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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended June 30, 2007; or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the transition period from to
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 OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
1301 NORTH TUSTIN AVENUE
SANTA ANA, CALIFORNIA 92705
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(714) 953-3503
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year,
if changed since last report)
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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 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]
There were 137,095,716 shares outstanding of the registrant's common stock as of
July 31, 2007.
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INTEGRATED HEALTHCARE HOLDINGS, INC.
FORM 10-Q
TABLE OF CONTENTS
Page
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of June 30, 2007 and March
31, 2007 - (unaudited) 3
Condensed Consolidated Statements of Operations for the three months
ended June 30, 2007 and 2006, as restated - (unaudited) 4
Condensed Consolidated Statements of Cash Flows for the three months
ended June 30, 2007 and 2006, as restated - (unaudited) 5
Notes to Condensed Consolidated Financial Statements -
(unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 24
Item 3. Quantitative and Qualitative Disclosures About Market Risk 36
Item 4. Controls and Procedures 37
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 37
Item 1A. Risk Factors 38
Item 6. Exhibits 38
Signatures 39
2
PART I - FINANCIAL INFORMATION
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(amounts in 000's, except par value)
(unaudited)
JUNE 30, MARCH 31,
2007 2007
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents $ 8,732 $ 7,844
Restricted cash -- 4,968
Accounts receivable, net of allowance for doubtful
accounts of $2,010 and $2,355, respectively 17,875 19,370
Security reserve funds 9,982 7,990
Deferred purchase price receivable 14,612 16,975
Inventories of supplies 6,028 5,944
Due from governmental payers 1,411 1,378
Prepaid expenses and other current assets 8,987 8,097
--------- ---------
Total current assets 67,627 72,566
Property and equipment, net 57,518 58,172
--------- ---------
Total assets $ 125,145 $ 130,738
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Debt, current $ 72,341 $ 72,341
Accounts payable 42,318 41,443
Accrued compensation and benefits 13,938 12,574
Warrant liability, current 14,906 14,906
Due to governmental payers -- 922
Other current liabilities 19,730 20,687
--------- ---------
Total current liabilities 163,233 162,873
Capital lease obligations, net of current portion
of $257 and $251, respectively 5,775 5,834
Minority interest in variable interest entity 1,597 1,716
--------- ---------
Total liabilities 170,605 170,423
--------- ---------
Commitments, contingencies and subsequent event
Stockholders' deficiency:
Common stock, $0.001 par value; 250,000 shares
authorized; 116,304 shares issued and outstanding 116 116
Additional paid in capital 25,589 25,589
Accumulated deficit (71,165) (65,390)
--------- ---------
Total stockholders' deficiency (45,460) (39,685)
--------- ---------
Total liabilities and stockholders' deficiency $ 125,145 $ 130,738
========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE UNAUDITED CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS.
3
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in 000's, except per share amounts)
(unaudited)
THREE MONTHS ENDED JUNE 30,
----------------------
2007 2006
--------- ---------
(restated)
Net operating revenues $ 86,791 $ 90,992
--------- ---------
Operating expenses:
Salaries and benefits 48,829 46,960
Supplies 12,303 12,028
Provision for doubtful accounts 8,231 9,673
Other operating expenses 16,698 18,355
Loss on sale of accounts receivable 2,586 2,339
Depreciation and amortization 793 670
--------- ---------
89,440 90,025
--------- ---------
Operating income (loss) (2,649) 967
--------- ---------
Other income (expense):
Interest expense, net (3,245) (3,246)
Change in fair value of derivative -- 4,325
--------- ---------
(3,245) 1,079
--------- ---------
Income (loss) before provision for income
taxes and minority interest (5,894) 2,046
Provision for income taxes -- --
Minority interest in variable interest entity 119 142
--------- ---------
Net income (loss) $ (5,775) $ 2,188
========= =========
Per Share Data:
Income (loss) per common share
Basic $ (0.05) $ 0.03
Diluted $ (0.05) $ 0.02
Weighted average shares outstanding
Basic 116,304 84,351
Diluted 116,304 127,297
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE UNAUDITED CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS.
4
z INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in 000's)
(unaudited)
THREE MONTHS ENDED JUNE 30,
--------------------
2007 2006
-------- --------
(restated)
Cash flows from operating activities:
Net income (loss) $ (5,775) $ 2,188
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization of property and equipment 793 670
Provision for doubtful accounts 8,231 9,673
Amortization of debt issuance costs and intangible assets -- 242
Change in fair value of derivative -- (4,325)
Minority interest in net loss of variable interest entity (119) (142)
Changes in operating assets and liabilities:
Accounts receivable (6,737) (10,078)
Security reserve funds (1,992) 5,897
Deferred purchase price receivables 2,363 (2,192)
Inventories of supplies (84) --
Due from governmental payers (33) (528)
Prepaid expenses and other current assets (890) 106
Accounts payable 875 (951)
Accrued compensation and benefits 1,364 1,438
Due to governmental payers (922) 1,802
Other current liabilities (956) (344)
-------- --------
Net cash provided by (used in) operating activities (3,882) 3,456
-------- --------
Cash flows from investing activities:
Decrease in restricted cash 4,968 --
Additions to property and equipment (139) (48)
-------- --------
Net cash provided by (used in) investing activities 4,829 (48)
-------- --------
Cash flows from financing activities:
Proceeds from long term debt -- 2,000
Variable interest entity distribution -- (180)
Payments on capital lease obligations (59) (23)
-------- --------
Net cash provided by (used in) financing activities (59) 1,797
-------- --------
Net increase in cash and cash equivalents 888 5,205
Cash and cash equivalents, beginning of period 7,844 4,970
-------- --------
Cash and cash equivalents, end of period $ 8,732 $ 10,175
======== ========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE UNAUDITED CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS.
5
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(UNAUDITED)
NOTE 1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying unaudited condensed consolidated financial statements
have been prepared in conformity with generally accepted accounting principles
in the United States of America ("U.S. GAAP")for interim consolidated financial
information and with the instructions for Form 10-Q and Article 10 of Regulation
S-X. In accordance with the instructions and regulations of the Securities and
Exchange Commission ("SEC") for interim reports, certain information and
footnote disclosures normally included in financial statements prepared in
conformity with U.S. GAAP for annual reports have been omitted or condensed.
The accompanying unaudited condensed consolidated financial statements
for Integrated Healthcare Holdings, Inc. and its subsidiaries (the "Company")
contain all adjustments, consisting only of normal recurring adjustments,
necessary to present fairly the Company's consolidated financial position as of
June 30, 2007, its results of operations for the three months ended June 30,
2007 and 2006, as restated, and its cash flows for the three months ended June
30, 2007 and 2006, as restated.
The results of operations for the three months ended June 30, 2007 are
not necessarily indicative of the results to be expected for the full year. The
information included in this Quarterly Report on Form 10-Q should be read in
conjunction with the audited consolidated financial statements for the year
ended March 31, 2007 and notes thereto included in the Company's Annual Report
on Form 10-K filed with the SEC on July 16, 2007.
LIQUIDITY AND MANAGEMENT'S PLANS - The accompanying unaudited condensed
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
$5,775 for the three months ended June 30, 2007 and has a working capital
deficit (in thousands) of $95,606 at June 30, 2007. All of the Company's debt
matured on June 13, 2007 and the Company is currently operating under a ninety
day Agreement to Forbear ("Forbearance Agreement"), dated June 18, 2007, with
its lenders to obtain new financing (Note 4).
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. In the Company's Annual Report for the year ended March 31, 2007, it's
independent registered public accountants expressed a substantial doubt about
the Company's ability to continue as a going concern. 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, California;
o 188-bed Western Medical Center in Anaheim, California;
o 178-bed Coastal Communities Hospital in Santa Ana, California; and
o 114-bed Chapman Medical Center in Orange, California.
6
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(UNAUDITED)
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.
RESTATEMENT - As described more fully in the Company's annual report on
Form 10-K for the year ended March 31, 2007, the statements of operations and
cash flows for the three months ended June 30, 2006 have been restated.
RECLASSIFICATION FOR PRESENTATION - Certain amounts previously reported
have been reclassified to conform to the current period's 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% and
74% of the net operating revenues for the three months ended June 30, 2007 and
2006, respectively.
CONSOLIDATION - The accompanying condensed consolidated financial
statements include the accounts of the Company and its wholly owned
subsidiaries.
The Company has also determined that Pacific Coast Holdings Investment,
LLC ("PCHI") (Note 8), is a variable interest entity as defined in Financial
Accounting Standards Board ("FASB") Interpretation Number ("FIN") No. 46R, and,
accordingly, the financial statements of PCHI are included in the accompanying
condensed consolidated financial statements.
All significant intercompany accounts and transactions have been
eliminated in consolidation.
USE OF ESTIMATES - The accompanying condensed consolidated financial
statements have been prepared in accordance with 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 condensed 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 Hospitals
charge all other patients prior to the application of discounts and allowances.
7
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(UNAUDITED)
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 and 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. The Company has established settlement receivables as of June
30 and March 31, 2007 (in thousands) of $2,146 and $909, 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 cost, must exceed the payment
rate for the DRG by a fixed threshold established annually by the Centers for
Medicare and Medicaid Services of the United States 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 is determined
by dividing total outlier payments by the sum of DRG 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 (1) the number of cases that qualify for outlier payments,
and (2) 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 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 recent
filed 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. There were
no adjustments for Final Notice of Program Reimbursement received recorded
during the three months ended June 30, 2007 and 2006. As of June 30 and March
31, 2007, the Company recorded reserves for excess outlier payments due to the
difference between the Hospitals actual cost to charge rates and the statewide
average in the amount (in thousands) of $1,854 and $1,831, respectively. These
reserves offset against the third party settlement receivables and are included
in due from government payers (in thousands) as a net receivable of $292 as of
June 30, 2007 and in due to government payers (in thousands) as a net payable of
$922 as of March 31, 2007.
The Hospitals receive supplemental payments from the State of
California to support indigent care (MediCal Disproportionate Share Hospital
payments or "DSH"). During the three months ended June 30, 2007 and 2006 the
Hospitals received payments (in thousands) of $3,755 and $8,636, respectively.
The related revenue recorded for the three months ended June 30, 2007 and 2006
was (in thousands) $3,496 and $7,743, respectively. As of June 30 and March 31,
2007, estimated DSH receivables (in thousands) of $1,119 and $1,378 are included
in due from governmental payers in the accompanying condensed consolidated
balance sheets.
The following is a summary of due from and due to governmental payers
as of June 30 and March 31, 2007:
8
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(UNAUDITED)
June 30, March 31,
2007 2007
------------ ------------
Due from governmental payers
Medicare and Medicaid $ 2,146 $ --
Outlier (1,854) --
DSH 1,119 1,378
------------ ------------
$ 1,411 $ 1,378
============ ============
Due to governmental payers
Medicare and Medicaid $ -- $ (909)
Outlier -- 1,831
------------ ------------
$ -- $ 922
============ ============
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 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 three months ended June 30, 2007 and 2006 were $1.6
million and $2.5 million, respectively.
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 qualify 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,
as well as certain other governmental receivables, over the age of 180 days were
fully reserved in contractual allowances as of March 31, 2007. During the
quarter the Company evaluated its historical experience and changed to a
graduated reserve percentage based on the age of governmental accounts. The
Company determined that the impact of the change for the three months ended and
as of June 30, 2007 is not material.
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 condensed consolidated financial statements.
9
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(UNAUDITED)
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'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 (Note 2). 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, 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
loss 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 June 30 and March 31,
2007, collected on behalf of the buyer of accounts receivable, is not included
in the Company's cash and cash equivalents.
LETTERS OF CREDIT - At June 30, 2007, the Company has two outstanding
standby letters of credit totaling $1.4 million. These letters of credit were
issued by the Company's Lender and correspondingly reduce the Company's
borrowing availability under its line of credit with the Lender (Note 4).
RESTRICTED CASH - As of March 31, 2007, 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.
10
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(UNAUDITED)
A certificate of deposit for $4.4 million was pledged to a commercial
bank that issued a standby letter of credit for $4.2 million in favor of an
insurance company that administered the Company's self-insured workers
compensation plan. During the three months ended June 30, 2007, the insurance
company drew down $2.6 million on the standby letter of credit. The Company
recorded the $2.6 million drawdown as a deposit for workers compensation claims
and a surety bond that the insurance company issued to a utility company on the
Company's behalf. The $2.6 million is included in prepaid expenses and other
current assets in the accompanying condensed consolidated balance sheet as of
June 30, 2007. The remaining restricted cash of $1.8 million was released to the
Company in June 2007.
A certificate of deposit for $552 thousand was pledged as a reserve
under the Company's capitation agreement with CalOptima. During the three months
ended June 30, 2007, the Company replaced the certificate of deposit with a
standby letter of credit for $169 thousand and the restricted cash of $552
thousand was released to the Company.
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.
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.
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 the Company 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 June 30, 2007.
DEBT ISSUANCE COSTS -These deferred charges related to credit agreement
fees (Note 4) and were amortized over the related lives of the agreements.
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. Through April 2007, the Company received 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 would 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 are recorded in the Company's results of operations in the periods when
11
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(UNAUDITED)
such amounts are determinable. 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 (loss) from CalOptima
capitation, net of third party claims and estimates of IBNR claims, for the
three months ended June 30, 2007 and June 30, 2006 were $(0.06) million and
$1.29 million, respectively. IBNR claims accruals at June 30 and March 31, 2007
were $3.4 million and $4.1 million, respectively. 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 June 30, 2007 no stock options have been granted under the
Company's stock incentive plan. On August 6, 2007, the Company's Board of
Directors approved the award of stock options (Note 10).
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 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 (Notes 4 and 5), 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 (Notes 4 and 5).
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 during the three
months ended June 30, 2007, the anti-dilutive effect of warrants has been
excluded in the calculations of diluted loss per share presented in the
accompanying condensed consolidated statements of operations.
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 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. The Company assesses the realization of deferred tax
assets to determine whether an income tax valuation allowance is required. The
Company has recorded a 100% valuation allowance on its deferred tax assets.
On July 13, 2006, the FASB issued FIN 48, "Accounting for Uncertainty
in Income Taxes - an interpretation of FASB Statement No. 109," which clarifies
the accounting and disclosure for uncertain tax positions. This interpretation
is effective for fiscal years beginning after December 15, 2006 and the Company
has implemented this interpretation as of April 1, 2007. FIN 48 prescribes a
recognition threshold and measurement attribute for recognition and measurement
of a tax position taken or expected to be taken in a tax return. FIN 48 also
provides guidance on de-recognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition.
12
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(UNAUDITED)
Under FIN 48, evaluation of a tax position is a two-step process. The
first step is to determine whether it is more-likely-than-not that a tax
position will be sustained upon examination, including the resolution of any
related appeals or litigation based on the technical merits of that position.
The second step is to measure a tax position that meets the more-likely-than-not
threshold to determine the amount of benefit to be recognized in the financial
statements. A tax position is measured at the largest amount of benefit that is
greater than 50 percent likely of being realized upon ultimate settlement. Tax
positions that previously failed to meet the more-likely-than-not recognition
threshold should be recognized in the first subsequent period in which the
threshold is met. Previously recognized tax positions that no longer meet the
more-likely-than-not criteria should be de-recognized in the first subsequent
financial reporting period in which the threshold is no longer met.
The adoption of FIN 48 at April 1, 2007 did not have a material effect
on the Company's financial position.
The Company and its subsidiaries file income tax returns in the U.S.
federal jurisdiction and California. The Company is no longer subject to U.S.
federal and state income tax examinations by tax authorities for years before
December 31, 2003 and December 31, 2002, respectively. Certain tax attributes
carried over from prior years continue to be subject to adjustment by taxing
authorities.
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.
RECENTLY ENACTED ACCOUNTING STANDARDS - 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 the consolidated statement of operations,
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 adoption of this
statement did not have a material impact on the Company's consolidated financial
position and results of operations.
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.
The Company is evaluating the impact, if any, that the adoption of this
statement will have on its consolidated results of operations and 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 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 statement is effective for
financial statements for fiscal years beginning after November 15, 2007. The
Company is evaluating the impact, if any, that the adoption of this statement
will have on its consolidated results of operations and financial position.
13
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(UNAUDITED)
NOTE 2 - 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 (Note 4). 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, as
defined. 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
Buyer's appraised value (the "95% Advance) 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") of the aggregate Advance Rate Amount 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 APA 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) is less than the amount of its Adjusted Value, as defined, 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 account. If the Seller fails to repurchase such
accounts, the Buyer shall deduct 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 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 APA, the key assumption used is 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 June 30, 2007, the Buyer has advanced
$565.1 million to the Company through the APA. In addition, the Company has
received $48.2 million in reserve releases from inception through June 30, 2007.
Payments posted on sold receivables approximated $610.0 million. Advances net of
payment and adjustment activity, cumulatively through June 30 and March 31, 2007
were $3.3 million and $7.0 million, respectively. Transaction Fees incurred for
the same periods were $10.4 million and $9.3 million, respectively.
The following table reconciles accounts receivable at June 30 and March
31, 2007, as reported, to the pro forma accounts receivable, as if the Company
had deferred recognition of the sales (non GAAP) (in thousands).
14
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(UNAUDITED)
June 30, 2007 March 31, 2007
---------------------------- ----------------------------
As reported Pro Forma As reported Pro Forma
------------ ------------ ------------ ------------
Accounts receivable
Governmental $ 7,203 $ 23,354 $ 7,958 $ 25,621
Non-governmental 12,682 51,083 13,767 51,229
------------ ------------ ------------ ------------
19,885 74,437 21,725 76,850
Less allowance for doubtful accounts (2,010) (18,280) (2,355) (16,267)
------------ ------------ ------------ ------------
Net patient accounts receivable 17,875 56,157 19,370 60,583
------------ ------------ ------------ ------------
Security reserve funds 9,982 -- 7,990 --
Deferred purchase price receivable 14,612 -- 16,975 --
------------ ------------ ------------ ------------
Receivable from Buyer of accounts 24,594 -- 24,965 --
------------ ------------ ------------ ------------
Advance rate amount in excess of collections -- (3,313) -- (6,957)
Transaction Fees deducted from Security
Reserve Funds -- (10,375) -- (9,291)
------------ ------------ ------------ ------------
$ 42,469 $ 42,469 $ 44,335 $ 44,335
============ ============ ============ ============
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 believes that the
foregoing method of segregating and controlling payments received from
governmental program payers complies with all applicable Reassignment Rules. As
of June 30, 2007 as shown above as the difference between the accounts
receivable - governmental as reported versus proforma amounts, the Company had
$16,151 thousand in governmental accounts receivable that had been reported as
sold which were subject to the foregoing limitation.
The Company records estimated Transaction Fees and estimated servicing
liability 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 three months ended
------------------
June 30, June 30,
2007 2006
------- -------
Transaction Fees deducted from Security
Reserve Funds - closed purchases $ 1,084 $ 1,215
------- -------
Change in accrued Transaction Fees - open purchases (32) (51)
Total Transaction Fees incurred 1,052 1,164
------- -------
Servicing expense for sold accounts receivable
- closed purchases 1,534 1,266
Change in accrued servicing expense for sold
accounts receivable - open purchases -- (91)
------- -------
Total servicing expense incurred 1,534 1,175
------- -------
Loss on sale of accounts receivable for
the period $ 2,586 $ 2,339
======= =======
15
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(UNAUDITED)
The related accrued Transaction Fee and accrued servicing liabilities
included in other current liabilities on the accompanying condensed consolidated
balance sheets are as follows (in thousands).
June 30, 2007 March 31, 2007
----------- -----------
Transaction fee liability 1,201 $ 1,233
Accrued servicing liability 789 $ 789
The accrued servicing liability recorded at June 30 and March 31, 2007,
approximates fair value in accordance with SFAS No. 140.
NOTE 3 - PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands).
JUNE 30, MARCH 31,
2007 2007
-------- --------
Buildings $ 33,697 $ 33,697
Land and improvements 13,523 13,523
Equipment 9,833 9,694
Assets under capital leases 6,505 6,505
-------- --------
63,558 63,419
Less accumulated depreciation (6,040) (5,247)
-------- --------
Property and equipment, net $ 57,518 $ 58,172
======== ========
Essentially all land and buildings are owned by PCHI (Notes 8 and 9).
The Hospitals are located in an area near active and substantial
earthquake faults. The Hospitals carry earthquake insurance with a policy limit
of $50.0 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. In addition, there could be other remediation costs pursuant to this
seismic retrofit.
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.
NOTE 4 - DEBT
On June 13, 2007 the Company received a notice of default on its debt
from Medical Provider Financial Corporation II ("the Lender"), an affiliate of
Medical Capital Corporation. 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.
The Company's debt consists of the following as of June 30 and March
31, 2007 (in thousands).
Secured note $ 10,700
Less derivative - warrant liability, current (10,700)
Secured acquisition loan 45,000
Secured line of credit, outstanding borrowings 27,341
--------
Total - all current $ 72,341
========
16
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(UNAUDITED)
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 the Lender, whereby the Company obtained
initial financing with annual interest at the rate of 14% in the amount of $80.0
million, consisting of a $30.0 million non-revolving Line of Credit and a $50.0
million Acquisition Loan (less $5.0 million repayment on December 12, 2005) in
the form of a real estate loan (collectively, the "Obligations"). The Company
used the proceeds from the $50.0 million Acquisition Loan and $3.0 million from
the Line of Credit to complete the Acquisition (Note 1).
As of June 30, 2007, the Company had no remaining availability under
its $30.0 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,
as defined.
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. In accordance with the Forbearance Agreement,
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 Holdings, LLC and Ganesha
Realty, LLC, (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 Holdings, LLC have agreed to pledge their membership
interests in PCHI as security for repayment of the Obligations, and (iv) OC-PIN
(Note 6) has agreed to guaranty the payment and performance of all the
Obligations.
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 $10.7 million 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).
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. The Company has classified the
December Note as current warrant liability in the accompanying condensed
consolidated balance sheets as of June 30 and March 31, 2007 (Note 5).
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.
17
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(UNAUDITED)
The Company is required to file a registration statement covering the
resale of all the shares of common stock underlying the December Note Warrant
and to use its reasonable best efforts to have the registration statement
declared effective by the SEC as soon as practicable thereafter.
NOTE 5 - 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 condensed consolidated balance sheets as of June 30
and March 31, 2007 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 June 30 and March 31, 2007, 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 46.5 million and 33.4 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) 26.1 million Shares of Common Stock, (2) Shares representing 31.09% of all
Common Stock and Common Stock Equivalents of the Company, or 61.9 million at
June 30 and March 31, 2007, 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 by 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 74.7
million 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 $2.45 million.
The Restructuring Warrants were exercisable beginning January 27, 2007
and expire on 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. In accordance with FAS No. 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 consolidated statement of operations.
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 28.7 million 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 $9,199 thousand. 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 June 30 and March 31, 2007. Additionally, the
remaining liability was revalued at March 31, 2007 in the amount of $4.2 million
relating to potential shares (20.8 million shares) which could be issued, if the
December Note warrant was to become issuable, which occurred on June 13, 2007
upon receipt of a notice of default from the Lender.
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 was accrued based on the transaction as of
March 31, 2007.
18
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(UNAUDITED)
The Company recorded a change in the fair value of derivative of (in
thousands) $0 and a gain of $4,325 for the three months ended June 30, 2007 and
2006, respectively. The related warrant liability as of June 30 and March 31,
2007 is $4.2 million (excluding the $10.7 million December Note Warrant
liability).
NOTE 6 - 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 $12.5 million into the escrow account. However, following
receipt of such funds, a disagreement arose between OC-PIN and the third party
which provided $11.0 million of the $12.5 million deposited into the escrow
account. In order to resolve this matter and to avoid potential litigation
involving the Company, the Company agreed to return $11.0 million 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. $1.5 million of the escrowed cash, plus a pro rata portion of the
accrued interest, was delivered to the Company for payment of
stock.
2. $11.0 million of the escrowed cash, plus a pro rata portion of the
accrued interest was delivered to OC-PIN.
3. 5.8 million of the escrowed shares of the Company's common stock
were delivered to OC-PIN.
4. 40.6 million of the escrowed shares of the Company's common stock
were delivered to the Company.
5. OC-PIN transferred $2.8 million from another account to the
Company for which OC-PIN received 10.8 million of the escrowed
shares.
6. The Company agreed to issue to OC-PIN 5.4 million 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.
7. The Company granted OC-PIN the right to purchase up to $6.7
million 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 25.9 million 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 5.4 million shares mentioned in
item (6) above. On September 12, 2006, the Company issued 3.2
million 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.
NOTE 7 - 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.
19
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(UNAUDITED)
Since the Company incurred losses for the three months ended June 30,
2007, antidilutive potential shares of common stock, consisting of 82.7 million
shares, issuable under warrants, have been excluded from the calculations of
diluted loss per share for the period.
Income per share for the three months ended June 30, 2006 was computed
as follows (in thousands except for per share amounts).
Numerator:
Net income $ 2,188
========
Denominator:
Weighted average common shares 84,351
Warrants 42,946
--------
Denominator for diluted calculation 127,297
========
NOTE 8 - RELATED PARTY TRANSACTIONS
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 June 30 and March 31, 2007. They are also the owners of the Restructuring
Warrants to purchase an additional 20.8 million shares of future stock in the
Company, issuable due to an anti dilution feature of the warrant (Note 5). As
described in Note 1, PCHI is a variable interest entity and, accordingly, the
Company has consolidated the financial statements of PCHI in the accompanying
condensed consolidated financial statements.
NOTE 9 - COMMITMENTS AND CONTINGENCIES
OPERATING LEASES - Concurrent with the closing of the Acquisition as of
March 8, 2005, the Company entered into a sale leaseback type 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 Hospitals 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 (Note 8).
CAPITAL LEASES - In connection with the Hospital Acquisition, the
Company also 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.
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 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 June 30 and
March 31, 2007, the Company had accrued $5.8 million and $4.9 million,
respectively, which is comprised of $1.3 million and $1.4 million, respectively,
in incurred and reported claims, along with $4.5 million and $3.5 million,
respectively, in estimated IBNR.
20
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(UNAUDITED)
The Company has also purchased occurrence coverage insurance to fund
its obligations under its workers' compensation program. The Company has 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 June 30 and
March 31, 2007, the Company had accrued $1.1 million and $1.0 million,
respectively, comprised of $0.3 million and $0.2 million, respectively, in
incurred and reported claims, along with $0.8 million and $0.8 million,
respectively, in estimated IBNR.
Effective May 1, 2007, the Company initiated a self-insured health
benefits plan for its employees. As a result, the Company has established and
maintains an accrual for IBNR claims arising from self-insured health benefits
provided to employees. The Company's IBNR accrual at June 30, 2007 was based
upon projections determined by an independent actuary. The Company determines
the adequacy of this accrual by evaluating its limited historical experience and
trends related to both health insurance claims and payments, information
provided by its insurance broker and third party administrator and industry
experience and trends. The accrual is an estimate and is subject to change. Such
change could be material to the Company's consolidated financial statements. As
of June 30, 2007, the Company had accrued $1.6 million, comprised of $0.3
million in incurred and reported claims, along with $1.3 million in estimated
IBNR. The Company believes this is the best estimate of the amount of IBNR
relating to self-insured health benefit claims at June 30, 2007. Since the
Company's self-insured health benefits plan was initiated in May 2007, the
Company has not yet established historical trends which, in the future, may
cause costs to fluctuate with increases or decreases in the average number of
employees, changes in claims experience, and changes in the reporting and
payment processing time for claims.
The Company has also purchased all risk umbrella liability policies
with aggregate limit of $19.0 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.
The Company finances various insurance policies at interest rates
ranging from 5.97% to 7.5% per annum. During the three months ended June 30,
2007 and 2006, the Company incurred finance charges (in thousands) of $53 and
$88, respectively, relating to such policies. As of June 30 and March 31, 2007,
the accompanying condensed consolidated balance sheets include the following
balances relating to the financed insurance policies (in thousands).
June 30, 2007 March 31, 2007
----------- -----------
Prepaid insurance $ 3,553 $ 5,004
(Included in prepaid expenses and other
current assets)
Accrued insurance premiums $ 2,676 $ 3,808
(Included in other current liabilities)
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 (Note 8). 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
$5.0 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 $5.0 million, pro
rated if less than all of the Condo Units are transferred.
21
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(UNAUDITED)
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 $2.5 million 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.
CLAIMS AND LAWSUITS - 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 June 30, 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.
On May 14, 2007, the Company filed suit in Orange County Superior Court
against three of the six members of its Board of Directors and also against the
Company's majority shareholder, OC-PIN. Among other things, the suit alleges
that the defendants breached fiduciary duties owed to the Company by putting
their own economic interests above those of the Company, its other shareholders,
creditors, employees and the public-at-large. The suit also alleges that
defendants' attempt to change the Company's management and control of the
existing Board could trigger an "Event of Default" under the express terms of
the Company's existing credit agreements with its secured lenders.
22
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(UNAUDITED)
On May 17, 2007, OC-PIN filed a separate suit against the Company 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 the Company's President has failed to call a special
shareholders' meeting so that OC-PIN could fill positions on the Company's Board
of Directors.
Both actions have been consolidated so they can be heard before one
judge. The Company 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 was 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 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 $50.0 thousand 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.
NOTE 10 - SUBSEQUENT EVENT
On August 6, 2007, the Board of Directors approved the granting of
options with the right to purchase an aggregate of 5,190 thousand shares of the
Company's common stock to eligible employees pursuant to the Company's 2006
Stock Incentive Plan. The grant price approved on that date is $0.26 per share.
The options are subject to various vesting periods and will expire seven years
from the date of grant.
23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
FORWARD-LOOKING INFORMATION
This Quarterly Report on Form 10-Q 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" in our Annual Report on Form
10-K filed on July 16, 2007 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.
CURRENT LIQUIDITY
The Company is currently operating under a ninety day Agreement to
Forbear ("Forbearance Agreement"), dated June 18, 2007, 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.
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;
24
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.
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
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 of $5,775 thousand during the three months ended June 30, 2007 and
has a working capital deficit of $95,606 thousand at June 30, 2007. All of the
Company's debt matured prior to March 31, 2007 and the Company is currently
operating under a ninety day Forbearance Agreement, dated June 18, 2007, with
its lenders to obtain new financing. The Forbearance Agreement expires on
September 17, 2007.
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 improve cash flow from operations:
1. Net operating revenues: Due primarily to the impact of improved
contracts, commercial, managed care, and other patient revenues
improved $6.8 million during the three months ended June 30, 2007
compared to the same period in 2006.
However, net collectible revenues (net operating revenues less
provision for doubtful accounts) for the three months ended June 30,
2007 and 2006 were $78.6 million and $81.3 million, respectively.
This was primarily due to the fact that the Company received a $3.5
million lump sum award from the State MediCal unit during the three
months ended June 30, 2006. Adjusting for this, revenues grew by 1%.
The Company has requested, but not yet been granted, additional
funding to support indigent care in the current year.
The Hospitals serve a disproportionate number of indigent patients
and receive governmental revenues and subsidies in support of care
for these patients. Governmental revenues include payments for
Medicaid, Medicaid DSH, and Orange County, CA (CalOptima).
Governmental revenues decreased $11.0 million for the three months
ended June 30, 2007 compared to the same period in 2006.
Inpatient admissions decreased by 2.3% to 6,719 for the three months
ended June 30, 2007 compared to 6,874 for the same period in 2006.
This was primarily attributable to the termination of CalOptima
capitation agreements. This resulted in a net reduction in
capitation revenues of $10.3 million compared to the three months
ended June 30, 2006. This was partially offset by a $3.6 million
increase in CalOptima fee-for-service revenues under continuing
agreements. The net difference in revenues is offset by a
corresponding reduction in direct operating expenses.
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 three months ended June 30,
2007 were $0.6 million, or 0.7%, lower than for the same period in
2006. Due to favorable claims experience the Company has secured
lower rates for insurance for the year ending 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
26
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 $45.0 million term loan, a $35.0 million non
revolving line of credit, a $10.7 million convertible term loan, and
a $50.0 million revolving line of credit. These loans would be
secured by essentially all of the Company's assets and certain
warrants would be issued. These terms have been approved by the
Company's Board of Directors. The agreements were also subject to
the approval and execution by the other credit parties. 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.
On August 6, 2007, the Company's Board of Directors reaffirmed its
resolution to work with its existing lenders to refinance and
encouraged the other credit parties to execute the proposed loan
agreements.
Upon execution, the revised terms are expected to reduce the
Company's cost of capital by $5.7 million per year.
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.
As of June 30, 2007, the Company had no availability under its $30.0
million Line of Credit as the maturity date had 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.
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 $80.0 million
of which $30.0 million is in the form of a non revolving Line of Credit and
$50.0 million (less $5.0 million repayment on December 12, 2005) is in the form
of an Acquisition Loan (collectively, the "Obligations"). The Company used the
proceeds from the $50.0 million Acquisition Loan and $3.0 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
Forbearance Agreement.
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 its 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 Forbearance Agreement.
LONG TERM LEASE COMMITMENT WITH VARIABLE INTEREST ENTITY - The Company
sold $5.0 million in limited partnership interests to finance the Acquisition
to Pacific Coast Holdings Investment, LLC ("PCHI") and 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 of $4,433 thousand arising from the
Company's sale of the real property of the Hospitals to PCHI has been eliminated
in the accompanying condensed 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 $210.0 million over the remainder of the lease term.
27
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 ACQUISITION DEBT). 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, as
defined. 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
Buyer's appraised value (the "95% Advance") 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") of the aggregate Advance Rate Amount 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 APA 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) is less than the amount of its Adjusted Value, as defined, 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 account. If the Seller fails to repurchase such
accounts, the Buyer shall deduct 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 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 is 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 June 30, 2007, the Buyer has advanced
$565.1 million to the Company through the APA. In addition, the Company has
received $48.2 million in reserve releases from inception through June 30, 2007.
Payments posted on sold receivables approximated $610.0 million. Advances net of
payment and adjustment activity, cumulatively through June 30 and March 31, 2007
were $3.3 million and $7.0 million respectively. Transaction fees incurred for
the same periods were $10.4 million and $9.3 million, respectively.
28
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) $2,586 and $2,339
for the three months ended June 30, 2007 and June 30, 2006, respectively.
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 condensed consolidated balance sheets as of June 30
and March 31, 2007 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 June 30 and March 31, 2007, 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 46.5 million and 33.4 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) 26.1 million Shares of Common Stock, (2) Shares representing 31.09% of all
Common Stock and Common Stock Equivalents of the Company, or 61.9 million at
June 30 and March 31, 2007, 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 by 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 74.7
million 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 $2.45 million.
The Restructuring Warrants were exercisable beginning January 27, 2007
and expire on 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. In accordance with FAS No. 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 consolidated statement of operations.
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 28.7 million 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 $9,199 thousand. 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 June 30 and March 31, 2007. Additionally, the
remaining liability was revalued at March 31, 2007 in the amount of $4.2 million
relating to potential shares (20.8 million shares) which could be issued, if the
December Note warrant was to become issuable, which occurred on June 13, 2007
upon receipt of a notice of default from the Lender.
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 was accrued based on the transaction as of
March 31, 2007.
The Company recorded a change in the fair value of derivative of (in
thousands) $0 and a gain of $4,325 for the three months ended June 30, 2007 and
2006, respectively. The related warrant liability as of June 30 and March 31,
2007 is $4.2 million (excluding the $10.7 million December Note Warrant
liability).
29
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.
RESULTS OF OPERATIONS
The following table sets forth, for the three months ended June 30,
2007 and 2006, our consolidated statements of operations expressed as a
percentage of net operating revenues.
Three months ended
June 30,
--------------------
2007 2006
------- -------
Net operating revenues 100.0% 100.0%
Operating expenses:
Salaries and benefits 56.3% 51.6%
Supplies 14.2% 13.2%
Provision for doubtful accounts 9.5% 10.6%
Other operating expenses 19.2% 20.2%
Loss on sale of accounts receivable 3.0% 2.6%
Depreciation and amortization 0.9% 0.7%
------- -------
Total operating expenses 103.1% 98.9%
------- -------
Operating income (loss) (3.1%) 1.1%
Other expense:
Interest expense, net (3.7%) (3.6%)
Change in fair value of derivative 0.0% 4.8%
------- -------
(3.7%) 1.2%
------- -------
Income (loss) before minority interest (6.8%) 2.3%
Minority interest in variable interest entity 0.1% 0.2%
------- -------
Net income (loss) (6.7%) 2.5%
======= =======
CONSOLIDATED RESULTS OF OPERATIONS - THREE MONTHS ENDED JUNE 30, 2007 and 2006
NET OPERATING REVENUES
Net operating revenues for the three months ended June 30, 2007
decreased 4.6% compared to the same period in 2006. During the three months
ended June 30, 2006 the Company received a $3.5 million, one time grant for
indigent care. Admissions for the three months ended June 30, 2007 decreased
2.3% compared to the same period in 2006. Revenue per admission (excluding the
$3.5 million grant) improved by 1.5% during the three months ended June 30,
2007. The underlying mix of patients remained fairly constant during the three
months ended June 30, 2007 and 2006. Based on average revenue for comparable
services from all other payers, revenues foregone under the charity policy,
including indigent care accounts, for the three months ended June 30, 2007 and
2006 were $1.6 million and $2.5 million, respectively.
Essentially all net operating revenues come from external customers.
The largest payers are the Medicare and Medicaid programs accounting for 65% and
74% of the net operating revenues for the three months ended June 30, 2007 and
2006, respectively.
Although not a GAAP measure, the Company defines "Net Collectable
Revenues" as net operating revenues less provision for doubtful accounts. This
eliminates the distortion caused by the changes in patient account
classification. Excluding the $3.5 million one time grant referred to above, Net
Collectable Revenues were $78.6 million and $77.8 million for the three months
ended June 30, 2007 and 2006, respectively, an increase of $0.8 million, or 3.3%
per admission.
30
OPERATING EXPENSES
Operating expenses for the three months ended June 30, 2007 decreased
to $89.4 million from $90.0 million, a decrease of $0.6 million or 0.7% compared
to the same period in 2006. The decrease in operating expenses was primarily the
result of the decline in admissions and a decrease in the provision for doubtful
accounts for the three month period.
Salaries and benefits increased $1.9 million (4.0%) for the three
months ended June 30, 2007 compared to the same period in 2006. Other operating
expenses decreased $1.7 million for the three months ended June 30, 2007
compared to the same period in 2006. The salary and benefits and other operating
expense variances are substantially offsetting as the result of bringing dietary
positions in-house and terminating contracts with outside vendors for dietary
services.
The provision for doubtful accounts for the three months ended June 30,
2007 decreased to $8.2 million from $9.7 million or 14.9% compared to the same
period in 2006. The decrease in the provision for doubtful accounts for the
three months ended June 30, 2007 is primarily due to improvements in recoveries
of bad debt and a reduction in unfunded patients compared to the same period in
2006.
The loss on sale of accounts receivable for the three months ended June
30, 2007 increased to $2.6 million from $2.3 million, an increase of $0.3
million or 13.0%. The increase in the loss on sale of accounts receivable for
the three months ended June 30, 2007 was primarily due to increased cost of
servicing the accounts.
OPERATING INCOME (LOSS)
Operating loss for the three months ended June 30, 2007 was $2.6
million compared to income of $1.0 million for the three months ended June 30,
2006. The decrease in operating income in 2007 is primarily due to the $3.5
million one time grant for indigent care received for the three months ended
June 30, 2006.
OTHER EXPENSE, NET
Other expense, net, changed primarily as a result of the changes in
fair value of warrants. For the three months ended June 30, 2007 there was no
change in the fair value of warrants. For the three months ended June 30, 2006
there was a $4.3 million reduction in the fair value of warrants resulting in a
gain.
Interest expense for the three months ended June 30, 2007 was
substantially unchanged compared to the same period in 2006.
NET INCOME (LOSS)
Net loss for the three months ended June 30, 2007 was $5.8 million
compared to net income of $2.2 million for the same period in 2006. The change
in net results for the three months ended June 30, 2007 was primarily due to the
decrease in net operating revenues, the decrease in the fair value of derivative
of $4.3 million and one time grant of $3.5 million during the three months ended
June 30, 2006.
CASH FLOW
Net cash provided by (used in) operating activities for the three
months ended June 30, 2007 and 2006 was ($3.9) million and $3.5 million,
respectively, including net losses of $5.0 million and $1.2 million,
respectively, adjusted for depreciation and other non-cash items. The Company
produced $1.1 million and $4.7 million in working capital for the three months
ended June 30, 2007 and 2006, 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 $1.3 million and $0.5
million, for the three months ended June 30, 2007 and 2006, respectively. Cash
provided by decreases in accounts receivable including security reserve fund and
deferred purchase price receivable, was $1.9 million and $3.3 million for the
three months ended June 30, 2007 and 2006, respectively.
Net cash provided by (used in) investing activities during the three
months ended June 30, 2007 and 2006 was $4.8 million and ($48.0) thousand,
respectively. In the three months ended June 30, 2007 and 2006, the Company
invested $139.0 thousand and $48.0 thousand, respectively, in new equipment.
During the three months ended June 30, 2007, $5.0 million in restricted cash was
released to the Company.
31
Net cash provided by (used in) financing activities for the three
months ended June 30, 2007 and 2006 was ($59) thousand and $1.8 million,
respectively. The increase in net cash provided by financing activities for the
three months ended June 30, 2006 was primarily represented by $2.0 million in
proceeds from credit facilities.
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 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 and 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. The Company has established settlement receivables as of June
30 and March 31, 2007 (in thousands) of $2,146 and $909, 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 cost, must exceed the payment
rate for the DRG 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 is determined
by dividing total outlier payments by the sum of DRG 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 (1) the number of cases that qualify for outlier payments,
and (2) 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 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 recent
filed 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
32
outlier settlement are examined by the Medicare fiscal intermediary. There were
no adjustments for Final Notice of Program Reimbursement received recoded during
the three months ended June 30, 2007 and 2006. As of June 30 and March 31, 2007,
the Company recorded reserves for excess outlier payments due to the difference
between the Hospitals actual cost to charge rates and the statewide average in
the amount (in thousands) of $1,854 and $1,831, respectively. These reserves
offset against the third party settlement receivables and are included in due
from government payers (in thousands) as a net receivable of $292 as of June 30,
2007 and in due to government payers (in thousands) as a net payable of $922 as
of March 31, 2007.
The Hospitals receive supplemental payments from the State of
California to support indigent care (MediCal Disproportionate Share Hospital
payments or "DSH"). During the three months ended June 30, 2007 and 2006 the
Hospitals received payments (in thousands) of $3,755 and $8,636, respectively.
The related revenue recorded for the three months ended June 30, 2007 and 2006
was (in thousands) $3,496 and $7,743, respectively. As of June 30 and March 31,
2007, estimated DSH receivables (in thousands) of $1,119 and $1,378 are included
in due from governmental payers in the accompanying condensed consolidated
balance sheets.
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 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 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.
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 three months ended June 30, 2007 and 2006 were $1.6
million and $2.5 million, respectively.
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,
as well as certain other governmental receivables, over the age of 180 days were
fully reserved in contractual allowances as of March 31, 2007. During the
quarter the Company evaluated its historical experience and changed to a
graduated reserve percentage based on the age of governmental accounts. The
Company determined that the impact of the change for the three months ended and
as of June 30, 2007 is not material.
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.
33
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.
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. Through April 2007, the Company received 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 (loss) from CalOptima capitation,
net of third party claims and estimates of IBNR claims, for the three months
ended June 30, 2007 and June 30, 2006 were $(0.06) million and $1.29 million,
respectively. IBNR claims accruals at June 30 and March 31, 2007 were $3.4
million and $4.1 million, respectively. 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.
The following table reconciles accounts receivable at June 30 and March
31, 2007, as reported, to the pro forma accounts receivable, as if the Company
had deferred recognition of the sales (non GAAP) (in thousands).
34
June 30, 2007 March 31, 2007
------------------------ ------------------------
As reported Pro Forma As reported Pro Forma
----------- --------- ----------- ---------
Accounts receivable
Governmental $ 7,203 $ 23,354 $ 7,958 $ 25,621
Non-governmental 12,682 51,083 13,767 51,229
----------- --------- ----------- ---------
19,885 74,437 21,725 76,850
Less allowance for doubtful accounts (2,010) (18,280) (2,355) (16,267)
----------- --------- ----------- ---------
Net patient accounts receivable 17,875 56,157 19,370 60,583
----------- --------- ----------- ---------
Security reserve funds 9,982 -- 7,990 --
Deferred purchase price receivable 14,612 -- 16,975 --
----------- --------- ----------- ---------
Receivable from Buyer of accounts 24,594 -- 24,965 --
----------- --------- ----------- ---------
Advance rate amount in excess of collections -- (3,313) -- (6,957)
Transaction Fees deducted from Security
Reserve Funds -- (10,375) -- (9,291)
----------- --------- ----------- ---------
$ 42,469 $ 42,469 $ 44,335 $ 44,335
=========== ========= =========== =========
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 believes that the
foregoing method of segregating and controlling payments received from
governmental program payers complies with all applicable Reassignment Rules. As
of June 30, 2007 as shown above in the difference between the accounts
receivable - governmental as reported versus proforma amounts, the Company had
$16,151 thousand 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 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 June 30 and
March 31, 2007, the Company had accrued $5.8 million and $4.9 million,
respectively, which is comprised of $1.3 million and $1.4 million, respectively,
in incurred and reported claims, along with $4.5 million and $3.5 million,
respectively, in estimated IBNR.
The Company has also purchased occurrence coverage insurance to fund
its obligations under its workers' compensation program. The Company has 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 June 30 and
March 31, 2007, the Company had accrued $1.1 million and $1.0 million,
respectively, comprised of $0.3 million and $0.2 million, respectively, in
incurred and reported claims, along with $0.8 million and $0.8 million,
respectively, in estimated IBNR.
35
Effective May 1, 2007, the Company initiated a self-insured health
benefits plan for its employees. As a result, the Company has established and
maintains an accrual for IBNR claims arising from self-insured health benefits
provided to employees. Our IBNR accrual at June 30, 2007 was based upon
projections determined by an independent actuary. We determine the adequacy of
this accrual by evaluating our limited historical experience and trends related
to both health insurance claims and payments, information provided to us by our
insurance broker and third party administrator and industry experience and
trends. The accrual is an estimate and is subject to change. Such change could
be material to the Company's consolidated financial statements. As of June 30,
2007, the Company had accrued $1.6 million, comprised of $0.3 million in
incurred and reported claims, along with $1.3 million in estimated IBNR. We
believe this is the best estimate of the amount of IBNR relating to self-insured
health benefit claims at June 30, 2007. Since the Company's self-insured health
benefits plan was initiated in May 2007, we have not yet established historical
trends which, in the future, may cause our costs to fluctuate with increases or
decreases in the average number of employees, changes in our claims experience,
and changes in the reporting and payment processing time for claims.
The Company has also purchased all risk umbrella liability policies
with aggregate limit of $19.0 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.
RECENT ACCOUNTING STANDARDS
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 the
consolidated statement of operations, 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 adoption of this statement did not have a
material impact on the Company's financial position and results of operations.
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 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 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 is evaluating the impact,
if any, that the adoption of this statement will have on its consolidated
results of operations and financial position.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
As of June 30, 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 4 and 5 to the condensed
consolidated financial statements as of and for the three months ended June 30,
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.
36
ITEM 4. CONTROLS AND PROCEDURES.
The Company maintains disclosure controls and procedures that are
designed to ensure that information required to be disclosed in the Company's
Exchange Act 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 the Company's management, including its 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). The Company's 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.
As of June 30, 2007, the end of the period of this report, the Company
carried out an evaluation, under the supervision and with the participation of
the Company's management, including the Company's Chief Executive Officer and
the Company's Chief Financial Officer, of the effectiveness of the design and
operation of the Company's disclosure controls and procedures. Based on the
foregoing, the Company's Chief Executive Officer and Chief Financial Officer
concluded that the Company's disclosure controls and procedures were effective.
Other than as described above, during the quarter ended June 30, 2007,
there were no changes in the Company's internal control over financial reporting
that have materially affected, or are reasonably likely to materially affect,
the Company's internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We and our subsidiaries 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 June 30, 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.
37
On May 14, 2007, the Company filed suit in Orange County Superior Court
against three of the six members of its Board of Directors and also against the
Company's majority shareholder, OC-PIN. Among other things, the suit alleges
that the defendants breached fiduciary duties owed to the Company by putting
their own economic interests above those of the Company, its other shareholders,
creditors, employees and the public-at-large. The suit also alleges that
defendants' attempt to change the Company's management and control of the
existing Board could trigger an "Event of Default" under the express terms of
the Company's existing credit agreements with its secured lenders.
On May 17, 2007, OC-PIN filed a separate suit against the Company 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 the Company's President has failed to call a special
shareholders' meeting so that OC-PIN could fill positions on the Company's Board
of Directors.
Both actions have been consolidated so they can be heard before one
judge. The Company 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 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 $50.0 thousand 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.
ITEM 1A. RISK FACTORS
There are no material changes from the risk factors previously disclosed
in our Annual Report on Form 10-K for the fiscal year ended March 31, 2007.
ITEM 6. EXHIBITS
Exhibit
Number Description
- ------ -----------
10.1 Agreement to Forbear executed June 18, 2007 (incorporated by reference
to Exhibit 99.1 to the Registrant's Report on Form 8-K filed on June
19, 2007).
10.2 Amendment No. 1 to Forbearance Agreement executed June 18, 2007
(incorporated by reference to Exhibit 99.2 to the Registrant's Report
on Form 8-K filed on June 19, 2007).
31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
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 200
38
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of
1934, the registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
INTEGRATED HEALTHCARE HOLDINGS, INC.
Dated: August 20, 2007 By: /s/ Steven R. Blake
------------------------------
Steven R. Blake
Chief Financial Officer
(Principal Financial Officer)
39