlled affiliates.

NOTE B – SIGNIFICANT ACCOUNTING POLICIES

Use of Estimates – The preparation of consolidated 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, disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expense

during the reporting period. Actual results could differ from those estimates. Significant estimates include the allowances for uncollectible accounts and contractuals, estimated

third-party settlements, self-insurance reserves and valuation of investments.

Cash and Cash Equivalents – Investments with maturities of three months or less when purchased are classified as cash equivalents, excluding amounts classified as assets limited as to use.

Accounts Receivable – Accounts receivable are reported in the consolidated balance sheets net of an estimated allowance for uncollectible, uncompensated care of $126.3 million and $108.5 million as of December 31, 2013 and 2012, respectively. Current operations are charged with a provision for uncollectible, uncompensated care based on experience, eligibility, and any other circumstances, which may affect the ability of patients to meet their obligations. Methodist routinely obtains assignment of (or is otherwise entitled to receive) patients’ benefits payable under their health insurance programs, plans, or policies (e.g., Medicare, Medicaid, health maintenance organizations, and commercial insurance policies).

Patient accounts receivable are stated at net realizable value. Accounts receivable are reduced by an allowance for contractual adjustments, based on expected payment rates from payors under current reimbursement methodologies, and also by an allowance for doubtful accounts. In evaluating the collectibility of accounts receivable, Methodist analyzes historical trends for each of its major payor sources of revenue to estimate an appropriate allowance for doubtful accounts and provision for uncollectible accounts. Management regularly reviews data about these major payor sources of revenue in

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HOUSTON METHODIST

NOTE B – SIGNIFICANT ACCOUNTING POLICIES – Continued

evaluating the sufficiency of the allowance for contractual adjustments and allowance for doubtful accounts.

For receivables associated with services provided to patients who have third-party coverage, Methodist analyzes contractually due amounts and provides an allowance for doubtful accounts and a provision for uncollectible accounts, if necessary (for example, for expected uncollectible deductibles and co-payments on accounts for which the third-party payor has not yet paid, or for payors who are known to be having financial difficulties that make the realization of amounts due unlikely). Receivables associated with self-pay patients are patients without insurance. Methodist records a significant provision for uncollectible accounts in the period of service on the basis of its past experience, which indicates that many patients are unable or unwilling to pay the portion of their bill for which they are financially responsible. The difference between the discounted rates and the amounts actually collected after all reasonable collection efforts have been exhausted is written off against the allowance for doubtful accounts in the period they are determined uncollectible.

Methodist’s allowance for doubtful accounts was 25.5% and 23.7% of patient accounts receivable (net of allowances for contractual allowance and discounts) as of

December 31, 2013 and 2012, respectively. In addition, Methodist’s bad debt write-offs

totaled $125.2 million and $135.1 million for fiscal years 2013 and 2012, respectively.

Methodist does not maintain a material allowance for doubtful accounts from third-party payors, nor did it have significant write-offs from third party payors.

The following table shows gross accounts receivable by payors:

December 31,

2013 2012

Managed care 47% 46% Medicare 33% 33% Self-pay 7% 8% Medicaid 9% 9% Other 4% 4%

Total 100% 100%

Approximately 23.7% of Methodist’s accounts receivable at December 31, 2013 is due from two managed care companies.

Net patient service revenue is reported at the estimated net realizable amounts due from third-party payors, patients, and others for services rendered. Methodist has agreements with third-party payors that provide for payments at amounts different from gross charges. Payment arrangements include prospectively determined rates per discharge, reimbursed costs, per diem payments, and discounted charges, including estimated retroactive settlements under payment agreements with third-party payors.

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HOUSTON METHODIST


Methodist recognizes patient service revenue associated with services provided to patients who have third-party payor coverage on the basis of contractual rates for the services rendered. Provisions for adjustments to net patient service revenue are accrued on an estimated basis in the period the related services are rendered and adjusted in future periods as final settlements are determined. For uninsured patients that do not qualify for charity care, Methodist recognizes revenue based on its discounted rates. On the basis of historical experience, a significant portion of Methodist’s uninsured patients will be unable or unwilling to pay for the services provided. Methodist records a significant provision for uncollectible accounts related to uninsured patients in the period the services are provided.

Operating Activities – Methodist considers activities directly related to patient care, education, and research as operating activities. These activities, including earnings from certain fixed income and equity investments used to support these activities of $12.1 million and $15.2 million for 2013 and 2012, respectively, are included in the determination of operating income in the consolidated statements of operations and changes in net assets. Other activities not directly related to patient care, education and research are excluded from operating income.

Other nonoperating activities include certain investment gains and losses realized from Methodist’s investment portfolio.

Excess of Revenue Over Expense – The consolidated statements of operations and changes in net assets include excess of revenue over expense. Changes in unrestricted net assets, which are excluded from excess of revenue over expense consistent with industry practice, include certain transfers of funds to or from restricted net assets, contributions of property and equipment, and contributions used to acquire property and equipment.

Uncompensated Care – Uncompensated care represents unrealizable patient charges at standard rates. Uncompensated care is classified as follows:

Community free, uncompensated care – Community free, uncompensated care generally represents unrealizable standard charges for care provided to financially and medically indigent (charity) patients with no obligation, or a discounted obligation, to pay. Community free, uncompensated care has been excluded from gross patient revenue in the amount of approximately $431.7 million and $338.6 million in 2013 and 2012, respectively.

Program-based free, uncompensated care – Program-based free, uncompensated care generally represents standard charges that are unrealizable because payment amounts are determined through contractual arrangements. For the years ended December 31, 2013 and 2012, program-based free, uncompensated care (contractual allowances) resulted from contractual arrangements with the sponsored Medicare programs (principally related to elderly patients) and Medicaid (principally related to indigent patients) and with commercial managed care programs and in

connection with Methodist’s self-pay discount policies.

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HOUSTON METHODIST


Program-based free, uncompensated care is reported as a deduction from gross patient revenue.

Policy-based free, uncompensated care – Policy-based free, uncompensated care generally represents standard charges that are unrealizable due to discounting in accordance with internally established policies and procedures. Policy-based free, uncompensated care is reported as a deduction from gross patient revenue.

Uncollectible, uncompensated care – Uncollectible, uncompensated care generally represents standard charges that are unrealizable due to an unwillingness to pay by those responsible for payment (bad debt). Uncollectible, uncompensated care is reported as a deduction from gross patient revenue.

Net Patient Revenue – Net patient revenue is reported at the estimated net realizable amounts from patients or third-party payors for services rendered, including estimated retroactive adjustments.

Retroactive adjustments are accrued on an estimated basis when the related services are rendered and adjusted in future periods as final settlements are determined. During 2013 and 2012, changes in estimates related to prior years increased net patient revenue by approximately $21.9 million and $14.7 million, respectively.

Net patient revenue is computed as follows (in thousands):

For the Years Ended December 31,

2013 2012

Gross patient revenue (net of community free, uncompensated care) $ 9,073,445 $ 7,873,394

Deductions from revenue: Program-based free, uncompensated care 6,508,209 5,562,921 Policy-based free, uncompensated care 18,251 17,957

Net patient revenue (net of program and

policy based free, uncompensated care) 2,546,985 2,292,516 Uncollectible, uncompensated care 127,793 137,497

Net patient revenue (net of uncollectible,

uncompensated care) $ 2,419,192 $ 2,155,019

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HOUSTON METHODIST


The following table shows gross (gross of community free, uncompensated care) and net patient revenue (net of program and policy based free, uncompensated care) by payors:

Gross

Net

As of December 31,

As of December 31,

2013

2012

2013

2012

Managed Care 39%

39%

62%

61%

Medicare 46%

45%

28%

29%

Medicaid 7%

7%

4%

4%

Self-Pay 5%

5%

3%

3%

Other 3%

4%

3%

3%

100%

100%

100%

100%

Financial Instruments – The carrying value of cash and cash equivalents, accounts receivable, and accounts payable approximates fair value due to the short-term nature of these financial instruments.

Investments are exposed to various risks, such as interest rate, credit, and overall market volatility. It is reasonably possible that changes in the values of investments will occur in the near term and that such changes could materially affect the amounts reported in the consolidated balance sheets and consolidated statements of operations and changes in net assets.

Inventory of Pharmaceuticals and Supplies – Inventory is valued at the lower of cost (determined by the weighted-average method) or market.

Property and Equipment – Property and equipment is carried at cost or, if donated, the fair market value at the time of donation, and include expenditures for new property and equipment and expenditures that substantially increase the useful life of existing property and equipment. Ordinary maintenance and repairs are charged to expense when incurred. Depreciation of property and equipment is provided using the straight-line method. Useful lives assigned are generally as recommended in the American Hospital Association publication Estimated Useful Lives of Depreciable Hospital Assets.

Long-lived assets to be held and used are reviewed for impairment whenever circumstances indicate that the carrying amount of an asset may not be recoverable. Long-lived assets that are to be disposed of are reported at the lower of carrying amount or fair value less costs to sell. Methodist records the fair value of a liability for an asset retirement obligation in the period in which it is incurred by capitalizing it as part of the carrying amount of the long-lived assets (see Note J).

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HOUSTON METHODIST


Other Assets – Other assets consist primarily of goodwill ($23.4 million) and deferred financing costs. Methodist tests for impairment of goodwill on an annual basis, or more frequently if indicators of impairment are present. Methodist did not record any goodwill impairments for the years ended 2013 or 2012. Premiums collected in connection with the issuance of fixed rate bonds, the cost of issuing fixed rate bonds, and premiums paid to insure variable rate demand bonds are capitalized and amortized over the term of the respective bond issue.

Paid Time Off (Vacation, Holiday and Sick Leave) Benefits – The cost of employees’ paid time off benefits is recorded at the time benefits are earned.

Professional and General Liability Self-Insurance – Methodist has a separate, revocable self-insurance trust for which funding has been actuarially determined for the payment of professional and general liability losses, related expenses, and the cost of administering the trust.

The assets of the revocable trust are reported in assets limited as to use in the consolidated balance sheets. Income from the trust assets are reported in other revenue in the consolidated statements of operations and changes in net assets. Professional and general liability losses and administrative costs are reported in services and other expense in the consolidated statements of operations and changes in net assets.

Unconditional Pledges and Unrestricted Contributions – Unrestricted contributions and pledges are recorded as other income (losses), primarily investment earnings (losses), net in the consolidated statements of operations and changes in net assets in the period of the contribution or pledge commitment. Donor-restricted pledges and contributions are recorded as temporarily or permanently restricted net assets when the pledge or contribution is made. Pledges receivable are reported at their net present value, discounted at rates ranging from 1.0% to 3.4%. As of December 31, 2013 and 2012, the amount of the discount was $5.9 million and $10.9 million, respectively.

Temporarily and Permanently Restricted Net Assets – Temporarily restricted net assets are those limited as to use by donors to a specific time period or purpose. Permanently restricted net assets are those that have been restricted by donors to be maintained in perpetuity. Temporarily restricted net assets released from restriction are recorded as increases in unrestricted net assets when costs are incurred for their restricted purposes. Temporarily and permanently restricted net assets are primarily restricted for patient care, research and education.

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HOUSTON METHODIST


Methodist’s permanently restricted net assets consist of individual endowment accounts. Unless otherwise directed by the donor, gifts received for endowment accounts are invested consistent with Methodist’s board-approved investment policy. Unless otherwise directed by the donor, Methodist has a policy of annually appropriating a certain percentage of each endowment account, which is then available to be spent consistent with donor intent. In order to preserve the real value of a donor ’s gift and to sustain funding consistent with donor intent, the annual appropriation rate is set to strike a reasonable balance between long-term objectives of preserving and growing each endowment fund for the future and providing stable, year-to-year appropriation amounts. From time to time, the fair value of assets associated with a permanently restricted endowment account may fall below the applicable endowments gift amount(s) due to unfavorable investment returns.

As of December 31, 2013, the fair value of assets associated with permanently restricted endowment accounts did not fall below the applicable endowment gift amount(s) for any of the endowments. As of December 31, 2013, the endowment accounts included in temporarily restricted net assets totaled $46.7 million. This amount was increased in 2013 by investment gains totaling $28.3 million and reduced by expenditures consistent with donor intent totaling $2.5 million.

As of December 31, 2012, the fair value of assets associated with permanently restricted endowment accounts that fell below the applicable endowment gift amount(s) totaled $139,000. As of December 31, 2012, the endowment accounts included in temporarily restricted net assets totaled $21.5 million. This amount was increased in 2012 by investment gains totaling $11.7 million and reduced by expenditures consistent with donor intent totaling $1.9 million.

Income Taxes – Methodist and most of its affiliates are 501(c)(3) organizations generally exempt from income taxes. As a result of its unrelated business taxable income activity and taxable subsidiary operations, there are net operating losses of approximately $127.5 million that are available to offset net taxable income through 2025. Substantially all of the related deferred tax assets of $44.2 million have been offset by a valuation allowance. The income tax provision and related tax assets and liabilities are immaterial. Methodist did not recognize any adjustments related to uncertain tax positions as of December 31, 2013.

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HOUSTON METHODIST


Subsequent Events — Methodist has evaluated subsequent events through March 31,

2014, which is the date the consolidated financial statements were issued. Effective

February 1, 2014, Methodist acquired a controlling interest in Christus St. John Hospital

in the Clear Lake area south of Houston and Methodist acquired the operating assets of

Christus St. Catherine Hospital in west Houston. The real property and improvements of

the Christus St. Catherine Hospital are now held in a joint operating company with

Methodist holding a controlling interest. The majority interest in the joint operating

companies is owned by Methodist and the minority interest is owned by Christus. St.

John Hospital will be operated as a Methodist acute care hospital and St. Catherine

Hospital will be repurposed as a long term care facility.

NOTE C – SERVICES PROVIDED TO THE COMMUNITY

Under legislation passed in the state of Texas, not-for-profit hospitals are required to provide a mandated amount of “Charity Care” and “Community Benefits,” as defined by the legislation. Methodist was in compliance with the legislation, providing an estimated total of $744.1 million and $703.8 million in combined Charity Care and Community Benefits based on estimated unreimbursed costs for the years ended December 31, 2013 and 2012, respectively, which exceeded the mandated amounts.

Through its controlled corporations, Methodist has a program to address specific health care needs that are not being met in the local community. Estimated charity care unreimbursed cost under this program for the years ended December 31, 2013 and 2012, totaled $174.7 million and $177.9 million, respectively. The method to estimate charity patient care costs is based on the cost to charge ratio, as defined by state of Texas statutory legislation, and then multiplying that ratio by the gross patient charges associated with providing care to financially or medically indigent patients, reduced by any payments received.

Methodist contributed to the advancement of medical science through direct financial support of research and medical education during 2013 and 2012. Approximately $115.3 million and $110.3 million in 2013 and 2012, respectively, was incurred in direct and indirect expense for Methodist’s internally funded research and educational programs, support of its multiyear primary affiliations with Weill Medical College at Cornell University and New York-Presbyterian Hospital, and its support of other affiliates, including Baylor College of Medicine. Methodist also provided financial support for education in several allied health professions.

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HOUSTON METHODIST

NOTE C – SERVICES PROVIDED TO THE COMMUNITY – Continued

The estimated unreimbursed costs of charity care and community benefits (in millions) are delineated below:


2013 2012

Charity Care: Unreimbursed cost of providing care to

financially and medically indigent patients $ 113.9 $ 109.0 Unreimbursed cost of providing government-

sponsored indigent health care (Medicaid) 4.7

- -60.6

Unreimbursed support provided through others 56.1 8.3

Total Charity Care 174.7 177.9

Community Benefits:

Health care professional education and other 39.3 36.6

Unreimbursed research-related costs 76.1 - - Unreimbursed cost of providing government-

sponsored health care (Medicare) 454.0 415.6

Total Community Benefits 569.4

525.9

Total Charity Care and Community Benefits $ 744.1 $ 703.8

Methodist’s participation in 2013 in an 1115 State of Texas Medicaid waiver program with a group of hospitals led by a regional anchor resulted in a decrease in the unreimbursed cost of providing government-sponsored indigent health care (Medicaid) and an increase of unreimbursed support provided through others.

NOTE D – ASSETS LIMITED AS TO USE

Assets limited as to use are internally designated for capital expansions or replacement, internally restricted in connection with self-insurance programs (see Note J), or externally restricted by donor specifications.

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HOUSTON METHODIST

NOTE D – ASSETS LIMITED AS TO USE – Continued

The following table sets forth the components of assets limited as to use by type of limitation (in thousands):

December 31,

2013 2012

Limited by Board for Expansion

Fixed Income Fund Cash and cash equivalents $ 751 $ 363 U.S. agencies 1,374,401 1,188,447

1,375,152 1,188,810

Equity Fund Cash and cash equivalents 84,352 46,473 Marketable equity securities 1,798,445 1,392,391

1,882,797 1,438,864

Limited Through Self-Insurance Trust Marketable equity securities 123,293 115,293

Limited by Donor or Time Restrictions

Cash and cash equivalents 6,637 148 U.S. agencies 13,749 9,743

Debt securities 16,200 16,017 Marketable equity securities 170,596 125,576 Pledges receivable 37,380 42,000

244,562 193,484

Other 4,504 4,504

Subtotal 3,630,308 2,940,955

Less amounts required to meet current obligations (1,434,466) (1,474,265)

Total $ 2,195,842 $ 1,466,690

The following table sets forth the components of the return on Methodist’s assets limited as to use (in thousands):


2013 2012

Investment income $ 39,014 $ 41,997 Net gains 524,281 229,574

Total $ 563,295 $ 271,571

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HOUSTON METHODIST


Investment income and net gains (losses) on the fixed income fund portion of assets limited as to use by Methodist’s Board of Directors (the Board) for expansion and assets limited through self-insurance trust are recorded in other revenue in the consolidated statements of operations and changes in net assets. Investment income and net gains (losses) on the equity fund portion of assets limited by the Board for expansion are recorded in other income (losses), primarily investment earnings (losses), net in the consolidated statements of operations and changes in net assets.

Investment income and net gains (losses) on funds limited by donor restrictions are recorded directly to restricted net assets in the consolidated statements of operations and changes in net assets.

Below is a summary of the classification of investment results in the consolidated financial statements (in thousands):

2013 2012

Other revenue $ 12,068 $ 15,192 Other income, primarily investment earnings, net 519,205 242,925 Temporarily restricted net assets–investment earnings, net 32,022 13,454

Total $ 563,295 $ 271,571

Methodist accounts for its investments in equity securities with readily determinable fair value and its investments in debt securities as trading securities. Accordingly, such investments are reported at fair value with changes in fair value reported in excess of revenue over expense.

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HOUSTON METHODIST


The fair value of assets limited as to use is as follows (in thousands):

December 31, 2013

Total

Investment Types Fair Value Level 1 Level 2

Assets:

Cash and cash equivalents $ 91,787 $ 91,787 $ - Fixed income securities:

U.S. Treasuries and U.S. agencies 1,386,322 - 1,386,322 Debt securities 21,443 21,443 -

U.S. equity securities 1,659,571 1,659,571 - International equity securities 431,430 431,430 -

Total assets at fair value

$ 3,590,553 $ 2,204,231 $ 1,386,322

December 31, 2012

Total

Investment Types Fair Value Level 1 Level 2

Assets:

Cash and cash equivalents $ 47,090 $ 47,090 $ - Fixed income securities:

U.S. Treasuries and U.S. agencies 1,197,567 - 1,197,567 Debt securities 20,240 20,240 -

U.S. equity securities 1,273,212 1,273,212 - International equity securities 356,342 356,342 -

Total assets at fair value

$ 2,894,451 $ 1,696,884 $ 1,197,567

Level 1 – Quoted prices (unadjusted) in active markets for identical assets that Methodist can access at the measurement date

Level 2 – Observable inputs other than quoted prices included in Level 1

Level 3 – Unobservable inputs. Methodist has no investments defined as Level 3 investments

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HOUSTON METHODIST


The fair value of the Level 1 securities represents the quoted market price multiplied by the quantity held. Level 2 securities include those that are valued using significant other observable inputs or quoted prices for similar assets. Methodist employs the market approach to value these securities. In this approach, the models used are primarily industry-standard models that consider various assumptions, including time value, volatility factors and current market and contractual prices for the underlying instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the market place throughout the full term of the instrument, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace.

NOTE E – PROPERTY AND EQUIPMENT

Below is a summary of property and equipment (in thousands):

December 31,

2013 2012

Buildings and improvements $ 2,636,659 $ 2,556,895 Equipment 1,415,442 1,331,254

4,052,101 3,888,149 Less accumulated depreciation (1,939,978) (1,755,023)

2,112,123 2,133,126 Land 220,058 213,881 Construction in progress 70,297 88,951

Property and equipment, net $ 2,402,478 $ 2,435,958

Depreciation expense for the years ended December 31, 2013 and 2012 was $195.4 million and $190.3 million, respectively. As of December 31, 2013 and 2012, property additions, included in accounts payable and accrued expense not paid, were $26.0 million and $23.2 million, respectively. As of December 31, 2013 and 2012, the change in property additions, included in accounts payable and accrued expense not paid, were an increase of $2.8 million and a decrease of $13.2 million, respectively.

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HOUSTON METHODIST

NOTE F – DEBT

Below is a summary of bonds payable (in millions):

December 31,

2013 2012

Series 2008A $ 346.0 $ 348.0 Series 2008B 180.1 212.6 Series 2008C 406.3 406.3 Series 2009A 20.1 45.1 Series 2009B - 37.5 Series 2009C 586.5 586.5 Unamortized premium – 2008B 3.1 4.7 Unamortized premium – 2009A .1 .6 Unamortized premium – 2009B - .2

1,542.2 1,641.5 Classified as current (1,393.7) (1,438.1)

Long term debt $ 148.5 $ 203.4

The carrying value of Methodist’s fixed rate debt was $203.4 million and $300.7 million as of December 31, 2013 and 2012, respectively, and the estimated fair value of Methodist’s fixed rate debt, based on current traded values, was $222.6 million and $328.0 million as of December 31, 2013 and 2012, respectively. The carrying amount of Methodist’s variable rate debt approximates fair value.

Methodist and certain other Methodist–controlled entities (Restricted Affiliates) are obligated in certain respects by agreements governing the 2008 and 2009 series bonds.

Summary consolidated financial information, excluding intercompany liabilities, for entities that are not Restricted Affiliates, as defined by the master trust indenture, as of December 31, 2013 and 2012, and for the years then ended follows (in thousands):

2013 2012

Total assets $ 7,619 $ 7,733 Total liabilities 878 508 Revenue in excess of expense 1,484 4,924

As of December 31, 2013 and 2012, the 2008A Bonds and 2008C Bonds were in the daily interest rate mode. The 2009C Bonds were in the commercial paper mode with interest rate periods of between 210 to 257 days.

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HOUSTON METHODIST

NOTE F – DEBT – Continued

While bonds are in the daily rate or commercial paper mode, they may be tendered by bondholders (“put”) on business days for full payment of principal and interest. The Series 2008B Bonds were issued on August 21, 2008 in the fixed rate serial mode.

To provide assurance of its ability to purchase tendered 2008A Bonds, 2008C Bonds and 2009C Bonds, Methodist intends to maintain unencumbered cash, cash equivalents, immediately saleable fixed income obligations (e.g., high-grade, fixed income investments), readily saleable equity investments and committed bank lines or similar bank facilities with a market value at least equal to the maximum aggregate purchase price that could become due on all bonds in a daily rate mode, weekly rate mode, or commercial paper rate mode. Methodist had a three year $100 million revolving line of credit with a large commercial bank, which was not drawn and expired on October 13, 2013.

Consistent with the put feature of Methodist’s 2008A Bonds, 2008C Bonds and 2009C Bonds, these bonds have been classified as current liabilities. The 2008B Bonds and 2009A Bonds have been classified as long-term liabilities, other than amounts due in 2014, which have been classified as current liabilities, as indicated below.

The 2008A Bonds, 2008C Bonds and 2009C Bonds may be converted to fixed rate obligations or other variable rate modes (e.g., weekly, commercial paper) at the option of Methodist.

The Restricted Affiliates have covenanted to abide by guidelines regarding repayment, financial performance and organizational changes defined in agreements and indentures related to the 2008 and 2009 series bonds. Management believes Methodist is in compliance with debt covenants.

The 2008A Bonds were issued in two subseries of $175 million each and have a final maturity date of December 1, 2041. Principal payments on the two subseries of 2008A Bonds of $2.0 million began in 2012, with remaining principal payments scheduled from 2013 through 2041. The 2008B Bonds were issued in seven series ranging from $31.3 million to $38.5 million. Principal payment on the first 2008B Bond series of $31.3 million began in 2012, with payments on the other six series scheduled from 2013 through 2018.

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HOUSTON METHODIST

NOTE F – DEBT – Continued

The 2008C Bonds have two subseries of $256.7 million and $149.6 million each. Principal payments on each of the two series of the 2008C Bonds are scheduled to commence in 2019, with a final maturity date of December 1, 2027. The 2009A Bonds were issued in three series ranging from $20.1 million to $25.0 million. Principal payments on the first 2009A Bond series of $25.0 million began in 2012, with payments on the other two series scheduled in 2013 and 2014. The 2009B Bonds were issued as two series of $34.1 million and $37.5 million each. Methodist exercised options to redeem $34.1 million of bonds in 2012 and $37.5 million of bonds in 2013. The 2009C Bonds were issued in two subseries of $450.0 million and $136.5 million each. Principal payments on each of the two series of the 2009C Bonds are scheduled to commence in 2028, with a final maturity date of December 1, 2039.

The aggregate annual maturities of bonds payable as of December 31, 2013, for the next five fiscal years and thereafter are as follows (in millions):

2014 $ 55.8 2015 36.9 2016 38.3 2017 39.6 2018 41.0 Thereafter 1,327.4

Total $ 1,539.0

The amortization of bond premium on the 2009A, 2009B and 2008B Bonds, which was accounted for as a reduction in interest expense, totaled $2.3 million and $3.6 million for the years ended December 31, 2013 and 2012, respectively. The average annual interest rate paid on all bonds was .97% and 1.14%, for the years ended December 31, 2013 and 2012, respectively.

NOTE G – OPERATING LEASE EXPENSE AND REVENUE

Minimum lease payments (in thousands) for all long-term, noncancelable operating leases for the five years subsequent to December 31, 2013, are approximately 2014 - $5,788; 2015 - $4,111; 2016 - $2,978; 2017 - $1,230; and 2018 - $456.

Rental expense under operating leases, including short-term leases, was $14.4 million and $12.4 million for the years ended December 31, 2013 and 2012, respectively.

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HOUSTON METHODIST

NOTE G – OPERATING LEASE EXPENSE AND REVENUE - Continued

Rental revenue (in thousands) for operating leases for the five years subsequent to December 31, 2013, is approximately 2014 - $27,403; 2015 - $20,683; 2016 - $14,143; 2017 - $9,590; 2018 - $4,716; and years after 2018 - $2,545. This revenue primarily relates to the leasing of medical office buildings (MOBs) space to physician practices at market rates. The approximate carrying value of the MOBs is $203.8 million with accumulated depreciation of $146.4 million as of December 31, 2013.

NOTE H – RETIREMENT PLANS

Most Methodist corporations participate in a noncontributory, defined contribution plan. The amounts incurred during 2013 and 2012 totaled $31.0 million and $29.6 million, respectively, and are included in salaries, wages, and related personnel costs in the consolidated statements of operations and changes in net assets.

Additionally, Methodist has a tax-sheltered annuity plan that includes an employer match calculated at 50% of an employee’s contribution up to 4% of pay. The contributions for the employer match on the tax-sheltered annuity plan totaled $12.7 million and $11.8 million during 2013 and 2012, respectively. These amounts are included in salaries, wages, and related personnel costs in the consolidated statements of operations and changes in net assets.

Certain executives participate in a Supplemental Executive Retirement Plan. The expense associated with this plan was $1.5 million and $1.1 million during 2013 and 2012, respectively. These amounts are included in salaries, wages, and related personnel costs in the consolidated statements of operations and changes in net assets.

NOTE I – FUNCTIONAL EXPENSES

The functional classification of expense was as follows (in thousands):


2013 2012

Patient care, research and medical education $ 1,940,474 $ 1,791,776 General and administrative 504,287 395,179

Total operating expense $ 2,444,761 $ 2,186,955

NOTE J – COMMITMENTS AND CONTINGENCIES

Methodist arranges for the issuance of bank letters of credit in connection with its financial obligations, such as claims administration funding and support of fronted insurance programs. As of December 31, 2013, outstanding letters of credit totaled $9.0 million and expire after a one-year term.

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HOUSTON METHODIST

NOTE J – COMMITMENTS AND CONTINGENCIES - Continued

Methodist is party to a number of pending or threatened lawsuits arising out of, or incidental to, the ordinary course of business for which it carries professional and general liability coverage and other insurance coverages. In the opinion of management, upon consultation with legal counsel, none of the pending or threatened lawsuits will have a material effect upon the financial position or results of operations of Methodist, and are properly reserved for.

Laws and regulations governing the Medicare and Medicaid programs and certain other third-party programs are complex and subject to interpretation. As a result, there is a reasonable possibility that recorded estimates of third-party settlements will change by a material amount in the near term. Methodist’s intent is to be in compliance with all applicable laws and regulations, and it is not aware of any significant pending or threatened investigations involving allegations of potential wrongdoing. Compliance with such laws and regulations can be subject to future review and interpretation. Changes in the Medicare and Medicaid programs and a reduction of funding could have an adverse effect on Methodist.

Methodist accounts for asset retirement obligations in accordance with authoritative guidance which clarifies that an entity is required to recognize a liability for the fair market value of a conditional asset retirement obligation when incurred if the liability’s fair value can be reasonably estimated. The corresponding cost is capitalized as part of the carrying amount of the related long-lived asset. The liability is accreted to its present value each period and the capitalized cost is depreciated over the useful life of the related asset.

The asset retirement obligation, totaling $7.0 million and $7.3 million as of December 31, 2013 and 2012, respectively, has been classified as a long-term liability. This liability was reduced by $216,000 and $282,000 in payments, increased by $243,000 and $253,000 in accretion expense and reduced by a $327,000 and $271,000 change in estimate for the years ended December 31, 2013 and 2012, respectively. The change in estimate was recorded as a decrease in the carrying value of Methodist’s various building facilities as of December 31, 2013 and 2012.

2013 KEY HOSPITAL VOLUME INDICATORS and

PAYOR MIX INFORMATION

%2013 2012 Change

Admissions: Methodist 36,310 35,542 2.2% Sugar Land 13,563 13,132 3.3% Willowbrook 14,471 13,757 5.2% West Houston 8,338 6,238 33.7% San Jacinto 12,360 12,242 1.0%

Total 85,042 80,911 5.1%

Inpatient Days: Methodist 231,750 226,480 2.3% Sugar Land 56,388 54,339 3.8% Willowbrook 58,498 55,974 4.5% West Houston 30,433 22,956 32.6% San Jacinto 61,906 61,359 0.9%

Total 438,975 421,108 4.2%

Average Length of Stay: Methodist 6.38 6.37 0.2% Sugar Land 4.16 4.14 0.5% Willowbrook 4.04 4.07 -0.6% West Houston 3.65 3.68 -0.8% San Jacinto 5.01 5.01 -0.1%

Total 5.16 5.20 -0.8%

Key Volume Indicators Hospital Operations

For the Year Ended December 31,

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%2013 2012 Change



Outpatient Equivalent Days: Methodist 138,203 126,240 9.5% Sugar Land 50,352 45,930 9.6% Willowbrook 45,767 42,150 8.6% West Houston 32,536 26,681 21.9% San Jacinto 42,044 40,957 2.7%

Total 308,902 281,958 9.6%

Equivalent Patient Days: Methodist 369,953 352,720 4.9% Sugar Land 106,740 100,269 6.5% Willowbrook 104,265 98,124 6.3% West Houston 62,969 49,637 26.9% San Jacinto 103,950 102,316 1.6%

Total 747,877 703,066 6.4%

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%2013 2012 Change



ER Visits: Methodist 61,043 55,370 10.2% Sugar Land 39,292 38,541 1.9% Willowbrook 56,527 54,403 3.9% West Houston 27,497 23,228 18.4% San Jacinto 50,585 54,472 -7.1%

Total 234,944 226,014 4.0%

Births: Methodist 1,058 1,064 -0.6% Sugar Land 2,672 2,699 -1.0% Willowbrook 3,174 3,112 2.0% West Houston 1,944 1,435 35.5% San Jacinto 1,654 1,542 7.3%

Total 10,502 9,852 6.6%

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Year Ended Year Ended Year Ended Year Ended2013 2012 2011 2010

Medicare 46.5% 46.1% 46.1% 46.5%

Medicaid 6.8% 7.1% 6.7% 6.6%

Total Government 53.3% 53.2% 52.8% 53.1%

Managed Care and Other 41.9% 41.9% 42.0% 42.2%

Self Pay 4.8% 4.9% 5.2% 4.7%

Grand Total 100.0% 100.0% 100.0% 100.0%

Houston Methodist

Payor Mix Summary

Consolidated Operations

(% Based on Gross Revenue )

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