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									                                       DRAFT 04/24/09




 Neighborhood Centers Inc.
  Consolidated Financial Statements
       and Single Audit Reports
for the year ended December 31, 2008
                                                                               DRAFT 04/24/09



                                            Independent Auditors’ Report



To the Board of Directors of
    Neighborhood Centers Inc.:

We have audited the accompanying consolidated statements of financial position of Neighborhood Centers Inc. as of
December 31, 2008 and 2007 and the related consolidated statements of activities, of functional expenses, and of
cash flows for the years then ended. These consolidated financial statements are the responsibility of the
management of Neighborhood Centers Inc. 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
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 our audits to obtain
reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated 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 consolidated financial statements referred to above present fairly, in all material respects, the
financial position of Neighborhood Centers Inc. as of December 31, 2008 and 2007 and the changes 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.

In accordance with Government Auditing Standards, we have also issued a report dated DATE OPEN, on our
consideration of Neighborhood Centers Inc.’s internal control over financial reporting and our tests of its compliance
with certain provisions of laws, regulations, contracts, and grant agreements and other matters. The purpose of that
report is to describe the scope of our testing of internal control over financial reporting and compliance and the
results of that testing, and not to provide an opinion on the internal control over financial reporting or on compliance.
That report is an integral part of an audit performed in accordance with Government Auditing Standards and should
be considered in assessing the results of our audit.

Our audits were performed for the purpose of forming an opinion on the basic consolidated financial statements of
Neighborhood Centers Inc. taken as a whole. The accompanying schedule of expenditures of federal awards for the
year ended December 31, 2008 is presented for purposes of additional analysis as required by U. S. Office of
Management and Budget Circular A-133, Audits of States, Local Governments, and Non-Profit Organizations, and
is not a required part of the basic consolidated financial statements. The accompanying schedule of expenditures of
state awards for the year ended December 31, 2008 is also provided for additional analysis as required by the State
of Texas Single Audit Circular, and is not a required part of the basic consolidated financial statements. The
information in these schedules has been subjected to the auditing procedures applied in the audit of the basic
consolidated financial statements and, in our opinion, is fairly stated, in all material respects, in relation to the basic
consolidated financial statements taken as a whole.


DATE OPEN PENDING MANAGEMENT REVIEW AND APPROVAL
                                     DRAFT 04/24/09




      Neighborhood Centers Inc.
        Consolidated Financial Statements
        and Independent Auditors’ Report
for the years ended December 31, 2008 and 2007
                                                                              DRAFT 04/24/09




                                           Independent Auditors’ Report



To the Board of Directors of
    Neighborhood Centers Inc.:

We have audited the accompanying consolidated statements of financial position of Neighborhood Centers Inc. as of
December 31, 2008 and 2007 and the related consolidated statements of activities, of functional expenses, and of
cash flows for the years then ended. These consolidated financial statements are the responsibility of the
management of Neighborhood Centers Inc. 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
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 our audits to obtain
reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated 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 consolidated financial statements referred to above present fairly, in all material respects, the
financial position of Neighborhood Centers Inc. as of December 31, 2008 and 2007 and the changes 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.

In accordance with Government Auditing Standards, we have also issued a report dated DATE OPEN, on our
consideration of Neighborhood Centers Inc.’s internal control over financial reporting and our tests of its compliance
with certain provisions of laws, regulations, contracts, and grant agreements and other matters. The purpose of that
report is to describe the scope of our testing of internal control over financial reporting and compliance and the
results of that testing, and not to provide an opinion on the internal control over financial reporting or on compliance.
That report is an integral part of an audit performed in accordance with Government Auditing Standards and should
be considered in assessing the results of our audit.


DATE OPEN PENDING MANAGEMENT REVIEW AND APPROVAL
                                                                        DRAFT 04/24/09
Neighborhood Centers Inc.
Consolidated Statements of Financial Position as of December 31, 2008 and 2007


                                                                                    2008           2007

                                    ASSETS

Cash and cash equivalents (Note 2)                                               $ 6,969,833    $ 7,854,948
Accounts and contracts receivable                                                 12,752,313      8,407,347
Prepaid expenses                                                                     950,950        494,498
Pledges receivable, net: (Note 3)
    United Way allocation                                                           4,064,761      3,554,926
    Other pledges receivable                                                        3,280,738      5,463,722
Contributed use of facilities                                                         716,228        815,018
Note receivable (Note 4)                                                            9,417,600
Investments: (Note 5)
    Reserve and capital expansion                                                 12,832,078      6,060,430
    Endowment                                                                      8,840,602     12,141,974
Property, plant, and equipment, net (Note 6)                                      17,145,473     16,534,691

TOTAL ASSETS                                                                     $ 76,970,576   $ 61,327,554



                        LIABILITIES AND NET ASSETS

Liabilities:
    Accounts payable                                                             $ 8,774,220    $ 6,574,758
    Accrued payroll expenses                                                       1,639,647        694,237
    Contract advances                                                              2,972,725      1,969,247
    Construction payable                                                             546,079
    Notes payable (Notes 7 and 8)                                                 13,118,400
    Capital lease obligation (Note 9)                                                411,632        562,193
         Total liabilities                                                        27,462,703       9,800,435

Net assets:
    Unrestricted                                                                   9,775,233     11,061,590
    Temporarily restricted (Note 10)                                              30,951,998     31,684,887
    Permanently restricted (Note 12)                                               8,780,642      8,780,642
         Total net assets                                                         49,507,873     51,527,119

TOTAL LIABILITIES AND NET ASSETS                                                 $ 76,970,576   $ 61,327,554



See accompanying notes to consolidated financial statements.




                                                      –2–
                                                                            DRAFT 04/24/09
Neighborhood Centers Inc.
Consolidated Statement of Activities for the year ended December 31, 2008


                                                                  TEMPORARILY    PERMANENTLY
                                                UNRESTRICTED       RESTRICTED     RESTRICTED      TOTAL


OPERATING REVENUE:
Government contracts (Note 11)                  $152,087,655                                   $152,087,655
Contributions:
    United Way                                                   $ 3,717,729                      3,717,729
    Other contributions                              389,761       6,573,073                      6,962,834
Program fees                                         746,836                                        746,836
Rental income                                        916,011                                        916,011
Operating investment return (Note 5)                 202,926                                        202,926
Other                                                 19,999                                         19,999
    Total operating revenue                     154,363,188        10,290,802                  164,653,990
Net assets released from restrictions:
    Program expenditures                           8,428,409       (8,428,409)
    Total                                       162,791,597         1,862,393                  164,653,990

OPERATING EXPENSES:
Program expenses:
    Children’s services                         138,470,374                                    138,470,374
    Family services                              13,771,892                                     13,771,892
    Senior services                               1,913,795                                      1,913,795
    Youth services                                  824,711                                        824,711
    Health services                                 728,720                                        728,720
         Total program expenses                 155,709,492                                    155,709,492
Management and general                             7,213,500                                      7,213,500
Fundraising                                          711,235                                        711,235
    Total operating expenses                    163,634,227                                    163,634,227

CHANGES IN NET ASSETS
   FROM OPERATIONS                                  (842,630)       1,862,393                     1,019,763

OTHER CHANGES IN NET ASSETS:
Endowment investment return (Notes 5 & 12)          (443,727)      (2,623,253)                   (3,066,980)
Contributions restricted for capital purposes                          27,971                        27,971
CHANGES IN NET ASSETS                             (1,286,357)        (732,889)                   (2,019,246)

Net assets, beginning of year                    11,061,590        31,684,887    $ 8,780,642    51,527,119

Net assets, end of year                         $ 9,775,233      $ 30,951,998    $ 8,780,642   $ 49,507,873



See accompanying notes to consolidated financial statements.




                                                      –3–
                                                                            DRAFT 04/24/09
Neighborhood Centers Inc.
Consolidated Statement of Activities for the year ended December 31, 2007


                                                                  TEMPORARILY    PERMANENTLY
                                                UNRESTRICTED       RESTRICTED     RESTRICTED      TOTAL


OPERATING REVENUE:
Government contracts (Note 11)                  $156,838,633                                   $156,838,633
Contributions:
    United Way                                                   $ 3,682,710                      3,682,710
    Other contributions                              226,544       2,237,418                      2,463,962
Program fees                                         788,077                                        788,077
Rental income                                        952,395                                        952,395
Operating investment return (Note 12)                349,495          268,298                       617,793
Other                                                135,079                                        135,079
    Total operating revenue                     159,290,223         6,188,426                  165,478,649
Net assets released from restrictions:
    Endowment earnings approved for expenditure 232,432              (232,432)
    Program expenditures                       5,610,739           (5,610,739)
    Total                                       165,133,394           345,255                  165,478,649

OPERATING EXPENSES:
Program expenses:
    Children’s services                         139,754,162                                    139,754,162
    Family services                              15,462,040                                     15,462,040
    Senior services                               1,976,525                                      1,976,525
    Youth services                                  534,563                                        534,563
    Health services                                 574,606                                        574,606
         Total program expenses                 158,301,896                                    158,301,896
Management and general                             6,232,118                                      6,232,118
Fundraising                                          610,698                                        610,698
    Total operating expenses                    165,144,712                                    165,144,712

CHANGES IN NET ASSETS
   FROM OPERATIONS                                   (11,318)         345,255                      333,937

OTHER CHANGES IN NET ASSETS:
Endowment investment return (Note 12)                 34,329          591,517                       625,846
Contributions restricted for capital purposes                       7,457,348                     7,457,348
Net assets released for property expenditures        405,906         (405,906)
CHANGES IN NET ASSETS                                428,917        7,988,214                     8,417,131

Reclassification of net assets (Note 12)          (2,031,736)       2,031,736

Net assets, beginning of year                    12,664,409        21,664,937    $ 8,780,642    43,109,988

Net assets, end of year                         $ 11,061,590     $ 31,684,887    $ 8,780,642   $ 51,527,119



See accompanying notes to consolidated financial statements.




                                                      –4–
                                                                                                                                      DRAFT 04/24/09
Neighborhood Centers Inc.
Consolidated Statement of Functional Expenses for the year ended December 31, 2008


                                                                                                                                MANAGEMENT
                                         CHILDREN’S         FAMILY            SENIOR               YOUTH            HEALTH          AND                             TOTAL
               EXPENSES                   SERVICES         SERVICES          SERVICES             SERVICES         SERVICES       GENERAL         FUNDRAISING      EXPENSES


Salaries and wages                    $ 15,326,367      $ 4,061,242      $     579,997        $     365,163    $     444,667    $ 3,995,395   $       324,081   $ 25,096,912
Health and retirement benefits           2,109,752          441,200             62,817               36,500           44,941        486,818            31,689      3,213,717
Payroll taxes                            1,480,394          397,972             63,803               36,957           40,644        356,409            26,426      2,402,605
Total salaries and related expenses      18,916,513        4,900,414           706,617              438,620          530,252      4,838,622           382,196     30,713,234
Assistance to individuals               113,032,141        5,416,553           258,094                  521              200          1,251               100    118,708,860
Occupancy                                 2,577,922          811,870            63,720              174,531           46,498        357,026            48,878      4,080,445
Fees and contract services                1,675,812        1,037,759           119,966              154,043           63,588        782,931           171,261      4,005,360
Supplies                                  1,290,239          383,932           602,115               22,212           12,403        126,698             5,629      2,443,228
Travel                                      104,796           60,773           111,950               11,669           12,680        172,977             5,856        480,701
Telephone                                   150,582          125,739            12,868               10,732            3,945         81,001             2,504        387,371
Purchase of equipment                        86,805          217,645            20,751                                   135         51,503             2,437        379,276
Professional development                    222,349           24,362             7,186                   475          31,380         40,296             4,711        330,759
Printing and publications                    68,522          116,726             1,908                 1,575           5,461         52,222            33,610        280,024
Postage                                     113,140           51,728               284                    58             782         27,795             5,209        198,996
Conferences and meetings                     23,927           32,190             1,266                   207           5,980         44,803            27,915        136,288
Other                                        55,499           65,690             4,030                   646          10,616        131,154             9,939        277,574
Total expenses before depreciation      138,318,247       13,245,381         1,910,755              815,289          723,920      6,708,279           700,245    162,422,116
Depreciation                                152,127            526,511            3,040                9,422            4,800       505,221            10,990       1,212,111
Total expenses                        $ 138,470,374     $ 13,771,892     $ 1,913,795          $     824,711    $     728,720    $ 7,213,500   $       711,235   $ 163,634,227



See accompanying notes to consolidated financial statements.




                                                                                        –5–
                                                                                                                                      DRAFT 04/24/09
Neighborhood Centers Inc.
Consolidated Statement of Functional Expenses for the year ended December 31, 2007


                                                                                                                                MANAGEMENT
                                         CHILDREN’S         FAMILY            SENIOR               YOUTH            HEALTH          AND                             TOTAL
               EXPENSES                   SERVICES         SERVICES          SERVICES             SERVICES         SERVICES       GENERAL         FUNDRAISING      EXPENSES


Salaries and wages                    $ 14,389,518      $ 3,040,558      $     599,511        $     238,127    $     352,184    $ 3,289,800   $       238,371   $ 22,148,069
Health and retirement benefits           2,070,393          382,664             69,777               24,976           35,182        419,367            29,782      3,032,141
Payroll taxes                            1,492,054          288,370             65,750               25,102           37,796        289,056            19,176      2,217,304
Total salaries and related expenses      17,951,965        3,711,592           735,038              288,205          425,162      3,998,223           287,329     27,397,514
Assistance to individuals               116,094,949        8,998,201           271,347                2,962              360            532                      125,368,351
Occupancy                                 2,094,395          632,588            88,832              140,455           41,000        332,633            32,591      3,362,494
Fees and contract services                1,048,856        1,155,070           106,230               61,500           62,367        701,195           213,943      3,349,161
Supplies                                  1,428,607          232,902           634,758               21,847            7,988        119,620             2,659      2,448,381
Travel                                       96,948           52,456           106,280                6,665            6,294        113,229             5,499        387,371
Telephone                                    87,953           53,646             9,677                2,805            2,930         61,744             7,296        226,051
Purchase of equipment                       433,539          113,066             6,140                                 5,816         68,665             5,928        633,154
Professional development                    168,309           16,678             6,311                   264           8,591         37,550             3,140        240,843
Printing and publications                    58,784           51,635             4,738                    66             708         60,610            13,064        189,605
Postage                                     102,999           62,544               307                   158             277         17,460             7,626        191,371
Conferences and meetings                     10,063           20,802               115                   200           3,310         28,796            15,982         79,268
Other                                        22,193           25,963             4,000                                 5,003        168,200             4,608        229,967
Total expenses before depreciation      139,599,560       15,127,143         1,973,773              525,127          569,806      5,708,457           599,665    164,103,531
Depreciation                                154,602            334,897            2,752                9,436            4,800       523,661            11,033       1,041,181
Total expenses                        $ 139,754,162     $ 15,462,040     $ 1,976,525          $     534,563    $     574,606    $ 6,232,118   $       610,698   $ 165,144,712



See accompanying notes to consolidated financial statements.




                                                                                        –6–
                                                                       DRAFT 04/24/09
Neighborhood Centers Inc.
Consolidated Statements of Cash Flows for the years ended December 31, 2008 and 2007


                                                                                       2008           2007

CASH FLOWS FROM OPERATING ACTIVITIES:
Changes in net assets                                                           $ (2,019,246)      $ 8,417,131
Adjustments to reconcile changes in net assets to net cash
provided by operating activities:
    Contributions restricted for capital expansion                                   (27,971)        (7,457,348)
    Realized and unrealized (gain) loss on investments                             3,545,205           (558,910)
    Depreciation                                                                   1,212,111          1,041,181
    Change in operating assets and liabilities:
        Accounts and contracts receivable                                         (4,344,966)         2,680,630
        Prepaid expenses                                                            (456,452)            11,898
        Pledges receivable (excluding capital expansion)                          (1,585,369)          (241,690)
        Contributed use of facilities                                                 98,790             98,790
        Accounts payable                                                           2,199,462         (2,242,791)
        Accrued payroll expenses                                                     945,410            145,319
        Contract advances                                                          1,003,478          1,969,247
    Net cash provided by operating activities                                           570,452      3,863,457

CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales and maturities of investments                                  1,180,000          4,602,407
Purchase of investments                                                             (937,806)        (3,113,313)
Net change in cash and money market funds held as investments                     (7,257,675)        (2,310,454)
Advances on note receivable                                                       (9,417,600)
Purchase of property, plant, and equipment                                        (1,276,814)        (1,537,987)
    Net cash used by investing activities                                        (17,709,895)        (2,359,347)

CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from notes payable                                                       13,118,400
Proceeds of contributions restricted for capital purposes                          3,286,489         4,783,881
Payments on capital lease obligation                                                (150,561)         (147,328)
    Net cash provided by financing activities                                     16,254,328         4,636,553

NET CHANGE IN CASH AND CASH EQUIVALENTS                                                (885,115)     6,140,663

Cash and cash equivalents, beginning of year                                       7,854,948         1,714,285

Cash and cash equivalents, end of year                                          $ 6,969,833        $ 7,854,948



Supplemental disclosure of cash flow information:
Interest expense                                                                       $178,141        $54,777
Contribution of marketable securities                                                   $27,008        $10,462



See accompanying notes to consolidated financial statements.




                                                            –7–
                                                                               DRAFT 04/24/09
Neighborhood Centers Inc.
Notes to Consolidated Financial Statements for the years ended December 31, 2008 and 2007


NOTE 1 – ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

Organization – Neighborhood Centers Inc. (Center) is a private nonprofit human services organization founded in
1907 and whose mission is bringing resources, education, and connection to underserved neighborhoods. The
Center operates in over 50 different locations throughout the Houston metropolitan area, and in Harris and twelve
surrounding counties, providing services to the community through child care management, Head Start, Early Head
Start and charter schools as well as programs for disaster recovery, early childhood development, the elderly,
families, and youth.

In January 2006, Choices in Education, Inc. (CIE) was formed as a Texas nonprofit corporation for the sole benefit
of NCI. Its purpose, among other things, was to conduct all educational activities previously carried on by NCI. In
October 2008, the bylaws and articles of incorporation were amended to change the name of CIE to NCI Community
Fund, Inc. (NCI Community Fund). The purpose of this change was to launch a new project to construct a building
in the Gulfton area of Houston which will include offices, classrooms, and space for a proposed community center,
charter school, and business tenants, including a credit union.

In April 2007, Neighborhood Centers Properties LLC (NCI Properties) was formed as a Texas limited liability
company whose sole member is the Center and whose purpose is to hold title to the portion of the 4500 Bissonnet
property that is leased to outside tenants. In December 2007, Neighborhood Centers Condominium Association
(Association) was formed as a Texas nonprofit corporation responsible for the operation of the 4500 Bissonnet
property and sole members are the Center and NCI Properties.

Basis of consolidation – These consolidated financial statements include the consolidated operations for the Center,
NCI Properties, the Association, and NCI Community Fund (collectively NCI). All balances and transactions
between these consolidated entities have been eliminated.

Tax status – The Center and NCI Community Fund are exempt from federal income taxes under §501(c)(3) of the
Internal Revenue Code and are classified as public charities under §509(a)(1). NCI Properties and the Association
are disregarded entities for purposes of federal income tax purposes and included with the Center’s federal tax
filings.

Net asset classification – Contributions, investment return and related net assets are classified based on the existence
or absence of donor-imposed restrictions, as follows:

   Unrestricted net assets include those net assets whose use is not restricted by donor-imposed stipulations, even
    though their use may be limited in other respects, such as by contract or board designation.
   Temporarily restricted net assets include contributions and investment return whose use is restricted by the
    donor for specific purposes or time periods. When a purpose restriction is accomplished or a time restriction
    ends, temporarily restricted net assets are released to unrestricted net assets.
   Permanently restricted net assets include contributions that donors have restricted to investment in perpetuity.
    The investment return from these assets may be used to support future emerging needs of NCI.

Estimates – Management must make estimates and assumptions to prepare financial statements in accordance with
accounting principles generally accepted in the United States of America. Those estimates and assumptions affect
the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, the reported revenues
and expenses, and the allocation of expenses among various functions. Actual results could vary from the estimates
that were used.

Operating revenues and expenses – NCI reports activities related to its endowment and property, plant, and
equipment separate from other revenues and expenses. Revenue and expenses except those in the endowment and
property categories are reported as operating.




                                                          –8–
                                                                               DRAFT 04/24/09
Cash equivalents include highly liquid financial instruments with original maturities of three months or less.

Pledges receivable that are expected to be collected within one year are recorded at net realizable value. Pledges
receivable that are expected to be collected after one year are discounted to estimate the present value of future cash
flows. Discounts are computed using risk-free interest rates applicable to the years in which the pledges were
received.

Investments are recorded at fair value. Investment return includes interest, dividends, and realized and unrealized
gains and losses, net of investment manager and custodial fees. Investment return is reported in the statement of
activities as an increase in unrestricted net assets unless the use of the income is limited by donor-imposed
restrictions or the endowments spending policy as discussed further in Note 12.

Fair value measurements – Effective January 1, 2008, NCI adopted SFAS 157, which provides a framework for
measuring fair value of certain assets and liabilities and expands disclosures about fair value measurements. As
defined in SFAS 157, fair value is the price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date. SFAS 157 establishes a fair value
hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted
quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to
unobservable inputs (Level 3 measurement). The three levels of the fair value hierarchy defined by SFAS 157 and a
description of the valuation methodologies used for instruments measured at fair value are as follows:

   Level 1 – Quoted prices (unadjusted) in active markets for identical assets or liabilities as of the reporting date.
    Level 1 primarily consists of financial instruments such as money market securities, mutual funds, equity
    securities and certificates of deposit.
   Level 2 – Pricing inputs other than quoted prices included in Level 1 that are observable for the asset or liability
    either directly or indirectly. NCI has no financial assets or financial liabilities with significant Level 2 inputs.
   Level 3 – Pricing inputs include those that are significant to the fair value of the financial asset or financial
    liability and are generally less observable from objective sources. NCI has no financial assets or financial
    liabilities with significant Level 3 inputs.

Property, plant, and equipment are recorded at cost if purchased and at fair value at the date of gift if donated. NCI
capitalizes property additions and improvements with a cost of more than $1,000. Depreciation of buildings and
equipment is provided on a straight-line basis over the estimated useful lives of the assets.

Fees for service – Revenue from government contracts, program fees, and rental income are recognized when the
related services are provided. Advances received from third parties for services not yet performed are included in
the statement of financial position as contract advances.

Contributions are recorded as revenue at fair value when an unconditional commitment is received from the donor.
Contributions received with donor stipulations that limit their use are recorded as restricted support. Conditional
contributions are recognized in the same manner when the conditions are substantially met. NCI recognizes gifts of
property and equipment as unrestricted support unless explicit donor stipulations specify how the donated assets
must be used. Gifts of long-lived assets with explicit restrictions that specify how the assets are to be used and gifts
of cash or other assets that must be used to acquire long-lived assets are reported as restricted support. Absent
explicit donor stipulations about how long those long-lived assets must be maintained, NCI reports expirations of
donor restrictions when the assets are placed in service.

Contributed materials, use of facilities and services are recognized as contributions at fair value when an
unconditional commitment is received from the donor. The related expense is recognized as the item is used.
Contributions of services are recognized if services received (a) create or enhance nonfinancial assets or (b) require
specialized skills, are provided by individuals possessing those skills, and would typically need to be purchased if
not provided by donation. A substantial number of volunteers have contributed significant amounts of time in
connection with programs, administration, and fundraising for which no amount has been recorded in the financial
statements because the donated services did not meet the criteria for recognition under generally accepted accounting
principles.




                                                          –9–
                                                                           DRAFT 04/24/09
Reclassifications – Certain reclassifications have been made to the prior year financial statements to conform with
the current presentation.


NOTE 2 – CASH AND CASH EQUIVALENTS

Cash and cash equivalents consist of the following:
                                                                                         2008              2007
Demand deposits                                                                      $   6,498,701    $   3,028,764
Money market funds                                                                         471,132        4,826,184
Total cash and cash equivalents                                                      $   6,969,833    $   7,854,948

NCI maintains cash for daily operations at several banking institutions. Bank deposits exceeded the federally
insured limit per depositor per institution. NCI has entered into a collateral agreement with one of its depository
institutions to collateralize deposits in excess of the federally insured limit with U. S. government debt securities
with a par value of approximately $5,000,000 at December 31, 2008.

NCI is required by contract to maintain separate bank accounts for Ripley House Charter School, which included
cash and cash equivalents of $607,203 at December 31, 2008 and $1,606,050 at December 31, 2007.


NOTE 3 – PLEDGES RECEIVABLE

Pledges receivable consist of the following:
                                                                                         2008              2007
Pledges receivable                                                                   $   7,389,372    $   9,099,359
Discount to net present value at 5%                                                        (43,873)         (80,711)
Pledges receivable, net                                                              $   7,345,499    $   9,018,648

At December 31, 2008, pledges receivable are scheduled to be collected as follows:

2009                                                                                                  $   6,771,914
2010 through 2014                                                                                           617,458
Total pledges receivable                                                                              $   7,389,372

In September 2008, a foundation made a conditional pledge of $800,000 toward the construction of the new Gulfton
Community Center. This pledge is conditional upon NCI raising the balance of the funds required to complete the
new community center from other sources. This pledge will be recognized when the conditions are substantially met.


NOTE 4 – NOTE RECEIVABLE

NCI entered into an agreement on November 20, 2008, to lend $9,417,600 to COCRF Investor V, LLC (“COCRF”).
The note is secured by COCRF’s bank accounts and membership interests in Greystone Tax Credit Fund 5, LLC and
Community Development Funding VII, LLC. The interest rate on the note consists of a fixed rate of 3.38%, of
which 1.00% is paid quarterly, and 2.38% that accrues and is payable at the note’s maturity date. Interest earned in
2008 was $36,253, of which $25,527 was accrued at December 31, 2008.

Subject to a put (“Put Right”) provision in the agreement, the note matures on November 20, 2018, at which time all
outstanding principal and interest will be paid. At any time after the seventh anniversary and before the eighth
anniversary of the note, NCI can exercise its Put Right that requires COCRF to purchase the note. The price of the
Put Right is the principal and accrued interest of the note at the time NCI exercises its Put Right.




                                                       – 10 –
                                                                               DRAFT 04/24/09
NOTE 5 – INVESTMENTS

Investments consist of the following:
                                                                                              2008                2007
                                                                                          FAIR VALUE         FAIR VALUE
                                                                                           LEVEL 1             LEVEL 1
                                                                                         MEASUREMENT        MEASUREMENT

Cash and money market funds                                                              $ 11,922,265       $ 4,664,590
Equity index mutual funds                                                                   4,972,211         8,232,959
U.S. government agency mutual funds                                                         4,101,184         1,000,940
Bond index mutual funds                                                                                       3,908,075
Certificates of deposit                                                                        659,920          200,000
Equity securities                                                                               17,100          195,840
Total investments                                                                        $ 21,672,680       $ 18,202,404

Pursuant to the issuance of the New Markets Tax Credit Financing Commitment (see Note 7), NCI is required to
maintain certain funds for the construction of the Gulfton community center. At December 31, 2008, money market
funds include $10,996,457 which are held with Capital One for this purpose.

Investments are exposed to various risks such as interest rate, market, and credit risks. Because of these risks, it is at
least reasonably possible that changes in the values of investment securities will occur in the near term and that such
changes could materially affect the amounts reported in the statement of financial position and statement of activities.

Net investment return includes earnings on cash and cash equivalents and consists of the following:

                                                                                              2008               2007
Interest and dividends                                                                   $      679,934     $     684,729
Realized and unrealized gain (loss) on investments                                           (3,543,988)          558,910
Investment return                                                                        $ (2,864,054)      $ 1,243,639


NOTE 6 – PROPERTY, PLANT, AND EQUIPMENT

The major components of property, plant, and equipment and their estimated useful lives are as follows:
                                                                                              2008               2007
Land                                                                                     $ 3,231,771        $ 3,231,771
Ripley House facility                                        30 years                     10,758,980         10,758,980
4500 Bissonnet Park and building improvements                10 to 50 years                5,884,790          5,718,821
Leasehold improvements                                       5 to 25 years                 1,162,374          1,121,421
Furniture, fixtures, and office equipment                    5 to 20 years                 2,129,837          1,892,058
Recreational, educational and other equipment                3 to 10 years                   337,269            213,205
Automotive equipment                                         3 to 5 years                    379,892            355,659
Construction in progress                                                                   2,176,426          1,040,527
Total property, plant, and equipment, at cost                                                26,061,339         24,332,442
Accumulated depreciation                                                                     (8,915,866)        (7,797,751)
Property, plant, and equipment, net                                                      $ 17,145,473       $ 16,534,691




                                                         – 11 –
                                                                            DRAFT 04/24/09
In 1998, NCI committed approximately $5 million and Ripley Foundation approximately $4 million toward the
construction of the new Ripley House. Upon completion of the facility, Ripley Foundation and NCI entered into a
30-year lease beginning December 15, 2000 that provides for the exclusive use of the 60,000 square foot facility by
NCI. The estimated fair value of this lease agreement was approximately $10,750,000 and is recorded as an asset in
property, plant, and equipment.

The cost of property used in operations but not recorded on the statement of financial position, because title is held
by federal grantors, was approximately $7,420,000 and $7,200,000 at December 31, 2008 and 2007, respectively. In
addition, construction costs related to the new Alief Head Start building of approximately $1,640,000 are included in
accounts receivable as costs and will be reimbursed by Head Start.


NOTE 7 – NEW MARKET TAX CREDITS NOTE PAYABLE

NCI Community Fund executed a loan agreement on November 20, 2008, that provides for borrowings of
$8,000,000 and $2,993,400, from Greystone Tax Credit Fund 5 LLC and Community Development Funding VII,
LLC, respectively. The loans are to finance the construction of a community center and educational, health, and
business facilities (Property) in the Gulfton area of Houston and are intended to be treated as a “qualified low-
income community investment” for purposes of generating New Market Tax Credits under Section 45D of the
Internal Revenue Code of 1986, as amended. The loans are secured by a construction deed of trust, security
agreement and fixture filing on the property and the underlying real estate and a guaranty by the Center of NCI
Community Fund’s obligations under the loan agreement.

Under the terms of the loan agreement, each loan has an interest rate of 1%, payable quarterly, and the principal
balance is due in its entirety on November 20, 2018. NCI Community Fund is not permitted to prepay any portion of
the loans until the seventh anniversary of the loans, after which time, it may prepay all or any portion of the loans
without penalty. At December 31, 2008, the balances outstanding on the loans remain at $8,000,000 and
$2,993,400, respectively.


NOTE 8 – HEAD START CONSTRUCTION NOTE PAYABLE

In January 2008, NCI entered into a loan agreement to finance the construction of the new Alief Head Start building.
The note has a fixed interest rate of 4.64%. Interest payments are due monthly until April 24, 2009 after which
monthly principal and interest payments totaling $19,346 are due until maturity on March 24, 2021. The note is
secured by the land, building and fixtures of the Alief Head Start facility.

Principal payments are due as follows:

2009                                                                                                   $      89,652
2010                                                                                                         139,776
2011                                                                                                         146,401
2012                                                                                                         153,341
2013                                                                                                         160,609
Thereafter                                                                                                 1,435,221
Total                                                                                                  $   2,125,000


NOTE 9 – CAPITAL LEASE

During 2006, NCI entered into a capital lease for the new telephone system. The leased asset is included in
furniture, fixtures, and equipment at a cost of $840,000. Accumulated depreciation and depreciation expense
includes $126,000 related to the leased telephone system. The lease includes a $1 purchase option at the end of the




                                                       – 12 –
                                                                             DRAFT 04/24/09
lease period. The interest rate is 14.57%. Future minimum lease payments are as follows:

2009                                                                                                     $    222,695
2010                                                                                                          222,695
2011                                                                                                           37,116
Total minimum lease payments                                                                                  482,506
Less amount representing interest                                                                             (70,874)
Present value of minimum lease payments                                                                  $    411,632


NOTE 10 – TEMPORARILY RESTRICTED NET ASSETS

Temporarily restricted net assets are available for the following periods or purposes:

                                                                                             2008            2007

New Century Campaign – community centers                                                 $ 13,948,712    $ 14,270,741
For future years:
    Use of donated facilities                                                                8,618,823       9,068,215
    United Way allocation                                                                    3,634,702       3,554,926
    Other pledges                                                                              395,211         256,661
Unappropriated endowment earnings                                                                            2,623,253
Hurricane assistance                                                                         1,998,427         809,274
Ripley House maintenance                                                                       909,944         742,334
Thrive grant                                                                                   587,760
VITA program                                                                                   455,614
Community centers                                                                              126,505
School uniforms                                                                                 43,115         43,082
Financial literacy                                                                             110,000
Day labor program                                                                                8,082         52,059
Nursing program                                                                                               103,747
Other                                                                                         115,103         160,595
Total temporarily restricted net assets                                                  $ 30,951,998    $ 31,684,887


NOTE 11 – GOVERNMENT CONTRACTS

NCI is a party to contracts with federal, state, and local governmental agencies. Should these contracts not be
renewed, a replacement for this source of support may not be forthcoming and related expenses would not be
incurred. Sources of significant government grants recognized include the following:

                                                                                             2008            2007

U.S. Department of Health & Human Services                                               $ 129,332,693   $ 135,850,012
U.S. Department of Labor                                                                     3,418,789       6,501,440
Department of Housing and Urban Development                                                  3,072,377
Texas Education Agency – State funds                                                         6,195,972       4,717,245
Local Initiative Matching Grants – HGAC                                                      4,394,350       5,153,653
Texas Department of Regulatory Services                                                      2,693,621       1,843,598
U.S. Department of Agriculture                                                               1,140,048       1,135,862
U.S. Department of Education                                                                   893,944         533,163
Other government agencies                                                                      945,861       1,103,660
Total government contracts                                                               $ 152,087,655   $ 156,838,633




                                                        – 13 –
                                                                               DRAFT 04/24/09
NOTE 12 – ENDOWMENT

NCI’s Endowment Fund (the Fund) was established for the purpose of assisting NCI in meeting its operating needs.
The Fund includes both donor-restricted endowment funds and funds designated by the Board of Directors to
function as endowment. The Board of Directors of NCI has interpreted the Texas Uniform Prudent Management of
Institutional Funds Act (TUPMIFA) as requiring the preservation of the fair value of the original gift as of the gift
date of the donor-restricted endowment funds absent explicit donor stipulations to the contrary. As a result of the
interpretation, NCI classifies as permanently restricted net assets (a) the original value of gifts donated to the
permanent endowment, (b) the original value of subsequent gifts to the permanent endowment, and (c) accumulation
to the permanent endowment made in accordance with the direction of the applicable donor gift instrument at the
time the accumulation is added to the fund. The remaining portion of the donor-restricted endowment fund that is
not classified in permanently restricted net assets is classified as temporarily restricted net assets until those amounts
are appropriated for expenditure by NCI in a manner consistent with the standard of prudence prescribed by
TUPMIFA. In accordance with TUPMIFA, the agency considers the following factors in making determination to
appropriate accumulated donor-restricted endowment funds:

(1)   The duration and preservation of the Fund
(2)   The purposes of the organization and the donor-restricted endowment fund
(3)   General economic conditions
(4)   The possible effect of inflation and deflation
(5)   The expected total return from income and the appreciation of investments
(6)   Other resources of the organization
(7)   The investment policies of the agency


Endowment net asset composition as of December 31, 2008:
                                                                       TEMPORARILY       PERMANENTLY
                                                    UNRESTRICTED        RESTRICTED        RESTRICTED            TOTAL


Donor-restricted general endowment funds           $    (259,706)                        $ 8,780,642       $ 8,520,936
Board designated general endowment funds                 319,666                                                 319,666
Endowment net assets                               $      59,960      $            0     $ 8,780,642       $ 8,840,602


Changes in endowment net assets for the year ended December 31, 2008 are as follows:
                                                                       TEMPORARILY       PERMANENTLY
                                                    UNRESTRICTED        RESTRICTED        RESTRICTED            TOTAL


Endowment net assets, January 1, 2008              $     503,687      $ 2,623,253        $ 8,780,642       $ 11,907,582
Investment return:
    Investment income                                     16,139             252,852                             268,991
    Net realized and unrealized loss                    (459,866)         (2,876,105)                         (3,335,971)
Total investment return                                 (443,727)         (2,623,253)                         (3,066,980)
Endowment net assets, December 31, 2008            $      59,960      $            0     $ 8,780,642       $ 8,840,602




                                                         – 14 –
                                                                              DRAFT 04/24/09
Endowment net asset composition as of December 31, 2007:
                                                                      TEMPORARILY        PERMANENTLY
                                                    UNRESTRICTED       RESTRICTED         RESTRICTED           TOTAL


Donor-restricted general endowment funds                              $ 2,623,253       $ 8,780,642        $ 11,403,895
Board designated general endowment funds            $     503,687                                               503,687
Endowment net assets                                $     503,687     $ 2,623,253       $ 8,780,642        $ 11,907,582


Changes in endowment net assets for the year ended December 31, 2007 are as follows:
                                                                      TEMPORARILY        PERMANENTLY
                                                    UNRESTRICTED       RESTRICTED         RESTRICTED           TOTAL


Endowment net assets, January 1, 2007               $ 2,501,094                         $ 8,780,642        $ 11,281,736
Net asset reclassification based on change in law       (2,031,736)   $ 2,031,736
Endowment net assets after reclassification               469,358        2,031,736         8,780,642         11,281,736
Investment return:
    Investment income                                      12,378          297,119                              309,497
    Net realized and unrealized gain                       21,951          526,830                              548,781
Total investment return                                    34,329          823,949                              858,278
Appropriation of endowment assets for
   expenditure                                                            (232,432)                            (232,432)
Endowment net assets, December 31, 2007             $     503,687     $ 2,623,253       $ 8,780,642        $ 11,907,582


Return Objectives and Risk Parameters

NCI has adopted investment and spending policies for endowment assets that have the primary objective of
achieving a long-term rate of return that will permit the Fund to assist NCI in meeting its operating needs while
maintaining its ability to provide for future needs without subjecting the endowment funds to imprudent risks.
Endowment assets include those assets of donor-restricted funds that the organization must hold in perpetuity or for
donor-specified period(s) as well as board-designated funds. Under this policy, as approved by the Board of
Directors, the endowment assets are invested in a manner that is intended to produce a total-portfolio, long-term real
return (above the CPI) of at least 5% (annualized, net of fees, over a full market cycle).

Strategies Employed for Achieving Objectives

To satisfy its long-term rate-of-return objectives, NCI relies on a total return strategy in which investment returns are
achieved through both capital appreciation (realized and unrealized) and current yield (interest and dividends). The
endowment fund targets a diversified asset allocation that places a greater emphasis on equity-based investments to
achieve its long-term return objectives with prudent risk constraints.

As different asset classes produce different returns during the course of the year, the portfolio’s asset allocation
changes accordingly. Therefore, rebalancing asset allocations to policy targets is essential for maintaining the risk
and return profile that has been adopted. NCI reviews the portfolio’s actual asset allocation, relative to established
policy target and ranges. If deemed necessary, the Finance and Administration Committee will make
recommendations to the Board of Directors for rebalancing the portfolio between the various assets classes based on
market values.




                                                           – 15 –
                                                                              DRAFT 04/24/09
Spending Policy and How the Investment Objectives Relate to Spending Policy

NCI has a total return spending rule that allows spending budgets to be funded from interest and dividend income,
realized gains, unused portions of prior year spending allowances that have been reinvested, and unrealized
appreciation (to use “unrealized appreciation”, units would have to be sold).

Annual expenditures shall not exceed 5% of the endowment fund’s total balance as of September 30 preceding NCI's
fiscal year in which the disbursement will be expended. A program disbursement shall not decrease the remaining
endowment fund balance below total contributions plus cumulative inflation adjustments (the inflation adjustment
shall be calculated using the Houston CPI index as of September 30). In the event expenditure as calculated above
would reduce, the endowment fund’s market value below total fund contributions (plus cumulative adjustment), a
deminimus expenditure will be allowed, calculated as the lesser of:

a) The amount calculated above, or
b) An amount not to exceed the endowment fund’s “natural income” for the 12 months ending September 30 of the
   year preceding NCI’s fiscal year in which the disbursement will be expended. The endowment fund’s natural
   income includes interest, dividends, and original issue discount income, net of investment expenses. Natural
   income does not include realized or unrealized capital gains or losses.

Over the long term, Neighborhood Centers Inc. expects the current spending policy to allow its endowment to grow
at an average of 5% annually. This is consistent with the organization’s objective to maintain the purchasing power
of the endowment asset held in perpetuity or for a specified term as well as to provide additional real growth through
new gifts and investment return.


NOTE 13 – EMPLOYEE BENEFIT PLANS

Pension plan – NCI participates in a multi-employer cash balance defined benefit pension plan (the Plan), as defined
by SFAS No. 87, Employers’ Accounting for Pensions. The Plan is sponsored by United Way of the Texas Gulf
Coast and there are 24 participating employers. In accordance with SFAS No. 87, an employer participating in a
multi-employer plan recognizes as net pension cost the required contribution for the period. NCI contributed to the
Plan approximately $600,000 in 2008 and 2007.

The Plan has been amended effective July 1, 2004, and all participating employers, including NCI, have elected 0%
as the pay-based credit rate on behalf of their participants beginning July 1, 2004 and the Plan was closed to new
entrants. All participants continue to receive interest credits on their existing accounts. NCI has not terminated its
participation in the Plan, and will continue with other participating employers to fund the Plan. The fiduciary
committee and participating employers will monitor the Plan. At some point in the future, NCI may elect to resume
benefit accruals for some or all of their employees. Should NCI decide to terminate participation in the Plan, it
would be required to record the full value of its allocable share of any unfunded liability at the point such termination
is probable and estimable.

403(b) savings plan – NCI offers a §403(b) employee savings plan to eligible employees over age 21. Participants
may elect to contribute up to 75% of their salary to the plan subject to IRS limits. NCI may make a discretionary
contribution each year of up to 3% of an employee’s annual salary. Additionally, NCI makes a matching
contribution equal to 100% of the first 3% of employee contributions plus 50% of the next 2% of employee
contributions. An independent corporate trustee maintains all contributions in trust and employees may select the
general type of investment for their individual account. NCI contributed approximately $343,000 and $329,000 to
the plan in 2008 and 2007, respectively.

Teacher retirement plan – Full-time employees of the Ripley House Charter School participate in the Teacher
Retirement System of Texas, a public employee retirement system. It is a cost-sharing, multi-employer defined
benefit pension plan. All risks and costs are the liabilities of the State of Texas. Plan members contribute 6.5% of
their annual covered salary. NCI made contributions of $113,000 and $97,000 to the plan in 2008 and 2007,
respectively.




                                                         – 16 –
                                                                           DRAFT 04/24/09
NOTE 14 – LEASE COMMITMENTS

Leases as lessor – NCI leases and subleases office space to tenants under noncancelable operating leases. The future
minimum rental income at December 31, 2008, is as follows:

2009                                                                                                  $    507,723
2010                                                                                                       306,466
2011                                                                                                         7,331
Total                                                                                                 $    821,520

Rental income on subleases totaled approximately $338,000 and $285,000 in 2008 and 2007, respectively.

Leases as lessee – NCI leases office space and certain equipment under noncancelable operating leases. The future
minimum rental expense under the leases at December 31, 2008, is as follows:

2009                                                                                                  $    990,020
2010                                                                                                       607,515
2011                                                                                                       437,140
2012                                                                                                       153,063
2013                                                                                                       152,220
Thereafter                                                                                                 607,870
Total                                                                                                 $ 2,947,828

Lease expense during 2008 and 2007 was approximately $583,000 and $531,000, respectively.


NOTE 15 – CONSTRUCTION COMMITMENTS

During 2008, NCI entered into construction contracts totaling $2,865,517 for the Gulfton community center project
and $2,237,090 for the Alief Head Start project. At December 31, 2008, $851,338 and $1,073,117 remains
outstanding under these contracts for the Gulfton and Alief projects, respectively.


NOTE 16 – SUBSEQUENT EVENTS

Subsequent to December 31, 2008, economic uncertainty and unstable financial markets have resulted in continued
declines in investment valuations. At the close of business on February 28, 2009, NCI’s investment portfolio had
declined in value by approximately 16%, which management believes was consistent with the global downturn in
equity markets, and would not affect the financial viability of NCI.




                                                      – 17 –
                                                                           DRAFT 04/24/09
Neighborhood Centers Inc.
Notes to Schedules of Expenditures of Federal and State Awards for the year ended December 31, 2008


NOTE 1 – SIGNIFICANT ACCOUNTING POLICIES

Basis of presentation – The schedules of expenditures of federal and state awards includes the government contract
activity of NCI and are presented on the accrual basis of accounting. The information in these schedules is presented
in accordance with requirements of OMB Circular A-133, Audits of States, Local Governments, and Non-Profit
Organizations. Allowable expenses are determined according to the standards of OMB Circular A-122, Cost
Principles for Non-Profit Organizations and are expensed in the statement of activities in conformity with generally
accepted accounting principles.


NOTE 2 – LOCAL MATCHING FUNDS

The revenue and expenditures of federal awards passed through Houston-Galveston Area Council for child care
management services to providers in the schedule of expenditures of federal and state awards excludes amounts
funded through local initiative matching grants. The portion of the funding for the local initiative match grants was
determined based upon the U.S. Department of Health and Human Services CCFD Allocations and Earmarks for
States report.


NOTE 3 – SUBRECIPIENTS

Of the federal expenditures presented in the schedule of expenditures of federal awards, NCI provided awards to
subrecipients as follows:
                                                                                FEDERAL CFDA        AMOUNT PROVIDED
                         PROGRAM TITLE                                             NUMBER            TO SUBRECIPIENT


U.S. DEPARTMENT OF HEALTH AND HUMAN SERVICES

Passed through City of Houston Department of Health and Human Services:                                     $97,484
#22 Special programs for the Aging, Title III, Part B                              93.044
#23 Special programs for the Aging, Title III, Part C                              93.045




                                                       – 26 –
                                                                               DRAFT 04/24/09



                     Report on Compliance and Other Matters and on Internal Control over
                        Financial Reporting Based on an Audit of Financial Statements
                        Performed in Accordance with Government Auditing Standards



To the Board of Directors of
    Neighborhood Centers Inc.:

We have audited the consolidated financial statements of Neighborhood Centers Inc. (NCI) for the year ended
December 31, 2008 and have issued our report thereon dated DATE OPEN. We conducted our audit in accordance
with auditing standards generally accepted in the United States of America and the standards applicable to financial
audits contained in Government Auditing Standards, issued by the Comptroller General of the United States.

Compliance and Other Matters – As part of obtaining reasonable assurance about whether NCI’s consolidated
financial statements are free of material misstatement, we performed tests of its compliance with certain provisions
of laws, regulations, contracts and grant agreements, noncompliance with which could have a direct and material
effect on the determination of financial statement amounts. However, providing an opinion on compliance with
those provisions was not an objective of our audit and, accordingly, we do not express such an opinion. The results
of our tests disclosed no instances of noncompliance or other matters that are required to be reported under
Government Auditing Standards.

Internal Control Over Financial Reporting – In planning and performing our audit, we considered NCI’s internal
control over financial reporting as a basis for designing our auditing procedures for the purpose of expressing our
opinion on the consolidated financial statements, but not for the purpose of expressing an opinion on the
effectiveness of NCI’s internal control over financial reporting. Accordingly, we do not express an opinion on the
effectiveness of NCI’s internal control over financial reporting.

A deficiency in internal control exists when the design or operation of a control does not allow management or
employees, in the normal course of performing their assigned functions, to prevent or detect and correct
misstatements on a timely basis. A material weakness is a deficiency, or combination of deficiencies, in internal
control, such that there is a reasonable possibility that a material misstatement of the entity’s financial statements will
not be prevented, or detected and corrected on a timely basis.

Our consideration of internal control over financial reporting was for the limited purpose described in the first
paragraph of this section and was not designed to identify all deficiencies in internal control that might be significant
deficiencies or material weaknesses. We did not identify any deficiencies in internal control over financial reporting
that we consider to be material weaknesses, as defined above.

This report is intended solely for the information and use of management, the board of directors, others within the
entity, and federal awarding agencies and pass-through entities and is not intended to be and should not be used by
anyone other than these specified parties.


DATE OPEN PENDING MANAGEMENT REVIEW AND APPROVAL




                                                          – 27 –
                                                                               DRAFT 04/24/09



                         Report on Compliance with Requirements Applicable to Each
                      Major Program and Internal Control over Compliance in Accordance
                      With OMB Circular A-133 and State of Texas Single Audit Circular



To the Board of Directors of
    Neighborhood Centers Inc.:

Compliance – We have audited the compliance of Neighborhood Centers Inc. (NCI) with the types of compliance
requirements described in the U.S. Office of Management and Budget (OMB) Circular A-133 Compliance
Supplement and in the State of Texas Single Audit Circular that are applicable to each of its major federal and state
programs for the year ended December 31, 2008. NCI’s major federal and state programs are identified in the
summary of auditors’ results section of the accompanying schedule of findings and questioned costs. Compliance
with the requirements of laws, regulations, contracts, and grants applicable to each of its major federal and state
programs is the responsibility of NCI’s management. Our responsibility is to express an opinion on NCI’s
compliance based on our audit.

We conducted our audit of compliance in accordance with auditing standards generally accepted in the United States
of America; the standards applicable to financial audits contained in Government Auditing Standards, issued by the
Comptroller General of the United States; OMB Circular A-133, Audits of States, Local Governments, and Non-
Profit Organizations and in the State of Texas Single Audit Circular. Those standards and circulars require that we
plan and perform the audit to obtain reasonable assurance about whether noncompliance with the types of
compliance requirements referred to above that could have a direct and material effect on a major federal or state
program occurred. An audit includes examining, on a test basis, evidence about NCI’s compliance with those
requirements and performing such other procedures, as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion. Our audit does not provide a legal determination on
NCI’s compliance with those requirements.

In our opinion, NCI complied, in all material respects, with the requirements referred to above that are applicable to
each of its major federal and state programs for the year ended December 31, 2008. However, the results of our
auditing procedures disclosed instances of noncompliance with those requirements, which are required to be reported
in accordance with OMB Circular A-133 and which are described in the accompanying schedule of findings and
questioned costs as findings #08-2 through #08-5.

Internal Control Over Compliance – The management of NCI is responsible for establishing and maintaining
effective internal control over compliance with the requirements of laws, regulations, contracts, and grants applicable
to federal and state programs. In planning and performing our audit, we considered NCI’s internal control over
compliance with the requirements that could have a direct and material effect on a major federal or state program in
order to determine our auditing procedures for the purpose of expressing our opinion on compliance, but not for the
purpose of expressing an opinion on the effectiveness of internal control over compliance. Accordingly, we do not
express an opinion on the effectiveness of NCI’s internal control over compliance.

A deficiency in internal control exists when the design or operation of a control does not allow management or
employees, in the normal course of performing their assigned functions, to prevent or detect and correct
misstatements on a timely basis. A material weakness is a deficiency, or combination of deficiencies, in internal
control, such that there is a reasonable possibility that a material misstatement of the entity’s financial statements will
not be prevented, or detected and corrected on a timely basis.

Our consideration of internal control over compliance was for the limited purpose described in the first paragraph of
this section and was not designed to identify all deficiencies in internal control that might be significant deficiencies




                                                          – 28 –
                                                                             DRAFT 04/24/09

or material weaknesses. We did not identify any deficiencies in internal control over compliance that we consider to
be material weaknesses.

A significant deficiency is a deficiency, or combination of deficiencies, in internal control that is less severe than a
material weakness, yet important enough to merit attention by those charged with governance. We consider the
deficiency in internal control over compliance described in the accompanying schedule of findings and questioned
costs as item #08-1 to be a significant deficiency.

NCI’s response to the findings identified in our audit are described in the accompanying schedule of findings and
questioned costs. We did not audit NCI’s response and, accordingly, we express no opinion on it.

This report is intended solely for the information and use of management, the board of directors, others within the
entity, and federal and state awarding agencies and pass-through entities and is not intended to be and should not be
used by anyone other than these specified parties.


DATE OPEN PENDING MANAGEMENT REVIEW AND APPROVAL




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                                                                           DRAFT 04/24/09
Neighborhood Centers Inc.
Schedule of Findings and Questioned Costs for the year ended December 31, 2008


Section I – Summary of Auditors’ Results

Financial Statements

Type of auditors’ report issued:                 unqualified        qualified      adverse       disclaimer

Internal control over financial reporting:
 Material weakness(es) identified?                                                yes           no
 Significant deficiency(ies) identified that
     are not considered to be material weakness(es)?                               yes           none reported

Noncompliance material to the financial statements noted?                          yes           no

Federal and State Awards

Internal control over major programs:
 Material weakness(es) identified?                                                yes           no
 Significant deficiency(ies) identified that
     are not considered to be material weakness(es)?                               yes           none reported

Type of auditor’s report issued
on compliance for major programs:                unqualified        qualified      adverse       disclaimer

Any audit findings disclosed that are required to be
reported in accordance with §510(a) of Circular A-133?                             yes           no

Identification of major programs:

CFDA Number                Name of Federal Program or Cluster
93.575                     Child Care and Development Block Grant
93.596                     Child Care Mandatory and Matching Funds
97.036                     Disaster Housing Assistance Program (DHAP)
84.010A                    Grants to Local Education Agencies – Title I, Part A

Grantor’s Number           Name of State Program
06260                      PRS – Relative Caregiver

Dollar threshold used to distinguish between Type A and Type B Federal programs:             $3,000,000

Auditee qualified as a low-risk auditee?                                           yes           no


Section II – Financial Statement Findings

There were no findings related to the financial statements which are required to be reported in accordance with
Government Auditing Standards.




                                                       – 30 –
                                                                             DRAFT 04/24/09
Section III – Federal Award Findings and Questioned Costs

Finding #08-1

Applicable federal program: Disaster Housing Assistance Program, CFDA #97.036

Criteria: The management of NCI is responsible for establishing and maintaining an effective system of internal
control over the financial reporting of billed receivables and revenue for each contract within the Disaster Housing
Assistance Programs (DHAP).

Significant deficiency: During our testing of compliance and internal controls for billing and reporting for the
DHAP contract grants, we noted errors in monthly billings which resulted in bill rejections and delay in payment.
Additionally, we noted that revenue per the general ledger had not been reconciled to the billings for these contracts.

Effect: Failure to adequately establish and maintain effective internal controls over billings and revenue for the
DHAP program could result in misstatements to NCI’s financial statements.

Recommendation: Formalize policies and develop procedures for the review of monthly billings and reconciliation
of DHAP billings to the general ledger.

Management’s response and corrective action: In January of 2009 NCI hired an administration manager to address
a variety of administrative issues, including billings for the DHAP contracts. Additionally we have added additional
oversight through increased review and supervision by our Management Services Department. These changes will
result in formalized processes and procedures for the billing and reconciliation of revenues for the DHAP contracts.

Responsible officer: Toyi Vaughan, Director of Management Services

Estimated Completion Date: April 30, 2009

Finding #08-2

Applicable federal program: Disaster Housing Assistance Program (DHAP), CFDA #97.036

Criteria: Contract provisions

Condition and context: NCI has contracted to provide case management services for the DHAP program. The
contracts between NCI and the housing authorities require that case management be documented in accordance with
the DHAP Case Management Guidelines published by the Department of Housing and Urban Development. The
guidelines set certain contact requirements including frequency of contact attempts and face-to-face visits. In
addition NCI is required to obtain an Individual Development Plan signed by each client and perform needs
assessments on a quarterly basis. Per review of a sample of case files for clients included in monthly billings during
the year we noted the following deficiencies:

   5 out of 25 clients tested did not have a signed individual development plan on file.
   4 out of 25 clients tested did not have documentation of the minimum contact requirements met for the month
    selected.
   For all clients selected we were unable to verify that all 2008 quarterly reassessments were performed.
   2 out of 25 client files indicated that the case should be closed; however since the client had not been removed
    from the database by the housing authority, services to these clients continued to be billed.

Questioned costs: Unknown

Recommendations: Implement procedures to ensure that case management requirements are being performed and
documented.




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                                                                           DRAFT 04/24/09
Management’s response and corrective action plan: We have instituted additional training programs to make
certain that our case managers are aware of the required documentation to properly support their case work.
Additionally, quality assurance for the Stay Connected program will report to and be directed by the Management
Services Department.

Responsible officer: Toyi Vaughan, Director of Management Services

Estimated completion date: Reporting responsibilities implemented April 16; training is ongoing

Finding #08-3

Applicable federal program: Disaster Housing Assistance Program (DHAP), CFDA #97.036

Criteria: Allowable costs

Condition and context: The Disaster Housing Assistance Program contract for case management services to those
displaced by hurricane disasters does not include direct assistance expenditures. During our testing of allowable
costs we noted direct assistance for transportation and grocery gift cards that were charged to this program. In
addition, we noted coding errors for office supply costs belonging to other NCI programs that were incorrectly coded
to this program.

Questioned costs: None, unit reimbursement contract

Recommendations: Re-emphasize the existing procedures for general ledger account coding and provide training for
new employees regarding proper account coding.

Management’s response and corrective action plan: We have tightened procedures for the use of grocery assistance
cards and we will re-emphasize through employee training the procedures for proper coding for each contract within
the Stay Connected program. Furthermore, we will be monitoring the coding of major expenditures.

Responsible Officer: Toyi Vaughan, Director of Management Services

Estimated Completion Date: Ongoing

Finding #08-4

Applicable federal programs:
Head Start and Early Head Start, CFDA #93.600
Child Care Mandatory and Matching Funds, CFDA #93.596

Criteria: Procurement, indirect cost pool

Condition and context: During our testing of procurement and allowable costs for the indirect cost pool, we noted
that expenditures for training consultants exceeding $100,000 were not subjected to the public bid process to obtain
formal quotes in accordance with NCI’s written procurement policies and the TWC financial manual §14.13.

Questioned costs: Unknown

Recommendations: Policies and procedures are appropriate, but were not followed. Re-emphasize to program
personnel the procurement process and the importance of adherence to NCI’s policies and procedures.

Management’s response and corrective action plan: The management consultants engaged provided certain skills
that we felt could not be found from other consultants. An error occurred when these expenses were charged to the
expenditures in the indirect cost pool rather than treated as unallowable costs. It should be noted that there is no




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                                                                             DRAFT 04/24/09
financial impact from this coding error, since the total costs in the indirect cost pool, even without this expenditure,
exceeded the amounts charged to programs using the percentage allocation rate approved by the cognizant agency.

Responsible Officer: Joseph Britt, Director of Procurement and Contract Administration

Estimated Completion Date: Immediately

Finding #08-5

Applicable federal programs: Child Care Mandatory and Matching Funds, CFDA #93.596, Passed through Coastal
Bend Workforce Development Board

Criteria: Contract provisions

Condition and context: NCI’s contract with Coastal Bend Workforce Development Board profits as any income
earned in excess of costs. This excess income is defined as program income and required to be utilized and reported
as such in accordance with OMB Circulars A-110, A-122 and Chapter 8 of the TWC Financial Manual. Program
income is required to be (1) deducted from the total program allowable cost to determine the net allowable costs on
which the Federal share of costs is based, (2) used to finance the non-Federal share of the program, or (3) added to
funds committed to the project by the Federal awarding agency and recipient and used to further eligible program
objectives. For the contract year ended September 30, 2008, the general ledger reported an excess of revenue over
costs per of approximately $125,000 attributable to the overhead fee charged under the contract budget.

Questioned costs: Unknown

Recommendation: Clarify with the funder whether the negotiated overhead fee is exempt from excess income
provisions and, if not, evaluate NCI’s current method of allocating indirect costs to all departments to determine
those overhead costs attributable to this contract.

Management’s response and corrective action plan: NCI’s contract budget clearly includes a management fee
component that has been agreed to by the grantor agency. We have modified the contract so that such fees related to
this contract are not considered to be excess income.

Responsible officer: Douglas Shadle, COO and Senior Vice President

Estimated completion date: Completed




                                                        – 33 –
                                                                           DRAFT 04/24/09


                                       Summary Schedule of Prior Audit Findings



The following were the audit findings for the year ended December 31, 2007, required to be reported in accordance
with OMB A-133 §.300(f).

Finding #07-1

Applicable federal program: Social Services Block Grant, Stay Connected, CFDA #93.667

Criteria: Allowable costs

Condition and context: OMB Circular A-122, Cost Principles for Non-Profit Organizations, requires that charges to
awards for salaries and wages, whether treated as direct costs or indirect costs should be based upon documentation
of actual personnel activity reports or a written cost allocation plan approved by the grantee’s cognizant agency.
NCI’s Disaster Relief Department (Stay Connected) utilizes federal funds from two different contracts and certain
other non-federal funding sources. The program manager, whose time is shared between contracts, does not
complete a personnel activity report based on actual time spent under each contract. The salaries and wages charged
to these contract awards for this position is based upon budgeted allocations.

Questioned costs: Unknown

Recommendations: Employees shared between contracts should complete personnel activity reports based upon
actual time worked or NCI should develop a cost allocation plan to be approved by the granting agencies.

Management’s response: The employee involved in this finding did in fact complete personnel activity reports
(timesheets). Those timesheets indicated that the employee spent his time exactly according to the time budgeted for
each program, which called into question the accuracy of the employee’s timesheet.

Corrective Action Plan: Management will stress the importance of keeping accurate timesheets based on time
actually spent.

Responsible Officer: Ron Jeffers, Controller

Estimated Completion Date: Ongoing

Management’s follow-up response: Management will stress the importance of keeping accurate timesheets based on
time actually spent.

Finding #07-2

Applicable federal program: Social Services Block Grant, Stay Connected, CFDA #93.667

Criteria: Allowable costs

Condition and context: The Houston Galveston Area Council federally funded contract for services and assistance
to those displaced by hurricane disasters does not allow certain types of direct assistance expenditures. During our
testing of allowable costs we noted direct assistance for rent and deposits, funeral expenses, furniture, and private
school tuition that are not allowable under this contract.

Questioned costs: We identified $62,946 of known questioned costs related to the exceptions described above.




                                                       – 34 –
                                                                               DRAFT 04/24/09
Recommendations: Review the existing procedures for general ledger account coding to determine the appropriate
levels of review and provide training for new employees regarding proper account coding.

Management’s response: Management’s original proposal provided that SSBG funds would be utilized to assist
with local relocation which included rent and deposits. It was later determined that these were not allowable costs
and they have been reclassified. These costs will no longer be coded to SSBG.

A few costs such as funeral expenses, furniture, and private school tuition were accidentally charged to SSBG due to
a coding error. They have since been reclassified and Stay Connected has put in place a three point review on all
purchase orders submitted.

Corrective Action Plan: A three point review of all purchases has been implemented.

Responsible Officer: Dave Detcher, Program Manager

Estimated Completion Date: Ongoing

Management’s follow-up response: Stay Connected has implemented a three point review of purchases. A Direct
Assistant Coordinator has been hired to process all requests and conducts the first review. The approving Director or
Assistant Director conducts the second review. NCI’s accounts payable conducts the final review.

Finding #07-3

Applicable federal programs: All programs

Criteria: Allowable costs, indirect costs

Condition and context: OMB Circular A-122, Cost Principles for Non-Profit Organizations, indicates that indirect
cost pool expenses are those that have been incurred for the overall general executive and administrative operations
of the organization and other expenses of a general nature which do not relate solely to any major function of the
organization. Additionally, expenses included in the indirect cost pool must be allowable expenditures in accordance
with OMB Circular A-122. During our compliance test of allowable costs included in the indirect cost pool we
noted $88,039 in expenditures that were erroneously coded to the indirect cost pool.

Questioned costs: None, indirect rate is set annually at a provisional rate.

Recommendations: Review the existing procedures for purchase order account coding to determine appropriate
levels of review.

Management’s response: It was management’s opinion at the time the expenditures were incurred that they were
allowable costs in accordance with OMB Circular A-122. After hearing the opinions and arguments of our auditors
we understand that these expenditures fall into a gray area and agree to remove them from the indirect cost pool for
purposes of determining our indirect cost rate.

Corrective Action Plan: None required.

Management’s follow-up response: Management has agreed to exclude the types of costs specified in the finding
from the indirect cost pool. These types of costs are now subject to a second level of review.

Finding #07-4

Applicable federal program: Social Services Block Grant, Stay Connected, CFDA #93.667

Criteria: Reporting




                                                         – 35 –
                                                                              DRAFT 04/24/09
Condition and context: The Houston Galveston Area Council federally funded contract for services and assistance
to those displaced by hurricane disasters requires that a service plan be completed for each eligible client and that all
eligible clients be recorded in the Taskforce Database System. During our testing of 40 clients we noted 5 instances
where the client and their information was not recorded in the Taskforce Database System and no service plan was
completed.

Questioned costs: None

Recommendations: Policies and procedures appear to be appropriate, but appear not to have been followed
consistently. Re-emphasize training of new personnel and adherence to NCI’s policies and procedures.

Management’s response: The program was without data entry personnel for some time. A data entry specialist has
since been added and new procedures for data entry and file creation have been implemented.

Corrective Action Plan: New procedures as discussed above. Also, emphasize existing procedures and ensure
adequate training.

Responsible Officer: Dave Detcher, Program Manager

Estimated Completion Date: New procedures already in place. Emphasis and training are ongoing.

Management’s Follow Up Response: New procedures have been implemented as follows: Data Entry is the starting
point for each file. When we receive a new client, Data Entry creates the new file and makes sure that the file is in
the NCI database. If it is discovered that there is missing information, Data Entry will notify the Assistant Director
and request the needed information.

Finding #07-5

Applicable federal program: Healthy Start Initiative, CFDA #93.926

Criteria: Reporting

Condition and context: The contract requirements for the Healthy Start program require that case management
services be provided only to eligible participants and documented in each participant’s file. In our testing of 25 case
management clients (with a total of 165 contacts reported), we noted 13 instances were the reported contact was not
documented in the participant file.

Questioned costs: None

Recommendations: Re-emphasize procedures for personnel regarding contract requirements for the documentation
of case management contacts.

Management’s response: The structured agenda for the weekly meeting of the direct services section will be
modified to include increased emphasis on timely recording of service activity. This oversight measure will be
supported by an increased sample size of consumer files that are routinely reviewed by the direct services
coordinator. This finding will be referenced during in-service meetings as will also be give special attention during
new orientation. A monthly tracking report will document incompleteness of files and record follow-up treatment.
To further reduce incompleteness of consumer records the Health Information Systems Analyst will randomly select
2-3 cases to review for consistency and documentation. All observations will become a part of the case management
procedures manual.

Corrective Action Plan: New procedures as discussed above.

Responsible Officer: Walter Jones, Program Manager




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                                                                             DRAFT 04/24/09
Estimated Completion Date: June 1, 2008

Management’s follow up response: The plan, as discussed above, was fully implemented by June 1, 2008 and
remains in effect.

Finding #07-6

Applicable federal programs:
Special Programs for the Aging, Title III, Part B, CFDA #93.044
Special Programs for the Aging, Title III, Part C, CFDA #93.045

Criteria: Subrecipient monitoring

Condition and context: OMB Circular A-110 requires that NCI, as the grantee agency, monitor their subrecipient’s
use of passed through federal funds to provide reasonable assurance that the subrecipient administers the federal
awards in compliance with laws, regulations, and the provisions of contracts or grant agreements and that
performance goals are achieved. Under the congregate meals contract NCI has contracted with 5 congregate meal
sites that are considered to be subrecipients. NCI does not currently have procedures in place to consistently monitor
each subrecipient, review subrecipient single audit reports annually and to document the monitoring being
performed.

Questioned costs: Unknown

Recommendations: Establish a consistent, documented monitoring process for subrecipients.

Management’s response: NCI Directors (Procurement, Controller, Management Services, Financial Planning and
CBI) will meet and update the subcontractor monitoring process and procedures to satisfy OMB Circular A-110. An
Assurance and Certification check list will be placed in each subcontractor file as a guide to assist with completeness
of recordkeeping. These measures will be placed in writing and mailed to all subcontractors and will become a part
of the internal records gathering process as a prerequisite to contracting. Senior services management will review
the Senior Nutrition Congregate Meal Program Monitoring Tool Checklist, make necessary changes and file the
update with NCI’s Management Services Division.

Corrective Action Plan: New procedures as discussed above.

Responsible Officer: Walter Jones, Program Manager

Estimated Completion Date: June 1, 2008

Management’s follow-up response: The plan, as discussed above, was implemented by June 1, 2008.




                                                        – 37 –
                                       – 38 –
                                                                             DRAFT 04/24/09
Estimated Completion Date: June 1, 2008

Management’s follow up response: The plan, as discussed above, was fully implemented by June 1, 2008 and
remains in effect.

Finding #07-6

Applicable federal programs:
Special Programs for the Aging, Title III, Part B, CFDA #93.044
Special Programs for the Aging, Title III, Part C, CFDA #93.045

Criteria: Subrecipient monitoring

Condition and context: OMB Circular A-110 requires that NCI, as the grantee agency, monitor their subrecipient’s
use of passed through federal funds to provide reasonable assurance that the subrecipient administers the federal
awards in compliance with laws, regulations, and the provisions of contracts or grant agreements and that
performance goals are achieved. Under the congregate meals contract NCI has contracted with 5 congregate meal
sites that are considered to be subrecipients. NCI does not currently have procedures in place to consistently
monitor each subrecipient, review subrecipient single audit reports annually and to document the monitoring being
performed.

Questioned costs: Unknown

Recommendations: Establish a consistent, documented monitoring process for subrecipients.

Management’s response: NCI Directors (Procurement, Controller, Management Services, Financial Planning and
CBI) will meet and update the subcontractor monitoring process and procedures to satisfy OMB Circular A -110. An
Assurance and Certification check list will be placed in each subcontractor file as a guide to ass ist with completeness
of recordkeeping. These measures will be placed in writing and mailed to all subcontractors and will become a part of
the internal records gathering process as a prerequisite to contracting. Senior services management will review the
Senior Nutrition Congregate Meal Program Monitoring Tool Checklist, make necessary changes and file the update
with NCI’s Management Services Division.

Corrective Action Plan: New procedures as discussed above.

Responsible Officer: Walter Jones, Program Manager

Estimated Completion Date: June 1, 2008

Management’s follow-up response: The plan, as discussed above, was implemented by June 1, 2008.




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