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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 December 31, 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
January 31, 2008.
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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 December 31, 2007
and March 31, 2007 - (unaudited) 3
Condensed Consolidated Statements of Operations for the
three and nine months ended December 31, 2007 and 2006, as
restated - (unaudited) 4
Condensed Consolidated Statement of Stockholders' Deficiency
for the nine months ended December 31, 2007 - (unaudited) 5
Condensed Consolidated Statements of Cash Flows for the nine
months ended December 31, 2007 and 2006, as restated -
(unaudited) 6
Notes to Condensed Consolidated Financial Statements -
(unaudited) 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 28
Item 3. Quantitative and Qualitative Disclosures About Market Risk 39
Item 4. Controls and Procedures 40
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 40
Item 1A. Risk Factors 41
Item 6. Exhibits 41
Signatures 43
2
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PART I - FINANCIAL INFORMATION
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(amounts in 000's, except par value)
(unaudited)
DECEMBER 31, MARCH 31,
2007 2007
----------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 1,452 $ 7,844
Restricted cash 17 4,968
Accounts receivable, net of allowance for doubtful
accounts of $15,835 and $2,355, respectively 53,291 19,370
Security reserve funds - 7,990
Deferred purchase price receivable - 16,975
Inventories of supplies 6,016 5,944
Due from governmental payers 1,757 1,378
Prepaid expenses and other current assets 7,816 8,097
----------- -----------
Total current assets 70,349 72,566
Property and equipment, net 56,309 58,172
Debt issuance costs, net 885 -
----------- -----------
Total assets $ 127,543 $ 130,738
=========== ===========
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Debt, current $ 2,300 $ 72,341
Accounts payable 44,430 41,443
Accrued compensation and benefits 15,562 12,574
Warrant liability - 14,906
Due to governmental payers 1,856 922
Other current liabilities 17,492 20,687
----------- -----------
Total current liabilities 81,640 162,873
Debt, non current 85,700 -
Capital lease obligations, net of current portion
of $272 and $251, respectively 5,635 5,834
Minority interest in variable interest entity 1,635 1,716
----------- -----------
Total liabilities 174,610 170,423
----------- -----------
Commitments and contingencies
Stockholders' deficiency:
Common stock, $0.001 par value; 400,000 and 250,000 shares authorized;
137,096 and 116,304 shares issued and outstanding, respectively 137 116
Additional paid in capital 56,134 25,589
Accumulated deficit (103,338) (65,390)
----------- -----------
Total stockholders' deficiency (47,067) (39,685)
----------- -----------
Total liabilities and stockholders' deficiency $ 127,543 $ 130,738
=========== ===========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
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INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in 000's, except per share amounts)
(unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
-------------------------- --------------------------
2007 2006 2007 2006
----------- ----------- ----------- -----------
(restated)
Net operating revenues $ 88,158 $ 87,137 $ 270,326 $ 263,472
----------- ----------- ----------- -----------
Operating expenses:
Salaries and benefits 53,924 49,467 153,876 144,894
Supplies 11,959 12,492 36,538 36,845
Provision for doubtful accounts 8,015 9,392 23,599 28,232
Other operating expenses 16,781 16,815 50,961 51,832
Loss on sale (gain on repurchase, net) of accounts
receivable (918) 2,442 4,079 7,411
Depreciation and amortization 834 677 2,427 2,002
----------- ----------- ----------- -----------
90,595 91,285 271,480 271,216
----------- ----------- ----------- -----------
Operating loss (2,437) (4,148) (1,154) (7,744)
----------- ----------- ----------- -----------
Other expense:
Interest expense, net (4,080) (3,240) (10,248) (9,893)
Warrant liability expense (11,404) - (11,404) -
Change in fair value of warrant liability (14,273) (6,133) (14,273) (1,029)
----------- ----------- ----------- -----------
(29,757) (9,373) (35,925) (10,922)
----------- ----------- ----------- -----------
Loss before provision for income
taxes and minority interest (32,194) (13,521) (37,079) (18,666)
Provision for income taxes - - - -
Minority interest in variable interest entity (1,105) 119 (869) 448
----------- ----------- ----------- -----------
Net loss $ (33,299) $ (13,402) $ (37,948) $ (18,218)
=========== =========== =========== ===========
Per Share Data:
Loss per common share
Basic ($0.24) ($0.15) ($0.29) ($0.21)
Diluted ($0.24) ($0.15) ($0.29) ($0.21)
Weighted average shares outstanding
Basic 137,096 87,557 130,140 85,645
Diluted 137,096 87,557 130,140 85,645
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
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INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIENCY
(amounts in 000's)
(unaudited)
Additional
Common Stock Paid-in Accumulated
Shares Amount Capital Deficit Total
----------- ----------- ----------- ----------- -----------
Balance, March 31, 2007 116,304 $ 116 $ 25,589 $ (65,390) $ (39,685)
Exercise of warrants 20,792 21 4,761 - 4,782
Issuance of warrants - - 25,677 - 25,677
Stock based compensation - - 107 - 107
Net loss - - - (37,948) (37,948)
----------- ----------- ----------- ----------- -----------
Balance, December 31, 2007 137,096 $ 137 $ 56,134 $(103,338) $ (47,067)
=========== =========== =========== =========== ===========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
5
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INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in 000's)
(unaudited)
NINE MONTHS ENDED
DECEMBER 31,
------------------------
2007 2006
-------- --------
(restated)
Cash flows from operating activities:
Net loss $(37,948) $(18,218)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization of property and equipment 2,427 2,002
Provision for doubtful accounts 23,599 28,232
Amortization of debt issuance costs 111 633
Common stock warrant expense 11,404 -
Change in fair value of warrant liability 14,273 1,036
Minority interest in net loss of variable interest entity 869 (794)
Noncash share-based compensation expense 107 -
Changes in operating assets and liabilities:
Accounts receivable (57,520) (32,509)
Security reserve funds 7,990 5,788
Deferred purchase price receivables 16,975 627
Inventories of supplies (72) (19)
Due from governmental payers (379) 938
Prepaid expenses, other current assets, and other assets 778 2,588
Accounts payable 2,987 7,778
Accrued compensation and benefits 2,988 2,584
Due to governmental payers 934 1,460
Other current liabilities (3,195) (893)
-------- --------
Net cash provided by (used in) operating activities (13,672) 1,233
-------- --------
Cash flows from investing activities:
Decrease in restricted cash 4,951 -
Additions to property and equipment (564) (187)
-------- --------
Net cash provided by (used in) investing activities 4,387 (187)
-------- --------
Cash flows from financing activities:
Proceeds from long term debt and drawdown on revolving line of credit 4,959 2,010
Long term debt issuance costs (1,493) -
Issuance of common stock 576 -
Variable interest entity distribution (950) (180)
Payments on capital lease obligations (199) (68)
-------- --------
Net cash provided by financing activities 2,893 1,762
-------- --------
Net increase (decrease) in cash and cash equivalents (6,392) 2,808
Cash and cash equivalents, beginning of period 7,844 4,970
-------- --------
Cash and cash equivalents, end of period $ 1,452 $ 7,778
======== ========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
6
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INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 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
December 31, 2007, its results of operations for the three and nine months ended
December 31, 2007 and 2006, as restated, and its cash flows for the nine months
ended December 31, 2007 and 2006, as restated.
The results of operations for the three and nine months ended December
31, 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 of $37.9 million
for the nine months ended December 31, 2007 and has a working capital deficit of
$11.3 million at December 31, 2007. The Company refinanced its outstanding debt
in October 2007 (Note 4).
Not withstanding the refinancing, these factors, among others, indicate
a need for the Company to take action to operate its business as a going
concern. In the Company's Annual Report for the year ended March 31, 2007, its
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 and managed care 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
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.
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INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 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 nine months ended December 31, 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 obtained all of its debt
financing from a Lender (Note 4) 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
63% of the net operating revenues for the three months ended December 31, 2007
and 2006, respectively, and 66% and 67% for the nine months ended December 31,
2007 and 2006, respectively. No other payers represent a significant
concentration of the Company's net operating revenues.
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 9), 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.
8
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INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 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 payables as of December
31, 2007 (in thousands) of $238 and receivables as of March 31, 2007 (in
thousands) of $909.
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, 2007 was a decrease from $24.485 thousand to $22.185 thousand. 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. The Company
recorded $755.4 thousand in Final Notice of Program Reimbursement settlements
during the nine months ended December 31, 2007. There were no adjustments for
Final Notice of Program Reimbursement received during the three months ended
December 31, 2007 and 2006 and the nine months ended December 30, 2006. As of
December 31 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 $1,618 and $1,831,
respectively. These reserves are combined with third party settlement estimates
and are included in due to government payers as a net payable (in thousands) of
$1,856 and $922 as of December 31 and March 31, 2007, respectively.
The Hospitals receive supplemental payments from the State of
California to support indigent care (MediCal Disproportionate Share Hospital
payments or "DSH") and from the California Medical Assistance Commission
("CMAC"). The Hospitals received supplemental payments (in thousands) of $9,629
and $5,493 during the three months ended December 31, 2007 and 2006,
respectively, and supplemental payments (in thousands) of $13,457 and $17,629
during the nine months ended December 31, 2007 and 2006, respectively. The
related revenue recorded for the three months ended December 31, 2007 and 2006
was (in thousands) $3,829 and $3,429, respectively, and $13,837 and $15,414 for
the nine months ended December 31, 2007 and 2006, respectively. As of December
31 and March 31, 2007, estimated DSH receivables (in thousands) of $1,757 and
$1,378 are included in due from governmental payers in the accompanying
condensed consolidated balance sheets.
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INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007
(UNAUDITED)
The following is a summary of due from and due to governmental payers as of
December 31 and March 31, 2007 (in thousands):
December 31, March 31,
2007 2007
----------- -----------
Due from government payers
Medicaid $ 1,757 $ 1,378
----------- -----------
$ 1,757 $ 1,378
=========== ===========
Due to government payers
Medicare $ 238 $ (909)
Outlier 1,618 1,831
----------- -----------
$ 1,856 $ 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% and 350% of the Federal Poverty Level qualify to pay a discounted rate
under California 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, were $2.2 million and $1.6
million for the three months ended December 31, 2007 and 2006, respectively, and
$5.8 million and $6.1 million for the nine months ended December 31, 2007 and
2006, 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. In June 2007, the
Company evaluated its historical experience and changed to a graduated reserve
percentage based on the age of governmental accounts. The impact of the change
was 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.
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INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 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 - Prior to the refinancing (Note 4)
effective October 9, 2007 (when the Company terminated its Accounts Purchase
Agreement (Note 2) and repurchased all its previously sold receivables), the
Company sold substantially all of its billed accounts receivable to a financing
company. The Company accounted 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 had surrendered control over those
assets was accounted for as a sale to the extent that consideration other than
beneficial interests in the transferred assets was received in exchange. Control
over transferred assets was surrendered only if all of the following conditions
were 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 accounted 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 were met and the transfer was accounted for as a sale,
the Company removed financial assets from the consolidated balance sheet and a
net loss was recognized in income at the time of sale. Effective October 9,
2007, the Company repurchased all its sold accounts receivable (Note 11).
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.
As of December 31, 2007, cash and cash equivalents includes $1.2
million deposited in lock box accounts that are swept daily by the Lender under
various credit agreements (Note 4).
Cash held in the Company's bank accounts as of March 31, 2007,
collected on behalf of the buyer of accounts receivable, was not included in the
Company's cash and cash equivalents (Note 2).
LETTERS OF CREDIT - At December 31, 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 credit agreements with the Lender
(Note 4).
RESTRICTED CASH - As of March 31, 2007, restricted cash consists of
amounts deposited in accounts in short term time deposits with a commercial bank
to collateralize the Company's obligations pursuant to certain agreements. As of
December 31, 2007, this collateral was no longer needed.
11
<Page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007
(UNAUDITED)
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 December 31, 2007.
DEBT ISSUANCE COSTS - This deferred charge consists of a $750.0
thousand origination fee for the Company's $50.0 million Revolving Line of
Credit (new debt) and $742.6 thousand in legal and other expenses incurred in
connection with the Company's refinancing paid to third parties (Note 4). These
amounts are amortized over the financing agreements three year life using the
straight-line method, which approximates the effective interest method. Other
credit agreements (Note 4) entered into on the October 9, 2007 effective date of
the $50.0 million Revolving Line of Credit were accounted for as extinguishment
of existing debt in accordance with EITF 96-19, "Debtor's Accounting for a
Modification or Exchange of Debt Instruments," and EITF 06-6, "Debtor's
Accounting for a Modification (or Exchange) of Convertible Debt Instruments."
Accordingly, debt issuance costs consisting of loan origination fees of $1.4
million paid to the Lender associated with those credit agreements were expensed
during the three months ended December 31, 2007. During the three months ended
December 31, 2007, $111.2 thousand of debt issuance costs were amortized. At
Decem ber 31, 2007, prepaid expenses and other current assets in the
accompanying condensed consolidated balance sheet includes $497.5 thousand as
the current portion of the debt issuance costs.
MEDICAL CLAIMS INCURRED BUT NOT REPORTED - The Company was 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
such amounts are
12
<Page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007
(UNAUDITED)
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 from CalOptima capitation, net of third
party claims and estimates of IBNR claims, for the three months ended December
31, 2007 and 2006 were $0.13 million and $0.70 million, respectively, and $0.32
million and $1.20 million for the nine months ended December 31, 2007 and 2006,
respectively. IBNR claims accruals at December 31 and March 31, 2007 were $1.9
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 measure compensation cost for stock-based employee
compensation plans at fair value at the grant date and recognize the expense
over the employee's requisite service period. The Company has adopted SFAS No.
123R (Note 7).
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 were subsequently required to be
accounted for as derivative liabilities. 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 and
credit agreements, 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
(Note 8).
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.
13
<Page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 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 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. SFAS 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 SFAS 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.
In December 2007, the FASB issued SFAS No. 141 (revised 2007),
"Business Combinations." SFAS 141R requires the acquiring entity in a business
combination to recognize all (and only) the assets acquired and liabilities
assumed in the transaction; establishes the acquisition-date fair value as the
measurement objective for all assets acquired and liabilities assumed; and
requires the acquirer to disclose to investors and other users all of the
information they need to evaluate and understand the nature and financial effect
of the business combination. The Company will adopt this statement for the
fiscal year beginning April 1, 2009.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling
Interests in Consolidated Financial Statements - an amendment of ARB No. 51."
SFAS 160 establishes accounting and reporting standards for the noncontrolling
interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160
is effective prospectively, except for certain retrospective disclosure
requirements, for fiscal years beginning after December 15, 2008. SFAS 160 will
be effective for the Company beginning April 1, 2009. The Company is evaluating
the impact, if any, that the adoption of this statement will have on its
financial statements.
14
<Page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007
(UNAUDITED)
NOTE 2 - ACCOUNTS RECEIVABLE
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 provided for the sale of 100% of the Company's
eligible accounts receivable, as defined, without recourse. The APA required the
Company to provide billing and collection services, maintain the individual
patient accounts, and resolve any disputes that arose between the Company and
the patient or other third party payer for no additional consideration.
Effective October 9, 2007, in conjunction with the Company's refinancing (Note
4), the APA was terminated and the Company repurchased the remaining outstanding
accounts receivable that been previously sold, totaling $6.8 million, resulting
in a gain on repurchase of accounts receivable of $0.9 million.
From inception of the APA through October 9, 2007 (date of termination)
the Buyer advanced $639.6 million to the Company through the APA. In addition,
the Company received $56.9 million in reserve releases from inception through
October 9, 2007. Payments posted on sold receivables from inception approximated
$671.3 million. Advances net of payment and adjustment activity, cumulatively
through October 9, 2007 (date of termination) and March 31, 2007 were ($5.4)
million and $7.0 million, respectively. Transaction Fees incurred for the same
periods (from inception) were $11.7 and $9.3 million, respectively.
The following table reconciles accounts receivable at 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).
March 31, 2007
---------------------------
As reported Pro Forma
----------- -----------
Accounts receivable
Governmental $ 7,958 $ 25,621
Non-governmental 13,767 51,229
----------- -----------
21,725 76,850
Less allowance for doubtful accounts (2,355) (16,267)
----------- -----------
Net patient accounts receivable 19,370 60,583
----------- -----------
Security reserve funds 7,990 -
Deferred purchase price receivable 16,975 -
----------- -----------
Receivable from Buyer of accounts 24,965 -
----------- -----------
Advance rate amount, net - (6,957)
Transaction Fees deducted from Security
Reserve Funds - (9,291)
----------- -----------
$ 44,335 $ 44,335
=========== ===========
The Company recorded estimated Transaction Fees and estimated servicing
liability related to the sold accounts receivable at the time of sale. The
estimated servicing liability was recorded at cost which approximated fair value
of providing such services. The loss (gain) on sale of accounts receivable is
comprised of the following (in thousands).
For the three months ended For the nine months ended
------------------------------- -------------------------------
December 31, December 31, December 31, December 31,
2007 2006 2007 2006
------------ ------------ ------------ ------------
Transaction Fees deducted from Security
Reserve Funds - closed purchases $ 165 $ 1,069 $ 2,395 $ 3,184
Change in accrued Transaction Fees - open
purchases (608) 134 (712) 369
------------ ------------ ------------ ------------
Total Transaction Fees incurred (443) 1,203 1,683 3,553
------------ ------------ ------------ ------------
Servicing expense for sold accounts
receivable - closed purchases 165 1,352 3,186 3,909
Change in accrued servicing expense for
sold accounts receivable - open
purchases (640) (112) (790) (50)
------------ ------------ ------------ ------------
Total servicing expense incurred (475) 1,240 2,396 3,859
------------ ------------ ------------ ------------
Loss on sale (gain on repurchase) of
accounts receivable for the period $ (918) $ 2,443 $ 4,079 $ 7,412
============ ============ ============ ============
15
<Page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007
(UNAUDITED)
The related accrued Transaction Fee and accrued servicing liabilities
included in other current liabilities on the accompanying condensed consolidated
balance sheet as of March 31, 2007 are as follows (in thousands).
March 31, 2007
--------------
Transaction fee liability $ 1,233
Accrued servicing liability $ 789
The accrued servicing liability recorded at 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).
DECEMBER 31, MARCH 31,
2007 2007
------------ ------------
Buildings $ 33,697 $ 33,697
Land and improvements 13,523 13,523
Equipment 10,258 9,694
Assets under capital leases 6,505 6,505
------------ ------------
63,983 63,419
Less accumulated depreciation (7,674) (5,247)
------------ ------------
Property and equipment, net $ 56,309 $ 58,172
============ ============
Essentially all land and buildings are owned by PCHI (Notes 9 and 10).
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 the Company's cash flow.
16
<Page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007
(UNAUDITED)
NOTE 4 - DEBT
The Company's debt payable to affiliates of Medical Capital
Corporation, namely Medical Provider Financial Corporation I, Provider Financial
Corporation II, and Medical Provider Financial Corporation III (collectively,
the "Lender") consists of the following as of December 31 and March 31, 2007 (in
thousands).
December 31, March 31,
2007 2007
------------ ------------
Current:
Secured note $ - $ 10,700
Less derivative - warrant liability, current - (10,700)
Secured acquisition loan - 45,000
Secured line of credit, outstanding borrowings - 27,341
Revolving line of credit, outstanding borrowings 2,300 -
------------ ------------
$ 2,300 $ 72,341
============ ============
Non-current:
Convertible note $ 10,700 $ -
Secured term note 45,000 -
Secured line of credit, outstanding borrowings 30,000 -
------------ ------------
$ 85,700 $ -
============ ============
Effective October 9, 2007 (the "Effective Date"), the Company and its
Lender executed agreements to refinance the Lender's credit facilities with the
Company aggregating up to $140.7 million in principal amount (the "New Credit
Facilities"). The New Credit Facilities replaced the Company's previous credit
facilities with the Lender, which matured on March 2, 2007. The Company had been
operating under an Agreement to Forbear with the Lender with respect to the
previous credit facilities.
The New Credit Facilities consist of the following instruments:
o An $80.0 million credit agreement, under which the Company issued a
$45.0 million Term Note bearing a fixed interest rate of 9% in the
first year and 14% after the first year, which was used to repay
amounts owing under the Company's existing $50.0 million real estate
term loan (secured acquisition loan).
o A $35.0 million Non-Revolving Line of Credit Note issued under the
$80.0 million credit agreement, bearing a fixed interest rate of 9.25%
per year and an unused commitment fee of 0.50% per year, which was used
to repay amounts owing under the Company's existing $30.0 million
secured line of credit, pay the origination fees on the other credit
facilities and for working capital.
o A $10.7 million credit agreement, under which the Company issued a
$10.7 million Convertible Term Note bearing a fixed interest rate of
9.25% per year, which was used to repay amounts owing under the
Company's existing $10.7 million secured note. The $10.7 million
Convertible Term Note is immediately convertible into common stock of
the Company at $0.21 per share during the term of the note.
o A $50.0 million Revolving Credit Agreement, under which the Company
issued a $50.0 million Revolving Line of Credit Note bearing a fixed
interest rate of 24% per year (subject to reduction to 18% if the $45.0
million Real Estate Term Loan is repaid prior to its maturity) and an
unused commitment fee of 0.50% per year, which was used to finance the
Company's accounts receivable and is available for working capital
needs.
Each of the above credit agreements and notes (i) required a 1.5%
origination fee due at funding, (ii) matures in three years, (iii) requires
monthly payments of interest and repayment of principal upon maturity, (iv) are
collateralized by all of the assets of the Company and its subsidiaries and the
real estate underlying the Company's hospital facilities (which are owned by
PCHI) and leased to the Company), and (v) are guaranteed by Orange County
Physicians Investment Network, LLC ("OC-PIN") and West Coast Holdings, LLC
("West Coast"), a member of PCHI, pursuant to separate Guaranty Agreements in
favor of the lender. Concurrently with the execution of the New Credit
Facilities, the Company issued new and amended warrants (Note 5).
17
<Page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007
(UNAUDITED)
The refinancing did not meet the requirements for a troubled debt
restructuring in accordance with SFAS 15, "Accounting by Debtors and Creditors
for Troubled Debt Restructuring." Under SFAS 15, a debtor must be granted a
concession by the creditor for a refinancing to be considered a troubled debt
restructuring. Although the New Credit Facilities have lower interest rates than
the previous credit facilities, the fair value of the New Warrants (Note 5)
resulted in the effective borrowing rate of the New Credit Facilities to
significantly exceed the effective rate of the previous credit facilities.
The nondetachable conversion feature of the $10.7 million Convertible
Term Note is out-of-the-money on the Effective Date. Pursuant to EITF 05-2, "The
Meaning of `Conventional Convertible Debt Instrument' in Issue No. 00-19," the
$10.7 million Convertible Term Note is considered conventional for purposes of
applying EITF 00-19, "Accounting for Derivative Financial Instruments Indexed
to, and Potentially Settled in, a Company's Own Stock."
The New Credit Facilities (excluding the $50.0 million Revolving Credit
Agreement, which did not modify or exchange any prior debt) meet the criteria of
EITF 06-6 for debt extinguishment accounting since the $10.7 million Convertible
Term Note includes a substantive conversion option compared to the previous
financing facilities. As a result, pursuant to EITF 96-19, related loan
origination fees were expensed in the three months ended December 31, 2007, and
legal fees and other expenses are being amortized over three years (Note 1).
Based on eligible receivables, as defined, the Company had
approximately $24 million of additional availability under its $50.0 million
Revolving Line of Credit at December 31, 2007.
The Company's New Credit Facilities are subject to certain financial
and restrictive covenants including debt service coverage ratio, minimum cash
collections, mergers and acquisitions, and other corporate activities common to
such financing arrangements. The Company was in compliance with all covenants or
obtained a temporary waiver from the Lender for noncompliance at December 31,
2007.
As a condition of the New Credit Facilities, the Company entered into
an Amended and Restated Triple Net Hospital Building Lease (the "Amended Lease")
with PCHI (Note 10). Concurrently with the execution of the Amended Lease, the
Company, PCHI, Ganesha Realty, LLC, ("Ganesha"), and West Coast entered into a
Settlement Agreement and Mutual Release (Note 10).
NOTE 5 - COMMON STOCK WARRANTS
NEW WARRANTS - Concurrently with the execution of the New Credit
Facilities (Note 4), the Company issued to an affiliate of the Lender a
five-year warrant to purchase the greater of 16,880,484 shares of the Company's
common stock or up to 4.95% of the Company's common stock equivalents, as
defined, at $0.21 per share (the "4.95% Warrant"). In addition, the Company and
the Lender entered into Amendment No. 2 to Common Stock Warrant, originally
dated December 12, 2005, which entitles an affiliate of the Lender to purchase
the greater of 26,097,561 shares of the Company's common stock or up to 31.09%
of the Company's common stock equivalents (the "31.09% Warrant"). Amendment No.
2 to the 31.09% Warrant extended the expiration date of the Warrant to October
9, 2017, removed the condition that it only be exercised if the Company is in
default of its previous credit agreements, and increased the exercise price to
$0.21 per share unless the Company's stock ceases to be registered under the
Securities Exchange Act of 1934, as amended. The 4.95% Warrant and the 31.09%
Warrant are collectively referred to herein as the "New Warrants."
The New Warrants were exercisable as of October 9, 2007, the Effective
Date of the New Credit Facilities. As of the Effective Date, the Company
recorded warrant expense, and a related warrant liability, of $10.2 million
relating to the New Warrants. In accordance with SFAS 133 and EITF 00-19, the
New Warrants were initially accounted for as liabilities and revalued at each
reporting date, and the changes in fair value of warrant liability on the
consolidated statement of operations.
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.
18
<Page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007
(UNAUDITED)
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 SFAS No. 133 and EITF 00-19, the Restructuring
Warrants were accounted for as liabilities and were revalued at each reporting
date, and the changes in fair value were recorded as change in fair value of
warrant liability 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 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 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 related warrant liability of $4.2 million (as of March 31,
2007) was reclassified to additional paid in capital when the 20.8 million
shares were issued to Dr. Chaudhuri and Mr. Thomas in July 2007.
Upon the Company's refinancing (Note 4) and the issuance of the New
Warrants, the remaining 24.9 million Restructuring Warrants held by Dr.
Chaudhuri and Mr. Thomas became exercisable on the Effective Date. Accordingly,
as of the Effective Date, the Company recorded warrant expense, and a related
warrant liability, of $1.2 million relating to the Restructuring Warrants. In
accordance with SFAS 133 and EITF 00-19, the Restructuring Warrants were
initially accounted for as liabilities and revalued at each reporting date, and
the changes in fair value of warrant liability on the consolidated statement of
operations.
19
<Page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007
(UNAUDITED)
RECLASSIFICATION OF WARRANTS - On December 31, 2007, the Company
received approval from the State of Nevada to increase its authorized shares of
common stock from 250 million to 400 million. As a result, the Company had
sufficient authorized shares at December 31, 2007, and thereby met all
requirements under EITF 00-19 to classify the warrants as equity. Accordingly,
effective December 31, 2007, the Company revalued the 24.9 million Restructuring
Warrants and the New Warrants resulting in a change in the fair value of warrant
liability of $2.9 million and $11.4 million, respectively, and reclassified the
combined warrant liability balance of $25.7 million to additional paid in
capital in accordance with EITF 00-19.
In summation, the Company recorded a common stock warrant expense of
$11.4 million for the three and nine months ended December 31, 2007. There was
no common stock warrant expense recorded during the three and nine months ended
December 31, 2006. The Company recorded a change in the fair value of warrant
liability of $14.3 million and $6.1 million for the three months ended December
31, 2007 and 2006, respectively, and $14.3 million and $1.0 million for the nine
months ended December 31, 2007 and 2006, respectively.
The Company used valuations prepared by an independent valuation firm
to determine the fair value of the underlying shares. The assumptions used in
Black-Scholes model were as follows:
October 9, 2007 December 31, 2007
-------------------------------- --------------------------------
Restructuring Warrants:
Risk-free interest rate 4.1% Risk-free interest rate 2.7%
Expected volatility 34.8% Expected volatility 26.9%
Dividend yield - Dividend yield -
Expected life (years) 0.30 Expected life (years) 0.07
Fair value of warrants $ 0.047 Fair value of warrants $ 0.161
Market value per share $ 0.14 Market value per share $ 0.25
New Warrants:
31.09% Warrant
Risk-free interest rate 4.7% Risk-free interest rate 4.0%
Expected volatility 47.0% Expected volatility 47.4%
Dividend yield - Dividend yield -
Expected life (years) 10.00 Expected life (years) 9.78
Fair value of warrants $ 0.089 Fair value of warrants $ 0.184
Market value per share $ 0.14 Market value per share $ 0.25
4.95% Warrant
Risk-free interest rate 4.4% Risk-free interest rate 3.5%
Expected volatility 35.2% Expected volatility 32.9%
Dividend yield - Dividend yield -
Expected life (years) 5.00 Expected life (years) 4.78
Fair value of warrants $ 0.043 Fair value of warrants $ 0.119
Market value per share $ 0.14 Market value per share $ 0.25
The expected volatility is based on an analysis, performed by an
independent valuation firm, of the Company's stock and the stock of the
following publicly traded companies that own hospitals.
Amsurg Inc. (AMSG)
Community Health Systems (CYH)
HCA Healthcare Company (HCA)
Health Management Associates Inc. (HMA)
Lifepoint Hospitals Inc. (LPNT)
Medcath Corp. (MDTH)
Tenet Healthcare Corp. (THC)
Triad Hospitals Inc. (TRI)
Universal Health Services Inc. Class B (USH)
The risk-free interest rate is based on the average yield on U.S.
Treasury zero-coupon issues with remaining terms equal to the expected terms of
the options. The dividend yield reflects that the Company has not paid any cash
dividends since inception and does not anticipate paying cash dividends in the
foreseeable future.
20
<Page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007
(UNAUDITED)
Although the Company believes this was the most reasonable and accurate
methodology to determine the Company's volatility, the circumstances affecting
volatility of the comparable companies selected may not be an accurate predictor
of the Company's volatility.
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 former 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. On September 12, 2006, the Company issued 3.2 million of
these shares to OC-PIN in full resolution of the Stock Purchase
Agreement.
NOTE 7 - STOCK OPTION PLAN
The Company's 2006 Stock Incentive Plan (the "Plan"), which is
shareholder-approved, permits the grant of share options to its employees and
board members for up to 12 million shares of common stock. The Company believes
that such awards better align the interests of its employees with those of its
shareholders. In accordance with the Plan, incentive stock options,
non-qualified stock options, and performance based compensation awards may not
be granted at less than 100 percent of the estimated fair market value of the
common stock on the date of grant. Incentive stock options granted to a person
owning more than 10 percent of the voting power of all classes of stock of the
Company may not be issued at less than 110 percent of the fair market value of
the stock on the date of grant. Option awards generally vest based on 3 years of
continuous service (1/3 of the shares vest on the twelve month anniversary of
the grant date, and an additional 1/12 of the shares vest on each subsequent
fiscal quarter-end of the Company following such twelve month anniversary).
Certain option awards provide for accelerated vesting if there is a change of
control, as defined. The option awards have 7-year contractual terms.
On August 6, 2007, the Board of Directors approved the initial granting
of options with the right to purchase an aggregate of 4,795 thousand shares of
the Company's common stock to eligible employees pursuant to the Plan. The grant
price approved on that date is $0.26 per share. For options granted to employees
who have been employed by the Company since its March 8, 2005 inception, vesting
retroactively commenced on March 8, 2005. Of the total options granted, 3,500
thousand are subject to this retroactive vesting. Vesting of the remaining 1,295
thousand granted options commenced on the August 6, 2007 grant date.
On October 10, 2007, the Board of Directors approved the granting of
options with the right to purchase an aggregate of 1,750 thousand shares of the
Company's common stock to members of the Board pursuant to the Plan. The grant
price approved on that date is $0.18 per share. Of the total options granted,
883.33 thousand were subject to immediate vesting on the grant date. Vesting of
the remaining 866.67 thousand granted options commenced on the October 10, 2007
grant date.
21
<Page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007
(UNAUDITED)
When the measurement date is certain, the fair value of each option
grant is estimated on the date of grant using the Black-Scholes valuation model
and the assumptions noted in the table below. Since there is limited historical
data with respect to both pre-vesting forfeiture and post-vesting termination,
the expected life of the options was determined utilizing the simplified method
described in the SEC's Staff Accounting Bulletin 107 ("SAB 107"). SAB 107
provides guidance whereby the expected term is calculated by taking the sum of
the vesting term plus the original contractual term and dividing that quantity
by two. The expected volatility is based on an analysis, performed by an
independent valuation firm, of the Company's stock and the stock of the
following publicly traded companies that own hospitals.
Amsurg Inc. (AMSG)
Community Health Systems (CYH)
HCA Healthcare Company (HCA)
Health Management Associates Inc. (HMA)
Lifepoint Hospitals Inc. (LPNT)
Medcath Corp. (MDTH)
Tenet Healthcare Corp. (THC)
Triad Hospitals Inc. (TRI)
Universal Health Services Inc. Class B (USH)
The risk-free interest rate is based on the average yield on U.S.
Treasury zero-coupon issues with remaining terms equal to the expected terms of
the options. The dividend yield reflects that the Company has not paid any cash
dividends since inception and does not anticipate paying cash dividends in the
foreseeable future.
Three months ended December 31, 2007
Expected dividend yield -
Risk-free interest rate 3.5% - 4.4%
Expected volatility 31.6% - 37.1%
Expected term (in years) 4.1- 5.8
Nine months ended December 31, 2007
Expected dividend yield -
Risk-free interest rate 3.5% - 4.5%
Expected volatility 31.6% - 37.1%
Expected term (in years) 3.6- 5.8
In accordance with SFAS No. 123R, the Company recorded $49.1 thousand
and $106.9 thousand of compensation expense relative to stock options during the
three and nine months ended December 31, 2007, no options were granted prior to
August 6, 2007. A summary of stock option activity for the period from June 30,
2007 through December 31, 2007 is presented as follows (there was no prior stock
option activity) (shares in thousands).
Weighted-
Weighted- average
average remaining Aggregate
exercise contractual intrinsic
Shares price term value
-------- -------- ----------- ---------
Outstanding, June 30, 2007 - $ -
Granted 4,795 $ 0.26
Exercised - $ -
Forfeited or expired (10) $ 0.26
--------
Outstanding, September 30, 4,785 $ 0.26
Granted 1,960 $ 0.19
Exercised - $ -
Forfeited or expired (30) $ 0.26
--------
Outstanding, December 31, 2007 6,715 $ 0.25 6.6 $ -
======== ======== =========== =========
Exercisable at December 31, 2007 4,055 $ 0.24 6.6 $ 0.01
======== ======== =========== =========
The weighted average grant date fair value of employee stock options
granted during the three months ended December 31, 2007 was $0.19. No options
were exercised during the three months ended December 31, 2007.
A summary of the Company's nonvested shares as of December 31, 2007,
and changes during the three and six months ended December 31, 2007 (there was
no prior stock option activity), is presented as follows (shares in thousand).
22
<Page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007
(UNAUDITED)
Weighted-
average
grant date
Shares fair value
---------- ----------
Nonvested at June 30, 2007 - $ -
Granted 1,879 $ 0.16
Vested - $ -
Forfeited (2) $ 0.16
----------
Nonvested at September 30, 2007 1,877 $ 0.16
Granted 1,960 $ 0.17
Vested (1,175) $ 0.15
Forfeited (2) $ 0.16
----------
Nonvested at December 31, 2007 2,660 $ 0.16
==========
As of December 31, 2007, there was $112.6 thousand of total
unrecognized compensation expense related to nonvested share-based compensation
arrangements granted under the Plan. That cost is expected to be recognized over
a weighted-average period of 2.2 years.
NOTE 8 - 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.
Since the Company incurred losses for the three and nine months ended
December 31, 2007, anti dilutive potential shares of common stock, consisting of
approximately 200 million and 100 million shares, respectively, issuable under
warrants and stock options, have been excluded from the calculations of diluted
loss per share for the period.
Since the Company incurred losses for the three and nine months ended
December 31, 2006, antidilutive potential shares of common stock consisting of
40.0 million issuable under warrants have been excluded from the calculations of
diluted loss per share for these periods.
NOTE 9 - 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 and
Ganesha; which are owned and co-managed by Dr. Shah, Dr. Chaudhuri, and Mr.
Thomas. Dr. Shah is also the co-manager and an investor in OC-PIN, which is the
largest shareholder of the Company. As the result of the partial exercise of the
Restructuring Warrants, Dr. Chaudhuri and Mr. Thomas are constructively the
holders of 49.5 million and 28.7 million shares of the outstanding stock of the
Company as of December 31 and March 31, 2007, respectively. They are also the
owners of the Restructuring Warrants to purchase up to 24.9 million shares of
future stock in the Company, issuable as of October 9, 2007 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.
During the three and nine months ended December 31, 2007, the Company
paid $1.5 million and $3.6 million, respectively, to a supplier that is also a
shareholder of the Company. For the same periods in 2006, the Company paid $0.3
million and $1.4 million, respectively, to the supplier.
NOTE 10 - 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. As a
condition of the New Credit Facilities (Note 4), the Company entered into an
Amended Lease with PCHI. The Amended Lease terminates on the 25-year anniversary
of the original lease (March 8, 2005), grants the Company the right to renew for
one additional 25-year period, and requires annual base rental payments of $8.3
million. However, until the Company refinances its $50.0 million Revolving Line
of Credit Loan with a stated interest rate less than 14% per annum or PCHI
refinances the $45.0 million Term Note, the annual base rental payments are
23
<Page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007
(UNAUDITED)
reduced to $7.1 million. In addition, the Company may offset against its rental
payments owed to PCHI interest payments that it makes to the Lender under
certain of its indebtedness discussed above. The Amended Lease also gives PCHI
sole possession of the medical office buildings located at 1901/1905 North
College Avenue, Santa Ana, California (the "College Avenue Property") that are
unencumbered by any claims by or tenancy of the Company. This lease commitment
with PCHI is eliminated in consolidation (Note 9).
Concurrently with the execution of the Amended Lease, the Company,
PCHI, Ganesha, and West Coast entered into a Settlement Agreement and Mutual
Release (the "Settlement Agreement") whereby the Company agreed to pay to PCHI
$2.5 million as settlement for unpaid rents specified in the Settlement
Agreement, relating to the College Avenue Property, and for compensation
relating to the medical office buildings located at 999 North Tustin Avenue in
Santa Ana, California, under a previously executed Agreement to Compensation.
This transaction with PCHI is eliminated in consolidation (Note 9).
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 December 31
and March 31, 2007, the Company had accrued $8.7 million and $4.9 million,
respectively, which is comprised of $2.0 million and $1.4 million, respectively,
in incurred and reported claims, along with $6.7 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 December 31
and March 31, 2007, the Company had accrued $0.8 million and $1.0 million,
respectively, comprised of $0.2 million and $0.2 million, respectively, in
incurred and reported claims, along with $0.6 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 December 31, 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 December 31, 2007, the Company had accrued $1.4 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 December 31, 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. The Company incurred finance charges
relating to such policies of (in thousands) $19 and $51 during the three months
24
<Page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007
(UNAUDITED)
ended December 31, 2007 and 2006, respectively, and (in thousands) $108 and $230
during the nine months ended December 31, 2007 and 2006, respectively. As of
December 31 and March 31, 2007, the accompanying condensed consolidated balance
sheets include the following balances relating to the financed insurance
policies (in thousands).
December 31, 2007 March 31, 2007
----------------- --------------
Prepaid insurance $ 1,771 $ 5,004
(Included in prepaid expenses and
other current assets)
Accrued insurance premiums $ 487 $ 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 9). 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.
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. Tenet did not prevail in its efforts to transfer the units to the Company.
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. It is
probable that any funds transferred to PCHI will be distributed to its partners
and reduce the Company's liquidity. In connection with the Company's refinancing
of its outstanding debt in October 2007, the issues raised in relation to the
Compensation Agreement have been settled (Note 11).
SEVERANCE AGREEMENT - Effective January 1, 2008, the Company entered
into a Severance Agreement With Mutual Releases ("Severance Agreement") and a
Consulting Agreement with a former officer of the Company.
Under the Severance Agreement, the Company will pay the former officer
compensation equivalent to 14 equal monthly installments. The amount of each
monthly installment shall be the sum of the former officer's base monthly
salary, net of required deductions, plus the monthly value of his health and
dental insurance, plus the monthly value of his automobile allowance. The
schedule of payments is as follows: (i) one lump sum payment equivalent to eight
(8) monthly installments, and (ii) the remaining six equal installments shall be
paid to him on or before the first business day of each month, commencing on
September 1, 2008. In addition, the Company paid a year end (December 31, 2007)
bonus of $30,000 to the former officer. The Severance Agreement also includes
mutual releases, specific waivers and releases, nondisclosure of confidential
information, return of property, future cooperation, non-disparagement, and
general provisions customary in such agreements. The entire amount of $480
thousand attributable to the Severance Agreement was expensed in the three
months ended December 31, 2007 and included in accrued compensation and benefits
in the accompanying consolidated balance as of December 31, 2007.
Under the terms of the Consulting Agreement, which is effective from
January 1, 2008 through June 30, 2008, the Company will pay the former officer
$180,000 consisting of one payment of $60,000 and four equal monthly
installments of $30,000 each, commencing April 1, 2008, with the last payment
due on July 1, 2008. As additional compensation for his services relating to the
proposed acquisition of Anaheim Memorial Medical Center (AMMC) by the Company,
the former officer is entitled to receive 0.5% of the total value of the
purchase, minus $30,000, or an estimated $310,000 if the acquisition of AMMC is
consummated at the currently proposed price. The Consulting Agreement contains
other provisions customary to such agreements.
25
<Page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007
(UNAUDITED)
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.
From time to time, health care facilities receive requests for
information in the form of a subpoena from licensing entities, such as the
Medical Board of California, regarding members of their medical staffs. Also,
California state law mandates that each medical staff is required to perform
peer review of its members. As a result of the performance of such peer reviews,
action is sometimes taken to limit or revoke an individual's medical staff
membership and privileges in order to assure patient safety. In August 2007, the
Company received such a subpoena from the Medical Board of California concerning
a member of the medical staff of one of the Company's facilities. The facility
is in the process of responding to the subpoena and is in the process of
reviewing the matter. Since the matter is in the early stage, the Company is not
able to determine the impact, if any, it may have on the Company's operations or
financial position.
Approximately 16% of the Company's employees are represented by labor
unions as of December 31, 2007. On December 31, 2006, the Company's collective
bargaining agreements with SEIU and CNA expired. Negotiations with both the SEIU
and CNA led to agreements being reached on May 9, 2007, and October 16, 2007,
for the respective unions. Both contracts were ratified by their respective
memberships. The new SEIU Agreement will run until December 31, 2009, and the
Agreement with the CNA will run until February 28, 2011. Both Agreements have
"no strike" provisions and compensation caps which provide the Company with long
term compensation and workforce stability.
Both unions filed grievances under the prior collective bargaining
agreements, in connection with allegations the agreements obligated the Company
to contribute to Retiree Medical Benefit Accounts. The Company does not agree
with this interpretation of the agreements but has agreed to submit the matters
to arbitration. Under the new agreements negotiated this year, the Company has
agreed to meet with each Union to discuss how to create a vehicle which would
have the purpose of providing a retiree medical benefit, not to exceed one
percent (1%) of certain employee's payroll. 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. Those grievances are
still pending as of this date, but 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 (as then constituted)
and also against the Company's largest shareholder, OC-PIN. The suit sought
damages, injunctive relief and the appointment of a provisional director. Among
other things, the Company alleges 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 further alleges the defendants' then threatened attempts to change the
composition of the Company's management and Board (as then constituted)
threatened to trigger multiple "Events of Default" under the express terms of
the Company's existing credit agreements with its secured Lender.
On May 17, 2007, OC-PIN filed a separate suit against the Company in
Orange County Superior Court. OC-PIN's suit sought injunctive relief and
damages. OC-PIN alleges the management issue referred to above, together with
issues related to monies claimed by OC-PIN, needed to be resolved before
completion of the Company's then pending refinancing of its secured debt. OC-PIN
further alleges that the Company's President failed to call a special
shareholders' meeting, thus denying OC-PIN the opportunity to elect a new member
to the Company's Board of Directors.
Both actions have since been consolidated before one judge. On July 11,
2007, the Company's motion seeking the appointment of an independent provisional
director to fill a vacant seventh Board seat was granted. On the same date,
OC-PIN's motion for a mandatory injunction forcing the Company's President to
notice a special shareholders meeting was denied. All parties to the litigation
thereafter consented to the Court's appointment of the Hon. Robert C. Jameson,
retired, as a member of the Company's Board.
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INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007
(UNAUDITED)
In December 2007, the Company entered into a mutual dismissal and
tolling agreement with OC-PIN. The consolidation suits between the Company, on
the one hand, and three members of its former Board are still pending. Given the
favorable rulings on July 11, 2007 and other factors, the Company continues to
prosecute its original action in hopes of recouping all, or at least a
substantial portion, of the economic losses caused by the defendants' alleged
multiple breaches of fiduciary duty and other wrongful conduct. The Company does
not anticipate the resolution of these ongoing claims for damages will have a
material adverse effect on its results of operations.
In late May 2007, Western Medical Center, Santa Ana ("Medical Center")
was notified by a May 25, 2007 letter from CMS which 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.
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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.
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 ("PCHI"), a company owned directly or indirectly by two
of the Company's largest shareholders.
SIGNIFICANT CHALLENGES
COMPANY - Our acquisition 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.
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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.
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 $37.9 million during the nine months ended December 31, 2007 and
has a working capital deficit of $11.3 million at December 31, 2007. The Company
refinanced its outstanding debt in October 2007, see "REFINANCING."
These factors, among others, indicate a need for the Company to take
action to operate its business as a going concern. There is no assurance that
the Company will be successful in 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
$6.9 million during the nine months ended December 31, 2007 compared to
the same period in 2006.
Net collectible revenues (net operating revenues less provision for
doubtful accounts) for the nine months ended December 31, 2007 and 2006
were $246.7 million and $235.2 million, respectively. During the nine
months ended December 31, 2007 and 2006, the Company received $3.0
million and $3.5 million lump sum awards from the State MediCal unit,
respectively. Adjusting for this, revenues grew by 2.8%.
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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
increased $1.7 million for the nine months ended December 31, 2007
compared to the same period in 2006.
Inpatient admissions increased by 1.5% to 14,140 for the nine months
ended December 31, 2007 compared to 13,936 for the same period in 2006.
2. Operating expenses: 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 nine months ended December 31, 2007 were
$271.5 million, or 0.1%, higher than for the same period in 2006. The
most significant improvement was the $4.6 million reduction in the
Provision for Doubtful Accounts due to improved collection experience.
The Company also replaced the Accounts Purchase Agreement with a
revolving credit agreement (see "REFINANCING"). As a result, the Loss
on Sale of Accounts Receivable decreased by $3.3 million. This was
partially offset by increased labor costs of $9.0 million (resulting
from wage increases, union settlements and severance agreement).
Financing costs: The Company completed the Acquisition of the Hospitals
with a high level of debt financing. Effective October 9, 2007, the
Company entered into new financing arrangements with Medical Capital
Corporation and its affiliates (see "REFINANCING").
The terms of the new financing are expected to reduce the Company's
cost of capital by $4.7 million in the first year of the new financing.
Additionally, the $50.0 million Revolving Credit Agreement provides an
estimated additional liquidity of $24 million based on eligible
receivables, as defined.
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.
REFINANCING - Effective October 9, 2007, the Company and affiliates of
Medical Capital Corporation, namely Medical Provider Financial Corporation I,
Provider Financial Corporation II, and Medical Provider Financial Corporation
III (collectively, the "Lender") executed agreements to refinance the Lender's
credit facilities with the Company aggregating up to $140.7 million in principal
amount (the "New Credit Facilities"). The New Credit Facilities replaced the
Company's previous credit facilities with the Lender, which matured on March 2,
2007. The Company had been operating under an Agreement to Forbear with the
Lender with respect to the previous credit facilities.
The New Credit Facilities consist of the following instruments:
o An $80.0 million credit agreement, under which the Company issued a
$45.0 million Term Note bearing a fixed interest rate of 9% in the
first year and 14% after the first year, which was used to repay
amounts owing under the Company's existing $50.0 million real estate
term loan.
o A $35.0 million Non-Revolving Line of Credit Note issued under the
$80.0 million credit agreement, bearing a fixed interest rate of 9.25%
per year and an unused commitment fee of 0.50% per year, which was used
to repay amounts owing under the Company's existing $30.0 million line
of credit, pay the origination fees on the other credit facilities and
for working capital.
o A $10.7 million credit agreement, under which the Company issued a
$10.7 million Convertible Term Note bearing a fixed interest rate of
9.25% per year, which was used to repay amounts owing under the
Company's existing $10.7 million loan. The $10.7 million Convertible
Term Note is convertible into common stock of the Company at $0.21 per
share during the term of the note.
o A $50.0 million Revolving Credit Agreement, under which the Company
issued a $50.0 million Revolving Line of Credit Note bearing a fixed
interest rate of 24% per year (subject to reduction to 18% if the $45.0
million Real Estate Term Loan is repaid prior to its maturity) and an
unused commitment fee of 0.50% per year, which was used to finance the
Company's accounts receivable.
Each of the above credit agreements and notes (i) required a 1.5%
origination fee due at funding, (ii) matures in three years, (iii) requires
monthly payments of interest and repayment of principal upon maturity, (iv) are
collateralized by all of the assets of the Company and its subsidiaries and the
real estate underlying the Company's hospital facilities (which are owned by
PCHI) and leased to the Company), and (v) are guaranteed by Orange County
Physicians Investment Network, LLC ("OC-PIN") and West Coast Holdings, LLC
("West Coast"), a member of PCHI, pursuant to separate Guaranty Agreements in
favor of the lender. Concurrently with the execution of the New Credit
Facilities, the Company issued new and amended warrants, see "NEW WARRANTS."
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The refinancing did not meet the requirements for a troubled debt
restructuring in accordance with SFAS 15, "Accounting by Debtors and Creditors
for Troubled Debt Restructuring." Under SFAS 15, a debtor must be granted a
concession by the creditor for a refinancing to be considered a troubled debt
restructuring. Although the New Credit Facilities have lower interest rates than
the previous credit facilities, the fair value of the New Warrants (Note 5)
resulted in the effective borrowing rate of the New Credit Facilities to
significantly exceed the effective rate of the previous credit facilities.
The nondetachable conversion feature of the $10.7 million Convertible
Term Note is out-of-the-money on the Effective Date. Pursuant to EITF 05-2, "The
Meaning of 'Conventional Convertible Debt Instrument' in Issue No. 00-19," the
$10.7 million Convertible Term Note is considered conventional for purposes of
applying EITF 00-19, "Accounting for Derivative Financial Instruments Indexed
to, and Potentially Settled in, a Company's Own Stock."
The New Credit Facilities (excluding the $50.0 million Revolving Credit
Agreement, which did not modify or exchange any prior debt) meet the criteria of
EITF 06-6 for debt extinguishment accounting since the $10.7 million Convertible
Term Note includes a substantive conversion option compared to the previous
financing facilities. As a result, pursuant to EITF 96-19, related loan
origination fees were expensed in the three months ended December 31, 2007, and
legal fees and other expenses are being amortized over three years (Note 1).
Based on eligible receivables, as defined, the Company had
approximately $24 million of additional availability under its Revolving Line of
Credit at December 31, 2007.
The Company's New Credit Facilities are subject to certain financial
and restrictive covenants including debt service coverage ratio, minimum cash
collections, mergers and acquisitions, and other corporate activities common to
such financing arrangements. The Company was in compliance with all covenants or
obtained a temporary waiver from the Lender for noncompliance at December 31,
2007.
Concurrently with the execution of the New Credit Facilities, the
Company issued to an affiliate of the Lender a five-year warrant to purchase the
greater of 16.9 million shares of the Company's common stock or up to 4.95% of
the Company's common stock equivalents, as defined, at $0.21 per share (the
"4.95% Warrant"). In addition, the Company and the Lender entered into Amendment
No. 2 to Common Stock Warrant, originally dated December 12, 2005, which
entitles an affiliate of the Lender to purchase the greater of 26.1 million
shares of the Company's common stock or up to 31.09% of the Company's common
stock equivalents (the "31.09% Warrant").
Concurrently with the execution of the Amended Lease, the Company,
PCHI, Ganesha Realty, LLC, and West Coast entered into a Settlement Agreement
and Mutual Release (the "Settlement Agreement") whereby the Company agreed to
pay to PCHI $2.5 million as settlement for unpaid rents specified in the
Settlement Agreement, relating to the medical office buildings located at
1901/1905 North College Avenue, Santa Ana, California (the "College Avenue
Property"), and for compensation relating to the medical office buildings
located at 999 North Tustin Avenue in Santa Ana, California, under a previously
executed Agreement to Compensation.
As a result of the Company's refinancing, the remaining 24.9 million
warrants held by Dr. Chaudhuri and Mr. Thomas became exercisable on the October
9, 2007 effective date of the refinancing (See "RESTRUCTURING WARRANTS").
LONG TERM LEASE COMMITMENT WITH VARIABLE INTEREST ENTITY - 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. As a condition of the New Credit
Facilities (Note 4), the Company entered into an Amended Lease with PCHI. The
Amended Lease terminates on the 25-year anniversary of the original lease (March
8, 2005), grants the Company the right to renew for one additional 25-year
period, and requires annual base rental payments of $8.3 million. However, until
the Company refinances its $50.0 million Revolving Line of Credit Loan with a
stated interest rate less than 14% per annum or PCHI refinances the $45.0
million Term Note, the annual base rental payments are reduced to $7.1 million.
In addition, the Company may offset against its rental payments owed to PCHI
interest payments that it makes to the Lender under certain of its indebtedness
discussed above. The Amended Lease also gives PCHI sole possession of the
College Avenue Property that are unencumbered by any claims by or tenancy of the
Company. This lease commitment with PCHI is eliminated in consolidation (Note
9).
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The Company remains primarily liable under the $45.0 million Term 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 $45.0 million Term Note 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. The APA provided for the sale of 100% of
the Company's eligible accounts receivable, as defined, without recourse. The
APA required the Company to provide billing and collection services, maintain
the individual patient accounts, and resolve any disputes that arose between the
Company and the patient or other third party payer for no additional
consideration. Effective October 9, 2007, the APA was terminated and the Company
repurchased the remaining outstanding accounts that been sold, totaling $6.8
million (See "REFINANCING").
From inception of the APA through October 9, 2007 (date of termination)
the Buyer advanced $639.6 million to the Company through the APA. In addition,
the Company received $56.9 million in reserve releases from inception through
October 9, 2007. Payments posted on sold receivables from inception approximated
$671.3 million. Advances net of payment and adjustment activity, cumulatively
through October 9, 2007 (date of termination) and March 31, 2007 were ($5.4)
million and $7.0 million, respectively. Transaction Fees incurred for the same
periods (from inception) were $11.7 and $9.3 million, respectively.
NEW WARRANTS - Concurrently with the execution of the New Credit
Facilities (Note 4), the Company issued to an affiliate of the Lender a
five-year warrant to purchase the greater of 16,880,484 shares of the Company's
common stock or up to 4.95% of the Company's common stock equivalents, as
defined, at $0.21 per share (the "4.95% Warrant"). In addition, the Company and
the Lender entered into Amendment No. 2 to Common Stock Warrant, originally
dated December 12, 2005, which entitles an affiliate of the Lender to purchase
the greater of 26,097,561 shares of the Company's common stock or up to 31.09%
of the Company's common stock equivalents (the "31.09% Warrant"). Amendment No.
2 to the 31.09% Warrant extended the expiration date of the Warrant to October
9, 2017, removed the condition that it only be exercised if the Company is in
default of its previous credit agreements, and increased the exercise price to
$0.21 per share unless the Company's stock ceases to be registered under the
Securities Exchange Act of 1934, as amended. The 4.95% Warrant and the 31.09%
Warrant are collectively referred to herein as the "New Warrants."
The New Warrants were exercisable as of October 9, 2007, the effective
date of the New Credit Facilities (the "Effective Date"). Accordingly, as of the
Effective Date, the Company recorded warrant expense, and a related warrant
liability, of $10.2 million relating to the New Warrants.
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 SFAS No. 133 and EITF 00-19, the Restructuring
Warrants were accounted for as liabilities and were revalued at each reporting
date, and the changes in fair value were 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 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 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.
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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 related warrant liability of $4.2 million (as of March 31,
2007) was reclassified to additional paid in capital when the 20.8 million
shares were issued to Dr. Chaudhuri and Mr. Thomas in July 2007.
Upon the Company's refinancing (See "REFINANCING") and the issuance of
the New Warrants, the remaining 24.9 million Restructuring Warrants held by Dr.
Chaudhuri and Mr. Thomas became exercisable on the Effective Date. Accordingly,
as of the Effective Date, the Company recorded warrant expense, and a related
warrant liability, of $1.2 million relating to the Restructuring Warrants.
RECLASSIFICATION OF WARRANTS - On December 31, 2007, the Company
received approval from the State of Nevada to increase its authorized shares of
common stock from 250 million to 400 million. This gave the Company sufficient
authorized shares to establish that the outstanding warrants, options, and
conversion rights were within its control. Accordingly, effective December 31,
2007, the Company revalued the 24.9 million Restructuring Warrants and the New
Warrants resulting in a change in the fair value of derivative of $2.9 million
and $11.4 million, respectively, and reclassified the combined warrant liability
balance of $25.7 million to additional paid in capital in accordance with EITF
00-19.
In summation, the Company recorded a common stock warrant expense of
$11.4 million for the three and nine months ended December 31, 2007. There was
no common stock warrant expense recorded during the three and nine months ended
December 31, 2006. The Company recorded a change in the fair value of derivative
of $14.3 million and $6.1 million for the three months ended December 31, 2007
and 2006, respectively, and $14.3 million and $1.0 million for the nine months
ended December 31, 2007 and 2006, respectively.
COMMITMENTS AND CONTINGENCIES - The State of California has imposed new
hospital seismic safety requirements. The Company operates four hospitals
located in an area near active earthquake faults. Under these new requirements,
the Company must meet stringent seismic safety criteria in the future, and, must
complete one set of seismic upgrades to the facilities by January 1, 2013. This
first set of upgrades is expected to require the Company to incur substantial
seismic retrofit costs. There are additional requirements that must be complied
with by 2030. The Company is currently estimating the costs of meeting these
requirements; however a total estimated cost has not yet been determined.
RESULTS OF OPERATIONS
The following table sets forth, for the three and nine months ended
December 31, 2007 and 2006, our unaudited condensed consolidated statements of
operations expressed as a percentage of net operating revenues.
Three months ended Nine months ended
December 31, December 31,
---------------------------- ----------------------------
2007 2006 2007 2006
------------ ------------ ------------ ------------
Net operating revenues 100.0% 100.0% 100.0% 100.0%
Operating expenses:
Salaries and benefits 61.1% 56.8% 56.9% 54.9%
Supplies 13.6% 14.3% 13.5% 14.0%
Provision for doubtful accounts 9.1% 10.8% 8.7% 10.7%
Other operating expenses 19.0% 19.3% 18.9% 19.7%
Loss on sale of accounts receivable (1.0%) 2.8% 1.5% 2.8%
Depreciation and amortization 0.9% 0.8% 0.9% 0.8%
------------ ------------ ------------ ------------
Total operating expenses 102.7% 104.8% 100.4% 102.9%
------------ ------------ ------------ ------------
Operating income (loss) (2.7%) (4.8%) (0.4%) (2.9%)
Other expense:
Interest expense, net (4.6%) (3.7%) (3.8%) (3.8%)
Warrant liability expense (12.9%) 0.0% (4.2%) 0.0%
Change in fair value of warranty liability (16.3%) (7.0%) (5.3%) (0.4%)
------------ ------------ ------------ ------------
(33.8%) (10.7%) (13.3%) (4.2%)
------------ ------------ ------------ ------------
Income (loss) before minority interest (36.5%) (15.5%) (13.7%) (7.1%)
Minority interest in variable interest entity (1.3%) 0.1% (0.3%) 0.2%
------------ ------------ ------------ ------------
Net income (loss) (37.8%) (15.4%) (14.0%) (6.9%)
============ ============ ============ ============
33
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CONSOLIDATED RESULTS OF OPERATIONS - THREE MONTHS ENDED DECEMBER 31, 2007 and
2006
NET OPERATING REVENUES
Net operating revenues for the three months ended December 31, 2007
increased 1.2% compared to the same period in 2006. This is mainly attributable
to admissions for the three months ended December 31, 2007 increasing by 1.2%
compared to the same period in 2006. Revenue per admission declined by 0.1%
during the three months ended December 31, 2007 compared to the three months
ended December 31, 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 December 31, 2007 and 2006 were $2.2
million and $1.6 million, respectively.
Essentially all net operating revenues come from external customers.
The largest payers are the Medicare and Medicaid programs accounting for 65% and
63% of the net operating revenues for the three months ended December 31, 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. Net Collectable Revenues were $80.1 million and $77.7 million
for the three months ended December 31, 2007 and 2006, respectively, an increase
of $2.4 million, or 1.8% per admission.
OPERATING EXPENSES
Operating expenses for the three months ended December 31, 2007 of
$90.6 million were substantially unchanged compared to the same period in 2006.
This was the net result of increases in salaries and benefits offset by
reductions in the loss on sale of accounts receivable and the provision for
doubtful accounts.
Salaries and benefits increased $4.5 million (9.0%) for the three
months ended December 31, 2007 compared to the same period in 2006. Other
operating expenses for the three months ended December 31, 2007 were
substantially unchanged compared to the same period in 2006. Salaries and
benefits increased as a percentage of revenue (see table) primarily due to wage
increases, bonuses and union settlements of $0.7 million and severance agreement
of $0.5 million during the three months ended December 31, 2007.
The provision for doubtful accounts for the three months ended December
31, 2007 decreased to $8.0 million from $9.4 million or 14.7% compared to the
same period in 2006. The decrease in the provision for doubtful accounts for the
three months ended December 31, 2007 is primarily due to improvements in
recoveries of bad debt and a reduction in unfunded patients compared to the same
period in 2006.
A gain on the repurchase of accounts receivable of $0.9 million for the
three months ended December 31, 2007 compared to a loss on sale of accounts
receivable of $2.4 million for the three months ended December 31, 2006 is a
result of the Company's termination of the APA and repurchase of previously sold
receivables in connection with its refinancing (See "REFINANCING").
OPERATING LOSS
Operating loss for the three months ended December 31, 2007 was $2.4
million compared to $4.1 million for the three months ended December 31, 2006.
The decrease in operating loss in 2007 is primarily due to increased volumes,
gain on the repurchase of accounts receivable and decrease in the provision for
doubtful accounts.
OTHER EXPENSE, NET
For the three months ended December 31, 2007 there was an $8.1 million
increase in the change in fair value of warrant liability compared to the
comparable period in 2006. For the three months ended December 31, 2007 there
was an $11.4 million increase in common stock warrant expense compared to the
comparable period in 2006. These were the result of new and revised warrants
issued in connection with a new financing arrangement and were required to be
recorded at fair value and immediately expensed under the provisions of EITF
00-19.
Interest expense for the three months ended December 31, 2007 was $4.1
million, or $0.9 million, more than the same period in 2006. This included $1.5
million in loan origination fee expense and amortization of loan fees associated
with our new financing arrangement.
NET LOSS
Net loss for the three months ended December 31, 2007 was $33.3 million
compared to $13.4 million for the same period in 2006. The change in net results
for the three months ended December 31, 2007 was primarily due to the change in
fair value of warrants and increase in common stock warrant expense compared to
the same period in 2006.
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CONSOLIDATED RESULTS OF OPERATIONS - NINE MONTHS ENDED DECEMBER 31, 2007 and
2006
NET OPERATING REVENUES
Net operating revenues for the nine months ended December 31, 2007
increased 2.6% compared to the same period in 2006. During the nine months ended
December 31, 2007 and 2006, the Company was granted $3.0 million and $3.5
million, respectively, for indigent care. Admissions for the nine months ended
December 31, 2007 increased 1.5% compared to the same period in 2006. Revenue
per admission improved by 1.1% during the nine months ended December 31, 2007.
Based on average revenue for comparable services from all other payers, revenues
foregone under the charity policy, including indigent care accounts, for the
nine months ended December 31, 2007 and 2006 were $5.8 million and $6.1 million,
respectively.
Essentially all net operating revenues come from external customers.
The largest payers are the Medicare and Medicaid programs accounting for 66% and
67% of the net operating revenues for the nine months ended December 31, 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. Net Collectable Revenues were $246.7 million and $235.2 million
for the nine months ended December 31, 2007 and 2006, respectively, an increase
of $11.5 million, or 3.4% per admission.
OPERATING EXPENSES
Operating expenses for the nine months ended December 31, 2007
increased to $271.5 million from $271.2 million, an increase of $0.26 million or
0.1% compared to the same period in 2006. The increase in operating expenses was
primarily the result of the increase in admissions. Operating expenses expressed
as a percentage of revenue for the nine months ended December 31, 2007 and 2006
were 100.4% and 102.9%, respectively.
Salaries and benefits increased $9.0 million (6.2%) for the nine months
ended December 31, 2007 compared to the same period in 2006, primarily due to
wage increases, bonuses and union settlements of $0.7 million and severance
agreement of $0.5 million during the nine months ended December 31, 2007. Other
operating expenses for the nine months ended December 31, 2007 were
substantially unchanged compared to the same period in 2006.
The provision for doubtful accounts for the nine months ended December
31, 2007 decreased to $23.6 million from $28.2 million or 16.4% compared to the
same period in 2006. The decrease in the provision for doubtful accounts for the
nine months ended December 31, 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 nine months ended
December 31, 2007 and 2006 was $4.1 million and $7.4 million. The decrease is
primarily due to the Company's termination of the APA on October 11, 2007 and
repurchase of previously sold receivables in connection with its refinancing
(See "REFINANCING").
OPERATING LOSS
Operating loss for the nine months ended December 31, 2007 was $1.2
million compared to a loss of $7.7 million for the nine months ended December
31, 2006. The decrease in operating loss in 2007 is primarily due to the
increase in revenues, decrease in the provision for doubtful accounts and
termination of the APA and repurchase of previously sold receivables in
connection with the refinancing.
OTHER EXPENSE, NET
For the nine months ended December 31, 2007 there was a $13.2 million
increase in the change in fair value of warrant liability compared to the
comparable period in 2006. For the nine months ended December 31, 2007 there was
an $11.4 million increase in common stock warrant expense compared to the
comparable period in 2006.
Interest expense for the nine months ended December 31, 2007 was $0.4
million more than the same period in 2006 due to $1.5 million in loan
origination fee expense and amortization of loan fees which was partially offset
by a reduction in interest rates under the new financing arrangement.
NET LOSS
Net loss for the nine months ended December 31, 2007 was $37.9 million
compared to $18.2 million for the same period in 2006.
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CASH FLOW
Net cash provided by (used in) operating activities for the nine months
ended December 31, 2007 and 2006 was ($13.7) million and $1.2 million,
respectively, including net losses, adjusted for depreciation and other non-cash
items (excludes provision for doubtful accounts) of $9.7 million and $14.5
million, respectively. The Company used $3.9 million and produced $15.8 million
in working capital for the nine months ended December 31, 2007 and 2006,
respectively. Net cash used in working capital activities primarily reflects
increases in accounts receivable (including security reserve fund and deferred
purchase price receivable) including the cost of repurchasing accounts
receivable partially offset by the increases in accounts payable and accrued
liabilities . Cash produced by growth in accounts payable, accrued compensation
and benefits and other current liabilities was $2.8 million and $9.5 million for
the nine months ended December 31, 2007 and 2006, respectively. Cash provided
(used) in accounts receivable, including security reserve fund and deferred
purchase price receivable (net of provision for doubtful accounts), was ($9.0)
million and $2.1 million for the nine months ended December 31, 2007 and 2006,
respectively. Th e $9.0 million used for the nine months ended December 31, 2007
primarily reflects the return of the Advance Rate Amount, net, and payment of
transaction fees in connection with the repurchase of accounts receivable and
termination of the APA.
Net cash provided by (used in) investing activities during the nine
months ended December 31, 2007 and 2006 was $4.4 million and ($0.2) million,
respectively. In the nine months ended December 31, 2007 and 2006, the Company
invested $0.6 million and $0.2 million, respectively, in new equipment. During
the nine months ended December 31, 2007, $5.0 million in restricted cash was
released to the Company.
Net cash provided by financing activities for the nine months ended
December 31, 2007 and 2006 was $2.9 million and $1.8 million, respectively. The
increase in net cash provided by financing activities for the nine months ended
December 31, 2007 and 2006 was primarily represented by $5.0 million and $2.0
million, respectively, 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 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.
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 payables as of December
31, 2007 (in thousands) of $238 and receivables as of March 31, 2007 (in
thousands) of $909.
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, 2007 was a decrease from $24.485 thousand to $22.185 thousand. 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. The Company
recorded $755.4 thousand in Final Notice of Program Reimbursement settlements
during the nine months ended December 31, 2007. There were no adjustments for
Final Notice of Program Reimbursement received during the three months ended
December 31, 2007 and 2006 and the nine months ended December 31, 2006. As of
December 31 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 $1,618 and $1,831,
respectively. These reserves are combined with third party settlement estimates
and are included in due to government payers as a net payable (in thousands) of
$1,856 and $922 as of December 31 and March 31, 2007, respectively.
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The Hospitals receive supplemental payments from the State of
California to support indigent care (MediCal Disproportionate Share Hospital
payments or "DSH") and from the California Medical Assistance Commission
("CMAC"). The Hospitals received supplemental payments (in thousands) of $9,629
and $5,493 during the three months ended December 31, 2007 and 2006,
respectively, and supplemental payments (in thousands) of $13,457 and $17,629
during the nine months ended December 31, 2007 and 2006, respectively. The
related revenue recorded for the three months ended December 31, 2007 and 2006
was (in thousands) $3,829 and $3,429, respectively, and $13,837 and $15,414 for
the nine months ended December 31, 2007 and 2006, respectively. As of December
31 and March 31, 2007, estimated DSH receivables (in thousands) of $1,757 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 condensed 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% and 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, were $2.2 million and $1.6 million for
the three months ended December 31, 2007 and 2006, respectively, and $5.8
million and $6.1 million for the nine months ended December 31, 2007 and 2006,
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. In June 2007, the
Company evaluated its historical experience and changed to a graduated reserve
percentage based on the age of governmental accounts. The impact of the change
was 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.
37
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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 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
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 December 31, 2007 and 2006 were $0.13 million and $0.70
million, respectively, and $.32 million and $1.20 million for the nine months
ended December 31, 2007 and 2006, respectively. IBNR claims accruals at December
31 and March 31, 2007 were $1.9 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.
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 December 31
and March 31, 2007, the Company had accrued $8.7 million and $4.9 million,
respectively, which is comprised of $2.0 million and $1.4 million, respectively,
in incurred and reported claims, along with $6.7 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 December 31
and March 31, 2007, the Company had accrued $0.8 million and $1.0 million,
respectively, comprised of $0.2 million and $0.2 million, respectively, in
incurred and reported claims, along with $0.6 million and $0.8 million,
respectively, in estimated IBNR.
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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 December 31, 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 December 31, 2007, the Company had accrued $1.4 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 December 31, 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.
RECENT ACCOUNTING STANDARDS
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.
In December 2007, the FASB issued SFAS No. 141 (revised 2007),
"Business Combinations." SFAS 141R requires the acquiring entity in a business
combination to recognize all (and only) the assets acquired and liabilities
assumed in the transaction; establishes the acquisition-date fair value as the
measurement objective for all assets acquired and liabilities assumed; and
requires the acquirer to disclose to investors and other users all of the
information they need to evaluate and understand the nature and financial effect
of the business combination. The Company will adopt this statement for the
fiscal year beginning April 1, 2009.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling
Interests in Consolidated Financial Statements - an amendment of ARB No. 51."
SFAS 160 establishes accounting and reporting standards for the noncontrolling
interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160
is effective prospectively, except for certain retrospective disclosure
requirements, for fiscal years beginning after December 15, 2008. SFAS 160 will
be effective for the Company beginning April 1, 2009. The Company is evaluating
the impact, if any, that the adoption of this statement will have on its
financial statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
As of December 31, 2007, we did not have any investment in or
outstanding liabilities under market rate sensitive instruments. We do not enter
into hedging instrument arrangements.
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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 December 31, 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 December 31,
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.
From time to time, health care facilities receive requests for
information in the form of a subpoena from licensing entities, such as the
Medical Board of California, regarding members of their medical staffs. Also,
California state law mandates that each medical staff is required to perform
peer review of its members. As a result of the performance of such peer reviews,
action is sometimes taken to limit or revoke an individual's medical staff
membership and privileges in order to assure patient safety. In August 2007, the
Company received such a subpoena from the Medical Board of California concerning
a member of the medical staff of one of the Company's facilities. The facility
has responded to the subpoena and is in the process of reviewing the matter.
Approximately 16% of the Company's employees are represented by labor
unions as of September 30, 2007. On December 31, 2006, the Company's collective
bargaining agreements with SEIU and CNA expired. Negotiations with both the SEIU
and CNA led to agreements being reached on May 9, 2007, and October 16, 2007,
for the respective unions. Both contracts were ratified by their respective
memberships. The new SEIU Agreement will run until December 31, 2009, and the
Agreement with the CNA will run until February 28, 2011. Both Agreements have
"no strike" provisions and compensation caps which provide the Company with long
term compensation and workforce stability.
Both unions filed grievances under the prior collective bargaining
agreements, in connection with allegations the agreements obligated the Company
to contribute to Retiree Medical Benefit Accounts. The Company does not agree
with this interpretation of the agreements but has agreed to submit the matters
to arbitration. Under the new agreements negotiated this year, the Company has
agreed to meet with each Union to discuss how to create a vehicle which would
have the purpose of providing a retiree medical benefit, not to exceed one
percent (1%) of certain employee's payroll. 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. Those grievances are
still pending as of this date, but the Company does not anticipate resolution of
the arbitrations will have a material adverse effect on our results of
operations.
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On May 14, 2007, the Company filed suit in Orange County Superior Court
against three of the six members of its Board of Directors (as then constituted)
and also against the Company's largest shareholder, OC-PIN. The suit sought
damages, injunctive relief and the appointment of a provisional director. Among
other things, the Company alleges 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 further alleges the defendants' then threatened attempts to change the
composition of the Company's management and Board (as then constituted)
threatened to trigger multiple "Events of Default" under the express terms of
the Company's existing credit agreements with its secured Lender.
On May 17, 2007, OC-PIN filed a separate suit against the Company in
Orange County Superior Court. OC-PIN's suit sought injunctive relief and
damages. OC-PIN alleges the management issue referred to above, together with
issues related to monies claimed by OC-PIN, needed to be resolved before
completion of the Company's then pending refinancing of its secured debt. OC-PIN
further alleges that the Company's President failed to call a special
shareholders' meeting, thus denying OC-PIN the opportunity to elect a new member
to the Company's Board of Directors.
Both actions have since been consolidated before one judge. On July 11,
2007, the Company's motion seeking the appointment of an independent provisional
director to fill a vacant seventh Board seat was granted. On the same date,
OC-PIN's motion for a mandatory injunction forcing the Company's President to
notice a special shareholders meeting was denied. All parties to the litigation
thereafter consented to the Court's appointment of the Hon. Robert C. Jameson,
retired, as a member of the Company's Board.
In December 2007, the Company entered into a mutual dismissal and
tolling agreement with OC-PIN. The consolidation suits between the Company, on
the one hand, and three members of its former Board are still pending. Given the
favorable rulings on July 11, 2007 and other factors, the Company continues to
prosecute its original action in hopes of recouping all, or at least a
substantial portion, of the economic losses caused by the defendants' alleged
multiple breaches of fiduciary duty and other wrongful conduct. The Company does
not anticipate the resolution of these ongoing claims for damages will have a
material adverse effect on its results of operations.
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.
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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On or about October 8, 2007, stockholders holding a majority of our
outstanding shares of Common Stock approved by written consent in lieu of a
meeting the amendment and restatement of our Articles of Incorporation for the
following purposes: (i) to increase the Company's authorized shares of Common
Stock, $.001 par value per share, from 250,000,000 to 400,000,000 shares; (ii)
to provide for the indemnification and exculpation of directors of the Company
in the Amended Articles as permitted under Nevada law; (iii) to eliminate
out-dated or irrelevant provisions in the original Articles of Incorporation
which were adopted in 1988 by the shell company that became Integrated
Healthcare Holdings, Inc., including eliminating the names and addresses of the
original incorporators, registered agent and directors of the Company; and (iv)
to consolidate in one document the original Articles of Incorporation of the
Company and various amendments that have been adopted since the original
Articles were filed. As of October 8, 2007, there were 137,095,716 shares of our
Common Stock outstanding. Stockholders holding a total of 108,636,716
outstanding shares of Common Stock, constituting a majority of our outstanding
shares entitled to vote, approved the Amended Articles.
For additional information please refer to the Information Statement on
Form 14C filed by the Company with the Securities and Exchange Commission on
December 10, 2007.
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ITEM 6. EXHIBITS
Exhibit
Number Description
- ------ -----------
3.1 Amended and Restated Articles of Incorporation (incorporated by
reference to Appendix A to the Registrant's Report on Form 14C filed
on December 10, 2007).
10.1 $80,000,000 Credit Agreement (incorporated by reference to Exhibit
99.1 to the Registrant's Report on Form 8-K filed on October 15,
2007).
10.2 $45,000,000 Term Note (incorporated by reference to Exhibit 99.2 to
the Registrant's Report on Form 8-K filed on October 15, 2007).
10.3 $35,000,000 Non Revolving Line of Credit Note (incorporated by
reference to Exhibit 99.3 to the Registrant's Report on Form 8-K
filed on October 15, 2007).
10.4 $50,000,000 Revolving Credit Agreement (incorporated by reference to
Exhibit 99.4 to the Registrant's Report on Form 8-K filed on October
15, 2007).
10.5 $50,000,000 Revolving Line of Credit Note (incorporated by reference
to Exhibit 99.5 to the Registrant's Report on Form 8-K filed on
October 15, 2007).
10.6 $10,700,000 Credit Agreement (incorporated by reference to Exhibit
99.6 to the Registrant's Report on Form 8-K filed on October 15,
2007).
10.7 $10,700,000 Convertible Term Note (incorporated by reference to
Exhibit 99.7 to the Registrant's Report on Form 8-K filed on October
15, 2007).
10.8 4.95% Common Stock Warrant (incorporated by reference to Exhibit
99.8 to the Registrant's Report on Form 8-K filed on October 15,
2007).
10.9 Amendment No. 2 to 31.09% Common Stock Warrant (incorporated by
reference to Exhibit 99.9 to the Registrant's Report on Form 8-K
filed on October 15, 2007).
10.10 Amended and Restated Triple Net Hospital Building Lease
(incorporated by reference to Exhibit 99.10 to the Registrant's
Report on Form 8-K filed on October 15, 2007).
10.11 Settlement Agreement and Mutual Release (incorporated by reference
to Exhibit 99.11 to the Registrant's Report on Form 8-K filed on
October 15, 2007).
10.12 Amended Employment Agreement of Bruce Mogel, dated as of
November 15, 2007 (incorporated by reference to Exhibit 99.1 to the
Registrant's Report on Form 8-K filed on November 19, 2007).
10.13 Severance Agreement with Mutual Releases of Larry B. Anderson, as
of December 31, 2007 (incorporated by reference to Exhibit 99.1 to
the Registrant's Report on Form 8-K filed on January 7, 2008).
10.14 Consulting Agreement of Larry B. Anderson, as of December 31,
2007(incorporated by reference to Exhibit 99.2 to the Registrant's
Report on Form 8-K filed on January 7, 2008).
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 2002
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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: February 14, 2008 By: /s/ Steven R. Blake
------------------------------
Steven R. Blake
Chief Financial Officer
(Principal Financial Officer)
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