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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended March 31, 2007; or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File Number 0-23511
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INTEGRATED HEALTHCARE HOLDINGS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Nevada 87-0573331
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
1301 North Tustin Avenue, Santa Ana, California 92705
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code: (714) 953-3503
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
(TITLE OF CLASS)
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Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes[ ] No[X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes[ ] No[X]
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes [ ] No [X]
The aggregate market value of voting stock held by non-affiliates of the
registrant was $2,657,625 as of July 3, 2007 (computed by reference to the last
sale price of a share of the registrant's common stock on that date as reported
by the Over the Counter Bulletin Board). For purposes of this computation, it
has been assumed that the shares beneficially held by directors and officers of
registrant were "held by affiliates"; this assumption is not to be deemed to be
an admission by such persons that they are affiliates of registrant.
There were 137,095,716 shares outstanding of the registrant's common stock as of
July 3, 2007.
DOCUMENTS INCORPORATED BY REFERENCE:
No portions of other documents are incorporated by reference into this Annual
Report.
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INTEGRATED HEALTHCARE HOLDINGS, INC.
FORM 10-K
ANNUAL REPORT FOR THE YEAR ENDED March 31, 2007
TABLE OF CONTENTS
PART I......................................................................................1
ITEM 1. BUSINESS.........................................................................1
ITEM 1A. RISK FACTORS...................................................................13
ITEM 2. PROPERTIES......................................................................19
ITEM 3. LEGAL PROCEEDINGS...............................................................20
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.............................21
PART II....................................................................................21
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES.........................................21
ITEM 6. SELECTED FINANCIAL DATA.........................................................23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIOAND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.................................24
ITEM 7A. QUANTITATIVE AND QULITQTIVE DISCLOSURES ABOUT MARKET RISK......................41
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.....................................42
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE ...................................................................42
ITEM 9A. CONTROLS AND PROCEDURES........................................................42
ITEM 9B. OTHER INFORMATION..............................................................43
PART III...................................................................................43
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.........................43
ITEM 11. EXECUTIVE COMPENSATION.........................................................46
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS .........................................................50
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE......52
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.........................................55
ITEM 15. EXHIBITS; FINANCIAL STATEMENT SCHEDULES........................................55
SIGNATURES.................................................................................60
PART I
FORWARD-LOOKING INFORMATION
This Annual Report on Form 10-K contains forward-looking statements, as
that term is defined in the Private Securities Litigation Reform Act of 1995.
These statements relate to future events or our future financial performance. In
some cases, you can identify forward-looking statements by terminology such as
"may," "will," "should," "expects," "plans," "anticipates," "believes,"
"estimates," "predicts," "potential" or "continue" or the negative of these
terms or other comparable terminology. These statements are only predictions and
involve known and unknown risks, uncertainties and other factors, including the
risks discussed under the caption "Risk Factors" herein that may cause our
company's or our industry's actual results, levels of activity, performance or
achievements to be materially different from those expressed or implied by these
forward-looking statements.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Except as may be required by applicable
law, we do not intend to update any of the forward-looking statements to conform
these statements to actual results.
As used in this report, the terms "we," "us," "our," "the Company,"
"Integrated Healthcare Holdings" or "IHHI" mean Integrated Healthcare Holdings,
Inc., a Nevada corporation, unless otherwise indicated.
EXPLANATORY NOTE REGARDING CHANGE IN FISCAL YEAR
On December 21, 2006 the Company changed its fiscal year end from December
31 to March 31 (see "Notes to Consolidated Financial Statements"). Unless
specifically indicated otherwise, any reference to "2007" or "fiscal 2007"
relates to March 31, 2007 or the year ended March 31, 2007 and any reference to
"2005" and "2004" or "fiscal 2005"and "fiscal 2004" relate to December 31, 2005
and December 31, 2004, respectively, or the year ended December 31, 2005 and
December 31, 2004, respectively. References to fiscal 2008 refer to the period
from April 1, 2007 to March31, 2008. The transition period, January 1 to March
31, 2006, is referred to as the "transition period".
ITEM 1. BUSINESS
BACKGROUND
Integrated Healthcare Holdings, Inc. is a predominantly physician owned
company that, on March 8, 2005, acquired and began operating the following four
hospital facilities in Orange County, California (referred to as the
"Hospitals"):
o 282-bed Western Medical Center in Santa Ana;
o 188-bed Western Medical Center in Anaheim;
o 178-bed Coastal Communities Hospital in Santa Ana; and
o 114-bed Chapman Medical Center in Orange.
Together we believe that the Hospitals represent approximately 12.7% of
all hospital beds in Orange County, California (based on the most recent data on
the Office of Statewide Health Planning and Development for California web site
as of April 23, 2007)
Prior to March 8, 2005, we were primarily a development stage company with
no material operations. On November 18, 2003, members of our current and former
executive management team purchased a controlling interest in the Company and
redirected its focus towards acquiring and operating hospitals and healthcare
facilities that are financially distressed and/or underperforming. On September
29, 2004, the Company entered into a definitive agreement to acquire the four
Hospitals from subsidiaries of Tenet Healthcare Corporation ("Tenet"), and the
transaction closed on March 8, 2005.
The transaction included operations of 4 licensed general acute care
hospitals with 762 beds. All four hospitals are accredited by the Joint
Commission on Accreditation of Healthcare Organizations and other appropriate
accreditation agencies that accredit specific programs. All properties are in
Orange County California, and operate as described below.
1
WESTERN MEDICAL CENTER - SANTA ANA. Western Medical Center - Santa Ana,
located at 1001 N. Tustin Avenue, Santa Ana, CA 92705, is Orange County's first
hospital, founded over 100 years ago. The hospital is one of IHHI's two
hospitals in Santa Ana, which are the only two general acute care hospitals in
this city of 350,000 persons. The hospital has 282 beds and provides quaternary,
tertiary and secondary services. It serves the entire county as one of only
three designated trauma centers in Orange County along with other tertiary
services such as burn center, kidney transplantation, emergency and scheduled
neurosurgical care, cardiac surgical services, a paramedic base station and
receiving center. The hospital also maintains Intensive Care Units for adults
and pediatrics, and a Neonatal Intensive Care Unit. Additionally the hospital
offers telemetry, neurosurgical definitive observation, geriatric, psychiatric,
medical, surgical, pediatric and obstetric inpatient services. Supporting these
services the hospital offers operating and recovery rooms, radiology services,
respiratory therapy services, clinical laboratories, pharmacy, physical and
occupational therapy services on an inpatient and most on an outpatient basis.
The hospital has approximately 750 physicians and 1,450 nurses and hospital
staff.
WESTERN MEDICAL CENTER - ANAHEIM. Western Medical Center - Anaheim,
located at 1025 South Anaheim Blvd., Anaheim, CA 92805, offers a full range of
acute medical and psychiatric care services serving northern Orange County and
providing tertiary services to Riverside County residents. The hospital offers
special expertise in the tertiary services of The Heart and Vascular Institute,
Behavioral Health Services. Additionally, the hospital provides the Women and
Children Health Services, and 24-hour Emergency Services. Supporting these
services the hospital offers critical care, medical, surgical and psychiatric
services supported by operating and recovery rooms, radiology services,
respiratory therapy services, clinical laboratories, pharmacy, physical and
occupational therapy services on an inpatient and most on an outpatient basis.
The hospital has approximately 300 physicians and 575 nurses and hospital staff.
COASTAL COMMUNITIES HOSPITAL - SANTA ANA. Coastal Communities Hospital,
located in Santa Ana at 2701 S. Bristol St., Santa Ana, CA 92704, has served the
community for more than 30 years, providing comprehensive medical and surgical
services in a caring and compassionate environment. The hospital is one of
IHHI's two hospitals in Santa Ana, which are the only two general acute care
hospitals in this city of 350,000 persons. The hospital has tailored its
services to meet the changing needs of the community. The hospital's staff
reflects the cultural diversity of the community and is particularly responsive
and sensitive to diverse health care needs. While services continue to expand,
the 178-bed facility is small enough to retain the family atmosphere associated
with a community hospital. The hospital offers critical care, medical, surgical
obstetric, psychiatric and sub acute services supported by operating and
recovery rooms, radiology services, respiratory therapy services, clinical
laboratories, pharmacy, physical and occupational therapy services on an
inpatient and most on an outpatient basis. The hospital has approximately 270
physicians and 570 nurses and hospital staff.
CHAPMAN MEDICAL CENTER - ORANGE. Founded in 1969, Chapman Medical Center
is a 114-bed acute care facility located at 2601 East Chapman Ave., Orange, CA
92869. The hospital's advanced capabilities position the facility as a leader in
specialty niche programs, including the following centers: Chapman Center for
Obesity (surgical weight loss program); Center for Heartburn and Swallowing;
Chapman Lung Center; Chapman Family Health Center; Doheny Eye Center; House Ear
Clinic; Center for Senior Mental Health; and Positive Action Center (Adult and
Adolescent Chemical Dependency Program). Supporting these services the hospital
offers critical care, medical, surgical and geriatric psychiatric services
supported by operating and recovery rooms, radiology services, respiratory
therapy services, clinical laboratories, pharmacy, physical and occupational
therapy services on an inpatient and most on an outpatient basis. The hospital
has approximately 300 physicians and 430 nurses and hospital staff.
On March 8, 2005, the Company assumed management responsibility and
control over the Hospitals. Prior to acquiring the Hospitals, our management
team had been working with the individual management staffs of the Hospitals on
a transition plan, so the transition occurred seamlessly. All primary systems
and controls have been successfully transitioned to our Company for the
effective management of the Hospitals. The Company achieved a number of key
milestones in transitioning the Hospitals including the following:
o Executed long term employment agreements with all key members of the
Hospitals' administrative staffs;
o Augmented our management capabilities in the areas of legal
compliance and managed care contracting;
o Implemented a full portfolio of insurances at costs which we believe
are a substantial discount from prior rates;
o Corporate administration and overhead has been established and will
be maintained at levels that are substantially less costly than
prior levels;
o Billing and collection activities have been centralized and are now
resident at IHHI; and
o Daily financial and accountability reporting systems have been
established which allow the Company to track financial and operating
performance in real time; and payer, vendor and physician contracts
have been reviewed and assigned and/or renewed where appropriate.
2
EMPLOYEES AND MEDICAL STAFF
At March 31, 2007, the Company had 2,900 full time equivalent employees.
Of these employees, 473 are represented by two labor unions, the California
Nurses Association and SIEU-United Healthcare Workers, who are covered by
collective bargaining agreements. While both of these agreements have expired,
negotiations are underway on new agreements. We believe that our relations with
our employees are good. The Company also had approximately 150 full time
equivalent individuals from contracting agencies at March 31, 2007, consisting
primarily of nursing staff.
Our hospitals are fully staffed by physicians and other independently
practicing medical professionals licensed by the state, who have been admitted
to the medical staff of the individual hospital. Under state laws and licensing
standards, hospitals' medical staffs are self-governing organizations subject to
ultimate oversight by the hospital's local governing board. None of these
physicians are employees of the hospitals. Physicians are not limited to medical
staff membership at our hospitals, and many are on staff at our other hospitals,
or hospitals not owned or operated by us. Physicians on our medical staffs are
free to terminate their membership on our medical staffs and admit their
patients to other hospitals, owned, or not owned by us. Non-physician staff,
including nurses, therapists, technicians, finance, registration, maintenance,
clerical, housekeeping, and administrative staff are generally employees of the
hospital, unless the service is provided by a third party contracted entity. We
are subject to federal minimum wage and hour laws and various state labor laws
and maintain an employee benefit plan.
Our hospitals' operations depend on the abilities, efforts, experience and
loyalty of our employees and physicians, most of who have no long-term
contractual relationship. Our ongoing business relies on our attraction of
skilled, quality employees, physicians and other healthcare professionals in all
disciplines.
We strive to successfully attract and retain key employees, physicians and
health care professionals. Our operations, financial position and cash flows
could be materially adversely affected by the loss of key employees or
sufficient numbers of qualified physicians and other health professionals. The
relations we have with our employees, physicians and other health care
professionals are key to our success and they are a priority in our management
philosophy.
Nursing can have a significant effect on our labor costs. The national
nursing shortage continues and is serious in California. The nursing shortage is
a significant issue for hospitals, as it is for us. The result has been an
increase in the cost of nursing personnel, thus affecting our labor expenses.
Additionally, California instituted mandatory nurse staffing ratios, thus
setting a high level of nurses to patients, but also requiring nursing staff
ratios be maintained at all times even when on breaks or lunch. These
requirements in the environment of a severe nursing shortage may cause the
limiting of patient admissions with an adverse effect on our revenues. The vast
majority of hospitals in California, including ours, are not at all times
meeting the state mandated nurse staffing ratios. Our plan is to improve
compliance and reduce the cost of contract labor needed to achieve the nurse
staffing ratios.
COMPETITION
Hospital competition is a community issue and unique to each facility. The
first factor is the services the hospital offers and the other hospitals in the
area offering the same or similar service. The hospital is dependent on the
physicians to admit the patients to the hospital. The number of physicians
around the hospital, their specialties, and the quality of medicine they
practice will have a major impact on the hospital competition. The ability of
the hospital to employ and retain qualified nurses, other healthcare
professionals and administrative staff will affect the hospitals'
competitiveness in the market place. A hospital's reputation and years of
service to the community affects its competitiveness with patients, physicians,
employees, and contracting health plans. Southern California is a highly
competitive managed health care market therefore the contracting relationships
with managed care organizations is a key factor in a hospital's competitiveness.
The hospital's location, the community immediately surrounding it and the access
to the hospital will affect the hospitals competitiveness. Other hospitals or
healthcare organizations serving the same locations determine the intensity of
the competition. The condition of the physical plant and the ability to invest
in new equipment and technology can affect the communities and physicians desire
to use the facility. The amount the hospital charges for services is also a
factor in the hospital's competitiveness. The funding sources of the competition
can also be a factor if a competitor is tax exempt; it has advantages not
available to our Hospitals, such as endowments, chartable contributions,
tax-exempt financing, and exemptions from taxes. Since these factors are
individual to each hospital, each hospital must develop its own strategies, to
address the competitive factors in its local.
3
OUR STRATEGY
Our goal is to provide high quality health care services in a community
setting that are responsive to the needs of the communities that we serve. To
accomplish our mission in the complex and competitive health care industry, our
operating strategies are to (1) improve the quality of care provided at our
hospitals by identifying best practices and implementing those best practices,
(2) improve operating efficiencies and reduce operating costs while maintaining
or improving the quality of care provided, (3) improve patient, physician and
employee satisfaction, and (4) improve recruitment and retention of nurses and
other employees. We intend to integrate and efficiently operate the four
Hospitals in order to achieve profitability from operations. We may also seek
additional acquisitions of hospitals or health facilities in the future when
opportunities for profitable growth arise.
HEALTH CARE REGULATION
CERTAIN BACKGROUND INFORMATION. Health care, as one of the largest
industries in the United States, continues to attract much legislative interest
and public attention. Changes in the Medicare and Medicaid programs and other
government health care programs, hospital cost containment initiatives by public
and private payers, proposals to limit payments and health care spending, and
industry wide competitive factors greatly impact the health care industry. The
industry is also subject to extensive federal, state and local regulation
relating to licensure, conduct of operations, ownership of facilities, physician
relationships, addition of facilities and services, and charges and effective
reimbursement rates for services. The laws, rules and regulations governing the
health care industry are extremely complex, and the industry often has little or
no regulatory or judicial interpretation for guidance. Compliance with such
regulatory requirements, as interpreted and amended from time to time, can
increase operating costs and thereby adversely affect the financial viability of
our business. Failure to comply with current or future regulatory requirements
could also result in the imposition of various civil and criminal sanctions
including fines, restrictions on admission, denial of payment for all or new
admissions, the revocation of licensure, decertification, imposition of
temporary management or the closure of a facility.
MEDICARE
GENERALLY. Each of the Hospitals participates in the Medicare program.
Health care providers have been and will continue to be affected significantly
by changes that have occurred in the last several years in federal health care
laws and regulations pertaining to Medicare. The purpose of much of the recent
statutory and regulatory activity has been to reduce the rate of increase in
Medicare payments and to make such payments more accurately reflect patient
resource use at hospitals. In addition, important amendments to the Medicare law
were made by the Medicare Prescription Drug, Improvement, and Modernization Act
of 2003 ("MMA") and the Deficit Reduction Act of 2005 ("DRA"). Although the most
significant provisions of MMA relate to an expansion of Medicare's coverage for
pharmaceuticals and changes intended to expand managed care under the Medicare
program, MMA also made many changes in the laws that are relevant to how
Medicare makes payments to hospitals, some of which could have an adverse impact
on the Hospitals' Medicare reimbursement. One focus of the DRA, which may affect
the Hospitals, is the requirement for hospitals to increase quality of care
reporting and an increased penalty for hospitals that fail to properly submit
quality data.
INPATIENT OPERATING COSTS. Medicare pays acute care hospitals, such as the
Hospitals, for most services provided to inpatients under a system known as the
"Prospective Payment System" or "PPS," pursuant to which hospitals are paid for
services based on predetermined rates. Medicare payments under PPS are based on
the Diagnosis Related Group ("DRG") to which each Medicare patient is assigned.
The DRG is determined by the patient's primary diagnosis and other factors for
each particular Medicare inpatient stay. The amount to be paid for each DRG is
established prospectively by the Centers for Medicare and Medicaid Services
("CMS"). The DRG amounts are not related to a hospital's actual costs or
variations in service or length of stay. Therefore, if a hospital incurs costs
in treating Medicare inpatients that exceed the DRG level of reimbursement plus
any outlier payments, then that hospital will experience a loss from such
services, which will have to be made up from other revenue sources. Payment
limitations implemented by other third party payers may restrict the ability of
a hospital to engage in such "cost-shifting." In August 2006, CMS implemented
significant changes to the Medicare program's inpatient acute care PPS that (1)
altered the way that DRG weights are calculated, abandoning the current
charge-based weight system in favor of a cost-based weight system and (2)
expanded the number of DRGs so that the severity of a given illness is taken
into account for purposes of payment. Such systemic changes took affect for
discharges occurring on and after October 1, 2006. Further, on April 13, 2007,
CMS proposed an expansion of the cost centers to be used for purposes of
calculating the new cost-based DRG weights. In this proposed rule, CMS also
proposed an entirely new "MS-DRG" inpatient PPS system that would dramatically
expand the severity-based DRGs and that would cut DRG payments under the
proposed MS-DRG system by 2.4% (through what CMS is calling a "behavioral
offset"). This proposed rule would also significantly cut capital cost
reimbursement for urban hospitals. It is not possible to determine at this time
whether such systemic changes will be adopted as proposed or, if adopted, how
they may affect the Hospitals.
4
For certain Medicare beneficiaries who have unusually costly hospital
stays (also known as "outliers"), CMS currently provides additional payments
above those specified for the DRG. To determine whether a case qualifies for
outlier payments, hospital-specific cost-to-charge ratios are applied to the
total covered charges for the case. Operating and capital costs for the case are
calculated separately by applying separate operating and capital cost-to-charge
ratios and combining these costs to compare them with a defined fixed-loss
outlier threshold for the specific DRG. There is no assurance that outlier
payments will continue to be provided at the same level if the changes in PPS
proposed by the Secretary on April 13, 2007 are adopted.
PPS payments are adjusted annually using an inflation index, based on the
change in a "market basket" of hospital costs of providing health care services.
There can be no assurance that future updates in PPS payments will keep pace
with inflation or with the increases in the cost of providing hospital services.
It is also possible that the prospective payment for capital costs at a Hospital
will not be sufficient to cover the actual capital-related costs of the Hospital
allocable to Medicare patients' stays.
OUTPATIENT SERVICES. All services paid under the outpatient PPS are
classified into groups called Ambulatory Payment Classifications or "APCs."
Services in each APC are similar clinically and in terms of the resources they
require. A payment rate is established for each APC. Depending on the services
provided, hospitals may be paid for more than one APC for an encounter. CMS will
make additional payment adjustments under Outpatient PPS, including "outlier"
payments for services where the hospital's cost exceeds 2.5 times the APC rate
for that service. In addition, certain other changes have reduced coinsurance
payments below what they would have originally been under outpatient PPS.
MEDICARE BAD DEBT. Medicare beneficiaries have a coinsurance payment and
annual deductible for most inpatient and outpatient hospital services. Hospitals
must first seek payment of any such coinsurance and deductible amounts from the
Medicare beneficiary. If, after reasonable collection efforts, a hospital is
unable to collect these coinsurance and deductible amounts, Medicare currently
reimburses hospitals 70 percent of the uncollected coinsurance and deductible
amount (known as "Medicare bad debt"). The President's fiscal year 2008 proposed
budget would phase out the reimbursement of most Medicare bad debt. It is not
possible to determine at this time whether such changes will be adopted by
Congress as proposed.
MEDICARE CONDITIONS OF PARTICIPATION. Hospitals must comply with
provisions called "Conditions of Participation" in order to be eligible for
Medicare reimbursement. CMS is responsible for ensuring that hospitals meet
these regulatory Conditions of Participation. Under the Medicare rules,
hospitals accredited by JCAHO are deemed to meet the Conditions of
Participation. The Hospitals are each currently accredited by JCAHO and are
therefore deemed to meet the Conditions of Participation.
MEDICARE AUDITS. Medicare participating hospitals are subject to audits
and retroactive audit adjustments with respect to reimbursement claimed under
the Medicare program. Medicare regulations also provide for withholding Medicare
payments in certain circumstances. Any such withholding with respect to the
Hospitals could have a material adverse effect on the Company. In addition,
contracts between hospitals and third party payers often have contractual audit,
setoff and withhold language that may cause substantial, retroactive
adjustments. Medicare requires certain financial information be reported on a
periodic basis, and with respect to certain types of classifications of
information, penalties are imposed for inaccurate reports. As these requirements
are numerous, technical and complex, there can be no assurance that the Company
will avoid incurring such penalties.
MEDICARE MANAGED CARE. The Medicare program allows various managed care
plans, now known as Medicare Advantage Plans, offered by private companies to
engage in direct managed care risk contracting with the Medicare program. Under
the Medicare Advantage program, these private companies agree to accept a fixed,
per-beneficiary payment from the Medicare program to cover all care that the
beneficiary may require. Generally, in order to engage in risk contracting, a
Medicare Advantage Plan must be licensed at the state level. In recent years,
many private companies have discontinued their Medicare Advantage Plans. The
result has been that the beneficiaries who were covered by the now-discontinued
Medicare plan have been shifted back into the Medicare fee-for-service program
or into a Medicare cost plan. The discontinuation of Medicare Advantage Plans
has adversely affected many health care providers across the country and could
materially adversely affect the Company. Also, the decrease in the number of
Medicare beneficiaries enrolled in the Medicare Advantage program has not gone
unnoticed by the Congress and CMS. Congress has recently increased payments to
such plans and made other changes to Medicare managed care to encourage
beneficiary enrollment in managed care plans. Future legislation or regulations
may be created that attempt to increase participation in the Medicare Advantage
program. The effect of these recent changes and any future
legislation/regulation is unknown but could materially and adversely affect the
Company.
5
MEDI-CAL (CALIFORNIA'S MEDICAID PROGRAM)
FEE-FOR-SERVICE PROGRAM. The Medi-Cal program is a joint federal/state
program that provides health care services to certain persons who are
financially needy. Each of the Hospitals participates in the Medi-Cal program.
The Medi-Cal program includes both a fee-for-service component and a managed
care component. Inpatient hospital services under the fee-for-service component
are reimbursed primarily under the Selective Provider Contracting Program
("SPCP"). The Company is located in an area which is currently a "closed area"
under the SPCP. In SPCP closed areas, private hospitals must hold a contract
with the Medi-Cal program in order to be paid for their inpatient services
(other than services performed in an emergency to stabilize a patient so that
they can be transferred to a contracting hospital and additional care rendered
to emergency patients who cannot be so stabilized for transfer). Contracting
hospitals are generally paid for these services on the basis of all inclusive
per diem rates they negotiate under their SPCP contracts. Outpatient hospital
services under the fee-for service-component are paid for on the basis of a fee
schedule, and it is not necessary for hospitals to hold SPCP contracts in order
to be paid for their outpatient services. Each Hospital currently has an SPCP
contract that is expected to remain in effect through at least November 17,
2007, and there can be no assurance that the Hospital will maintain SPCP status
thereafter or that the current Medi-Cal payment arrangements will continue.
There can be no assurance that the SPCP contract rates paid to the Hospitals
will cover each Hospital's cost of providing care. The Medi-Cal payment rates
for outpatient services cover only a small portion of a Hospital's cost of
providing care.
MEDI-CAL MANAGED CARE. In addition to the fee-for-service component of
Medi-Cal, Orange County (where the Hospitals are located) participates in the
Medi-Cal managed care program. Many Medi-Cal beneficiaries in Orange County are
covered under Medi-Cal managed care, and not under fee-for-service Medi-Cal.
Medi-Cal managed care in Orange County is provided through a County Organized
Health System known as CalOptima. A hospital that wants to participate in
Medi-Cal managed care on a capitated basis must contract with CalOptima, and is
typically paid a capitated amount each month to provide, or arrange for the
provision of, specified services to CalOptima members assigned to the hospital.
The capitated hospital is financially responsible for a predetermined list of
services, whether those services are provided at the capitated hospital or
another service provider. Western Medical Center--Santa Ana had a capitated
contract with CalOptima which terminated as of June 2006. Coastal Communities
Hospital has a capitated contract with CalOptima which terminated in April 2007.
There can be no assurance that the capitated payments received by Western
Medical Center--Santa Ana were adequate to reimburse its costs of providing care
under its CalOptima contract, or that the capitated payments that have been
received and in the future will be received by Coastal Communities Hospital will
be adequate to cover its costs of providing care under its capitated contract.
Mid-year 2006, CalOptima began entering into contracts with hospitals on a fee
for services basis for managed care Medi-Cal enrollees managed directly by
CalOptima and setting rates for hospitals accepting non-CalOptima managed
CalOptima beneficiaries. The rates in these contracts are based on an Orange
County average California Medical Assistance Commission ("CAMC") rate or this
individual hospital's CMAC rate. CMAC rates are negotiated rates below the
hospital's costs. Chapman Medical Center, Coastal Communities Hospital, Western
Medical Center Anaheim and Western Medical Center Santa Ana entered into these
CalOptima fee for service contracts effective June 2006. A hospital which does
not have a contract with CalOptima may provide covered services on an emergency
basis, or pursuant to arrangements with other entities which have contracts with
CalOptima. There are ongoing disputes between CalOptima and hospitals in Orange
County concerning the amount CalOptima is obligated to pay for emergency
services furnished by non-contracting hospitals. An amendment to the federal
Medicaid Act which became effective January 1, 2007, appears to limit
reimbursement from Medi-Cal managed care plans, like CalOptima, to hospital
providers of emergency services that do not have contracts with those plans to
the average Selective Provider Contracting Program contract rate in the State
for general acute care hospitals or the average contract rate for tertiary
hospitals. It is unclear how this amendment will ultimately be interpreted and
applied. There can be no assurance that the amount paid to any of the Hospitals
for services covered under CalOptima which are covered or not covered under a
contract between CalOptima and the Hospital will be adequate to reimburse a
Hospital's costs of providing care.
MEDI-CAL DSH PAYMENTS. Some of the Hospitals receive substantial
additional Medi-Cal reimbursement as a disproportionate share ("DSH") hospital
from the DSH Replacement Fund and the Private Hospital Supplemental Fund.
Hospitals qualify for this additional funding based on the proportion of
services they provide to Medi-Cal beneficiaries and other low-income patients.
Payments to a hospital from the State's DSH Replacement Fund are determined on a
formula basis set forth in California law and the Medi-Cal State Plan. Hospitals
receive funds from the Private Hospital Supplemental Fund pursuant to amendments
to their SPCP contracts negotiated with the California Medical Assistance
Commission. The Medi-Cal funding for DSH hospitals, however, is dependent on
state general fund appropriations, and there can be no assurance that the state
6
will fully fund the Medi-Cal DSH payment programs. There also can be no
assurance that the Hospitals which qualify as DSH will be able to negotiate SPCP
contract amendments for Private Hospital Supplemental Fund Payments, although
state law currently provides that a qualifying hospital may not receive less
from the Private Hospital Supplemental Fund than it received from predecessor
funds in the State's 2002-03 fiscal year. The state programs under which special
payments are made to DSH hospitals are set to expire as of June 30, 2010. There
can be no assurance the programs will be extended or replaced by similar
programs. In addition, the federal government has recently proposed regulations
which could have a significant negative affect on DSH reimbursement to
California hospitals, including the Hospitals, if they become effective.
WORKER'S COMPENSATION REIMBURSEMENT
FEE SCHEDULES. A portion of the Hospitals' revenues are expected to come
from Workers' Compensation program reimbursements. As part of an effort in 2003
to control costs under the Workers' Compensation program, the California
legislature enacted Labor Code Section 5307.1, which sets reimbursement for
hospital inpatient and outpatient services, including outpatient surgery
services, at a maximum of 120% of the current Medicare fee schedule for
hospitals. The Administrative Director of the Division of Workers' Compensation
is authorized to develop and, after public hearings, to adopt a fee schedule for
outpatient surgery services, but this schedule may not be more than 120% of the
current Medicare fee schedule for hospitals. This fee limitation limits the
amount that the Hospitals will be paid for their services provided to Workers'
Compensation patients.
PROVIDER NETWORKS. Under California law, employers may establish medical
provider networks for Workers' Compensation patients and may restrict their
employees' access to medical services to providers that are participants in
those networks. Employers are free to choose which providers will and will not
participate in their networks, and employers pay participating providers on the
basis of negotiated rates that may be lower than those that would otherwise be
provided for by the Workers' Compensation fee schedules. Employers may also
chose to contract with licensed Health Maintenance Organizations ("HMOs") and
restrict access by their employees to participating providers of these HMOs. The
Hospitals are participating providers in several Workers' Compensation networks,
and to the extent that the Hospitals are required to negotiate and accept lower
reimbursement rates to participate in these networks, there may be an adverse
financial impact on the Company. Also, network providers are required to provide
treatment in accordance with utilization controls to be established by the
Department of Workers' Compensation. Therefore, as network participants, such
utilization controls may limit the services for which the Hospital is
reimbursed, which would have an adverse financial impact on the Company.
FURTHER REFORM. There will likely continue to be substantial activity in
the California Workers' Compensation reform area. In the past, the legislature
has considered a number of bills, some of which would further reduce the maximum
reimbursement for medical services, including hospital services. It is expected
that any revisions to the Workers' Compensation fee schedule, when and if
implemented, will reduce the fees the Hospitals receive for Workers'
Compensation patients. The impact of such possible future fee schedule changes
cannot be estimated at this time. It is also possible that the profitability of
the Company could be impacted by other future Workers' Compensation cost control
efforts.
COMMERCIAL INSURANCE
Many private insurance companies contract with hospitals on a "preferred"
provider basis, and many insurers have introduced plans known as preferred
provider organizations ("PPOs"). Under preferred provider plans, patients who
use the services of contracted providers are subject to more favorable
copayments and deductibles than apply when they use non-contracted providers. In
addition, under most health maintenance organizations ("HMOs"), private payers
limit coverage to those services provided by selected hospitals. With this
contracting authority, private payers direct patients away from nonselected
hospitals by denying coverage for services provided by them. The Hospitals
currently have several managed care contracts. If the Company's managed care
contract rates are unfavorable or are reduced in the future, this may negatively
impact the Company's profitability.
EMTALA
In response to concerns regarding inappropriate hospital transfers of
emergency patients based on the patient's inability to pay for the services
provided, Congress enacted the Emergency Medical Treatment and Labor Act
("EMTALA") in 1986. This so-called "anti-dumping" law imposes certain
requirements on hospitals with Medicare provider agreements to (1) provide a
medical screening examination for any individual who comes to the hospital's
emergency department, (2) provide necessary stabilizing treatment for emergency
medical conditions and labor, and (3) not transfer a patient until the
individual is stabilized, unless the benefits of transfer outweigh the risks or
the patient gives informed consent to the transfer. Since the Hospitals must
7
provide emergency services without regard to a patient's ability to pay,
complying with EMTALA could have an adverse impact on the profitability of the
Hospitals, depending upon the number of patients treated in or through the
emergency room who are unable to pay. Failure to comply with the law can result
in exclusion of the physician from the Medicare and/or Medicaid programs or
termination of the hospital's Medicare provider agreements, as well as civil
penalties.
ANTI-KICKBACK, FRAUD AND SELF-REFERRAL REGULATIONS
FEDERAL ANTI-KICKBACK LAW. The Social Security Act's illegal remuneration
provisions (the "Anti-kickback Statute") prohibit the offer, payment,
solicitation or receipt of remuneration (including any kickback, bribe or
rebate), directly or indirectly, overtly or covertly, in cash or in kind, for
(a) the referral of patients or arranging for the referral of patients to
receive services for which payment may be made in whole or in part under a
federal health care program, which includes Medicare, Medicaid and TRICARE
(formerly CHAMPUS, which provides benefits to dependents of members of the
uniformed services) and any state health care program, or (b) the purchase,
lease, order, or arranging for the purchase, lease or order of any good,
facility, service or item for which payment may be made under the above payment
programs. The Anti-kickback Statute contains both criminal and civil sanctions,
which are enforced by the Office of Inspector General of DHHS ("OIG") and the
United States Department of Justice. The criminal sanctions for a conviction
under the Anti-kickback Statute are imprisonment for not more than five years, a
fine of not more than $50,000 for each offense, or both, with higher penalties
potentially being imposed under the federal Sentencing Guidelines. In addition
to the imposition of criminal sanctions, the Secretary of DHHS may exclude any
person or entity that commits an act described in the Anti-kickback Statute from
participation in the Medicare program and direct states to also exclude that
person from participation in state health care programs. The Secretary of DHHS
can exercise this authority based on an administrative determination, without
obtaining a criminal conviction. The burden of proof for the exclusion would be
one that is customarily applicable to administrative proceedings, which is a
lower standard than that required for a criminal conviction. In addition,
violators of the Anti-kickback Statute may be subjected to civil money penalties
of $50,000 for each prohibited act and up to three times the total amount of
remuneration offered, paid, solicited, or received, without regard to whether a
portion of such remuneration was offered, paid, solicited, or received for a
lawful purpose.
There is ever-increasing scrutiny by federal and state law enforcement
authorities, OIG, DHHS, the courts and Congress of arrangements between health
care providers and potential referral sources to ensure that the arrangements
are not designed as a mechanism to exchange remuneration for patient care
referrals and opportunities. The law enforcement authorities, the courts and
Congress have also demonstrated a willingness to look behind the formalities of
an entity's structure to determine the underlying purpose of payments between
health care providers and potential referral sources. Enforcement actions have
been increased, and, generally, courts have broadly interpreted the scope of the
Anti-kickback Statute, and have held, for example, that the Anti-kickback
Statute may be violated if merely one purpose of a payment arrangement is to
induce referrals. In addition, the OIG has long been on record that it believes
that physician investments in health care companies can violate the
Anti-kickback Statute and the OIG has demonstrated an aggressive attitude toward
enforcement of the Anti-kickback Statute in the context of ownership
relationships.
The OIG has issued regulations specifying certain payment practices that
will not be treated as a criminal offense under the Anti-kickback Statute and
that will not provide a basis for exclusion from the Medicare or Medicaid
programs (the "Safe Harbor Regulations"). These regulations include, among
others, safe harbors for certain investments in both publicly traded and
non-publicly traded companies. However, investments in the Company will not be
protected by either of these safe harbor regulations. Nevertheless, the fact
that a specific transaction does not meet all of the criteria of a "safe harbor"
does not mean that such transaction constitutes a violation of the Anti-kickback
Statute, and the OIG has indicated that any arrangement that does not meet all
of the elements of a safe harbor will be evaluated on its specific facts and
circumstances to determine whether the Anti-kickback Statute has been violated
and, thus, if prosecution is warranted.
The OIG is authorized to issue advisory opinions which interpret the
Anti-kickback Statute and has issued several advisory opinions addressing
investments by physicians in health care businesses. Based upon those opinions,
it appears unlikely that the OIG would be willing to issue an advisory opinion
protecting physician investments in the Company, and no such opinion has been
requested by the Company. The Company nevertheless believes, based upon a
federal court decision involving physician investments in clinical laboratories,
that investments in it by physicians are not automatically prohibited by the
Anti-kickback Statute, depending upon the circumstances surrounding such
investment. The Company has reviewed the terms of the purchase of ownership
interests in the Company by OC-PIN (as defined below under "Risk Factors")
(which is owned by physicians that refer patients to the Hospitals) and has
determined that the purchase should not violate the Anti-kickback Statute. The
Company is also in the process of reviewing the related-party lease with Pacific
Coast Holdings Investment, LLC ("PCHI"), a company owned directly or indirectly
by two of the Company's largest shareholders, including physicians practicing at
the Hospitals, to assure the terms remain at fair market value.
8
The OIG also has identified many hospital-physician compensation
arrangements that are potential violations of the Anti-kickback Statute,
including: (a) payment of any incentive for the referral of patients; (b) use of
free or discounted office space or equipment; (c) provision of free or
discounted services, such as billing services; (d) free training; (e) income
guarantees; (f) loans which are not fair market value or which may be forgiven;
(g) payment for services which require few, if any substantive duties by the
physician or payment for services in excess of fair market value of the
services; and (h) purchasing goods or services from physicians at prices in
excess of fair market value. The Company has reviewed many of its compensation
relationships with physicians, and on-going reviews are occurring, in an effort
to ensure that such relationships do not violate the Anti-kickback Statute.
CALIFORNIA ANTI-KICKBACK PROHIBITIONS California law prohibits
remuneration of any kind in exchange for the referral of patients regardless of
the nature of the payer of such services, and is therefore broader in this
regard than is the federal statute. Nevertheless, this statute specifically
provides that a medically necessary referral is not illegal solely because the
physician that is making the referral has an ownership interest in the health
care facility to which the referral is made if the physician's return on
investment is based upon the amount of the physician's capital investment or
proportional ownership and such ownership is not based upon the number or value
of patients referred. Further, opinions of the California Attorney General
indicate that distributions paid to physicians who invest in entities that
conduct health related businesses generally do not violate California's
anti-kickback law when the entity conducts a bona fide business, services
performed are medically needed, and profit distributions are based upon each
investor's proportional ownership interest, rather than the relative volume of
each investor's utilization of the entity's business. California has a separate
anti-kickback statute which applies only under the Medi-Cal program and which
largely parallels the prohibitions of the federal anti-kickback statute. The
Company believes that analysis under this Medi-Cal anti-kickback statue will be
the same as under the federal Anti-kickback Statute discussed above.
FALSE AND OTHER IMPROPER CLAIMS THE federal government is authorized to
impose criminal, civil and administrative penalties on any person or entity that
files a false claim for payment from the Medicare or Medi-Cal programs. In
addition to other federal criminal and civil laws which punish health care
fraud, the federal government, over the past several years, has accused an
increasing number of health care providers of violating the federal Civil False
Claims Act. The False Claims Act imposes civil liability (including substantial
monetary penalties and damages) on any person or corporation which (1) knowingly
presents a false or fraudulent claim for payment to the federal government; (2)
knowingly uses a false record or statement to obtain payment; or (3) engages in
a conspiracy to defraud the federal government to obtain allowance for a false
claim. False claims allegations could arise, for example, with respect to the
Hospital's billings to the Medicare program for its services or the submission
by the Hospital of Medicare cost reports. Specific intent to defraud the federal
government is not required to act with knowledge. Instead, the False Claims Act
defines "knowingly" to include not only actual knowledge of a claim's falsity,
but also reckless disregard for or intentional ignorance of the truth or falsity
of a claim. Because the Hospitals perform hundreds of procedures a year for
which they are paid by Medicare, and there is a relatively long statute of
limitations, a billing error or cost reporting error could result in significant
civil or criminal penalties.
Under the qui tam, or whistleblower, provisions of the False Claims Act,
private parties may bring actions on behalf of the federal government. These
private parties, often referred to as relators, are entitled to share in any
amounts recovered by the government through trial or settlement. Both direct
enforcement activity by the government and whistleblower lawsuits have increased
significantly in recent years and have increased the risk that a health care
company, like us, will have to defend a false claims action, pay fines or be
excluded from the Medicare and Medicaid programs as a result of an investigation
resulting from a whistleblower case. Although the Company intends that the
operations of the Hospitals will materially comply with both federal and state
laws related to the submission of claims, there can be no assurance that a
determination that we have violated these claims-related laws will not be made,
and any such determination would have a material adverse effect on the Company.
In addition to the False Claims Act, federal civil monetary penalties
provisions authorize the imposition of substantial civil money penalties against
an entity which engages in activities including, but not limited to, (1)
knowingly presenting or causing to be presented, a claim for services not
provided as claimed or which is otherwise false or fraudulent in any way; (2)
knowingly giving or causing to be given false or misleading information
reasonably expected to influence the decision to discharge a patient; (3)
offering or giving remuneration to any beneficiary of a federal health care
program likely to influence the selection of a particular provider, practitioner
or supplier for the ordering or receipt of reimbursable items or services; (4)
arranging for reimbursable services with an entity which is excluded from
participation from a federal health care program; (5) knowingly or willfully
soliciting or receiving remuneration for a referral of a federal health care
program beneficiary; or (6) using a payment intended for a federal health care
9
program beneficiary for another use. The Secretary of DHHS, acting through the
OIG, also has both mandatory and permissive authority to exclude individuals and
entities from participation in federal health care programs pursuant to this
statute. Also, it is a criminal federal health care fraud offense to: (1)
knowingly and willfully execute or attempt to execute any scheme to defraud any
health care benefit program, including any private or governmental program; or
(2) to obtain, by means of false or fraudulent pretenses, any property owned or
controlled by any health care benefit program. Penalties for a violation of this
federal law include fines and/or imprisonment, and a forfeiture of any property
derived from proceeds traceable to the offense. In addition, if an individual is
convicted of a criminal offense related to participation in the Medicare program
or any state health care program, or is convicted of a felony relating to health
care fraud, the Secretary of DHHS is required to bar the individual from
participation in federal health care programs and to notify the appropriate
state agencies to bar the individuals from participation in state health care
programs.
While the criminal statutes are generally reserved for instances of
fraudulent intent, the federal government is applying its criminal, civil and
administrative penalty statutes in an ever-expanding range of circumstances. For
example, the government has taken the position that a pattern of claiming
reimbursement for unnecessary services violates these statutes if the claimant
merely should have known the services were unnecessary, even if the government
cannot demonstrate actual knowledge. The government has also taken the position
that claiming payment for low-quality services is a violation of these statutes
if the claimant should have known that the care was substandard. In addition,
some courts have held that a violation of the Stark law or the Anti-kickback
Statute can result in liability under the federal False Claims Act.
Noncompliance with other regulatory requirements can also lead to liability
under the False Claims Act if it can be established that compliance with those
requirements is necessary in order for a hospital to be paid for its services.
Claims filed with private insurers can also lead to criminal and civil
penalties under federal law, including, but not limited to, penalties relating
to violations of federal mail and wire fraud statutes and of HIPAA's (as defined
below) provisions which have made the defrauding of any health care insurer,
whether public or private, a crime. The Hospitals are also subject to various
state insurance statutes and regulations that prohibit the Hospitals from
submitting inaccurate, incorrect or misleading claims. The Company intends that
the Hospitals will comply with all state insurance laws and regulations
regarding the submission of claims. IHHI cannot assure, however, that each
Hospital's insurance claims will never be challenged or that the Hospitals will
in all instances comply with all laws regulating its claims. If a Hospital were
found to be in violation of a state insurance law or regulation, the Hospital
could be subject to fines and criminal penalties, which would have an adverse
effect on IHHI's business and operating results.
FEDERAL PHYSICIAN SELF-REFERRAL LAW Provisions of the Social Security Act
commonly referred to as the "Stark" law prohibit referrals by a physician of
Medicare patients to providers for a broad range of health services if the
physician (or his or her immediate family member) has an ownership or other
financial arrangement with the provider, unless an exception applies. The
"designated health services" to which the Stark law applies include all
inpatient and outpatient services provided by hospitals. Hospitals cannot bill
for services they provide as a result of referrals that are made in violation of
the Stark law. In addition, a violation of the Stark law may result in a denial
of payment, require refunds to patients and to the Medicare program, civil
monetary penalties of up to $15,000 for each violation, civil monetary penalties
of up to $100,000 for certain "circumvention schemes" and exclusion from
participation in the Medicare, Medicaid and other federal programs. Violations
of the Stark law may also be actionable as violations of the federal False
Claims Act.
Notwithstanding the breadth of the Stark law's general prohibition, the
law contains an exception which protects ownership interests held by physicians
in hospitals where the referring physician is authorized to perform services at
the hospital and the physician's ownership is in the hospital itself, and not
merely in a subdivision of the hospital. The Hospitals intend to rely upon this
exception to protect the ownership interests that physicians hold in them.
Although the Company does not believe that any of its Hospital's will be
considered to be "specialty hospitals", changes in this area of the law that
would affect the classification of the Hospitals as "specialty hospitals" may
affect the Company's operations. Furthermore, in the fiscal year 2008 Inpatient
Prospective Payment System proposed rule issued on April 13, 2007, CMS proposed
to require hospitals to disclose to patients whether they are owned in part or
in whole by physicians, and if so, to make available the names of the physician
owners. In addition, CMS proposed that as a condition of continued medical staff
membership, physicians would be required to inform patients of their ownership
interests in a hospital at the time they refer patients to that hospital.
However, because similar disclosure requirements are already imposed by
California law (see "Disclosure of Financial Interests" section below), it is
unlikely that CMS' implementation of such requirement would have a material
affect on the Company's operations. Also, CMS will require hospitals to disclose
information concerning physician investment and compensation arrangements, and
by July 2007, approximately 500 hospitals will be required to complete a
Financial Relationship Disclosure Report ("Report") and submit the information
to CMS for review. CMS has indicated that it may implement a regular mandatory
disclosure process that will apply to all Medicare participating hospitals. The
Company is unaware of whether any of its Hospitals will be required to submit
10
such Reports, however, the Company does not anticipate that any such reporting
requirements will materially affect the Company's operations.
In addition to physician ownership, the Hospitals have arrangements by
which they compensate various physicians for services. Payments by the Company
to such physicians will constitute financial relationships for purposes of the
Stark law. Exemptions exist under the Stark law and its implementing regulations
for various types of compensation relationships. The Company will endeavor to
ensure that all of its financial relationships qualify for one or more
exemptions under the Stark law. However, there can be no assurance that the
Company will be successful in structuring all of its relationships with
physicians so as to qualify for protection under one or more of the Stark law's
exceptions.
CALIFORNIA PHYSICIAN SELF-REFERRAL LAW RESTRICTIONS on financial
relationships between physicians and businesses to which they refer patients for
specified types of services, including some services which will be provided by
the Hospitals, also exist under California law. As is the case under federal
law, the California self-referral restrictions can be triggered by financial
relationships other than ownership. However, these laws contain a broad
exemption permitting referrals to be made to a hospital so long as the referring
physician is not compensated by the hospital for the referral and any equipment
lease between the hospital and the physician satisfies certain requirements.
An additional requirement imposed by California's self-referral laws is
that any non-emergency imaging services performed for a Workers' Compensation
patient with equipment that, when new, had a value of $400,000 or more must be
pre-approved by the Workers' Compensation insurer or self-insured employer. This
provision may require that preauthorization be obtained for MRI services ordered
by the Hospitals' physician owners and others who have financial relationships
with the Company. It is possible that insurers may refuse to provide any
required preauthorizations in connection with referrals of Workers' Compensation
patients made to the Hospitals by physicians who have financial relationships
with it. However, given that MRI services for Workers' Compensation patients are
not anticipated to represent a material portion of the Hospitals' services, the
Company does not believe that any such refusals to provide required
preauthorizations would have a material impact upon it.
LICENSING
Health facilities, including the Hospitals, are subject to numerous legal,
regulatory, professional and private licensing, certification and accreditation
requirements. These include requirements relating to Medicare participation and
payment, state licensing agencies, private payers and the Joint Commission on
Accreditation of Healthcare Organizations ("Joint Commission"). Renewal and
continuance of certain of these licenses, certifications and accreditations are
based on inspections, surveys, audits, investigations or other reviews, some of
which may require or include affirmative action or response by the Company.
These activities generally are conducted in the normal course of business of
health facilities. Nevertheless, an adverse determination could result in a loss
or reduction in a Hospital's scope of licensure, certification or accreditation,
or could reduce the payment received or require repayment of amounts previously
remitted. Any failure to obtain, renew or continue a license, certification or
accreditation required for operation of a Hospital could result in the loss of
utilization or revenues, or the loss of the Company's ability to operate all or
a portion of a Hospital, and, consequently, could have a material and adverse
effect on the Company.
DISCLOSURE OF FINANCIAL INTERESTS
California law provides that it is unlawful for a physician to refer a
patient to an organization in which the physician or the physician's immediate
family has a significant beneficial interest unless the physician first
discloses in writing to the patient that there is such an interest and advises
the patient regarding alternative services, if such services are available. A
"significant beneficial interest" means any financial interest equal to or
greater than the lesser of five percent of the total beneficial interest or
$5,000. This disclosure requirement may be satisfied by the posting of a
conspicuous sign likely to be seen by all patients who use the facility or by
providing patients with written disclosure statements. Physicians must also make
disclosure of entities in which they hold significant financial interests to a
patient's payer upon the request of the payer (not to be made more than once a
year). A violation of this disclosure requirement constitutes "unprofessional
conduct," and is grounds for the suspension or revocation of the physician's
license. Further, it is deemed a misdemeanor punishable by imprisonment not to
exceed six months, or by a fine not to exceed $2,500.
11
In addition, California's general self-referral laws require that any
physician who refers a person to, or seeks consultation from an organization in
which the physician has a financial interest, must disclose the financial
interest to the patient, or the parent or legal guardian of the patient, in
writing, at the time of the referral or request for consultation. This
requirement applies regardless of whether the financial interest is otherwise
protected by one of the exemptions under the self-referral law. There is no
minimum threshold of ownership required in order for this disclosure requirement
to be triggered, and this disclosure requirement cannot be satisfied by the
posting of a sign. A violation of this disclosure requirement may be subject to
civil penalties of up to $5,000.00 for each offense. Physician investors in the
Company will be individually responsible for complying with these disclosure
requirements with respect to their referrals to the Hospital. The obligation of
physicians with financial interests in the Company to make such disclosures or
the effect of such disclosures on patients may have an adverse impact on the
Company.
HIPAA
The Health Insurance Portability and Accountability Act of 1996 and its
implementing regulations ("HIPAA") mandated the adoption of standards for the
exchange of health information in an effort to encourage overall administrative
simplification and enhance the effectiveness and efficiency of the health care
industry. Under HIPAA, health care providers and other "covered entities" such
as health insurance companies and other third-party payers, must adopt uniform
standards for the electronic transmission of, billing statements and insurance
claims forms. These standards require the use of standard data formats and code
sets when electronically transmitting information in connection with health
claims and equivalent encounter information, health care payment and remittance
advice and health claim status. If we or our payers are unable to exchange
information in connection with the specified transactions because of an
inability to comply fully with the regulations, we are required to exchange the
information using paper. If we are forced to submit paper claims to payers, it
will significantly increase our costs associated with billing and could delay
payment of claims.
On January 23, 2004, DHHS published a final rule that adopted the National
Provider Identifier ("NPI") as the standard unique health identifier for health
care providers. When the NPI is implemented, health care providers, including
our Hospitals, must use only the NPI to identify themselves in connection with
electronic transactions. Legacy numbers, such as Medicaid numbers, CHAMPUS
numbers and Blue Cross-Blue Shield numbers, will not be permitted. Health care
providers will no longer have to keep track of multiple numbers to identify
themselves in the standard electronic transactions with one or more health
plans. The NPI is a 10-digit all numeric number that will be assigned to
eligible health care providers, including our hospitals, by the National
Provider System ("NPS"), an independent government contractor. Our hospitals
must obtain and start using NPIs in connection with the standard electronic
transactions no later than May 23, 2007. Compliance with this deadline was
extended recently to May 23, 2008 provided we exercise diligent efforts to
implement our use of NPIs.
DHHS also has promulgated security standards and privacy standards which
are aimed, in part, at protecting the confidentiality, availability and
integrity of health information by health plans, health care clearinghouses and
health care providers that receive, store, maintain or transmit health and
related financial information in electronic form, regardless of format. The
privacy standards require compliance with rules governing the use and disclosure
of patient health and billing information. They create new rights for patients
in their health information, such as the right to amend their health
information, and they require us to impose these rules, by contract, on any
business associate to which we disclose such information to perform functions on
our behalf. These provisions required us to implement expensive computer
systems, employee training programs and business procedures to protect the
privacy and security of each patient health information and enable electronic
billing and claims submissions consistent with HIPAA.
The security standards require us to maintain reasonable and appropriate
administrative, technical and physical safeguards to ensure the integrity,
confidentiality and the availability of electronic health and related financial
information. The security standards were designed to protect electronic
information against reasonably anticipated threats or hazards to the security or
integrity of the information and to protect the information against unauthorized
use or disclosure.
HIPAA provides both criminal and civil fines and penalties for covered
entities that fail to comply with it. Violations of the privacy or security
standards could result in civil penalties of up to $25,000 per violation in each
calendar year and criminal penalties of up to $250,000 per violation. In
addition, the Hospitals are also subject to state privacy laws, which in some
cases are more restrictive than HIPAA and impose additional penalties.
Compliance with the HIPAA privacy, security and electronic transmission
regulations will require significant changes in information and claims
processing practices utilized by health care providers, including the Company.
Estimates vary widely on the economic cost of implementing these provisions of
HIPAA. DHHS estimates the total nationwide cost of compliance with the privacy
rule alone at approximately five billion dollars; the Blue Cross and Blue Shield
Association estimated that the nationwide cost of compliance may exceed forty
billion dollars. As such, the future financial effect of these regulations on
the Company is uncertain at this time.
12
CORPORATE PRACTICE OF MEDICINE
California has laws that prohibit non-professional corporations and other
entities from employing or otherwise controlling physicians or that prohibits
certain direct and indirect payment arrangements between health care providers.
Although we intend to exercise care in structuring our arrangements with health
care providers to comply with relevant California law, and we believe that such
arrangements will comply with applicable laws in all material respects, we
cannot give you any assurance that governmental officials charged with
responsibility for enforcing these laws will not assert that the Company, or
certain transactions that we are involved in, are in violation of such laws, or
that the courts will ultimately interpret such laws in a manner consistent with
our interpretations.
CERTAIN ANTITRUST CONSIDERATIONS
The addition of physician-investors in the Company could affect
competition in the geographic area in which its Hospitals operate in various
ways. Such effects on competition could give rise to claims that the Hospitals,
their arrangements with consumers and business entities or with physicians
violate federal and state antitrust and unfair competition laws under a variety
of theories. Accordingly, there can be no assurance that the activities or
operations of the Hospitals will comply with federal and state antitrust or
unfair competition laws, or that the Federal Trade Commission, the Antitrust
Division of the Department of Justice, or any other party, including a physician
participating in the Company's business, or a physician denied participation in
the Company's business, will not challenge or seek to delay or enjoin the
activities of the Company on antitrust or other grounds. If such a challenge is
made, there can be no assurance that such challenge would be unsuccessful. We
have not obtained an analysis of any possible antitrust implications of the
activities of the Company or of the continuing arrangements and anticipated
operations of the Hospitals.
ENVIRONMENTAL REGULATIONS
Our health care operations generate medical waste that must be disposed of
in compliance with federal, state and local environmental laws, rules and
regulations. Our operations, as well as our purchases and sales of facilities,
also are subject to compliance with various other environmental laws, rules and
regulations.
CORPORATE HISTORY
The Company was originally incorporated under the laws of the State of
Utah on July 31, 1984 under the name "Aquachlor Marketing Inc." On December 23,
1988, the Company reincorporated in the State of Nevada. From 1989 until 2003,
the Company was a development stage company with no material assets, revenues or
business operations. On November 18, 2003, a group of investors purchased a
controlling interest in the Company (then known as First Deltavision) with the
objective of transforming the Company into a leading provider of high quality,
cost-effective healthcare through the acquisition and management of financially
distressed and/or under performing hospitals and other healthcare facilities. On
September 29, 2004, the Company entered into a definitive agreement to acquire
the four Hospitals from Tenet and the transaction closed on March 8, 2005
In the first quarter of 2004, the Company changed its fiscal year end from
June 30 to December 31, and changed the Company's name to "Integrated Healthcare
Holdings, Inc". On December 21, 2006, the Company changed its fiscal year end
from December 31 to March 31.
Our principal executive offices are located at 1301 North Tustin Avenue,
Santa Ana, California 92705, and our telephone number is (714) 953-3503.
ITEM 1A. RISK FACTORS
An investment in our common stock involves a high degree of risk. You
should consider carefully the following information about these risks, together
with the other information contained in this report, before you decide to buy
our common stock. The risks and uncertainties described below are not the only
ones we face. Additional risks and uncertainties not presently known to us or
that we currently deem immaterial may also impair our operations. If any of the
following risks actually occur, our business would likely suffer and our results
could differ materially from those expressed in any forward-looking statements
contained in this Annual Report on Form 10-K including our consolidated
financial statements and related notes. In such case, the trading price of our
common stock could decline, and you may lose all or part of the money you paid
to buy our common stock.
13
ALL OF OUR LONG-TERM AND OTHER DEBT HAS MATURED AND OUR LENDER HAS
DECLARED US IN DEFAULT. WE ARE CURRENTLY OPERATING UNDER AN AGREEMENT TO
FORBEAR.
On March 8, 2007, approximately $83 million in long-term and other debt
that we owe to Medical Provider Financial Corporation II or its affiliates
matured. On June 13, 2007 the Company received a notice of default on this debt
from the lender. On June 18, 2007, the Company entered into a forbearance
agreement with the lender. This agreement provides, among other provisions, that
the lender will forgo exercising any of its rights and remedies under the
various credit agreements, for a period of ninety days. During this time the
Company intends to continue its efforts to refinance its existing matured debt.
There can be no assurance, however, that the Company will able to raise
sufficient funds to cure its defaulted debt obligations and/or refinance this
debt. If the Company cannot refinance, restructure or retire this debt or raise
sufficient additional capital, the Company's status as a viable going business
concern will remain in doubt and we may be forced to curtail or cease our
operations or declare bankruptcy, which would likely cause our shareholders to
lose all or substantially all of their investment in the Company.
WE MUST OBTAIN ADDITIONAL CAPITAL WHICH, IF AVAILABLE, WILL LIKELY RESULT
IN SUBSTANTIAL DILUTION TO OUR CURRENT SHAREHOLDERS.
We will require additional capital to fund our business. If we raise
additional funds through the issuance of common or preferred equity, warrants or
convertible debt securities, these securities will likely substantially dilute
the equity interests and voting power of our current shareholders, and may have
rights, preferences or privileges senior to those of the rights of our current
shareholders. We cannot predict whether additional financing will be available
to us on favorable terms or at all.
WE ARE CURRENTLY INVOLVED IN LITIGATION WITH VARIOUS MEMBERS OF OUR BOARD
OF DIRECTORS AND SIGNIFICANT SHAREHOLDERS.
On May 14, 2007, IHHI filed suit in Orange County Superior Court against
three of the six members of its Board of Directors and also against IHHI's
largest shareholder, Orange County Physician Investment Network, LLC ("OC-PIN").
Among other things, the suit alleges that the defendants breached fiduciary
duties owed to IHHI by putting their own economic interests above those of IHHI,
its other shareholders, creditors, employees and the public-at-large. The suit
also alleges that defendants' attempt to change IHHI's management and control of
the existing Board could trigger an "Event of Default" under the express terms
of IHHI's existing credit agreements with its secured lender.
On May 17, 2007, OC-PIN filed a separate suit against IHHI in Orange
County Superior Court. OC-PIN's suit alleges the management issue referred to
above must be resolved prior to the completion of the refinancing. OC-PIN
further alleges that IHHI's President has failed to call a special shareholders'
meeting so that OC-PIN could fill positions on IHHI's Board of Directors.
Both actions have been consolidated so they can be heard before one judge.
IHHI has filed a motion to appoint an independent provisional director to the
vacant seventh Board seat. OC-PIN has filed an application for an order noticing
a special shareholders meeting. These and other preliminary matters were heard
on July 2, 2007 and a ruling issued on July 11, 2007 appointing an independent
director for the term of the lawsuit.
The circumstances underlying this litigation have been a significant
distraction to Company management and the Board of Directors, and may have
prevented the Company from pursuing a successful restructuring of its business
and other profitable business opportunities.
WE HAVE INCURRED A SIGNIFICANT LOSS IN OPERATIONS TO DATE. IF OUR
SUBSTANTIAL LOSSES CONTINUE, THE MARKET VALUE OF OUR COMMON STOCK WILL LIKELY
DECLINE AND WE MAY LACK THE ABILITY TO CONTINUE AS A GOING CONCERN.
As of March 31, 2007, we had an accumulated deficit (in thousands) of
$65,390. We incurred a net loss of $ 20,538 for the year ended March 31, 2007.
This loss, among other things, has had a material adverse effect on our
stockholders' equity and working capital. All of the Company's debt matured
prior to year end and the Company is currently operating under a ninety day
forbearance agreement with its lenders to obtain new financing. The Hospitals
continued to experience losses at levels comparable to their pre-acquisition
performance. We are attempting to improve our operating results and financial
condition through a combination of contract negotiations, expense reductions,
and new issues of equity. However, new issues of equity are encumbered by
warrant anti dilution provisions and there can be no assurance that we will
achieve profitability in the future. If we are unable to achieve and maintain
profitability, the market value of our common stock will likely decline, and we
may lack the ability to continue as a going concern.
14
OUR INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM HAS EXPRESSED DOUBT
ABOUT OUR ABILITY TO CONTINUE AS A GOING CONCERN.
Our consolidated financial statements as of March 31, 2007 have been
prepared under the assumption that we will continue as a going concern for the
year ending March 31, 2008. Our independent registered public accounting firm
has issued a report (see F-1) that included an explanatory paragraph referring
to our losses from operations and net capital deficiency and expressing
substantial doubt as to our ability to continue as a going concern without
additional capital becoming available. Our ability to continue as a going
concern in the long term is dependent upon our ability to obtain additional
equity or debt financing, attain further operating efficiencies, reduce
expenditures, and, ultimately, to generate revenues and net income. The
financial statements presented in this report do not include any adjustments
that might result from the outcome of this uncertainty.
WE HAVE A HIGH DEGREE OF LEVERAGE AND SIGNIFICANT DEBT SERVICE
OBLIGATIONS.
The debt service requirements on our $83 million in debt amount to
approximately $0.9 million per month. Our relatively high level of debt and debt
service requirements have several effects on our current and future operations,
including the following: (i) we will need to devote a significant portion of our
cash flow to service debt, reducing funds available for operations and future
business opportunities and increasing our vulnerability to adverse economic and
industry conditions and competition; (ii) our leveraged position increases our
vulnerability to competitive pressures; (iii) the covenants and restrictions
contained in agreements relating to our indebtedness restrict our ability to
borrow additional funds, dispose of assets, issue additional equity or pay
dividends on or repurchase common stock; and (iv) funds available for working
capital, capital expenditures, acquisitions and general corporate purposes are
limited. Any default under the documents governing our indebtedness could have a
significant adverse effect on our business and the market value of our common
stock.
THE SUCCESS OF THE COMPANY WILL DEPEND ON PAYMENTS FROM THIRD PARTY
PAYERS, INCLUDING GOVERNMENT HEALTH CARE PROGRAMS. IF THESE PAYMENTS ARE REDUCED
OR DELAYED, OUR REVENUE WILL DECREASE.
We will be largely dependent upon private and governmental third party
sources of payment for the services provided to patients in the Hospitals. The
amount of payment a hospital receives for the various services it renders will
be affected by market and cost factors, perhaps adversely, as well as other
factors over which we have no control, including political concerns over the
cost of medical care, Medicare and Medicaid regulations and the cost containment
and utilization decisions of third party payers. Any meaningful reduction in the
amounts paid by these third party payers for services rendered at the Hospitals
will have a material adverse effect on our revenues.
PROVIDING QUALITY MEDICAL SERVICES FROM TALENTED PHYSICIANS IS CRITICAL TO
OUR BUSINESS.
Our business model depends, in large part, upon the efforts and success of
the physicians who will perform services at the Hospitals and the strength of
our relationships with these physicians. Any failure of these physicians to
maintain the quality of medical care provided or to otherwise adhere to
professional guidelines at the Hospitals, or any damage to the reputation of a
key physician or group of physicians, could damage the Company's and the
Hospitals' reputations in the medical marketplace and may subject us to
liability and significantly reduce our revenue and increase our costs.
IF EITHER THE COMPANY OR THE HOSPITALS FAIL TO COMPLY WITH APPLICABLE LAWS
AND REGULATIONS, WE MAY SUFFER PENALTIES OR BE REQUIRED TO MAKE SIGNIFICANT
CHANGES TO OUR OPERATIONS.
The Company and the Hospitals are subject to many laws and regulations at
the federal, state and local levels. These laws and regulations require the
Hospitals to meet various licensing, certification and other requirements,
including those relating to:
o physician ownership of the Hospital;
o payments to specialty hospitals, should any of the Hospitals be
determined to be a specialty hospital;
o prohibited inducements for patient referrals and restrictions on
payments for marketing;
o the adequacy of medical care, equipment, personnel, operating
policies and procedures;
o maintenance and protection of records; and
o environmental protection.
15
If the Company fails to comply with applicable laws and regulations, it
could suffer civil or criminal penalties. A number of initiatives have been
proposed during the past several years to reform various aspects of the health
care system. In the future, different interpretations or enforcement of existing
or new laws and regulations could subject the current practices to allegations
of impropriety or illegality, or could require the Company to make changes in
its facilities, equipment, personnel, services, capital expenditure programs and
operating expenses. Current or future legislative initiatives or government
regulation may have a material adverse effect on the Hospitals' operations or
reduce the demand for their services.
THE COMPANY CONDUCTS ON-GOING REVIEWS OF ITS COMPLIANCE WITH VARIOUS LAWS
RELATED TO PHYSICIAN ARRANGEMENTS, WHICH MAY REVEAL VIOLATIONS THAT COULD
SUBJECT THE COMPANY TO FINES OR PENALTIES.
The Company and the Hospitals have entered into a variety of relationships
with physicians. In an increasingly complex legal and regulatory environment,
these relationships may pose a variety of legal or business risks. The Company
conducts reviews of its compliance with the federal Anti-kickback Statute, Stark
law and other applicable laws as they relate to the Company's relationships with
referring physicians.
The Company's largest shareholder, OC-PIN, is owned and controlled by
physicians who also refer to and practice at the Hospitals. OC-PIN may receive
dividends as a shareholder. In addition, three of the members of OC-PIN serve as
members of the Board of Directors of the Company, which directors receive
payment for their services as directors. One of these directors is also
the Chairman of our Board. One OC-PIN director was also formerly
employed by the Company, Dr. Anil Shah, and the Company has severed that
employment relationship and is currently making payment under a severance
package in accordance with the employment agreement. In addition, the Hospitals
have various relationships with physicians who are not owners of the Company, as
well as with OC-PIN physicians, including medical directorships, sharing in risk
pools and service arrangements.
The Company has undertaken a review of its agreements with physicians and
has a review process in place to ensure that such agreements are in writing and
comply with applicable laws. Although there may have been arrangements in the
past with physicians that may not have been memorialized in a written agreement
or may have expired and not been timely renewed or may have been entered into
after services commenced, each of which may have lead to violations of the Stark
law, the Company's current review process should prevent such occurrences.
Additionally, the Company has reviewed the terms of the purchase of ownership
interests in the Company by OC-PIN (which is owned by physicians that refer
patients to the Hospitals) and has determined that the purchase should be
determined to be permissible under applicable law. The Company has also reviewed
certain related party transactions, such as director fees for physician
directors and payment of the employment severance package to Dr. Anil Shah, an
OC-PIN member. In addition, the Company is in the process of reviewing the
related party lease with Pacific Coast Holdings Investment, LLC, a company owned
directly or indirectly by two of the Company's largest shareholders. If the
Company or the Hospitals are not in compliance with federal and state fraud and
abuse laws and physician self-referral laws, the Company could be subject to
repayment obligations, fines, penalties, exclusive from participation in federal
health care programs, and other sanctions which would have a material adverse
effect on the Company's profitability.
COST CONTAINMENT PROGRAMS IMPOSED BY THIRD-PARTY PAYERS, INCLUDING
GOVERNMENT HEALTH CARE PROGRAMS, MAY DECREASE THE COMPANY'S REVENUE.
The health care industry is currently undergoing significant changes and
is regularly subject to regulatory and political intervention. We expect to
derive a considerable portion of the Company's revenue through the Hospitals
from government-sponsored health care programs and third-party payers (such as
employers, private insurers, HMOs or preferred provider organizations). The
health care industry is experiencing a trend toward cost containment as
government and private third-party payers seek to impose lower payment and
utilization rates and negotiate reduced payment schedules with service
providers. The Company believes that these trends will continue to result in a
reduction from historical levels in per-patient revenue for hospitals. It is
distinctly possible that reimbursement from government and private third-party
payers for many procedures performed at the Hospital may be reduced in the
future. Further reductions in payments or other changes in reimbursement for
health care services could have a material adverse effect on the Company's
business, financial condition and/or results of operations. Further, rates paid
by private third-party payers are generally higher than Medicare, Medicaid and
HMO payment rates. Any decrease in the relative number of patients covered by
private insurance would have a material adverse effect on the Company's revenues
and operations.
16
MEDICAL STAFF
The primary relationship between a hospital and physicians who practice in
it is through the hospital's organized medical staff. Medical staff bylaws,
rules and policies establish the criteria and procedures at acute care
hospitals, by which a physician may have his or her privileges, participation or
membership curtailed, denied or revoked. Physicians who are denied medical staff
membership or certain clinical privileges, or who have such membership,
participation or privileges curtailed, denied or revoked often file legal
actions against hospitals. Such actions may include a wide variety of claims,
some of which could result in substantial uninsured damages to a hospital. In
addition, failure of the governing body to adequately oversee the conduct of its
medical staff may result in hospital liability to third parties.
LICENSING, SURVEYS, INVESTIGATIONS AND AUDITS
Health facilities, including the Hospitals, are subject to numerous legal,
regulatory, professional and private licensing, certification and accreditation
requirements. These include requirements relating to Medicare participation and
payment, state licensing agencies, private payers and the Joint Commission.
Renewal and continuance of certain of these licenses, certifications and
accreditations are based on inspections, surveys, audits, investigations or
other reviews, some of which may require or include affirmative action or
response by the Company. These activities generally are conducted in the normal
course of business of health facilities. Nevertheless, an adverse determination
could result in a loss or reduction in a Hospital's scope of licensure,
certification or accreditation, or could reduce the payment received or require
repayment of amounts previously remitted. Any failure to obtain, renew or
continue a license, certification or accreditation required for operation of a
Hospital could result in the loss of utilization or revenues, or the loss of the
Company's ability to operate all or a portion of a Hospital, and, consequently,
could have a material and adverse effect on the Company.
NURSING SHORTAGE
Health care providers depend on qualified nurses to provide quality
service to patients. There is currently a nationwide shortage of qualified
nurses. This shortage and the more stressful working conditions it creates for
those remaining in the profession are increasingly viewed as a threat to patient
safety and may trigger the adoption of state and federal laws and regulations
intended to reduce that risk. For example, California has adopted legislation
and regulations mandating a series of specific minimum patient-to-nurse ratios
in all acute care hospital nursing units. Any failure by the Hospital to comply
with nurse staff ratios could result in action by licensure authorities and may
constitute evidence of negligence per se in the event any patient is harmed as
the result of inadequate nurse staffing. The vast majority of hospitals in
California, including ours, are not at all times meeting the state mandated
nurse staffing ratios.
In response to the shortage of qualified nurses, health care providers
have increased and could continue to increase wages and benefits to recruit or
retain nurses and have had to hire expensive contract nurses. The shortage could
also limit the operations of healthcare providers by limiting the number of
patient beds available. The Company has increased and is likely to have to
continue to increase wages and benefits to recruit and retain nurses. The
Company may also need to engage expensive contract nurses until permanent staff
nurses can be hired to replace any departing nurses.
UNION CONTRACTS HAVE EXPIRED AND THERE CAN BE NO ASSURANCE THAT OPERATIONS
WILL REMAIN LEVEL IN THE EVENT OF A LABOR DISPUTE
Approximately 16% of our employees were represented by labor unions as of
March 31, 2007. On December 31, 2006, our collective bargaining agreements with
the California Nurses Association covering certain of our nursing staff and with
the Service Employee International Union covering certain of clerical and other
staff expired. Terms of the expired collective bargaining agreements remain in
place until new agreements are reached. We are currently negotiating with these
unions regarding successor collective bargaining agreements. Although the new
agreements are expected to have provisions to increase wages and benefits, the
unions have agreed to an arbitration process to resolve any issues not resolved
through normal renegotiations. The agreed-to arbitration process provides the
greatest assurance that the unions will not engage in strike activity during the
negotiation of new agreements and prevents the arbitrator from ordering us to
pay market-leading wages for a particular hospital. We do not anticipate the new
agreements will have a material adverse effect on our results of operations.
17
Both unions have filed grievances in connection with allegations the
agreement obligated the Company to contribute to a Retiree Medical Benefit
Account. The Company does not agree with this interpretation of the agreement
but has agreed to submit the matter to arbitration. CNA has also filed
grievances related to the administration of increases at one facility, change in
pay practice at one facility and several wrongful terminations. We do not
anticipate resolution of the arbitrations will have a material adverse effect on
our results of operations.
EARTHQUAKE SAFETY COMPLIANCE
The Hospitals are located in an area near active and substantial
earthquake faults. The Hospitals carry earthquake insurance with a policy limit
of $50 million. A significant earthquake could result in material damage and
temporary or permanent cessation of operations at one or more of the Hospitals.
In addition, the State of California has imposed new hospital seismic safety
requirements. Under these new requirements, the Hospitals must meet stringent
seismic safety criteria in the future, and, must complete one set of seismic
upgrades to each facility by January 1, 2013. This first set of upgrades is
expected to require the Company to incur substantial seismic retrofit expenses.
There are additional requirements that must be complied with by 2030. The costs
of meeting these requirements have not yet been determined. Compliance with
seismic ordinances will be a costly venture and could have a material adverse
effect on our cash flow.
WE FACE INTENSE COMPETITION IN OUR BUSINESS.
The healthcare industry is highly competitive. We compete with a variety
of other organizations in providing medical services, many of which have greater
financial and other resources and may be more established in their respective
communities than we are. Competing companies may offer newer or different
centers or services than we do and may thereby attract patients or customers who
are presently patients, customers or are otherwise receiving our services.
WE MAY BE LIABLE FOR LOSSES NOT COVERED BY OR IN EXCESS OF OUR INSURANCE.
An increasing trend in malpractice litigation claims, rising costs of
malpractice litigation, losses associated with these malpractice lawsuits and a
constriction of insurers have caused many insurance carriers to raise the cost
of insurance premiums or refuse to write insurance policies for hospital
facilities. Accordingly, we have increased on retention limits and our estimated
reserves may not be adequate.
A SIGNIFICANT PORTION OF OUR BUSINESS IS CONCENTRATED IN CERTAIN MARKETS
AND THE RESPECTIVE ECONOMIC CONDITIONS OR CHANGES IN THE LAWS AFFECTING OUR
BUSINESS IN THOSE MARKETS COULD HAVE A MATERIAL ADVERSE EFFECT ON THE COMPANY.
We receive all of our inpatient services revenue from operations in Orange
County, California. The economic condition of this market could affect the
ability of our patients and third-party payers to reimburse us for our services,
through its effect on disposable household income and the tax base used to
generate state funding for Medicaid programs. An economic downturn, or changes
in the laws affecting our business in our market and in surrounding markets,
could have a material adverse effect on the Company.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
18
ITEM 2. PROPERTIES
In March 2005, the Company completed the acquisition of the Hospitals and
their associated real estate from Tenet. At the closing of the acquisition, the
Company transferred all of the fee interests in the acquired real estate to
Pacific Coast Holdings Investment, LLC, a company owned directly or indirectly
by two of the Company's largest shareholders. The Company entered into a Triple
Net Lease, dated March 7, 2005, under which it leased back from PCHI all of the
real estate that it transferred to PCHI. Additionally, the Company leases
property from other lessors. As of March 31, 2007, the Company's principal
facilities are listed in the following table:
APPROXIMATE
AGGREGATE
SQUARE LEASE INITIAL LEASE
PROPERTY FOOTAGE RATE EXPIRATION
-------- ------- ---- ----------
Western Medical Center-Santa Ana 360,000 See note 1. Feb. 28, 2030
1001 North Tustin Avenue
Santa Ana, CA 92705
Administrative Building 40,000 See note 1. Feb. 28, 2030
1301 N. Tustin Avenue
Santa Ana, CA
Western Medical Center-Anaheim 132,000 See note 1 Feb. 28, 2030
1025 South Anaheim Boulevard
Anaheim, CA 92805
Coastal Communities Hospital 115,000 See note 1. Feb. 28, 2030
2701 South Bristol Street
Santa Ana, CA 92704
Doctor's Hospital Medical Office Building 37,000 See note 2. March 30, 2009
1901/1905 N. College Avenue
Santa Ana, CA 92706
Chapman Medical Center 140,000 See note 3. December 31, 2023
2601 East Chapman Avenue
Orange, CA 92869
1. Initial monthly lease rate for all five properties equals one twelfth
of (a) the amount obtained by multiplying $50 million by the sum of the
average annual interest rate charged on the loan secured by the first lien
deed of trust on the Hospital Properties for the preceding month (the
"Real Estate Loan") plus the "landlord's spread" (for the first year, the
difference between 12% and the annual interest rate on the Real Estate
Loan up to 2.5%, and then 2.5% thereafter), plus (b) beginning on the
earlier of the refinancing of the Hospital Properties or March 8, 2007,
$2.5 million and CPI adjustments (this is subject to the Forbearance
Agreement). This is leased from PCHI.
2. Initial monthly lease rate for all of the medical office properties
equals the rent received from the tenants of these properties less the
actual monthly costs to operate the properties, including insurance and
real property taxes. This is leased from PCHI.
3. Leased from an unrelated party. Monthly lease payments are
approximately $112,092.
The State of California has established standards intended to ensure that
all hospitals in the state withstand earthquakes and other seismic activity
without collapsing or posing the threat of significant loss of life. We are
required to meet these standards by December 31, 2012. In addition, over time,
hospitals must meet performance standards meant to ensure that they are capable
of providing medical services to the public after an earthquake or other
disaster. Ultimately, all general acute care hospitals in California must
conduct all necessary seismic evaluations and be retrofitted, if needed, by 2030
to be in substantial compliance with the highest seismic performance standards.
Management has not completed engineering studies nor developed compliance plans
for the acquired hospitals. At this time, all of our general acute care
hospitals in California are in compliance with all current seismic requirements.
Until completion of the engineering studies, the Company is unable to estimate
the costs of complying with future seismic regulations, which could be material.
The Company believes that its current leased space is adequate for its
Current purposes and for the next fiscal year.
19
ITEM 3. LEGAL PROCEEDINGS
On May 14, 2007, IHHI filed suit in Orange County Superior Court against
three of the six members of its Board of Directors and also against IHHI's
largest shareholder, OC-PIN. Among other things, the suit alleges that the
defendants breached fiduciary duties owed to IHHI by putting their own economic
interests above those of IHHI, its other shareholders, creditors, employees and
the public-at-large. The suit also alleges that defendants' attempt to change
IHHI's management and control of the existing Board could trigger an "Event of
Default" under the express terms of IHHI's existing credit agreements with its
secured lender. IHHI is seeking, among other items, the appointment of an
independent and impartial provisional director.
On May 17, 2007, OC-PIN filed a separate suit against IHHI in Orange
County Superior Court. OC-PIN's suit alleges the management issue referred to
above must be resolved prior to the completion of the refinancing. OC-PIN
further alleges that IHHI's President has failed to call a special shareholders'
meeting so that OC-PIN could fill positions on IHHI's Board of Directors. OC-PIN
seeks, among other items, to require IHHI to hold a special shareholders meeting
whereat the shareholders would vote to fill the vacant seat on the Board of
Directors.
Both actions have been consolidated so they can be heard before one judge.
IHHI has filed a motion to appoint an independent provisional director to the
vacant seventh Board seat. OC-PIN has filed an application for an order noticing
a special shareholders meeting. These and other preliminary matters were heard
on July 2, 2007 and a ruling issued on July 11, 2007 appointing an independent
director for the term of the lawsuit.
In late May 2007, Western Medical Center, Santa Ana ("Medical Center") was
notified by a May 25, 2007 letter from the U.S. Department of Health Services,
Centers for Medicare and Medicaid Services ("CMS"), that CMS had identified one
case that was a potential violation of the federal patient anti-dumping law
(officially, the Emergency Medical Treatment and Active Labor Act or "EMTALA").
In June 2007, Lumetra, a Medicare quality improvement organization, notified
Medical Center that it was aiding CMS in its investigation of the same matter.
Medical Center has responded to CMS and Lumetra that its actions were
appropriate and did not violate EMTALA. The complaint from CMS and the notice
from Lumetra are the first steps in a determination by the Office of Inspector
General ("OIG") of the U.S. Department of Health and Human Services whether to
seek enforcement action for a violation of EMTALA. The potential sanctions which
may be imposed by the OIG for a violation of EMTALA are a civil money penalty up
to $50,000 for a confirmed violation and possible exclusion from the Medicare
and Medi-Cal Programs. The Company has notified both CMS and Lumetra that it
believes that a violation of the EMTALA statutes and regulations did not occur
nor should it be subject to any civil money penalties. As a prophylactic matter
it has also reviewed and revised its policies and procedures regarding
communication and admission practices through the hospital's emergency
department and has conducted further EMTALA in service training.
Approximately 16% of the Company's employees were represented by labor
unions as of March 31, 2007. On December 31, 2006, the Company's collective
bargaining agreements with SEIU and CNA expired. Terms of the expired collective
bargaining agreements remain in place until new agreements are reached. The
Company is currently negotiating with these unions regarding successor
collective bargaining agreements. Although the new agreements are expected to
have provisions to increase wages and benefits, the unions have agreed to an
arbitration process to resolve any issues not resolved through normal
renegotiations. The agreed-to arbitration process provides the greatest
assurance that the unions will not engage in strike activity during the
negotiation of new agreements and prevents the arbitrator from ordering us to
pay market-leading wages for a particular hospital. The Company does not
anticipate the new agreements will have a material adverse effect on our results
of operations.
Both unions have filed grievances in connection with allegations the
agreement obligated the Company to contribute to a Retiree Medical Benefit
Account. The Company does not agree with this interpretation of the agreement
but has agreed to submit the matter to arbitration. CNA has also filed
grievances related to the administration of increases at one facility, change in
pay practice at one facility and several wrongful terminations. We do not
anticipate resolution of the arbitrations will have a material adverse effect on
our results of operations.
We and our subsidiaries are involved in various other legal proceedings
most of which relate to routine matters incidental to our business. We do not
believe that the outcome of these matters is likely to have a material adverse
effect on the Company.
20
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our 2006 annual meeting of stockholders was held on November 29, 2006. Of
the 87,557,430 shares eligible to vote, 70,839,630 appeared by proxy and
established a quorum for the meeting. The matters listed in the table below were
approved by a majority of the shareholders appearing at the meeting.
ELECTION OF
DIRECTORS VOTES FOR VOTES AGAINST VOTES WITHHELD NOT VOTED
--------- --------- ------------- -------------- ---------
Maurice J. DeWald 70,703,430 0 136,200 16,717,800
Bruce Mogel 70,703,430 0 136,200 16,717,800
Ajay Meka, M.D. 70,703,430 0 136,200 16,717,800
Syed Salman J. Naqvi, M.D. 70,703,430 0 136,200 16,717,800
J. Fernando Niebla 70,703,430 0 136,200 16,717,800
Anil V. Shah, M.D. 65,327,430 0 5,512,200 16,717,800
APPROVAL OF 2006
STOCK INCENTIVE PLAN VOTES FOR VOTES AGAINST VOTES WITHHELD NOT VOTED
--------- ------------- -------------- ---------
70,745,130 94,500 0 16,717,800
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
The Company's common stock is listed for trading on the OTC Bulletin Board
under the symbol "IHCH.OB" The trading market for the Common Stock has been
extremely thin. In view of the extreme thinness of the trading market, the
prices reflected on the chart below as reported on the OTC Bulletin Board may
not be indicative of the price at which any prior or future transactions were or
may be effected in the Common Stock. Stockholders are cautioned against drawing
any conclusions from the data contained herein, as past results are not
necessarily indicative of future stock performance.
The following table sets forth the quarterly high and low bid price for
the Company's Common Stock for each quarter for the period from January 1, 2005
through March 31, 2007, as quoted on the Over-the-Counter Bulletin Board. Such
Over-the-Counter market quotations reflect inter dealer prices, without retail
mark-up, mark-down or commission, and may not necessarily represent actual
transactions.
- --------------------- ------------------- -------------------
PERIOD HIGH LOW
------ ---- ---
- --------------------- ------------------- -------------------
Jan 2005 - Mar 2005 $1.55 $0.36
- --------------------- ------------------- -------------------
Apr 2005- Jun 2005 $1.13 $0.61
- --------------------- ------------------- -------------------
Jul 2005 - Sep 2005 $0.80 $0.51
- --------------------- ------------------- -------------------
Oct 2005 - Dec 2005 $0.60 $0.35
- --------------------- ------------------- -------------------
Jan 2006 - Mar 2006 $0.50 $0.26
- --------------------- ------------------- -------------------
Apr 2006 - Jun 2006 $0.40 $0.15
- --------------------- ------------------- -------------------
Jul 2006 - Sep 2006 $0.25 $0.08
- --------------------- ------------------- -------------------
Oct 2006 - Dec 2006 $0.50 $0.10
- --------------------- ------------------- -------------------
Jan 2007--Mar 2007 $0.40 $0.20
- --------------------- ------------------- -------------------
As of the date of this report, there were approximately 226 record holders
of the Company's common stock; this number does not include an indeterminate
number of stockholders whose shares may be held by brokers in street name. The
Company has not paid and does not expect to pay any dividends on its shares of
common stock for the foreseeable future, as any earnings will be retained for
use in the business.
21
The following table provides summary information concerning the Company's
equity compensation plan as of March 31, 2007.
Equity Compensation Plan Information
- ------------------------------------------------------------------------------------------------------------
Plan Category Number of Securities to Weighted-average Number of securities
be issued upon exercise exercise price of remaining available for
of outstanding options, outstanding options, future issuance under
warrants and rights warrants and rights equity compensation
plans (excluding
securities reflected in
column (a))
(a) (b) (c)
- ------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------
Equity compensation
plans approved by - - 12,000,000
security holders
- ------------------------------------------------------------------------------------------------------------
Equity compensation
plans not approved by - - -
security holders
- ------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------
Total - - 12,000,000
- ------------------------------------------------------------------------------------------------------------
STOCK PERFORMANCE GRAPH
The following graph shows the cumulative, five year, split adjusted total
return for our Common Stock (including trading in our Common Stock under our
current name and under our previous name, First Deltavision, Inc.), compared to
two major indices. The Standard & Poor's 500 Stock Index includes 500 companies
representing all major industries. The Dow Jones US Healthcare Providers
measures owners and operators of providers of health care. Performance data
assumes that $100.00 was invested on March 31, 2002 in our Common Stock and each
of the indices. The data assumes the reinvestment of all cash dividends and the
cash value of other distributions. Stock price performance shown in the graph is
not necessarily indicative of future stock price performance.
[STOCK PERFORMANCE GRAPH APPEARS HERE]
S&P500 Close Index
- ------ ----- -----
29-Mar-02 1,147.39 100.00
31-Mar-03 848.18 73.92
31-Mar-04 1,126.21 98.15
31-Mar-05 1,180.59 102.89
31-Mar-06 1,302.89 113.55
31-Mar-07 1,422.53 123.98
IHHI Stock Price
- ----------------
29-Mar-02 2.25 100.00
31-Mar-03 0.40 17.78
31-Mar-04 0.72 32.00
31-Mar-05 1.07 47.56
31-Mar-06 0.30 13.33
31-Mar-07 0.12 5.33
Dow Jones US Healthcare Providers
- ---------------------------------
29-Mar-02 280.87 100.00
31-Mar-03 239.91 85.42
31-Mar-04 328.35 116.90
31-Mar-05 445.67 158.67
31-Mar-06 528.08 188.02
31-Mar-07 553.04 196.90
22
ITEM 6. SELECTED FINANCIAL DATA
The following selected condensed consolidated financial information should
be read in conjunction with "Item 7 - Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the consolidated financial
statements and footnotes included elsewhere in this Form 10-K. We had no
material business operations prior to the year ended December 31, 2004.
AT OR FOR THE PERIOD ENDED
($ in 000's except per share amounts)
Year ended Year ended Year ended Year ended Year ended
March 31, 2007 December 31, 2005 December 31, 2004 December 31, 2003 June 30, 2003
-------------- ----------------- ----------------- ----------------- -------------
(RESTATED)
SELECTED BALANCE SHEET DATA:
Net working capital $ (90,307) $ 8,063 $ (12,132) $ 149 $ (107)
Property and equipment 58,172 59,431 57 47 --
Other Assets -- 1,141 11,187 156 --
Long term debt -- 70,331 -- -- --
Warrant liability - non current -- 21,065 -- -- --
Capital lease obligations 5,834 4,961 -- -- --
Minority interest 1,716 3,342 -- -- --
Stockholders' Equity (Deficiency) (39,685) (31,064) (888) 353 (107)
SELECTED INCOME STATEMENT DATA:
Net operating revenue $ 350,672 $ 283,698 $ -- $ -- $ --
Salaries and Benefits (194,865) (153,574) -- -- --
Supplies (49,577) (39,250) -- -- --
Other Operating Expenses (66,229) (58,715) (1,840) (28) (35)
Warrant Expenses (693) (17,604) -- -- --
Depreciation and Amortization (2,495) (2,178) -- -- --
Interest Expense (12,515) (9,925) -- -- --
Provision for Income Taxes (5) (5) -- -- --
Net loss before minority interest (21,131) (46,833) (1,840) (28) (35)
Net loss attributable to common
stock $ (20,538) $ (45,175) $ (1,840) $ (28) $ (35)
============= ============= ============= ============= =============
PER SHARE DATA:
Net loss:
Basic and fully diluted $ (0.23) $ (0.50) $ (0.09) $ (0.01) $ (0.03)
Weighted average number of common
shares outstanding: 90,291 90,330 19,987 3,471 1,342
Long term debt and warrant liability non current as of March 31, 2007 were
$0 because all notes and warrants were due in less than one year.
23
On March 8, 2005 the Company completed the acquisition and commenced
operation of the Hospitals. Prior to that time the Company reported activity as
a development stage enterprise. The operating results data presented above are
not necessarily indicative of our future results of operations. Reasons for this
include, but are not limited to: changes in Medicare regulations; Medicaid
funding levels set by the State of California and the County of Orange; levels
of malpractice expense and settlement trends; availability of trained health
care personnel and changes in occupancy levels and patient volumes. Factors that
affect patient volumes and, thereby, our results of operations at our hospitals
and related health care facilities include, but are not limited to: (1)
unemployment levels; (2) the business environment of local communities; (3) the
number of uninsured and underinsured individuals in local communities treated at
our hospitals; (4) seasonal cycles of illness; (5) climate and weather
conditions; (6) physician recruitment, retention and attrition; (7) local health
care competitors; (8) managed care contract negotiations or terminations; (9)
factors relating to the timing of elective procedures.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
FORWARD-LOOKING INFORMATION
This Annual Report on Form 10-K contains forward-looking statements, as
that term is defined in the Private Securities Litigation Reform Act of 1995.
These statements relate to future events or our future financial performance. In
some cases, you can identify forward-looking statements by terminology such as
"may," "will," "should," "expects," "plans," "anticipates," "believes,"
"estimates," "predicts," "potential" or "continue" or the negative of these
terms or other comparable terminology. These statements are only predictions and
involve known and unknown risks, uncertainties and other factors, including the
risks discussed under the caption "Risk Factors" herein that may cause our
company's or our industry's actual results, levels of activity, performance or
achievements to be materially different from those expressed or implied by these
forward-looking statements.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Except as may be required by applicable
law, we do not intend to update any of the forward-looking statements to conform
these statements to actual results.
CURRENT LIQUIDITY
The Company is currently operating under a ninety day Agreement to Forbear
from its major lenders. Should the Company be unable to obtain financing from
another lender prior to the expiration of the forbearance period under the
Forbearance Agreement and the Lenders exercise their full remedies under the
current Credit Agreements, the Company believes that it will be unable to
continue as a going concern.
OVERVIEW
On March 8, 2005, the Company completed its acquisition (the
"Acquisition") of four Orange County, California Hospitals and associated real
estate, including: (i) 282-bed Western Medical Center - Santa Ana, CA; (ii)
188-bed Western Medical Center - Anaheim, CA; (iii) 178-bed Coastal Communities
Hospital in Santa Ana, CA; and (iv) 114-bed Chapman Medical Center in Orange, CA
(collectively, the "Hospitals") from Tenet Healthcare Corporation ("Tenet"). The
Hospitals were assigned to four wholly owned subsidiaries of the Company formed
for the purpose of completing the Acquisition. The Company also acquired the
following real estate, leases and assets associated with the Hospitals: (i) a
fee interest in the Western Medical Center at 1001 North Tustin Avenue, Santa
Ana, CA, a fee interest in the administration building at 1301 North Tustin
Avenue, Santa Ana, CA, certain rights to acquire condominium suites located in
the medical office building at 999 North Tustin Avenue, Santa Ana, CA, and the
business known as the West Coast Breast Cancer Center; (ii) a fee interest in
the Western Medical Center at 1025 South Anaheim Blvd., Anaheim, CA; (iii) a fee
interest in the Coastal Communities Hospital at 2701 South Bristol Street, Santa
Ana, CA, and a fee interest in the medical office building at 1901 North College
Avenue, Santa Ana, CA; (iv) a lease for the Chapman Medical Center at 2601 East
Chapman Avenue, Orange, CA, and a fee interest in the medical office building at
2617 East Chapman Avenue, Orange, CA; and (v) equipment and contract rights. At
the closing of the Acquisition, the Company transferred all of the fee interests
in the acquired real estate (the "Hospital Properties") to Pacific Coast
Holdings Investment, LLC, a company owned directly or indirectly by two of the
Company's largest shareholders.
24
SIGNIFICANT CHALLENGES
COMPANY - Our acquisition of the Hospitals involves numerous potential
risks, including:
o potential loss of key employees and management of acquired
companies;
o difficulties integrating acquired personnel and distinct cultures;
o difficulties integrating acquired companies into our proposed
operating, financial planning and financial reporting systems;
o diversion of management attention; and
o assumption of liabilities and potentially unforeseen liabilities,
including liabilities for past failure to comply with healthcare
regulations.
Our acquisition also involved significant cash expenditures, debt
incurrence and integration expenses that has seriously strained our financial
condition. If we are required to issue equity securities to raise additional
capital, existing stockholders will likely be substantially diluted, which could
affect the market price of our stock.
INDUSTRY - Our Hospitals receive a substantial portion of their revenues
from Medicare and Medicaid. The healthcare industry is experiencing a strong
trend toward cost containment, as the government seeks to impose lower
reimbursement and resource utilization group rates, limit the scope of covered
services and negotiate reduced payment schedules with providers. These cost
containment measures generally have resulted in a reduced rate of growth in the
reimbursement for the services that we provide relative to the increase in our
cost to provide such services.
Changes to Medicare and Medicaid reimbursement programs have limited, and
are expected to continue to limit, payment increases under these programs. Also,
the timing of payments made under the Medicare and Medicaid programs is subject
to regulatory action and governmental budgetary constraints resulting in a risk
that the time period between submission of claims and payment could increase.
Further, within the statutory framework of the Medicare and Medicaid programs, a
substantial number of areas are subject to administrative rulings and
interpretations which may further affect payments.
Our business is subject to extensive federal, state and, in some cases,
local regulation with respect to, among other things, participation in the
Medicare and Medicaid programs, licensure and certification of facilities, and
reimbursement. These regulations relate, among other things, to the adequacy of
physical property and equipment, qualifications of personnel, standards of care,
government reimbursement and operational requirements. Compliance with these
regulatory requirements, as interpreted and amended from time to time, can
increase operating costs and thereby adversely affect the financial viability of
our business. Because these regulations are amended from time to time and are
subject to interpretation, we cannot predict when and to what extent liability
may arise. Failure to comply with current or future regulatory requirements
could also result in the imposition of various remedies including (with respect
to inpatient care) fines, restrictions on admission, denial of payment for all
or new admissions, the revocation of licensure, decertification, imposition of
temporary management or the closure of a facility or site of service.
We are subject to periodic audits by the Medicare and Medicaid programs,
which have various rights and remedies against us if they assert that we have
overcharged the programs or failed to comply with program requirements. Rights
and remedies available to these programs include repayment of any amounts
alleged to be overpayments or in violation of program requirements, or making
deductions from future amounts due to us. These programs may also impose fines,
criminal penalties or program exclusions. Other third-party payer sources also
reserve rights to conduct audits and make monetary adjustments in connection
with or exclusive of audit activities.
The healthcare industry is highly competitive. We compete with a variety
of other organizations in providing medical services, many of which have greater
financial and other resources and may be more established in their respective
communities than we are. Competing companies may offer newer or different
centers or services than we do and may thereby attract patients or customers who
are presently patients, customers or are otherwise receiving our services. An
increasing trend in malpractice litigation claims, rising costs of malpractice
litigation, losses associated with these malpractice lawsuits and a constriction
of insurers have caused many insurance carriers to raise the cost of insurance
premiums or refuse to write insurance policies for hospital facilities. Also, a
tightening of the reinsurance market has affected property, auto and excess
liability insurance carriers. Accordingly, the costs of all insurance premiums
have increased.
25
An increasing trend in malpractice litigation claims, rising costs of
malpractice litigation, losses associated with these malpractice lawsuits and a
constriction of insurers have caused many insurance carriers to raise the cost
of insurance premiums or refuse to write insurance policies for hospital
facilities. Also, a tightening of the reinsurance market has affected property,
auto and excess liability insurance carriers. Accordingly, the costs of all
insurance premiums have increased.
We receive all of our inpatient services revenue from operations in Orange
County, California. The economic condition of this market could affect the
ability of our patients and third-party payers to reimburse us for our services,
through its effect on disposable household income and the tax base used to
generate state funding for Medicaid programs. An economic downturn, or changes
in the laws affecting our business in our market and in surrounding markets,
could have a material adverse effect on our financial position, results of
operations and cash flows.
LIQUIDITY AND CAPITAL RESOURCES
The accompanying consolidated financial statements have been prepared on a
going concern basis, which contemplates the realization of assets and settlement
of obligations in the normal course of business. The Company incurred a net loss
(in thousands) of $20,538 during the year ended March 31, 2007 and has a working
capital deficit (in thousands) of $90,307 at March 31, 2007. All of the
Company's debt matured prior to year end and the Company is currently operating
under a ninety day forbearance agreement with its lenders to obtain new
financing.
These factors, among others, indicate a need for the Company to take
action to resolve its financing issues and operate its business as a going
concern. There is no assurance that the Company will be successful in obtaining
a new financing agreement, improving reimbursements or reducing operating
expenses
Management has also been working on improvements in several areas that the
Company believes will mitigate the working capital deficits (comparisons are
between the 12 months ended March 31, 2007 and 2006 which represents the first 2
comparative full years of operations since the acquisition):
1. Net operating revenues: The Hospitals serve a disproportionate number of
indigent patients and receive governmental revenues and subsidies in
support of care for these patients. We have received increases in
Medicaid, Medicaid DSH, and Orange County, CA (CalOptima) payments.
Increased reimbursement and support in these areas represent $ 23.4
million improvement over the preceding year. We reduced our capitation
agreement with the CalOptima program by $31.8 million compared to the
preceding year. Because there was a corresponding reduction in cost and
offsetting increases in fee-for-service volumes from CalOptima patients,
net operating revenues were not significantly affected. Commercial and
managed care rate improvements were approximately $17.8 million in 2007
compared to the year ended March 31, 2006. Net collectible revenues (net
operating revenues less provision for doubtful accounts) for the year
ended March 31, 2007 were $315.5 million or 3.1% higher than the $306.1
million for the same period in the preceding year. An $18.0 million
increase in charity (gross charge) write-offs (to $42.2 million in 2007)
was, however, only partially offset by the $7.4 million reduction in the
provision for doubtful accounts from the same period in the preceding
year. Inpatient admissions increased only slightly by 1.1% to 27,806 in
the year ended March 31, 2007.
2. Operating expenses (excluding provision for doubtful accounts included
above): Management is working aggressively to reduce cost without
reduction in service levels. These efforts have in large part been offset
by inflationary pressures. Operating expenses before interest and warrants
for the year ended March 31, 2007 were $0.2 million lower than for the
same period in the preceding year. Due to favorable claims experience the
Company has secured lower rates for insurance for the year ended March 31,
2008 for Risk, Workers Compensation and Employee Health. The estimated
annual savings are projected to be $6.0 million.
3. Financing costs: The Company completed the Acquisition of the Hospitals
with a high level of debt financing. Additionally, the Company entered
into an Accounts Purchase Agreement and is incurring significant discounts
on the sale of accounts receivable. As described in the notes to the
consolidated financial statements, the largest investor was unable to meet
all the commitments under the stock purchase agreement. As a result, the
Company incurred additional interest costs from default rates and higher
than planned borrowings. On February 21, 2007, the Company signed a term
sheet with Medical Capital Corporation for a new financing arrangement.
The proposed agreement called for replacing all of the Company's existing
debt as well as the APA with a new financing structure consisting of a $45
million term loan, a $35 million non revolving line of credit, a $10.7
million convertible term loan, and a $50 million revolving line of credit.
These faculties would be secured by essentially all of the Company's
assets and certain warrants would be issued. These steps are subject to
26
the approval of the Company's Board of Directors which currently is
comprised of three representatives of the lead investor, two outside
directors, and one officer of the Company and, accordingly, may not be
assured. On July 11, 2007 the Superior Court appointed an independent
director for the term of a lawsuit (see discussion under Item 1A) They
were also subject to the approval of the other credit parties. The
estimated annual savings were projected to be $5.7 million effective March
8, 2007. The Credit Parties failed to execute the proposed agreements, the
proposal was rescinded and Notices of Default and a Forbearance Agreement
for ninety days were executed on June 18, 2007. The parties are actively
seeking replacement financing during the forbearance period. There can be
no assurance that the Company will be successful in obtaining refinancing.
If the Company is not successful, it will be unable to continue as a going
concern.
The foregoing analysis presumes that capital expenditures to replace
equipment can be kept to an immaterial amount in the short term. It is the
intent of management to fund future capital expenditures from operations.
ACQUISITION DEBT - Effective March 3, 2005, in connection with the
Acquisition, the Company and its subsidiaries collectively entered into a credit
agreement (the "Credit Agreement") with Medical Provider Financial Corporation
II ("the Lender"), whereby the Company obtained initial financing in the form of
a loan with interest at the rate of 14% per annum in the amount of $80,000,000
of which $30,000,000 is in the form of a non revolving Line of Credit and
$50,000,000 (less $5,000,000 repayment on December 12, 2005) is in the form of
an Acquisition Loan (collectively, the "Obligations"). The Company used the
proceeds from the $50 million Acquisition Loan and $3 million from the Line of
Credit to complete the Acquisition. The Acquisition Loan and Line of Credit are
secured by a lien on substantially all of the assets of the Company and its
subsidiaries, including without limitation, a pledge of the capital stock by the
Company in its wholly owned Hospitals. This debt, in the amount of 72.3 million,
matured on March 8, 2007, is currently due and is subject to the Agreement to
Forbear.
SECURED SHORT TERM NOTE - On December 12, 2005, the company entered into a
credit agreement with the lender, whereby the lender loaned the Company $10.7
million. This was primarily due to the Company's inability to secure the
required equity pursuant to it's Stock Purchase Agreement with OC-PIN. The $10.7
million short term note matured on December 12, 2006 and was extended through
March 2, 2007. The note is secured by substantially all the assets of the
Company and is further collateralized by the December Note Warrant which is
exercisable by the lender in the event of default by the Company. The $10.7
million note is current, due and payable, the underlying warrant is exercisable
as the Company received a formal notice of default from its lender on June 18,
2007. The Short Term Note is subject to the Agreement to Forbear.
LONG TERM LEASE COMMITMENT WITH VARIABLE INTEREST ENTITY - The Company
sold $5 million in limited partnership interests to finance the Acquisition and
to Pacific Coast Holdings Investment, LLC ("PCHI") guaranteed the Company's
Acquisition Loan. Concurrent with the close on the Acquisition, the Company sold
substantially all of the real property acquired in the Acquisition to PCHI. PCHI
is a related party entity that is affiliated with the Company through common
ownership and control. Additionally, a gain (in thousands) of $4,433 arising
from the Company's sale of the real property of the Hospitals to PCHI has been
eliminated in the accompanying consolidated financial statements so as to record
the land and buildings at the Company's cost. Upon such sale, the Company
entered into a 25 year lease agreement with PCHI involving substantially all of
the real property acquired in the Acquisition. The commitment on this lease
agreement is approximately $210 million over the remainder of the lease term.
The Company remains primarily liable under the Acquisition Loan note
notwithstanding its guarantee by PCHI, and this note is cross collateralized by
substantially all of the Company's assets and all of the real property of the
Hospitals. All of the Company's operating activities are directly affected by
the real property that was sold to PCHI. Given these factors, the Company has
indirectly guaranteed the indebtedness of PCHI. The Company is standing ready to
perform on the Acquisition Loan should PCHI not be able to perform and has
undertaken a contingent obligation to make future payments if those triggering
events or conditions occur.
ACCOUNTS PURCHASE AGREEMENT - In March 2005, the Company entered into an
Accounts Purchase Agreement (the "APA") for a minimum of two years with Medical
Provider Financial Corporation I, an unrelated party (the "Buyer"). The Buyer is
an affiliate of the Lender (see Note 8). The APA provides for the sale of 100%
of the Company's eligible accounts receivable, as defined, without recourse. The
APA provides for the Company to provide billing and collection services,
maintain the individual patient accounts, and resolve any disputes that arise
between the Company and the patient or other third party payer for no additional
consideration.
27
The accounts receivable are sold weekly based on separate bills of sale
for each Hospital. The purchase price is comprised of two components, the
advance rate amount and the Deferred Purchase Price Receivable amount. The
advance rate amount is based on the buyer's appraisal of accounts receivable
accounts. The buyer's appraisal is developed internally by the buyer and does
not necessarily reflect the net realizable value or the fair value of the
accounts receivable sold. At the time of sale, the Buyer advances 95% of the
buyers appraised value (the "95% Advance"; increased from 85% at Buyer's
election effective January 1, 2006) on eligible accounts to the Company and
holds the remaining 5% as part of the security reserve funds on sold accounts
(the "Security Reserve Funds"), which is non-interest bearing. Except in the
case of a continuing default, the Security Reserve Funds can not exceed 15% (the
"15% Cap", decreased from 25% at Buyer's election effective March 31, 2006) of
the aggregate advance rate amount, as defined, of the open purchases. The
Company is charged a "purchase discount" (the "Transaction Fee") of 1.35% per
month of the advance rate amount of each tranche of accounts receivable accounts
purchased until closed based on application of cash collections up to the
advance rate amount for that tranche, at which time the Buyer deducts the
Transaction Fee from the Security Reserve Funds. The Company holds cash
collected in its lockbox in a fiduciary role for the Buyer and records the cash
as part of Security Reserve Funds. Collections are applied by the buyer on a
dollar value basis, not by specific identification, to the respective Hospital's
most aged open purchase until the tranche is closed. The agreement further
provides that if the amount collected (as to each Account purchased within 180
days of the Billing Date on any Account (including Substitute Assets) purchased
by Buyer be less than the amount of its Adjusted Value, then such seller shall
remit to Buyer the amount of such difference between the Adjusted Value of the
Account and the amount actually collected on such Account by Buyer as the
repurchase price for such accounts. If the Seller fails to repurchase such
accounts, the Buyer shall deduct this from the Advance Rate Amount and Deferred
Purchase Price otherwise payable for all accounts with respect to any purchase,
an amount equal to the Adjusted Value of such uncollected account less the
deferred portion of the purchase price thereof, thereby closing the tranche.
These provisions have not been applied in the contract to date due to the more
timely closure of tranches.
Collections in excess of the advance rate amount are credited by the buyer
to Security Reserve Funds and ultimately released to the Company to pay down the
Deferred Purchase Price Receivable. The Deferred Purchase Price Receivable
approximates fair value and represents amounts the Company expects to collect,
based on regulations, contracts, and historical collection experience, in excess
of the advance rate amount. In determining the fair value of the Deferred
Purchase Price Receivable recorded upon sales of accounts receivable accounts
under the Accounts Purchase Agreement, the key assumption used was the
application of a short-term discount rate. If the discount rate applied
increased by 10%, the adverse effect on the Deferred Purchase Price Receivable
and related loss on sale of accounts receivable would be insignificant. This
amount is unsecured.
From inception of the APA through March 31, 2007, the buyer has advanced
approximately $501 million to the Company through the APA. In addition, the
Company has received approximately $41.7 million in reserve releases from
inception through March 31, 2007. Payments posted on sold receivables
approximated $524 million. Advances net of payment and adjustment activity,
cumulatively through March 31, 2007 and December 31, 2005 were $7.0 million and
$8.8 million respectively. Transaction fees incurred for the same periods were
$9.3 million and $3.3 million respectively.
The Company records estimated Transaction Fees and estimated servicing
expense related to the sold accounts receivable at the time of sale. The Company
incurred loss on sale of accounts receivable of (in thousands) $10,388 and
$8,470 for the years ended March 31, 2007 and December 31, 2005, respectively,
and $2,808 for the three months ended March 31, 2006.
COMMON STOCK WARRANTS
DECEMBER NOTE WARRANT In accordance with SFAS No. 150, the Company has
included the December Note value of $10.7 million in warrant liabilities,
current, in the accompanying consolidated balance sheets as of March 31, 2007
and December 31, 2005 and recomputed the fair value in accordance with SFAS No.
133 at each reporting date. Under the terms of the December Credit Agreement,
any proceeds from the sale of stock received under the December Note Warrant
that are in excess of the December Note and related issuance costs are to be
paid to the Company as paid in capital. Accordingly, the fair value of the
December Note Warrant would contractually continue to be $10.7 million (plus any
issuance and exercise costs, which are considered immaterial).
At March 31, 2007 and December 31, 2005 the estimated potential number of
shares was calculated using the market price and $10.7 million liability of the
Company. The estimated number of shares were 33.4 million and 21.8 million,
respectively. The maximum number of share issuable in the event of default in
accordance with the December Note Warrant agreement however, is the greatest of:
(1) 26,097,561 Shares of Common Stock, (2) Shares representing 31.09% of all
Common Stock and Common Stock Equivalents of the Company, and (3) the fair
market value of Shares of Common Stock equal to the amount of the $10,7 million
loan not repaid at maturity or default of such Loan, plus any accrued and unpaid
interest thereon, Lender's fees, costs and expenses, and attorneys' fees. Any
amounts received from the lender from the sale of stock they received when they
exercise the warrants in excess of that required to retire the $10.7 million
debt would be paid to the Company as additional paid in capital.
28
RESTRUCTURING WARRANTS The Company entered into a Rescission,
Restructuring and Assignment Agreement with Dr. Kali Chaudhuri and Mr. William
Thomas on January 27, 2005 (the "Restructuring Agreement"). Previously, the
Company had obtained financing from Dr. Chaudhuri and Mr. Thomas and had issued
to them a $500,000 secured convertible promissory note that was convertible into
approximately 88.8% of the Company's issued and outstanding common stock on a
fully-diluted basis, a $10 million secured promissory note, and a Real Estate
Purchase Option agreement originally dated September 28, 2004 to purchase 100%
of substantially all of the real property in the Acquisition for $5 million (the
"Real Estate Option"), all of which together with related accrued interest
payable pursuant to the terms of the notes were rescinded and cancelled.
Pursuant to the Restructuring Agreement, the company released its initial
deposit of $10 million plus accrued interest on the Acquisition back to Dr.
Chaudhuri and issued non-convertible secured promissory notes totaling
$1,264,014 and warrants to purchase up to 74,700,000 shares of the Company's
common stock (the "Warrants") to Dr. Chaudhuri and Mr. Thomas (not to exceed
24.9% of the Company's fully diluted capital stock at the time of exercise).
Concurrent with the close of the Acquisition, the Company repaid the
non-convertible secured promissory notes of $1,264,014 to Dr. Chaudhuri and Mr.
Thomas. In addition, the Company amended the Real Estate Option to provide for
Dr. Chaudhuri's purchase of a 49% interest in PCHI for $2,450,000.
As a result of the Company not being able to determine the maximum number
of shares that could be required to be issued under the December Note Warrant
executed on December 12, 2005, the Company reclassified these warrants from
permanent equity to liability as of this date. The fair value (in thousands) of
the warrants on the date of reclassification was $17,605 and accordingly the
Company recorded warrant expense of $389 for the difference between the amount
reclassified from permanent equity and the fair value on the reclassification
date. In accordance with SFAS No.133, "Accounting for Derivative Instruments and
Hedging Activities", these warrants are revalued at each reporting date, and the
changes in fair value are recorded as Change in fair value of derivative on the
statement of operations.
The Restructuring Warrants were exercisable beginning January 27, 2007 and
expire 3.5 years from the date of issuance (July 27, 2008). The exercise price
for the first 43 million shares purchased under the Restructuring Warrants is
$0.003125 per share, and the exercise or purchase price for the remaining 31.7
million shares is $0.078 per share if exercised between January 27, 2007 and
July 26, 2007, $0.11 per share if exercised between July 27, 2007 and January
26, 2008, and $0.15 per share thereafter.
During February 2007 Dr Chaudhuri and Mr. Thomas submitted an exercise
under these warrants to the Company. At March 31, 2007 the Company recorded the
issuance of 28,746,857 net shares under this exercise following resolution of
certain legal issues relating thereto. The issuance of these shares resulted in
a transfer from warrant liability to equity totaling (in thousands) $9,199.
These shares were issued to Dr Chaudhuri and Mr. Thomas on July 2, 2007. The
shares pursuant to this exercise were recorded as issued and outstanding at
March 31, 2007. Additionally, the remaining liability was revalued at March 31,
2007 in the amount of $4.2 million relating to potential shares (approximately
20.8 million shares) which could be issued, if the December Note warrant was to
become issuable. The parties agreed that this occurred on June 13, 2007 upon
receipt of a notice of default from the Lender. The market price of the
Company's stock at subsequent exercise date and the number of shares relating
thereto were used to value the liability of $4.2 million and accordingly the
Company recognized a gain of $133 related to the change in fair value of
derivative for the year ended March 31, 2007. Furthermore based upon the
execution of the additional share exercise on July 2, 2007, prior to the
issuance of this report, an additional warrant expense of $693 thousand was also
recognized.
In prior periods the Company computed the change in fair value of the
Restructuring Warrants based on the fair value of the underlying shares and the
estimated maximum number of shares of 43.3 million that could be issued under
the Restructuring Warrants. The Company estimated the number of potential shares
under the Restructuring Warrants as this was not certain as the first exercise
date had not been reached.
For periods prior to the date the warrants became exercisable (January 27,
2007), the Company used valuations prepared by an independent valuation firm to
determine the fair value of the underlying shares. The assumptions used in the
Black-Scholes model were as follows:
December 31, 2005
-----------------
Risk-free interest rate 4.4%
Expected volatility 28.6%
Dividend yield --
Expected life (years) 2.57
Fair value of warrants $0.487
Market value per share $0.49
March 31, 2006
--------------
Risk-free interest rate 4.8%
Expected volatility 27.9%
Dividend yield --
Expected life (years) 2.32
Fair value of warrants $0.297
Market value per share $0.30
29
Due to the fact that the Company emerged from the development stage in
2005, the independent valuation firm computed the volatility of the Company's
stock based on an average of the following public companies that own hospitals:
Amsurg Inc (AMSG)
Community Health Systems (CYH)
HCA Healthcare Company (HCA)
Health Management Associates Inc. (HMA)
Lifepoint Hospitals Inc. (LPNT)
Medcath Corp. (MDTH)
Tenet Healthcare Corp. (THC)
Triad Hospitals Inc. (TRI)
Universal Health Services Inc., Class B (UHS)
Although management believes this was the most reasonable and accurate
methodology to determine the Company's volatility, the circumstances affecting
volatility of the comparable companies selected may not be an accurate predictor
of the Company's volatility.
The Company recorded (in thousands) a common stock warrant expense of
$17,604 and a change (in thousands) in the fair value of derivative of $3,460
for the year ended December 31, 2005. The change in fair value of the derivative
for the three months ended March 31, 2006 was (in thousands)a gain of $ 8,218.
The related warrant liability as of March 31, 2007 and December 31, 2005 is (in
thousands) $4,206 (excluding the $10.7 million December Note Warrant liability)
and $21,065, respectively.
COMMITMENTS AND CONTINGENCIES - The State of California has imposed new
hospital seismic safety requirements. The Company operates four hospitals
located in an area near active earthquake faults. Under these new requirements,
the Company must meet stringent seismic safety criteria in the future, and, must
complete one set of seismic upgrades to the facilities by January 1, 2013. This
first set of upgrades is expected to require the Company to incur substantial
seismic retrofit costs. There are additional requirements that must be complied
with by 2030. The Company is currently estimating the costs of meeting these
requirements; however a total estimated cost has not yet been determined.
TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS
==============================================================================================
Payments due by period
==============================================================================================
Less than More than
Contractual Obligations Total 1 year 1-3 years 3-5 years 5 years
==============================================================================================
Debt
Obligations $ 83,041 $ 83,041 $ - $ - $ -
==============================================================================================
Capital Lease
Obligations 13,339 $ 952 1,904 1,739 8,744
==============================================================================================
Operating Lease
Obligations 20,060 $ 1,476 2,061 1,760 14,763
==============================================================================================
Purchase Obligations 6,741 3,179 3,562
==============================================================================================
==============================================================================================
Total $ 123,181 $ 88,648 $ 7,527 $ 3,499 $23,507
==============================================================================================
The above table excludes future payments between IHHI and the consolidated
VIE totaling approximately $210 million and these payments are eliminated during
consolidation for reporting.
30
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
FISCAL YEAR ENDED MARCH 31, 2007 COMPARED TO FISCAL YEAR ENDED DECEMBER
31, 2005
The following table sets forth, for the years ended March 31, 2007 and
December 31, 2005, our consolidated statements of operations expressed as a
percentage of net operating revenues. The year ended December 31, 2005 reflects
only the 299 days of operations from the Acquisition date.
Years ended
March 31, December 31,
2007 2005
---- ----
Net operating revenues 100% 100%
Operating expenses 102% 106%
Operating loss (2%) (6%)
Other income (expense):
Interest expense, net (4%) (4%)
Common stock warrant expense -- (6%)
Change in fair value of derivative -- (1%)
Other income (expense), net (4%) (11%)
Income (loss) before provision for income
taxes and minority interest (6%) (17%)
Provision for income taxes -- --
Minority interest in variable interest entity -- 1%
Net income (loss) (6%) (16%)
NET OPERATING REVENUES - Net operating revenues less provision for
doubtful accounts increased approximately 28.1% to approximately $315.5 million
during the fiscal year ended March 31, 2007 from approximately $246.3 million
during the fiscal year ended December 31, 2005. The increase is primarily due to
an increase in volumes. Adjusted patient days increased approximately 20.9% and
adjusted admissions increased approximately 21.9%. The increased volumes are due
to a 22.1% increase in the number of operating days during the fiscal year ended
March 31, 2007, as the acquisition of Hospitals occurred on March 8, 2005. Also
contributing to the increase in net operating revenues less provision for
doubtful accounts is negotiated contract increases executed during the latter
part of fiscal 2005 and fiscal 2007 and an increase in bad debt recoveries
during fiscal 2007.
OPERATING EXPENSES - Operating expenses less provision for doubtful
accounts as a percentage of net operating revenues less provision for doubtful
accounts decreased by approximately 3.9% during fiscal 2007 compared to fiscal
2005. The reduction is primarily due to cost reductions and improved
efficiencies.
Salaries and benefits decreased approximately 0.6% as a percentage of net
operating revenues less provision for doubtful accounts during fiscal 2007
compared to fiscal 2005. Salaries and benefits percentage increases due to wage
increases and associated with bringing certain previously contracted services in
house were offset by decreases due to labor and staffing efficiencies realized.
Supplies expense as a percentage of net operating revenues less provision
for doubtful accounts decreased slightly from approximately 15.9% in fiscal 2005
to approximately 15.7% in fiscal 2007.
Remaining operating expenses as a percentage of net operating revenues
less provision for doubtful accounts decreased by approximately 3.1% during
fiscal 2007 compared to fiscal 2005. The decrease is primarily due to reductions
in contract service expenses, including reductions caused by bringing certain
services in house, to other operating cost reductions and to improved
efficiencies realized during fiscal 2007.
31
OPERATING LOSS - Loss from operations as a percentage of net revenues less
provision for doubtful accounts decreased by approximately 3.9% during fiscal
2007 compared to fiscal 2005. The decrease is due to increases in negotiated
contract rates and bad debt recoveries in addition to increased cost
efficiencies realized during fiscal 2007.
OTHER INCOME (EXPENSE) - Other income (expense), net changed primarily as
a result of the changes in common stock warrant expense. As described more fully
in our Annual Report on Form 10-K for the year ended December 31, 2005, warrants
were initially valued and expensed during fiscal 2005, resulting in a valuation
and expense of approximately $21.1 million at December 31, 2005 and for the year
then ended, respectively. During and subsequent to fiscal 2007, as described
more fully in Note 11 and Note 18 to the Consolidated Financial Statements
contained in this Annual Report on Form 10-K, certain exercises of warrants
occurred. The warrant transactions resulted in the Company recognizing a gain of
approximately $133 thousand related to the change in fair value of derivative
and additional warrant expense of approximately $693 thousand for the year ended
March 31, 2007.
Net interest expense increased to approximately $12.5 million in fiscal
2007 from approximately $9.9 million in fiscal 2005. Net interest expense
amounted to approximately 4% of net operating revenues less provision for
doubtful accounts during fiscal 2007 and fiscal 2005.
NET LOSS - Net loss for the year ended March 31, 2007 was $20.5 million
compared to a net loss of $45.2 million for the year ended December 31, 2005.
The decrease in net loss in fiscal 2007 was primarily due to a decrease in
Common stock expense of approximately $20.5 million and a decrease in operating
losses of approximately $7.8 million offset by an increase in interest expense
of approximately $2.6 million.
CASH FLOW - Net cash provided (used) by operating activities for the years
ended March 31, 2007 and December 31, 2005 and 2004 respectively was $2.5
million, ($15.2) million, and ($0.9) million, respectively, consisting primarily
of $16.6 million, $21.1 million and $1.7 million of net losses, respectively,
adjusted for depreciation and other non-cash items. The Company produced $19.1
million, $5.9 million and $0.9 million in working capital for the years ended
March 31, 2007 and December 31, 2005 and 2004, respectively. Net cash produced
in working capital activities primarily reflects the increases in accounts
payable and accrued liabilities partially offset by increases in accounts
receivable including security reserve fund and deferred purchase price
receivable, Cash produced by growth in accounts payable and accrued liabilities
was $11.1 million, $54.1 million and $0.9 million, for the years ended March 31,
2007 and December 31, 2005 and 2004, respectively. Cash used by increases in
accounts receivable including security reserve fund and deferred purchase price
receivable, was $0.9, $39.5 and $0 for the years ended March 31, 2007 and
December 31, 2005 and 2004 respectively.
Net cash used in investing activities during the years ended March 31,
2007 and December 31, 2005 and 2004 respectively was $0.6 million, $63.7
million, and $1.1 million, respectively. In the year ended March 31, 2007 the
Company invested $0.6 million in new equipment. In the year ended December 31,
2005 the Company used $63.2 million to complete the acquisition of four
hospitals. Prior to this the Company was a development stage enterprise.
Net cash provided by financing activities for the years ended March 31,
2007 and December 31, 2005 and 2004 respectively was $1.0 million, $92.8 million
and $1.9 million which primarily represents $2.0 million, $77.8 million and $0
proceeds from the credit facilities executed to facilitate the hospital
acquisition in March 2005 and provide working capital for operations
FISCAL YEAR ENDED DECEMBER 31, 2005 COMPARED TO FISCAL YEAR ENDED DECEMBER
31, 2004
The Company acquired the Hospitals on March 8, 2005, representing 9.8
months of operations for the 2005 fiscal year. Prior to March 8, 2005, the
Company was a development stage enterprise with no revenues and limited
expenses. Since the Company had no operations prior to 2005, we compare our 2005
financial performance to prior years' financial performance of the Hospitals
while they were owned by Tenet. This information was provided to us by Tenet in
conjunction with our acquisition of the Hospitals. While we believe such
information to be reliable and to have been prepared in accordance with
generally accepted accounting principles, the financial information provided to
us by Tenet relating to the Hospitals prior to March 8, 2005 was not prepared by
us or audited by our independent accounting firm.
32
NET OPERATING REVENUES - Net operating revenues of approximately $284
million for the period from March 8, 2005 through December 31, 2005 compare
favorably to the prorated revenues of $257 million under Tenet in the preceding
year (a 10% increase). This is the result of favorable rate negotiations with
payers following the change in ownership. Patient days were relatively flat
declining approximately 0.3%. A number of contract increases were executed
during the fourth quarter of 2005.
OPERATING EXPENSES - Operating expenses, net of noncash charges, of
approximately $297 million for the period from March 8, 2005 through December
31, 2005 increased 0.7% from the prorated operating expenses, net of noncash
charges, of $295 million under Tenet in the preceding year. Wage increases
averaged 7% in 2005 as the result of Tenet's commitment to employees that the
Company agreed to honor. These were offset by improved efficiencies..
OTHER EXPENSE - Other expense includes interest expense of $9.9 million
and noncash charges relating to warrant expense of $21.6 million. Warrant
expense includes a $17.6 million expense for warrants granted in connection with
a restructuring of our agreement with our lead investor, Dr. Kali Chaudhuri, in
January 2005 and closing on the Hospital Acquisition in March 2005. This was a
one time noncash charge. Additionally, a noncash charge of $3.5 million was
recognized for the change in carrying value on the warrants (as described more
fully in the notes to the consolidated financial statements contained in this
Annual Report on Form 10-K). Since this was characterized as a financing
activity in our amended Form 10-Q/As for the 2005 quarters, we have classified
the costs with other financing costs below the loss from operations in our
consolidated statements of operations for the year ended December 31, 2005.
THREE MONTHS ENDED MARCH 31, 2006 [AUDITED] COMPARED TO THREE MONTHS ENDED
MARCH 31, 2005 [UNAUDITED]
The following table sets forth, for the three months ended March 31, 2006
and 2005, our consolidated statements of operations expressed as a percentage of
net operating revenues. The three months ended March 31, 2005 reflects only the
24 days of operations from the Acquisition date.
Three months ended
March 31,
2006 2005
---- ----
Net operating revenues 100% 100%
Operating expenses 103% 105%
Operating loss (3%) (5%)
Other income (expense):
Interest expense, net (4%) (3%)
Common stock warrant expense -- (79%)
Change in fair value of derivative 9% --
Other income (expense), net 6% (82%)
Income (loss) before provision for income
taxes and minority interest 3% (87%)
Provision for income taxes -- (4%)
Minority interest in variable interest entity 0% --
Net income (loss) 3% (91%)
33
NET OPERATING REVENUES
Consolidated net operating revenues, on a calendar day basis (using 24
days for the three months ended March 31, 2005- "Acquisition" days), increased
5.7% during the three months ended March 31, 2006 as a result of contract rate
increases. Average daily census remained unchanged.
OPERATING EXPENSES
Operating expenses decreased as a percent of revenues by 1.7% during the
three months ended March 31, 2006 which equates to inflationary increases (net
of efficiencies) of 4.8%.
The provision for doubtful accounts as a percentage of revenue decreased
to 9.6% for the three months ended March 31, 2006 from 14.4% in the comparable
period in 2005, more than offsetting the $2.8 million loss on sale of accounts
receivable incurred during the three months ended March 31, 2006.
Salaries and benefits (adjusted for Acquisition days) increased $2.0
million or 4.3% during the three months ended March 31, 2006, slightly under the
average wage increase which ranged from 5-6%. Supplies increased $0.6 million or
5.8% during the three months ended March 31, 2006 primarily due to inflationary
pressures.
Remaining operating expenses (adjusted for Acquisition days) increased
approximately $4.6 million during the three months ended March 31, 2006. The
most significant increases in other operating expenses related to medical fees
for emergency coverage, data processing fees for system conversions and medical
equipment repairs.
OPERATING LOSS
Loss from operations as a percent of revenue improved by 1.7% during the
three months ended March 31, 2006 due to rate improvements in excess of cost
increases.
OTHER INCOME (EXPENSE), NET
Other income (expense), net, changed primarily as a result of the changes
in fair value of warrants. The initial valuation of warrants issued in the first
quarter of 2005 was $17,215,000. As described more fully in our Annual Report on
Form 10-K for the year ended December 31, 2005, this was revalued to $17,604,292
on December 12, 2005 and subsequently increased to $21,064,669 as of December
31, 2005. As of March 31, 2006, the fair value of these warrants had decreased
to $12,846,650, resulting in a gain of $8,218,019 during the three months ended
March 31, 2006.
Interest costs of 3.7% of revenue during the three months ended March 31,
2006 and 3.1% of revenue during the three months ended March 31, 2005 were
relatively consistent between the periods as a percentage of revenue.
PROVISION FOR INCOME TAXES
The provision for income taxes for the three months ended March 31, 2006
was $5 thousand compared to $0.9 million for the comparable period in 2005. The
provision for income taxes during the three months ended March 31, 2005 was
reversed in the subsequent quarter as a result of the impact of the
implementation of the Accounts Purchase Agreement.
NET INCOME (LOSS)
Net income for the three months ended March 31, 2006 was $2.4 million
compared to a net loss of $19.9 million for the three months ended March 31,
2005. The decrease in the loss in 2006 was primarily due to the decrease in
Common stock expense of $17.2 million and the increase in the fair value of
derivative of $8.2 million.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
REVENUE RECOGNITION - Net operating revenues are recognized in the period
in which services are performed and are recorded based on established billing
rates (gross charges) less estimated discounts for contractual allowances,
principally for patients covered by Medicare, Medicaid, managed care and other
health plans. Gross charges are retail charges. They are not the same as actual
pricing, and they generally do not reflect what a hospital is ultimately paid
and, therefore, are not displayed in the consolidated statements of operations.
Hospitals are typically paid amounts that are negotiated with insurance
companies or are set by the government. Gross charges are used to calculate
Medicare outlier payments and to determine certain elements of payment under
managed care contracts (such as stop-loss payments). Because Medicare requires
that a hospital's gross charges be the same for all patients (regardless of
payer category), gross charges are also what our Hospitals charge all other
patients prior to the application of discounts and allowances.
34
Revenues under the traditional fee-for-service Medicare and Medicaid
programs are based primarily on prospective payment systems. Discounts for
retrospectively cost-based revenues and certain other payments, which are based
on the Hospitals' cost reports, are estimated using historical trends and
current factors. Cost report settlements for retrospectively cost-based revenues
under these programs are subject to audit and administrative and judicial
review, which can take several years until final settlement of such matters are
determined and completely resolved. Estimates of settlement receivables or
payables related to a specific year are updated periodically, at year end, and
at the time the cost report is filed with the fiscal intermediary. Typically, no
further updates are made to the estimates until the final Notice of Program
Reimbursement is received, at which time the cost report for that year has been
audited by the fiscal intermediary. There could be a one to two year time lag
between the submission of a cost report and receipt of the Final Notice of
Program Reimbursement. Since the laws, regulations, instructions and rule
interpretations governing Medicare and Medicaid reimbursement are complex and
change frequently, the estimates recorded by the Hospitals could change by
material amounts. During the year ended March 31, 2007 the Company recorded
approximately $394 thousand of additional reductions of revenue for Final
Notices of Program Reimbursement received during the year. There were no final
Notices of Program Reimbursement during the three months ended March 31, 2006 or
the year ended December 31, 2005. The Company has established settlement
receivables as of March 31, 2007 and December 31, 2005 (in thousands) of $909
and $2,273, respectively.
Outlier payments, which were established by Congress as part of the
diagnosis-related groups (DRG) prospective payment system, are additional
payments made to hospitals for treating Medicare patients who are costlier to
treat than the average patient in the same DRG. To qualify as a cost outlier, a
hospital's billed (or gross) charges, adjusted to hospital specific costs, must
exceed the prospective (includes the DRG base payment, indirect medical
education payment, disproportionate share payment and new technology add on
payment) payment rate for the case by a fixed threshold established annually by
the Centers for Medicare and Medicaid Services of the United State Department of
Health and Human Services (CMS). Under Sections 1886(d) and 1886(g) of the
Social Security Act, CMS must project aggregate annual outlier payments to all
prospective payment system hospitals to be not less than 5% or more than 6% of
total DRG payments (Outlier Percentage). The Outlier Percentage of payments is
determined by dividing total outlier payments by the sum of prospective and
outlier payments. CMS annually adjusts the fixed threshold to bring expected
outlier payments within the mandated limit. A change to the fixed threshold
affects total outlier payments by changing both the number of cases that qualify
for outlier payments, and the dollar amount hospitals receive for those cases
that still qualify. The most recent change to the cost outlier threshold that
became effective on October 1, 2006 was an increase from $23,600 to $24,485. CMS
projects this will result in an Outlier Payment Percentage that is approximately
5.1% of total payments. The Medicare fiscal intermediary calculates the cost of
a claim by multiplying the billed charges by the cost-to-charge ratio from the
hospital's most recently filed Medicare cost report.
The Hospitals received new provider numbers in 2005 and, because there was
no specific history, the Hospitals were reimbursed for outliers based on
published statewide averages. If the computed cost exceeds the sum of the DRG
payment plus the fixed threshold, the hospital receives 80% of the difference as
an outlier payment. Medicare has reserved the option of adjusting outlier
payments, through the cost report, to the hospital's actual cost-to-charge
ratio. Upon receipt of the current payment cost-to-charge ratios from the fiscal
intermediary, any variance between current payments and the estimated final
outlier settlement are examined by the Medicare fiscal intermediary. During the
year ended March 31, 2007 the Company recorded approximately $1,919 thousand of
additional revenue for a Final Notice of Program Reimbursement received. As of
March 31, 2007 and December 31, 2005, the Company recorded reserves for excess
outlier payments due to the difference between the Hospital's actual cost to
charge rates and the statewide average in the amount (in thousands) of $1,831
and $2,170, respectively. These reserves are offset against the third party
settlement receivables and are included in due to governmental payers as a net
payable (in thousands) of $922 as of March 31, 2007 and as a net receivable (in
thousands) of $104 included in due from governmental payers as of December 31,
2005.
The Hospitals receive supplemental payments from the State of California
to support indigent care (MediCal Disproportionate Share Hospital payments or
"DSH"). During the years ended March 31, 2007, and December 31, 2005 and 2004
the Hospitals received payments (in thousands) of $24,526, $11,022 and $-0-
respectively. The increase is the result of the State becoming more current in
their payments and the timing of the State's payments. During the three months
ended March 31, 2006 the Hospitals received payments (in thousands) of $575. The
related revenue recorded for the years ended March 31, 2007, and December 31,
2005 and 2004, and the three months ended March 31, 2006 was (in thousands)
$17,897, $13,943, $-0-, and $4,240, respectively.
35
Revenues under managed care plans are based primarily on payment terms
involving predetermined rates per diagnosis, per-diem rates, discounted
fee-for-service rates and/or other similar contractual arrangements. These
revenues are also subject to review and possible audit by the payers. The payers
are billed for patient services on an individual patient basis. An individual
patient's bill is subject to adjustment on a patient by patient basis in the
ordinary course of business by the payers following their review and
adjudication of each particular bill. The Hospitals estimate the discounts for
contractual allowances utilizing billing data on an individual patient basis. At
the end of each month, the Hospitals estimate the expected reimbursement for
patients of managed care plans based on the applicable contract terms. These
estimates are continuously reviewed for accuracy by taking into consideration
known contract terms as well as payment history. Although the Hospitals do not
separately accumulate and disclose the aggregate amount of adjustments to the
estimated reimbursements for every patient bill, management believes the
estimation and review process allows for timely identification of instances
where such estimates need to be revised. The Company does not believe there were
any adjustments to estimates of individual patient bills that were material to
its net operating revenues.
The Hospitals provide charity care to patients whose income level is below
300% of the Federal Poverty Level. Patients with income levels between 300% to
350% of the Federal Poverty Level qualify to pay a discounted rate under AB774
based on various government program reimbursement levels. Patients without
insurance are offered assistance in applying for Medicaid and other programs
they may be eligible for, such as state disability, Victims of Crime, or county
indigent programs. Patient advocates from the Hospitals' Medical Eligibility
Program (MEP) screen patients in the hospital and determine potential linkage to
financial assistance programs. They also expedite the process of applying for
these government programs. Based on average revenue for comparable services from
all other payers, revenues foregone under the charity policy, including indigent
care accounts, for the years ended March 31, 2007 and December 31, 2005 and 2004
were approximately $8.1 million, $2.9 million and $-0-, respectively, and for
the three months ended March 31, 2006 were approximately $1.5 million.
Receivables from patients who are potentially eligible for Medicaid are
classified as Medicaid pending under the MEP, with appropriate contractual
allowances recorded. If the patient does not quality for Medicaid, the
receivables are reclassified to charity care and written off, or they are
reclassified to self-pay and adjusted to their net realizable value through the
provision for doubtful accounts. Reclassifications of Medicaid pending accounts
to self-pay do not typically have a material impact on the results of operations
as the estimated Medicaid contractual allowances initially recorded are not
materially different than the estimated provision for doubtful accounts recorded
when the accounts are reclassified. All accounts classified as pending Medicaid
are reserved for their full value in contractual allowances when they reach 180
days old.
The Company is not aware of any material claims, disputes, or unsettled
matters with any payers that would affect revenues that have not been adequately
provided for in the accompanying consolidated financial statements.
PROVISION FOR DOUBTFUL ACCOUNTS - The Company provides for accounts
receivable that could become uncollectible by establishing an allowance to
reduce the carrying value of such receivables to their estimated net realizable
value. The Hospitals estimate this allowance based on the aging of their
accounts receivable, historical collections experience for each type of payer
and other relevant factors. There are various factors that can impact the
collection trends, such as changes in the economy, which in turn have an impact
on unemployment rates and the number of uninsured and underinsured patients,
volume of patients through the emergency department, the increased burden of
co-payments to be made by patients with insurance and business practices related
to collection efforts. These factors continuously change and can have an impact
on collection trends and the estimation process. The Company recently completed
a lag study which showed that the allowances recorded have been reasonable.
The Company's policy is to attempt to collect amounts due from patients,
including co-payments and deductibles due from patients with insurance, at the
time of service while complying with all federal and state laws and regulations,
including, but not limited to, the Emergency Medical Treatment and Labor Act
(EMTALA). Generally, as required by EMTALA, patients may not be denied emergency
treatment due to inability to pay. Therefore, until the legally required medical
screening examination is complete and stabilization of the patient has begun,
services are performed prior to the verification of the patient's insurance, if
any. In non-emergency circumstances or for elective procedures and services, it
is the Hospitals' policy, when appropriate, to verify insurance prior to a
patient being treated.
36
MEDICAL CLAIMS INCURRED BUT NOT REPORTED - The Company is contracted with
CalOptima, which is a county sponsored entity that operates similarly to an HMO,
to provide health care services to indigent patients at a fixed amount per
enrolled member per month. The Company receives payments from CalOptima based on
a fixed fee multiplied by the number of enrolled members at the Hospitals
("Capitation Fee"). The Company recognizes these Capitation Fees as revenues on
a monthly basis.
In certain circumstances, members will receive health care services from
hospitals not owned by the Company. In these cases, the Company records
estimates of patient member claims incurred but not reported (IBNR) for services
provided by other health care institutions. IBNR claims are estimated using
historical claims patterns, current enrollment trends, hospital
pre-authorizations, member utilization patterns, timeliness of claims
submissions, and other factors. There can, however, be no assurance that the
ultimate liability will not exceed estimates. Adjustments to the estimated IBNR
claims recorded in the Company's results of operations in the periods when such
amounts are determined. Per guidance under Statement of Financial Accounting
Standards ("SFAS") No. 5, the Company accrues for IBNR claims when it is
probable that expected future health care costs and maintenance costs under an
existing contract have been incurred and the amount can be reasonably estimable.
The Company records a charge related to these IBNR claims against its net
operating revenues. The Company's net revenues from CalOptima capitation, net of
third party claims and estimates of IBNR claims, for the years ended March 31,
2007 and December 31, 2005 and 2004 were approximately $1.3 million, $3.2
million and $-0-, respectively, and for the three months ended March 31, 2006
were approximately $1.4 million. The Company's direct cost of providing services
to patient members is included in the Company's normal operating expenses.
TRANSFERS OF FINANCIAL ASSETS - The Company sells substantially all of its
billed accounts receivable to a financing company. The Company accounts for its
sale of accounts receivable in accordance with SFAS No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities-
A replacement of SFAS No. 125". A transfer of financial assets in which the
Company has surrendered control over those assets is accounted for as a sale to
the extent that consideration other than beneficial interests in the transferred
assets is received in exchange. Control over transferred assets is surrendered
only if all of the following conditions are met:
1. The transferred assets have been isolated from the transferor (i.e.,
they are beyond the reach of the transferor and its creditors);
2. Each transferee has the unconditional right to pledge or exchange
the transferred assets it received; and
3. The Company does not maintain effective control over the transferred
assets either (a) through an agreement that entitles and obligates
the transferor to repurchase or redeem the transferred assets before
their maturity or (b) through the ability to unilaterally cause the
holder to return specific assets, other than through a cleanup call.
If a transfer of financial assets does not meet the criteria for a sale as
described above, the Company and transferee account for the transfer as a
secured borrowing with pledge of collateral.
37
The following table reconciles accounts receivable at March 31, 2007 and
December 31, 2005, as reported, to the pro forma accounts receivable, as if the
Company had deferred recognition of the sales (non GAAP) (in thousands).
March 31, 2007 December 31, 2005
As reported Pro Forma As reported Pro Forma
----------- --------- ----------- ---------
Accounts receivable
Governmental $ 7,958 $ 25,621 $ 10,395 $ 23,772
Non-governmental 13,767 51,229 8,728 45,564
-------- -------- -------- --------
21,725 76,850 19,123 69,336
Less allowance for doubtful accounts (2,355) (16,267) (3,148) (17,723)
-------- -------- -------- --------
Net patient accounts receivable 19,370 60,583 15,975 51,613
-------- -------- -------- --------
Security reserve funds 7,990 -- 14,217 --
Deferred purchase price receivables 16,975 -- 9,338 --
-------- -------- -------- --------
Receivable from Buyer of accounts 24,965 -- 23,555 --
Advance rate amount in excess of collections -- (6,957) -- (8,753)
Transaction Fees deducted from Security
Reserve Funds -- (9,291) -- (3,330)
-------- -------- -------- --------
$ 44,335 $ 44,335 $ 39,530 $ 39,530
======== ======== ======== ========
Any other term of the APA notwithstanding, the parties agreed as follows:
(a) all accounts derived from any government program payer including, without
limitation, the Medicare, Medi-Cal, or CHAMPUS programs, shall be handled as set
forth in a Deposit Account Security Agreement entered into by the parties, which
provides for the segregation and control of governmental payments by the
Company, (b) the parties agreed to take such further actions and execute such
further agreements as are reasonably necessary to effectuate the purpose of the
APA and to comply with the laws, rules, and regulations of the Medicare and
other government programs regarding the reassignment of claims and payment of
claims to parties other than the provider ("Reassignment Rules"), and (c) until
such time as accounts are delivered by the Company to the Buyer controlled
lockbox, the Company shall at all times have sole dominion and control over all
payments due from any government program payer. The Company's management
believes that the foregoing method of segregating and controlling payments
received from governmental program payers complies with all applicable
Reassignment Rules. As of March 31, 2007 as shown above in the difference
between the accounts receivable - governmental as reported versus proforma
amounts, the Company had (in thousands) $17,662 in governmental accounts
receivable that had been reported as sold which were subject to the foregoing
limitation.
INSURANCE - The Company accrues for estimated general and professional
liability claims, to the extent not covered by insurance, when they are probable
and reasonably estimable. The Company has purchased as primary coverage a claims
made form insurance policy for general and professional liability risks.
Estimated losses within general and professional liability retentions from
claims incurred and reported, along with incurred but not reported (IBNR)
claims, are accrued based upon actuarially determined projections and are
discounted to their net present value using a weighted average risk-free
discount rate of 5%. To the extent that subsequent claims information varies
from estimates, the liability is adjusted in the period such information becomes
available. As of March 31, 2007 and December 31, 2005, the Company had accrued
approximately $4.9 million and $2.3 million, respectively, comprised of
approximately $1.4 million and $0.6 million, respectively, in incurred and
reported claims, along with approximately $3.5 million and $1.7 million,
respectively, in estimated IBNR.
The Company has also purchased as primary coverage occurrence from
insurance policies to help fund its obligations under its workers' compensation
program for which the Company is responsible to reimburse the insurance carrier
for losses within a deductible of $500,000 per claim, to a maximum aggregate
deductible of $9,000,000. For the policy year ended May 15, 2006, the Company is
responsible to reimburse the insurance carrier for losses within a deductible of
$500,000 per claim, to a maximum aggregate deductible of $9,000,000. As of May
15, 2006, the Company changed to a "guaranteed cost" policy, under which the
carrier pays all workers' compensation claims, with no deductible or
reimbursement required of the Company. The company accrues for estimated
workers' compensation claims, to the extent not covered by insurance, when they
are probable and reasonably estimable. The ultimate costs related to this
program include expenses for deductible amounts associated with claims incurred
and reported in addition to an accrual for the estimated expenses incurred in
connection with IBNR claims. Claims are accrued based upon actuarially
determined projections and are discounted to their net present value using a
weighted average risk-free discount rate of 5%. To the extent that subsequent
claims information varies from estimates, the liability is adjusted in the
period such information becomes available As of March 31, 2007 and December 31,
2005, the Company had accrued approximately $1.0 million and $1.3 million,
respectively, comprised of approximately $0.2 million and $0.3 million,
respectively, in incurred and reported claims, along with $0.8 million and $1.0
million, respectively, in estimated IBNR.
38
The Company has also purchased all risk umbrella liability policies with
aggregate limit of $19 million. The umbrella policies provide coverage in excess
of the primary layer and applicable retentions for all of its insured liability
risks, including general and professional liability and the workers'
compensation program.
VARIABLE INTEREST ENTITY - Concurrent with the close on the Acquisition,
and pursuant to an agreement dated September 28, 2004, as amended and restated
on November 16, 2004, Dr. Chaudhuri and Dr. Shah exercised their option to
purchase all of the equity interests in PCHI, which simultaneously acquired
title to substantially all of the real property acquired by the Company in the
Acquisition. The Company received $5 million and PCHI guaranteed the Company's
Acquisition Loan. The Company remains primarily liable under the Acquisition
Loan note notwithstanding its guarantee by PCHI, and this note is
cross-collateralized by substantially all of the Company's assets and all of the
real property of the Hospitals. All of the Company's operating activities are
directly affected by the real property that was sold to PCHI. Given these
factors, the Company has indirectly guaranteed the indebtedness of PCHI. The
Company is a guarantor on the Acquisition Loan should PCHI not be able to
perform and has undertaken a contingent obligation to make future payments if
those triggering events or conditions occur. PCHI is a related party entity that
is affiliated with the Company through common ownership and control. It is owned
51% by West Coast Holdings, LLC (Dr. Shah and investors) and 49% by Ganesha
Realty, LLC (Dr. Chaudhuri and Mr. Thomas). Under FIN 46R a company is required
to consolidate the financial statements of any entity that cannot finance its
activities without additional subordinated financial support, and for which one
company provides the majority of that support through means other than
ownership. Effective March 8, 2005, the Company determined that it provided the
majority of financial support to PCHI through various sources including lease
payments, remaining primarily liable under the Acquisition Loan, and
cross-collateralization of the Company's non-real estate assets to secure the
Acquisition Loan. Accordingly, the Company included the net assets of PCHI, net
of consolidation adjustments, in its consolidated financial statements (in
thousands).
March 31, 2007 December 31,2005
-------------- ----------------
Total Assets $ 46,465 $ 48,068
Total Liabilities $ 45,537 $ 44,727
Members' Equity $ 927 $ 3,342
Selected information from PCHI's results of operations for the years ended
March 31, 2007 and December 31, 2005 and for the three months ended March 31,
2006 is as follows (in thousands):
March 31, 2007 December 31, 2005 December 31, 2004 March 31, 2006
-------------- ----------------- ----------------- --------------
Net revenues $ 6,554 $ 7,277 $ - $ 1,545
Net loss $ (593) $ (1,658) $ - $ (100)
Consolidation adjustments to reflect the effects of the following matters
are included in the accompanying consolidated financial statements:
The Company's rental income and expense in the Hospitals has been
eliminated, consolidating PCHI's ownership of the land and buildings in the
accompanying financial statements. The amount of rents incurred and eliminated
(in thousands) for the years ended March 31, 2007 and December 31, 2005 and 2004
was $6,554, $7,277 and $-0-, respectively, and for the three months ended March
31, 2006 was $1,554.
Additionally, a gain (in thousands) of $4,433 arising from the Company's
sale of the real property of the Hospitals to PCHI has been eliminated to record
the land and buildings at the Company's cost. Essentially all Land and Buildings
in the accompanying consolidated balance sheets are owned by PCHI.
PCHI's equity accounts have been classified as a minority interest in a
variable interest entity. The Company has a 25 year lease commitment to PCHI
with rental payments equal to the following components:
i. Interest expense on the Acquisition Loan, or successor upon
refinancing, and
ii. Up to 2.5% spread subject to adjustment annually in accordance with
the Consumer Price Index, and
iii. Amortization expense of $2.5 million per year.
39
Concurrent with the close of the Acquisition, the Company entered into a
sale-leaseback transaction with PCHI involving substantially all of the real
property acquired in the Acquisition, except for the fee interest in the medical
office building at 2617 East Chapman Avenue, for an initial term of 25 years and
an option to renew for an additional 25 years. The rental payments are variable
based primarily on the terms of financing. Based on the existing arrangements,
aggregate payments are estimated to be approximately $226 million over the
remainder of the initial term. IHHI and PCHI are currently negotiating revisions
to the lease agreement. Any revisions could result in an increase or decrease to
this commitment. As long as PCHI is consolidated the related impact on rental
income and expense should be eliminated. Any increase in payments to PCHI would
likely be distributed to the partners and have a corresponding adverse impact on
cash flow. Rental payments under the PCHI Lease are variable. IHHI is also
required to forward to PCHI Based on the existing terms of the PCHI Lease, IHHI
is also required to pay PCHI, subject to certain deferral rights, any rent
received from tenants in medical office buildings which are part of the leased
premises, less certain operating, insurance and tax expenses. Based on the
existing arrangements, aggregate payments are expected to be approximately $210
million over the remainder of the initial term of the PCHI Lease. The parties to
the PCHI Lease are currently evaluating whether it is appropriate to revise
certain terms of the PCHI Lease. Any revisions could result in an increase or
decrease to this commitment. As long as PCHI is consolidated the related impact
on rental income and expense should be eliminated. Any increase in payments to
PCHI would likely be distributed to the partners and have a corresponding
adverse impact on cash flow.
Additionally, the tenant is responsible for seismic remediation (SB 1953)
under the terms of the lease agreement.
RECENT ACCOUNTING STANDARDS
In November 2004, the FASB issued SFAS No. 151, Inventory Pricing ("SFAS
151"). SFAS 151 amends the guidance in ARB No. 43, Chapter 4, "Inventory
Pricing," to clarify the accounting for abnormal amounts of idle facility
expense, freight, handling costs, and wasted material (spoilage). This statement
requires that those items be recognized as current period charges. In addition,
SFAS 151 requires that allocation of fixed production overheads to the costs of
conversion be based on the normal capacity of the production facilities. This
statement is effective for inventory costs incurred during fiscal years
beginning after June 15, 2005. The adoption of SFAS 151 did not have a material
impact on the Company's consolidated results of operations or financial
position.
In November 2005, the FASB issued Staff Positions ("FSPs") Nos. FSPs 115-1
and 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments, in response to EITF 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments
("EITF 03-1"). FSPs 115-1 and 124-1 provide guidance regarding the determination
as to when an investment is considered impaired, whether that impairment is
other than temporary, and the measurement of an impairment loss. FSPs 115-1 and
124-1 also include accounting considerations subsequent to the recognition of an
other than temporary impairment and requires certain disclosures about
unrealized losses that have not been recognized as other than temporary
impairments. These requirements are effective for annual reporting periods
beginning after December 15, 2005. The adoption of the impairment guidance
contained in FSPs 115-1 and 124-1 did not have a material impact on the
Company's consolidated results of operations or financial position.
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain
Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140."
SFAS 155, among other things: permits the fair value re-measurement of any
hybrid financial instrument that contains an embedded derivative that otherwise
would require bifurcation and establishes a requirement to evaluate interests in
securitized financial assets to identify interests that are freestanding
derivatives or that are hybrid financial instruments that contain an embedded
derivative requiring bifurcation. SFAS 155 is effective for all financial
instruments acquired or issued in fiscal years beginning after September 15,
2006. The Company has evaluated the effect of adopting this statement and
concluded that it will not have a material effect on the Company's financial
position and results of operations.
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of
Financial Assets - an amendment of FASB Statement No. 140," with respect to the
accounting for separately recognized servicing assets and servicing liabilities.
SFAS 156 permits the choice of either the amortization method or the fair value
measurement method, with changes in fair value recorded in income, for the
subsequent measurement for each class of separately recognized servicing assets
and servicing liabilities. The statement is effective for years beginning after
September 15, 2006, with earlier adoption permitted. The Company is currently
evaluating the effect that adopting this statement will have on the Company's
financial position and results of operations.
40
In April 2006, the FASB issued FASB Staff Position ("FSP") FIN 46(R)-6,
"Determining the Variability to Be Considered in Applying FASB Interpretation
No. 46(R)" (FSP FIN 46(R)-6"), that became effective beginning July 2006. FSP
FIN 46(R)-6 clarifies that the variability to be considered in applying FIN
46(R) shall be based on an analysis of the design of the variable interest
entity. The adoption of this FSP did not have a material impact on the Company's
consolidated financial position or results of operations.
In June 2006, the FASB issued FASB Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109" ("FIN
48"). FIN 48 clarifies the circumstances in which a tax benefit may be recorded
with respect to uncertain tax positions. The Interpretation provides guidance
for determining whether tax benefits may be recognized with respect to uncertain
tax positions and, if recognized, the amount of such tax benefits that may be
recorded. Under the provisions of FIN 48, tax benefits associated with a tax
position may be recorded only if it is more likely than not that the claimed tax
position will be sustained upon audit. The statement is effective for years
beginning after December 15, 2006. The Company adopted FIN No. 48 as of April 1,
2007. The adoption of this interpretation will not have a material effect on the
Company's consolidated results of operations or consolidated financial position.
In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements". This Statement establishes a single authoritative definition of
fair value, sets out a framework for measuring fair value, and requires
additional disclosures about fair value measurements. FASB 157 applies only to
fair value measurements that are already required or permitted by other
accounting standards. The statement is effective for financial statements for
fiscal years beginning after November 15, 2007, with earlier adoption permitted.
SFAS No. 157 will be adopted during Q1 of FY 2008. The adoption of this
pronouncement is not expected to have a material effect on the Company's
consolidated results of operations or consolidated financial position.
In September 2006, the FASB issued SFAS No. 158, Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB
Statement No. 87, 88, 106 and 132(R). Under this SFAS, companies must recognize
a net liability or asset to report the funded status of their defined benefit
pension and other postretirement benefit plans (collectively referred to herein
as "benefit plans") on their balance sheets. SFAS 158 also changed certain
disclosures related to benefit plans. The adoption of SFAS 158 did not have a
material impact on the Company's consolidated results of operations or financial
position.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities-Including an amendment of FASB
Statement No. 115 ("SFAS 159"). SFAS 159 permits entities to choose to measure
many financial instruments and certain other items at fair value. Most of the
provisions of SFAS 159 apply only to entities that elect the fair value option;
however, the amendment to FASB Statement No. 115, Accounting for Certain
Investments in Debt and Equity Securities, applies to all entities with
available for sale and trading securities. The Company will adopt SFAS 159 in
the first interim quarterly period of fiscal 2008 and is evaluating the impact,
if any, that the adoption of this statement will have on its consolidated
results of operations and financial position.
OFF BALANCE SHEET ARRANGEMENTS
As of March 31, 2007 the Company had no off-balance sheet arrangements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of March 31, 2007, we did not have any investment in or outstanding
liabilities under market rate sensitive instruments. We do not enter into
hedging instrument arrangements. On December 12, 2005 we entered into a
derivative financial instrument solely for the purpose of securing a related
loan. This is discussed more fully in the Notes 8 and 11 to the consolidated
financial statements as of and for the year ended March 31, 2007.
In determining the fair value of the Deferred Purchase Price Receivable
recorded upon sales of accounts receivable accounts under the Accounts Purchase
Agreement, the key assumption used was the application of a short-term discount
rate. If the discount rate applied increased by 10%, the adverse effect on the
Deferred Purchase Price Receivable and related loss on sale of accounts
receivable would be insignificant.
41
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following consolidated financial statements are filed as a part of
this report beginning on page F-1:
------ -------------------------------------------------------------------
PAGE DESCRIPTION
------ -------------------------------------------------------------------
F-1 Report of Independent Registered Public Accounting Firm
------ -------------------------------------------------------------------
F-3 Report of prior Independent Registered Public Accounting Firm
------ -------------------------------------------------------------------
F-4 Consolidated Balance Sheets as of March 31, 2007 and
December 31, 2005
------ -------------------------------------------------------------------
F-5 Consolidated Statements of Operations for the years ended
March 31,2007 and December 31, 2005 and 2004 and the three months
ended March 31, 2006
------ -------------------------------------------------------------------
F-6 Consolidated Statements of Stockholders' Deficiency for the years
ended March 31, 2007 and December 31, 2005 and 2004 and the three
months ended March 31, 2006
------ -------------------------------------------------------------------
F-7 Consolidated Statements of Cash Flows for the years ended
March 31, 2007 and December 31, 2005 and 2004 and the three
months ended March 31, 2006
------ -------------------------------------------------------------------
F-8 Notes to Consolidated Financial Statements
------ -------------------------------------------------------------------
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
ITEM 9A. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are designed to ensure
that information required to be disclosed in the Company's periodic reports is
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms, and that such information is accumulated and
communicated to our management, including our Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions regarding required
disclosure based closely on the definition of "disclosure controls and
procedures" in Rule 15d-15(e). Our disclosure controls and procedures are
designed to provide a reasonable level of assurance of reaching the Company's
desired disclosure control objectives. In designing and evaluating the
disclosure controls and procedures, management recognized that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives and management
necessarily was required to apply its judgment in evaluating the cost benefit
relationship of possible controls and procedures.
We conducted an evaluation under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures as of March 31, 2007. This evaluation was
based on the framework in Internal Control Integrated Framework published by the
Committee of Sponsoring Organizations of the Treadway Commission. During
previous quarters we also conducted evaluations of the effectiveness of our
disclosure controls and identified certain material weaknesses, discussed below.
We restated our financial statements for the quarterly periods ended March
31, June 30, and September 30, 2006. The restatements were necessary due to
errors in calculating net revenues and patient accounts receivable. One
correction resulted in the write off of patient accounts receivable for services
provided under capitated contracts. Two others resulted in the correction of
interim revenue calculations affecting the revenues, receivables and third party
settlements (as more fully described in Note 19 to consolidated financial
statements). In reviewing the circumstances underlying the restatements, we
determined that the errors resulted from a material weakness in our internal
controls over the timely preparation and review of account reconciliations.
During the third quarter of fiscal year ended March 31, 2007, we implemented
changes to controls and processes that include: (i) new procedures to segregate
certain responsibilities among staff; (ii) new procedures regarding the manner
in which patient accounts receivable for services provided under capitated
contracts should be recorded, (iii) new procedures to monitor the timely,
accurate preparation and review of accounts reconciliations and (iv) new
procedures to improve the education and understanding by our staff in accounting
for capitation agreements.
42
The evaluation by management as of March 31, 2007 concluded that the
Company's disclosure controls and procedures are effective as of March 31, 2007.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
During the quarter ended March 31, 2007, there were no changes in our
internal control over financial reporting that materially affected, or are
reasonably likely to affect, our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The following table contains certain information concerning our directors
and executive officers as of June 30, 2007:
---------------------------- ------ --------------------------------------- ----------------------
NAME AGE POSITION WITH COMPANY DATE BECAME DIRECTOR
---------------------------- ------ --------------------------------------- ----------------------
Ajay G. Meka, M.D. 56 Chairman of the Board September 28, 2006
---------------------------- ------ --------------------------------------- ----------------------
Anil V. Shah, M.D. 57 Director January 31, 2005
---------------------------- ------ --------------------------------------- ----------------------
Bruce Mogel 49 Director, Chief Executive Officer November 18, 2003
---------------------------- ------ --------------------------------------- ----------------------
Maurice J. DeWald 67 Director August 1, 2005
---------------------------- ------ --------------------------------------- ----------------------
Syed Salman J. Naqvi, M.D. 45 Director August 1, 2005
---------------------------- ------ --------------------------------------- ----------------------
J. Fernando Niebla 67 Director August 1, 2005
---------------------------- ------ --------------------------------------- ----------------------
Larry B. Anderson 58 President
---------------------------- ------ --------------------------------------- ----------------------
Steven R. Blake 54 Chief Financial Officer
---------------------------- ------ --------------------------------------- ----------------------
Daniel J. Brothman 52 Senior Vice President Operations
---------------------------- ------ --------------------------------------- ----------------------
Milan Mehta 48 Senior Vice President Contracts and
Special Projects
---------------------------- ------ --------------------------------------- ----------------------
AJAY G. MEKA, M.D has been Chairman of the Board of Directors of the
Company since September 28, 2006. Dr. Meka has been a licensed physician in
California for the past 23 years. He is a board certified physician practicing
in Orange County, California. Dr. Meka received his medical degree from Guntur
Medical College in Gunter, India. He performed his postgraduate training at
Brooklyn Jewish Hospital and Coney Island Hospital, both in Brooklyn, New York.
ANIL V. SHAH, M.D. has been a director of the Company since January 31,
2005 and served as Chairman of the Board of Directors through September 28,
2006. The scope of his executive services to the Company is described in his
employment agreement dated March 7, 2005. He is also co manager of Orange County
Physicians Investment Network, LLC ("OC-PIN"), the Company's principal
stockholder. Dr. Shah is a Board certified cardiologist active in practice for
the last 23 years. He is an interventional and nuclear cardiologist and also
performs cutting edge imaging techniques including CT angiography of the heart.
Dr. Shah was a fellow in cardiology and subsequently a research fellow in
nuclear cardiology at the VA Hospital Wadsworth and UCLA School of Medicine. He
has held several positions at hospitals where he practices and has been an
active speaker at various forums in his field.
BRUCE MOGEL has served Chief Executive Officer and director of the Company
since November 18, 2003. Mr. Mogel has over 25 years of experience in
operational management and has held several lead executive roles in the
healthcare field. Most recently, from 1999-2002, Mr. Mogel served as Executive
Vice President of Operations for Doctors' Community Healthcare Corp, where he
was responsible for the operations and profitability of five acute care
hospitals and one psychiatric hospital, and managed a team of six hospital CEOs
and other senior management members. Mr. Mogel earned his Bachelor's degree from
The State University of New York at Buffalo with a degree in English.
43
MAURICE J. DEWALD has served as a member of the Board of Directors of the
Company since August 1, 2005 and sits on the Audit Committee, Compensation
Committee, Finance Committee and Special Committee. Mr. DeWald is Chairman and
Chief Executive Officer of Verity Financial Group, Inc., a private investment
firm that he founded in 1992. From 1962-1991, Mr. DeWald was with KPMG, LLP, one
of the world's largest international accounting and tax consulting firms, where
he served at various times as director and as the Managing Partner of the
Chicago, Orange County and Los Angeles Offices. Mr. DeWald is a director of
Mizuho Corporate Bank of California, Advanced Materials Group, Inc, NNN
Healthcare/Office REIT, Inc. and FileScan, Inc., and is a former director of
Tenet Healthcare Corporation and Quality Systems, Inc. He also sits on the
Advisory Council of the University of Notre Dame Mendoza School of Business. Mr.
DeWald is a past Chairman and director of United Way of Greater Los Angeles. Mr.
DeWald received a B.B.A. from the University of Notre Dame in 1962. He is also a
Certified Public Accountant.
SYED SALMAN J. NAQVI, M.D. has served as a member of the Board of
Directors of the Company since August 1, 2005 and sits on the Compensation
Committee. He is a practicing physician in Orange County, California and is
Board Certified in Pulmonary Medicine. He also serves as Chief of Staff of the
Pulmonary Department at Kindred Hospital in Westminster, California, and the
Medical Director of the Cardio-Pulmonary Department and the Subacute Unit at
Coastal Communities Hospital in Santa Ana, California, which has been owned by
the Company since March 2005. Dr. Naqvi also serves as a member of the Board of
Directors of Relief International, a nonprofit agency providing emergency
relief, rehabilitation and development assistance to victims of natural
disasters and conflicts worldwide. Dr. Naqvi a member of the Board of the
Company's principal stockholder, OC-PIN.
J. FERNANDO NIEBLA has served as a member of the Board of Directors of the
Company since August 1, 2005 and sits on the Audit Committee, Compensation
Committee, Finance Committee and Special Committee. He has served as President
of International Technology Partners, LLC, an information technology and
business consulting services company based on Orange County, California since
August 1998. He is also a founder of Infotec Development Inc. and Infotec
Commercial Systems, two national information technology firms. He currently
serves on the Boards of Directors of Union Bank of California, Pacific Life
Corp. and Granite Construction Corp., the Board of Trustees of the Orange County
Health Foundation, and is the Chairman of the California Advisory Committee to
Nacional Financiera, a Mexican Government agency similar to the U.S. Government
Small Business Administration office. Mr. Niebla holds a B.S. degree in
Electrical Engineering from the University of Arizona and an M.S. QBA from the
University of Southern California.
LARRY B. ANDERSON has served as President of the Company since November
2003 and served as a director of the Company from November 2003 until August 1,
2005. Mr. Anderson has over 20 years of senior level executive experience in an
enterprise with over $65 billion per year in sales. A California licensed
attorney since 1975, Mr. Anderson specializes in employment and business law
matters, including collective bargaining, arbitrations, unfair labor practices
and court cases as well as transactional work in contracts and due diligence.
From 2002-2003, as the Executive Vice President, Human Resources and General
Counsel, Litigation, Mr. Anderson managed all litigation for a seven hospital
chain in Southern California. Mr. Anderson earned his Bachelor of Arts degree in
Political Science from California State University, Long Beach, and his law
degree from Loyola University.
STEVEN R. BLAKE has served as Chief Financial Officer of the Company since
July 1, 2005 and is a California licensed Certified Public Accountant. Mr. Blake
came to the Company with over 20 years of experience in multi-hospital financial
management. He also has extensive experience serving in financial roles with
public companies. Most recently, he served as Regional Vice President of Finance
for Tenet Healthcare Corporation ("Tenet"), a position he held for over 17
years. In this position, Mr. Blake was responsible for the financial management
of numerous Tenet assets covering five western states (California, Arizona,
Washington, Nebraska and Texas). Mr. Blake's strong hospital financial
background combined with his knowledge of public company requirements made him a
strong addition to the Company's corporate team.
DANIEL J. BROTHMAN has served as Senior Vice President, Operations of the
Company and Chief Executive Officer of Western Medical Center Santa Ana since
March 8, 2005. Mr. Brothman is an experienced single and multi-hospital
operations executive. Since 1999, prior to the acquisition of the Hospitals by
the Company he helped build the Western Medical Center in Santa Ana for Tenet
Healthcare Corporation. Mr. Brothman also ran Columbia Healthcare's Utah
Division from 1996-1998. Mr. Brothman has in excess of 30 years experience in
hospital administration. Mr. Brothman earned his Bachelor of Arts degree from
Washington University at St. Louis and his Master's in Health Care
Administration from the University of Colorado at Denver.
MILAN MEHTA is Senior Vice President, Contracts & Special Projects of the
Company since March 2005. Mr. Mehta has over 21 years experience in healthcare.
Prior to joining IHHI, he was Vice President for managed care contracting for
HealthSouth Corp's western division comprising of several states. Mr. Mehta has
over 15 years experience in negotiating with commercial healthcare payors. Prior
to joining HealthSouth Corp, Mr. Mehta was employed by OrNda Healthcorp for 11
years. Mr. Mehta has an MBA from California Lutheran University, Thousand Oaks,
Ca and a Bachelors in Accounting from Calcutta University.
44
Directors DeWald and Niebla constitute the Audit Committee of the Board of
Directors. The Company does not have a Nominating Committee as the entire Board
of Directors performs the functions of this committee and this process has been
adequate to handle the Board nomination process to date. Directors DeWald, Meka,
Naqvi and Niebla each satisfy the definition of "independent director"
established in the NASDAQ listing standards. The Board of Directors has
determined that Director DeWald is an "audit committee financial expert" as
defined in the SEC rules.
Directors are elected at our annual meeting and serve until the following
annual meeting.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires our officers
and directors, and persons who own more than 10% of a registered class of our
equity securities, to file reports of ownership and changes in ownership with
the SEC. Officers, directors and greater than 10% stockholders are required by
SEC regulation to furnish us with copies of all Section 16(a) reports they file.
Based solely upon the copies of Section 16(a) reports which we received
from such persons or written representations from them regarding their
transactions in our common stock, we believe that, during the year ended March
31, 2007, all such forms were filed in a timely fashion.
CODE OF ETHICS
We have adopted a Code of Business Conduct and Ethics that applies to our
employees (including our principal executive officer, principal financial
officer and controller) and our directors. Our Code of Business Conduct and
Ethics can be obtained free of charge by sending a request to our Corporate
Secretary to the following address: Integrated Healthcare Holdings, Inc., Attn:
Larry Anderson, 1301 North Tustin Avenue, Santa Ana, California 92705.
STOCKHOLDER RECOMMENDATION OF NOMINEES
While there are no formal procedures for stockholders to recommend
nominations, the Board of Directors will consider stockholder recommendations.
Such recommendations should be addressed to the Corporate Secretary at the
address listed above.
STOCKHOLDER COMMUNICATIONS
In order to facilitate communications with the Board of Directors, or any
individual members or any Committees of the Board of Directors, stockholders
should direct all communication in writing to our General Counsel at Integrated
Healthcare Holdings, Inc., 1301 North Tustin Avenue, Santa Ana, California
92705, who will forward all such correspondence to the Board of Directors,
individual members of the Board of Directors or applicable chairpersons of any
Committee of the Board of Directors, as appropriate and as directed in the
communication.
AUDIT COMMITTEE
The Audit Committee of the Board of Directors was formed in August 2005
and consists of our two independent directors, Maurice DeWald and J. Fernando
Niebla, who joined the Board of Directors in August 2005. The Board of Directors
has determined that Maurice DeWald is an "audit committee financial expert" as
defined in the rules and regulations of the SEC. The Audit Committee of the
Board of Directors preapproves all audit and permissible non-audit services to
be performed by the independent auditors. The Audit Committee will also advise
management on the engagement of experts with sufficient expertise to advise on
accounting and financial reporting of complex financial transactions. All
members of the Audit Committee attended all 14 committee meetings held during
fiscal 2007. The Audit Committee Charter was filed previously as APPENDIX A to
the Company's Proxy Statement dated November 14, 2006.
Management is responsible for the Company's internal controls and
financial reporting process. The independent registered public accounting firm
is responsible for performing an independent audit of the Company's consolidated
financial statements in accordance with the standards of the Public Company
Accounting Oversight Board (United States) and to issue a report on these
financial statements. The Audit Committee's responsibility is to oversee these
activities.
In this context, the Audit committee has met and held discussions with
management and the independent registered public accounting firm. Management
represented to the Audit Committee that the Company's consolidated financial
statements were prepared in accordance with accounting principals generally
accepted in the United States and the Audit Committee has reviewed and discussed
the consolidated financial statements with management and the independent
registered public accounting firm. The Audit Committee also discussed with the
independent registered public accounting firm matters required to be discussed
by Statement on Auditing Standards No. 61, "Communication with Audit
Committees," as modified or supplemented, including the auditor's judgments
about the quality , as well as the acceptability, of our accounting principles
as applied in the financial reporting.
45
Our independent registered public accounting firm also provided to the
Audit Committee the written disclosures required by the Independence Standards
Board Standard No. 1 (Independence Discussions with Audit Committees), and the
Audit Committee discussed with the independent registered public accounting firm
that firm's independence as well as internal quality control procedures.
Based on the Audit Committee's discussions with management and the
independent registered public accounting firm and the Audit Committee's review
of the representations of management and the report of the independent
registered public accounting firm to the Audit Committee, the Audit Committee
recommended to the Board of Directors, and the Board has approved, that the
audited consolidated financial statements be included in the Company's Annual
Report on Form 10K for the year ended March 31, 2007 for filing with the
Securities and Exchange Commission. This report is submitted by Mr. DeWald,
Chair and Mr. Niebla.
ITEM 11. EXECUTIVE COMPENSATION
The Compensation Committee of the Board of Directors was formed in October
2005 and consists of three directors, Mr. Maurice DeWald, Dr. Syed Naqvi and Mr.
J. Fernando Niebla, chair. In fiscal year 2007, the Compensation Committee held
six meetings. The Compensation Committee is responsible for overseeing the
administration of the Company's executive compensation programs, establishing
and interpreting the Company's compensation policies and approving all
compensation paid to executive officers, including the named executive officers
listed in the Summary Compensation Table.
The following table sets forth summary information regarding compensation
earned by (i) our Principal Executive Officer and our Principal Financial
Officer during fiscal year 2007; (ii) each of our three other most highly
compensated executive officers employed by us as of March 31, 2007 whose salary
and bonus for the fiscal year ended March 31, 2007 was in excess of $100,000 for
their services rendered in all capacities to us; and (iii) two additional
individuals for whom disclosure would be required to be provided but for the
fact that the individual was not serving as an executive officer at March 31,
2007. The listed individuals are referred to as the "Named Executive Officers".
46
SUMMARY COMPENSATION TABLE
Name and Salary Bonus All Other Total
Principal Position Year ($) ($) Compensation $
------------------ ---- --------- --------- ------------ ----------
Bruce Mogel 2007 $ 360,050 - $ 17,244 $ 377,294
Principal Executive
Officer (1)
Steven R. Blake 2007 $ 284,519 - $ 18,978 $ 303,497
Principal Financial
Officer (2)
Larry B. Anderson 2007 $ 360,000 - $ 23,892 $ 383,892
President (2)
Daniel J. Brothman 2007 $ 351,089 - $ 23,169 $ 374,258
Senior Vice President
Operations (2)
Milan Mehta (3) 2007 $ 259,854 - $ 14,071 $ 273,925
Senior Vice President
Contracts & Special Projects
Anil V. Shah 2007 $ 567,692 - - $ 567,692
M.D. Executive Chairman
(Former)
(1) All other compensation includes auto allowance of $20,518 and the
balance is Company contribution to the 401K plan.
(2) All other compensation includes auto allowance of $12,000 and the
balance is Company contribution to the 401K plan.
(3) All other compensation includes auto allowance of $9,600 and the
balance is Company contribution to the 401K plan.
(4) Mr. Mehta is the brother in law of the Director, Anil V. Shah .
During the periods covered by this table, none of the Company's executive
officers were granted any stock option or stock appreciation right. Accordingly,
no tables relating to such items have been included within this Item.
COMPENSATION DISCUSSION AND ANALYSIS
The Compensation Committee of the Board of Directors has established a
compensation program for our executive officers. The objectives of this program
are to attract and retain highly qualified individuals to enable the Company to
achieve the business plan approved by the Board. This program provides for total
compensation for the executive officers consisting of three components, salary,
discretionary bonus and stock options. The Committee is in the process of
implementing the stock option portion of the program. These elements have been
chosen to remain competitive in the current health care environment. The
Committee has not recommended any bonuses for fiscal 2007. The total
compensation for each named executive is recommended to the Compensation
Committee by the CEO after considering the local healthcare market with the
final compensation decisions being made by the Compensation Committee. The CEO
also consults with the CFO on salary decisions and informs the Chair of the
Compensation Committee about any adjustments from time to time.
During the year ended March 31, 2007 the CFO was given an increase after
review and approval by the Compensation Committee after evaluation of
remuneration offered by competing companies for positions of similar complexity.
47
EMPLOYMENT CONTRACTS, SEVERANCE AGREEMENTS AND CHANGE OF CONTROL ARRANGEMENTS
In February 2005, we entered into three-year employment agreements with
Messrs. Mogel, Anderson and Ligon, with each agreement on the following terms:
o Base salary of $360,000 per year;
o Bonus as determined by the Board of Directors;
o Stock options for 1,000,000 shares, vesting annually in three equal
installments; (which options have not been issued).
o Standard medical and dental insurance;
o Up to four weeks vacation annually;
o Monthly auto allowance of $1,000, and use of cellular telephone; and
o Twelve months severance pay upon termination without cause or
resignation for cause.
In February 2005, the Company entered into a three-year employment
agreement with Daniel J. Brothman on substantially the same terms as those
described above, except with a base salary of $350,000 per year and stock
options for two million shares (which have not been granted).
In February 2005, the Company entered into a three-year employment
agreement with Milan Mehta on substantially the same terms as those described
above, except with a base salary of $250,000 per year and stock options for five
hundred thousand shares (which have not been granted).
In March 2005, the Company entered into a three-year employment agreement
with Steven R. Blake on substantially the same terms as those described above,
except with a base salary that is currently set at $275,000 (reflecting Mr.
Blake's role as Chief Financial Officer of the Company beginning in July 2005)
and stock options for 150,000 shares (which have not been granted). This
agreement was modified In February 2007 to increase the annual salary to
$350,000.
In April 2005, the Company entered into a three-year employment agreement
with Anil V. Shah as Executive Chairman on substantially the same terms as
above, except with a base salary of $500,000 per year and stock options for one
million shares (which have not been granted).
In July and August 2006, Messrs. Anderson, Mogel, Ligon and Dr. Shah
entered into a letter agreement surrendering any rights to stock options.
The Outstanding Equity Awards at Year end, Option Exercises and Stock
Vested, Pension benefits, and Nonqualified Deferred Compensation tables are not
included as there are no items to report.
48
POTENTIAL PAYMENTS UPON TERMINATION
The Company's executive officers have employment agreements which provide,
generally, for payments in the event of resignation for cause. Cause includes,
among other items, changes in job duties, reporting relationships, bankruptcy of
the Company or change in shareholders of over 50% of the stock. The executive
officer would be entitled to twelve months salary, benefits and health
insurance, but not any additional accruals of paid time off, vacation or sick
pay.
The following table provides information concerning the estimated payments and
benefits that would be provided in the circumstances described above for each of
the named executive officers. Payments and benefits are estimated assuming that
the triggering event took place on the last business day of fiscal 2007 (March
31, 2007), and the price per share of the Company's common stock is the closing
price on the OTCBB as of that date ($0.32). There can be no assurance that a
triggering event would produce the same or similar results as those estimated
below if such event occurs on any other date or at any other price, of if any
other assumption used to estimate potential payments and benefits is not
correct. The amounts which would be due the named executive officers as of year
end, if they resigned for cause is as follows.
PAYMENTS DUE UPON TERMINATION
Name
and Twelve Employee
Principal Months Health Car Other
Position Salary Insurance Allowance Benefits Total
-------- --------- --------- --------- -------- -----
Bruce Mogel $ 360,000 $ 16,286 $ 12,000 $ 388,286
Chief Executive Officer
Steven R. Blake $ 350,000 $ 16,286 $ 12,000 $ 378,286
Chief Financial Officer
Larry B. Anderson $ 360,000 $ 12,235 $ 12,000 $ 384,235
President
Daniel J. Brothman $ 350,000 $ 16,286 $ 12,000 $ 378,286
Senior Vice President,
Operations
Milan Mehta $ 250,000 $ 16,286 $ 9,600 $ 275,886
Senior Vice President,
Contracts & Special Projects
49
COMPENSATION OF DIRECTORS
DIRECTOR COMPENSATION
Fees Earned or
Name Paid in Cash Total
($) ($)
---------------------------- -------------- -------------
Ajay Meka, M.D. $ 32,000 $ 32,000
Maurice J. DeWald $ 128,000 $ 128,000
Syed Salman J. Naqvi, M.D. $ 48,500 $ 48,500
J. Fernando Niebla $ 127,750 $ 127,750
The current compensation for Directors is as follows:
i. Cash - Each non-employee Director receives an annual retainer
fee of $30,000 and an attendance fee of $1,500 for each Board
meeting attended, and a separate $1,000 fee for each committee
meeting attended. Committee Chairmen receive an additional
annual retainer of $5,000;
ii. Stock - A director who is not an employee or an owner of the
company may receive options to purchase shares of IHHI stock
at the direction of the Board. To date, none have been granted
by the Board.
iii. Travel Reimbursement - All travel and related expenses
incurred by Directors to attend Board meetings, committee
meetings and other IHHI activities are reimbursed by IHHI.
iv. Mr. DeWald and Mr. Niebla are members of the Finance
Committee, which has met extensively.
Employee directors receive no compensation for Board service and the
Company does not provide any retirement benefits to non-employee directors.
Directors Shah and Mogel are not included above as all compensation paid to them
is included in the Summary Compensation Table.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The compensation committee consists of three of the Company's independent
directors, Mr. Niebla, Mr. DeWald and Dr Naqvi. There are no interlocks between
our executive officers and the members of the Compensation Committee.
COMPENSATION COMMITTEE REPORT
THE INFORMATION CONTAINED IN THIS REPORT SHALL NOT BE DEEMED TO BE
"SOLICITING MATERIAL" OR "FILED" WITH THE SEC OR SUBJECT TO THE LIABILITIES OF
SECTION 18 OF THE EXCHANGE ACT, EXCEPT TO THE EXTENT THAT THE COMPANY
SPECIFICALLY INCORPORATES IT BY REFERENCE INTO A DOCUMENT FILED UNDER THE
SECURITIES ACT OR THE EXCHANGE ACT.
The Compensation Committee of the Board of Directors has reviewed and
discussed The Compensation Discussion and Analysis required by item 402(b) of
Regulation S-K with management and based on sush review and discussion, has
recommended to the Board of Directors that the Compensation Discussion and
Analysis be included in this Form 10-K for the year ended March 31, 2007. The
members of the Compensation Committee making this recommendation are Mr. Niebla,
Chair, and Mr. DeWald and Dr. Naqvi.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
The following table sets forth information known to us with respect to the
beneficial ownership of our common stock as of July 3, 2007, unless otherwise
noted, by:
o each shareholder known to us to own beneficially more than 5%
of our common stock;
o each of our directors and each of our executive officers at
March 31, 2007; and
o all of our current directors and executive officers as a
group.
Except as otherwise noted below, the address of each person or entity
listed on the table is 1301 North Tustin Avenue, Santa Ana, California 92705.
The address of Dr. Kali Chaudhuri and William Thomas is 6800 Indiana Avenue,
Suite 130, Riverside, CA 92506.
50
Security Ownership of Certain Beneficial Owners
AMOUNT AND
NATURE OF
BENEFICIAL PERCENTAGE
NAME OWNERSHIP (1) OF TOTAL
- ---------------------------------------------------------------------- ------------- ----------
DIRECTORS AND EXECUTIVE OFFICERS
Ajay Meka, M.D. 0 --
Anil V. Shah, M.D. (1) 59,098,430 43.1%
Bruce Mogel (2) 54,903,786 40.0%
Syed Salman Naqvi, M.D. - --
Larry B. Anderson 5,112,000 3.7%
PRINCIPAL SHAREHOLDERS (OTHER THAN THOSE NAMED ABOVE:
Orange County Physicians Investment Network, LLC ("OC-PIN") (1) 59,098,430 43.1%
Kali Chaudhuri M.D. (2) 39,789,788 29.0%
William E Thomas (2) 9,748,498 7.1%
(1) Dr. Anil Shah is co-manager and part owner of OC-PIN. Dr. Shah
disclaims beneficial ownership of all shares held by OC-PIN except to the extent
of his respective pecuniary interests therein.
(2) Shares issued on July 3, 2007. Dr. Kali Chaudhuri and Mr. William E
Thomas have entered into separate irrevocable proxies providing Bruce Mogel with
limited voting rights over all of their shares. Accordingly all shares held by
Dr. Kali Chaudhuri and Mr. William E Thomas are deemed beneficially owned by
Bruce Mogel.
Security Ownership of Management
AMOUNT AND
NATURE OF
BENEFICIAL PERCENTAGE
NAME OWNERSHIP OF TOTAL
----------------------------- ------------- ------------
Ajay Meka, M.D.(1) 0 --
Anil V. Shah, M.D. (1) 59,098,430 43%
Maurice J. DeWald - --
Jaime Ludmir, M.D. - --
Bruce Mogel (2) 54,903,786 40%
Syed Salman Naqvi, M.D. (1) - --
Larry B. Anderson 5,112,000 4%
Steven R. Blake - --
Daniel J. Brothman - --
Milan Mehta - --
All current directors and
executive officers as a group
(10 persons) 119,114,216 87%
1) Dr, Ajay Meka, Dr. Anil Shah and Dr. Syed Salman Naqvi are co
managers and part owners of OC-PIN. Dr. Shah, Dr. Naqvi and OC-PIN
may be deemed to be a "group" for purposes of Section 13(d) (3) of
the Securities Exchange Act of 1934. Dr. Shah and Dr. Naqvi each
disclaim beneficial ownership of all shares held by OC-PIN except to
the extent of their respective pecuniary interests therein.
2) Dr. Kali Chaudhuri and Mr. William E Thomas have entered into
separate irrevocable proxies providing Bruce Mogel with limited
voting rights over all of their shares. Accordingly all shares held
by Dr. Kali Chaudhuri and Mr. William E Thomas are deemed
beneficially owned by Bruce Mogel.
51
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
CERTAIN RELATIONSHIPS
Milan Mehta, senior vice president contracts and special pricing, is the
brother in law of Director Anil V. Shah.
TRANSACTIONS WITH RELATED PARTIES
The following is a summary of certain transactions occurring in the last
three years between the Company and its directors, officers and 5% or greater
shareholders (other than compensatory arrangements which are described above):
In January 2004, the Company began reimbursing Mogel Management, LLC for
approximately 3,400 square feet of office space within an office building that
is leased to Mogel Management, LLC, a company owned by Bruce Mogel, Larry B.
Anderson and James T. Ligon. The Company reimbursed Mogel Management, LLC for
its use of space in the amount of $5,717 per month. This arrangement ended in
February, 2006.
On January 1, 2004, the Company acquired Mogel Management Group, Inc., an
operating company owned by Messrs. Mogel, Anderson and Ligon, for promissory
notes with an aggregate principal amount of $60,000. The notes were forgiven
during 2004, and were reflected in the Company's consolidated statement of
operations for the year ended December 31, 2004.
On November 16, 2004, the Company entered into a Purchase Option Agreement
(the "Purchase Option Agreement") with Dr. Anil V. Shah or his assignee, OC-PIN,
granting to OC-PIN an option (the "Purchase Option") to (i) purchase up to
50,000,000 shares of common stock of the Company for an aggregate of $15,000,000
and (ii) invest $2,500,000 for a 49% membership interest in a new limited
liability company (the "Real Estate LLC") to be formed for the purpose of
holding real estate which the Company agreed to acquire from subsidiaries of
Tenet Healthcare Corporation. The Company also granted a stock option to Dr.
Anil V. Shah individually providing that, if the Purchase Option is exercised in
full by OC-PIN, the Company will provide Dr. Shah with an additional right to
purchase 10,000,000 shares of common stock of the Company for $0.25 per share.
On January 28, 2005, the Company entered into a Stock Purchase Agreement
(the "Stock Purchase Agreement") with OC-PIN, under which (i) the Purchase
Option Agreement was terminated, and (ii) OC-PIN agreed to invest $30,000,000 in
the Company for an aggregate of 108,000,000 shares of common stock of the
Company.
Also, on January 27, 2005, the Company entered into a Rescission,
Restructuring and Assignment Agreement (the "Restructuring Agreement") with Kali
P. Chaudhuri, M.D., William E. Thomas, and Anil V. Shah, M.D. The Restructuring
Agreement amended and canceled certain portions of an agreement under which Dr.
Chaudhuri agreed to acquire stock in the Company. Also under the Restructuring
Agreement, (i) OC-PIN agreed to pay or cause to be paid to Dr. Chaudhuri his
escrow deposit of $10,000,000 plus accrued interest, and (ii) OC-PIN and Dr.
Chaudhuri agreed to form a new real estate holding company to own and operate
the Real Estate LLC, with Dr. Chaudhuri to own no more than 49% of the Real
Estate LLC.
On March 7, 2005, upon acquisition of the Hospitals, the Company
transferred its right to all of the fee interests in the Hospital Properties to
Pacific Coast Holdings Investments, LLC ("PCHI"). PCHI is 51% owned by West
Coast Holdings, LLC (owned in part by Dr. Anil Shah) and 49% by Ganesha Realty
LLC (owned in part by Dr. Kali Chaudhuri). The Company entered into a Triple Net
Lease under which it leased back from PCHI all of the Hospital Properties.
On or about June 16, 2005, the Company extended OC-PIN's additional
financing commitment under the Stock Purchase Agreement when the Company entered
into the following new agreements:
o First Amendment to the Stock Purchase Agreement, dated as of June 1, 2005
(the "First Amendment"); and
o Escrow Agreement, dated as of June 1, 2005, by and among the Company,
OC-PIN and City National Bank (the "Escrow Agreement").
52
The following material terms were contained in the First Amendment and the
Escrow Agreement:
o OC-PIN's total stock purchase commitment under the Stock Purchase
Agreement was reduced from $30 million to $25 million;
o A total of 57,250,000 shares of the Company's common stock previously
issued to OC-PIN were placed in an escrow account with City National Bank
in July 2005. OC-PIN had until September 1, 2005 to make monthly
installments into the escrow account up to an aggregate of approximately
$15,000,000. Such portion of the escrowed shares which were fully paid was
to be returned to OC-PIN and the balance was to be transferred back to the
Company;
o OC-PIN agreed to reimburse the Company for $707,868 of its additional debt
financing costs incurred since March 8, 2005. As of December 31, 2005,
$340,000 of these costs had been recovered by the Company;
o The Company would work to complete a new borrowing transaction; and
o Upon receipt of at least $5,000,000 of new capital under the First
Amendment, the Company would call a shareholders meeting to reelect
directors.
Under the First Amendment and the Escrow Agreement, OC-PIN deposited a
total of $12,500,000 into the escrow account. However, following receipt of such
funds, a disagreement arose between OC-PIN and the third party which provided
$11,000,000 of the $12,500,000 deposited into the escrow account. In order to
resolve this matter and to avoid potential litigation involving the Company, the
Company agreed to return $11,000,000 of these funds and provide OC-PIN with a
limited opportunity to provide alternative financing. Therefore, effective
October 31, 2005, the Company entered into a Second Amendment to the Stock
Purchase Agreement (the "Second Amendment"), pursuant to which the Company and
OC-PIN issued escrow instructions to release escrowed funds as of November 2,
2005, terminate the Escrow Agreement and distribute the assets in the escrow
account as follows:
1. $1,500,000 of the escrowed cash, plus a pro rata portion of the accrued
interest, was delivered to the Company for payment of stock.
2. $11,000,000 of the escrowed cash, plus a pro rata portion of the accrued
interest was delivered to OC-PIN.
3. 5,798,831 of the escrowed shares of the Company's common stock were
delivered to OC-PIN.
4. 40,626,684 of the escrowed shares of the Company's common stock were
delivered to the Company.
5. OC-PIN transferred $2,800,000 from another account to the Company for
which OC-PIN received 10,824,485 of the escrowed shares.
6. The Company agreed to issue to OC-PIN 5,400,000 shares of its common stock
multiplied by the percentage of OC-PIN's payment required to be made under
the Stock Purchase Agreement, as amended, which had been made to date. As
of December 31, 2005, 3,110,400 of these shares were not issued due to a
dispute with OC-PIN over the Company's recovery of $367,868 in additional
interest costs pursuant to the First Amendment. The Company resolved this
dispute with OC-PIN on July 25, 2006.
7. The Company granted OC-PIN the right to purchase up to $6,700,000 of
common stock within 30 calendar days following the cure of the Company's
default relating to the Credit Agreement at a price of $0.2586728 per
share or a maximum of 25,901,447 shares of its common stock, plus interest
on the purchase price at 14% per annum from September 12, 2005 through the
date of closing on the funds from OC-PIN. Upon one or more closings on
funds received under this section of the Second Amendment, the Company
will issue an additional portion of the 5,400,000 shares mentioned in item
(6) above.
8. On September 12, 2006, the Company issued 3,625,114 shares of stock to
OC-PIN in full resolution of the Stock Purchase Agreement.
53
ACQUISITION DEBT - Effective March 3, 2005, in connection with the
Acquisition, the Company and its subsidiaries collectively entered into a credit
agreement (the "Credit Agreement") with Medical Provider Financial Corporation
II ("the Lender"), whereby the Company obtained initial financing in the form of
a loan with interest at the rate of 14% per annum in the amount of $80,000,000
of which $30,000,000 is in the form of a non revolving Line of Credit and
$50,000,000 (less $5,000,000 repayment on December 12, 2005) is in the form of
an Acquisition Loan (collectively, the "Obligations"). OC-PIN and PCHI were
parties to the Credit Agreement and provided various guaranties and security
interests to the lender.
SECURED SHORT TERM NOTE - On December 12, 2005, the company entered into a
credit agreement with the lender, whereby the lender loaned the Company $10.7
million. OC-PIN and PCHI were parties to the credit agreement for this financing
and provided various guaranties and security interests to the lender.
REVIEW, APPROVAL OR RATIFICATION OF TRANSACTIONS WITH RELATED PARTIES
The Company's Human Resource policies provide guidance for Conflicts of
Interest and their relation to the standards of ethical behavior expected of
employees. The policies specifically require immediate written disclosure of any
business, financial, or other relationship that either creates, or is perceived
to create a conflict of interest. The Corporate Compliance Officer is
responsible for monitoring compliance with this policy.
As part of the quarterly disclosure control procedures, the Chief
Financial Officer and Chief Executive Officer for each hospital disclose or
certify that employees or officers have not acted in a manner inconsistent the
Company policy related to Conflict of Interest. The Corporate CFO and Director
of Internal Audit monitor certifications for potential disclosure events.
Company policy requires the General Counsel review and approval of all
contracts involving related parties, including contracts with related parties
who are considered potential referral sources. The Audit Committee has requested
that the General Counsel provide periodic updates of such transactions to the
Committee.
During the acquisition, the Company entered into agreements with the
Medical Executive staff (MEC) at the largest hospital, Western Medical Center -
Santa Ana (WMC-SA) requiring the MEC's' advance consent for all agreements
involving hospital operations with related parties, excluding the lease
arrangements between the company and PCHI. The same agreement was subsequently
offered to each of the other hospitals' Medical Staffs, but not ultimately
executed by them. Notwithstanding this fact, the Company applies the disclosure
provisions applicable to WMC-SA to all of its facilities.
DIRECTOR INDEPENDENCE
Directors DeWald, Meka, Naqvi and Niebla each satisfy the definition of
"independent director" as established in the NASDAQ listing standards.
54
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The following table sets forth the aggregate fees that we incurred for
audit and non-audit services provided by BDO Seidman, LLP and by Ramirez
International, which acted as independent auditors for the years ended March 31,
2007 and December 31, 2005, respectively and performed audit services for us
during those periods. The audit fees include only fees that are customary under
generally accepted auditing standards and are the aggregate fees that we
incurred for professional services rendered for the audit of our financial
statements for the years ended March 31, 2007 and December 31, 2005,
respectively.
NATURE OF FEES
Fees incurred from BDO Seidman LLP:
For the year For the three
ended months ended
March 31, 2007 March 31, 2006
-------------- --------------
Audit fees (financial) $ 1,400,000 $ -
Audit related fees -
Tax fees - -
All other - -
-------------- --------------
Total fees $ 1,400,000 $ -
============== ==============
Fees incurred from Ramirez and Associates:
For the year For the nine
ended months ended
December 31, 2005 September 30, 2006
----------------- ------------------
Audit fees (financial) $ 1,237,194 $ 199,726
Audit related fees 26,011 -
Tax fees 1,593,270 -
All other - -
- -
----------------- ------------------
Total fees $ 2,856,475 $ 199,726
================= ==================
The Audit Committee of the Board of Directors pre-approves all audit and
permissible non-audit services to be performed by the independent auditors. The
Board of Directors of the Company considered that the provision of the services
and the payment of the fees described above are compatible with maintaining the
auditors' independence.
ITEM 15. EXHIBITS; FINANCIAL STATEMENT SCHEDULES
Exhibits required to be filed are listed below and except where
incorporated by reference, immediately follow the Financial Statements. Each
document filed with this report is marked with an asterisk (*). References to
the "Commission" mean the U.S. Securities and Exchange Commission.
- -------------- -----------------------------------------------------------------
Exhibit
Number Description
- ------ -----------
- -------------- -----------------------------------------------------------------
2.1 Asset Sale Agreement, dated September 29, 2004, by and among the
Registrant and certain subsidiaries of Tenet Healthcare
Corporation (AHM CGH, Inc., Health Resources Corporation of
America - California, SHL/O Corp., and UWMC Hospital Corporation)
(incorporated herein by reference from Exhibit 10.2 to the
Registrant's Current Report on Form 8-K filed with the Commission
on November 22, 2004).
- -------------- -----------------------------------------------------------------
2.2 First Amendment to Asset Sale Agreement dated January 28, 2005,
by and among the Registrant and certain subsidiaries of Tenet
Healthcare Corporation (incorporated herein by reference from
Exhibit 99.4 to the Registrant's Current Report on Form 8-K filed
with the Commission on February 2, 2005).
- -------------- -----------------------------------------------------------------
2.3 Second Amendment to Asset Sale Agreement, effective as of January
1, 2005, by and among the Registrant and certain subsidiaries of
Tenet Healthcare Corporation (incorporated herein by reference
from Exhibit 99.1 to the Registrant's Current Report on Form 8-K
filed with the Commission on March 14, 2005).
- -------------- -----------------------------------------------------------------
2.4 Third Amendment to Asset Sale Agreement, effective as of March 8,
2005, by and among the Registrant and certain subsidiaries of
Tenet Healthcare Corporation (incorporated herein by reference
from Exhibit 99.2 to the Registrant's Current Report on Form 8-K
filed with the Commission on March 14, 2005).
- -------------- -----------------------------------------------------------------
55
3.1 Articles of Incorporation of the Registrant (incorporated herein
by reference from Exhibits 3.3, 3.4 and 3.6 to Form 10-SB filed
by the Registrant on December 16, 1997).
- -------------- -----------------------------------------------------------------
3.2 Certificate of Amendment to Articles of Incorporation of the
Registrant (incorporated by reference to Appendix A to
Registrant's Definitive Information Statement on Schedule 14C
filed by the Registrant on October 20, 2004).
- -------------- -----------------------------------------------------------------
3.3 Amended and Restated Bylaws of the Registrant (incorporated
herein by reference from Exhibit 3.1 to the Registrant's Current
Report on Form 8-K filed with the Commission on October 26,
2005).
- -------------- -----------------------------------------------------------------
4.4 Integrated Healthcare Holdings, Inc. 2006 Stock Incentive Plan
(incorporated by reference to Appendix B to the Registrant's
Definitive Proxy Statement on Schedule 14A filed by the
Registrant on November 14, 2006).
- -------------- -----------------------------------------------------------------
4.5 Form of Notice of Stock Option Award and Stock Option Agreement.
(incorporated herein by reference from Exhibit 4.5 to the
Registrant's Registration Statement under the Securities and
Exchange Act of 1933 on Form S-8 filed with the Commission on
February 2, 2007).
- -------------- -----------------------------------------------------------------
10.1 Rescission, Restructuring and Assignment Agreement, dated January
27, 2005, by and among the Registrant, Kali P. Chaudhuri, M.D.,
William E. Thomas, Anil V. Shah, M.D., and Orange County
Physicians Investment Network, LLC (incorporated herein by
reference from Exhibit 99.1 to the Registrant's Current Report on
Form 8-K filed with the Commission on February 2, 2005).
- -------------- -----------------------------------------------------------------
10.2 Stock Purchase Agreement, dated January28, 2006, by and between
the Registrant and Orange County Physicians Investment Network,
LLC (incorporated herein by reference from Exhibit 99.2 to the
Registrant's Current Report on Form 8-K filed with the Commission
on February 2, 2005).
- -------------- -----------------------------------------------------------------
10.3 Guaranty Agreement, dated as of March 3, 2005, by Orange County
Physicians Investment Network, LLC in favor of Medical Provider
Financial Corporation II (incorporated herein by reference from
Exhibit 99.3 to the Registrant's Current Report on Form 8-K filed
with the Commission on March 14, 2005).
- -------------- -----------------------------------------------------------------
10.4 Guaranty Agreement, dated as of March 3, 2005, by Pacific Coast
Holdings Investments, LLC in favor of Medical Provider Financial
Corporation II (incorporated herein by reference from Exhibit
99.4 to the Registrant's Current Report on Form 8-K filed with
the Commission on March 14, 2005).
- -------------- -----------------------------------------------------------------
10.5 Subordination Agreement, dated as of March 3, 2005, by and among
the Registrant and its subsidiaries, Pacific Coast Holdings
Investments, LLC, and Medical Provider Financial Corporation II
(incorporated herein by reference from Exhibit 99.5 to the
Registrant's Current Report on Form 8-K filed with the Commission
on March 14, 2005).
- -------------- -----------------------------------------------------------------
10.6 Credit Agreement, dated as of March 3, 2005, by and among the
Registrant and its subsidiaries, Pacific Coast Holdings
Investments, LLC and its members, and Medical Provider Financial
Corporation II (incorporated herein by reference from Exhibit
99.6 to the Registrant's Current Report on Form 8-K filed with
the Commission on March 14, 2005).
- -------------- -----------------------------------------------------------------
10.6.1 Amendment No. 1 to Credit Agreement, dated as of December 18,
2006, by and among Integrated Healthcare Holdings, Inc., WMC-SA,
Inc., WMC-A, Inc., Chapman Medical Center, Inc., Coastal
Communities Hospital, Inc., Pacific Coast Holdings Investment,
LLC, Orange County Physicians Investment Network, LLC, Ganesha
Realty, LLC, West Coast Holdings, LLC, and Medical Provider
Financial Corporation II (incorporated by reference to Exhibit
99.1 to the Registrant's Report on Form 8-K filed on December 26,
2006).
- -------------- -----------------------------------------------------------------
10.6.2 Agreement to Forbear, dated as of December 18, 2006, by and among
Integrated Healthcare Holdings, Inc., WMC-SA, Inc., WMC-A, Inc.,
Chapman Medical Center, Inc., Coastal Communities Hospital, Inc.,
Pacific Coast Holdings Investment, LLC, Orange County Physicians
Investment Network, LLC, Ganesha Realty, LLC, West Coast
Holdings, LLC, Medical Provider Financial Corporation II, and
Healthcare Financial Management & Acquisitions, Inc (incorporated
by reference to Exhibit 99.2 to the Registrant's Report on Form
8-K filed on December 26, 2006).
- -------------- -----------------------------------------------------------------
56
- -------------- -----------------------------------------------------------------
10.7 Form of $50 million acquisition note by the Registrant and its
subsidiaries (incorporated herein by reference from Exhibit 99.7
to the Registrant's Current Report on Form 8-K filed with the
Commission on March 14, 2005).
- -------------- -----------------------------------------------------------------
10.8 Form of $30 million line of credit note by the Registrant and its
subsidiaries (incorporated herein by reference from Exhibit 99.8
to the Registrant's Current Report on Form 8-K filed with the
Commission on March 14, 2005).
- -------------- -----------------------------------------------------------------
10.9 Triple Net Hospital and Medical Office Building Lease dated March
7, 2005, as amended by Amendment No. 1 To Triple Net Hospital and
Medical Office Building Lease (incorporated herein by reference
from Exhibit 99.9 to the Registrant's Current Report on Form 8-K
filed with the Commission on March 14, 2005).
- -------------- -----------------------------------------------------------------
10.10 Employment Agreement with Bruce Mogel dated February 25, 2005
(incorporated herein by reference from Exhibit 10.16 to the
Registrant's Annual Report on Form 10-KSB filed with the
Commission on March 31, 2005).
- -------------- -----------------------------------------------------------------
10.11 Employment Agreement with Larry B. Anderson dated February 25,
2005 (incorporated herein by reference from Exhibit 10.17 to the
Registrant's Annual Report on Form 10-KSB filed with the
Commission on March 31, 2005).
- -------------- -----------------------------------------------------------------
10.12 Employment Agreement with James T. Ligon dated February 25, 2005
(incorporated herein by reference from Exhibit 10.18 to the
Registrant's Annual Report on Form 10-KSB filed with the
Commission on March 31, 2005).
- -------------- -----------------------------------------------------------------
10.12.1 Severance Agreement with James T. Ligon dated January 20, 2006
(incorporated herein by reference from Exhibit 99.1 to the
Registrant's Current Report on Form 8-K filed with the Commission
on January 26, 2006).
- -------------- -----------------------------------------------------------------
10.13 Employment Agreement with Milan Mehta, dated February 25, 2005
(incorporated herein by reference from Exhibit 10.19 to the
Registrant's Annual Report on Form 10-KSB filed with the
Commission on March 31, 2005).
- -------------- -----------------------------------------------------------------
10.14 Employment Agreement with Hari S. Lal dated February 25, 2004
(incorporated herein by reference from Exhibit 10.20 to the
Registrant's Annual Report on Form 10-KSB filed with the
Commission on March 31, 2005).
- -------------- -----------------------------------------------------------------
10.15 Employment Agreement with Daniel J. Brothman dated December 31,
2005 (incorporated herein by reference from Exhibit 10.21 to the
Registrant's Annual Report on Form 10-KSB filed with the
Commission on March 31, 2005).
- -------------- -----------------------------------------------------------------
10.16 Employment Agreement with Steve R. Blake dated March 21, 2005
(incorporated herein by reference from Exhibit 10.22 to the
Registrant's Annual Report on Form 10-KSB filed with the
Commission on March 31, 2005).
- -------------- -----------------------------------------------------------------
10.16.1 Letter of Amendment to Employment Agreement of Steven R. Blake,
dated as of February 14, 2007 (incorporated herein by reference
from Exhibit 99.1 to the Registrant's Current Report on Form 8-K
filed with the Commission on February 21, 2007).
- -------------- -----------------------------------------------------------------
10.17 Employment Agreement with Dr. Anil Shah, dated March 7, 2005.
- -------------- -----------------------------------------------------------------
10.18 Amendment to Employment Agreement dated August 5, 2006 by and
among the Company and each of Anil V. Shah, Hari S. Lal, Bruce
Mogel and Larry B. Anderson(incorporated herein by reference from
Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q
filed with the Commission on November 14, 2006).
- -------------- -----------------------------------------------------------------
10.19 Agreement to Forbear executed June 18, 2007. (incorporated herein
by reference from Exhibit 99.1 to the Registrant's Current Report
on Form 8-K filed with the Commission on June 19, 2007).
- -------------- -----------------------------------------------------------------
10.20 Amendment No. 1 to Forbearance Agreement executed June 18, 2007.
(incorporated herein by reference from Exhibit 99.1 to the
Registrant's Current Report on Form 8-K filed with the Commission
on June 19, 2007).
- -------------- -----------------------------------------------------------------
21.1 The subsidiaries of the Registrant are WMC-SA, Inc., a California
corporation, WMC-A, Inc., a California corporation, Chapman
Medical Center, Inc., a California corporation, Coastal
Communities Hospital, Inc., a California corporation, and Mogel
Management, Inc., a Nevada corporation.
- -------------- -----------------------------------------------------------------
23.1 Consent of BDO, LLP
- -------------- -----------------------------------------------------------------
31.1 Certification of Chief Executive Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002 *
- -------------- -----------------------------------------------------------------
57
31.2 Certification of Chief Financial Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002 *
- -------------- -----------------------------------------------------------------
32.1 Certification of Chief Executive Officer Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002 *
- -------------- -----------------------------------------------------------------
32.2 Certification of Chief Financial Officer Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002 *
- -------------- -----------------------------------------------------------------
The following financial statement schedule is the only schedule required
to be filed under the applicable accounting regulations of the Securities and
Exchange Commission.
INTEGRATED HEALTHCARE HOLDINGS, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
[amounts in '000's]
BALANCE AT
BEGINNING OF BALANCE AT
PERIOD DESCRIPTION PERIOD ADDITIONS DEDUCTIONS END OF PERIOD
- ------ ----------- ------ --------- ---------- -------------
Accounts Receivable:
Year ended March 31, 2007 Allowance for doubtful accounts $ 2,463 $ 35,169 $ 35,277 $ 2,355
Three months ended March 31, 2006 Allowance for doubtful accounts $ 3,148 $ 8,330 $ 9,015 $ 2,463
Year ended December 31, 2005 Allowance for doubtful accounts $ -- $ 37,349 $ 34,201 $ 3,148
Year ended December 31, 2004 Allowance for doubtful accounts $ -- $ -- $ -- $ --
Deferred tax assets:
Year ended March 31, 2007 Valuation allowance $ 19,041 $ 14,684 $ -- $ 33,725
Three months ended March 31, 2006 Valuation allowance $ 14,775 $ 4,266 $ -- $ 19,041
Year ended December 31, 2005 Valuation allowance $ 800 $ 13,975 $ -- $ 14,775
Year ended December 31, 2004 Valuation allowance $ 41 $ 759 $ -- $ 800
58
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
INTEGRATED HEALTHCARE HOLDINGS, INC.
Dated: July 16, 2007 /s/ Bruce Mogel
----------------------------------------
Bruce Mogel
Chief Executive Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Dated: July 12, 2007 /s/ Ajay Meka, M.D.
----------------------------------------
Ajay Meka, M.D
Chairman of the Board of Directors
Dated: July 12, 2007 /s/ Bruce Mogel
----------------------------------------
Bruce Mogel
Director and Chief Executive Officer
(Principal Executive Officer)
Dated: July 12, 2007 /s/ Maurice J. DeWald
----------------------------------------
Maurice J. DeWald
Director
Hon. Robert Jamison
----------------------------------------
Hon. Robert Jamison
Director
Dated: July 12, 2007 /s/ Syed S. Naqvi, M.D.
----------------------------------------
Syed S. Naqvi, M.D.
Director
Dated: July 12, 2007 /s/ J. Fernando Niebla
----------------------------------------
J. Fernando Niebla
Director
Dated: July 12, 2007 /s/ Anil V. Shah, M.D.
----------------------------------------
Anil V. Shah, M.D.
Director
59
Report of Independent Registered Public Accounting Firm
Board of Directors
Integrated Healthcare Holdings, Inc.
Santa Ana, California
We have audited the accompanying consolidated balance sheet of Integrated
Healthcare Holdings, Inc. and consolidated entities (the "Company") as of March
31, 2007 and the related consolidated statements of operations, stockholders'
deficiency, and cash flows for the three months ended March 31, 2006 and for the
year ended March 31, 2007. We have also audited the schedule as listed in the
accompanying index. These consolidated financial statements and schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, 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 consolidated financial position of the
Company at March 31 2007, and the results of its operations and its cash flows
for the three months ended March 31, 2006 and for the year ended March 31, 2007,
in conformity with accounting principles generally accepted in the United States
of America.
Also in our opinion, the schedule presents fairly, in all material respects, the
information set forth therein for the three months ended March 31, 2006 and the
year ended March 31, 2007.
We also have audited the adjustment described in Note 2 that was applied to
restate the consolidated financial statements as of and for the year ended
December 31, 2005 to correct an error. In our opinion, such adjustment is
appropriate and has been properly applied. We were not engaged to audit, review,
or apply any procedures to the consolidated financial statements as of and for
the year ended December 31, 2005 of the Company other than with respect to the
adjustment, and accordingly, we do not express an opinion or any other form of
assurance on the consolidated financial statements as of and for the year ended
December 31, 2005 taken as a whole.
F-1
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has suffered recurring losses
from operations and has a significant working capital deficit and a net capital
deficiency at March 31, 2007. In addition, all of the Company's debt matured as
of March 31, 2007 and the Company is currently operating under a ninety day
Forbearance Agreement. These factors raise substantial doubt about the Company's
ability to continue as a going concern. Management's plans in regard to these
matters are also described in Note 1. The consolidated financial statements do
not include any adjustments that might result from the outcome of this
uncertainty.
As discussed in Note 2 to the consolidated financial statements, effective
September 30, 2006, the Company changed its method of quantifying misstatements
of prior year financial statements. The Company adopted the dual method, as
required by SEC Staff Accounting Bulletin No. 108, "CONSIDERING THE EFFECTS OF
PRIOR YEAR MISSTATEMENTS WHEN QUANTIFYING MISSTATEMENTS IN CURRENT YEAR
FINANCIAL STATEMENTS."
BDO Seidman, LLP
Costa Mesa, California
July 13, 2007
F-2
Report of Independent Registered Public Accounting Firm
The Board of Directors of
Integrated Healthcare Holdings, Inc.:
We have audited, before the effects of the adjustment for correction of the
error described in Note 2, the accompanying consolidated balance sheet of
Integrated Healthcare Holdings, Inc. and consolidated entities (the "Company")
as of December 31, 2005 and the related consolidated statements of operations,
stockholders' equity (deficiency) and cash flows for the years ended December
31, 2005 and 2004. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. 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, based on our audits and except for the error described in Note
2, the consolidated financial statements referred to above present fairly, in
all material respects, the financial position of the Company as of December 31,
2005 and the results of its operations and cash flows for the years ended
December 31, 2005 and 2004, in conformity with generally accepted accounting
principles in the United States of America.
We were not engaged to audit, review, or apply any procedures to the adjustments
for the correction of the error described in Note 2, and accordingly, we do not
express an opinion or any other form of assurance about whether such adjustments
are appropriate and have been properly applied. Those adjustments were audited
by BDO Seidman, LLP.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As shown in the financial statements,
the Company has incurred net losses and, as of December 31, 2005, had a
substantial stockholders' deficiency. Further, the Company has substantial
balances of notes payable which, under the terms of the agreements, are
scheduled to mature during 2006 and early in 2007. The Company has not
identified alternate sources of capital to meet its refinancing requirements.
These factors raise substantial doubt about the Company's ability to continue as
a going concern. The financial statements do not include any adjustments that
might be necessary if the Company is unable to continue as a going concern.
/s/ RAMIREZ INTERNATIONAL
Financial & Accounting Services, Inc.
July 11, 2006
Irvine, California
F-3
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
[amounts in '000's except par value]
December 31, 2005
March 31, 2007 [restated See Note 2]
-------------- ---------------------
Current assets:
Cash and cash equivalents $ 7,844 $ 13,916
Restricted cash 4,968 4,972
Accounts receivable, net of allowance for doubtful
accounts of $2,355 at March 31, 2007 19,370 15,975
and $3,148 at December 31, 2005
Security reserve funds 7,990 14,217
Deferred purchase price receivable 16,975 9,338
Inventories of supplies 5,944 5,720
Due from governmental payers 1,378 3,025
Prepaid expenses and other current assets 8,097 6,694
--------- ---------
Total current assets 72,566 73,857
Property and equipment, net 58,172 59,431
Debt issuance costs, net -- 1,141
--------- ---------
Total assets $ 130,738 $ 134,429
========= =========
Current liabilities:
Debt, current $ 72,341 $ --
Accounts payable 41,443 26,836
Accrued compensation and benefits 12,574 12,533
Warrant liability, current 14,906 10,700
Due to governmental payers 922 --
Other current liabilities 20,687 15,725
--------- ---------
Total current liabilities 162,873 65,794
Debt - noncurrent -- 70,331
Capital lease obligations 5,834 4,961
Warrant liability -- 21,065
Minority interest in variable interest entity 1,716 3,342
--------- ---------
Total liabilities 170,423 165,493
--------- ---------
Commitments, contingencies and subsequent events
Stockholders' deficiency:
Common stock, $0.001 par value; 250,000 shares authorized; 116,304 shares
and 83,932 shares issued and outstanding at
March 31, 2007 and 116 84
December 31, 2005, respectively
Additional paid in capital 25,589 16,126
Accumulated deficit (65,390) (47,274)
--------- ---------
Total stockholders' deficiency (39,685) (31,064)
--------- ---------
Total liabilities and stockholders' deficiency $ 130,738 $ 134,429
========= =========
The accompanying notes are an integral part of these consolidated financial statements
F-4
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
[amounts in '000's except per share amounts]
For the
For the years ended three months ended
-------------------------------------------------------------------------------
March 31, 2007 December 31, 2005 December 31, 2004 March 31, 2006
------------- ----------------- ----------------- --------------
[restated See Note 2] [restated See Note 19]
Net operating revenues $ 350,672 $ 283,698 $ -- $ 86,645
--------- --------- --------- ---------
Operating Expenses:
Salaries and benefits 194,865 153,574 -- 48,731
Supplies 49,577 39,250 -- 12,066
Provision for doubtful accounts 35,169 37,349 -- 8,330
Other operating expenses 66,229 58,716 1,840 16,711
Loss on sale of accounts receivable 10,388 8,470 -- 2,808
Depreciation and amortization 2,495 2,178 -- 673
--------- --------- --------- ---------
358,723 299,537 1,840 89,319
--------- --------- --------- ---------
Operating loss (8,051) (15,839) (1,840) (2,674)
--------- --------- --------- ---------
Other expense (income):
Interest expense 12,515 9,925 -- 3,217
Common stock warrant expense 693 17,604 -- --
Change in fair value of derivative (133) 3,460 -- (8,218)
--------- --------- --------- ---------
13,075 30,989 -- (5,001)
--------- --------- --------- ---------
Income (loss) before provision for income
taxes and minority interest (21,126) (46,828) (1,840) 2,327
Provision for income taxes (5) (5) -- (5)
Minority interest in variable
interest entity 593 1,658 -- 100
--------- --------- --------- ---------
Net income (loss) $ (20,538) $ (45,175) $ (1,840) $ 2,422
========= ========= ========= =========
Per share data:
Income (loss) per common share
Basic $ (0.23) $ (0.50) $ (0.09) $ 0.03
Diluted $ (0.23) $ (0.50) $ (0.09) $ 0.02
Weighted average shares outstanding
Basic 90,291 90,330 19,987 84,281
Diluted 90,291 90,330 19,987 127,228
The accompanying notes are an integral part of these consolidated financial statements
F-5
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIENCY
[amounts in '000's]
Additional
Common Stock Paid-in Accumulated
Shares Amount Capital Deficit Total
------ ------ ------- ------- -----
Balance, December 31, 2003 19,380 $ 19 $ 551 $ (219) $ 351
Issuance of debt for the acquisition
of MMG -- -- -- (40) (40)
Issuance of common stock for
cash at $0.25 per share 200 -- 50 -- 50
Issuance of common stock for
cash at $0.50 per share 1,200 1 589 -- 590
Net loss -- -- -- (1,840) (1,840)
-------- -------- -------- -------- --------
Balance, December 31, 2004 20,780 20 1,190 (2,099) (889)
Issuance of common stock for
cash at $0.50 per share 1,179 1 598 -- 599
Issuance of common stock for
cash to OC-PIN 61,973 63 14,338 -- 14,401
Net Loss [restated See Note 2] -- -- -- (45,175) (45,175)
-------- -------- -------- -------- --------
Balance, December 31, 2005 [restated] 83,932 84 16,126 (47,274) (31,064)
(See Note 2)
Issuance of common stock
to OC-PIN 3,625 3 129 -- 132
Options issued to vendor -- -- 164 -- 164
Exercise of warrant 28,747 29 9,170 -- 9,199
Net income for the three months
ended March 31, 2006 -- -- -- 2,422 2,422
Net loss for the year
ended March 31, 2007 -- -- -- (20,538) (20,538)
-------- -------- -------- -------- --------
Balance, March 31, 2007 116,304 $ 116 $ 25,589 $(65,390) $(39,685)
======== ======== ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements
F-6
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
[amounts in '000's]
For the
For the year ended three months ended
---------------------------------------------------------------------------
March 31, 2007 December 31, 2005 December 31, 2004 March 31, 2006
-------------- ----------------- ----------------- --------------
[restated See Note 2] restated See Note 19]
Cash flows from operating activities:
Net income (loss) $(20,538) $(45,175) $ (1,840) $ 2,422
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization of property and equipment 2,495 2,133 62 673
Provision for doubtful accounts 35,169 37,349 -- 8,330
Amortization of debt issuance costs and intangible assets 900 837 -- 241
Common stock warrant expense 693 17,604 -- --
Change in fair value of derivative (133) 3,460 -- (8,218)
Non cash forgiveness of debt -- -- (60) --
Minority interest in net loss of variable interest entity (593) (1,658) -- (100)
Changes in operating assets and liabilities:
Accounts receivable (40,212) (53,324) -- (6,682)
Security reserve funds 6,798 (14,217) -- (571)
Deferred purchase price receivable (2,620) (9,338) -- (5,017)
Inventories of supplies (158) 299 -- (66)
Due from governmental payers 5,209 (3,025) -- (3,562)
Prepaid expenses and other current assets 3,808 (4,215) (11) 247
Accounts payable 12,710 26,679 130 1,897
Accrued compensation and benefits 990 11,733 800 (949)
Due to governmental payers 652 -- -- 270
Other current liabilities (2,647) 15,640 -- 2,311
-------- -------- -------- --------
Net cash provided by (used in) operating activities 2,523 (15,218) (919) (8,774)
-------- -------- -------- --------
Cash flows from investing activities:
Acquisition of hospital assets -- (63,172) (1,142) --
Decrease (increase) in restricted cash 4 (4,972) -- --
Proceeds from minority interest in PCHI -- 5,000 -- --
Acquisition of subsidiary, net of cash acquired -- -- 9 --
Additions to property and equipment (644) (564) (21) (83)
-------- -------- -------- --------
Net cash used in investing activities (640) (63,708) (1,154) (83)
-------- -------- -------- --------
Cash flows from financing activities:
Proceeds from long term debt -- 50,000 1,264 --
Long term debt issuance costs -- (1,933) -- --
Proceeds from secured notes payable 2,010 10,700 -- --
Variable interest entity distribution (732) -- -- (201)
Drawdown from line of credit -- 25,331 -- 132
Issuance of common stock -- 15,000 640 --
Advances from shareholders -- -- 73 --
Repayments of debt -- (6,264) (100) --
Payments on capital lease obligation (287) (62) -- (20)
-------- -------- -------- --------
Net cash provided by (used in) financing activities 991 92,772 1,877 (89)
-------- -------- -------- --------
Net increase (decrease) in cash and cash equivalents 2,874 13,846 (196) (8,946)
Cash and cash equivalents, beginning of period 4,970 70 266 13,916
-------- -------- -------- --------
Cash and cash equivalents, end of period $ 7,844 $ 13,916 $ 70 $ 4,970
======== ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements
F-7
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007
NOTE 1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
LIQUIDITY AND MANAGEMENT'S PLANS - The accompanying consolidated
financial statements have been prepared on a going concern basis, which
contemplates the realization of assets and settlement of obligations in the
normal course of business. The Company incurred a net loss (in thousands) of
$20,538 for the year ended March 31, 2007 and has a working capital deficit (in
thousands) of $90,307 at March 31, 2007. All of the Company's debt matured prior
to year end and the Company is currently operating under a ninety day
Forbearance Agreement with its lenders to obtain new financing (see Note 18).
These factors, among others, indicate a need for the Company to take
action to resolve its financing issues and operate its business as a going
concern (see Note 18). The Company has received increased reimbursements from
governmental payers over the past year and is aggressively seeking to obtain
future increases. The Company is seeking to reduce operating expenses while
continuing to maintain service levels. There can be no assurance that the
Company will be successful in obtaining a new financing agreement, improving
reimbursements or reducing operating expenses.
DESCRIPTION OF BUSINESS - The Company was organized under the laws of
the State of Utah on July 31, 1984 under the name of Aquachlor Marketing.
Aquachlor Marketing never engaged in business activities. In December 1988,
Aquachlor Marketing merged with Aquachlor, Inc., a Nevada corporation
incorporated on December 20, 1988. The Nevada Corporation became the surviving
entity and changed its name to Deltavision, Inc. In March 1997, Deltavision,
Inc. received a Certificate of Revival from the State of Nevada using the name
First Deltavision, Inc. In March 2004, First Deltavision, Inc. changed its name
to Integrated Healthcare Holdings, Inc. In these consolidated financial
statements, the Company refers to Integrated Healthcare Holdings, Inc. and its
subsidiaries.
Prior to March 8, 2005, the Company was a development stage enterprise
with no material operations and no revenues from operations. On September 29,
2004, the Company entered into a definitive agreement to acquire four hospitals
(the "Hospitals") from subsidiaries of Tenet Healthcare Corporation ("Tenet"),
and completed the transaction on March 8, 2005 (the "Acquisition"). The
Hospitals are:
o 282-bed Western Medical Center in Santa Ana;
o 188-bed Western Medical Center in Anaheim;
o 178-bed Coastal Communities Hospital in Santa Ana; and
o 114-bed Chapman Medical Center in Orange.
The Company enters into agreements with third-party payers, including
government programs and managed care health plans, under which rates are based
upon established charges, the cost of providing services, predetermined rates
per diagnosis, fixed per diem rates or discounts from established charges.
During the 24 days ended March 31, 2005, substantially all of Tenet's negotiated
rate agreements were assigned to the Hospitals. The Company received Medicare
provider numbers in April 2005 and California State Medicaid Program provider
numbers were received in June 2005.
CHANGE IN FISCAL YEAR - On December 21, 2006, the Company's Board of
Directors approved a change in the Company's fiscal year end from December 31 to
March 31. The Board of Directors believes this is in the best interest of the
Company's shareholders, because this corresponds with the completion of the
first full twelve months of operations of the Hospitals, that were acquired by
the Company on March 8, 2005, and this change will likely reduce the Company's
fiscal year end accounting and compliance costs. This annual report includes
consolidated Balance Sheets as of March 31, 2007 and December 31, 2005, and
consolidated Statements of Operations, Changes in Stockholders Deficiency, and
Cash Flows for the years ended March 31, 2007, December 31, 2005 and 2004 and
for the three months ended March 31, 2006.
F-8
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007
Condensed Unaudited information for the three months ended March 31,
2005 is as follows (in thousands except per share amounts):
Results from operations:
Net operating revenues $ 21,747
Operating expenses (22,788)
--------
Operating loss (1,041)
Interest expense-net 666
Common stock warrant expense 17,215
Income tax provision 944
Minority interest (9)
--------
Net loss $(19,857)
========
Loss per common share
basic and diluted $ (0.22)
Statement of cash flows:
Net loss $(19,857)
Adjustments for non-cash charges 17,531
Changes in working capital (3,826)
--------
Cash used in operations (6,152)
Cash flows used in investing activities (63,172)
Cash flows from financing activities 75,668
--------
Net increase in cash 6,344
Cash beginning of period 70
--------
Cash end of period $ 6,414
========
RECLASSIFICATION FOR PRESENTATION - Certain amounts previously reported
have been reclassified to conform to the current year's presentation. The
provision for doubtful accounts has been shown separately on the consolidated
statement of cash flows. The calculation of the estimated amount of charity care
has been updated to conform to the current presentation. Cash in the Company's
lockbox at December 31, 2005 has been reclassified to Security Reserve Funds, to
conform to the current presentation.
CONCENTRATION OF CREDIT RISK - The Company secures all of its working
capital from the sale of accounts receivable and obtained all of its debt from
affiliates of Medical Capital Corporation and, thus, is subject to significant
credit risk if they are unable to perform.
The Hospitals are subject to licensure by the State of California and
accreditation by the Joint Commission on Accreditation of Healthcare
Organizations. Loss of either licensure or accreditation would impact the
ability to participate in various governmental and managed care programs, which
provide the majority of the Company's revenues.
Essentially all Net Operating Revenues come from external customers.
The largest payers are the Medicare and Medicaid programs accounting for 65% of
the Net Operating Revenues for the year ended March 31, 2007, 73% of Net
Operating Revenues for the three months ended March 31, 2006 and 74% of the Net
Operating Revenues for the year ended December 31, 2005.
CONSOLIDATION - The accompanying consolidated financial statements
include the accounts of the Company and its wholly owned subsidiaries.
F-9
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007
The Company has also determined that Pacific Coast Holdings Investment,
LLC ("PCHI") (Note 15), is a variable interest entity as defined in Financial
Accounting Standards Board Interpretation Number (FIN) No. 46R and, accordingly,
the financial statements of PCHI are included in the accompanying consolidated
financial statements.
All significant intercompany accounts and transactions have been
eliminated in consolidation.
USE OF ESTIMATES - The accompanying consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
in the United States of America ("U.S. GAAP") and prevailing practices for
investor owned entities within the healthcare industry. The preparation of
financial statements in conformity with U.S. GAAP requires management to make
estimates and assumptions that affect the amounts reported in the consolidated
financial statements and accompanying notes. Management regularly evaluates the
accounting policies and estimates that are used. In general, management bases
the estimates on historical experience and on assumptions that it believes to be
reasonable given the particular circumstances in which its Hospitals operate.
Although management believes that all adjustments considered necessary for fair
presentation have been included, actual results may materially vary from those
estimates.
REVENUE RECOGNITION - Net operating revenues are recognized in the
period in which services are performed and are recorded based on established
billing rates (gross charges) less estimated discounts for contractual
allowances, principally for patients covered by Medicare, Medicaid, managed care
and other health plans. Gross charges are retail charges. They are not the same
as actual pricing, and they generally do not reflect what a hospital is
ultimately paid and, therefore, are not displayed in the consolidated statements
of operations. Hospitals are typically paid amounts that are negotiated with
insurance companies or are set by the government. Gross charges are used to
calculate Medicare outlier payments and to determine certain elements of payment
under managed care contracts (such as stop-loss payments). Because Medicare
requires that a hospital's gross charges be the same for all patients
(regardless of payer category), gross charges are also what our Hospitals charge
all other patients prior to the application of discounts and allowances.
Revenues under the traditional fee-for-service Medicare and Medicaid
programs are based primarily on prospective payment systems. Discounts for
retrospectively cost-based revenues and certain other payments, which are based
on the Hospitals' cost reports, are estimated using historical trends and
current factors. Cost report settlements for retrospectively cost-based revenues
under these programs are subject to audit and administrative and judicial
review, which can take several years until final settlement of such matters are
determined and completely resolved. Estimates of settlement receivables or
payables related to a specific year are updated periodically, at year end, and
at the time the cost report is filed with the fiscal intermediary. Typically, no
further updates are made to the estimates until the final Notice of Program
Reimbursement is received, at which time the cost report for that year has been
audited by the fiscal intermediary. There could be a one to two year time lag
between the submission of a cost report and receipt of the Final Notice of
Program Reimbursement. Since the laws, regulations, instructions and rule
interpretations governing Medicare and Medicaid reimbursement are complex and
change frequently, the estimates recorded by the Hospitals could change by
material amounts. During the year ended March 31, 2007 the Company recorded
approximately $394 thousand of additional reductions of revenue for Final
Notices of Program Reimbursement received during the year. There were no final
Notices of Program Reimbursement during the three months ended March 31, 2006 or
the year ended December 31, 2005. The Company has established settlement
receivables as of March 31, 2007 and December 31, 2005 (in thousands) of $909
and $2,273, respectively.
Outlier payments, which were established by Congress as part of the
diagnosis-related groups (DRG) prospective payment system, are additional
payments made to hospitals for treating Medicare patients who are costlier to
treat than the average patient in the same DRG. To qualify as a cost outlier, a
hospital's billed (or gross) charges, adjusted to hospital specific costs, must
exceed the prospective (includes the DRG base payment, indirect medical
education payment, disproportionate share payment and new technology add on
payment) payment rate for the case by a fixed threshold established annually by
the Centers for Medicare and Medicaid Services of the United State Department of
Health and Human Services (CMS). Under Sections 1886(d) and 1886(g) of the
Social Security Act, CMS must project aggregate annual outlier payments to all
prospective payment system hospitals to be not less than 5% or more than 6% of
total DRG payments (Outlier Percentage). The Outlier Percentage of payments is
determined by dividing total outlier payments by the sum of prospective and
outlier payments. CMS annually adjusts the fixed threshold to bring expected
outlier payments within the mandated limit. A change to the fixed threshold
affects total outlier payments by changing both the number of cases that qualify
for outlier payments, and the dollar amount hospitals receive for those cases
that still qualify. The most recent change to the cost outlier threshold that
became effective on October 1, 2006 was an increase from $23,600 to $24,485. CMS
projects this will result in an Outlier Payment Percentage that is approximately
5.1% of total payments. The Medicare fiscal intermediary calculates the cost of
a claim by multiplying the billed charges by the cost-to-charge ratio from the
hospital's most recently filed Medicare cost report.
F-10
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007
The Hospitals received new provider numbers in 2005 and, because there
was no specific history, the Hospitals were reimbursed for outliers based on
published statewide averages. If the computed cost exceeds the sum of the DRG
payment plus the fixed threshold, the hospital receives 80% of the difference as
an outlier payment. Medicare has reserved the option of adjusting outlier
payments, through the cost report, to the hospital's actual cost-to-charge
ratio. Upon receipt of the current payment cost-to-charge ratios from the fiscal
intermediary, any variance between current payments and the estimated final
outlier settlement are examined by the Medicare fiscal intermediary. During the
year ended March 31, 2007 the Company recorded approximately $1,919 thousand of
additional revenue for a Final Notice of Program Reimbursement received. As of
March 31, 2007 and December 31, 2005, the Company recorded reserves for excess
outlier payments due to the difference between the Hospital's actual cost to
charge rates and the statewide average in the amount (in thousands) of $1,831
and $2,170, respectively. These reserves are offset against the third party
settlement receivables and are included in due to governmental payers as a net
payable (in thousands) of $922 as of March 31, 2007 and as a net receivable (in
thousands) of $104 included in due from governmental payers as of December 31,
2005.
The Hospitals receive supplemental payments from the State of
California to support indigent care (MediCal Disproportionate Share Hospital
payments or "DSH"). During the years ended March 31, 2007, and December 31, 2005
and 2004 the Hospitals received payments (in thousands) of $24,526, $11,022 and
$-0- respectively. The increase is the result of the State becoming more current
in their payments and the timing of the State's payments. During the three
months ended March 31, 2006 the Hospitals received payments (in thousands) of
$575. The related revenue recorded for the years ended March 31, 2007, and
December 31, 2005 and 2004, and the three months ended March 31, 2006 was (in
thousands) $17,897, $13,943, $-0-, and $4,240, respectively.
Revenues under managed care plans are based primarily on payment terms
involving predetermined rates per diagnosis, per-diem rates, discounted
fee-for-service rates and/or other similar contractual arrangements. These
revenues are also subject to review and possible audit by the payers. The payers
are billed for patient services on an individual patient basis. An individual
patient's bill is subject to adjustment on a patient by patient basis in the
ordinary course of business by the payers following their review and
adjudication of each particular bill. The Hospitals estimate the discounts for
contractual allowances utilizing billing data on an individual patient basis. At
the end of each month, the Hospitals estimate the expected reimbursement for
patients of managed care plans based on the applicable contract terms. These
estimates are continuously reviewed for accuracy by taking into consideration
known contract terms as well as payment history. Although the Hospitals do not
separately accumulate and disclose the aggregate amount of adjustments to the
estimated reimbursements for every patient bill, management believes the
estimation and review process allows for timely identification of instances
where such estimates need to be revised. The Company does not believe there were
any adjustments to estimates of individual patient bills that were material to
its net operating revenues.
The Hospitals provide charity care to patients whose income level is
below 300% of the Federal Poverty Level. Patients with income levels between
300% to 350% of the Federal Poverty Level qualify to pay a discounted rate under
AB774 based on various government program reimbursement levels. Patients without
insurance are offered assistance in applying for Medicaid and other programs
they may be eligible for, such as state disability, Victims of Crime, or county
indigent programs. Patient advocates from the Hospitals' Medical Eligibility
Program (MEP) screen patients in the hospital and determine potential linkage to
financial assistance programs. They also expedite the process of applying for
these government programs. Based on average revenue for comparable services from
all other payers, revenues foregone under the charity policy, including indigent
care accounts, for the years ended March 31, 2007 and December 31, 2005 and 2004
were approximately $8.1 million, $2.9 million and $-0-, respectively, and for
the three months ended March 31, 2006 were approximately $1.5 million.
Receivables from patients who are potentially eligible for Medicaid are
classified as Medicaid pending under the MEP, with appropriate contractual
allowances recorded. If the patient does not quality for Medicaid, the
receivables are reclassified to charity care and written off, or they are
reclassified to self-pay and adjusted to their net realizable value through the
provision for doubtful accounts. Reclassifications of Medicaid pending accounts
to self-pay do not typically have a material impact on the results of operations
as the estimated Medicaid contractual allowances initially recorded are not
materially different than the estimated provision for doubtful accounts recorded
when the accounts are reclassified. All accounts classified as pending Medicaid
are reserved for their full value in contractual allowances when they reach 180
days old.
The Company is not aware of any material claims, disputes, or unsettled
matters with any payers that would affect revenues that have not been adequately
provided for in the accompanying consolidated financial statements.
PROVISION FOR DOUBTFUL ACCOUNTS - The Company provides for accounts
receivable that could become uncollectible by establishing an allowance to
reduce the carrying value of such receivables to their estimated net realizable
value. The Hospitals estimate this allowance based on the aging of their
F-11
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007
accounts receivable, historical collections experience for each type of payer
and other relevant factors. There are various factors that can impact the
collection trends, such as changes in the economy, which in turn have an impact
on unemployment rates and the number of uninsured and underinsured patients,
volume of patients through the emergency department, the increased burden of
co-payments to be made by patients with insurance and business practices related
to collection efforts. These factors continuously change and can have an impact
on collection trends and the estimation process.
The Company's policy is to attempt to collect amounts due from
patients, including co-payments and deductibles due from patients with
insurance, at the time of service while complying with all federal and state
laws and regulations, including, but not limited to, the Emergency Medical
Treatment and Labor Act (EMTALA). Generally, as required by EMTALA, patients may
not be denied emergency treatment due to inability to pay. Therefore, until the
legally required medical screening examination is complete and stabilization of
the patient has begun, services are performed prior to the verification of the
patient's insurance, if any. In non-emergency circumstances or for elective
procedures and services, it is the Hospitals' policy, when appropriate, to
verify insurance prior to a patient being treated.
TRANSFERS OF FINANCIAL ASSETS - The Company sells substantially all of
its billed accounts receivable to a financing company (see Note 4). The Company
accounts for its sale of accounts receivable (see Note 4) in accordance with
SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities- A replacement of SFAS No. 125". A transfer of
financial assets in which the Company has surrendered control over those assets
is accounted for as a sale to the extent that consideration other than
beneficial interests in the transferred assets is received in exchange. Control
over transferred assets is surrendered only if all of the following conditions
are met:
1. The transferred assets have been isolated from the transferor
(i.e., they are beyond the reach of the transferor and its
creditors);
2. Each transferee has the unconditional right to pledge or
exchange the transferred assets it received; and
3. The Company does not maintain effective control over the
transferred assets either (a) through an agreement that
entitles and obligates the transferor to repurchase or redeem
the transferred assets before their maturity or (b) through
the ability to unilaterally cause the holder to return
specific assets, other than through a cleanup call.
If a transfer of financial assets does not meet the criteria for a sale
as described above, the Company and transferee account for the transfer as a
secured borrowing with pledge of collateral, and accordingly the Company is
prevented from derecognizing the transferred financial assets. Where
derecognizing criteria are met and the transfer is accounted for as a sale, the
Company removes financial assets from the consolidated balance sheet and a net
gain is recognized in income at the time of sale.
CASH AND CASH EQUIVALENTS - The Company considers all highly liquid
debt investments purchased with a maturity of three months or less to be cash
equivalents. At times, cash balances held at financial institutions are in
excess of federal depository insurance limits. The Company has not experienced
any losses on cash and cash equivalents.
Cash held in the Company's bank accounts as of March 31, 2007 and
December 31, 2005, collected on behalf of the buyer of accounts receivable, is
not included in the Company's cash and cash equivalents.
RESTRICTED CASH - Restricted cash consists of amounts deposited in
short term time deposits with a commercial bank to collateralize the Company's
obligations pursuant to certain agreements. A certificate of deposit for $4.4
million is pledged to a commercial bank that issued a standby letter of credit
for $4.2 million in favor of an insurance company that is the administrator of
the Company's self-insured workers compensation plan. A certificate of deposit
for $552 (in thousands) is pledged as a reserve under the Company's capitation
agreement with CalOptima.
INVENTORIES OF SUPPLIES- Inventories consist of supplies valued at the
lower of average cost or market.
PROPERTY AND EQUIPMENT - Property and equipment are stated at cost,
less accumulated depreciation and any impairment write-downs related to assets
held and used. Additions and improvements to property and equipment are
capitalized at cost. Expenditures for maintenance and repairs are charged to
expense as incurred. Capital leases are recorded at the beginning of the lease
term as property and equipment and a corresponding lease liability is
recognized. The value of the property and equipment under capital lease is
recorded at the lower of either the present value of the minimum lease payments
or the fair value of the asset. Such assets, including improvements, are
amortized over the shorter of either the lease term or their estimated useful
life.
F-12
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007
The Company uses the straight-line method of depreciation for buildings
and improvements, and equipment over their estimated useful lives of 25 years
and 3 to 15 years, respectively.
DEBT ISSUANCE COSTS -These deferred charges related to credit agreement
fees (Note 8) and were amortized over the related lives of the agreements.
LONG-LIVED ASSETS - The Company evaluates its long-lived assets for
possible impairment whenever circumstances indicate that the carrying amount of
the asset, or related group of assets, may not be recoverable from estimated
future cash flows. However, there is an evaluation performed at least annually.
Fair value estimates are derived from independent appraisals, established market
values of comparable assets or internal calculations of estimated future net
cash flows. The estimates of future net cash flows are based on assumptions and
projections believed by management to be reasonable and supportable. These
assumptions take into account patient volumes, changes in payer mix, revenue,
and expense growth rates and changes in legislation and other payer payment
patterns. The Company believes there has been no impairment in the carrying
value of its property and equipment at March 31, 2007.
MEDICAL CLAIMS INCURRED BUT NOT REPORTED - The Company is contracted
with CalOptima, which is a county sponsored entity that operates similarly to an
HMO, to provide health care services to indigent patients at a fixed amount per
enrolled member per month. The Company receives payments from CalOptima based on
a fixed fee multiplied by the number of enrolled members at the Hospitals
("Capitation Fee"). The Company recognizes these Capitation Fees as revenues on
a monthly basis.
In certain circumstances, members will receive health care services
from hospitals not owned by the Company. In these cases, the Company records
estimates of patient member claims incurred but not reported (IBNR) for services
provided by other health care institutions. IBNR claims are estimated using
historical claims patterns, current enrollment trends, hospital
pre-authorizations, member utilization patterns, timeliness of claims
submissions, and other factors. There can, however, be no assurance that the
ultimate liability will not exceed estimates. Adjustments to the estimated IBNR
claims recorded in the Company's results of operations in the periods when such
amounts are determined. Per guidance under Statement of Financial Accounting
Standards ("SFAS") No. 5, the Company accrues for IBNR claims when it is
probable that expected future health care costs and maintenance costs under an
existing contract have been incurred and the amount can be reasonably estimated.
The Company records a charge related to these IBNR claims against its net
operating revenues. The Company's net revenues from CalOptima capitation, net of
third party claims and estimates of IBNR claims, for the years ended March 31,
2007 and December 31, 2005 and 2004 were approximately $1.3 million, $3.2
million and $-0-, respectively, and for the three months ended March 31, 2006
were approximately $1.4 million. The Company's direct cost of providing services
to patient members is included in the Company's normal operating expenses.
STOCK-BASED COMPENSATION - SFAS No. 123R, "Share Based Payment"
requires companies to record compensation cost for stock-based employee
compensation plans at fair value at the grant date. The Company has adopted SFAS
No. 123R. As of March 31, 2007 no stock options have been granted under the
Company's stock incentive plan.
FAIR VALUE OF FINANCIAL INSTRUMENTS - The Company's financial
instruments recorded in the consolidated balance sheets include cash and cash
equivalents, restricted cash, receivables, accounts payable, and other
liabilities including warrant liability and long term debt. The recorded
carrying value of such financial instruments approximates a reasonable estimate
of their fair value.
To finance the Acquisition, the Company entered into agreements that
contained warrants (see Notes 8 and 11), which are required to be accounted for
as derivative liabilities in accordance with SFAS No. 133. A derivative is an
instrument whose value is derived from an underlying instrument or index such as
a future, forward, swap, or option contract, or other financial instrument with
similar characteristics, including certain derivative instruments embedded in
other contracts ("embedded derivatives") and for hedging activities. As a matter
of policy, the Company does not invest in separable financial derivatives or
engage in hedging transactions. However, the Company may engage in complex
transactions in the future that also may contain embedded derivatives.
Derivatives and embedded derivatives, if applicable, are measured at fair value
and marked to market through earnings.
WARRANTS - In connection with its Acquisition of the Hospitals, the
Company entered into complex transactions that contain warrants requiring
accounting treatment in accordance with SFAS No. 133, SFAS No. 150 and EITF No.
00-19 (see Notes 8 and 11).
F-13
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007
INCOME [LOSS] PER COMMON SHARE - Income (loss) per share is calculated
in accordance with SFAS No. 128, "Earnings per Share." Basic income (loss) per
share is based upon the weighted average number of common shares outstanding.
Due to the losses from operations incurred by the Company, the anti-dilutive
effect of warrants has been excluded in the calculations of diluted loss per
share for those periods presented in the accompanying Consolidated Statements of
Operations with net losses.
INCOME TAXES - The Company accounts for income taxes in accordance with
SFAS No. 109. Deferred income tax assets and liabilities are determined based on
the differences between the book and tax basis of assets and liabilities and are
measured using the currently enacted tax rates and laws. A valuation allowance
is recorded against deferred tax assets when it is more likely than not that
such deferred tax assets will not be realized.
SEGMENT REPORTING - The Company operates in one line of business, the
provision of health care services through the operation of general hospitals and
related health care facilities. The Company's Hospitals generated substantially
all of its net operating revenues during the periods since the Acquisition.
The Company's four general Hospitals and related health care facilities
operate in one geographic region in Orange County, California. The region's
economic characteristics, the nature of the Hospitals' operations, the
regulatory environment in which they operate, and the manner in which they are
managed are all similar. This region is an operating segment, as defined by SFAS
No. 131. In addition, the Company's general Hospitals and related health care
facilities share certain resources and benefit from many common clinical and
management practices. Accordingly, the Company aggregates the facilities into a
single reportable operating segment.
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid during the years ended March 31, 2007 and December 31,
2005 and 2004 was (in thousands) $12,158, $9,224, and $-0-, respectively.
Interest paid during the three months ended March 31, 2006 was (in thousands)
$2,605.
The Company made cash payments (in thousands) for taxes of $5 during
the year ended March 31, 2007, $1,400 during the year ended December 31, 2005
and $5 during the three months ended March 31, 2006.
The Company entered into new capital lease obligations of (in
thousands) $749 and $5,109 during the years ended March 31, 2007 and December
31, 2005. The Company revised its initial estimate of a capital lease obligation
by (in thousands) $437 during the three months ended March 31, 2006. The Company
rescinded a secured promissory note for the return of a deposit on hospital
assets of (in thousands) $10,000 during the year ended December 31, 2005. The
Company had a non cash exercise of a warrant of (in thousands) $9,199 during the
year ended March 31, 2007. During the year ended March 31, 2007 the Company
recorded the non cash issuance of options to a vendor with a value (in
thousands) of $164.
RECENTLY ENACTED ACCOUNTING STANDARDS - In November 2004, the FASB
issued SFAS No. 151, Inventory Pricing ("SFAS 151"). SFAS 151 amends the
guidance in ARB No. 43, Chapter 4, "Inventory Pricing," to clarify the
accounting for abnormal amounts of idle facility expense, freight, handling
costs, and wasted material (spoilage). This statement requires that those items
be recognized as current period charges. In addition, SFAS 151 requires that
allocation of fixed production overheads to the costs of conversion be based on
the normal capacity of the production facilities. This statement is effective
for inventory costs incurred during fiscal years beginning after June 15, 2005.
The adoption of SFAS 151 did not have a material impact on the Company's
consolidated results of operations or financial position.
In November 2005, the FASB issued Staff Positions ("FSPs") Nos. FSPs
115-1 and 124-1, The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments, in response to EITF 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments
("EITF 03-1"). FSPs 115-1 and 124-1 provide guidance regarding the determination
as to when an investment is considered impaired, whether that impairment is
other than temporary, and the measurement of an impairment loss. FSPs 115-1 and
124-1 also include accounting considerations subsequent to the recognition of an
other than temporary impairment and require certain disclosures about unrealized
losses that have not been recognized as other than temporary impairments. These
requirements are effective for annual reporting periods beginning after December
15, 2005. The adoption of the impairment guidance contained in FSPs 115-1 and
124-1 did not have a material impact on the Company's consolidated results of
operations or financial position.
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain
Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140."
SFAS 155, among other things: permits the fair value re-measurement of any
hybrid financial instrument that contains an embedded derivative that otherwise
would require bifurcation and establishes a requirement to evaluate interests in
securitized financial assets to identify interests that are freestanding
derivatives or that are hybrid financial instruments that contain an embedded
derivative requiring bifurcation. SFAS 155 is effective for all financial
F-14
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007
instruments acquired or issued in fiscal years beginning after September 15,
2006. The Company has evaluated the effect of adopting this statement and
concluded that it will not have a material effect on the Company's financial
position and results of operations.
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing
of Financial Assets - an amendment of FASB Statement No. 140," with respect to
the accounting for separately recognized servicing assets and servicing
liabilities. SFAS 156 permits the choice of either the amortization method or
the fair value measurement method, with changes in fair value recorded in
income, for the subsequent measurement for each class of separately recognized
servicing assets and servicing liabilities. The statement is effective for years
beginning after September 15, 2006, with earlier adoption permitted. The Company
is currently evaluating the effect that adopting this statement will have on the
Company's financial position and results of operations.
In April 2006, the FASB issued FASB Staff Position ("FSP") FIN 46(R)-6,
"Determining the Variability to Be Considered in Applying FASB Interpretation
No. 46(R)" (FSP FIN 46(R)-6"), that became effective beginning July 2006. FSP
FIN 46(R)-6 clarifies that the variability to be considered in applying FIN
46(R) shall be based on an analysis of the design of the variable interest
entity. The adoption of this FSP did not have a material impact on the Company's
consolidated financial position or results of operations.
In June 2006, the FASB issued FASB Interpretation No. 48, "Accounting
for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109"
("FIN 48"). FIN 48 clarifies the circumstances in which a tax benefit may be
recorded with respect to uncertain tax positions. The Interpretation provides
guidance for determining whether tax benefits may be recognized with respect to
uncertain tax positions and, if recognized, the amount of such tax benefits that
may be recorded. Under the provisions of FIN 48, tax benefits associated with a
tax position may be recorded only if it is more likely than not that the claimed
tax position will be sustained upon audit. The statement is effective for years
beginning after December 15, 2006. The Company adopted FIN No. 48 as of April 1,
2007. The adoption of this interpretation will not have a material effect on the
Company's consolidated results of operations or consolidated financial position.
In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements". This Statement establishes a single authoritative definition of
fair value, sets out a framework for measuring fair value, and requires
additional disclosures about fair value measurements. FASB 157 applies only to
fair value measurements that are already required or permitted by other
accounting standards. The statement is effective for financial statements for
fiscal years beginning after November 15, 2007, with earlier adoption permitted.
SFAS No. 157 will be adopted during the first interim quarterly period of fiscal
2008. The adoption of this pronouncement is not expected to have a material
effect on the Company's consolidated results of operations or consolidated
financial position.
In September 2006, the FASB issued SFAS No. 158, Employers' Accounting
for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB
Statement No. 87, 88, 106 and 132(R). Under this SFAS, companies must recognize
a net liability or asset to report the funded status of their defined benefit
pension and other postretirement benefit plans (collectively referred to herein
as "benefit plans") on their balance sheets. SFAS 158 also changed certain
disclosures related to benefit plans. The adoption of SFAS 158 did not have a
material impact on the Company's consolidated results of operations or financial
position.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option
for Financial Assets and Financial Liabilities-Including an amendment of FASB
Statement No. 115 ("SFAS 159"). SFAS 159 permits entities to choose to measure
many financial instruments and certain other items at fair value. Most of the
provisions of SFAS 159 apply only to entities that elect the fair value option;
however, the amendment to FASB Statement No. 115, Accounting for Certain
Investments in Debt and Equity Securities, applies to all entities with
available for sale and trading securities. The Company will adopt SFAS 159 in
the first interim quarterly period of fiscal 2008 and is evaluating the impact,
if any, that the adoption of this statement will have on its consolidated
results of operations and financial position.
F-15
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007
NOTE 2 - CORRECTION OF ERROR
In September, 2006, the Securities and Exchange Commission released
Staff Accounting Bulletin No. 108 ("SAB 108"). SAB 108 provides interpretative
guidance on how the effects of the carryover or reversal of prior year
misstatements should be considered in quantifying a current year misstatement.
The Company adopted SAB 108 during the interim quarterly period ended September
30, 2006. The effect of adopting this statement was considered in evaluating the
impact of an error that was identified during October, 2006 in the overstatement
(in thousands) of net operating revenues and accounts receivable by $617 that
existed at December 31, 2005. The error was the result of an incorrect account
reconciliation, not a matter of estimation. The overstatement of accounts
receivable, net operating revenues, and the related understatement of income
(loss) before minority interest and provision for income taxes, and net loss,
accumulated deficit and stockholders' deficiency by (in thousands) $617 was
determined by the Company to be immaterial to the consolidated financial
statements as of and for the year ended December 31, 2005 in accordance with
Staff Accounting Bulletin No. 108. However, in accordance with the dual approach
outlined in SAB 108, the amounts included in these consolidated financial
statements as of and for the year ended December 31, 2005 have been restated to
reflect the correction.
The following table sets forth the amounts as originally reported in
the consolidated balance sheet as of December 31, 2005 and statement of
operations for the year ended December 31, 2005 and the effects of the
correction of the error as described above (in thousands):
As previously
reported As restated
-------- -----------
Balance Sheet:
Accounts receivable $ 16,592 $ 15,975
Total assets $ 135,046 $ 134,429
Accumulated deficit $ (46,657) $ (47,274)
Total stockholders' deficiency $ (30,447) $ (31,064)
Loss per common share $ (0.49) $ (0.50)
NOTE 3 - ACQUISITION
On March 8, 2005, the Company completed its acquisition of four Orange
County, California hospitals and associated real estate, from Tenet. The
Hospitals were assigned to four wholly owned subsidiaries of the Company formed
for the purpose of completing the Acquisition. The Company also acquired the
following real estate, leases and assets associated with the Hospitals:
i. a fee interest in the Western Medical Center at 1001 North
Tustin Avenue, Santa Ana, CA, a fee interest in the
administration building at 1301 North Tustin Avenue, Santa
Ana, CA, certain rights to acquire condominium suites located
in the medical office building at 999 North Tustin Avenue,
Santa Ana, CA, and the business known as the West Coast Breast
Cancer Center;
ii. a fee interest in the Western Medical Center at 1025 South
Anaheim Blvd., Anaheim, CA;
iii. a fee interest in the Coastal Communities Hospital at 2701
South Bristol Street, Santa Ana, CA, and a fee interest in the
medical office building at 1901 North College Avenue, Santa
Ana, CA;
iv. a lease for the Chapman Medical Center at 2601 East Chapman
Avenue, Orange, CA, and a fee interest in the medical office
building at 2617 East Chapman Avenue, Orange, CA; and
v. equipment and contract rights.
Subsequently the Company entered into a sale leaseback transaction for
substantially all of the real estate with PCHI (see additional information at
Note 15).
F-16
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007
The purchase price, after all purchase price adjustments, of the
Acquisition amounted to (in thousands) $66,247. The fair value of the assets
acquired and related costs consisted of the following (in thousands):
Property and equipment $55,834
Inventories 6,019
Prepaid expenses 2,461
-------
64,314
Debt issuance costs 1,933
-------
$66,247
=======
The Company financed the Acquisition and related financing costs (see
Note 8) by obtaining a $50 million Acquisition Loan, drawing $3 million on a
working capital line of credit, selling shares of the Company's common stock for
$10.1 million, and receiving $5 million in proceeds from minority investments in
PCHI.
The following unaudited supplemental pro forma information represents
the Company's consolidated results of operations as if the Acquisition had
occurred on January 1, 2004 and after giving effect to certain adjustments
including interest expense, depreciation expense, and related tax effects. In
addition, the following unaudited pro forma information includes the
nonrecurring items related to the issuance of 74,700,000 common stock warrants
(Note 11), which resulted in an expense of $17,604,292 that the Company recorded
during the year ended December 31, 2005 and restructuring charges of $3,147,000
incurred by Tenet during the three months ended March 31, 2005. Such unaudited
pro forma information does not purport to be indicative of operating results
that would have been reported had the Acquisition occurred on January 1, 2004 or
future operating results (in thousands except per share amounts).
PRO FORMA (UNAUDITED)
For the Years ended
December 31, 2005 December 31, 2004
----------------- -----------------
Net operating revenues $ 338,994 $ 314,752
Net loss $ (59,464) $ 42,747)
Per share data:
Basic and fully diluted loss per common
share $ (0.71) $ (0.52)
Weighted average shares outstanding 83,817 81,960
NOTE 4 - ACCOUNTS PURCHASE AGREEMENT
In March 2005, the Company entered into an Accounts Purchase Agreement
(the "APA") for a minimum of two years with Medical Provider Financial
Corporation I, an unrelated party (the "Buyer"). The Buyer is an affiliate of
the Lender (see Note 8). The APA provides for the sale of 100% of the Company's
eligible accounts receivable, as defined, without recourse. The APA provides for
the Company to provide billing and collection services, maintain the individual
patient accounts, and resolve any disputes that arise between the Company and
the patient or other third party payer for no additional consideration.
The accounts receivable are sold weekly based on separate bills of sale
for each Hospital. The purchase price is comprised of two components, the
advance rate amount and the Deferred Purchase Price Receivable amount. The
advance rate amount is based on the buyer's appraisal of accounts receivable
accounts. The buyer's appraisal is developed internally by the buyer and does
not necessarily reflect the net realizable value or the fair value of the
accounts receivable sold. At the time of sale, the Buyer advances 95% of the
buyers appraised value (the "95% Advance"; increased from 85% at Buyer's
election effective January 1, 2006) on eligible accounts to the Company and
holds the remaining 5% as part of the security reserve funds on sold accounts
(the "Security Reserve Funds"), which is non-interest bearing. Except in the
case of a continuing default, the Security Reserve Funds can not exceed 15% (the
"15% Cap", decreased from 25% at Buyer's election effective March 31, 2006) of
the aggregate advance rate amount, as defined, of the open purchases. The
Company is charged a "purchase discount" (the "Transaction Fee") of 1.35% per
month of the advance rate amount of each tranche of accounts receivable accounts
purchased until closed based on application of cash collections up to the
advance rate amount for that tranche, at which time the Buyer deducts the
Transaction Fee from the Security Reserve Funds. The Company holds cash
F-17
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007
collected in its lockbox in a fiduciary role for the Buyer and records the cash
as part of Security Reserve Funds. Collections are applied by the buyer on a
dollar value basis, not by specific identification, to the respective Hospital's
most aged open purchase until the tranche is closed. The agreement further
provides that if the amount collected (as to each Account purchased within 180
days of the Billing Date on any Account (including Substitute Assets) purchased
by Buyer be less than the amount of its Adjusted Value, then such seller shall
remit to Buyer the amount of such difference between the Adjusted Value of the
Account and the amount actually collected on such Account by Buyer as the
repurchase price for such accounts. If the Seller fails to repurchase such
accounts, the Buyer shall deduct this from the Advance Rate Amount and Deferred
Purchase Price otherwise payable for all accounts with respect to any purchase,
an amount equal to the Adjusted Value of such uncollected account less the
deferred portion of the purchase price thereof, thereby closing the tranche.
These provisions have not been applied in the contract to date due to the more
timely closure of tranches.
Collections in excess of the advance rate amount are credited by the
buyer to Security Reserve Funds and ultimately released to the Company to pay
down the Deferred Purchase Price Receivable. The Deferred Purchase Price
Receivable approximates fair value and represents amounts the Company expects to
collect, based on regulations, contracts, and historical collection experience,
in excess of the advance rate amount. In determining the fair value of the
Deferred Purchase Price Receivable recorded upon sales of accounts receivable
accounts under the Accounts Purchase Agreement, the key assumption used was the
application of a short-term discount rate. If the discount rate applied
increased by 10%, the adverse effect on the Deferred Purchase Price Receivable
and related loss on sale of accounts receivable would be insignificant. The
Deferred Purchase Price Receivable is unsecured.
From inception of the APA through March 31, 2007, the buyer has
advanced approximately $501 million to the Company through the APA. In addition,
the Company has received approximately $41.7 million in reserve releases from
inception through March 31, 2007. Payments posted on sold receivables
approximated $524 million. Advances net of payment and adjustment activity,
cumulatively through March 31, 2007 and December 31, 2005 were $7.0 million and
$8.8 million respectively. Transaction fees incurred for the same periods were
$9.3 million and $3.3 million respectively.
The following table reconciles accounts receivable at March 31, 2007
and December 31, 2005, as reported, to the pro forma accounts receivable, as if
the Company had deferred recognition of the sales (non GAAP) (in thousands).
March 31, 2007 December 31, 2005
As reported Pro Forma As reported Pro Forma
----------- --------- ----------- ---------
Accounts receivable
Governmental $ 7,958 $ 25,621 $ 10,395 $ 23,772
Non-governmental 13,767 51,229 8,728 45,564
-------- -------- -------- --------
21,725 76,850 19,123 69,336
Less allowance for doubtful accounts (2,355) (16,267) (3,148) (17,723)
-------- -------- -------- --------
Net patient accounts receivable 19,370 60,583 15,975 51,613
-------- -------- -------- --------
Security reserve funds 7,990 -- 14,217 --
Deferred purchase price receivables 16,975 -- 9,338 --
-------- -------- -------- --------
Receivable from Buyer of accounts 24,965 -- 23,555 --
Advance rate amount in excess of collections -- (6,957) -- (8,753)
Transaction Fees deducted from Security
Reserve Funds -- (9,291) -- (3,330)
-------- -------- -------- --------
$ 44,335 $ 44,335 $ 39,530 $ 39,530
======== ======== ======== ========
Any other term of the APA notwithstanding, the parties agreed as
follows: (a) all accounts derived from any government program payer including,
without limitation, the Medicare, Medi-Cal, or CHAMPUS programs, shall be
handled as set forth in a Deposit Account Security Agreement entered into by the
parties, which provides for the segregation and control of governmental payments
by the Company, (b) the parties agreed to take such further actions and execute
such further agreements as are reasonably necessary to effectuate the purpose of
the APA and to comply with the laws, rules, and regulations of the Medicare and
other government programs regarding the reassignment of claims and payment of
claims to parties other than the provider ("Reassignment Rules"), and (c) until
such time as accounts are delivered by the Company to the Buyer controlled
lockbox, the Company shall at all times have sole dominion and control over all
payments due from any government program payer. The Company's management
believes that the foregoing method of segregating and controlling payments
received from governmental program payers complies with all applicable
Reassignment Rules. As of March 31, 2007 as shown above in the difference
between the accounts receivable - governmental as reported versus proforma
amounts, the Company had (in thousands) $17,662 in governmental accounts
receivable that had been reported as sold which were subject to the foregoing
limitation.
F-18
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007
The Company records estimated Transaction Fees and estimated servicing
expense related to the sold accounts receivable at the time of sale. The
estimated servicing liability is recorded at cost which approximates fair value
of providing such services. The loss on sale of accounts receivable is comprised
of the following (in thousands):
For the
For the Year Ended Three Months Ended
March 31, 2007 December 31, 2005 March 31, 2006
-------------- ----------------- --------------
Transaction Fees deducted from Security
Reserve Funds - closed purchases $ 4,568 $ 3,330 $ 1,394
Accrued Transaction Fees - open purchases 262 863 108
------- ------- -------
Total Transaction Fees incurred 4,830 4,193 1,502
------- ------- -------
Servicing expense for sold accounts receivable
- closed purchases 5,525 3,597 1,231
Accrued servicing expense for sold accounts
receivable - open purchases 33 680 75
------- ------- -------
Total servicing expense incurred 5,558 4,277 1,306
------- ------- -------
Loss on sale of accounts receivable for
the period $10,388 $ 8,470 $ 2,808
======= ======= =======
The related accrued Transaction Fee and accrued servicing liabilities
included in other current liabilities on the accompanying consolidated balance
sheets are as follows (in thousands).
March 31, 2007 December 31, 2005
-------------- -----------------
Transaction Fee liability $ 1,233 $ 863
Accrued servicing liability $ 789 $ 681
The accrued servicing liability recorded at March 31, 2007 and December
31, 2005, approximates fair value in accordance with SFAS No. 140.
NOTE 5 - GOVERNMENT PAYERS
Amounts due from government payers consist (in thousands) of:
March 31, 2007 December 31, 2005
-------------- -----------------
DSH receivable $ 1,378 $ 2,921
Cost report receivables - 104
---------- ----------
Total $ 1,378 $ 3,025
========== ==========
F-19
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007
Amounts due to Government payers consist (in thousands) of:
March 31, 2007 December 31, 2005
-------------- -----------------
Medicare Outlier $ 1,831 $ -
Cost report receivables (909) -
-------------- -----------------
Total $ 922 $ -
============== =================
NOTE 6 - PREPAID EXPENSES AND OTHER CURRENT ASSETS
Prepaid expenses and other current assets consist (in thousands) of:
March 31, 2007 December 31, 2005
-------------- -----------------
Prepaid insurance $ 5,004 $ 1,428
Prepaid taxes 64 1,400
Deposit for EDP services - 901
Other 3,029 2,965
-------------- -----------------
Total $ 8,097 $ 6,694
============== =================
NOTE 7 - PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
March 31, 2007 December 31, 2005
-------------- -----------------
Building $ 33,697 $ 33,697
Land and improvements 13,523 13,523
Equipment 9,694 9,240
Assets under capital leases 6,505 5,109
-------------- -----------------
63,419 61,569
Less accumulated depreciation (5,247) (2,138)
-------------- -----------------
Property and equipment, net $ 58,172 $ 59,431
============== =================
Depreciation and amortization expense related to property and equipment
(including assets under capital leases) (in thousands) for the years ended March
31, 2007 and December 31, 2005 and 2004 was $2,495, $2,133 and $62,
respectively, and for the three months ended March 31, 2006 was $673.
Depreciation and amortization reflected in the consolidated statement of
operations for the year ended December 31, 2005 also reflected amortization
related to an intangible asset in the amount of $45 (in thousands).
The Hospitals are located in an area near active and substantial
earthquake faults. The Hospitals carry earthquake insurance with a policy limit
of $50 million. A significant earthquake could result in material damage and
temporary or permanent cessation of operations at one or more of the Hospitals.
In addition, the State of California has imposed new hospital seismic safety
requirements. Under these new requirements, the Hospitals must meet stringent
seismic safety criteria in the future, and, must complete one set of seismic
upgrades to each facility by January 1, 2013. This first set of upgrades is
expected to require the Company to incur substantial seismic retrofit expenses.
There are additional requirements that must be complied with by 2030. The costs
of meeting these requirements have not yet been determined. Compliance with
seismic ordinances will be a costly venture and could have a material adverse
effect on our cash flow.
F-20
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007
NOTE 8 - DEBT
All of the Company's debt has matured and the Company is currently
operating under a ninety day Forbearance Agreement with its lenders to obtain
new financing (see Note 18). The Company's debt consists of the following (in
thousands):
March 31, 2007 December 31, 2005
-------------- -----------------
Debt - current
Secured note $ 10,700 $ 10,700
Less derivative - warrant liability, current (10,700) (10,700)
Secured acquisition loan 45,000 -
Secured line of credit, outstanding borrowings 27,341 -
-------------- -----------------
Total $ 72,341 $ -
============== =================
Debt - non current
Secured acquisition loan $ - $ 45,000
Secured line of credit, outstanding borrowings - 25,331
-------------- -----------------
Total $ - $ 70,331
============== =================
The Company borrowed all of its debt from affiliates of Medical Capital
Corporation. Effective March 3, 2005, the Company entered into a credit
agreement (the "Credit Agreement") with Medical Provider Financial Corporation
II ("the Lender"), whereby the Company obtained initial financing with annual
interest at the rate of 14% in the amount of $80,000,000 consisting of a
$30,000,000 non-revolving Line of Credit and a $50,000,000 Acquisition Loan
(less $5,000,000 repayment on December 12, 2005) in the form of a real estate
loan (collectively, the "Obligations"). The Company used the proceeds from the
$50 million Acquisition Loan and $3 million from the Line of Credit to complete
the Acquisition (see Note 3).
As of March 31, 2007, the Company had no remaining availability under
its $30 million Line of Credit as the maturity date has passed. The Line of
Credit is to be used for the purpose of providing (a) working capital financing
for the Company and its subsidiaries, (b) funds for other general corporate
purposes of the Company and its subsidiaries, and (c) other permitted purposes.
Effective January 1, 2006, the Company and the Lender agreed to an
amendment to the Obligations that changed the interest rate from 14% per annum
to prime plus 5.75% per annum (14.00% per annum at March 31, 2007). In
accordance with the Forbearance Agreement (Note 18) this debt accrues interest
at a fixed rate of 14% per annum.
Interest payments are due on the Obligations on the first business day
of each calendar month while any Obligation is outstanding. The Obligations
matured on March 2, 2007. Under the Credit Agreement, all future capital
contributions to the Company by Orange County Physicians Investment Network, LLC
("OC-PIN") shall be used by the Company as mandatory prepayments of the Line of
Credit.
The Acquisition Loan and Line of Credit are secured by a lien on
substantially all of the assets of the Company and its subsidiaries, including,
without limitation, a pledge of the capital stock by the Company in its wholly
owned Hospitals. In addition, (i) PCHI has agreed to guaranty the payment and
performance of the Obligations, (ii) West Coast and Ganesha, (the members of
PCHI), have each agreed to pledge their membership interests in PCHI as security
for repayment of the Obligations, (iii) the members of West Coast have agreed to
pledge their membership interests in PCHI as security for repayment of the
Obligations, and (iv) OC-PIN (see Note 16) has agreed to guaranty the payment
and performance of all the Obligations.
CREDIT AGREEMENT FEES - Concurrently with the execution and delivery of
the Credit Agreement and as a condition to the funding of the Acquisition Loan
the Company paid (in thousands) the Lender a total of $1,600 in origination fees
and paid the Lender's legal fees of approximately $333. The Company amortized
the debt issuance costs of $1,933 over the two year term of the Obligations
through March 3, 2007 (the date of the expiration of the credit agreement). The
Company recognized interest expense, including amortization of fees on short
term note below, for the years ended March 31, 2007 and December 31 2005 (in
thousands) of $1,009 and $792, respectively, and $242 for the three months ended
March 31, 2006.
F-21
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007
SECURED SHORT TERM NOTE - On December 12, 2005, the Company entered
into a credit agreement (the "December Credit Agreement") with the Lender. Under
the December Credit Agreement, the Lender loaned $10,700,000 to the Company (the
"December Note"). Interest is payable monthly at the rate of 12% per annum and
the December Note originally due on December 12, 2006 was extended to March 2,
2007 pursuant to an agreement dated December 22, 2006 (see below). In
consideration for the extension the Company paid loan and legal fees in the
amount of $107,000 and $2,500 respectively. The loan and legal fees were
amortized over the three month extension through March 2, 2007.
The December Note is secured by substantially all of the Company's
assets. In addition, the Company issued a common stock warrant (the "December
Note Warrant") to the Lender as collateral under the December Note. The December
Note Warrant is exercisable by the Lender only in the event that a default has
occurred and is continuing on the December Note (see Note 18). The Company has
classified the December Note as current warrant liability in the accompanying
consolidated balance sheets as of March 31, 2007 and December 31, 2005 (see Note
11).
On December 22, 2006, the Company, Pacific Coast Holdings Investment,
LLC, West Coast Holdings, LLC, Orange County Physicians Investment Network, LLC,
Ganesha Realty, LLC, and the Lender, executed Amendment No.1 to Credit
Agreement, dated as of December 18, 2006 (the "Amendment"), that amends the
December Credit Agreement.
The Amendment extended the "Stated Maturity Date", as defined in the
Credit Agreement, to March 2, 2007 from December 12, 2006. Also on December 22,
2006, the parties to the Credit Agreement executed an Agreement to Forbear (the
"December Forbearance Agreement") relating to the Credit Agreement and the
December Note issued in connection with the original Credit Agreement.
Under the December Forbearance Agreement, the Company agreed with the
Lender to change the date by which the Company is required to file a
registration statement covering the resale of all the shares of common stock
underlying the December Note Warrant to May 15, 2007, and to use its reasonable
best efforts to have the registration statement declared effective by the
Securities and Exchange Commission as soon as practicable but no later than 90
days after such date (or 120 days if the registration statement is reviewed by
the SEC). The December Note Warrant is subject to the new Forbearance Agreement
discussed at Note 18.
NOTE 9 - OTHER CURRENT LIABILITIES
Other current liabilities consist (in thousands) of:
March 31, 2007 December 31, 2005
-------------- -----------------
Accrued general and professional liability retentions $ 4,961 $ 2,650
Accrued CalOptima liability 4,112 6,120
Accrued insurance premiums 3,808 -
Accrued professional fees 884 1,616
Accrued workers compensation retentions 997 949
Accrued interest 981 701
Accrued contract nursing costs 565 961
Other 4,379 2,728
-------------- -----------------
Total $ 20,687 $ 15,725
============== =================
NOTE 10 - INCOME TAXES
The Company accounts for income taxes in accordance with SFAS No. 109
"Accounting for Income Taxes" which requires the liability approach for the
effect of income taxes. Under the liability method, deferred tax assets and
liabilities are recognized using tax rates for the effect of temporary
differences between book and tax basis of recorded assets and liabilities. The
provision for income taxes consists of provisions for federal and state income
taxes.
The preparation of consolidated financial statements in conformity with
U.S. GAAP requires the Company to make estimates and assumptions that affect the
reported amount of tax-related assets and liabilities and income tax provisions.
The Company assesses the recoverability of the deferred tax assets on an ongoing
basis. In making this assessment the Company is required to consider all
available positive and negative evidence to determine whether, based on such
evidence, it is more likely than not that some portion or all of the net
deferred assets will be realized in future periods. This assessment requires
significant judgment. In addition, the Company has made significant estimates
involving current and deferred income taxes, tax attributes relating to the
interpretation of various tax laws, historical bases of tax attributes
associated with certain tangible and intangible assets and limitations
surrounding the realization of the deferred tax assets. The Company does not
recognize current and future tax benefits until it is deemed probable that
certain tax positions will be sustained.
F-22
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007
The provision for income taxes consisted of the following (in
thousands):
For the Years Ended For the Three Months Ended
March 31, 2007 December 31, 2005 December 31, 2004 March 31, 2006
-------------- ----------------- ----------------- --------------
Current income tax provision
Federal $ - $ - $ - $ -
State 5 5 - 5
-------------- ----------------- ----------------- --------------
5 5 - 5
-------------- ----------------- ----------------- --------------
Deferred income tax benefit
Federal - - - -
State - - - -
-------------- ----------------- ----------------- --------------
- - - -
-------------- ----------------- ----------------- --------------
Income tax provision $ 5 $ 5 $ - $ 5
============== ================= ================= ==============
A reconciliation between the amount of reported income tax expense and
the amount computed by multiplying loss from continuing operations before income
taxes by the statutory federal income tax rate is as follows (in thousands):
For the Years Ended For the Three Months Ended
March 31, 2007 December 31, 2005 December 31, 2004 March 31, 2006
-------------- ----------------- ----------------- --------------
U.S. federal statutory income taxes $ (7,184) $ (15,358) $ (625) $ 789
State and local income taxes, net
of federal benefits (1,226) (2,665) (107) (348)
Change in valuation allowance 14,684 14,841 759 4,446
Other (6,269) 3,187 (27) (4,882)
-------------- ----------------- ----------------- --------------
Income tax provision $ 5 $ 5 $ - $ 5
============== ================= ================= ==============
Deferred income taxes reflect the tax effects of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amount used for income tax purposes. The following table
discloses those significant components of deferred tax assets and liabilities,
including the valuation allowance (in thousands):
March 31, 2007 December 31, 2005
-------------- -----------------
Deferred tax assets:
Allowance for doubtful accounts $ 1,052 $ 1,349
Accrued vacation 2,542 1,923
Tax credits 14,913 6,580
Net operating losses 12,334 4,061
Other 2,885 862
-------------- -----------------
33,725 14,775
Valuation allowance (33,725) (14,775)
-------------- -----------------
Total deferred tax assets $ - $ -
============== =================
F-23
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007
The valuation allowances above were recorded based on an assessment of
the realization of deferred tax assets as described below. The Company assesses
the realization of deferred tax assets to determine whether an income tax
valuation allowance is required. The Company recorded a 100% valuation allowance
on its deferred tax based primarily on the following factors:
o cumulative losses in recent years;
o income/losses expected in future years;
o unsettled circumstances that, if unfavorably resolved, would
adversely affect future operations and profit levels;
o the availability, or lack thereof, of taxable income in
prior carryback periods that would limit realization of tax
benefits;
o the carryforward period associated with the deferred tax
assets and liabilities.
ACQUISITION - The Acquisition was an asset purchase transaction and the
Company will not benefit from the net operating losses of the acquired Hospitals
prior to the date of acquisition. In connection with the Company's completion of
the Acquisition in March 2005, the Company sold substantially all of the real
estate of the acquired hospitals to PCHI. For income tax purposes, the sale of
the real estate of the acquired hospitals is subject to review by the Internal
Revenue Service. The IRS could require the Company to report dividend and/or
interest income. If the Company is required to report dividend and/or interest
income in connection with this transaction, the Company would be required to
withhold 28% on any deemed dividend or interest income. The Company's sale of
real estate to PCHI on March 8, 2005 for $5 million plus the assumption of the
Acquisition Loan is a taxable event to the Company.
PCHI TAX STATUS - PCHI is a limited liability corporation. PCHI's
owners plan to make tax elections for it to be treated as a disregarded entity
for tax reporting whereby, in a manner similar to a partnership. PCHI's taxable
income or loss will flow through to its owners and be their separate
responsibility. Accordingly, the accompanying consolidated financial statements
do not include any amounts for the income tax expense or benefit, or liabilities
related to PCHI's income or loss.
The Company has Net Operating Loss carryfowards which expire as follows
(in thousands):
Federal State
Tax year ended December 31, Amount Expiring Amount Expiring
--------------------------- --------------- ---------------
2011 $ 8 -
2013 - $ 127
2014 - $ 1,682
2015 - $ 12,712
2017 $ 13 -
2018 $ 7 -
2019 $ 13 -
2020 $ 17 $ 2,048
2021 $ 15 -
2022 $ 35 -
2023 $ 102 -
2024 $ 1,688 -
2025 $ 8,857 -
NOTE 11 - COMMON STOCK WARRANTS
DECEMBER NOTE WARRANT In accordance with SFAS No. 150, the Company has
included the December Note value of $10.7 million in warrant liabilities,
current, in the accompanying consolidated balance sheets as of March 31, 2007
and December 31, 2005 and recomputed the fair value in accordance with SFAS No.
133 at each reporting date. Under the terms of the December Credit Agreement,
any proceeds from the sale of stock received under the December Note Warrant
that are in excess of the December Note and related issuance costs are to be
paid to the Company as paid in capital. Accordingly, the fair value of the
December Note Warrant would contractually continue to be $10.7 million (plus any
issuance and exercise costs, which are considered immaterial).
F-24
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007
At March 31, 2007 and December 31, 2005 the estimated potential number
of shares was calculated using the market price and $10.7 million liability of
the Company. The estimated number of shares was 33.4 million and 21.8 million,
respectively. The maximum number of share issuable in the event of default in
accordance with the December Note Warrant agreement however, is the greatest of:
(1) 26,097,561 Shares of Common Stock, (2) Shares representing 31.09% of all
Common Stock and Common Stock Equivalents of the Company, and (3) the fair
market value of Shares of Common Stock equal to the amount of the $10,7 million
loan not repaid at maturity or default of such Loan, plus any accrued and unpaid
interest thereon, Lender's fees, costs and expenses, and attorneys' fees. Any
amounts received from the lender from the sale of stock they received when they
exercise the warrants in excess of that required to retire the $10.7 million
debt would be paid to the Company as additional paid in capital.
RESTRUCTURING WARRANTS The Company entered into a Rescission,
Restructuring and Assignment Agreement with Dr. Kali Chaudhuri and Mr. William
Thomas on January 27, 2005 (the "Restructuring Agreement"). Pursuant to the
Restructuring Agreement, the Company issued warrants to purchase up to
74,700,000 shares of the Company's common stock (the "Restructuring Warrants")
to Dr. Chaudhuri and Mr. Thomas (not to exceed 24.9% of the Company's fully
diluted capital stock at the time of exercise). In addition, the Company amended
the Real Estate Option to provide for Dr. Chaudhuri's purchase of a 49% interest
in PCHI for $2,450,000.
As a result of the Company not being able to determine the maximum
number of shares that could be required to be issued under the December Note
Warrant executed on December 12, 2005, the Company reclassified these warrants
from permanent equity to liability as of this date. The fair value (in
thousands) of the warrants on the date of reclassification was $17,605 and
accordingly the Company recorded warrant expense of $389 for the difference
between the amount reclassified from permanent equity and the fair value on the
reclassification date. In accordance with FAS 133, these warrants are revalued
at each reporting date, and the changes in fair value are recorded as Change in
fair value of derivative on the statement of operations.
The Restructuring Warrants were exercisable beginning January 27, 2007
and expire 3.5 years from the date of issuance (July 27, 2008). The exercise
price for the first 43 million shares purchased under the Restructuring Warrants
is $0.003125 per share, and the exercise or purchase price for the remaining
31.7 million shares is $0.078 per share if exercised between January 27, 2007
and July 26, 2007, $0.11 per share if exercised between July 27, 2007 and
January 26, 2008, and $0.15 per share thereafter.
During February 2007 Dr Chaudhuri and Mr. Thomas submitted an exercise
under these warrants to the Company. At March 31, 2007 the Company recorded the
issuance of 28,746,857 net shares under this exercise following resolution of
certain legal issues relating thereto. The issuance of these shares resulted in
an addition to additional paid in capital and to common stock totaling (in
thousands) $9,199. These shares were issued to Dr Chaudhuri and Mr. Thomas on
July 2, 2007. The shares pursuant to this exercise were recorded as issued and
outstanding at March 31, 2007. Additionally, the remaining liability was
revalued at March 31, 2007in the amount of $4.2 million relating to potential
shares (approximately 20.8 million shares) which could be issued, if the
December Note warrant was to become issuable. The parties agreed that this
occurred on June 13, 2007 upon receipt of a notice of default from the Lender.
See subsequent exercise at Note 18.
The market price of the Company's stock at subsequent exercise date and
the number of shares relating thereto were used to value the liability of $4.2
million and accordingly the Company recognized a gain of $133 related to the
change in fair value of derivative for the year ended March 31, 2007.
Furthermore based upon the execution of the additional share exercise on July 2,
2007, prior to the issuance of this report, an additional warrant expense of
$693 thousand was also recognized.
In prior periods the Company computed the change in fair value of the
Restructuring Warrants based on the fair value of the underlying shares and the
estimated maximum number of shares of 43.3 million that could be issued under
the Restructuring Warrants. The Company estimated the number of potential shares
under the Restructuring Warrants as this was not certain as the first exercise
date had not been reached.
Based on the foregoing warrant exercises, the total number of warrants
actually exercised was approximately 49.5 million.
F-25
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007
For periods prior to the date the warrants became exercisable (January
27, 2007), the Company used valuations prepared by an independent valuation firm
to determine the fair value of the underlying shares. The assumptions used in
Black-Scholes model were as follows:
December 31, 2005
-----------------
Risk-free interest rate 4.4%
Expected volatility 28.6%
Dividend yield --
Expected life (years) 2.57
Fair value of warrants $0.487
Market value per share $0.49
March 31, 2006
--------------
Risk-free interest rate 4.8%
Expected volatility 27.9%
Dividend yield --
Expected life (years) 2.32
Fair value of warrants $0.297
Market value per share $0.30
Due to the fact that the Company emerged from the development stage in
2005, the independent valuation firm computed the volatility of the Company's
stock based on an average of the following public companies that own hospitals:
Amsurg Inc (AMSG)
Community Health Systems (CYH)
HCA Healthcare Company (HCA)
Health Management Associates Inc. (HMA)
Lifepoint Hospitals Inc. (LPNT)
Medcath Corp. (MDTH)
Tenet Healthcare Corp. (THC)
Triad Hospitals Inc. (TRI)
Universal Health Services Inc., Class B (UHS)
Although the Company believes this was the most reasonable and accurate
methodology to determine the Company's volatility, the circumstances affecting
volatility of the comparable companies selected may not be an accurate predictor
of the Company's volatility.
The Company recorded (in thousands) a common stock warrant expense of
$17,604 and a change (in thousands) in the fair value of derivative of $3,460
for the year ended December 31, 2005. The change in fair value of the derivative
for the three months ended March 31, 2006 was (in thousands)a gain of $ 8,218.
The related warrant liability as of March 31, 2007 and December 31, 2005 is (in
thousands) $4,206 (excluding the $10.7 million December Note Warrant liability)
and $21,065, respectively.
NOTE 12 - RETIREMENT PLAN
The Company has a 401K plan for its employees. All employees with 90
days of service are eligible to participate, unless they are covered by a
collective bargaining agreement which precludes coverage. The Company matches
employee contributions up to 3% (5% prior to May 1, 2006) of the employee's
compensation, subject to IRS limits. During the years ended March 31, 2007,
December 31, 2005, and December 31, 2004 and the three months ended March 31,
2006 the company incurred expenses of $3,053, $3,522, $ -0- and $1,128,
respectively, which are included in Salaries and Benefits in the accompanying
Consolidated Statements of Operations.
F-26
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007
NOTE 13 - COMMON STOCK
STOCK PURCHASE AGREEMENT - On January 28, 2005, the Company entered
into a Stock Purchase Agreement (the "Stock Purchase Agreement") with OC-PIN a
company founded by Dr. Anil V. Shah, a board member, and owned by a number of
physicians practicing at the acquired Hospitals. This agreement was subsequently
amended to include the following.
Under the First Amendment and the related Escrow Agreement, OC-PIN
deposited a total of $12,500,000 into the escrow account. However, following
receipt of such funds, a disagreement arose between OC-PIN and the third party
which provided $11,000,000 of the $12,500,000 deposited into the escrow account.
In order to resolve this matter and to avoid potential litigation involving the
Company, the Company agreed to return $11,000,000 of these funds and provided
OC-PIN with a limited opportunity to provide alternative financing. Therefore,
effective October 31, 2005, the Company entered into a Second Amendment to the
Stock Purchase Agreement (the "Second Amendment"), pursuant to which the Company
and OC-PIN issued escrow instructions to release escrowed funds as of November
2, 2005, terminate the Escrow Agreement and distribute the assets in the escrow
account as follows:
i. $1,500,000 of the escrowed cash, plus a pro rata portion of
the accrued interest, was delivered to the Company for
payment of stock.
ii. $11,000,000 of the escrowed cash, plus a pro rata portion of
the accrued interest was delivered to OC-PIN.
iii. 5,798,831 of the escrowed shares of the Company's common
stock were delivered to OC-PIN.
iv. 40,626,684 of the escrowed shares of the Company's common
stock were delivered to the Company.
v. OC-PIN transferred $2,800,000 from another account to the
Company for which OC-PIN received 10,824,485 of the escrowed
shares.
vi. The Company agreed to issue to OC-PIN 5,400,000 shares of
its common stock multiplied by the percentage of OC-PIN's
payment required to be made under the Stock Purchase
Agreement, as amended, which had been made to date.
vii. The Company granted OC-PIN the right to purchase up to
$6,700,000 of common stock within 30 calendar days following
the cure of the Company's default relating to the Credit
Agreement at a price of $0.2586728 per share or a maximum of
25,901,447 shares of its common stock, plus interest on the
purchase price at 14% per annum from September 12, 2005
through the date of closing on the funds from OC-PIN.
Upon one or more closings on funds received under this section of the
Second Amendment, the Company agreed to issue an additional portion of the
5,400,000 shares mentioned in item (vi.) above. On September 12, 2006, the
Company issued 3,625,114 of these shares to OC-PIN in full resolution of the
Stock Purchase Agreement.
The Company's debt covenants restrict the ability to pay dividends.
The 28,746,860 shares of stock issued under the exercise of the
Restructuring Warrant (see Note 11) are included in the total shares reported as
outstanding at March 31, 2007, as they are in the process of being formally
issued.
NOTE 14 - INCOME (LOSS) PER SHARE
Income (loss) per share has been calculated under SFAS No. 128,
"Earnings per Share." SFAS 128 requires companies to compute income (loss) per
share under two different methods, basic and diluted. Basic income (loss) per
share is calculated by dividing the net income (loss) by the weighted average
shares of common stock outstanding during the period. Diluted income (loss) per
share is calculated by dividing the net income (loss) by the weighted average
shares of common stock outstanding during the period and dilutive potential
shares of common stock. Dilutive potential shares of common stock, as determined
under the treasury stock method, consist of shares of common stock issuable upon
exercise of stock warrants or options, net of shares of common stock assumed to
be repurchased by the Company from the exercise proceeds.
F-27
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007
Since the Company incurred losses for the years ended March 31, 2007
and December 31, 2005, antidilutive potential shares of common stock, consisting
of approximately 83 million and 43 million shares issuable under warrants,
respectively, have been excluded from the calculations of diluted loss per share
for those periods. For the year ended December 31, 2004 there were no dilutive
securities outstanding.
Income per share for the three months ended March 31, 2006 was computed
as follows (in thousands except per share amounts):
Three months ended
March 31, 2006
--------------
Numerator:
Net income $ 2,422
==============
Denominator:
Weighted average common shares 84,281
Warrants 42,947
--------------
Denominator for diluted calculation 127,228
==============
Income per share - basic $ 0.03
Income per share - diluted $ 0.02
The number of shares into which the December Note warrant could convert
is not included in the calculation of diluted income per share, as the related
December Note was in default and thus the warrant had vested. The inclusion of
the warrant on an as converted basis would not change the amount of reported
diluted income per share.
NOTE 15 - VARIABLE INTEREST ENTITY
Concurrent with the close on the Acquisition, and pursuant to an
agreement dated September 28, 2004, as amended and restated on November 16,
2004, Dr. Chaudhuri and Dr. Shah exercised their option to purchase all of the
equity interests in PCHI, which simultaneously acquired title to substantially
all of the real property acquired by the Company in the Acquisition. The Company
received $5 million and PCHI guaranteed the Company's Acquisition Loan. The
Company remains primarily liable under the Acquisition Loan note notwithstanding
its guarantee by PCHI, and this note is cross-collateralized by substantially
all of the Company's assets and all of the real property of the Hospitals. All
of the Company's operating activities are directly affected by the real property
that was sold to PCHI. Given these factors, the Company has indirectly
guaranteed the indebtedness of PCHI. The Company is a guarantor on the
Acquisition Loan should PCHI not be able to perform and has undertaken a
contingent obligation to make future payments if those triggering events or
conditions occur. PCHI is a related party entity that is affiliated with the
Company through common ownership and control. It is owned 51% by West Coast
Holdings, LLC (Dr. Shah and investors) and 49% by Ganesha Realty, LLC (Dr.
Chaudhuri and Mr. Thomas). Under FIN 46R (see Note 1) a company is required to
consolidate the financial statements of any entity that cannot finance its
activities without additional subordinated financial support, and for which one
company provides the majority of that support through means other than
ownership. Effective March 8, 2005, the Company determined that it provided the
majority of financial support to PCHI through various sources including lease
payments, remaining primarily liable under the Acquisition Loan, and
cross-collateralization of the Company's non-real estate assets to secure the
Acquisition Loan. Accordingly, the Company included the net assets of PCHI, net
of consolidation adjustments, in its consolidated financial statements (in
thousands).
March 31, 2007 December 31, 2005
-------------- -----------------
Total Assets $ 46,465 $ 48,068
Total Liabilties $ 45,537 $ 44,727
Members' Equity $ 927 $ 3,342
F-28
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007
Selected information from PCHI's results of operations for the years
ended March 31, 2007 and December 31, 2005 and for the three months ended March
31, 2006 is as follows (in thousands):
March 31, 2007 December 31, 2005 December 31, 2004 March 31, 2006
-------------- ----------------- ----------------- --------------
Net revenues $ 6,554 $ 7,277 $ - $ 1,545
Net loss $ (593) $ (1,658) $ - $ (100)
Consolidation adjustments to reflect the effects of the following
matters are included in the accompanying consolidated financial statements:
The Company's rental income and expense in the Hospitals has been
eliminated, consolidating PCHI's ownership of the land and buildings in the
accompanying consolidated financial statements. The amount of rent incurred and
eliminated (in thousands) for the years ended March 31, 2007 and December 31,
2005 and 2004 was $6,554, $7,277 and $-0-, respectively, and for the three
months ended March 31, 2006 was $1,554.
Additionally, a gain (in thousands) of $4,433 arising from the
Company's sale of the real property of the Hospitals to PCHI has been eliminated
to record the land and buildings at the Company's cost. Essentially all Land and
Buildings in the accompanying consolidated balance sheets are owned by PCHI.
PCHI's equity accounts have been classified as a minority interest in a
variable interest entity. The Company has a 25 year lease commitment to PCHI
with rental payments equal to the following components:
i. Interest expense on the Acquisition Loan, or successor upon
refinancing, and
ii. Up to 2.5% spread subject to adjustment annually in
accordance with the Consumer Price Index, and
iii. Amortization expense of $2.5 million per year.
Concurrent with the close of the Acquisition, the Company entered into
a sale-leaseback transaction with PCHI involving substantially all of the real
property acquired in the Acquisition, except for the fee interest in the medical
office building at 2617 East Chapman Avenue, for an initial term of 25 years and
option to renew for an additional 25 years. The rental payments are variable
based primarily on the terms of financing. Based on the existing arrangements,
aggregate payments are estimated to be approximately $210 million over the
remainder of the initial term. IHHI and PCHI are currently negotiating revisions
to the lease agreement. Any revisions could result in an increase or decrease to
this commitment. As long as PCHI is consolidated the related impact on rental
income and expense should be eliminated. Any increase in payments to PCHI would
likely be distributed to the partners and have a corresponding adverse impact on
cash flow. Rental payments under the PCHI Lease are variable. IHHI is also
required to forward to PCHI Based on the existing terms of the PCHI Lease, IHHI
is also required to pay PCHI, subject to certain deferral rights, any rent
received from tenants in medical office buildings which are part of the leased
premises, less certain operating, insurance and tax expenses. Based on the
existing arrangements, aggregate payments are expected to be approximately $210
million over the remainder of the initial term of the PCHI Lease. The parties to
the PCHI Lease are currently evaluating whether it is appropriate to revise
certain terms of the PCHI Lease. Any revisions could result in an increase or
decrease to this commitment. As long as PCHI is consolidated the related impact
on rental income and expense should be eliminated. Any increase in payments to
PCHI would likely be distributed to the partners and have a corresponding
adverse impact on cash flow.
Additionally, the tenant is responsible for seismic remediation (SB
1953) under the terms of the lease agreement (see Note 7).
NOTE 16 - RELATED PARTIES
PCHI - The Company leases substantially all of the real property of the
acquired Hospitals from PCHI. PCHI is owned by two LLC's, namely West Coast
Holdings, LLC and Ganesha Realty, LLC; which are owned and co-managed by Dr.
Shah, Dr. Chaudhuri, and Mr. Thomas. Dr. Shah is a director of the Company and
is also the co-manager and an investor in OC-PIN, which is the majority
shareholder of the Company. As the result of the partial exercise of the
Restructuring Warrant on February 6, 2007, Dr. Chaudhuri and Mr. Thomas are
constructively the holders of 24.9% of the outstanding stock of the Company as
of March 31, 2007. They are also the owners of the Restructuring Warrants to
purchase up to 24.9% of future stock in the Company, issuable due to an anti
dilution feature of the warrant (see Notes 11 and 18). As described in Note 15,
the Company has consolidated the financial statements of PCHI in the
accompanying consolidated financial statements
F-29
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007
In December 2006, the Company reported a termination of the employment
agreement with its former chairman. Estimated termination benefits of
approximately $400 thousand were fully accrued as of March 31, 2007.
NOTE 17 - COMMITMENTS AND CONTINGENCIES
OPERATING LEASES - As described in Note 15, the Company entered into a
sale leaseback agreement with a related party entity, PCHI. The Company leases
substantially all of the real estate of the acquired Hospitals and medical
office buildings from PCHI. The term of the lease for the Hospital is
approximately 25 years, commencing March 8, 2005 and terminating on February 28,
2030. The Company has the option to extend the term of this triple net lease for
an additional term of 25 years. This lease commitment with PCHI is eliminated in
consolidation (see Note 15).
Additionally, in connection with the Acquisition, the Company assumed
the leases for the Chapman facility, which include buildings, land, and other
equipment with terms that were extended concurrently with the assignment of the
leases to December 31, 2023.
The following is a schedule of the Company's future minimum operating
lease payments, excluding the triple net lease with PCHI, that have initial or
remaining non-cancelable lease terms in excess of one year as of March 31, 2007:
Year ended March 31,
(in thousands)
2008 $ 1,476
2009 1,124
2010 937
2011 937
2012 823
Thereafter 14,763
----------
Total $ 20,060
==========
Total rental expense for the years ended March 31, 2007 and December
31, 2005 and 2004 was (in thousands) $1,839, $2,276 and $68, respectively, and
for the three months ended March 31, 2006 was $393. The Company received
sublease rental income in relation to certain leases of approximately (in
thousands) $759, $536, and -0- for the years ended March 31, 2007 and December
31, 2005 and 2004 and $190 for the three months ended March 31, 2006.
F-30
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007
CAPITAL LEASES - The Company has long-term lease obligations for the
buildings at the Chapman facility as well certain equipment. For financial
reporting purposes, these leases have been classified as capital leases;
accordingly, assets with a net book value of $5,872 and $4,887 are included in
property and equipment in the accompanying consolidated balance sheet as of
March 31, 2007 and December 31, 2005, respectively. The following is a schedule
of future minimum lease payments under the capitalized building and equipment
leases together with the present value of the net minimum lease payments as of
March 31, 2007:
Year ended March 31, (in thousands)
-------------------- --------------
2008 $ 952
2009 952
2010 952
2011 932
2012 807
Thereafter 8,744
--------------
Total minimum lease payments 13,339
Less amount representing interest (7,254)
--------------
Present value of net minimum lease payments 6,085
less current portion (251)
--------------
Noncurrent portion $ 5,834
==============
INSURANCE - The Company accrues for estimated general and professional
liability claims, to the extent not covered by insurance, when they are probable
and reasonably estimable. The Company has purchased as primary coverage a claims
made form insurance policy for general and professional liability risks.
Estimated losses within general and professional liability retentions from
claims incurred and reported, along with incurred but not reported (IBNR)
claims, are accrued based upon projections determined by an independent actuary
and are discounted to their net present value using a weighted average risk-free
discount rate of 5%. To the extent that subsequent claims information varies
from estimates, the liability is adjusted in the period such information becomes
available. As of March 31, 2007 and December 31, 2005, the Company had accrued
approximately $4.9 million and $2.3 million, respectively, comprised of
approximately $1.4 million and $0.6 million, respectively, in incurred and
reported claims, along with approximately $3.5 million and $1.7 million,
respectively, in estimated IBNR.
The Company has also purchased as primary coverage occurrence from
insurance policies to help fund its obligations under its workers' compensation
program for which the Company is responsible to reimburse the insurance carrier
for losses within a deductible of $0.5 million per claim, to a maximum aggregate
deductible of $9 million. For the policy year ended May 15, 2006, the Company is
responsible to reimburse the insurance carrier for losses within a deductible of
$500,000 per claim, to a maximum aggregate deductible of $9,000,000. As of May
15, 2006, the Company changed to a "guaranteed cost" policy, under which the
carrier pays all workers' compensation claims, with no deductible or
reimbursement required of the Company. The Company accrues for estimated
workers' compensation claims, to the extent not covered by insurance, when they
are probable and reasonably estimable. The ultimate costs related to this
program include expenses for deductible amounts associated with claims incurred
and reported in addition to an accrual for the estimated expenses incurred in
connection with IBNR claims. Claims are accrued based upon projections
determined by an independent actuary and are discounted to their net present
value using a weighted average risk-free discount rate of 5%. To the extent that
subsequent claims information varies from estimates, the liability is adjusted
in the period such information becomes available. As of March 31, 2007 and
December 31, 2005, the Company had accrued approximately $1.0 million and $1.3
million, respectively, comprised of approximately $0.2 million and $0.3 million,
respectively, in incurred and reported claims, along with $0.8 million and $1.0
million, respectively, in estimated IBNR.
The Company has also purchased all risk umbrella liability policies
with aggregate limit of $19 million. The umbrella policies provide coverage in
excess of the primary layer and applicable retentions for all of its insured
liability risks, including general and professional liability and the workers'
compensation program.
AGREEMENT FOR COMPENSATION - In connection with the close of the
Acquisition, the Company entered into an Agreement for Compensation Related to
the 999 Medical Office Building (the "Compensation Agreement") with PCHI, a
related party (see Note 15). In the amended Asset Sale Agreement with Tenet,
certain medical office condominium units (the "Condo Units") were excluded from
the Company's Hospital Acquisition due to the condominium association of the
Condo Units having the right of first refusal to purchase such real property. As
a result, the Company's purchase price of the Hospitals from Tenet was reduced
by $5 million. Pursuant to the amended Asset Sale Agreement, upon the expiration
of the applicable right of first refusal, Tenet was to transfer title to the
Condo Units to the Company in exchange for consideration of $5 million, pro
rated if less than all of the Condo Units are transferred.
F-31
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007
Pursuant to the Compensation Agreement, the Company was to acquire
title to the Condo Units upon expiration of the applicable' right of first
refusal and then transfer such title to the Condo Units to PCHI. In the event of
the Company's failure to obtain title to the Condo Units, the Company was to pay
to PCHI a sum to be agreed upon between the Company, PCHI, and the owners of
PCHI, but not less than the product of $2,500,000 multiplied by a fraction, the
numerator of which shall be the number of Condo Units not acquired by the
Company and transferred to PCHI, and the denominator equal to the total Condo
Units of twenty-two. Tenet did not prevail in its efforts to transfer the units
to the Company. The Company is prepared to dispute PCHI's potential claim. The
Company has not accrued a liability for such a claim which would otherwise be
eliminated in consolidation. If the Company is not successful in its defense
against this claim the resultant distribution would result in a material adverse
impact on cash flow.
As the financial statements of the related party entity, PCHI, a
variable interest entity, are included in the Company's accompanying
consolidated financial statements, management has determined that any future
payment to PCHI under the Compensation Agreement would reduce the Company's gain
on sale of assets to PCHI, which has been eliminated in consolidation. In the
event of a settlement it is probable that any funds transferred to PCHI will be
distributed to its partners and reduce the Company's liquidity.
PURCHASE COMMITMENTS
The Company has purchase commitments extending over one year with two
suppliers. Commitments total $3,179, $3,013, and $549 for the years ending March
31, 2008, 2009 and 2010, respectively.
CLAIMS AND LAWSUITS
In addition to the following disclosures, the Company is party to
further lawsuits as noted at Note 18.
The Company and the Hospitals are subject to various legal proceedings,
most of which relate to routine matters incidental to operations. The results of
these claims cannot be predicted, and it is possible that the ultimate
resolution of these matters, individually or in the aggregate, may have a
material adverse effect on the Company's business (both in the near and long
term), financial position, results of operations, or cash flows. Although the
Company defends itself vigorously against claims and lawsuits and cooperates
with investigations, these matters (1) could require payment of substantial
damages or amounts in judgments or settlements, which individually or in the
aggregate could exceed amounts, if any, that may be recovered under insurance
policies where coverage applies and is available, (2) cause substantial expenses
to be incurred, (3) require significant time and attention from the Company's
management, and (4) could cause the Company to close or sell the Hospitals or
otherwise modify the way its business is conducted. The Company accrues for
claims and lawsuits when an unfavorable outcome is probable and the amount is
reasonably estimable.
Approximately 16% of the Company's employees were represented by labor
unions as of March 31, 2007. On December 31, 2006, the Company's collective
bargaining agreements with SEIU and CNA expired. Terms of the expired collective
bargaining agreements remain in place until new agreements are reached. The
Company is currently negotiating with these unions regarding successor
collective bargaining agreements. Although the new agreements are expected to
have provisions to increase wages and benefits, the unions have agreed to an
arbitration process to resolve any issues not resolved through normal
renegotiations. The agreed-to arbitration process provides the greatest
assurance that the unions will not engage in strike activity during the
negotiation of new agreements and prevents the arbitrator from ordering us to
pay market-leading wages for a particular hospital. The Company does not
anticipate the new agreements will have a material adverse effect on our results
of operations.
Both unions have filed grievances in connection with allegations the
agreement obligated the Company to contribute to a Retiree Medical Benefit
Account. The Company does not agree with this interpretation of the agreement
but has agreed to submit the matter to arbitration. CNA has also filed
grievances related to the administration of increases at one facility, change in
pay practice at one facility and several wrongful terminations. The Company does
not anticipate resolution of the arbitrations will have a material adverse
effect on our results of operations.
F-32
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007
NOTE 18 - SUBSEQUENT EVENTS
On June 13, 2007 the Company received a notice of default on its debt
from its Lender. On June 18, 2007, the Company entered into a Forbearance
Agreement with the Lender. This agreement provides, among other provisions, that
the Lender will forgo exercising any of its rights and remedies under the
various credit agreements, for ninety days. During this time the Company will
continue its efforts to refinance its existing matured debt.
On May 14, 2007, IHHI filed suit in Orange County Superior Court
against three of the six members of its Board of Directors and also against
IHHI's majority shareholder, OC-PIN. Among other things, the suit alleges that
the defendants breached fiduciary duties owed to IHHI by putting their own
economic interests above those of IHHI, its other shareholders, creditors,
employees and the public-at-large. The suit also alleges that defendants'
attempt to change IHHI's management and control of the existing Board could
trigger an "Event of Default" under the express terms of IHHI's existing credit
agreements with its secured lender.
On May 17, 2007, OC-PIN filed a separate suit against IHHI in Orange
County Superior Court. OC-PIN's suit alleges the management issue referred to
above must be resolved prior to the completion of the refinancing. OC-PIN
further alleges that IHHI's President has failed to call a special shareholders'
meeting so that OC-PIN could fill positions on IHHI's Board of Directors.
Both actions have been consolidated so they can be heard before one
judge. IHHI has filed a motion to appoint an independent provisional director to
the vacant seventh Board seat. OC-PIN has filed an application for an order
noticing a special shareholders meeting. These and other preliminary matters
were heard on July 2, 2007 and a ruling issued on July 11, 2007 appointing an
independent director for the term of the lawsuit.
On July 2, 2007 the Company accepted, due to the default and subsequent
vesting of the December Note Warrant, an additional exercise under the
anti-dilution provisions the Restructuring Warrant Agreement by Dr. Chaudhuri
and Mr. Thomas. The exercise resulted in additional shares issuable of 20.8
million shares for consideration of $576 thousand in cash. The effect of this
exercise resulted in additional warrant expense for the year ended March 31,
2007 of $693 thousand, which has been accrued based on the transaction as of
March 31, 2007.
In late May 2007, Western Medical Center, Santa Ana ("Medical Center")
was notified by a May 25, 2007 letter from the U.S. Department of Health
Services, Centers for Medicare and Medicaid Services ("CMS"), that CMS had
identified one case that was a potential violation of the federal patient
anti-dumping law (officially, the Emergency Medical Treatment and Active Labor
Act or "EMTALA"). In June 2007, Lumetra, a Medicare quality improvement
organization, notified Medical Center that it was aiding CMS in its
investigation of the same matter. Medical Center has responded to CMS and
Lumetra that its actions were appropriate and did not violate EMTALA. The
complaint from CMS and the notice from Lumetra are the first steps in a
determination by the Office of Inspector General ("OIG") of the U.S. Department
of Health and Human Services whether to seek enforcement action for a violation
of EMTALA. The potential sanctions which may be imposed by the OIG for a
violation of EMTALA are a civil money penalty up to $50,000 for a confirmed
violation and possible exclusion from the Medicare and Medi-Cal Programs. The
Company has notified both CMS and Lumetra that it believes that a violation of
the EMTALA statutes and regulations did not occur nor should it be subject to
any civil money penalties. As a prophylactic matter it has also reviewed and
revised its policies and procedures regarding communication and admission
practices through the hospital's emergency department and has conducted further
EMTALA in service training.
F-33
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007
NOTE 19 - QUARTERLY RESULTS
The following tables contain selected unaudited consolidated statements of
operations and loss per share data for each quarter in the years ended March 31,
2007 and December 31, 2005 (in thousands, except for per share data):
For the three months ended
March 31, 2007 December 31, 2006 September 30, 2006 June 30, 2006
----------------- ----------------- ------------------ ----------------
[restated] [restated]
---------- ----------
Net operating revenues $ 87,200 $ 87,137 $ 85,343 $ 90,992
Operating loss $ (307) $ (4,148) $ (4,563) $ 967
Net income (loss) $ (2,320) $ (13,402) $ (7,004) $ 2,188
Income (loss) per common share
Basic $ (0.02) $ (0.15) $ (0.08) $ 0.03
Diluted $ (0.02) $ (0.15) $ (0.08) $ 0.02
Weighted average shares outstanding
Basic 104,486 87,557 85,013 84,351
Diluted 104,486 87,557 85,013 127,297
For the three months ended
December 31, 2005 September 30, 2005 June 30, 2005 March 31, 2005(1)
----------------- ------------------ ------------------ ----------------
Net operating revenues $ 87,140 $ 91,620 $ 83,191 $ 21,747
Operating loss $ (2,509) $ (4,152) $ (8,137) $ (1,041)
Net income (loss) $ (8,625) $ (6,497) $ (10,196) $ (19,857)
Income (loss) per common share
Basic $ (0.10) $ (0.09) $ (0.08) $ (0.22)
Diluted $ (0.10) $ (0.09) $ (0.08) $ (0.22)
Weighted average shares outstanding
Basic 90,330 69,853 124,539 88,494
Diluted 90,330 69,853 124,539 88,494
(1) Includes the acquired Hospitals from March 8, 2005.
F-34
The amounts (unaudited) reported for the three months ended June 30,
and September 30, 2006, the six months ended September 30, 2006, and the related
condensed balance sheets as of June 30, 2006 and September 30, 2006, differ from
the amounts reported previously as follows (amounts in '000's except per share
amounts):
AS FILED ADJ RESTATED
-------- --- --------
THREE MONTHS ENDED MARCH 31, 2006
Net operating revenues $ 86,164 $ 481 $ 86,645
Operating loss $ (3,088) $ 414 $ (2,674)
Net income (loss) $ 2,535 $ (113) $ 2,422
Income (loss) per common
share
Basic $ 0.03 $ (0.00) $ 0.03
Diluted $ 0.02 $ (0.00) $ 0.02
Weighted average shares
outstanding
Basic 84,281 84,281
Diluted 127,228 127,228
THREE MONTHS ENDED JUNE 30, 2006
Net operating revenues $ 89,877 $ 1,115 $ 90,992
Operating loss $ (148) $ 1,115 $ 967
Net income (loss) $ 1,328 $ 860 $ 2,188
Income (loss) per common
share
Basic $ 0.02 $ 0.01 $ 0.03
Diluted $ 0.01 $ 0.01 $ 0.02
Weighted average shares
outstanding
Basic 84,351 84,351
Diluted 127,297 127,297
THREE MONTHS ENDED SEPTEMBER 30, 2006
Net operating revenues $ 87,035 $ (1,692) $ 85,343
Operating loss $ (3,049) $ (1,514) $ (4,563)
Net income (loss) $ (5,490) $ (1,514) $ (7,004)
Income (loss) per common
share
Basic $ (0.06) $ (0.02) $ (0.08)
Diluted $ (0.06) $ (0.02) $ (0.08)
Weighted average shares
outstanding
Basic 85,013 85,013
Diluted 85,013 85,013
SIX MONTHS ENDED SEPTEMBER 30, 2006
Net operating revenues $ 176,912 $ (577) $ 176,335
Operating loss $ (3,197) $ (399) $ (3,596)
Net income (loss) $ (4,162) $ (654) $ (4,816)
Income (loss) per common
share
Basic $ (0.05) $ (0.01) $ (0.06)
Diluted $ (0.05) $ (0.01) $ (0.06)
Weighted average shares
outstanding
Basic 84,684 84,684
Diluted 84,684 84,684
F-35
AS OF JUNE 30, 2006 AS FILED ADJ AS RESTATED
-------- --- -----------
Balance Sheet:
Current assets $ 74,444 $ 41 $ 74,485
Total assets $ 133,342 $ 41 $ 133,383
Current liabilities $ 152,776 $ (819) $ 151,957
Total liabilities $ 160,410 $ (819) $ 159,591
Accumulated deficit $ (43,410) $ 860 $ (42,550)
Total stockholders' deficiency $ (27,068) $ 860 $ (26,208)
AS OF SEPTEMBER 30, 2006 AS FILED ADJ AS RESTATED
-------- --- -----------
Balance Sheet:
Current assets $ 70,117 $ (654) $ 69,463
Total assets $ 128,234 $ (654) $ 127,580
Current liabilities $ 153,450 $ -- $ 153,450
Total liabilities $ 160,792 $ -- $ 160,792
Accumulated deficit $ (48,901) $ (654) $ (49,555)
Total stockholders' deficiency $ (32,558) $ (654) $ (33,212)
The adjustments to the quarters ended March 31, 2006, June 30, 2006 and
September 30, 2006 are summarized as follows (in thousands):
THREE MONTHS ENDED
INCREASE (DECREASE) NET INCOME MAR 31, 2006 JUN 30, 2006 SEP 30, 2006
- ------------------------------ ------------- ------------- --------------
Misapplication of payments received
from Medicare in error and incorrect
source documents used in settlement
calculation of estimates in error $ 290 $ 348 $ (626)
Interest income and expense calculated
in error (446) -- --
Insurance payments by third party
administrator recorded in the incorrect
quarter in error -- 471 (471)
Failure to properly reflect financing
of insurance policies 121 -- --
Error in eliminating transactions
within the subsidiaries 230 -- --
Errors in accruing liabilities (207) -- (345)
All others - net 189 41 (72)
------------- ------------- -------------
Total $ (113) $ 860 $ (1,514)
============= ============= =============
F-36