<page>
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
(Amendment No. 1)
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended March 31, 2008; or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File Number 0-23511
----------------
INTEGRATED HEALTHCARE HOLDINGS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Nevada 87-0573331
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
1301 North Tustin Avenue, Santa Ana, California 92705
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code: (714) 953-3503
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
(TITLE OF CLASS)
----------------
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes[ ] No[X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes[ ] No[X]
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [ ]
Smaller reporting company [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes [ ] No [X]
The aggregate market value of voting stock held by non-affiliates of the
registrant was $3,596,300 as of September 28, 2007 (computed by reference to the
last sale price of a share of the registrant's common stock on that date as
reported by the Over the Counter Bulletin Board). For purposes of this
computation, it has been assumed that the shares beneficially held by directors
and officers of registrant were "held by affiliates"; this assumption is not to
be deemed to be an admission by such persons that they are affiliates of
registrant.
There were 161,973,929 shares outstanding of the registrant's common stock as of
August 5, 2008.
DOCUMENTS INCORPORATED BY REFERENCE:
No portions of other documents are incorporated by reference into this Annual
Report.
================================================================================
<page>
EXPLANATORY NOTE
This Amendment No. 1 on Form 10-K/A (the "Amendment") amends the annual
report of Integrated Healthcare Holdings, Inc. (the "Company") on Form 10-K for
the year ended March 31, 2008 as filed with the Securities and Exchange
Commission on July 14, 2008 (the "Original Filing"). On August 20, 2008, the
Company's Audit Committee determined that the Company's consolidated financial
statements for the year ended March 31, 2008 should be restated due to a
technical violation of covenants under the Company's principal credit agreements
arising from an overstatement of net revenues and accounts receivable and other
operating expenses and accounts payable during the 2008 fiscal year. These
errors resulted from the incorrect recording of certain contractual discounts
for patient accounts receivable and revenue related to the Company's subacute
unit at its Chapman facility. The correction of these errors resulted in
noncompliance by the Company with the amended Minimum Fixed Charge Coverage
Ratio at March 31, 2008 under its principal outside credit agreements (Note 5).
Due to the technical violation of covenants under these credit agreements as of
March 31, 2008, the Company was required to reclassify the non-current portion
of its outstanding debt to current.
The Company restated its consolidated financial statements for the year
ended March 31, 2008, and has included the restated consolidated financial
statements in this Form 10-K/A. See Note 16 in the accompanying notes to
consolidated financial statements.
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
FORM 10-K/A
ANNUAL REPORT FOR THE YEAR ENDED MARCH 31, 2008
TABLE OF CONTENTS
PART I.........................................................................3
ITEM 1. BUSINESS............................................................3
ITEM 1A. RISK FACTORS......................................................18
ITEM 2. PROPERTIES.........................................................25
ITEM 3. LEGAL PROCEEDINGS..................................................27
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................29
PART II.......................................................................30
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES....30
ITEM 6. SELECTED FINANCIAL DATA............................................32
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS........................................33
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK........52
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA........................52
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE ........................................52
ITEM 9A. CONTROLS AND PROCEDURES...........................................52
ITEM 9B. OTHER INFORMATION.................................................54
PART III......................................................................55
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE............55
ITEM 11. EXECUTIVE COMPENSATION............................................59
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS ................................63
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE....................................................64
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES............................67
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES........................68
SIGNATURES....................................................................71
2
<page>
PART I
FORWARD-LOOKING INFORMATION
This Annual Report on Form 10-K/A contains forward-looking statements,
as that term is defined in the Private Securities Litigation Reform Act of 1995.
These statements relate to future events or our future financial performance. In
some cases, you can identify forward-looking statements by terminology such as
"may," "will," "should," "expects," "plans," "anticipates," "believes,"
"estimates," "predicts," "potential" or "continue" or the negative of these
terms or other comparable terminology. These statements are only predictions and
involve known and unknown risks, uncertainties and other factors, including the
risks discussed under the caption "Risk Factors" herein that may cause our
Company's or our industry's actual results, levels of activity, performance or
achievements to be materially different from those expressed or implied by these
forward-looking statements.
Although we believe that the expectations reflected in the
forward-looking statements are reasonable, we cannot guarantee future results,
levels of activity, performance or achievements. Except as may be required by
applicable law, we do not intend to update any of the forward-looking statements
to conform these statements to actual results.
As used in this report, the terms "we," "us," "our," "the Company,"
"Integrated Healthcare Holdings" or "IHHI" mean Integrated Healthcare Holdings,
Inc., a Nevada corporation, unless otherwise indicated.
EXPLANATORY NOTE REGARDING CHANGE IN FISCAL YEAR
On December 21, 2006 the Company changed its fiscal year end from
December 31 to March 31. Unless specifically indicated otherwise, any reference
to "2008" and "2007" or "fiscal 2008" and "fiscal 2007" relate to March 31, 2008
and 2007 and the years then ended, respectively, and any reference to "2005" or
"fiscal 2005" relates to December 31, 2005 or the year ended December 31, 2005.
The transition period, January 1 to March 31, 2006, is referred to as the
"transition period".
ITEM 1. BUSINESS
BACKGROUND
Integrated Healthcare Holdings, Inc. is a predominantly physician owned
company that, on March 8, 2005, acquired and began operating the following four
hospital facilities in Orange County, California (referred to as the
"Hospitals"):
o 282-bed Western Medical Center in Santa Ana
o 188-bed Western Medical Center in Anaheim
o 178-bed Coastal Communities Hospital in Santa Ana
o 114-bed Chapman Medical Center in Orange
Together we believe that the Hospitals represent approximately 12.2% of
all hospital available beds in Orange County, California (based on the most
recent data on the Office of Statewide Health Planning and Development for
California web site as of June 15, 2008)
Prior to March 8, 2005, we were primarily a development stage company
with no material operations. On November 18, 2003, members of our current and
former executive management purchased a controlling interest in the Company and
redirected its focus towards acquiring and operating hospitals and healthcare
facilities that are financially distressed and/or underperforming. On September
29, 2004, the Company entered into a definitive agreement to acquire the four
Hospitals from subsidiaries of Tenet Healthcare Corporation ("Tenet"), and the
transaction closed on March 8, 2005.
The transaction included operations of four licensed general acute care
hospitals with a total of 762 beds. All four hospitals are accredited by the
Joint Commission on Accreditation of Healthcare Organizations and other
appropriate accreditation agencies that accredit specific programs. All
properties are in Orange County California, and operate as described below.
3
<page>
WESTERN MEDICAL CENTER - SANTA ANA. Western Medical Center - Santa Ana,
located at 1001 North Tustin Avenue, Santa Ana, CA 92705, is Orange County's
first hospital, founded over 100 years ago. The hospital is one of IHHI's two
hospitals in Santa Ana, which are the only two general acute care hospitals in
this city of 350,000 people. The hospital has 282 beds and provides quaternary,
tertiary and secondary services. It serves the entire county as one of only
three designated trauma centers in Orange County along with other tertiary
services such as burn center, kidney transplantation, emergency and scheduled
neurosurgical care, cardiac surgical services, a paramedic base station and
receiving center. The hospital also maintains Intensive Care Units for adults
and pediatrics, and a Neonatal Intensive Care Unit. Additionally the hospital
offers telemetry, neurosurgical definitive observation, geriatric, psychiatric,
medical, surgical, pediatric and obstetric inpatient services. Supporting these
services the hospital offers operating and recovery rooms, radiology services,
respiratory therapy services, clinical laboratories, pharmacy, physical and
occupational therapy services on an inpatient and most on an outpatient basis.
The hospital has approximately 175 active physicians and 535 employee nurses,
and hospital staff.
WESTERN MEDICAL CENTER - ANAHEIM. Western Medical Center - Anaheim,
located at 1025 South Anaheim Boulevard, Anaheim, CA 92805, offers a full range
of acute medical and psychiatric care services serving northern Orange County
and providing tertiary services to Riverside County residents. The hospital
offers special expertise in the tertiary services of The Heart and Vascular
Institute, and Behavioral Health Services. Additionally, the hospital provides
the Women and Children Health Services, and 24-hour Emergency Services.
Supporting these services the hospital offers critical care, medical, surgical
and psychiatric services supported by operating and recovery rooms, radiology
services, respiratory therapy services, clinical laboratories, pharmacy,
physical and occupational therapy services on an inpatient and most on an
outpatient basis. The hospital has approximately 75 active physicians and 295
employee nurses, and hospital staff.
COASTAL COMMUNITIES HOSPITAL - SANTA ANA. Coastal Communities Hospital,
located in Santa Ana at 2701 South Bristol Street, Santa Ana, CA 92704, has
served the community for more than 30 years, providing comprehensive medical and
surgical services in a caring and compassionate environment. The hospital is one
of IHHI's two hospitals in Santa Ana, which are the only two general acute care
hospitals in this city of 350,000 people. The hospital has tailored its services
to meet the changing needs of the community. The hospital's staff reflects the
cultural diversity of the community and is particularly responsive and sensitive
to diverse healthcare needs. While services continue to expand, the 178-bed
facility is small enough to retain the family atmosphere associated with a
community hospital. The hospital offers critical care, medical, surgical
obstetric, psychiatric and sub acute services supported by operating and
recovery rooms, radiology services, respiratory therapy services, clinical
laboratories, pharmacy, physical and occupational therapy services on an
inpatient and most on an outpatient basis. The hospital has approximately 55
active physicians and 260 employee nurses, and hospital staff.
CHAPMAN MEDICAL CENTER - ORANGE. Founded in 1969, Chapman Medical
Center is a 114-bed acute care facility located at 2601 East Chapman Avenue,
Orange, CA 92869. The hospital's advanced capabilities position the facility as
a leader in specialty niche programs, including the following centers: Chapman
Center for Obesity (surgical weight loss program); Center for Heartburn and
Swallowing; Chapman Lung Center; Chapman Family Health Center; Doheny Eye
Center; House Ear Clinic; Center for Senior Mental Health; and Positive Action
Center (Adult and Adolescent Chemical Dependency Program). Supporting these
services the hospital offers critical care, medical, surgical and geriatric
psychiatric services supported by operating and recovery rooms, radiology
services, respiratory therapy services, clinical laboratories, pharmacy,
physical and occupational therapy services on an inpatient and most on an
outpatient basis. The hospital has approximately 45 active physicians and 115
employee nurses, and hospital staff.
On March 8, 2005, the Company assumed management responsibility and
control over the Hospitals. All primary systems and controls have been
successfully transitioned to our Company for the effective management of the
Hospitals.
4
<page>
EMPLOYEES AND MEDICAL STAFF
At March 31, 2008, the Company had approximately 3,075 employees. Of
these employees, approximately 620 are represented by two labor unions, the
California Nurses Association and SIEU-United Healthcare Workers, who are
covered by collective bargaining agreements. We believe that our relations with
our employees are good. The Company also had approximately 170 individuals from
contracting agencies at March 31, 2008, consisting primarily of nursing staff.
Our hospitals are fully staffed by physicians and other independently
practicing medical professionals licensed by the state, who have been admitted
to the medical staff of the individual hospital. Under state laws and licensing
standards, hospitals' medical staffs are self-governing organizations subject to
ultimate oversight by the hospital's local governing board. None of these
physicians are employees of the hospitals. Physicians are not limited to medical
staff membership at our hospitals, and many are on staff at our other hospitals,
or hospitals not owned or operated by us. Physicians on our medical staffs are
free to terminate their membership on our medical staffs and admit their
patients to other hospitals, owned, or not owned by us. Non-physician staff,
including nurses, therapists, technicians, finance, registration, maintenance,
clerical, housekeeping, and administrative staff are generally employees of the
hospital, unless the service is provided by a third party contracted entity. We
are subject to federal minimum wage and hour laws and various state labor laws
and maintain an employee benefit plan.
Our hospitals' operations depend on the abilities, efforts, experience
and loyalty of our employees and physicians, most of who have no long-term
contractual relationship. Our ongoing business relies on our attraction of
skilled, quality employees, physicians and other healthcare professionals in all
disciplines.
We strive to successfully attract and retain key employees, physicians
and healthcare professionals. Our operations, financial position and cash flows
could be materially adversely affected by the loss of key employees or
sufficient numbers of qualified physicians and other healthcare professionals.
The relations we have with our employees, physicians, and other healthcare
professionals are key to our success and they are a priority in our management
philosophy.
Nursing can have a significant effect on our labor costs. The national
nursing shortage continues and is serious in California. The nursing shortage is
a significant issue for hospitals, as it is for us. The result has been an
increase in the cost of nursing personnel, thus affecting our labor expenses.
Additionally, California instituted mandatory nurse staffing ratios, thus
setting a high level of nurses to patients, but also requiring nursing staff
ratios be maintained at all times even when on breaks or lunch. These
requirements in the environment of a severe nursing shortage may cause the
limiting of patient admissions with an adverse effect on our revenues. The vast
majority of hospitals in California, including ours, are not at all times
meeting the state mandated nurse staffing ratios. Our plan is to improve
compliance and reduce the cost of contract labor needed to achieve the nurse
staffing ratios.
5
<page>
COMPETITION
Hospital competition is a community issue and unique to each facility.
The first factor is the services the hospital offers and the other hospitals in
the area offering the same or similar service. The hospital is dependent on the
physicians to admit the patients to the hospital. The number of physicians
around the hospital, their specialties, and the quality of medicine they
practice will have a major impact on the hospital competition. The ability of
the hospital to employ and retain qualified nurses, other healthcare
professionals, and administrative staff will affect the hospitals'
competitiveness in the market place. A hospital's reputation and years of
service to the community affects its competitiveness with patients, physicians,
employees, and contracting health plans. Southern California is a highly
competitive managed healthcare market therefore the contracting relationships
with managed care organizations is a key factor in a hospital's competitiveness.
The hospital's location, the community immediately surrounding it and the access
to the hospital will affect the hospital's competitiveness. Other hospitals or
healthcare organizations serving the same locations determine the intensity of
the competition. The condition of the physical plant and the ability to invest
in new equipment and technology can affect the communities and physicians desire
to use the facility. The amount the hospital charges for services is also a
factor in the hospital's competitiveness. The funding sources of the competition
can also be a factor if a competitor is tax exempt; it has advantages not
available to our Hospitals, such as endowments, chartable contributions,
tax-exempt financing, and exemptions from taxes. Since these factors are
individual to each hospital, each hospital must develop its own strategies, to
address the competitive factors in its local.
OUR STRATEGY
Our goal is to provide high quality healthcare services in a community
setting that are responsive to the needs of the communities that we serve. To
accomplish our mission in the complex and competitive healthcare industry, our
operating strategies are to (1) improve the quality of care provided at our
hospitals by identifying best practices and implementing those best practices,
(2) improve operating efficiencies and reduce operating costs while maintaining
or improving the quality of care provided, (3) improve patient, physician and
employee satisfaction, and (4) improve recruitment and retention of nurses and
other employees. We continue to integrate and efficiently operate the four
Hospitals in order to achieve profitability from operations. We may also seek
additional acquisitions of hospitals or health facilities in the future when
opportunities for profitable growth arise.
HEALTHCARE REGULATION
CERTAIN BACKGROUND INFORMATION. Health care, as one of the largest
industries in the United States, continues to attract much legislative interest
and public attention. Changes in the Medicare and Medicaid programs and other
government healthcare programs, hospital cost containment initiatives by public
and private payers, proposals to limit payments and healthcare spending, and
industry wide competitive factors greatly impact the healthcare industry. The
industry is also subject to extensive federal, state and local regulation
relating to licensure, conduct of operations, ownership of facilities, physician
relationships, addition of facilities and services, and charges and effective
reimbursement rates for services. The laws, rules and regulations governing the
healthcare industry are extremely complex, and the industry often has little or
no regulatory or judicial interpretation for guidance. Compliance with such
regulatory requirements, as interpreted and amended from time to time, can
increase operating costs and thereby adversely affect the financial viability of
our business. Failure to comply with current or future regulatory requirements
could also result in the imposition of various civil and criminal sanctions
including fines, restrictions on admission, denial of payment for all or new
admissions, the revocation of licensure, decertification, imposition of
temporary management or the closure of a facility.
6
<page>
MEDICARE
GENERALLY. Each of the Hospitals participates in the Medicare program.
Healthcare providers have been and will continue to be affected significantly by
changes that have occurred in the last several years in federal healthcare laws
and regulations pertaining to Medicare. The purpose of much of the recent
statutory and regulatory activity has been to reduce the rate of increase in
Medicare payments and to make such payments more accurately reflect patient
resource use at hospitals. In addition, important amendments to the Medicare law
were made by the Medicare Prescription Drug, Improvement, and Modernization Act
of 2003 ("MMA") and the Deficit Reduction Act of 2005 ("DRA"). Although the most
significant provisions of MMA relate to an expansion of Medicare's coverage for
pharmaceuticals and changes intended to expand managed care under the Medicare
program, MMA also made many changes in the laws that are relevant to how
Medicare makes payments to hospitals, some of which could have an adverse impact
on the Hospitals' Medicare reimbursement. One focus of the DRA, which may affect
the Hospitals, is the requirement for hospitals to increase quality of care
reporting and an increased penalty for hospitals that fail to properly submit
quality data.
INPATIENT OPERATING COSTS. Medicare pays acute care hospitals, such as
the Hospitals, for most services provided to inpatients under a system known as
the Prospective Payment System ("PPS") pursuant to which hospitals are paid for
services based on predetermined rates. Medicare payments under PPS are based on
the Diagnosis Related Group ("DRG") to which each Medicare patient is assigned.
The DRG is determined by the patient's primary diagnosis and other factors for
each particular Medicare inpatient stay. The amount to be paid for each DRG is
established prospectively by the Centers for Medicare and Medicaid Services
("CMS"). The DRG amounts are not related to a hospital's actual costs or
variations in service or length of stay. Therefore, if a hospital incurs costs
in treating Medicare inpatients that exceed the DRG level of reimbursement plus
any outlier payments, then that hospital will experience a loss from such
services, which will have to be made up from other revenue sources. Payment
limitations implemented by other third party payers may restrict the ability of
a hospital to engage in such "cost-shifting." In October 2006, CMS implemented
significant changes to the Medicare program's inpatient acute care PPS that (1)
altered the way that DRG weights are calculated, abandoning the charge-based
weight system in favor of a cost-based weight system and (2) expanded the number
of DRGs so that the severity of a given illness is taken into account for
purposes of payment. Such systemic changes took affect for discharges occurring
on and after October 1, 2006 and are being phased in over a three year period
through federal fiscal year ("FFY") 2008 which began on October 1, 2007.
CMS determined that hospitals would respond to the new MS DRG system
with improvements in documentation and coding procedures that would result in a
4.8% national increase in payments (the impact on individual hospitals could not
be determined as it would vary based on the services provided by the hospital).
To offset this, the FFY 2008 final rule included reductions in payments of 1.2%
for FFY 2008, 1.8% for FFY 2009, and 1.8% for FFY 2010. CMS has proposed an
adjustment to the reduction for FFY 2009 from 1.8% to 0.9% in their proposed FFY
2009 PPS rules, published April 30, 2008 in the Federal Register. At this time,
it is not known if the proposed reduction will be adopted, or if adopted, what
the affect will be on the Hospitals.
For certain Medicare beneficiaries who have unusually costly hospital
stays (also known as "outliers"), CMS currently provides additional payments
above those specified for the DRG. To determine whether a case qualifies for
outlier payments, hospital-specific cost-to-charge ratios are applied to the
total covered charges for the case. Operating and capital costs for the case are
calculated separately by applying separate operating and capital cost-to-charge
ratios and combining these costs to compare them with a defined fixed-loss
outlier threshold for the specific DRG.
PPS payments are adjusted annually using an inflation index, based on
the change in a "market basket" of hospital costs of providing healthcare
services. There can be no assurance that future updates in PPS payments will
keep pace with inflation or with the increases in the cost of providing hospital
services. It is also possible that the prospective payment for capital costs at
a Hospital will not be sufficient to cover the actual capital-related costs of
the Hospital allocable to Medicare patients' stays.
7
<page>
OUTPATIENT SERVICES. All services paid under the outpatient PPS are
classified into groups called Ambulatory Payment Classifications ("APC").
Services in each APC are similar clinically and in terms of the resources they
require. A payment rate is established for each APC. Depending on the services
provided, hospitals may be paid for more than one APC for an encounter. CMS will
make additional payment adjustments under outpatient PPS, including "outlier"
payments for services where the hospital's cost exceeds 2.5 times the APC rate
for that service. In addition, certain other changes have reduced coinsurance
payments below what they would have originally been under outpatient PPS.
MEDICARE BAD DEBT. Medicare beneficiaries have a coinsurance payment
and annual deductible for most inpatient and outpatient hospital services.
Hospitals must first seek payment of any such coinsurance and deductible amounts
from the Medicare beneficiary. If, after reasonable collection efforts, a
hospital is unable to collect these coinsurance and deductible amounts, Medicare
currently reimburses hospitals 70 percent of the uncollected coinsurance and
deductible amount (known as "Medicare bad debt"). The President's fiscal year
2009 proposed budget would phase out the reimbursement of most Medicare bad
debt. It is not possible to determine at this time whether such changes will be
adopted by Congress as proposed.
MEDICARE CONDITIONS OF PARTICIPATION. Hospitals must comply with
provisions called "Conditions of Participation" in order to be eligible for
Medicare reimbursement. CMS is responsible for ensuring that hospitals meet
these regulatory Conditions of Participation. Under the Medicare rules,
hospitals accredited by the Joint Commission on Accreditation of Healthcare
Organizations ("JCAHO") are deemed to meet the Conditions of Participation. The
Hospitals are each currently accredited by JCAHO and are therefore deemed to
meet the Conditions of Participation.
MEDICARE AUDITS. Medicare participating hospitals are subject to audits
and retroactive audit adjustments with respect to reimbursement claimed under
the Medicare program. Medicare regulations also provide for withholding Medicare
payments in certain circumstances. Any such withholding with respect to the
Hospitals could have a material adverse effect on the Company. In addition,
contracts between hospitals and third party payers often have contractual audit,
setoff and withhold language that may cause substantial, retroactive
adjustments. Medicare requires certain financial information be reported on a
periodic basis, and with respect to certain types of classifications of
information, penalties are imposed for inaccurate reports. As these requirements
are numerous, technical and complex, there can be no assurance that the Company
will avoid incurring such penalties. Such penalties could materially and
adversely affect the Company.
MEDICARE MANAGED CARE. The Medicare program allows various managed care
plans, now known as Medicare Advantage Plans, offered by private companies to
engage in direct managed care risk contracting with the Medicare program. Under
the Medicare Advantage program, these private companies agree to accept a fixed,
per-beneficiary payment from the Medicare program to cover all care that the
beneficiary may require. Generally, in order to engage in risk contracting, a
Medicare Advantage Plan must be licensed at the state level. In recent years,
many private companies have discontinued their Medicare Advantage Plans. The
result has been that the beneficiaries who were covered by the now-discontinued
Medicare plan have been shifted back into the Medicare fee-for-service program
or into a Medicare cost plan. Also, the decrease in the number of Medicare
beneficiaries enrolled in the Medicare Advantage program has not gone unnoticed
by Congress and CMS. Congress has recently increased payments to such plans and
made other changes to Medicare managed care to encourage beneficiary enrollment
in managed care plans. Future legislation or regulations may be created that
attempt to increase participation in the Medicare Advantage program. The effect
of these recent changes and any future legislation/regulation is unknown but
could materially and adversely affect the Company.
8
<page>
MEDI-CAL (CALIFORNIA'S MEDICAID PROGRAM)
FEE-FOR-SERVICE PROGRAM. The Medi-Cal program is a joint federal/state
program that provides healthcare services to certain persons who are financially
needy. Each of the Hospitals participates in the Medi-Cal program. The Medi-Cal
program includes both a fee-for-service component and a managed care component.
Inpatient hospital services under the fee-for-service component are reimbursed
primarily under the Selective Provider Contracting Program ("SPCP"), which are
negotiated by the California Medical Assistance Commission ("CMAC"). The SPCP
and CMAC system for payments to hospitals are designed to pay hospitals below
their costs of services to Medi-Cal beneficiaries. The Company is located in an
area which is currently a "closed area" under the SPCP. In SPCP closed areas,
private hospitals must hold a contract with the Medi-Cal program in order to be
paid for their inpatient services (other than services performed in an emergency
to stabilize a patient so that they can be transferred to a contracting hospital
and additional care rendered to emergency patients who cannot be so stabilized
for transfer or where no contracting hospital accepts the patient). Contracting
hospitals are generally paid for these services on the basis of all inclusive
per diem rates they negotiate under their SPCP/CMAC contracts. Outpatient
hospital services under the fee-for service-component are paid for on the basis
of a fee schedule, and it is not necessary for hospitals to hold SPCP/CMAC
contracts in order to be paid for their outpatient services. Each Hospital
currently has an SPCP/CMAC contract in which it is contractually bound to
continue until November 26, 2009, and there can be no assurance that the
Hospital will maintain SPCP status thereafter or that the current Medi-Cal
payment arrangements will continue. There can be no assurance that the SPCP/CMAC
contract rates paid to the Hospitals will cover each Hospital's cost of
providing care. The Medi-Cal payment rates for outpatient services cover only a
small portion of a Hospital's cost of providing care.
MEDI-CAL MANAGED CARE. In addition to the fee-for-service component of
Medi-Cal, Orange County, California (where the Hospitals are located)
participates in the Medi-Cal managed care program. Many Medi-Cal beneficiaries
in Orange County are covered under Medi-Cal managed care, and not under
fee-for-service Medi-Cal. Medi-Cal managed care in Orange County is provided
through a County Organized Health System known as CalOptima. An Orange County
hospital that wants to participate in Medi-Cal managed care on a capitated basis
must contract with CalOptima, and is typically paid a capitated amount each
month to provide, or arrange for the provision of, specified services to
CalOptima members assigned to the hospital. The capitated hospital is
financially responsible for a predetermined list of services, whether those
services are provided at the capitated hospital or another service provider,
provided during the term of the contract, including allowable claims received
after contract termination. Western Medical Center - Santa Ana had a capitated
contract with CalOptima which terminated as of June 2006. Coastal Communities
Hospital had a capitated contract with CalOptima which terminated in April 2007.
There can be no assurance that the capitated payments received by Western
Medical Center - Santa Ana and Coastal Communities Hospital were adequate to
reimburse its costs of providing care under its CalOptima contract, or that the
capitated payments that have been received will be adequate to cover its costs
of providing care under its capitated contract. Mid-year 2006, CalOptima began
entering into contracts with hospitals on a fee-for-services basis for managed
care Medi-Cal enrollees managed directly by CalOptima and CalOptima's capitated
hospitals. The rates in these contracts are based on the greater of an Orange
County average SPCP/CMAC rate or the individual hospital's SPCP/CMAC rate.
Chapman Medical Center, Coastal Communities Hospital, Western Medical Center -
Anaheim and Western Medical Center - Santa Ana entered into these CalOptima fee
for service contracts effective June 2006. A hospital which does not have a
contract with CalOptima may provide covered services. However, there are ongoing
disputes between CalOptima and hospitals in Orange County concerning the amount
CalOptima is obligated to pay for emergency services furnished by
non-contracting hospitals. An amendment to the federal Medicaid Act which became
effective January 1, 2007, appears to set reimbursement from Medi-Cal managed
care plans, like CalOptima, to hospital providers of emergency services that do
not have contracts with those plans at an average SPCP/CMAC contracted rate for
general acute care hospitals or the average contract rate for tertiary
hospitals. The State of California has not established a definition
differentiating general acute care hospitals from tertiary hospitals or the
mechanism for determining the rates specified in the amendment. It is unclear
how this amendment will ultimately be interpreted and applied. There can be no
assurance that the amount paid to any of the Hospitals for services covered
under CalOptima which are covered or not covered under a contract between
CalOptima and the Hospital will be adequate to reimburse a Hospital's costs of
providing care.
9
<page>
MEDI-CAL DSH PAYMENTS. Some of the Hospitals receive substantial
additional Medi-Cal reimbursement as a disproportionate share ("DSH") hospital
from the DSH Replacement Fund and the Private Hospital Supplemental Fund.
Hospitals qualify for this additional funding based on the proportion of
services they provide to Medi-Cal beneficiaries and other low-income patients.
Payments to a hospital from the State's DSH Replacement Fund are determined on a
formula basis set forth in California law and the Medi-Cal State Plan. Hospitals
receive funds from the Private Hospital Supplemental Fund pursuant to amendments
to their SPCP contracts negotiated with CMAC. The Medi-Cal funding for DSH
hospitals, however, is dependent on state general fund appropriations, and there
can be no assurance that the state will fully fund the Medi-Cal DSH payment
programs. There also can be no assurance that the Hospitals which qualify for
DSH will be able to negotiate SPCP contract amendments for Private Hospital
Supplemental Fund Payments, although state law currently provides that a
qualifying hospital may not receive less from the Private Hospital Supplemental
Fund than it received from predecessor funds in the State's 2002-03 fiscal year.
The state programs under which special payments are made to DSH hospitals are
set to expire as of June 30, 2010. There can be no assurance the programs will
be extended or replaced by similar programs. In addition, the federal government
has recently proposed regulations which could have a significant negative affect
on DSH reimbursement to California hospitals, including the Hospitals, if they
become effective. Such changes could materially and adversely affect the
Company.
WORKERS' COMPENSATION REIMBURSEMENT
FEE SCHEDULES. A portion of the Hospitals' revenues are expected to
come from Workers' Compensation program reimbursements. As part of an effort in
2003 to control costs under the Workers' Compensation program, the California
legislature enacted Labor Code Section 5307.1, which sets reimbursement for
hospital inpatient and outpatient services, including outpatient surgery
services, at a maximum of 120% of the current Medicare fee schedule for
hospitals. The Administrative Director of the Division of Workers' Compensation
is authorized to develop and, after public hearings, to adopt a fee schedule for
outpatient surgery services, but this schedule may not be more than 120% of the
current Medicare fee schedule for hospitals. This fee limitation limits the
amount that the Hospitals will be paid for their services provided to Workers'
Compensation patients.
PROVIDER NETWORKS. Under California law, employers may establish
medical provider networks for Workers' Compensation patients and may restrict
their employees' access to medical services to providers that are participants
in those networks. Employers are free to choose which providers will and will
not participate in their networks, and employers pay participating providers on
the basis of negotiated rates that may be lower than those that would otherwise
be provided for by the Workers' Compensation fee schedules. Employers may also
choose to contract with licensed Health Maintenance Organizations ("HMO") and
restrict access by their employees to participating providers of these HMOs. The
Hospitals are participating providers in several Workers' Compensation networks,
and to the extent that the Hospitals are required to negotiate and accept lower
reimbursement rates to participate in these networks, there may be an adverse
financial impact on the Company. Also, network providers are required to provide
treatment in accordance with utilization controls to be established by the
Department of Workers' Compensation. Therefore, as network participants, such
utilization controls may limit the services for which the Hospital is
reimbursed, which would have an adverse financial impact on the Company.
FURTHER REFORM. There will likely continue to be substantial activity
in the California Workers' Compensation reform area. In the past, the
legislature has considered a number of bills, some of which would further reduce
the maximum reimbursement for medical services, including hospital services. It
is expected that any revisions to the Workers' Compensation fee schedule, when
and if implemented, will reduce the fees the Hospitals receive for Workers'
Compensation patients. The impact of such possible future fee schedule changes
cannot be estimated at this time. It is also possible that the profitability of
the Company could be impacted by other future Workers' Compensation cost control
efforts.
10
<page>
COMMERCIAL INSURANCE
Many private insurance companies contract with hospitals on a
"preferred" provider basis, and many insurers have introduced plans known as
preferred provider organizations ("PPO"). Under preferred provider plans,
patients who use the services of contracted providers are subject to more
favorable copayments and deductibles than apply when they use non-contracted
providers. In addition, under most HMOs, private payers limit coverage to those
services provided by selected hospitals. With this contracting authority,
private payers direct patients away from nonselected hospitals by denying
coverage for services provided by them. The Hospitals currently have several
managed care contracts. If the Company's managed care contract rates are
unfavorable or are reduced in the future, this may negatively impact the
Company's profitability.
EMTALA
In response to concerns regarding inappropriate hospital transfers of
emergency patients based on the patient's inability to pay for the services
provided, Congress enacted the Emergency Medical Treatment and Labor Act
("EMTALA") in 1986. This so-called "anti-dumping" law imposes certain
requirements on hospitals with Medicare provider agreements to (1) provide a
medical screening examination for any individual who comes to the hospital's
emergency department, (2) provide necessary stabilizing treatment for emergency
medical conditions and labor, and (3) not transfer a patient until the
individual is stabilized, unless the benefits of transfer outweigh the risks or
the patient gives informed consent to the transfer. Since the Hospitals must
provide emergency services without regard to a patient's ability to pay,
complying with EMTALA could have an adverse impact on the profitability of the
Hospitals, depending upon the number of patients treated in or through the
emergency room who are unable to pay. Failure to comply with the law can result
in exclusion of the physician from the Medicare and/or Medicaid programs or
termination of the hospital's Medicare provider agreements, as well as civil
penalties.
ANTI-KICKBACK, FRAUD AND SELF-REFERRAL REGULATIONS
FEDERAL ANTI-KICKBACK LAW. The Social Security Act's illegal
remuneration provisions (the "Anti-kickback Statute") prohibit the offer,
payment, solicitation or receipt of remuneration (including any kickback, bribe
or rebate), directly or indirectly, overtly or covertly, in cash or in kind, for
(a) the referral of patients or arranging for the referral of patients to
receive services for which payment may be made in whole or in part under a
federal healthcare program, which includes Medicare, Medicaid and TRICARE
(formerly CHAMPUS, which provides benefits to dependents of members of the
uniformed services) and any state healthcare program, or (b) the purchase,
lease, order, or arranging for the purchase, lease or order of any good,
facility, service or item for which payment may be made under the above payment
programs. The Anti-kickback Statute contains both criminal and civil sanctions,
which are enforced by the Office of Inspector General ("OIG") of Department of
Health & Human Services ("DHHS") and the United States Department of Justice.
The criminal sanctions for a conviction under the Anti-kickback Statute are
imprisonment for not more than five years, a fine of not more than $50,000 for
each offense, or both, with higher penalties potentially being imposed under the
federal Sentencing Guidelines. In addition to the imposition of criminal
sanctions, the Secretary of DHHS may exclude any person or entity that commits
an act described in the Anti-kickback Statute from participation in the Medicare
program and direct states to also exclude that person from participation in
state healthcare programs. The Secretary of DHHS can exercise this authority
based on an administrative determination, without obtaining a criminal
conviction. The burden of proof for the exclusion would be one that is
customarily applicable to administrative proceedings, which is a lower standard
than that required for a criminal conviction. In addition, violators of the
Anti-kickback Statute may be subjected to civil money penalties of $50,000 for
each prohibited act and up to three times the total amount of remuneration
offered, paid, solicited, or received, without regard to whether a portion of
such remuneration was offered, paid, solicited, or received for a lawful
purpose.
11
<page>
There is ever-increasing scrutiny by federal and state law enforcement
authorities, OIG, DHHS, the courts, and Congress of arrangements between
healthcare providers and potential referral sources to ensure that the
arrangements are not designed as a mechanism to exchange remuneration for
patient care referrals and opportunities. The law enforcement authorities, the
courts, and Congress have also demonstrated a willingness to look behind the
formalities of an entity's structure to determine the underlying purpose of
payments between healthcare providers and potential referral sources.
Enforcement actions have been increased and, generally, the courts have broadly
interpreted the scope of the Anti-kickback Statute and have held, for example,
that the Anti-kickback Statute may be violated if merely one purpose of a
payment arrangement is to induce referrals. In addition, the OIG has long been
on record that it believes that physician investments in healthcare companies
can violate the Anti-kickback Statute and the OIG has demonstrated an aggressive
attitude toward enforcement of the Anti-kickback Statute in the context of
ownership relationships.
The OIG has issued regulations specifying certain payment practices
that will not be treated as a criminal offense under the Anti-kickback Statute
and that will not provide a basis for exclusion from the Medicare or Medicaid
programs (the "Safe Harbor Regulations"). These regulations include, among
others, safe harbors for certain investments in both publicly traded and
non-publicly traded companies. However, investments in the Company will not be
protected by either of these safe harbor regulations. Nevertheless, the fact
that a specific transaction does not meet all of the criteria of a "safe harbor"
does not mean that such transaction constitutes a violation of the Anti-kickback
Statute, and the OIG has indicated that any arrangement that does not meet all
of the elements of a safe harbor will be evaluated on its specific facts and
circumstances to determine whether the Anti-kickback Statute has been violated
and, thus, if prosecution is warranted.
The OIG is authorized to issue advisory opinions which interpret the
Anti- kickback Statute and has issued several advisory opinions addressing
investments by physicians in healthcare businesses. Based upon those opinions,
it appears unlikely that the OIG would be willing to issue an advisory opinion
protecting physician investments in the Company, and no such opinion has been
requested by the Company. The Company nevertheless believes, based upon a
federal court decision involving physician investments in clinical laboratories,
that investments in it by physicians are not automatically prohibited by the
Anti- kickback Statute, depending upon the circumstances surrounding such
investment. The Company has reviewed the terms of the purchase of ownership
interests in the Company by Orange County Physician Investment Network, LLC
("OC-PIN") (which is owned by physicians that refer patients to the Hospitals)
and has determined that the purchase should not violate the Anti-kickback
Statute.
The OIG also has identified many hospital-physician compensation
arrangements that are potential violations of the Anti-kickback Statute,
including: (a) payment of any incentive for the referral of patients; (b) use of
free or discounted office space or equipment; (c) provision of free or
discounted services, such as billing services; (d) free training; (e) income
guarantees; (f) loans which are not fair market value or which may be forgiven;
(g) payment for services which require few, if any substantive duties by the
physician or payment for services in excess of fair market value of the
services; and (h) purchasing goods or services from physicians at prices in
excess of fair market value. The Company has reviewed many of its compensation
relationships with physicians, and on-going reviews are occurring, in an effort
to ensure that such relationships do not violate the Anti-kickback Statute.
12
<page>
CALIFORNIA ANTI-KICKBACK PROHIBITIONS. California law prohibits
remuneration of any kind in exchange for the referral of patients regardless of
the nature of the payer of such services, and is therefore broader in this
regard than is the federal statute. Nevertheless, this statute specifically
provides that a medically necessary referral is not illegal solely because the
physician that is making the referral has an ownership interest in the
healthcare facility to which the referral is made if the physician's return on
investment is based upon the amount of the physician's capital investment or
proportional ownership and such ownership is not based upon the number or value
of patients referred. Further, opinions of the California Attorney General
indicate that distributions paid to physicians who invest in entities that
conduct health related businesses generally do not violate California's
anti-kickback law when the entity conducts a bona fide business, services
performed are medically needed, and profit distributions are based upon each
investor's proportional ownership interest, rather than the relative volume of
each investor's utilization of the entity's business. California has a separate
anti-kickback statute which applies only under the Medi-Cal program and which
largely parallels the prohibitions of the federal Anti-kickback Statute. The
Company believes that analysis under this Medi-Cal anti-kickback statue will be
the same as under the federal Anti-kickback Statute discussed above.
FALSE AND OTHER IMPROPER CLAIMS. The federal government is authorized
to impose criminal, civil, and administrative penalties on any person or entity
that files a false claim for payment from the Medicare or Medi-Cal programs. In
addition to other federal criminal and civil laws which punish healthcare fraud,
the federal government, over the past several years, has accused an increasing
number of healthcare providers of violating the federal Civil False Claims Act.
The False Claims Act imposes civil liability (including substantial monetary
penalties and damages) on any person or corporation which (1) knowingly presents
a false or fraudulent claim for payment to the federal government; (2) knowingly
uses a false record or statement to obtain payment; or (3) engages in a
conspiracy to defraud the federal government to obtain allowance for a false
claim. False claims allegations could arise, for example, with respect to the
Hospital's billings to the Medicare program for its services or the submission
by the Hospital of Medicare cost reports. Specific intent to defraud the federal
government is not required to act with knowledge. Instead, the False Claims Act
defines "knowingly" to include not only actual knowledge of a claim's falsity,
but also reckless disregard for or intentional ignorance of the truth or falsity
of a claim. Because the Hospitals perform hundreds of procedures a year for
which they are paid by Medicare, and there is a relatively long statute of
limitations, a billing error or cost reporting error could result in significant
civil or criminal penalties.
Under the qui tam, or whistleblower, provisions of the False Claims
Act, private parties may bring actions on behalf of the federal government.
These private parties, often referred to as relators, are entitled to share in
any amounts recovered by the government through trial or settlement. Both direct
enforcement activity by the government and whistleblower lawsuits have increased
significantly in recent years and have increased the risk that a healthcare
company, like us, will have to defend a false claims action, pay fines or be
excluded from the Medicare and Medicaid programs as a result of an investigation
resulting from a whistleblower case. Although the Company intends that the
operations of the Hospitals will materially comply with both federal and state
laws related to the submission of claims, there can be no assurance that a
determination that we have violated these claims-related laws will not be made,
and any such determination would have a material adverse effect on the Company.
In addition to the False Claims Act, federal civil monetary penalties
provisions authorize the imposition of substantial civil money penalties against
an entity which engages in activities including, but not limited to, (1)
knowingly presenting or causing to be presented, a claim for services not
provided as claimed or which is otherwise false or fraudulent in any way; (2)
knowingly giving or causing to be given false or misleading information
reasonably expected to influence the decision to discharge a patient; (3)
offering or giving remuneration to any beneficiary of a federal healthcare
program likely to influence the selection of a particular provider, practitioner
or supplier for the ordering or receipt of reimbursable items or services; (4)
arranging for reimbursable services with an entity which is excluded from
participation from a federal healthcare program; (5) knowingly or willfully
soliciting or receiving remuneration for a referral of a federal healthcare
program beneficiary; or (6) using a payment intended for a federal healthcare
13
<page>
program beneficiary for another use. The Secretary of DHHS, acting through the
OIG, also has both mandatory and permissive authority to exclude individuals and
entities from participation in federal healthcare programs pursuant to this
statute. Also, it is a criminal federal healthcare fraud offense to: (1)
knowingly and willfully execute or attempt to execute any scheme to defraud any
healthcare benefit program, including any private or governmental program; or
(2) to obtain, by means of false or fraudulent pretenses, any property owned or
controlled by any healthcare benefit program. Penalties for a violation of this
federal law include fines and/or imprisonment, and a forfeiture of any property
derived from proceeds traceable to the offense. In addition, if an individual is
convicted of a criminal offense related to participation in the Medicare program
or any state healthcare program, or is convicted of a felony relating to
healthcare fraud, the Secretary of DHHS is required to bar the individual from
participation in federal healthcare programs and to notify the appropriate state
agencies to bar the individuals from participation in state healthcare programs.
While the criminal statutes are generally reserved for instances of
fraudulent intent, the federal government is applying its criminal, civil, and
administrative penalty statutes in an ever-expanding range of circumstances. For
example, the government has taken the position that a pattern of claiming
reimbursement for unnecessary services violates these statutes if the claimant
merely should have known the services were unnecessary, even if the government
cannot demonstrate actual knowledge. The government has also taken the position
that claiming payment for low-quality services is a violation of these statutes
if the claimant should have known that the care was substandard. In addition,
some courts have held that a violation of the Stark Law or the Anti-kickback
Statute can result in liability under the federal False Claims Act.
Noncompliance with other regulatory requirements can also lead to liability
under the False Claims Act if it can be established that compliance with those
requirements is necessary in order for a hospital to be paid for its services.
Claims filed with private insurers can also lead to criminal and civil
penalties under federal law, including, but not limited to, penalties relating
to violations of federal mail and wire fraud statutes and of the Health
Insurance Portability and Accountability Act of 1996 and its implementing
regulations ("HIPAA") provisions which have made the defrauding of any
healthcare insurer, whether public or private, a crime. The Hospitals are also
subject to various state insurance statutes and regulations that prohibit the
Hospitals from submitting inaccurate, incorrect or misleading claims. The
Company intends that the Hospitals will comply with all state insurance laws and
regulations regarding the submission of claims. IHHI cannot assure, however,
that each Hospital's insurance claims will never be challenged or that the
Hospitals will in all instances comply with all laws regulating its claims. If a
Hospital were found to be in violation of a state insurance law or regulation,
the Hospital could be subject to fines and criminal penalties, which would have
an adverse effect on IHHI's business and operating results.
FEDERAL PHYSICIAN SELF-REFERRAL LAW. Provisions of the Social Security
Act commonly referred to as the Stark Law prohibit referrals by a physician of
Medicare patients to providers for a broad range of health services if the
physician (or his or her immediate family member) has an ownership or other
financial arrangement with the provider, unless an exception applies. The
"designated health services" to which the Stark Law applies include all
inpatient and outpatient services provided by hospitals. Hospitals cannot bill
for services they provide as a result of referrals that are made in violation of
the Stark Law. In addition, a violation of the Stark Law may result in a denial
of payment, require refunds to patients and to the Medicare program, civil
monetary penalties of up to $15,000 for each violation, civil monetary penalties
of up to $100,000 for certain "circumvention schemes" and exclusion from
participation in Medicare, Medicaid, and other federal programs. Violations of
the Stark Law may also be actionable as violations of the federal False Claims
Act.
14
<page>
Notwithstanding the breadth of the Stark Law's general prohibition, the
law contains an exception which protects ownership interests held by physicians
in hospitals where the referring physician is authorized to perform services at
the hospital and the physician's ownership is in the hospital itself, and not
merely in a subdivision of the hospital. The Hospitals intend to rely upon this
exception to protect the ownership interests that physicians hold in them.
Although the Company does not believe that any of its Hospital's will be
considered to be "specialty hospitals", changes in this area of the law that
would affect the classification of the Hospitals as "specialty hospitals" may
affect the Company's operations. Furthermore, in the fiscal year 2009 Inpatient
Prospective Payment System proposed rule issued on April 14, 2008, CMS proposed
to require hospitals to disclose to patients whether they are owned in part or
in whole by physicians, and if so, to make available the names of the physician
owners. In addition, CMS proposed that as a condition of continued medical staff
membership, physicians would be required to inform patients of their ownership
interests in a hospital at the time they refer patients to that hospital.
However, because similar disclosure requirements are already imposed by
California law (see "Disclosure of Financial Interests" section below), it is
unlikely that CMS' implementation of such requirement would have a material
affect on the Company's operations. Also, CMS will require hospitals to disclose
information concerning physician investment and compensation arrangements, and
by July 2007, approximately 500 hospitals will be required to complete a
Financial Relationship Disclosure Report ("Report") and submit the information
to CMS for review. CMS has indicated that it may implement a regular mandatory
disclosure process that will apply to all Medicare participating hospitals. The
Company is unaware of whether any of its Hospitals will be required to submit
such Reports, however, the Company does not anticipate that any such reporting
requirements will materially affect the Company's operations.
In addition to physician ownership, the Hospitals have arrangements by
which they compensate various physicians for services. Payments by the Company
to such physicians will constitute financial relationships for purposes of the
Stark Law. Exemptions exist under the Stark Law and its implementing regulations
for various types of compensation relationships. The Company will endeavor to
ensure that all of its financial relationships qualify for one or more
exemptions under the Stark Law. However, there can be no assurance that the
Company will be successful in structuring all of its relationships with
physicians so as to qualify for protection under one or more of the Stark Law's
exceptions.
CALIFORNIA PHYSICIAN SELF-REFERRAL LAW RESTRICTIONS. Restrictions on
financial relationships between physicians and businesses to which they refer
patients for specified types of services, including some services which will be
provided by the Hospitals, also exist under California law. As is the case under
federal law, the California self-referral restrictions can be triggered by
financial relationships other than ownership. However, these laws contain a
broad exemption permitting referrals to be made to a hospital so long as the
referring physician is not compensated by the hospital for the referral and any
equipment lease between the hospital and the physician satisfies certain
requirements.
An additional requirement imposed by California's self-referral laws is
that any non-emergency imaging services performed for a Workers' Compensation
patient with equipment that, when new, had a value of $400,000 or more must be
pre-approved by the Workers' Compensation insurer or self-insured employer. This
provision may require that preauthorization be obtained for MRI services ordered
by the Hospitals' physician owners and others who have financial relationships
with the Company. It is possible that insurers may refuse to provide any
required preauthorizations in connection with referrals of Workers' Compensation
patients made to the Hospitals by physicians who have financial relationships
with it. However, given that MRI services for Workers' Compensation patients are
not anticipated to represent a material portion of the Hospitals' services, the
Company does not believe that any such refusals to provide required
preauthorizations would have a material impact upon it.
15
<page>
LICENSING
Health facilities, including the Hospitals, are subject to numerous
legal, regulatory, professional, and private licensing, certification, and
accreditation requirements. These include requirements relating to Medicare
participation and payment, state licensing agencies, private payers and the
Joint Commission on Accreditation of Healthcare Organizations ("Joint
Commission"). Renewal and continuance of certain of these licenses,
certifications and accreditations are based on inspections, surveys, audits,
investigations or other reviews, some of which may require or include
affirmative action or response by the Company. These activities generally are
conducted in the normal course of business of health facilities. Nevertheless,
an adverse determination could result in a loss or reduction in a Hospital's
scope of licensure, certification or accreditation, or could reduce the payment
received or require repayment of amounts previously remitted. Any failure to
obtain, renew or continue a license, certification or accreditation required for
operation of a Hospital could result in the loss of utilization or revenues, or
the loss of the Company's ability to operate all or a portion of a Hospital,
and, consequently, could have a material and adverse effect on the Company.
DISCLOSURE OF FINANCIAL INTERESTS
California law provides that it is unlawful for a physician to refer a
patient to an organization in which the physician or the physician's immediate
family has a significant beneficial interest unless the physician first
discloses in writing to the patient that there is such an interest and advises
the patient regarding alternative services, if such services are available. A
"significant beneficial interest" means any financial interest equal to or
greater than the lesser of five percent of the total beneficial interest or
$5,000. This disclosure requirement may be satisfied by the posting of a
conspicuous sign likely to be seen by all patients who use the facility or by
providing patients with written disclosure statements. Physicians must also make
disclosure of entities in which they hold significant financial interests to a
patient's payer upon the request of the payer (not to be made more than once a
year). A violation of this disclosure requirement constitutes "unprofessional
conduct," and is grounds for the suspension or revocation of the physician's
license. Further, it is deemed a misdemeanor punishable by imprisonment not to
exceed six months, or by a fine not to exceed $2,500.
In addition, California's general self-referral laws require that any
physician who refers a person to, or seeks consultation from an organization in
which the physician has a financial interest, must disclose the financial
interest to the patient, or the parent or legal guardian of the patient, in
writing, at the time of the referral or request for consultation. This
requirement applies regardless of whether the financial interest is otherwise
protected by one of the exemptions under the self-referral law. There is no
minimum threshold of ownership required in order for this disclosure requirement
to be triggered, and this disclosure requirement cannot be satisfied by the
posting of a sign. A violation of this disclosure requirement may be subject to
civil penalties of up to $5,000 for each offense. Physician investors in the
Company will be individually responsible for complying with these disclosure
requirements with respect to their referrals to the Hospital. The obligation of
physicians with financial interests in the Company to make such disclosures or
the effect of such disclosures on patients may have an adverse impact on the
Company.
HIPAA
HIPAA mandated the adoption of standards for the exchange of health
information in an effort to encourage overall administrative simplification and
enhance the effectiveness and efficiency of the healthcare industry. Under
HIPAA, healthcare providers and other "covered entities" such as health
insurance companies and other third-party payers, must adopt uniform standards
for the electronic transmission of billing statements and insurance claims
forms. These standards require the use of standard data formats and code sets
when electronically transmitting information in connection with health claims
and equivalent encounter information, healthcare payment and remittance advice
and health claim status. If we or our payers are unable to exchange information
in connection with the specified transactions because of an inability to comply
fully with the regulations, we are required to exchange the information using
paper. If we are forced to submit paper claims to payers, it will significantly
increase our costs associated with billing and could delay payment of claims.
16
<page>
On January 23, 2004, DHHS published a final rule that adopted the
National Provider Identifier ("NPI") as the standard unique health identifier
for healthcare providers. When the NPI is implemented, healthcare providers,
including our Hospitals, must use only the NPI to identify themselves in
connection with electronic transactions. Legacy numbers, such as Medicaid
numbers, CHAMPUS numbers, and Blue Cross-Blue Shield numbers, will not be
permitted. Healthcare providers will no longer have to keep track of multiple
numbers to identify themselves in the standard electronic transactions with one
or more health plans. The NPI is a 10-digit all numeric number that will be
assigned to eligible healthcare providers, including our hospitals, by the
National Provider System ("NPS"), an independent government contractor. Our
hospitals have obtained and are using NPIs in connection with the standard
electronic transactions.
DHHS also has promulgated security standards and privacy standards
which are aimed, in part, at protecting the confidentiality, availability and
integrity of health information by health plans, healthcare clearinghouses and
healthcare providers that receive, store, maintain or transmit health and
related financial information in electronic form, regardless of format. The
privacy standards require compliance with rules governing the use and disclosure
of patient health and billing information. They create new rights for patients
in their health information, such as the right to amend their health
information, and they require us to impose these rules, by contract, on any
business associate to which we disclose such information to perform functions on
our behalf. These provisions required us to implement expensive computer
systems, employee training programs and business procedures to protect the
privacy and security of each patient health information and enable electronic
billing and claims submissions consistent with HIPAA.
The security standards require us to maintain reasonable and
appropriate administrative, technical, and physical safeguards to ensure the
integrity, confidentiality and the availability of electronic health and related
financial information. The security standards were designed to protect
electronic information against reasonably anticipated threats or hazards to the
security or integrity of the information and to protect the information against
unauthorized use or disclosure.
HIPAA provides both criminal and civil fines and penalties for covered
entities that fail to comply. Violations of the privacy or security standards
could result in civil penalties of up to $25,000 per violation in each calendar
year and criminal penalties of up to $250,000 per violation. In addition, the
Hospitals are also subject to state privacy laws, which in some cases are more
restrictive than HIPAA and impose additional penalties.
Compliance with the HIPAA privacy, security and electronic transmission
regulations will require significant changes in information and claims
processing practices utilized by healthcare providers, including the Company.
Estimates vary widely on the economic cost of implementing these provisions of
HIPAA. DHHS estimates the total nationwide cost of compliance with the privacy
rule alone at approximately five billion dollars; the Blue Cross and Blue Shield
Association estimated that the nationwide cost of compliance may exceed forty
billion dollars. As such, the future financial effect of these regulations on
the Company is uncertain at this time.
CORPORATE PRACTICE OF MEDICINE
California has laws that prohibit non-professional corporations and
other entities from employing or otherwise controlling physicians or that
prohibits certain direct and indirect payment arrangements between healthcare
providers. Although we intend to exercise care in structuring our arrangements
with healthcare providers to comply with relevant California law, and we believe
that such arrangements will comply with applicable laws in all material
respects, we cannot give you any assurance that governmental officials charged
with responsibility for enforcing these laws will not assert that the Company,
or certain transactions that we are involved in, are in violation of such laws,
or that the courts will ultimately interpret such laws in a manner consistent
with our interpretations.
CERTAIN ANTITRUST CONSIDERATIONS
The addition of physician-investors in the Company could affect
competition in the geographic area in which its Hospitals operate in various
ways. Such effects on competition could give rise to claims that the Hospitals,
their arrangements with consumers and business entities or with physicians
violate federal and state antitrust and unfair competition laws under a variety
of theories. Accordingly, there can be no assurance that the activities or
operations of the Hospitals will comply with federal and state antitrust or
unfair competition laws, or that the Federal Trade Commission, the Antitrust
17
<page>
Division of the Department of Justice, or any other party, including a physician
participating in the Company's business, or a physician denied participation in
the Company's business, will not challenge or seek to delay or enjoin the
activities of the Company on antitrust or other grounds. If such a challenge is
made, there can be no assurance that such challenge would be unsuccessful. We
have not obtained an analysis of any possible antitrust implications of the
activities of the Company or of the continuing arrangements and anticipated
operations of the Hospitals.
ENVIRONMENTAL REGULATIONS
Our healthcare operations generate medical waste that must be disposed
of in compliance with federal, state, and local environmental laws, rules, and
regulations. Our operations, as well as our purchases and sales of facilities,
also are subject to compliance with various other environmental laws, rules, and
regulations. Remediation costs relating to toxic substances, if encountered
during construction, could be material to the Company.
CORPORATE HISTORY
The Company was originally incorporated under the laws of the State of
Utah on July 31, 1984 under the name "Aquachlor Marketing Inc." On December 23,
1988, the Company reincorporated in the State of Nevada. From 1989 until 2003,
the Company was a development stage company with no material assets, revenues or
business operations. On November 18, 2003, a group of investors purchased a
controlling interest in the Company (then known as First Deltavision) with the
objective of transforming the Company into a leading provider of high quality,
cost-effective health care through the acquisition and management of financially
distressed and/or underperforming hospitals and other healthcare facilities. On
September 29, 2004, the Company entered into a definitive agreement to acquire
the four Hospitals from Tenet and the transaction closed on March 8, 2005
In the first quarter of 2004, the Company changed its fiscal year end
from June 30 to December 31, and changed the Company's name to "Integrated
Healthcare Holdings, Inc." On December 21, 2006, the Company changed its fiscal
year end from December 31 to March 31. Our principal executive offices are
located at 1301 North Tustin Avenue, Santa Ana, California 92705, and our
telephone number is (714) 953-3503.
ITEM 1A. RISK FACTORS
An investment in our common stock involves a high degree of risk. You
should consider carefully the following information about these risks, together
with the other information contained in this report. Our business is subject to
a number of risks and uncertainties - many of which are beyond our control -
that may cause our actual operating results or financial performance to be
materially different from our expectations. You should consider carefully the
following information about these risks, together with the other information
contained in this report, before you decide to buy our common stock. The risks
and uncertainties described below are not the only ones we face. Additional
risks and uncertainties not presently known to us or that we currently deem
immaterial may also impair our operations. If any of the following risks
actually occur, our business would likely suffer and our results could differ
materially from those expressed in any forward-looking statements contained in
this Annual Report on Form 10-K/A including our consolidated financial
statements and related notes. In such case, the trading price of our common
stock could decline, and shareholders could lose all or part of their
investment.
WE MUST OBTAIN ADDITIONAL CAPITAL WHICH, IF AVAILABLE, WILL LIKELY RESULT IN
SUBSTANTIAL DILUTION TO OUR CURRENT SHAREHOLDERS.
We will require additional capital to fund our business. If we raise
additional funds through the issuance of common or preferred equity, warrants or
convertible debt securities, these securities will likely substantially dilute
the equity interests and voting power of our current shareholders, and may have
rights, preferences or privileges senior to those of the rights of our current
shareholders. We cannot predict whether additional financing will be available
to us on favorable terms or at all.
18
<page>
WE ARE CURRENTLY INVOLVED IN LITIGATION WITH VARIOUS CURRENT AND FORMER MEMBERS
OF OUR BOARD OF DIRECTORS AND A SIGNIFICANT SHAREHOLDER.
On May 14, 2007, IHHI filed suit in Orange County Superior Court
against three of the six members of its Board of Directors (as then constituted)
and also against IHHI's largest shareholder, OC-PIN. Among other things, the
suit alleges that the defendants breached fiduciary duties owed to IHHI by
putting their own economic interests above those of IHHI, its other
shareholders, creditors, employees and the public-at-large. The suit also
alleges that the defendants' attempt to change IHHI's management and control of
the existing Board could trigger an "Event of Default" under the express terms
of IHHI's existing credit agreements with its secured lender.
On May 17, 2007, OC-PIN filed a separate suit against IHHI in Orange
County Superior Court. Both actions have been consolidated so they can be heard
before one judge. This litigation is ongoing, and is discussed in further detail
below under "Item 3. Legal Proceedings."
The circumstances underlying this litigation have been a significant
distraction to Company management and the Board of Directors, and may have
prevented the Company from pursuing a successful restructuring of its business
and other profitable business opportunities. A trial date has been set for
January 26, 2009, and the parties are currently moving forward with discovery.
On June 19, 2008 the Company received a demand from OC-PIN requesting
that it provide notice of a special shareholders meeting by no later than June
26, 2008, with the meeting to occur on a date during the week of July 21-25,
2008. OC PIN stated that the business to be conducted at the special
shareholders meeting is to (1) repeal the amendment to the Company's bylaws on
June 3, 2008 establishing a procedure for nominating candidates for election as
director, (2) remove the entire Board of Directors of the Company, and (3)
nominate and elect a new slate of individuals to the Board of Directors. On June
24, 2008, OC-PIN's counsel sent the Company an additional letter demanding that
the Company immediately close its stock transfer books or immediately set the
Record Date for the requested special shareholders meeting, and waive the record
search required under Rule 14a-13(a)(3) of the Securities and Exchange
Commission.
On June 26, 2008, the Company sent OC-PIN a letter indicating that the
Company could not comply with this demand because, among other reasons, OC-PIN
has not furnished the consent of the Company's principal lender, which consent
is required under the Company's Credit Agreements, aggregating up to $140.7
million, prior to taking any of the actions proposed to be taken by OC-PIN at
the special shareholders meeting. In the absence of the lender's consent, the
actions proposed by OC-PIN would entitle the lender to certain remedies which
would have a material adverse effect on the Company and its shareholders.
Further, OC-PIN had not followed the procedures contained in the Company's
bylaws for nominating and electing directors of the Company, making the demand
defective under the bylaws. Regarding the setting of a record date, the Company
is obligated under Rule 14a-13(a)(3) to provide at least 20 business days prior
notice to all banks, brokers and other "street name" holders of its stock in
advance of the record date for any shareholder meeting at which the Company
intends to solicit proxies or consents, and the Company would be in violation of
this requirement if it acceded to the demand of OC-PIN's counsel to waive this
requirement. The Company believes its positions are justified, and intends to
vigorously oppose any attempt by OC-PIN to force the Company to take actions
that would put it in default with its lender or cause it to violate the federal
securities laws.
On July 8, 2008, in a separate action, OC-PIN filed a complaint against
the Company in Orange County Superior Court alleging causes of action for breach
of contract, specific performance, reformation, fraud, negligent
misrepresentation and declaratory relief. The complaint alleges that the Stock
Purchase Agreement that the Company executed with OC-PIN on January 28, 2005
"inadvertently omitted" an anti-dilution provision (the "Allegedly Omitted
Provision") which would have allowed OC-PIN a right of first refusal to purchase
common stock of the Company on the same terms as any other investor in order to
maintain OC-PIN's holding at no less than 62.4% of the common stock on a fully
diluted basis. The complaint further alleges that the Company has issued stock
19
<page>
options under a Stock Incentive Plan and warrants to its lender in violation of
the Allegedly Omitted Provision. The complaint further alleges that the issuance
of warrants to purchase the Company's stock to Dr. Kali P. Chaudhuri and William
Thomas, and their exercise of a portion of those warrants, were improper under
the Allegedly Omitted Provision. The Company believes that this lawsuit is
wholly without merit and intends to contest these claims vigorously. However, at
this early stage, the Company is unable to determine the cost of defending this
lawsuit or the impact, if any, that this lawsuit may have on the Company's
results of operations or financial condition.
WE HAVE INCURRED A SIGNIFICANT LOSS IN OPERATIONS TO DATE. IF OUR SUBSTANTIAL
LOSSES CONTINUE, THE MARKET VALUE OF OUR COMMON STOCK WILL LIKELY DECLINE
FURTHER AND WE MAY LACK THE ABILITY TO CONTINUE AS A GOING CONCERN.
As of March 31, 2008, we had an accumulated deficit of $104,993,000. We
incurred a net loss of $ 39,603,000 for the year ended March 31, 2008. A
component of this loss relating to warrants, totaling $25,677,000, was
reclassified in accordance with generally accepted accounting principles from a
liability to equity, so its impact on our stockholders' deficiency was zero.
This loss, among other things, has had a material adverse effect on our
stockholders' equity and working capital. We are attempting to improve our
operating results and financial condition through a combination of contract
negotiations, expense reductions, and new issues of equity. However, new issues
of equity are encumbered by warrant anti-dilution provisions and there can be no
assurance that we will achieve profitability in the future. The Company's $50.0
million Revolving Credit Agreement provides an estimated additional liquidity as
of March 31, 2008 of $26.9 million based on eligible receivables, as defined. If
we are unable to achieve and maintain profitability, the market value of our
common stock will likely decline further, and we will lack the ability to
continue as a going concern.
WE HAVE A HIGH DEGREE OF LEVERAGE AND SIGNIFICANT DEBT SERVICE OBLIGATIONS.
The debt service requirements on our $96 million in debt amount (as of
March 31, 2008) to approximately $0.9 million per month. Our relatively high
level of debt and debt service requirements have several effects on our current
and future operations, including the following: (i) we will need to devote a
significant portion of our cash flow to service debt, reducing funds available
for operations and future business opportunities and increasing our
vulnerability to adverse economic and industry conditions and competition; (ii)
our leveraged position increases our vulnerability to competitive pressures;
(iii) the covenants and restrictions contained in agreements relating to our
indebtedness restrict our ability to borrow additional funds, dispose of assets,
issue additional equity or pay dividends on or repurchase common stock; and (iv)
funds available for working capital, capital expenditures, acquisitions and
general corporate purposes are limited. Any default under the documents
governing our indebtedness could have a significant adverse effect on our
business and the market value of our common stock.
THE SUCCESS OF THE COMPANY WILL DEPEND ON PAYMENTS FROM THIRD PARTY PAYERS,
INCLUDING GOVERNMENT HEALTH CARE PROGRAMS. IF THESE PAYMENTS ARE REDUCED OR
DELAYED, OUR REVENUE WILL DECREASE.
We are largely dependent upon private and governmental third party
sources of payment for the services provided to patients in the Hospitals. The
amount of payment a hospital receives for the various services it renders will
be affected by market and cost factors, perhaps adversely, as well as other
factors over which we have no control, including political concerns over the
cost of medical care, Medicare and Medicaid regulations, and the cost
containment and utilization decisions of third party payers. Any meaningful
reduction in the amounts paid by these third party payers for services rendered
at the Hospitals will have a material adverse effect on our revenues and cash
flows.
IF WE ARE UNABLE TO ENTER INTO MANAGED CARE PROVIDER ARRANGEMENTS ON ACCEPTABLE
TERMS, OR IF WE HAVE DIFFICULTY COLLECTING FROM MANAGED CARE PAYERS, OUR RESULTS
OF OPERATIONS COULD BE ADVERSELY AFFECTED.
It would harm our business if we were unable to enter into managed care
provider arrangements on acceptable terms. Any material reductions in the
payments that we receive for our services, coupled with any difficulties in
collecting receivables from managed care payers, could have a material adverse
effect on our financial condition, results of operations or cash flows.
20
<page>
CHANGES IN THE MEDICARE AND MEDICAID PROGRAMS OR OTHER GOVERNMENT HEALTH CARE
PROGRAMS COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS.
The Medicare and Medicaid programs are subject to statutory and
regulatory changes, administrative rulings, interpretations and determinations
concerning patient eligibility requirements, funding levels and the method of
calculating payments or reimbursements, among other things; requirements for
utilization review; and federal and state funding restrictions, all of which
could materially increase or decrease payments from these government programs in
the future, as well as affect the cost of providing services to our patients and
the timing of payments to our facilities. We are unable to predict the effect of
future government health care funding policy changes on our operations. If the
rates paid by governmental payers are reduced, if the scope of services covered
by governmental payers is limited or if we, or one or more of our subsidiaries'
hospitals, are excluded from participation in the Medicare or Medicaid program
or any other government health care program, there could be a material adverse
effect on our business, financial condition, results of operations or cash
flows.
OUR BUSINESS CONTINUES TO BE ADVERSELY AFFECTED BY A HIGH VOLUME OF UNINSURED
AND UNDERINSURED PATIENTS.
Like other organizations in the health care industry, we continue to
provide services to a high volume of uninsured patients and more patients than
in prior years with an increased burden of co-payments and deductibles as a
result of changes in their health care plans. We continue to experience a high
level of uncollectible accounts, and, unless our business mix shifts toward a
greater number of insured patients or the trend of higher co-payments and
deductibles reverses, we anticipate this high level of uncollectible accounts to
continue.
COST CONTAINMENT, PAY FOR PERFORMANCE, AND OTHER PROGRAMS IMPOSED BY THIRD-PARTY
PAYERS, INCLUDING GOVERNMENT HEALTH CARE PROGRAMS, MAY DECREASE THE COMPANY'S
REVENUE.
The health care industry is currently undergoing significant changes
and is regularly subject to regulatory and political intervention. We expect to
derive a considerable portion of the Company's revenue through the Hospitals
from government-sponsored health care programs and third-party payers (such as
employers, private insurers, HMOs or preferred provider organizations). The
health care industry is experiencing a trend toward cost containment as
government and private third-party payers seek to impose lower payment and
utilization rates and negotiate reduced payment schedules with service
providers. The Company believes that these trends will continue to result in a
reduction from historical levels in per-patient revenue for hospitals. It is
distinctly possible that reimbursement from government and private third-party
payers for many procedures performed at the Hospital may be reduced in the
future. Further reductions in payments or other changes in reimbursement for
health care services could have a material adverse effect on the Company's
business, financial condition and/or results of operations. Further, rates paid
by private third-party payers are generally higher than Medicare, Medicaid and
HMO payment rates. Any decrease in the relative number of patients covered by
private insurance would have a material adverse effect on the Company's revenues
and operations.
PROVIDING QUALITY MEDICAL SERVICES FROM TALENTED PHYSICIANS IS CRITICAL TO OUR
BUSINESS.
Our business depends, in large part, upon the efforts and success of
the physicians who will perform services at the Hospitals and the strength of
our relationships with these physicians. Any failure of these physicians to
maintain the quality of medical care provided or to otherwise adhere to
professional guidelines at the Hospitals, or any damage to the reputation of a
key physician or group of physicians, could damage the Company's and the
Hospitals' reputations in the medical marketplace and may subject us to
liability and significantly reduce our revenue and increase our costs.
Like many hospitals, we face a growing shortage of primary care and
specialty physicians. Should this shortage continue or worsen, the utilization
of our hospitals may be adversely impacted. This could have a negative impact on
our revenues and profitability.
21
<page>
MEDICAL STAFF
The primary relationship between a hospital and physicians who practice
in it is through the hospital's organized medical staff. Medical staff bylaws,
rules and policies establish the criteria and procedures at acute care
hospitals, by which a physician may have his or her privileges, participation or
membership curtailed, denied or revoked. Physicians who are denied medical staff
membership or certain clinical privileges, or who have such membership,
participation or privileges curtailed, denied or revoked often file legal
actions against hospitals. Such actions may include a wide variety of claims,
some of which could result in substantial uninsured damages to a hospital. In
addition, failure of the governing body to adequately oversee the conduct of its
medical staff may result in hospital liability to third parties.
NURSING SHORTAGE
Health care providers depend on qualified nurses to provide quality
service to patients. There is currently a nationwide shortage of qualified
nurses. This shortage and the more stressful working conditions it creates for
those remaining in the profession are increasingly viewed as a threat to patient
safety and may trigger the adoption of state and federal laws and regulations
intended to reduce that risk. For example, California has adopted legislation
and regulations mandating a series of specific minimum patient-to-nurse ratios
in all acute care hospital nursing units. Any failure by the Hospital to comply
with nurse staff ratios could result in action by licensure authorities and may
constitute evidence of negligence per se in the event any patient is harmed as
the result of inadequate nurse staffing. The vast majority of hospitals in
California, including ours, are not at all times meeting the state mandated
nurse staffing ratios.
In response to the shortage of qualified nurses, health care providers
have increased-and could continue to increase-wages and benefits to recruit or
retain nurses; many providers have had to hire expensive contract nurses. The
shortage could also limit the operations of healthcare providers by limiting the
number of patient beds available. The Company has likewise increased and is
likely to have to continue to increase-wages and benefits to recruit and retain
nurses. The Company may also need to engage expensive contract nurses until
permanent staff nurses can be hired to replace any departing nurses.
UNION CONTRACTS HAVE BEEN RENEWED BUT THERE CAN BE NO ASSURANCE THAT THE
CONTRACTS WILL BE RENEWED IN THE FUTURE.
Approximately 20% of the Company's employees are represented by labor
unions as of March 31, 2008. On December 31, 2006, the Company's collective
bargaining agreements with the California Nurses Association ("CNA") covering
certain of our nursing staff and with the Service Employee International Union
("SEIU") 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. We do not anticipate the new agreements will have a
material adverse effect on our results of operations.
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.
22
<page>
IF EITHER THE COMPANY OR THE HOSPITALS FAIL TO COMPLY WITH APPLICABLE LAWS AND
REGULATIONS, WE MAY SUFFER PENALTIES OR BE REQUIRED TO MAKE SIGNIFICANT CHANGES
TO OUR OPERATIONS.
The health care industry is required to comply with extensive and
complex laws and regulations at the federal, state and local government levels
relating to, among other things:
o Hospital billing practices and prices for services;
o Relationships with physicians and other referral sources;
o Adequacy of medical care and quality of medical equipment and
services;
o Ownership of facilities;
o Qualifications of medical and support personnel;
o Confidentiality, maintenance and security issues associated with
health-related information and patient records;
o The screening, stabilization and transfer of patients who have
emergency medical conditions;
o Licensure and accreditation of our facilities;
o Operating policies and procedures; and
o Construction or expansion of facilities and services.
Among these laws are the False Claims Act, HIPAA, the federal
anti-kickback statute and the Stark Law. These laws, and particularly the
anti-kickback statute and the Stark Law, impact the relationships that we may
have with physicians and other referral sources. We have a variety of financial
relationships with physicians who refer patients to our facilities. We also
provide financial incentives, including minimum revenue guarantees, to recruit
physicians into communities served by our hospitals. The OIG has enacted safe
harbor regulations that outline practices that are deemed protected from
prosecution under the anti-kickback statute. A number of our current
arrangements, including financial relationships with physicians and other
referral sources, may not qualify for safe harbor protection under the
anti-kickback statute. While the failure to meet a safe harbor does not mean
that the arrangement necessarily violates the anti-kickback statute, the
arrangement may be subject to greater scrutiny. We cannot assure that practices
that are outside of a safe harbor will not be found to violate the anti-kickback
statute.
These laws and regulations are extremely complex and, in some cases, we
do not have the benefit of definitive interpretations by either regulators or
courts. In the future, it is possible that different interpretations or
enforcement of these laws and regulations could subject our current or past
practices to allegations of impropriety or illegality or could require us to
make changes in our facilities, equipment, personnel, services, capital
expenditure programs and operating expenses. A finding that we have violated one
or more of these laws or regulations, or even public announcement that we are
being investigated for possible violations could have a material adverse effect
on our business and our business reputation could suffer significantly.
Additionally, we cannot predict with any certainty whether new legislation or
regulation, at either the state or federal level, will be implemented and
whether those developments will impact our operations or finances.
THE COMPANY CONDUCTS ON-GOING REVIEWS OF ITS COMPLIANCE WITH VARIOUS LAWS
RELATED TO PHYSICIAN ARRANGEMENTS, WHICH MAY REVEAL VIOLATIONS THAT COULD
SUBJECT THE COMPANY TO FINES OR PENALTIES.
The Company and the Hospitals have entered into a variety of
relationships with physicians. In an increasingly complex legal and regulatory
environment, these relationships may pose a variety of legal or business risks.
The Company conducts reviews of its compliance with the federal Anti-kickback
Statute, Stark law and other applicable laws as they relate to the Company's
relationships with referring physicians.
The Company's largest shareholder, OC-PIN, is owned and controlled by
physicians who also refer to and practice at the Hospitals. OC-PIN may receive
dividends as a shareholder. In addition, one of the members of OC-PIN serves as
Chairman of the Board of Directors of the Company. As a director, he receives
payment from the Company for his service as Chairman. In addition, the Hospitals
have various relationships with physicians who are not owners of the Company, as
well as with OC-PIN physicians, including medical directorships, sharing in risk
pools and service arrangements.
23
<page>
The Company entered into a sale leaseback transaction for substantially
all of the real estate with Pacific Coast Holdings Investment, LLC ("PCHI")
whereby 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 co-managed by physician investors.
The Company has undertaken a review of its agreements with physicians
and has a review process in place to ensure that such agreements are in writing
and comply with applicable laws. Although there may have been arrangements in
the past with physicians that may not have been memorialized in a written
agreement or may have expired and not been timely renewed or may have been
entered into after services commenced, each of which may have lead to violations
of the Stark law, the Company's current review process should prevent such
occurrences. Additionally, the Company has reviewed the terms of the purchase of
ownership interests in the Company by OC-PIN (which is owned by physicians that
refer patients to the Hospitals) and has determined that the purchase should be
determined to be permissible under applicable law. The Company has also reviewed
certain related party transactions, such as director fees for physician
directors and payment of the employment severance package to Dr. Anil Shah, an
OC-PIN member. If the Company or the Hospitals are not in compliance with
federal and state fraud and abuse laws and physician self-referral laws, the
Company could be subject to repayment obligations, fines, penalties, exclusive
from participation in federal health care programs, and other sanctions which
would have a material adverse effect on the Company's profitability.
LICENSING, SURVEYS, INVESTIGATIONS AND AUDITS
Health facilities, including the Hospitals, are subject to numerous
legal, regulatory, professional and private licensing, certification and
accreditation requirements. These include requirements relating to Medicare and
Medi-Cal participation and payment, state licensing agencies, private payers and
the Joint Commission. Renewal and continuance of certain of these licenses,
certifications and accreditations are based on inspections, surveys, audits,
investigations or other reviews, some of which may require or include
affirmative action or response by the Company. These activities generally are
conducted in the normal course of business of health facilities. Nevertheless,
an adverse determination could result in a loss or reduction in a Hospital's
scope of licensure, certification or accreditation, or could reduce the payment
received or require repayment of amounts previously remitted. Any failure to
obtain, renew or continue a license, certification or accreditation required for
operation of a Hospital could result in the loss of utilization or revenues, or
the loss of the Company's ability to operate all or a portion of a Hospital,
and, consequently, could have a material and adverse effect on the Company.
EARTHQUAKE SAFETY COMPLIANCE
The Hospitals are located in an area near active and substantial
earthquake faults. The Hospitals carry earthquake insurance with a policy limit
of $50 million. A significant earthquake could result in material damage and
temporary or permanent cessation of operations at one or more of the Hospitals.
In addition, the State of California has imposed new hospital seismic safety
requirements. Under these new requirements, the Hospitals must meet stringent
seismic safety criteria in the future, and, must complete one set of seismic
upgrades to each facility by January 1, 2013. This first set of upgrades is
expected to require the Company to incur substantial seismic retrofit expenses.
In addition, there could be other remediation costs pursuant to this seismic
retrofit.
The State of California has introduced a new seismic review methodology
known as HAZUS. The HAZUS methodology may preclude the need for some structural
modifications. Three of the four Hospitals have requested HAZUS review and one
of them has already received a favorable notice pertaining to structural
reclassification.
There are additional requirements that must be complied with by 2030.
The costs of meeting these requirements have not yet been determined. Compliance
with seismic ordinances will be a costly venture and could have a material
adverse effect on our cash flow.
24
<page>
WE FACE INTENSE COMPETITION IN OUR BUSINESS.
The healthcare industry is highly competitive. We compete with a
variety of other organizations in providing medical services, many of which have
greater financial and other resources and may be more established in their
respective communities than we are. Competing companies may offer newer or
different centers or services than we do and may thereby attract patients or
customers who are presently patients, customers or are otherwise receiving our
services.
Some of the hospitals that compete with our hospitals are owned by
government agencies or not-for-profit organizations. Tax-exempt competitors may
have certain financial advantages not available to our facilities, such as
endowments, charitable contributions, tax-exempt financing, and exemptions from
sales, property and income taxes. In certain states, including California, some
not-for-profit hospitals are permitted by law to directly employ physicians
while for-profit hospitals are prohibited from doing so. We also face increasing
competition from physician-owned specialty hospitals and freestanding surgery,
diagnostic and imaging centers for market share in high margin services and for
quality physicians and personnel. If competing health care providers are better
able to attract more patients, recruit and retain physicians, expand services or
obtain favorable managed care contracts at their facilities, we may continue to
experience a decline in patient volume levels.
A SIGNIFICANT PORTION OF OUR BUSINESS IS CONCENTRATED IN CERTAIN MARKETS AND THE
RESPECTIVE ECONOMIC CONDITIONS OR CHANGES IN THE LAWS AFFECTING OUR BUSINESS IN
THOSE MARKETS COULD HAVE A MATERIAL ADVERSE EFFECT ON THE COMPANY.
We receive all of our inpatient services revenue from operations in
Orange County, California. The economic condition of this market could affect
the ability of our patients and third-party payers to reimburse us for our
services, through its effect on disposable household income and the tax base
used to generate state funding for Medicaid programs. An economic downturn, or
changes in the laws affecting our business in our market and in surrounding
markets, could have a material adverse effect on the Company.
WE MAY BE LIABLE FOR LOSSES NOT COVERED BY OR IN EXCESS OF OUR INSURANCE.
An increasing trend in malpractice litigation claims, rising costs of
malpractice litigation, losses associated with these malpractice lawsuits and a
constriction of insurers have caused many insurance carriers to raise the cost
of insurance premiums or refuse to write insurance policies for hospital
facilities. Accordingly, we have increased on retention limits and our estimated
reserves may not be adequate.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
In March 2005, the Company completed the acquisition of the Hospitals
and their associated real estate from Tenet. At the closing of the acquisition,
the Company transferred all of the fee interests in the acquired real estate to
PCHI, a company owned indirectly by two of the Company's largest shareholders.
The Company entered into a Triple Net Lease dated March 7, 2005 (amended and
restated as of October 1, 2007) under which it leased back from PCHI all of the
real estate that it transferred to PCHI. Additionally, the Company leases
property from other lessors. As of March 31, 2008, the Company's principal
facilities are listed in the following table:
25
<page>
APPROXIMATE
AGGREGATE
SQUARE LEASE INITIAL LEASE
PROPERTY FOOTAGE RATE EXPIRATION
-------- ------- ---- ----------
Western Medical Center-Santa Ana 360,000 See note 1. February 28, 2030
1001 North Tustin Avenue
Santa Ana, CA 92705
Administrative Building 40,000 See note 1. February 28, 2030
1301 N. Tustin Avenue
Santa Ana, CA
Western Medical Center-Anaheim 132,000 See note 1. February 28, 2030
1025 South Anaheim Boulevard
Anaheim, CA 92805
Coastal Communities Hospital 115,000 See note 1. February 28, 2030
2701 South Bristol Street
Santa Ana, CA 92704
Chapman Medical Center 140,000 See note 2. December 31, 2023
2601 East Chapman Avenue
Orange, CA 92869
1. Effective October 1, 2007, the Company entered into an amended and
restated 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 medical office buildings located
at 1901/1905 North College Avenue, Santa Ana, California that are
unencumbered by any claims by or tenancy of the Company. Lease payments
to PCHI are eliminated in consolidation.
2. Leased from an unrelated party. Monthly lease payments are
approximately $112,000.
The State of California has established standards intended to ensure
that all hospitals in the state withstand earthquakes and other seismic activity
without collapsing or posing the threat of significant loss of life. The
Hospitals are located in an area near active and substantial earthquake faults.
The Hospitals carry earthquake insurance with a policy limit of $50 million. A
significant earthquake could result in material damage and temporary or
permanent cessation of operations at one or more of the Hospitals. In addition,
the State of California has imposed new hospital seismic safety requirements.
Under these new requirements, the Hospitals must meet stringent seismic safety
criteria in the future, and, must complete one set of seismic upgrades to each
facility by January 1, 2013. This first set of upgrades is expected to require
the Company to incur substantial seismic retrofit expenses. In addition, there
could be other remediation costs pursuant to this seismic retrofit.
The State of California has introduced a new seismic review methodology
known as HAZUS. The HAZUS methodology may preclude the need for some structural
modifications. Three of the four Hospitals have requested HAZUS review and one
of them has already received a favorable notice pertaining to structural
reclassification.
26
<page>
There are additional requirements that must be complied with by 2030.
The costs of meeting these requirements have not yet been determined. Compliance
with seismic ordinances will be a costly venture and could have a material
adverse effect on our cash flow.
The Company believes that its current leased space is adequate for its
current purposes and for the next fiscal year.
ITEM 3. LEGAL PROCEEDINGS
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 20% of the Company's employees are represented by labor
unions as of March 31, 2008. 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, change in medical benefits at two facilities, 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.
27
<page>
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. On April
16, 2008, the Company filed an amended complaint, alleging that the defendant
directors' failure to timely approve a refinancing package offered by the
Company's largest lender caused the Company to default on its then-existing
loans. Also on April 16, 2008, these directors filed cross-complaints against
the Company for alleged failures to honor its indemnity obligations to them in
this litigation. 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. A trial date has been set for January 26, 2009, and the parties are
currently moving forward with discovery. The Company does not anticipate the
resolution of these ongoing claims for damages will have a material adverse
effect on its results of operations.
On June 19, 2008 the Company received a demand from OC-PIN requesting
that it provide notice of a special shareholders meeting by no later than June
26, 2008, with the meeting to occur on a date during the week of July 21-25,
2008. OC PIN stated that the business to be conducted at the special
shareholders meeting is to (1) repeal the amendment to the Company's bylaws on
June 3, 2008 establishing a procedure for nominating candidates for election as
director, (2) remove the entire Board of Directors of the Company, and (3)
nominate and elect a new slate of individuals to the Board of Directors. On June
24, 2008, OC-PIN's counsel sent the Company an additional letter demanding that
the Company immediately close its stock transfer books or immediately set the
Record Date for the requested special shareholders meeting, and waive the record
search required under Rule 14a-13(a)(3) of the Securities and Exchange
Commission.
On June 26, 2008, the Company sent OC-PIN a letter indicating that the
Company could not comply with this demand because, among other reasons, OC-PIN
has not furnished the consent of the Company's principal lender, which consent
is required under the Company's Credit Agreements, aggregating up to $140.7
million, prior to taking any of the actions proposed to be taken by OC-PIN at
the special shareholders meeting. In the absence of the lender's consent, the
actions proposed by OC-PIN would entitle the lender to certain remedies which
would have a material adverse effect on the Company and its shareholders.
Further, OC-PIN had not followed the procedures contained in the Company's
bylaws for nominating and electing directors of the Company, making the demand
defective under the bylaws. Regarding the setting of a record date, the Company
is obligated under Rule 14a-13(a)(3) to provide at least 20 business days prior
notice to all banks, brokers and other "street name" holders of its stock in
advance of the record date for any shareholder meeting at which the Company
intends to solicit proxies or consents, and the Company would be in violation of
this requirement if it acceded to the demand of OC-PIN's counsel to waive this
requirement. The Company believes its positions are justified, and intends to
vigorously oppose any attempt by OC-PIN to force the Company to take actions
that would put it in default with its lender or cause it to violate the federal
securities laws.
28
<page>
On July 8, 2008, in a separate action, OC-PIN filed a complaint against
the Company in Orange County Superior Court alleging causes of action for breach
of contract, specific performance, reformation, fraud, negligent
misrepresentation and declaratory relief. The complaint alleges that the Stock
Purchase Agreement that the Company executed with OC-PIN on January 28, 2005
"inadvertently omitted" an anti-dilution provision (the "Allegedly Omitted
Provision") which would have allowed OC-PIN a right of first refusal to purchase
common stock of the Company on the same terms as any other investor in order to
maintain OC-PIN's holding at no less than 62.4% of the common stock on a fully
diluted basis. The complaint further alleges that the Company has issued stock
options under a Stock Incentive Plan and warrants to its lender in violation of
the Allegedly Omitted Provision. The complaint further alleges that the issuance
of warrants to purchase the Companys stock to Dr. Kali P. Chaudhuri and William
Thomas, and their exercise of a portion of those warrants, were improper under
the Allegedly Omitted Provision. The Company believes that this lawsuit is
wholly without merit and intends to contest these claims vigorously. However, at
this early stage, the Company is unable to determine the cost of defending this
lawsuit or the impact, if any, that this lawsuit may have on the Company's
results of operations or financial condition.
We and our subsidiaries are involved in various other legal proceedings
most of which relate to routine matters incidental to our business. We do not
believe that the outcome of these matters is likely to have a material adverse
effect on the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our 2007 annual meeting of stockholders was held on September 5, 2007.
Of the 137,095,716 shares eligible to vote, 128,537,092 appeared in person or by
proxy and established a quorum for the meeting. The matters listed in the table
below were approved by the requisite votes.
ELECTION OF
DIRECTORS VOTES FOR VOTES WITHHELD NOT VOTED
--------- --------- -------------- ---------
Maurice J. DeWald 69,436,662 2,000 59,098,430
Hon. C. Robert Jameson 69,437,662 1,000 59,098,430
Ajay Meka, M.D. 69,436,662 2,000 59,098,430
Michael Metzler 69,437,662 1,000 59,098,430
Bruce Mogel 69,436,662 2,000 59,098,430
J. Fernando Niebla 69,436,662 2,000 59,098,430
William E. Thomas 69,437,662 1,000 59,098,430
RATIFICATION OF THE
APPOINTMENT OF
BDO SEIDMAN, LLP AS
INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
FOR THE YEAR ENDING
MARCH 31, 2008 VOTES FOR VOTES AGAINST VOTES WITHHELD NOT VOTED
----------- ------------- -------------- ---------
123,265,903 3,089 5,268,100 0
29
<page>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
The Company's common stock is listed for trading on the OTC Bulletin
Board under the symbol "IHCH.OB." The trading market for the Company's common
stock has been extremely thin. In view of the extreme thinness of the trading
market, the prices reflected on the chart below as reported on the OTC Bulletin
Board may not be indicative of the price at which any prior or future
transactions were or may be effected in the Company's common stock. Stockholders
are cautioned against drawing any conclusions from the data contained herein, as
past results are not necessarily indicative of future stock performance.
The following table sets forth the quarterly high and low bid price for
the Company's common stock for each quarter for the period from April 1, 2006
through March 31, 2008, as quoted on the Over-the-Counter Bulletin Board. Such
Over-the-Counter market quotations reflect inter dealer prices, without retail
mark-up, mark-down or commission, and may not necessarily represent actual
transactions.
- --------------------- ------------------- -------------------
PERIOD HIGH LOW
------ ---- ---
- --------------------- ------------------- -------------------
Apr 2006 - Jun 2006 $0.40 $0.15
- --------------------- ------------------- -------------------
Jul 2006 - Sep 2006 $0.25 $0.08
- --------------------- ------------------- -------------------
Oct 2006 - Dec 2006 $0.50 $0.10
- --------------------- ------------------- -------------------
Jan 2007 - Mar 2007 $0.40 $0.20
- --------------------- ------------------- -------------------
Apr 2007 - Jun 2007 $0.32 $0.12
- --------------------- ------------------- -------------------
Jul 2007 - Sep 2007 $0.23 $0.12
- --------------------- ------------------- -------------------
Oct 2007 - Dec 2007 $0.33 $0.14
- --------------------- ------------------- -------------------
Jan 2008 - Mar 2008 $0.25 $0.10
- --------------------- ------------------- -------------------
As of the date of this report, there were approximately 223 record
holders of the Company's common stock; this number does not include an
indeterminate number of stockholders whose shares may be held by brokers in
street name. The Company has not paid and does not expect to pay any dividends
on its shares of common stock for the foreseeable future, as any earnings will
be retained for use in the business.
30
<page>
The following table provides summary information concerning the
Company's equity compensation plan as of March 31, 2008.
Equity Compensation Plan Information
- ------------------------------------------------------------------------------------------------------------
Plan Category Number of Securities to Weighted-average Number of securities
be issued upon exercise exercise price of remaining available for
of outstanding options, outstanding options, future issuance under
warrants and rights warrants and rights equity compensation
plans (excluding
securities reflected in
column (a))
(a) (b) (c)
- ------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------
Equity compensation
plans approved by 7,445,000 $ 0.24 5,925,957
security holders
- ------------------------------------------------------------------------------------------------------------
Equity compensation
plans not approved by - - -
security holders
- ------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------
Total 7,445,000 $ 0.24 5,925,957
- ------------------------------------------------------------------------------------------------------------
STOCK PERFORMANCE TABLE
The following table shows the cumulative, five year, split adjusted
total return for our Common Stock (including trading in our Common Stock under
our current name and under our previous name, First Deltavision, Inc.), compared
to two major indices. The Standard & Poor's 500 Stock Index includes 500
companies representing all major industries. The Dow Jones US Healthcare
Providers measures owners and operators of providers of health care. Performance
data assumes that $100.00 was invested on March 31, 2003 in our Common Stock and
each of the indices. The data assumes the reinvestment of all cash dividends and
the cash value of other distributions. Stock price performance shown in the
table is not necessarily indicative of future stock price performance.
S&P500 Close Index
- ------ ----- -----
31-Mar-03 848.18 100.00
31-Mar-04 1,126.21 132.78
31-Mar-05 1,180.59 139.19
31-Mar-06 1,302.89 153.61
31-Mar-07 1,422.53 167.72
31-Mar-08 1,322.70 155.95
IHHI Stock Price
- ----------------
31-Mar-03 $ 0.40 100.00
31-Mar-04 $ 0.72 180.00
31-Mar-05 $ 1.07 267.50
31-Mar-06 $ 0.30 75.00
31-Mar-07 $ 0.32 80.00
31-Mar-08 $ 0.12 30.00
Dow Jones US Healthcare Providers
- ---------------------------------
31-Mar-03 239.91 100.00
31-Mar-04 328.35 136.86
31-Mar-05 445.67 185.77
31-Mar-06 528.08 220.12
31-Mar-07 553.04 230.52
31-Mar-08 446.71 186.20
31
<page>
ITEM 6. SELECTED FINANCIAL DATA
The following selected condensed consolidated financial information
should be read in conjunction with "Item 7 - Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the consolidated
financial statements and notes included elsewhere in this Form 10-K/A. We had no
material business operations prior to the fiscal year ended December 31, 2005.
AS OF OR FOR THE PERIOD ENDED
($ in 000's except per share amounts)
Year ended Year ended Year ended Year ended Year ended
---------- ---------- ---------- ---------- ----------
March 31, 2008 March 31, 2007 December 31, 2005 December 31, 2004 December 31, 2003
-------------- -------------- ----------------- ----------------- -----------------
(restated)
SELECTED BALANCE SHEET DATA:
Net working capital $ (98,859) $ (90,307) $ 8,063 $ (12,132) $ 149
Property and equipment 56,917 58,172 59,431 57 47
Other assets 759 - 1,141 11,187 156
Long term debt - - 70,331 - -
Warrant liability - non current - - 21,065 - -
Capital lease obligations 6,375 5,834 4,961 - -
Minority interest 1,150 1,716 3,342 - -
Stockholders' equity (deficiency) (48,708) (39,685) (31,064) (888) 353
SELECTED INCOME STATEMENT DATA:
Net operating revenue $ 367,721 $ 350,672 $ 283,698 $ - $ -
Salaries and benefits (209,680) (194,865) (153,574) - -
Supplies (50,126) (49,577) (39,250) - -
Provision for doubtful accounts (30,958) (35,169) (37,349) - -
Other operating expenses (68,959) (66,652) (58,716) (1,840) (28)
Warrant expense (11,404) (693) (17,604) - -
Depreciation and amortization (3,134) (2,495) (2,178) - -
Interest expense (13,209) (12,092) (9,925) - -
Provision for income taxes (28) (5) (5) - -
Net loss before minority interest (38,129) (21,131) (46,833) (1,840) (28)
Net loss attributable to common
stock $ (39,603) $ (20,538) $ (45,175) $ (1,840) $ (28)
PER SHARE DATA:
Net loss:
Basic and fully diluted $ (0.30) $ (0.23) $ (0.50) $ (0.09) $ (0.01)
Weighted average number of
common shares outstanding: 131,869 90,291 90,330 19,987 3,471
Long term debt is $0 as of March 31, 2008 due to the Company's
noncompliance with a debt covenant which required the non current portion of the
Company's debt relating to the refinancing, effective October 9, 2007, to be
reclassified to current (see Notes 5 and 16 in the notes to the accompanying
consolidated financial statements). Effective December 31, 2007, all warrant
liability was reclassified to equity. Long term debt and warrant liability - non
current as of March 31, 2007 were $0 because all notes and warrants were due in
less than one year.
On March 8, 2005 the Company completed the acquisition and commenced
operation of the Hospitals. Prior to that time the Company reported activity as
a development stage enterprise. The operating results data presented above are
not necessarily indicative of our future results of operations. Reasons for this
include, but are not limited to: changes in Medicare regulations; Medicaid
funding levels set by the State of California and the County of Orange; levels
of malpractice expense and settlement trends; availability of trained healthcare
personnel and changes in occupancy levels and patient volumes. Factors that
affect patient volumes and, thereby, our results of operations at our hospitals
and related healthcare facilities include, but are not limited to: (1)
unemployment levels; (2) the business environment of local communities; (3) the
number of uninsured and underinsured individuals in local communities treated at
our hospitals; (4) seasonal cycles of illness; (5) climate and weather
conditions; (6) physician recruitment, retention and attrition; (7) local
healthcare competitors; (8) managed care contract negotiations or terminations;
and (9) factors relating to the timing of elective procedures.
32
<page>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
FORWARD-LOOKING INFORMATION
This Annual Report on Form 10-K/A contains forward-looking statements,
as that term is defined in the Private Securities Litigation Reform Act of 1995.
These statements relate to future events or our future financial performance. In
some cases, you can identify forward-looking statements by terminology such as
"may," "will," "should," "expects," "plans," "anticipates," "believes,"
"estimates," "predicts," "potential" or "continue" or the negative of these
terms or other comparable terminology. These statements are only predictions and
involve known and unknown risks, uncertainties and other factors, including the
risks discussed under the caption "Risk Factors" herein that may cause our
Company's or our industry's actual results, levels of activity, performance or
achievements to be materially different from those expressed or implied by these
forward-looking statements.
Although we believe that the expectations reflected in the
forward-looking statements are reasonable, we cannot guarantee future results,
levels of activity, performance or achievements. Except as may be required by
applicable law, we do not intend to update any of the forward-looking statements
to conform these statements to actual results.
As used in this report, the terms "we," "us," "our," "the Company,"
"Integrated Healthcare Holdings" or "IHHI" mean Integrated Healthcare Holdings,
Inc., a Nevada corporation, unless otherwise indicated.
Unless otherwise indicated, all amounts included in this Item 7 are
expressed in thousands (except per share amounts).
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 indirectly by two of the
Company's largest shareholders.
33
<page>
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.
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.
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.
34
<page>
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 $39.6 million and reported net cash used in operating activities
of $11.3 million during the year ended March 31, 2008 and the Company had a
working capital deficit of $98.9 million at March 31, 2008. A component of this
loss, totaling $25.7 million relating to warrants, was reclassified from
liability to equity, thus having no impact on our stockholders' deficiency. The
Company refinanced its outstanding debt in October 2007, see "REFINANCING."
Notwithstanding the refinancing, these factors, among others, raise
substantial doubt about the Company's ability to continue as a going concern and
indicate a need for the Company to take action to continue 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
$17.0 million during the year ended March 31, 2008 compared to fiscal
2007.
Net collectible revenues (net operating revenues less provision for
doubtful accounts) for the year ended March 31, 2008 and 2007 were
$336.8 million and $315.5 million, respectively. During the year ended
March 31, 2008 and 2007, the Company received $4.8 million and $3.5
million lump sum awards from the State Medi-Cal unit, respectively.
Adjusting for this, revenues grew by 4.5%. 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 $13.7
million for the year ended March 31, 2008 compared to the same period
in fiscal year 2007.
Inpatient admissions increased by 0.7% to 28.004 for the year ended
March 31, 2008 compared to 27.806 for the year ended March 31, 2007.
2. Operating expenses: Management is working aggressively to reduce costs
without reduction in service levels. These efforts have in large part
been offset by inflationary pressures. Operating expenses before
interest and warrants for the year ended March 31, 2008 were $366.9
million, or 2.2%, higher than for the same period in fiscal year 2007.
The most significant improvement was the $4.1 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 $6.3 million. This was
partially offset by increased labor costs of $14.8 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 $4.5 million in the first year of the new financing.
Additionally, the $50.0 million Revolving Credit Agreement provides an
estimated additional liquidity as of March 31, 2008 of $26.9 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.
35
<page>
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 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, see "NEW WARRANTS."
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 (see "NEW
WARRANTS") 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 year ended March 31, 2008, and legal fees
and other expenses are being amortized over three years.
36
<page>
Based on eligible receivables, as defined, the Company had
approximately $26.9 million of additional availability under its Revolving Line
of Credit at March 31, 2008.
The Company's New Credit Facilities are subject to certain financial
and restrictive covenants, as amended, including debt service coverage ratio,
minimum cash collections, dividend restrictions, mergers and acquisitions, and
other corporate activities common to such financing arrangements. Effective for
the period from January 1, 2008 through June 30, 2009, the Lender amended the
New Credit Facilities whereby the Minimum Fixed Charge Coverage Ratio, as
defined, was reduced from 1.0 to 0.4. However, as described in Note 16 in the
accompanying consolidated financial statements, the Company was not in
compliance with the amended Minimum Fixed Charge Coverage Ratio at March 31,
2008. Due to the technical violation of the covenant under the New Credit
Facilities as of March 31, 2008, the Company was required to reclassify the non
current portion of its outstanding debt to current.
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, as defined, at $0.21 per share (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 (see "REFINANCING"), 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 is unencumbered by any claims by or tenancy
of the Company. This lease commitment with PCHI is eliminated in consolidation.
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.
37
<page>
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 in addition to the release of security reserve funds and deferred
purchase price receivables (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 (see "REFINANCING"), 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, as defined, at $0.21 per share (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. 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 in the
Company's consolidated statements 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.
The Restructuring Warrants were exercisable beginning January 27, 2007
and expire on July 27, 2008. The exercise price for the first 43.0 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 in the Company's consolidated statements of
operations.
38
<page>
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
$9.2 million. 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 in cash. The effect of this
exercise resulted in additional warrant expense for the year ended March 31,
2007 of $693, 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
amended its Articles of Incorporation 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.
The Company recorded common stock warrant expense of $11.4 million,
$693, and $17.6 million during the years ended March 31, 2008 and 2007, and
December 31, 2005, respectively. There was no common stock warrant expense
recorded during the three months ended March 31, 2006. The Company recorded a
change in the fair value of warrant liability of $14.3 million, $(133.0), $3.5
million, and $(8.2) million for the years ended March 31, 2008 and 2007 and
December 31, 2005, and the three months ended March 31, 2006, respectively.
39
<page>
COMMITMENTS AND CONTINGENCIES - The State of California has imposed new
hospital seismic safety requirements. The Company operates four hospitals
located in an area near active earthquake faults. Under these new requirements,
the Company must meet stringent seismic safety criteria in the future, and, must
complete one set of seismic upgrades to the facilities by January 1, 2013. This
first set of upgrades is expected to require the Company to incur substantial
seismic retrofit costs. There are additional requirements that must be complied
with by 2030. The Company is currently estimating the costs of meeting these
requirements; however a total estimated cost has not yet been determined.
TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS -
===========================================================================================
Payments due by period
===========================================================================================
Less than More than
Contractual obligations Total 1 year 1-3 years 3-5 years 5 years
===========================================================================================
Debt obligations $ 95,579 $ 95,579 $ - $ - $ -
===========================================================================================
Capital lease obligations 13,776 1,240 2,459 2,078 7,999
===========================================================================================
Operating lease obligations 23,593 1,549 2,552 2,529 16,963
===========================================================================================
Purchase obligations 13,404 3,663 6,677 3,064 -
===========================================================================================
===========================================================================================
Total $ 146,352 $ 102,031 $ 11,688 $ 7,671 $ 24,962
===========================================================================================
The above table excludes future payments based on existing arrangements totaling
approximately $156 million between the Company and PCHI, its variable interest
entity. These payments are eliminated in consolidation.
CASH FLOW - Net cash provided by (used in) operating activities for the
years ended March 31, 2008 and 2007 and December 31, 2005 was $(11.3) million,
$2.5 million, and $(15.2) million, respectively, including net losses, adjusted
for depreciation and other non-cash items (excludes provision for doubtful
accounts and minority interest) of $10.4 million, $16.6 million, and $21.1
million, respectively. The Company used $0.8 million and produced $19.1 million
and $5.9 million in working capital for the years ended March 31, 2008 and 2007
and December 31, 2005, 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 $4.6 million, $11.1
million, and $54.1 million for the years ended March 31, 2008 and 2007 and
December 31, 2005, respectively. Cash used in accounts receivable, including
security reserve fund and deferred purchase price receivable (net of provision
for doubtful accounts), was $6.4 million, $0.9 million, and $39.5 million for
the years ended March 31, 2008 and 2007 and December 31, 2005, respectively. The
$6.4 million used for the year ended March 31, 2008 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 years
ended March 31, 2008 and 2007 and December 31, 2005 was $4.0 million, $(0.6)
million, and $(63.7) million, respectively. In the years ended March 31, 2008
and 2007, the Company invested $0.9 million and $0.6 million in cash,
respectively, in new equipment. In the year ended December 31, 2005, the Company
used $63.2 million to complete the acquisition of four hospitals. During the
year ended March 31, 2008, $4.9 million in restricted cash was released to the
Company.
40
<page>
Net cash provided by financing activities for the years ended March 31,
2008 and 2007 and December 31, 2005 was $2.5 million, $1.0 million, and $92.8
million, respectively. The increase in net cash provided by financing activities
for the years ended March 31, 2008 and 2007 and December 31, 2005 was primarily
represented by $5.7 million, $2.0 million, and $77.8 million, respectively, in
proceeds from credit facilities.
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
FISCAL YEAR ENDED MARCH 31, 2008 COMPARED TO FISCAL YEAR ENDED MARCH 31, 2007
The following table sets forth, for the years ended March 31, 2008 and
2007, our consolidated statements of operations expressed as a percentage of net
operating revenues.
Years ended March 31,
----------------------------
2008 2007
------------ ------------
Net operating revenues 100% 100%
Operating expenses 100% 102%
------------ ------------
Operating income (loss) 0% (2%)
------------ ------------
Other expense:
Interest expense, net (4%) (4%)
Common stock warrant expense (3%) 0%
Change in fair value of warrant liability (4%) 0%
------------ ------------
Other expense, net (11%) (4%)
------------ ------------
Loss before provision for income
taxes and minority interest (11%) (6%)
Provision for income taxes (0%) 0%
Minority interest in variable interest entity (0%) 0%
------------ ------------
Net loss (11%) (6%)
============ ============
41
<page>
NET OPERATING REVENUES - Net operating revenues for the year ended
March 31, 2008 increased 4.8% compared to the same period in fiscal year 2007
from $350.7 million to $367.7 million. During the years ended March 31, 2008 and
2007, the Company was granted $4.8 million and $3.5 million, respectively, for
indigent care. Admissions for the year ended March 31, 2008 increased 0.7%
compared to the same period in fiscal year 2007. Revenue per admission improved
by 4.1% during the year ended March 31, 2008 as a result of negotiated managed
care and governmental payment rate increases. Based on average revenue for
comparable services from all other payers, revenues foregone under the charity
policy, including indigent care accounts, for the years ended March 31, 2008 and
2007 were $7.4 million and $8.1 million, respectively.
Essentially all net operating revenues come from external customers.
The largest payers are the Medicare and Medicaid programs accounting for 66% and
65% of the net operating revenues for the years ended March 31, 2008 and 2007,
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 $336.8 million (net revenues of
$367.7 million less $30.9 million in provision for doubtful accounts) and $315.5
million (net revenues of $350.7 million less $35.2 million in provision for
doubtful accounts) for the years ended March 31, 2008 and 2007, respectively, an
increase of $21.3 million, or 6.0% per admission. In addition to the payment
rate increases to revenue referred to above, this was the result of 6.3%
improvement in collection.
OPERATING EXPENSES - Operating expenses for the year ended March 31,
2008 increased to $366.9 million from $359.1 million, an increase of $7.8
million or 2.2% compared to the same period in fiscal year 2007. The increase in
operating expenses was primarily the result of the increase in admissions of
0.7%. Operating expenses expressed as a percentage of net operating revenues for
the years ended March 31, 2008 and 2007 were 99.8% and 102.3%, respectively.
This improvement is substantially a result of the improvement in revenues. On a
per admission basis operating expenses increased only 1.5%.
Salaries and benefits increased $14.8 million (7.6%) for the year ended
March 31, 2008 compared to the same period in fiscal year 2007, primarily due to
wage increases, bonuses and union settlements of $0.7 million and severance
agreement of $0.5 million during the year ended March 31, 2008. Other operating
expenses relative to net operating revenues for the year ended March 31, 2008
were substantially unchanged compared to the same period in fiscal year 2007.
The provision for doubtful accounts for the year ended March 31, 2008
decreased to $30.9 million from $35.2 million, or 12.2%, compared to the same
period in fiscal year 2007. The decrease in the provision for doubtful accounts
for the year ended March 31, 2008 is primarily due to improvements in recoveries
of bad debt and a reduction in unfunded patients compared to the same period in
fiscal year 2007.
The loss on sale of accounts receivable for the years ended March 31,
2008 and 2007 was $4.1 million and $10.4 million, respectively. 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 INCOME (LOSS) - Operating income for the year ended March 31,
2008 was $0.8 million compared to a loss of $8.5 million for the year ended
March 31, 2007. The increase in income in fiscal year 2008 is primarily due to
the increase in revenues, decrease in the provision for doubtful accounts,
termination of the APA, and repurchase of previously sold receivables in
connection with the refinancing.
OTHER INCOME (EXPENSE) - For the year ended March 31, 2008 there was a
$14.4 million increase in the change in fair value of warrant liability compared
to the comparable period in fiscal year 2007. For the year ended March 31, 2008
there was a $10.7 million increase in common stock warrant expense compared to
the comparable period in fiscal year 2007.
42
<page>
Interest expense for the year ended March 31, 2008 was $1.1 million
more than the same period in fiscal year 2007 due to $1.6 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 arrangements.
NET LOSS - Net loss for the year ended March 31, 2008 was $39.6 million
compared to a net loss of $20.5 million for the same period in fiscal year 2007.
FISCAL YEAR ENDED MARCH 31, 2007 COMPARED TO FISCAL YEAR ENDED DECEMBER 31, 2005
The following table sets forth, for the years ended March 31, 2007 and
December 31, 2005, our consolidated statements of operations expressed as a
percentage of net operating revenues. The year ended December 31, 2005 reflects
only the 299 days of operations from the Acquisition date.
Years ended
----------------------------
March 31, December 31,
2007 2005
------------ ------------
Net operating revenues 100% 100%
Operating expenses 102% 106%
------------ ------------
Operating loss (2%) (6%)
------------ ------------
Other expense:
Interest expense, net (4%) (4%)
Common stock warrant expense 0% (6%)
Change in fair value of warrant liability 0% (1%)
------------ ------------
Other expense, net (4%) (11%)
------------ ------------
Loss before provision for income
taxes and minority interest (6%) (17%)
Provision for income taxes 0% 0%
Minority interest in variable interest entity 0% 1%
------------ ------------
Net loss (6%) (16%)
============ ============
NET OPERATING REVENUES - Net operating revenues less provision for
doubtful accounts increased approximately 28.1% to approximately $315.5 million
during the fiscal year ended March 31, 2007 from approximately $246.3 million
during the fiscal year ended December 31, 2005. The increase is primarily due to
an increase in volumes. Adjusted patient days increased approximately 20.9% and
adjusted admissions increased approximately 21.9%. The increased volumes are due
to a 22.1% increase in the number of operating days during the fiscal year ended
March 31, 2007, as the acquisition of Hospitals occurred on March 8, 2005. Also
contributing to the increase in net operating revenues less provision for
doubtful accounts is negotiated contract increases executed during the latter
part of fiscal 2005 and fiscal 2007 and an increase in bad debt recoveries
during fiscal 2007.
43
<page>
OPERATING EXPENSES - Operating expenses less provision for doubtful
accounts as a percentage of net operating revenues less provision for doubtful
accounts decreased by approximately 3.7% during fiscal 2007 compared to fiscal
2005. The reduction is primarily due to cost reductions and improved
efficiencies.
Salaries and benefits decreased approximately 0.6% as a percentage of
net operating revenues less provision for doubtful accounts during fiscal 2007
compared to fiscal 2005. Salaries and benefits percentage increases due to wage
increases and associated with bringing certain previously contracted services in
house were offset by decreases due to labor and staffing efficiencies realized.
Remaining operating expenses as a percentage of net operating revenues
less provision for doubtful accounts decreased by approximately 2.9% during
fiscal 2007 compared to fiscal 2005. The decrease is primarily due to reductions
in contract service expenses, including reductions caused by bringing certain
services in house, to other operating cost reductions and to improved
efficiencies realized during fiscal 2007.
OPERATING LOSS - Loss from operations as a percentage of net revenues
less provision for doubtful accounts decreased by approximately 3.7% during
fiscal 2007 compared to fiscal 2005. The decrease is due to increases in
negotiated contract rates and bad debt recoveries in addition to increased cost
efficiencies realized during fiscal 2007.
OTHER INCOME (EXPENSE) - Other income (expense), net changed primarily
as a result of the changes in common stock warrant expense. As described more
fully in our Annual Report on Form 10-K for the year ended December 31, 2005,
warrants were initially valued and expensed during fiscal 2005, resulting in a
valuation and expense of approximately $21.1 million at December 31, 2005 and
for the year then ended, respectively. During and subsequent to fiscal 2007, as
described more fully in Note 11 and Note 18 to the Consolidated Financial
Statements contained in this Annual Report on Form 10-K/A, certain exercises of
warrants occurred. The warrant transactions resulted in the Company recognizing
a gain of approximately $133 related to the change in fair value of derivative
and additional warrant expense of approximately $693 for the year ended March
31, 2007.
Net interest expense increased to approximately $12.1 million in fiscal
2007 from approximately $9.9 million in fiscal 2005. Net interest expense
amounted to approximately 4% of net operating revenues less provision for
doubtful accounts during fiscal 2007 and fiscal 2005.
NET LOSS - Net loss for the year ended March 31, 2007 was $20.5 million
compared to a net loss of $45.2 million for the year ended December 31, 2005.
The decrease in net loss in fiscal 2007 was primarily due to a decrease in
warrant expense of approximately $16.9 million and a decrease in operating
losses of approximately $7.4 million offset by an increase in interest expense
of approximately $2.2 million.
44
<page>
THREE MONTHS ENDED MARCH 31, 2006 [AUDITED] COMPARED TO THREE MONTHS ENDED
MARCH 31, 2005 [UNAUDITED]
The following table sets forth, for the three months ended March 31,
2006 and 2005, our consolidated statements of operations expressed as a
percentage of net operating revenues. The three months ended March 31, 2005
reflects only the 24 days of operations from the Acquisition date.
Three months ended March 31,
--------------------------------
2006 2005
--------------- -------------
Net operating revenues 100% 100%
Operating expenses 103% 105%
--------------- -------------
Operating loss (3%) (5%)
--------------- -------------
Other income (expense):
Interest expense, net (4%) (3%)
Common stock warrant expense 0% (79%)
Change in fair value of warrant liability 9% 0%
--------------- -------------
Other income (expense), net 5% (82%)
--------------- -------------
Income (loss) before provision for income
taxes and minority interest 2% (87%)
Provision for income taxes 0% (4%)
Minority interest in variable interest entity 0% 0%
--------------- -------------
Net income (loss) 2% (91%)
=============== =============
NET OPERATING REVENUES - Consolidated net operating revenues, on a
calendar day basis (using 24 days for the three months ended March 31, 2005 -
"Acquisition" days), increased 5.7% during the three months ended March 31, 2006
as a result of contract rate increases. Average daily census remained unchanged.
OPERATING EXPENSES - Operating expenses decreased as a percent of
revenues by 1.7% during the three months ended March 31, 2006 which equates to
inflationary increases (net of efficiencies) of 4.8%.
The provision for doubtful accounts as a percentage of revenue
decreased to 9.6% for the three months ended March 31, 2006 from 14.4% in the
comparable period in 2005, more than offsetting the $2.8 million loss on sale of
accounts receivable incurred during the three months ended March 31, 2006.
Salaries and benefits (adjusted for Acquisition days) increased $2.0
million or 4.3% during the three months ended March 31, 2006, slightly under the
average wage increase which ranged from 5-6%. Supplies increased $0.6 million or
5.8% during the three months ended March 31, 2006 primarily due to inflationary
pressures.
Remaining operating expenses (adjusted for Acquisition days) increased
approximately $4.6 million during the three months ended March 31, 2006. The
most significant increases in other operating expenses related to medical fees
for emergency coverage, data processing fees for system conversions and medical
equipment repairs.
OPERATING LOSS - Loss from operations as a percent of revenue improved
by 1.7% during the three months ended March 31, 2006 due to rate improvements in
excess of cost increases.
45
<page>
OTHER INCOME (EXPENSE), NET - Other income (expense), net, changed
primarily as a result of the changes in fair value of warrants. The initial
valuation of warrants issued in the first quarter of 2005 was $17.2 million. As
described more fully in our Annual Report on Form 10-K for the year ended
December 31, 2005, this was revalued to $17.6 million on December 12, 2005 and
subsequently increased to $21.1 million as of December 31, 2005. As of March 31,
2006, the fair value of these warrants had decreased to $12.9 million, resulting
in a gain of $8.2 million during the three months ended March 31, 2006.
Interest costs of 3.7% of revenue during the three months ended March
31, 2006 and 3.1% of revenue during the three months ended March 31, 2005 were
relatively consistent between the periods as a percentage of revenue.
PROVISION FOR INCOME TAXES - The provision for income taxes for the
three months ended March 31, 2006 was $5 compared to $0.9 million for the
comparable period in 2005. The provision for income taxes during the three
months ended March 31, 2005 was reversed in the subsequent quarter as a result
of the impact of the implementation of the Accounts Purchase Agreement.
NET INCOME (LOSS) - Net income for the three months ended March 31,
2006 was $2.4 million compared to a net loss of $19.9 million for the three
months ended March 31, 2005. The decrease in the loss in 2006 was primarily due
to the decrease in Common stock expense of $17.2 million and the increase in the
fair value of derivative of $8.2 million.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
REVENUE RECOGNITION - Net operating revenues are recognized in the
period in which services are performed and are recorded based on established
billing rates (gross charges) less estimated discounts for contractual
allowances, principally for patients covered by Medicare, Medicaid, managed care
and other health plans. Gross charges are retail charges. They are not the same
as actual pricing, and they generally do not reflect what a hospital is
ultimately paid and therefore are not displayed in the consolidated statements
of operations. Hospitals are typically paid amounts that are negotiated with
insurance companies or are set by the government. Gross charges are used to
calculate Medicare outlier payments and to determine certain elements of payment
under managed care contracts (such as stop-loss payments). Because Medicare
requires that a hospital's gross charges be the same for all patients
(regardless of payer category), gross charges are also what the 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 of $12 and
settlement receivables of $909 as of March 31, 2008 and 2007, respectively.
Outlier payments, which were established by Congress as part of the
diagnosis-related groups ("DRG") prospective payment system, are additional
payments made to Hospitals for treating Medicare patients who are costlier to
treat than the average patient in the same DRG. To qualify as a cost outlier, a
hospital's billed (or gross) charges, adjusted to cost, must exceed the payment
rate for the DRG by a fixed threshold established annually by the Centers for
Medicare and Medicaid Services of the United States Department of Health and
Human Services ("CMS"). Under Sections 1886(d) and 1886(g) of the Social
Security Act, CMS must project aggregate annual outlier payments to all
prospective payment system Hospitals to be not less than 5% or more than 6% of
46
<page>
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 to $22.185. 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, a hospital receives 80% of the difference as
an outlier payment. Medicare has reserved the option of adjusting outlier
payments, through the cost report, to a 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 and $1,919 in Final Notice of Program Reimbursement settlements
during the years ended March 31, 2008 and 2007, respectively. There were no
adjustments for Final Notice of Program Reimbursement received during the year
ended December 31, 2005 and the three months ended March 31, 2006. As of March
31, 2008 and 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 of $1,678 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 of $1,690 and $922 as of March 31,
2008 and 2007, respectively.
The Hospitals receive supplemental payments from the State of
California to support indigent care (Medi-Cal Disproportionate Share Hospital
payments or "DSH") and from the California Medical Assistance Commission
("CMAC"). The Hospitals received supplemental payments of $16,175, $24,526, and
$11,022, and $575 during the years ended March 31, 2008 and 2007 and December
31, 2005, and the three months ended March 31, 2006, respectively. The related
revenue recorded for the years ended March 31, 2008 and 2007 and December 31,
2005, and for the three months ended March 31, 2006 was $19,675, $17,897,
$13,943, and $4,240, respectively. As of March 31, 2008 and 2007, estimated DSH
receivables of $4,877 and $1,378 are included in due from governmental payers in
the accompanying 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.
47
<page>
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 $7.4 million, $8.1 million, $2.9
million, and $1.5 million for the years ended March 31, 2008 and 2007 and
December 31, 2005, and the three months ended March 31, 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, 2008 and 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 consolidated financial statements.
PROVISION FOR DOUBTFUL ACCOUNTS - The Company provides for accounts
receivable that could become uncollectible by establishing an allowance to
reduce the carrying value of such receivables to their estimated net realizable
value. The Hospitals estimate this allowance based on the aging of their
accounts receivable, historical collections experience for each type of payer
and other relevant factors. There are various factors that can impact the
collection trends, such as changes in the economy, which in turn have an impact
on unemployment rates and the number of uninsured and underinsured patients,
volume of patients through the emergency department, the increased burden of
co-payments to be made by patients with insurance and business practices related
to collection efforts. These factors continuously change and can have an impact
on collection trends and the estimation process.
The Company'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 was contracted
with CalOptima, which is a county sponsored entity that operates similarly to an
HMO, to provide healthcare 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.
48
<page>
In certain circumstances, members would receive healthcare 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 healthcare 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 SFAS No. 5, the Company
accrues for IBNR claims when it is probable that expected future healthcare
costs and maintenance costs under an existing contract have been incurred and
the amount can be reasonably estimated. The Company records a charge related to
these IBNR claims against its net operating revenues. The Company's net revenues
from CalOptima capitation, net of third party claims and estimates of IBNR
claims, for the years ended March 31, 2008 and 2007 and December 31, 2005, and
the three months ended March 31, 2006 were $0.35 million, $1.3 million, $3.2
million, and $1.4 million, respectively. IBNR claims accruals at March 31, 2008
and 2007 were $1.5 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 and are discounted to their net present value using a weighted
average risk-free discount rate of 5%. To the extent that subsequent claims
information varies from estimates, the liability is adjusted in the period such
information becomes available. As of March 31, 2008 and 2007, the Company had
accrued $9.9 million and $4.9 million, respectively, which is comprised of $3.0
million and $1.4 million, respectively, in incurred and reported claims, along
with $6.9 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 and are discounted to their net present value using a weighted
average risk-free discount rate of 5%. To the extent that subsequent claims
information varies from estimates, the liability is adjusted in the period such
information becomes available. As of March 31, 2008 and 2007, the Company had
accrued $710 and $1,000, respectively, comprised of $169 and $200, respectively,
in incurred and reported claims, along with $541 and $800, 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 March 31, 2008 was based
upon projections. 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 March 31, 2008, the Company
had accrued $1.7 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 March 31, 2008. 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.
49
<page>
The Company has also purchased umbrella liability policies with
aggregate limits of $25 million. The umbrella policies provide coverage in
excess of the primary layer and applicable retentions for insured liability
risks such as general and professional liability, auto liability, and workers
compensation (employers liability).
The Company finances various insurance policies at interest rates
ranging from 4.23% to 6.35% per annum. The Company incurred finance charges
relating to such policies of $123, $248, $89, and $1 during the years ended
March 31, 2008 and 2007 and December 31, 2005, and the three months ended March
31, 2006, respectively.
VARIABLE INTEREST ENTITY - Concurrent with the close on the
Acquisition, and pursuant to an agreement dated September 28, 2004, as amended
and restated on November 16, 2004, Dr. Chaudhuri and Dr. Shah exercised their
option to purchase all of the equity interests in PCHI, which simultaneously
acquired title to substantially all of the real property acquired by the Company
in the Acquisition. The Company received $5.0 million and PCHI guaranteed the
Company's Acquisition Loan (the Acquisition Loan was refinanced on October 9,
2007 with a $45.0 million Term Note). 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 a guarantor 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. PCHI is a related party entity that
is affiliated with the Company through common ownership and control. It is owned
51% by West Coast Holdings, LLC (Dr. Shah and investors) and 49% by Ganesha
Realty, LLC (Dr. Chaudhuri and Mr. Thomas). Under FIN 46R, a company is required
to consolidate the financial statements of any entity that cannot finance its
activities without additional subordinated financial support, and for which one
company provides the majority of that support through means other than
ownership. Effective March 8, 2005, the Company determined that it provided the
majority of financial support to PCHI through various sources including lease
payments, remaining primarily liable under the $45.0 million Term Note, and
cross collateralization of the Company's non-real estate assets to secure the
$45.0 million Term Note. Accordingly, the Company included the net assets of
PCHI, net of consolidation adjustments, in its consolidated financial statements
at March 31.
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. SFAS No. 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.
On February 14, 2008, the FASB issued FASB Staff Position No. FAS
157-1, "Application of FASB Statement No. 157 to FASB Statement No. 13 and Other
Accounting Pronouncements That Address Fair Value Measurements for Purposes of
Lease Classification or Measurement under Statement 13" ("FSP FAS 157-1"). This
Statement does not apply under FASB Statement No. 13, "Accounting for Leases,"
and other accounting pronouncements that address fair value measurements for
purposes of lease classification or measurement under Statement 13. This scope
exception does not apply to assets acquired and liabilities assumed in a
business combination that are required to be measured at fair value under SFAS
141 or SFAS 141R, regardless of whether those assets and liabilities are related
to leases.
50
<page>
On February 12, 2008, the FASB issued FASB Staff Position No. FAS
157-2, "Effective Date of FASB Statement No. 157" ("FSP FAS 157-2"). With the
issuance of FSP FAS 157-2, the FASB agreed to: (a) defer the effective date in
SFAS No. 157 for one year for certain nonfinancial assets and nonfinancial
liabilities, except those that are recognized or disclosed at fair value in the
financial statements on a recurring basis (at least annually), and (b) remove
certain leasing transactions from the scope of SFAS No. 157. The deferral is
intended to provide the FASB time to consider the effect of certain
implementation issues that have arisen from the application of SFAS No. 157 to
these assets and liabilities.
In December 2007, the FASB issued SFAS No. 141(R) "Business
Combinations" ("SFAS 141R"). The statement retains the purchase method of
accounting for acquisitions, but requires a number of changes, including changes
in the way assets and liabilities are recognized in the purchase accounting as
well as requiring the expensing of acquisition-related costs as incurred.
Furthermore, SFAS 141R provides guidance for recognizing and measuring the
goodwill acquired in the business combination and determines what information to
disclose to enable users of the financial statements to evaluate the nature and
financial effects of the business combination. SFAS 141R is effective for fiscal
years beginning on or after December 15, 2008. Earlier adoption is prohibited.
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 No. 159 permits entities to choose to measure many
financial instruments and certain other items at fair value. Most of the
provisions of SFAS No. 159 apply only to entities that elect the fair value
option; however, the amendment to SFAS 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. 160, "Noncontrolling
Interests in Consolidated Financial Statements -- An Amendment of ARB No. 51"
("SFAS 160"). SFAS 160 requires all entities to report noncontrolling(minority)
interests in subsidiaries as equity in the consolidated financial statements.
Also, SFAS 160 is intended to eliminate the diversity in practice regarding the
accounting for transactions between an equity and noncontrolling interests by
requiring that they be treated as equity transactions. SFAS 160 is effective for
fiscal years beginning on or after December 15, 2008. Earlier adoption is
prohibited. SFAS 160 must be applied prospectively as of the beginning of the
fiscal year in which it is initially applied, except for the presentation and
disclosure requirements, which must be applied retrospectively for all periods
presented. The Company has not yet evaluated the impact that SFAS 160 will have
on its consolidated results of operations or financial position.
In March 2008, the FASB issued SFAS No. 161, "Disclosures about
Derivative Instruments and Hedging Activities" ("SFAS 161"). SFAS 161 is
intended to improve financial reporting of derivative instruments and hedging
activities by requiring enhanced disclosures to enable financial statement users
to better understand the effects of derivatives and hedging on an entity's
financial position, financial performance and cash flows. The provisions of SFAS
161 are effective for interim periods and fiscal years beginning after November
15, 2008. The Company does not anticipate that the adoption of SFAS No. 161 will
have a material impact on its consolidated results of operations or financial
position.
51
<page>
May 9, 2008, the FASB issued FASB Staff Position No. APB 14-1,
"Accounting for Convertible Debt Instruments That May Be Settled in Cash upon
Conversion (Including Partial Cash Settlement)" ("FSP APB 14-1"). FSP APB 14-1
clarifies that convertible debt instruments that may be settled in cash upon
conversion (including partial cash settlement) are not addressed by paragraph 12
of APB Opinion No. 14, "Accounting for Convertible Debt and Debt Issued with
Stock Purchase Warrants." Additionally, FSP APB 14-1 specifies that issuers of
such instruments should separately account for the liability and equity
components in a manner that will reflect the entity's nonconvertible debt
borrowing rate when interest cost is recognized in subsequent periods. FSP APB
14-1 is effective for financial statements issued for fiscal years beginning
after December 15, 2008, and interim periods within those fiscal years. The
Company has not yet evaluated the impact that FSP APB 14-1 will have on its
consolidated results of operations or financial position.
OFF BALANCE SHEET ARRANGEMENTS
As of March 31, 2008 the Company had no off-balance sheet arrangements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of March 31, 2008, we did not have any investment in or outstanding
liabilities under market rate sensitive instruments. We do not enter into
hedging instrument arrangements.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following consolidated financial statements are filed as a part of
this report beginning on page F-1:
------ -------------------------------------------------------------------
PAGE DESCRIPTION
------ -------------------------------------------------------------------
F-1 Report of Independent Registered Public Accounting Firm
------ -------------------------------------------------------------------
F-2 Report of prior Independent Registered Public Accounting Firm
------ -------------------------------------------------------------------
F-3 Consolidated Balance Sheets as of March 31, 2008 (restated) and 2007
------ -------------------------------------------------------------------
F-4 Consolidated Statements of Operations for the years ended
March 31, 2008 (restated) and 2007 and December 31, 2005 and the
three months ended March 31, 2006
------ -------------------------------------------------------------------
F-5 Consolidated Statements of Stockholders' Deficiency for the years
ended March 31, 2008 (restated) and 2007 and December 31, 2005
and the three months ended March 31, 2006
------ -------------------------------------------------------------------
F-6 Consolidated Statements of Cash Flows for the years ended
March 31, 2008 (restated) and 2007 and December 31, 2005 and the
three months ended March 31, 2006
------ -------------------------------------------------------------------
F-7 Notes to Consolidated Financial Statements
------ -------------------------------------------------------------------
F-41 Schedule II - Valuation and Qualifying Accounts for the years
ended March 31, 2008 and 2007 and December 31, 2005 and the three
months ended March 31, 2006
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
ITEM 9A(T). CONTROLS AND PROCEDURES
Management's Report on Internal Control Over Financial Reporting -
Management of Integrated Healthcare Holdings, Inc. is responsible for the
preparation, integrity and fair presentation of its published consolidated
financial statements. The financial statements have been prepared in accordance
with U.S. generally accepted accounting principles and, as such, include amounts
based on judgments and estimates made by management. The Company also prepared
the other information included in the annual report and is responsible for its
accuracy and consistency with the consolidated financial statements.
52
<page>
Management is also responsible for establishing and maintaining
effective internal control over financial reporting. The Company's internal
control over financial reporting includes those policies and procedures that
pertain to the Company's ability to record, process, summarize and report
reliable financial data. The Company maintains a system of internal control over
financial reporting, which is designed to provide reasonable assurance to the
Company's management and board of directors regarding the preparation of
reliable published financial statements and safeguarding of the Company's
assets. The system includes a documented organizational structure and division
of responsibility, established policies and procedures, including a code of
conduct to foster a strong ethical climate, which are communicated throughout
the Company, and the careful selection, training and development of our people.
The Board of Directors, acting through its Audit Committee, is
responsible for the oversight of the Company's accounting policies, financial
reporting, and internal control. The Audit Committee of the Board of Directors
is comprised entirely of outside directors who are independent of management.
The Audit Committee is responsible for the appointment and compensation of the
independent registered public accounting firm. It meets periodically with
management, the independent registered public accounting firm, and the internal
auditors to ensure that they are carrying out their responsibilities. The Audit
Committee is also responsible for performing an oversight role by reviewing and
monitoring the financial, accounting and auditing procedures of the Company in
addition to reviewing the Company's financial reports. Internal auditors monitor
the operation of the internal control system and report findings and
recommendations to management and the Audit Committee. Corrective actions are
taken to address control deficiencies and other opportunities for improving the
internal control system as they are identified. The independent registered
public accounting firm and the internal auditors have full and unlimited access
to the Audit Committee, with or without management, to discuss the adequacy of
internal control over financial reporting, and any other matters which they
believe should be brought to the attention of the Audit Committee.
Management recognizes that there are inherent limitations in the
effectiveness of any system of internal control over financial reporting,
including the possibility of human error and the circumvention or overriding of
internal control. Accordingly, even effective internal control over financial
reporting can provide only reasonable assurance with respect to financial
statement preparation and may not prevent or detect misstatements. Further,
because of changes in conditions, the effectiveness of internal control over
financial reporting may vary over time.
The Company assessed its internal control system as of March 31, 2008
in relation to criteria for effective internal control over financial reporting
described in "Internal Control - Integrated Framework" issued by the Committee
of Sponsoring Organizations of the Treadway Commission. Based on its assessment,
the Company has determined that, as of March 31, 2008, its system of internal
control over financial reporting was not effective. 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. The Company identified a weakness
in the level of clerical effort involved in the calculation of contractual
discounts for certain long term patients and implemented new procedures that
centralize the calculations and provide greater structure and oversight designed
to reduce the risk of clerical error. The Company identified as a result of this
change clerical errors at one of its facilities that, while not otherwise
material, resulted in a technical violation of its loan covenants because they
were not detected timely. Based on the foregoing, the Company's Chief Executive
Officer and Chief Financial Officer concluded that the Company's disclosure
controls and procedures were not effective as of March 31, 2008 as previously
reported. We believe the modified procedures provide adequate evidence that the
weakness was remediated as of June 30, 2008.
53
<page>
This annual report does not include an attestation report of the
Company's registered public accounting firm regarding internal control over
financial reporting. Management's report was not subject to attestation by the
Company's registered public accounting firm pursuant to temporary rules of the
Securities and Exchange Commission that permit the Company to provide only
management's report in this annual report.
ITEM 9B. OTHER INFORMATION
On June 10, 2008, the Company and Medical Provider Financial
Corporation I entered into Amendment No. 1 to $50 Million Revolving Credit
Agreement. The Amendment is effective for the period from January 1, 2008
through June 30, 2009, and reduced the minimum fixed charge coverage ratio, as
defined in the $50 Million Revolving Credit Agreement, from 1.0 to 0.4. A copy
of the Amendment is filed as Exhibit 10.11.1 to this Report.
On June 20, 2008, the Company and Medical Provider Financial
Corporation III entered into Amendment No. 2 to $50 Million Revolving Credit
Agreement. The Amendment replaced in its entirety the definition of Material
Adverse Effect. A copy of the Amendment is filed as Exhibit 10.11.2 to this
Report.
54
<page>
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The following table contains certain information concerning our
directors and executive officers as of March 31, 2008:
---------------------------- ------ --------------------------------------- ----------------------
NAME AGE POSITION WITH COMPANY DATE BECAME DIRECTOR
---------------------------- ------ --------------------------------------- ----------------------
Ajay G. Meka, M.D. 57 Chairman of the Board September 28, 2006
---------------------------- ------ --------------------------------------- ----------------------
Maurice J. DeWald 68 Director August 1, 2005
---------------------------- ------ --------------------------------------- ----------------------
Hon. C. Robert Jameson 68 Director July 11, 2007
---------------------------- ------ --------------------------------------- ----------------------
Michael Metzler 62 Director September 5, 2007
---------------------------- ------ --------------------------------------- ----------------------
Bruce Mogel 50 Director, Chief Executive Officer & November 18, 2003
President
---------------------------- ------ --------------------------------------- ----------------------
J. Fernando Niebla 68 Director August 1, 2005
---------------------------- ------ --------------------------------------- ----------------------
William E. Thomas 59 Director September 5, 2007
---------------------------- ------ --------------------------------------- ----------------------
Steven R. Blake 55 Chief Financial Officer &
Executive Vice President, Finance
---------------------------- ------ --------------------------------------- ----------------------
Daniel J. Brothman 53 Chief Operating Officer
---------------------------- ------ --------------------------------------- ----------------------
Jeremiah R. Kanaly 61 Chief Accounting Officer & Treasurer
---------------------------- ------ --------------------------------------- ----------------------
AJAY G. MEKA, M.D has been Chairman of the Board of Directors of the
Company since September 28, 2006. Dr. Meka has been a licensed physician in
California for the past 23 years. He is a board certified physician practicing
in Orange County, California. Dr. Meka received his medical degree from Guntur
Medical College in Gunter, India. He performed his postgraduate training at
Brooklyn Jewish Hospital and Coney Island Hospital, both in Brooklyn, New York.
MAURICE J. DEWALD has served as a member of the Board of Directors of
the Company since August 1, 2005 and sits on the Audit Committee, Compensation
Committee, Finance Committee and Special Committee. Mr. DeWald is Chairman and
Chief Executive Officer of Verity Financial Group, Inc., a private investment
firm that he founded in 1992. From 1962-1991, Mr. DeWald was with KPMG LLP, one
of the world's largest international accounting and tax consulting firms, where
he served at various times as director and as the Managing Partner of the
Chicago, Orange County and Los Angeles Offices. Mr. DeWald is a director of
Mizuho Corporate Bank of California, Advanced Materials Group, Inc., NNN
Healthcare/Office REIT, Inc., and FileScan, Inc., and is a former director of
Tenet Healthcare Corporation and Quality Systems, Inc. He also sits on the
Advisory Council of the University of Notre Dame Mendoza School of Business. Mr.
DeWald is a past Chairman and director of United Way of Greater Los Angeles. Mr.
DeWald received a B.B.A. from the University of Notre Dame in 1962. He is also a
Certified Public Accountant.
HON. C. ROBERT JAMESON has been a director of the Company since July
11, 2007. Judge Jameson is a retired Orange County Superior judge now affiliated
with Judicate West, handling complex alternative dispute resolution matters.
Before leaving the bench, he was Presiding Judge of the Orange County Superior
Court Appellate Division. Judge Jameson obtained his B.A. degree in Political
Science from the University of California at Davis in 1963 and his Juris Doctor
degree at the University of California, Hastings College of the Law in 1966. He
served as a judge from 1984-2005 and also was President of the Banyard Inn of
Court and an Adjunct Professor of Law at Whittier Law School during his tenure.
Judge Jameson was awarded "Judge of the Year" nine times over the course of his
career by organizations such as: the Orange County Bar Association Business
Litigation section, Orange County Trial Lawyers, the American Board of Trial
Advocates and the Consumer Attorneys of California.
55
<page>
MICHAEL METZLER has served as President and Chief Executive Officer of
the Santa Ana Chamber of Commerce since January 1983. Mr. Metzler directs and
controls all activities of this multi-million dollar organization and its
subsidiaries, including SACPAC, the chamber's political action committee, and
the Greater Santa Ana Vitality Foundation, the chamber's charitable foundation.
He has led numerous community initiatives and campaigns that have grown the
local economy and advanced the prosperity of business, including a $145 million
local school bond campaign in 1999, a $100+ million private development
initiative in 2005, and a new career-oriented technical high school in 2006. He
also founded the chamber's nationally award-winning 73,000-circulation
newspaper, CityLine, in 1996, for which he serves as its publisher. Mr. Metzler
has served on numerous community boards, city commissions and county, regional,
state, and national task forces, and currently serves as Chairman of the Board
of Trustees of Coastal Communities Hospital. Metzler also was a founder of the
Santa Ana Business Bank and sits on its Board of Directors. Mr. Metzler is a
graduate of California State University, Fullerton, and attended Loyola
University School of Law and the Peter F. Drucker Graduate School of Management
at Claremont University.
BRUCE MOGEL has served Chief Executive Officer and director of the
Company since November 18, 2003. Mr. Mogel has over 25 years of experience in
operational management and has held several lead executive roles in the
healthcare field. Most recently, from 1999-2002, Mr. Mogel served as Executive
Vice President of Operations for Doctors' Community Healthcare Corp, where he
was responsible for the operations and profitability of five acute care
hospitals and one psychiatric hospital, and managed a team of six hospital CEOs
and other senior management members. Mr. Mogel earned his Bachelor's degree from
The State University of New York at Buffalo with a degree in English.
J. FERNANDO NIEBLA has served as a member of the Board of Directors of
the Company since August 1, 2005 and sits on the Audit Committee, Compensation
Committee, Finance Committee and Special Committee. He has served as President
of International Technology Partners, LLC, an information technology and
business consulting services company based on Orange County, California since
August 1998. He is also a founder of Infotec Development Inc. and Infotec
Commercial Systems, two national information technology firms. He currently
serves on the Boards of Directors of Union Bank of California, Pacific Life
Corp. and Granite Construction Corp., the Board of Trustees of the Orange County
Health Foundation, and is the Chairman of the California Advisory Committee to
Nacional Financiera, a Mexican Government agency similar to the U.S. Government
Small Business Administration office. Mr. Niebla holds a B.S. degree in
Electrical Engineering from the University of Arizona and an M.S. QBA from the
University of Southern California.
WILLIAM E. THOMAS is the Executive Vice President and General Counsel
of Strategic Global Management, Inc., a healthcare ventures firm in Riverside,
California. Mr. Thomas has served in such capacity since October of 1998. Prior
to that Mr. Thomas was a founding and managing partner of a law firm in
Riverside, California specializing in business, real estate, and other
transactional matters. Mr. Thomas graduated from the University of California at
Santa Barbara with a Bachelor of Arts degree in History and Political Science.
He holds a Juris Doctor degree from the University of California, Hastings
College of the Law, and a Master of Laws degree from New York University. He is
a member of the California Bar Association.
STEVEN R. BLAKE has served as Chief Financial Officer of the Company
since July 1, 2005 and Executive Vice President, Finance since March 21, 2008.
He is a California licensed Certified Public Accountant. Mr. Blake came to the
Company with over 20 years of experience in multi-hospital financial management.
He also has extensive experience serving in financial roles with public
companies. Most recently, he served as Regional Vice President of Finance for
Tenet Healthcare Corporation ("Tenet"), a position he held for over 17 years. In
this position, Mr. Blake was responsible for the financial management of
numerous Tenet assets covering five western states (California, Arizona,
Washington, Nebraska and Texas). Mr. Blake's strong hospital financial
background combined with his knowledge of public company requirements made him a
strong addition to the Company's corporate team.
56
<page>
DANIEL J. BROTHMAN has served as Chief Operating Officer since May 6,
2008 and as Chief Executive Officer of Western Medical Center - Santa Ana since
March 8, 2005. Mr. Brothman also served as Senior Vice President, Operations of
the Company from March 8, 2005 to May 6, 2008. Mr. Brothman is an experienced
single and multi-hospital operations executive. Since 1999, prior to the
acquisition of the Hospitals by the Company he helped build the Western Medical
Center in Santa Ana for Tenet. Mr. Brothman also ran Columbia Healthcare's Utah
Division from 1996 to 1998. Mr. Brothman has in excess of 30 years experience in
hospital administration. Mr. Brothman earned his Bachelor of Arts degree from
Washington University at St. Louis and his Master's in Health Care
Administration from the University of Colorado at Denver.
JEREMIAH R. KANALY has served as Chief Accounting Officer and Treasurer
of the Company since September 2007. Mr. Kanaly has over 30 years experience in
financial management. Mr. Kanaly is a former partner with KPMG LLP and has
served as Chief Financial Officer of several companies including ViewSonic
Corporation and Saleen Inc., and as a consultant with Resources Global. Mr.
Kanaly is a graduate of the Anderson School of Management at the University of
California at Los Angeles and California State University at Northridge. He is a
California licensed Certified Public Accountant.
Directors DeWald, Metzler, and Niebla constitute the Audit Committee of
the Board of Directors. The Company does not have a Nominating Committee as the
entire Board of Directors performs the functions of this committee and this
process has been adequate to handle the Board nomination process to date.
Directors DeWald, Meka, Metzler, and Niebla each satisfy the definition of
"independent director" established in the NASDAQ listing standards. The Board of
Directors has determined that Director DeWald is an "audit committee financial
expert" as defined in the SEC rules.
Directors are elected at our annual meeting and serve until the
following annual meeting.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires our
officers and directors, and persons who own more than 10% of a registered class
of our equity securities, to file reports of ownership and changes in ownership
with the SEC. Officers, directors and greater than 10% stockholders are required
by SEC regulation to furnish us with copies of all Section 16(a) reports they
file.
Based solely upon the copies of Section 16(a) reports which we received
from such persons or written representations from them regarding their
transactions in our common stock, we believe that, during the year ended March
31, 2008, all such forms were filed in a timely fashion.
CODE OF ETHICS
We have adopted a Code of Business Conduct and Ethics that applies to
our employees (including our principal executive officer, principal financial
officer, principal accounting officer, and controller) and our directors. Our
Code of Business Conduct and Ethics can be obtained free of charge by sending a
request to our Corporate Secretary at the following address: Integrated
Healthcare Holdings, Inc., Attn: J. Scott Schoeffel, 1301 North Tustin Avenue,
Santa Ana, California 92705.
STOCKHOLDER RECOMMENDATION OF NOMINEES
While there are no formal procedures for stockholders to recommend
nominations, the Board of Directors will consider stockholder recommendations.
Such recommendations should be addressed to the Corporate Secretary at the
address listed above.
57
<page>
STOCKHOLDER COMMUNICATIONS
In order to facilitate communications with the Board of Directors, or
any individual members or any committees of the Board of Directors, stockholders
should direct all communication in writing to our General Counsel at Integrated
Healthcare Holdings, Inc., 1301 North Tustin Avenue, Santa Ana, California
92705, who will forward all such correspondence to the Board of Directors,
individual members of the Board of Directors or applicable chairpersons of any
committee of the Board of Directors, as appropriate and as directed in the
communication.
AUDIT COMMITTEE
The Audit Committee of the Board of Directors was formed in August 2005
and consists of three of our independent directors, Maurice DeWald and J.
Fernando Niebla, who joined the Board of Directors in August 2005, and Michael
Metzler, who joined the Board of Directors in September 2007. The Board of
Directors has determined that Maurice DeWald is an "audit committee financial
expert" as defined in the rules and regulations of the SEC. The Audit Committee
of the Board of Directors preapproves all audit and permissible non-audit
services to be performed by the independent auditors. The Audit Committee will
also advise management on the engagement of experts with sufficient expertise to
advise on accounting and financial reporting of complex financial transactions.
Mr. DeWald and Mr. Niebla attended all 7 Audit Committee meetings held during
fiscal 2008; Mr. Metzler attended all 3 meetings in fiscal 2008 that were held
subsequent to his appointment to the Audit Committee. The Audit Committee
Charter was filed previously as APPENDIX A to the Company's Proxy Statement
dated November 14, 2006.
Management is responsible for the Company's internal controls and
financial reporting process. The independent registered public accounting firm
is responsible for performing an independent audit of the Company's consolidated
financial statements in accordance with the standards of the Public Company
Accounting Oversight Board (United States) and to issue a report on these
consolidated financial statements. The Audit Committee's responsibility is to
oversee these activities.
In this context, the Audit Committee has met and held discussions with
management and the independent registered public accounting firm. Management
represented to the Audit Committee that the Company's consolidated financial
statements were prepared in accordance with accounting principals generally
accepted in the United States and the Audit Committee has reviewed and discussed
the consolidated financial statements with management and the independent
registered public accounting firm. The Audit Committee also discussed with the
independent registered public accounting firm matters required to be discussed
by Statement on Auditing Standards No. 114, "Communication with Audit
Committees," as modified or supplemented, including the auditor's judgment about
the quality, as well as the acceptability, of our accounting principles as
applied in the financial reporting.
Our independent registered public accounting firm also provided to the
Audit Committee the written disclosures required by the Independence Standards
Board Standard No. 1 (Independence Discussions with Audit Committees), and the
Audit Committee discussed with the independent registered public accounting firm
that firm's independence as well as internal quality control procedures.
Based on the Audit Committee's discussions with management and the
independent registered public accounting firm and the Audit Committee's review
of the representations of management and the report of the independent
registered public accounting firm to the Audit Committee, the Audit Committee
recommended to the Board of Directors, and the Board has approved, that the
audited consolidated financial statements be included in the Company's Annual
Report on Form 10-K for the year ended March 31, 2008 for filing with the
Securities and Exchange Commission. This report was submitted by Mr. DeWald,
Chair, and Messrs. Metzler and Niebla. On August 20, 2008, the Audit Committee
determined that the Company's consolidated financial statements for the year
ended March 31, 2008 should be restated due to a technical violation of
covenants under the Company's principal credit agreements. Accordingly, the
Company has included the restated consolidated financial statements in this Form
10-K/A. See Notes 5 and 16 in the accompanying notes to consolidated financial
statements.
58
<page>
ITEM 11. EXECUTIVE COMPENSATION
The Compensation Committee of the Board of Directors was formed in
October 2005 and consists of three directors, Mr. Maurice DeWald, Mr. J.
Fernando Niebla, chair, and Mr. William E. Thomas. In our fiscal year ended
March 31, 2008, the Compensation Committee held twelve meetings. The
Compensation Committee is responsible for overseeing the administration of the
Company's executive compensation programs, establishing and interpreting the
Company's compensation policies and approving all compensation paid to executive
officers, including the named executive officers listed in the Summary
Compensation Table.
The following table sets forth summary information regarding
compensation to (i) our Chief Executive Officer and our Chief Financial Officer
during the fiscal year ended March 31, 2008; (ii) each of our other most highly
compensated executive officers employed by us as of March 31, 2008 whose salary
and bonus for the fiscal year ended March 31, 2008 was in excess of $100,000 for
their services rendered in all capacities to us; and (iii) one additional
individual for whom disclosure would be required to be provided but for the fact
that the individual was not serving as an executive officer at March 31, 2008.
The listed individuals are referred to as the "Named Executive Officers."
SUMMARY COMPENSATION TABLE
Option All other
Name and Salary Bonus awards compensation Total
Principal Position Year ($) ($)(6) ($)(7) ($) ($)
- ------------------------------------- ---------- ------------ ------------ ------------ -------------- -------------
Bruce Mogel 2008 438,154 70,000 - 67,578 575,732
Chief Executive Officer (1) 2007 360,050 - - 17,244 377,294
Steven R. Blake 2008 350,000 46,375 - 46,206 442,581
Chief Financial Officer & 2007 284,519 - - 18,978 303,497
Executive Vice President, Finance (2)
Daniel J. Brothman 2008 377,692 46,375 21,000 19,248 464,315
Chief Operating Officer (3) 2007 351,089 - - 23,169 374,258
Jeremiah R. Kanaly 2008 142,788 18,188 - 9,341 170,317
Chief Accounting Officer & 2007 - - - - -
Treasurer (4)
Larry B. Anderson 2008 525,231 30,000 - 145,102 700,333
President (5) 2007 360,000 - - 23,892 383,892
(Former)
(1) All other compensation for 2008 includes auto allowance of $16,000,
Manager's Time Off (MTO) pay out of $40,385 for accrued and untaken vacation
hours and the balance is Company contribution to the 401(k) plan.
(2) All other compensation for 2008 includes auto allowance of $12,000, MTO
pay out of $25,375 for accrued and untaken vacation hours and the balance is
Company contribution to the 401(k) plan.
(3) All other compensation for 2008 includes auto allowance of $12,000 and
the balance is Company contribution to the 401(k) plan.
(4) Salary commenced on September 10, 2007. All other compensation includes
auto allowance of $7,000 and the balance is Company contribution to the 401(k)
plan.
(5) All other compensation for 2008 includes auto allowance of $17,000, a
MTO pay out of $55,385 for accrued and untaken vacation hours, and $60,000 in
consulting fees paid to Mr. Anderson under the Consulting Agreement executed
between Mr. Anderson and the Company on December 31, 2007.
59
<page>
(6) During the year ended March 31, 2008, the Company implemented the
Corporate Team Bonus Plan for 2007/2008. Under this discretionary plan, eligible
employees could receive bonuses based on the Company's performance and
individual performances. For the year ended March 31, 2008, in June 2008, the
Company awarded eligible employees an aggregate of $494,669 in discretionary
bonuses, which was approved by the Company's Board of Directors. Of such amount,
the Named Executive Officers, Bruce Mogel, Steven Blake, Daniel Brothman, and
Jeremiah Kanaly received $30,000, $26,375, $26,375, and $17,188, respectively.
All bonuses under the plan were paid on June 6, 2008. Remaining amounts relate
to discretionary bonuses for calendar year 2007 that were paid in December 2007.
(7) Values in this column represent the amounts expensed by the Company in
2008 for portions of awards granted in 2008. These amounts do not represent the
intrinsic or market value of the awards on the date of grant, at year end or at
present. For grant date values of all outstanding options at March 31, 2008,
please see table entitled "Outstanding Equity Awards at Fiscal Year-End."
The following table sets forth summary information regarding stock
options the Company has granted to the Named Executive Officers as of March 31,
2008 under the Company's 2006 Stock Incentive Plan.
OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END
Equity
incentive
plan awards:
Number of Number of Number of
securities securities securities
underlying underlying underlying Option Grant date
unexercised unexercised unexercised exercise Option fair value
Grant options options unearned price expiration per share
Name date exercisable unexercisable options ($) date ($)
- ----------------------- -------------------- ------------ -------------- -------------- --------- ----------------- ----------
Bruce Mogel - - - - - - -
Steven R. Blake (1) August 6, 2007 - 300,000 300,000 0.26 August 6, 2014 0.03
Daniel J. Brothman (2) August 6, 2007 1,000,000 - - 0.26 August 6, 2014 0.02
Jeremiah R. Kanaly (1) December 13, 2007 - 200,000 200,000 0.30 December 13, 2014 0.09
(1) 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.
(2) Vesting retroactively commenced on March 8, 2005, all options were
fully vested as of March 31, 2008.
EMPLOYMENT CONTRACTS, SEVERANCE AGREEMENTS AND CHANGE OF CONTROL ARRANGEMENTS
We have amended employment agreements with Messrs. Mogel, Brothman, and
Blake, and entered into an employment agreement with Mr. Kanaly.
On November 15, 2007, the Company amended the employment agreement with
its CEO, Bruce Mogel, to increase his base salary from $360,000 per year to
$525,000 per year. The agreement also specifies that he is eligible to receive
performance based incentive compensation up to $97,500 for the year ended March
31, 2008 and $195,000 each year thereafter. Mr. Mogel's auto allowance was
increased from $1,000 to $2,000 per month. Mr. Mogel's agreement also provides
for stock options (none of which were granted as of March 31, 2008), medical and
dental insurance, and up to four weeks vacation annually.
Effective March 21, 2008, the Company amended the employment agreement
with its CFO, Steven Blake, to increase his base salary from $350,000 per year
to $422,000 per year. The agreement also specifies that he is eligible to
receive performance based incentive compensation during each fiscal year as
determined by the Company's Board of Directors and CEO. Mr. Blake's agreement
also provides for stock options (300,000 options were granted as of March 31,
2008), auto allowance ($1,000 per month), medical and dental insurance, and up
to four weeks vacation annually.
60
<page>
Effective May 6, 2008, the Company amended the employment agreement
with its COO, Daniel Brothman, to increase his base salary from $350,000 per
year to $422,000 per year. The agreement also specifies that he is eligible to
receive performance based incentive compensation during each fiscal year as
determined by the Company's Board of Directors and CEO. Mr. Brothman's agreement
also provides for stock options (1,000,000 options were granted as of March 31,
2008), auto allowance ($1,000 per month), medical and dental insurance, and up
to four weeks vacation annually.
Effective September 10, 2007, the Company entered into an employment
agreement with its CAO & Treasurer, Jeremiah Kanaly. The agreement specifies
that Mr. Kanaly's base salary is $275,000 per year and that he is eligible to
receive performance based incentive compensation during each fiscal year as
determined by the Company's Board of Directors and CEO. Mr. Kanaly's agreement
also provides for stock options (200,000 options were granted as of March 31,
2008), auto allowance ($1,000 per month), medical and dental insurance, and up
to four weeks vacation annually.
On December 31, 2007, the Company entered into a Severance Agreement
With Mutual Releases ("Severance Agreement") and a Consulting Agreement with
Larry B. Anderson. Under the Severance Agreement, Mr. Anderson terminated his
employment as President of the Company by mutual agreement, effective December
31, 2007.
Under the Severance Agreement, Mr. Anderson could receive consideration
currently valued at approximately $465,000. The Company will pay Mr. Anderson
compensation equivalent to fourteen equal monthly installments. The amount of
each monthly installment shall be the sum of Mr. Anderson'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 upfront payment equivalent to eight
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 Mr. Anderson. 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.
Under the terms of the Consulting Agreement, which is effective from
January 1, 2008 through June 30, 2008, the Company will pay Mr. Anderson
$180,000 consisting of one upfront 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 special projects, such as
his services relating to the then-proposed acquisition of a specifically
identified hospital by the Company, Mr. Anderson would be entitled to receive
0.5% of the total value of the purchase, minus $30,000, or an estimated $310,000
if the acquisition was consummated at the then-proposed price. Such acquisition
was not consummated by the Company. The Consulting Agreement contains other
provisions customary to such agreements.
Pension benefits and Nonqualified Deferred Compensation tables are not
included as there are no items to report.
POTENTIAL PAYMENTS UPON TERMINATION
Each of the Company's Named Executive Officers have employment
agreements which provide, generally, for payments in the event of resignation
for cause. Cause includes, among other items, changes in job duties, reporting
relationships, bankruptcy of the Company or change in shareholders of over 50%
of the stock. Each Named Executive Officer would be entitled to twelve months
salary, benefits and health insurance, but not any additional accruals of paid
time off, vacation or sick pay.
The following table provides information concerning the estimated
payments and benefits that would be provided in the circumstances described
above for each of the Named Executive Officers. Payments and benefits are
estimated assuming that the triggering event took place on the last business day
of fiscal 2008 (March 31, 2008), and the price per share of the Company's common
stock is the closing price on the OTCBB as of that date ($0.12). There can be no
assurance that a triggering event would produce the same or similar results as
those estimated below if such event occurs on any other date or at any other
price, of if any other assumption used to estimate potential payments and
benefits is not correct. The amounts which would be due the Named Executive
Officers as of year end, if they resigned for cause is as follows.
61
<page>
PAYMENTS DUE UPON TERMINATION
Name
and Employee
Principal Health Car Other
Position Salary Insurance Allowance Benefits Total
-------- --------- --------- --------- -------- ---------
Bruce Mogel $ 787,500 $ 24,612 $ 36,000 - $ 848,112
Chief Executive Officer(1)
Steven R. Blake $ 422,000 $ 16,408 $ 12,000 - $ 450,408
Chief Financial Officer &
Executive Vice President,
Finance(2)
Daniel J. Brothman $ 350,000 $ 16,408 $ 12,000 - $ 378,408
Senior Vice President,
Operations(2)
Jeremiah R. Kanaly $ 275,000 $ 8,704 $ 12,000 - $ 295,704
Chief Accounting Officer &
Treasurer(2)
(1) Represents payments for 18 months per employment agreement.
(2) Represents payments for 12 months per employment agreement.
COMPENSATION OF DIRECTORS
The following table provides information concerning the compensation of
our non-management directors during the fiscal year ended March 31, 2008.
DIRECTOR COMPENSATION
Fees earned Stock
or paid in cash options Total
Name ($) ($) ($)
- ------------------------- --------------- ----------- -------------
Ajay G. Meka, M.D. 15,125 8,000 23,125
Maurice J. DeWald 112,750 13,033 125,783
Hon. C. Robert Jameson 17,750 3,100 20,850
Michael Metzler 17,250 3,100 20,350
J. Fernando Niebla 106,500 13,033 119,533
William E. Thomas 23,000 3,100 26,100
Our current compensation and reimbursement policy for Directors is as follows:
i. Cash - Each non-employee Director receives an annual fee of
$30,000 and an attendance fee of $1,500 for each Board
meeting attended, and a separate $1,000 fee for each
committee meeting attended. Committee Chairmen receive an
additional annual retainer of $5,000.
ii. Stock - Options were granted to Directors during the year
ended March 31, 2008. Values for stock options represent
the amounts expensed by the Company in 2008. These amounts
do not represent the intrinsic or market value of the
awards on the date of grant, at year end or at present.
iii. Travel Reimbursement - All travel and related expenses
incurred by Directors to attend Board meetings, committee
meetings and other IHHI activities are reimbursed by IHHI.
Employee directors receive no compensation for Board service and the
Company does not provide any retirement benefits to non-employee directors.
Director Mogel is not included above as all compensation paid to him is included
in the Summary Compensation Table.
62
<page>
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The compensation committee consists of three of the Company's
independent directors, Mr. Niebla, Mr. DeWald and Mr. Thomas. There are no
interlocks between our executive officers and the members of the Compensation
Committee.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
For a discussion of securities authorized for issuance under equity
compensation plans, please refer to Item 5 above.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information known to us with respect to
the beneficial ownership of our common stock as of June 16, 2008, unless
otherwise noted, by:
o each shareholder known to us to own beneficially more than 5%
of our common stock;
o each of our directors and each of our executive officers at
March 31, 2008; and
o all of our current directors and executive officers as a
group.
Except as otherwise noted below, the address of each person or entity
listed on the table is 1301 North Tustin Avenue, Santa Ana, California 92705.
The address of Dr. Kali Chaudhuri and William E. Thomas is 6800 Indiana Avenue,
Suite 130, Riverside, CA 92506.
BENEFICIAL PERCENTAGE OF
NAME OWNERSHIP (1) TOTAL (2)
- --------------------------------------------------------------------------------
DIRECTORS AND EXECUTIVE OFFICERS
Ajay G. Meka, M.D. 166,666 (3) *
Maurice J. DeWald 283,332 (4) *
Hon. C. Robert Jameson 50,000 (5) *
Michael Metzler 50,000 (6) *
Bruce Mogel 54,903,786 (7) 40.0%
J. Fernando Niebla 283,332 (8) *
William E. Thomas 14,694,210 (9) 10.3%
Steven R. Blake - -
Daniel J. Brothman 1,000,000 (10) *
Jerry Kanaly - -
- --------------------------------------------------------------------------------
All current directors and executive
officers as a group (10 persons) 61,682,828 45.0%
PRINCIPAL STOCKHOLDERS (other than
those named above)
Orange County Physicians Investment
Network, LLC 59,098,430 43.1%
Kali P. Chaudhuri, M.D. 59,772,290 (12) 38.1%
Healthcare Financial Management
& Acquisitions, Inc. 124,174,203 (13) 47.5%
Medical Provider Financial
Corporation III 50,952,381 (14) 27.1%
* Less than 1%
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or investment
power with respect to securities. Shares of Common Stock subject to options,
warrants and convertible instruments that are exercisable or convertible
currently or within 60 days of June 16, 2008 are deemed outstanding for
computing the percentage of the person holding such option, warrant or
convertible instrument, but are not deemed outstanding for computing the
percentage of any other person. Except as reflected in the footnotes or pursuant
to applicable community property laws, the persons named in the table have sole
voting and investment power with respect to all shares of Common Stock
beneficially owned.
63
<page>
(2) Percentages are based on 137,095,716 shares of Common Stock outstanding as
of June 16, 2008, which does not include up to 12,000,000 shares of Common Stock
which may be issued under the Company's 2006 Stock Incentive Plan.
(3) Consists of a portion of a stock option award approved by the Board of
Directors which is exercisable within 60 days of June 16, 2008, pursuant to the
Company's 2006 Stock Incentive Plan. Dr. Meka is a member of Orange County
Physicians Investment Network, LLC ("OC-PIN") and disclaims beneficial ownership
of shares held by OC-PIN except to the extent of his pecuniary interest therein.
(4) Consists of a portion of a stock option award approved by the Board of
Directors which is exercisable within 60 days of June 16, 2008 pursuant to the
Company's 2006 Stock Incentive Plan.
(5) Consists of a portion of a stock option award approved by the Board of
Directors which is exercisable within 60 days of June 16, 2008 pursuant to the
Company's 2006 Stock Incentive Plan.
(6) Consists of a portion of a stock option award approved by the Board of
Directors which is exercisable within 60 days of June 16, 2008 pursuant to the
Company's 2006 Stock Incentive Plan.
(7) Includes shares held by Dr. Kali P. Chaudhuri (39,789,788) and William E
Thomas (9,748,498), each of whom has entered into separate irrevocable proxies
expiring in July 2009 providing Mr. Mogel with limited voting rights over all of
their shares with respect to certain matters that may be voted on by
stockholders. Accordingly, all shares held by Dr. Kali P. Chaudhuri and William
E Thomas are deemed beneficially owned by Bruce Mogel, although Mr. Mogel has no
pecuniary interest in any such shares. Mr. Mogel holds 5,365,500 shares in his
name or affiliated entity.
(8) Consists of a stock option award approved by the Board of Directors which is
exercisable within 60 days of June 16, 2008 pursuant to the Company's 2006 Stock
Incentive Plan.
(9) Consists of 9,748,498 issued and outstanding shares, 4,895,712 shares which
may be acquired upon exercise of a warrant which expires in July 2008, and a
portion of a stock option award approved by the Board of Directors which is
exercisable within 60 days of June 16, 2008 pursuant to the Company's 2006 Stock
Incentive Plan.
(10) Consists of a portion of a stock option award approved by the Board of
Directors which is exercisable within 60 days of June 16, 2008 pursuant to the
Company's 2006 Stock Incentive Plan.
(11) Consists of a portion of a stock option award approved by the Board of
Directors which is exercisable within 60 days of June 16, 2008 pursuant to the
Company's 2006 Stock Incentive Plan.
(12) Consists of 39,789,788 issued and outstanding shares plus 19,982,502 shares
which may be acquired upon exercise of a warrant which expires in July 2008.
(13) Healthcare Financial Management & Acquisitions, Inc., which is affiliated
with the Company's principal lender, Medical Capital Corporation, holds two
warrants to acquire 31.09% and 4.95% of the outstanding shares of Common Stock
of the Company.
(14) Medical Provider Financial Corporation III, which is affiliated with the
Company's principal lender, Medical Capital Corporation, holds a convertible
term note in the principal amount of $10.7 million convertible into Common Stock
of the Company at the rate of $0.21 per share.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
TRANSACTIONS WITH RELATED PARTIES
On July 2, 2007, the Company issued an aggregate of 49,538,286 shares
of its common stock upon exercise of outstanding warrants of the Company. The
Company issued 39,789,788 shares of common stock to Kali P. Chaudhuri, M.D. and
9,748,498 shares of common stock to William E. Thomas pursuant to the exercise
of warrants, dated January 31, 2005, held by each of them.
64
<page>
Of these shares, an aggregate of 28,746,857 shares of common stock were
issued to Messrs. Chaudhuri and Thomas pursuant to the "net exercise" provisions
of their warrants, effective February 6, 2007. An aggregate of 20,791,429 shares
were issued pursuant to the cash exercise provisions of their warrants effective
July 2, 2007. Payment for the "net exercise" shares consisted of cancellation of
warrants to acquire an aggregate of 283,499 shares of common stock. Payment for
the cash exercise shares consisted of an aggregate of $575,755 in cash received
by the Company from Messrs. Chaudhuri and Thomas.
The above issuances of securities were not registered under the
Securities Act of 1933, as amended (the "Act"). The securities were issued in
private transactions exempt from registration pursuant to Section 4(2) of the
Act and Regulation D promulgated thereunder.
Effective October 9, 2007, the Company and Medical Capital Corporation
and its affiliates (collectively, "MedCap"), which own beneficially more than 5%
of our outstanding stock, executed agreements to refinance MedCap'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 MedCap (the "Prior Debt"), which matured on
March 2, 2007. The Company had been operating under an Agreement to Forbear with
MedCap with respect to the Prior Debt.
Each of the following 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, a company owned indirectly by two of the Company's largest shareholders,
and leased to the Company), and (v) are guaranteed by Orange County Physicians
Investment Network, LLC and West Coast Holdings, LLC ("West Coast") pursuant to
separate Guaranty Agreements in favor of the lender. West Coast is a member of
PCHI. PCHI, West Coast, Ganesha, and OC-PIN are credit parties to the New 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, 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. The $50.0 million Revolving Line of
Credit did not modify or exchange any Prior Debt.
From October 9, 2007, the date of refinancing, through March 31, 2008,
the Company incurred interest expense related to the New Credit Facilities of
approximately $5.0 million. For the period from April 1, 2007 through October 8,
2007, the Company incurred interest expense on the Prior Debt of approximately
$5.8 million. The highest aggregate amount of outstanding principal during the
year ended March 31, 2008 was approximately $100.9 million on January 31, 2008
65
<page>
(approximately $95.8 million was outstanding on May 31, 2008). With the
exception of recurring principal payments (and advances) on the $50.0 million
Revolving Line of Credit and the refinancing on October 9, 2007, the Company did
not make any principal payments during the year ended March 31, 2008. Debt
issuance costs of approximately $2.9 million were incurred in connection with
the New Credit Facilities, of which $1.6 million was expensed as of March 31,
2008, and approximately $1.3 million will be amortized over the remaining term
of the New Credit Facilities.
Concurrently with the execution of the New Credit Facilities, the
Company issued to an affiliate of MedCap 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 MedCap entered into Amendment No. 2 to
Common Stock Warrant, originally dated December 12, 2005, which entitles an
affiliate of MedCap 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, 2012, 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.
As a condition of the New Credit Facilities, the Company entered into
an Amended and Restated Triple Net Hospital Building Lease with PCHI (the
"Amended Lease"). The Amended Lease terminates on the 25-year anniversary of the
original lease (March 8, 2005) (and grants the Company the right to renew for
one additional 25-year period) and requires annual base rental payments of $8.3
million (but 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 Real Estate Loan, 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 MedCap 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 "Kindred Property") that are unencumbered by any claims by
or tenancy of the Company.
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 Kindred 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.
REVIEW, APPROVAL OR RATIFICATION OF TRANSACTIONS WITH RELATED PARTIES
The Company's human resource written policies and procedures provide
guidance for conflicts of interest and their relation to the standards of
ethical behavior expected of employees. The policies specifically require
immediate written disclosure of any business, financial, or other relationship
that either creates, or is perceived to create a conflict of interest. The
Corporate Compliance Officer is responsible for monitoring compliance with this
policy.
As part of the quarterly disclosure control procedures, the Chief
Financial Officer and Chief Executive Officer for each hospital disclose or
certify that employees or officers have not acted in a manner inconsistent with
the Company policy related to Conflict of Interest. The CFO and Director of
Internal Audit monitor certifications for potential disclosure events.
Company policy requires the General Counsel to review and approve all
contracts involving related parties, including contracts with related parties
who are considered potential referral sources. The Audit Committee has requested
that the General Counsel provide periodic updates of such transactions to the
Committee.
During the acquisition, the Company entered into agreements with the
Medical Executive committee ("MEC") at the largest hospital, Western Medical
Center - Santa Ana ("WMC-SA") requiring MEC's advance consent for all agreements
involving hospital operations with related parties, excluding the lease
arrangements between the Company and PCHI. The same agreement was subsequently
offered to each of the other hospitals' medical staffs, but not ultimately
executed by them. Notwithstanding this fact, the Company applies the disclosure
provisions applicable to WMC-SA to all of its facilities.
66
<page>
DIRECTOR INDEPENDENCE
Directors DeWald, Meka, Metzler, and Niebla each satisfy the definition
of "independent director" as established in the NASDAQ listing standards.
Directors DeWald, Metzler, and Niebla constitute the Audit Committee of the
Board of Directors. The Company does not have a Nominating Committee as the
entire Board of Directors performs the functions of this committee and this
process has been adequate to handle the Board nomination process to date. The
Board of Directors has determined that Director DeWald is an "audit committee
financial expert" as defined in the SEC rules.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The following table sets forth the aggregate fees that we incurred for
audit and non-audit services provided by BDO Seidman, LLP, which acted as our
independent registered public accounting firm for the years ended March 31, 2008
and 2007, and performed audit services for us during those periods. The audit
fees include only fees that are customary under generally accepted auditing
standards and are the aggregate fees that we incurred for professional services
rendered for the years ended March 31, 2008 and 2007.
For the year ended March 31,
----------------------------
2008 2007
------------ ------------
Audit fees (financial) $ 1,293,000 $ 1,400,000
Audit related fees - -
Tax fees - -
All other - -
------------ ------------
Total fees $ 1,293,000 $ 1,400,000
============ ============
The Audit Committee of the Board of Directors pre-approves all audit
and permissible non-audit services to be performed by the independent auditors.
The Board of Directors of the Company considered that the provision of the
services and the payment of the fees described above are compatible with
maintaining the auditors' independence.
67
<page>
ITEM 15. EXHIBITS; FINANCIAL STATEMENT SCHEDULES
Exhibits required to be filed are listed below and except where
incorporated by reference, immediately follow the Financial Statements. Each
document filed with this report is marked with an asterisk (*). References to
the "Commission" mean the U.S. Securities and Exchange Commission.
- -------------- -----------------------------------------------------------------
Exhibit
Number Description
- ------ -----------
- -------------- -----------------------------------------------------------------
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).
- -------------- -----------------------------------------------------------------
3.2 Amended and Restated Bylaws (incorporated by reference to Exhibit
3.1 to the Registrant's Current Report on Form 8-K filed with the
Commission on June 9, 2008).
- -------------- -----------------------------------------------------------------
4.1 Integrated Healthcare Holdings, Inc. 2006 Stock Incentive Plan
(incorporated by reference to Appendix B to the Registrant's
Definitive Proxy Statement on Schedule 14A filed by the
Registrant on November 14, 2006).
- -------------- -----------------------------------------------------------------
4.2 Form of Notice of Stock Option Award and Stock Option Agreement.
(incorporated herein by reference from Exhibit 4.5 to the
Registrant's Registration Statement under the Securities and
Exchange Act of 1933 on Form S-8 filed with the Commission on
February 2, 2007).
- -------------- -----------------------------------------------------------------
10.1 Triple Net Hospital and Medical Office Building Lease dated March
7, 2005, as amended by Amendment No. 1 To Triple Net Hospital and
Medical Office Building Lease (incorporated herein by reference
from Exhibit 99.9 to the Registrant's Current Report on Form 8-K
filed with the Commission on March 14, 2005).
- -------------- -----------------------------------------------------------------
10.1.1 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).
- -------------- -----------------------------------------------------------------
10.1.2 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).
- -------------- -----------------------------------------------------------------
10.2 Employment Agreement with Bruce Mogel dated February 25, 2005
(incorporated herein by reference from Exhibit 10.16 to the
Registrant's Annual Report on Form 10-KSB filed with the
Commission on March 31, 2005).
- -------------- -----------------------------------------------------------------
10.2.1 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).
- -------------- -----------------------------------------------------------------
10.3 Employment Agreement with Larry B. Anderson dated February 25,
2005 (incorporated herein by reference from Exhibit 10.17 to the
Registrant's Annual Report on Form 10-KSB filed with the
Commission on March 31, 2005).
- -------------- -----------------------------------------------------------------
10.3.1 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).
- -------------- -----------------------------------------------------------------
10.3.2 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).
68
<page>
- -------------- -----------------------------------------------------------------
10.4 Employment Agreement with Daniel J. Brothman dated December 31,
2005 (incorporated herein by reference from Exhibit 10.21 to the
Registrant's Annual Report on Form 10-KSB filed with the
Commission on March 31, 2005).
- -------------- -----------------------------------------------------------------
10.4.1 Amended Employment Agreement between Integrated Healthcare
Holdings, Inc. and Daniel J. Brothman(incorporated by reference
to Exhibit 99.2 to the Registrant's Report on Form 8-K filed on
May 23, 2008).
- -------------- -----------------------------------------------------------------
10.5 Employment Agreement with Steve R. Blake dated March 21, 2005
(incorporated herein by reference from Exhibit 10.22 to the
Registrant's Annual Report on Form 10-KSB filed with the
Commission on March 31, 2005).
- -------------- -----------------------------------------------------------------
10.5.1 Letter of Amendment to Employment Agreement of Steven R. Blake,
dated as of February 14, 2007 (incorporated herein by reference
from Exhibit 99.1 to the Registrant's Current Report on Form 8-K
filed with the Commission on February 21, 2007).
- -------------- -----------------------------------------------------------------
10.5.2 Amendment #2 to Employment Agreement between Integrated
Healthcare Holdings, Inc. and Steve Blake (incorporated by
reference to Exhibit 99.1 to the Registrant's Report on Form 8-K
filed on April 8, 2008).
- -------------- -----------------------------------------------------------------
10.5.3 Amended Employment Agreement between Integrated Healthcare
Holdings, Inc. and Steven R. Blake(incorporated by reference to
Exhibit 99.1 to the Registrant's Report on Form 8-K filed on May
23, 2008).
- -------------- -----------------------------------------------------------------
10.6 Employment Agreement between Integrated Healthcare Holdings, Inc.
and Jeremiah R. Kanaly, dated as of September 10, 2007
(incorporated by reference to Exhibit 99.1 to the Registrant's
Report on Form 8-K filed on September 13, 2007).
- -------------- -----------------------------------------------------------------
10.7 Agreement to Forbear executed June 18, 2007. (incorporated herein
by reference from Exhibit 99.1 to the Registrant's Current Report
on Form 8-K filed with the Commission on June 19, 2007).
- -------------- -----------------------------------------------------------------
10.7.1 Amendment No. 1 to Forbearance Agreement executed June 18, 2007.
(incorporated herein by reference from Exhibit 99.1 to the
Registrant's Current Report on Form 8-K filed with the Commission
on June 19, 2007).
- -------------- -----------------------------------------------------------------
10.8 $80,000,000 Credit Agreement, dated October 9, 2007 (incorporated
by reference to Exhibit 99.1 to the Registrant's Report on Form
8-K filed on October 15, 2007).
- -------------- -----------------------------------------------------------------
10.9 $45,000,000 Term Note, dated October 9, 2007 (incorporated by
reference to Exhibit 99.2 to the Registrant's Report on Form 8-K
filed on October 15, 2007).
- -------------- -----------------------------------------------------------------
10.10 $35,000,000 Non Revolving Line of Credit Note, dated October 9,
2007 (incorporated by reference to Exhibit 99.3 to the
Registrant's Report on Form 8-K filed on October 15, 2007).
- -------------- -----------------------------------------------------------------
10.11 $50,000,000 Revolving Credit Agreement, dated October 9, 2007
(incorporated by reference to Exhibit 99.4 to the Registrant's
Report on Form 8-K filed on October 15, 2007).
- -------------- -----------------------------------------------------------------
10.11.1 Amendment No. 1 to $50,000,000 Revolving Credit Agreement, dated
June 10, 2008 *
- -------------- -----------------------------------------------------------------
10.11.2 Amendment No. 2 to $50,000,000 Revolving Credit Agreement, dated
June 20, 2008 *
69
<page>
- -------------- -----------------------------------------------------------------
10.12 $50,000,000 Revolving Line of Credit Note, dated October 9, 2007
(incorporated by reference to Exhibit 99.5 to the Registrant's
Report on Form 8-K filed on October 15, 2007).
- -------------- -----------------------------------------------------------------
10.13 $10,700,000 Credit Agreement, dated October 9, 2007 (incorporated
by reference to Exhibit 99.6 to the Registrant's Report on Form
8-K filed on October 15, 2007).
- -------------- -----------------------------------------------------------------
10.14 $10,700,000 Convertible Term Note, dated October 9, 2007
(incorporated by reference to Exhibit 99.7 to the Registrant's
Report on Form 8-K filed on October 15, 2007).
- -------------- -----------------------------------------------------------------
10.15 4.95% Common Stock Warrant, dated October 9, 2007 (incorporated
by reference to Exhibit 99.8 to the Registrant's Report on Form
8-K filed on October 15, 2007).
- -------------- -----------------------------------------------------------------
10.16 31.09% Common Stock Warrant, dated December 12, 2005
(incorporated by reference to Exhibit 99.4 to the Registrant's
Report on Form 8-K filed on December 20, 2005).
- -------------- -----------------------------------------------------------------
10.16.1 Amendment No. 1 to 31.09% Common Stock Warrant, dated April 26,
2006 *
- -------------- -----------------------------------------------------------------
10.16.2 Amendment No. 2 to 31.09% Common Stock Warrant, dated October 9,
2007 (incorporated by reference to Exhibit 99.9 to the
Registrant's Report on Form 8-K filed on October 15, 2007).
- -------------- -----------------------------------------------------------------
21.1 The subsidiaries of the Registrant are WMC-SA, Inc., a California
corporation, WMC-A, Inc., a California corporation, Chapman
Medical Center, Inc., a California corporation, Coastal
Communities Hospital, Inc., a California corporation, and Mogel
Management, Inc., a Nevada corporation.
- -------------- -----------------------------------------------------------------
23.1 Consent of BDO Seidman, LLP *
- -------------- -----------------------------------------------------------------
23.2 Consent of Ramirez International *
- -------------- -----------------------------------------------------------------
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 *
- -------------- -----------------------------------------------------------------
70
<page>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
INTEGRATED HEALTHCARE HOLDINGS, INC.
Dated: August 22, 2008 /s/ Bruce Mogel
----------------------------------------
Bruce Mogel
Chief Executive Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Dated: August 22, 2008 /s/ Bruce Mogel
----------------------------------------
Bruce Mogel
Chief Executive Officer and Director
(Principal Executive Officer)
Dated: August 22, 2008 /s/ Steven R. Blake
----------------------------------------
Steven R. Blake
Chief Financial Officer
(Principal Financial Officer)
Dated: August 22, 2008 /s/ Jeremiah R. Kanaly
----------------------------------------
Jeremiah R. Kanaly
Chief Accounting Officer and Treasurer
(Principal Accounting Officer)
Dated:
----------------------------------------
Ajay Meka, M.D
Chairman of the Board of Directors
Dated: August 22, 2008 /s/ Maurice J. DeWald
----------------------------------------
Maurice J. DeWald
Director
Dated: August 22, 2008 /s/ Hon. C. Robert Jameson
----------------------------------------
Hon. C. Robert Jameson Director
Dated: August 22, 2008 /s/ Michael Metzler
----------------------------------------
Michael Metzler
Director
Dated: August 22, 2008 /s/ J. Fernando Niebla
----------------------------------------
J. Fernando Niebla
Director
Dated: August 22, 2008 /s/ William E. Thomas
----------------------------------------
William E. Thomas
Director
71
<page>
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
Integrated Healthcare Holdings, Inc.
Santa Ana, California
We have audited the accompanying consolidated balance sheets of Integrated
Healthcare Holdings, Inc. and consolidated entities (the "Company") as of March
31, 2008 and 2007 and the related consolidated statements of operations,
stockholders' deficiency, and cash flows for each of the two years then ended
and for the three month period ended March 31, 2006. We have also audited the
schedule as listed in the accompanying index (Item 8). These consolidated
financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Integrated
Healthcare Holdings, Inc. at March 31, 2008 and 2007, and the results of its
operations and its cash flows for each of the two years then ended and for the
three month period ended March 31, 2006, in conformity with accounting
principles generally accepted in the United States of America.
Also in our opinion, the schedule as listed in the accompanying index presents
fairly, in all material respects, the information set forth therein for the
years ended March 31, 2008 and 2007 and for the three month period ended March
31, 2006.
As discussed in Notes 5 and 16 to the consolidated financial statements, the
Company has restated its consolidated financial statements as of and for the
year ended March 31, 2008.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has suffered recurring losses,
has a significant working capital deficit and a net stockholders' deficiency at
March 31, 2008. These factors raise substantial doubt about the Company's
ability to continue as a going concern. Management's plans in regard to these
matters are also described in Note 1. The consolidated financial statements do
not include any adjustments that might result from the outcome of this
uncertainty.
As discussed in Note 1 to the consolidated financial statements, effective April
1, 2007 the Company adopted Financial Accounting Standards Board Interpretation
No. 48, "Accounting for Uncertainty in Income Taxes - an interpretation of FASB
No. 109" and effective April 1, 2006, adopted Statement of Financial Accounting
Standards No. 123R, "Share-Based Payment."
/s/ BDO Seidman, LLP
Costa Mesa, California
July 11, 2008, except for the effects of the
restatements described in Notes 5 and 16 to the consolidated
financial statements, which are as of August 22, 2008.
F-1
<page>
Report of Independent Registered Public Accounting Firm
The Board of Directors of
Integrated Healthcare Holdings, Inc.:
We have audited the accompanying consolidated statements of operations,
stockholders' equity (deficiency) and cash flows of Integrated Healthcare
Holdings, Inc. and consolidated entities (the "Company") for the year ended
December 31, 2005. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, based on our audit, the consolidated financial statements
referred to above present fairly, in all material respects, the results of
operations and cash flows of the Company for the year ended December 31, 2005,
in conformity with generally accepted accounting principles in the United States
of America.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As shown in the financial statements,
the Company has incurred net losses and, as of December 31, 2005, had a
substantial stockholders' deficiency. Further, the Company had substantial
balances of notes payable which, under the terms of the agreements, were
scheduled to mature during 2006 and early in 2007. The Company had not
identified alternate sources of capital to meet its refinancing requirements.
These factors raise substantial doubt about the Company's ability to continue as
a going concern. The financial statements do not include any adjustments that
might be necessary if the Company is unable to continue as a going concern.
/s/ RAMIREZ INTERNATIONAL
Financial & Accounting Services, Inc.
July 11, 2006
Irvine, California
F-2
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
(amounts in 000's, except par value)
MARCH 31, MARCH 31,
2008 2007
--------- ---------
(restated)
ASSETS
Current assets:
Cash and cash equivalents $ 3,141 $ 7,844
Restricted cash 20 4,968
Accounts receivable, net of allowance for doubtful
accounts of $14,383 and $2,355, respectively 57,482 19,370
Security reserve funds -- 7,990
Deferred purchase price receivable -- 16,975
Inventories of supplies, at cost 5,853 5,944
Due from governmental payers 4,877 1,378
Prepaid insurance 721 5,004
Other prepaid expenses and current assets 5,811 3,093
--------- ---------
Total current assets 77,905 72,566
Property and equipment, net 56,917 58,172
Debt issuance costs, net 759 --
--------- ---------
Total assets $ 135,581 $ 130,738
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Debt, current $ 95,579 $ 72,341
Accounts payable 46,681 41,443
Accrued compensation and benefits 14,701 12,574
Warrant liability, current -- 14,906
Due to governmental payers 1,690 922
Accrued insurance retentions 12,332 4,961
Other current liabilities 5,781 15,726
--------- ---------
Total current liabilities 176,764 162,873
Capital lease obligations, net of current portion
of $406 and $251, respectively 6,375 5,834
Minority interest in variable interest entity 1,150 1,716
--------- ---------
Total liabilities 184,289 170,423
--------- ---------
Commitments, contingencies, and subsequent events
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 56,148 25,589
Accumulated deficit (104,993) (65,390)
--------- ---------
Total stockholders' deficiency (48,708) (39,685)
--------- ---------
Total liabilities and stockholders' deficiency $ 135,581 $ 130,738
========= =========
The accompanying notes are an integral part of these consolidated financial statements.
F-3
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in 000's, except per share amounts)
FOR THE
FOR THE YEAR ENDED THREE MONTHS
----------------------------------- ENDED
MARCH 31, MARCH 31, DECEMBER 31, MARCH 31,
2008 2007 2005 2006
--------- --------- --------- ---------
(restated)
Net operating revenues $ 367,721 $ 350,672 $ 283,698 $ 86,645
--------- --------- --------- ---------
Operating expenses:
Salaries and benefits 209,680 194,865 153,574 48,731
Supplies 50,126 49,577 39,250 12,066
Provision for doubtful accounts 30,958 35,169 37,349 8,330
Other operating expenses 68,959 66,652 58,716 16,808
Loss on sale of accounts receivable 4,079 10,388 8,470 2,808
Depreciation and amortization 3,134 2,495 2,178 673
--------- --------- --------- ---------
366,936 359,146 299,537 89,416
--------- --------- --------- ---------
Operating income (loss) 785 (8,474) (15,839) (2,771)
--------- --------- --------- ---------
Other income (expense):
Interest expense, net (13,209) (12,092) (9,925) (3,120)
Warrant expense (11,404) (693) (17,604) --
Change in fair value of warrant liability (14,273) 133 (3,460) 8,218
--------- --------- --------- ---------
(38,886) (12,652) (30,989) 5,098
--------- --------- --------- ---------
Income (loss) before provision for income
taxes and minority interest (38,101) (21,126) (46,828) 2,327
Provision for income taxes (28) (5) (5) (5)
Minority interest net loss (income)
in variable interest entity (1,474) 593 1,658 100
--------- --------- --------- ---------
Net income (loss) $ (39,603) $ (20,538) $ (45,175) $ 2,422
========= ========= ========= =========
Per Share Data:
Income (loss) per common share
Basic ($0.30) ($0.23) ($0.50) $ 0.03
Diluted ($0.30) ($0.23) ($0.50) $ 0.02
Weighted average shares outstanding
Basic 131,869 90,291 90,330 84,281
Diluted 131,869 90,291 90,330 127,228
The accompanying notes are an integral part of these consolidated financial statements.
F-4
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIENCY
(amounts in 000's)
Additional
Common Stock Paid-in Accumulated
Shares Amount Capital Deficit Total
--------- --------- --------- --------- ---------
Balance, December 31, 2004 20,780 $ 20 $ 1,190 $ (2,099) $ (889)
Issuance of common stock 63,152 64 14,936 -- 15,000
Net loss -- -- -- (45,175) (45,175)
--------- --------- --------- --------- ---------
Balance, December 31, 2005 83,932 84 16,126 (47,274) (31,064)
Issuance of common stock 3,625 3 129 -- 132
Exercise of warrants 28,747 29 9,170 -- 9,199
Warrants issued to vendor -- -- 164 -- 164
Net income for the three months
ended March 31, 2006 -- -- -- 2,422 2,422
Net loss for the year
ended March 31, 2007 -- -- -- (20,538) (20,538)
--------- --------- --------- --------- ---------
Balance, March 31, 2007 116,304 116 25,589 (65,390) (39,685)
Exercise of warrants 20,792 21 4,761 -- 4,782
Issuance of warrants -- -- 25,677 -- 25,677
Share-based compensation -- -- 121 -- 121
Net loss (restated) -- -- -- (39,603) (39,603)
--------- --------- --------- --------- ---------
Balance, March 31, 2008 (restated) 137,096 $ 137 $ 56,148 $(104,993) $ (48,708)
========= ========= ========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements.
F-5
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in 000's)
FOR THE YEAR ENDED FOR THE THREE
-------------------------------------------------- MONTHS ENDED
MARCH 31, MARCH 31, DECEMBER 31, MARCH 31,
2008 2007 2005 2006
--------------- --------------- --------------- --------------
(restated)
Cash flows from operating activities:
Net income (loss) $ (39,603) $ (20,538) $ (45,175) $ 2,422
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization of property and equipment 3,134 2,495 2,133 673
Provision for doubtful accounts 30,958 35,169 37,349 8,330
Amortization of debt issuance costs and intangible assets 236 900 837 241
Common stock warrant expense 11,404 693 17,604 --
Change in fair value of warrant liability 14,273 (133) 3,460 (8,218)
Minority interest in net income (loss) of variable
interest entity 1,474 (593) (1,658) (100)
Noncash share-based compensation expense 121 -- -- --
Changes in operating assets and liabilities:
Accounts receivable (69,070) (40,212) (53,324) (6,682)
Security reserve funds 7,990 6,798 (14,217) (571)
Deferred purchase price receivable 23,765 (2,620) (9,338) (5,017)
Inventories of supplies 91 (158) 299 (66)
Due from governmental payers (3,499) 5,209 (3,025) (3,562)
Prepaid insurance, other prepaid expenses and
current assets, and other assets 2,063 3,808 (4,215) 247
Accounts payable 5,238 12,710 26,679 1,897
Accrued compensation and benefits 2,127 990 11,733 (949)
Due to governmental payers 768 652 -- 270
Accrued insurance retentions and other current liabilities (2,729) (2,647) 15,640 2,311
------------ ------------ ------------ ------------
Net cash provided by (used in) operating activities (11,259) 2,523 (15,218) (8,774)
------------ ------------ ------------ ------------
Cash flows from investing activities:
Decrease (increase) in restricted cash 4,948 4 (4,972) --
Acquisition of hospital assets -- -- (63,172) --
Proceeds from minority interest in PCHI -- -- 5,000 --
Additions to property and equipment (921) (644) (564) (83)
------------ ------------ ------------ ------------
Net cash provided by (used in) investing activities 4,027 (640) (63,708) (83)
------------ ------------ ------------ ------------
Cash flows from financing activities:
Proceeds from revolving line of credit, net 3,090 -- -- --
Proceeds from debt 2,658 2,010 86,031 132
Debt issuance costs (1,493) -- (1,933) --
Repayments of debt -- -- (6,264) --
Issuance of common stock 576 -- 15,000 --
Variable interest entity distribution (2,040) (732) -- (201)
Payments on capital lease obligations (262) (287) (62) (20)
------------ ------------ ------------ ------------
Net cash provided by (used in) financing activities 2,529 991 92,772 (89)
------------ ------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents (4,703) 2,874 13,846 (8,946)
Cash and cash equivalents, beginning of period 7,844 4,970 70 13,916
------------ ------------ ------------ ------------
Cash and cash equivalents, end of period $ 3,141 $ 7,844 $ 13,916 $ 4,970
============ ============ ============ ============
The accompanying notes are an integral part of these consolidated financial statements
F-6
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
NOTE 1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
LIQUIDITY AND MANAGEMENT'S PLANS - The accompanying consolidated
financial statements have been prepared on a going concern basis, which
contemplates the realization of assets and settlement of obligations in the
normal course of business. The Company has incurred significant losses to date
including a net loss of $39.6 million and experienced negative cash flow from
operations of $11.3 million for the year ended March 31, 2008 and has a working
capital deficit of $98.9 million and accumulated stockholders' deficiency of
$48.7 million at March 31, 2008. The Company refinanced all its outstanding debt
in October 2007. The Company's $50.0 million Revolving Credit Agreement provides
an estimated additional liquidity as of March 31, 2008 of $26.9 million based on
eligible receivables, as defined (Note 5). In addition, the Company was not in
compliance with the amended Minimum Fixed Charge Coverage Ratio, as defined, at
March 31, 2008. The result of this noncompliance was to reclassify non current
debt to current at March 31, 2008 (Note 16). The Company's liquidity is highly
dependent upon the continued availability under this financing.
Notwithstanding the refinancing, these factors, among others, raise
substantial doubt about the Company's ability to continue as a going concern and
indicate a need for the Company to take action to continue to operate its
business as a going concern. The Company has negotiated increased reimbursements
from governmental payers and managed care 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") (Note 2). 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.
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.
BASIS OF PRESENTATION - The accompanying consolidated financial
statements include the accounts of the Company and its wholly owned
subsidiaries.
F-7
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
The Company has also determined that Pacific Coast Holdings Investment,
LLC ("PCHI") (Note 12), is a variable interest entity as defined in Financial
Accounting Standards Board ("FASB") Interpretation Number ("FIN") 46R, and,
accordingly, the financial statements of PCHI are included in the accompanying
consolidated financial statements.
All significant intercompany accounts and transactions have been
eliminated in consolidation. Unless otherwise indicated, all amounts included in
these notes to the consolidated financial statements are expressed in thousands
(except per share amounts, percentages and stock option prices and values).
RECLASSIFICATION FOR PRESENTATION - Certain immaterial amounts
previously reported have been reclassified to conform to the current period's
presentation.
CONCENTRATION OF CREDIT RISK - The Company has secured its working
capital and its long term debt from the same Lender (Note 5) 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 66%,
65%, 74%, and 73% of the net operating revenues for the years ended March 31,
2008 and 2007 and December 31, 2005, and the three months ended March 31, 2006,
respectively. No other payers represent a significant concentration of the
Company's net operating revenues.
USE OF ESTIMATES - The accompanying consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
in the United States of America ("U.S. GAAP") and prevailing practices for
investor owned entities within the healthcare industry. The preparation of
financial statements in conformity with U.S. GAAP requires management to make
estimates and assumptions that affect the amounts reported in the consolidated
financial statements and accompanying notes. Management regularly evaluates the
accounting policies and estimates that are used. In general, management bases
the estimates on historical experience and on assumptions that it believes to be
reasonable given the particular circumstances in which its Hospitals operate.
Although management believes that all adjustments considered necessary for fair
presentation have been included, actual results may materially vary from those
estimates.
REVENUE RECOGNITION - Net operating revenues are recognized in the
period in which services are performed and are recorded based on established
billing rates (gross charges) less estimated discounts for contractual
allowances, principally for patients covered by Medicare, Medicaid, managed care
and other health plans. Gross charges are retail charges. They are not the same
as actual pricing, and they generally do not reflect what a hospital is
ultimately paid and therefore are not displayed in the consolidated statements
of operations. Hospitals are typically paid amounts that are negotiated with
insurance companies or are set by the government. Gross charges are used to
calculate Medicare outlier payments and to determine certain elements of payment
under managed care contracts (such as stop-loss payments). Because Medicare
requires that a hospital's gross charges be the same for all patients
(regardless of payer category), gross charges are also what the Hospitals charge
all other patients prior to the application of discounts and allowances.
F-8
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
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 several years 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 of $12 and
settlement receivables of $909 as of March 31, 2008 and 2007, respectively.
Outlier payments, which were established by Congress as part of the
diagnosis-related groups ("DRG") prospective payment system, are additional
payments made to Hospitals for treating Medicare patients who are costlier to
treat than the average patient in the same DRG. To qualify as a cost outlier, a
hospital's billed (or gross) charges, adjusted to cost, must exceed the payment
rate for the DRG by a fixed threshold established annually by the Centers for
Medicare and Medicaid Services of the United States Department of Health and
Human Services ("CMS"). Under Sections 1886(d) and 1886(g) of the Social
Security Act, CMS must project aggregate annual outlier payments to all
prospective payment system Hospitals to be not less than 5% or more than 6% of
total DRG payments ("Outlier Percentage"). The Outlier Percentage is determined
by dividing total outlier payments by the sum of DRG and outlier payments. CMS
annually adjusts the fixed threshold to bring expected outlier payments within
the mandated limit. A change to the fixed threshold affects total outlier
payments by changing (1) the number of cases that qualify for outlier payments,
and (2) the dollar amount Hospitals receive for those cases that still qualify.
The most recent change to the cost outlier threshold that became effective on
October 1, 2007 was a decrease from $24.485 to $22.185. 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, a hospital receives 80% of the difference as
an outlier payment. Medicare has reserved the option of adjusting outlier
payments, through the cost report, to a 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 and $1,919 in Final Notice of Program Reimbursement settlements
during the years ended March 31, 2008 and 2007, respectively. There were no
adjustments for Final Notice of Program Reimbursement received during the year
ended December 31, 2005 and the three months ended March 31, 2006. As of March
31, 2008 and 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 of $1,678 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 of $1,690 and $922 as of March 31,
2008 and 2007, respectively.
F-9
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
The Hospitals receive supplemental payments from the State of
California to support indigent care (Medi-Cal Disproportionate Share Hospital
payments or "DSH") and from the California Medical Assistance Commission
("CMAC") under the SB 1100 and SB 1255 programs. The Hospitals received
supplemental payments of $16,175, $24,526, and $11,022, and $575 during the
years ended March 31, 2008 and 2007 and December 31, 2005, and the three months
ended March 31, 2006, respectively. The related revenue recorded for the years
ended March 31, 2008 and 2007 and December 31, 2005, and for the three months
ended March 31, 2006 was $19,375, $17,897, $13,943, and $4,240, respectively. As
of March 31, 2008 and 2007, estimated DSH receivables of $4,877 and $1,378 are
included in due from governmental payers in the accompanying consolidated
balance sheets.
The following is a summary of due from and due to governmental payers
as of March 31:
March 31, March 31,
2008 2007
-------------- --------------
Due from government payers
Medicaid $ 4,877 $ 1,378
-------------- --------------
$ 4,877 $ 1,378
============== ==============
Due to government payers
Medicare $ 12 $ (909)
Outlier 1,678 1,831
-------------- --------------
$ 1,690 $ 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 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 $7.4 million, $8.1 million, $2.9
million, and $1.5 million for the years ended March 31, 2008 and 2007 and
December 31, 2005, and the three months ended March 31, 2006, respectively.
F-10
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
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, 2008 and 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 consolidated financial statements.
PROVISION FOR DOUBTFUL ACCOUNTS - The Company provides for accounts
receivable that could become uncollectible by establishing an allowance to
reduce the carrying value of such receivables to their estimated net realizable
value. The Hospitals estimate this allowance based on the aging of their
accounts receivable, historical collections experience for each type of payer
and other relevant factors. There are various factors that can impact the
collection trends, such as changes in the economy, which in turn have an impact
on unemployment rates and the number of uninsured and underinsured patients,
volume of patients through the emergency department, the increased burden of
copayments 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 copayments 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 nonemergency 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 5)
effective October 9, 2007 (when the Company terminated its Accounts Purchase
Agreement (Note 3) and repurchased all its previously sold receivables), the
Company sold substantially all of its billed accounts receivable to a financial
institution. 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 did 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 was
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.
F-11
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
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 March 31, 2008, cash and cash equivalents includes $3.0 million
deposited in lock box accounts that are swept daily by the Lender under various
credit agreements (Note 5).
Cash held in the Company's bank accounts as of March 31, 2007,
collected on behalf of the buyer of accounts receivable, is not included in the
Company's cash and cash equivalents. Such amounts are treated as part of the
security reserve funds in connection with the Accounts Purchase Agreement (Note
3).
LETTERS OF CREDIT - At March 31, 2008, 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 5).
RESTRICTED CASH - As of March 31, 2007, restricted cash consists of
amounts deposited in short term time deposits with a commercial bank to
collateralize the Company's obligations pursuant to certain agreements. As of
March 31, 2008, this collateral is no longer needed.
INVENTORIES OF SUPPLIES - Inventories of supplies are valued at the
lower of weighted 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, where applicable.
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.
F-12
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
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 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 March 31, 2008.
DEBT ISSUANCE COSTS - This deferred charge consists of the $750.0
origination fee for the Company's $50.0 million Revolving Line of Credit (new
debt) and $742.6 in legal and other expenses incurred in connection with the
Company's refinancing paid to third parties (Note 5). 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 5) 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
as an interest charge during the year ended March 31, 2008. Debt issuance costs
of $236.3, $899.6, $836.7, and $241.6 were amortized during the years ended
March 31, 2008 and 2007, December 31, 2005, and the three months ended March 31,
2006, respectively. At March 31, 2008 and 2007, prepaid expenses and other
current assets in the accompanying consolidated balance sheets included $497.5
and $0, respectively, 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 healthcare 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 healthcare 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 healthcare 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 SFAS No. 5, the Company
accrues for IBNR claims when it is probable that expected future healthcare
costs and maintenance costs under an existing contract have been incurred and
the amount can be reasonably estimated. The Company records a charge related to
these IBNR claims against its net operating revenues. The Company's net revenues
from CalOptima capitation, net of third party claims and estimates of IBNR
claims, for the years ended March 31, 2008 and 2007 and December 31, 2005, and
the three months ended March 31, 2006 were $0.35 million, $1.3 million, $3.2
million, and $1.4 million, respectively. IBNR claims accruals at March 31, 2008
and 2007 were $1.5 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.
F-13
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
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. Effective April 1, 2006, the
Company adopted SFAS No. 123R (Note 9).
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 5 and 6), 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 5 and 6).
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 11). Due to the net losses incurred by the Company, the anti-dilutive
effects of warrants and stock options have been excluded in the calculations of
diluted loss per share for those periods presented in the accompanying
consolidated statements of operations with net losses.
SUPPLEMENTAL CASH FLOW INFORMATION - Interest paid during the years
ended March 31, 2008 and 2007 and December 31, 2005, and the three months ended
March 31, 2006 was $11.3 million, $12.2 million, $9.2 million, and $2.6 million,
respectively.
The Company made cash payments for taxes of $3 during the year ended
March 31, 2008, $5 during the year ended March 31, 2007 and the three months
ended March 31, 2006, and $1.4 million during the year ended December 31, 2005.
The $1.4 million in taxes paid during the year ended December 31, 2005 was fully
refunded to the Company during the year ended March 31, 2007.
The Company entered into new capital lease obligations of $958, $749
and $5,109 during the years ended March 31, 2008 and 2007 and December 31, 2005,
respectively. The Company revised its initial estimate of a capital lease
obligation by $437 during the three months ended March 31, 2006. The Company
rescinded a secured promissory note for the return of a deposit on hospital
assets of $10.0 million during the year ended December 31, 2005. During the year
ended March 31, 2008, the Company reclassified warrant liability of $25,677 to
equity (Note 6). The Company had non cash exercises of warrants of $4,206 and
$9,199 during the years ended March 31, 2008 and 2007, respectively. During the
year ended March 31, 2007 the Company recorded the non cash issuance of warrants
to a vendor with a value of $164. Effective October 9, 2007, in conjunction with
the Company's refinancing (Note 5), the Accounts Purchase Agreement was
terminated and the Company repurchased the remaining outstanding accounts that
been sold, for $6.8 million (funded through the initial advance on the $50.0
million Revolving Line of Credit) in addition to the release of security reserve
funds and deferred purchase price receivables.
F-14
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
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.
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. Penalties or interest, if any, arising from federal or state taxes
are recorded as a component of the income tax provision.
SEGMENT REPORTING - The Company operates in one line of business, the
provision of healthcare services through the operation of general hospitals and
related healthcare 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 healthcare 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 healthcare
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 No. 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.
F-15
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
On February 14, 2008, the FASB issued FASB Staff Position No. FAS
157-1, "Application of FASB Statement No. 157 to FASB Statement No. 13 and Other
Accounting Pronouncements That Address Fair Value Measurements for Purposes of
Lease Classification or Measurement under Statement 13" ("FSP FAS 157-1"). This
Statement does not apply under FASB Statement No. 13, "Accounting for Leases,"
and other accounting pronouncements that address fair value measurements for
purposes of lease classification or measurement under Statement 13. This scope
exception does not apply to assets acquired and liabilities assumed in a
business combination that are required to be measured at fair value under SFAS
141 or SFAS 141R, regardless of whether those assets and liabilities are related
to leases.
On February 12, 2008, the FASB issued FASB Staff Position No. FAS
157-2, "Effective Date of FASB Statement No. 157" ("FSP FAS 157-2"). With the
issuance of FSP FAS 157-2, the FASB agreed to: (a) defer the effective date in
SFAS No. 157 for one year for certain nonfinancial assets and nonfinancial
liabilities, except those that are recognized or disclosed at fair value in the
financial statements on a recurring basis (at least annually), and (b) remove
certain leasing transactions from the scope of SFAS No. 157. The deferral is
intended to provide the FASB time to consider the effect of certain
implementation issues that have arisen from the application of SFAS No. 157 to
these assets and liabilities.
In December 2007, the FASB issued SFAS No. 141(R) "Business
Combinations" ("SFAS 141R"). The statement retains the purchase method of
accounting for acquisitions, but requires a number of changes, including changes
in the way assets and liabilities are recognized in the purchase accounting as
well as requiring the expensing of acquisition-related costs as incurred.
Furthermore, SFAS 141R provides guidance for recognizing and measuring the
goodwill acquired in the business combination and determines what information to
disclose to enable users of the financial statements to evaluate the nature and
financial effects of the business combination. SFAS 141R is effective for fiscal
years beginning on or after December 15, 2008. Earlier adoption is prohibited.
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 No. 159 permits entities to choose to measure many
financial instruments and certain other items at fair value. Most of the
provisions of SFAS No. 159 apply only to entities that elect the fair value
option; however, the amendment to SFAS 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. 160, "Noncontrolling
Interests in Consolidated Financial Statements -- An Amendment of ARB No. 51"
("SFAS 160"). SFAS 160 requires all entities to report noncontrolling(minority)
interests in subsidiaries as equity in the consolidated financial statements.
Also, SFAS 160 is intended to eliminate the diversity in practice regarding the
accounting for transactions between an equity and noncontrolling interests by
requiring that they be treated as equity transactions. SFAS 160 is effective for
fiscal years beginning on or after December 15, 2008. Earlier adoption is
prohibited. SFAS 160 must be applied prospectively as of the beginning of the
fiscal year in which it is initially applied, except for the presentation and
disclosure requirements, which must be applied retrospectively for all periods
presented. The Company has not yet evaluated the impact that SFAS 160 will have
on its consolidated results of operations or financial position.
In March 2008, the FASB issued SFAS No. 161, "Disclosures about
Derivative Instruments and Hedging Activities" ("SFAS 161"). SFAS 161 is
intended to improve financial reporting of derivative instruments and hedging
activities by requiring enhanced disclosures to enable financial statement users
to better understand the effects of derivatives and hedging on an entity's
financial position, financial performance and cash flows. The provisions of SFAS
161 are effective for interim periods and fiscal years beginning after November
15, 2008. The Company does not anticipate that the adoption of SFAS No. 161 will
have a material impact on its consolidated results of operations or financial
position.
F-16
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
May 9, 2008, the FASB issued FASB Staff Position No. APB 14-1,
"Accounting for Convertible Debt Instruments That May Be Settled in Cash upon
Conversion (Including Partial Cash Settlement)" ("FSP APB 14-1"). FSP APB 14-1
clarifies that convertible debt instruments that may be settled in cash upon
conversion (including partial cash settlement) are not addressed by paragraph 12
of APB Opinion No. 14, "Accounting for Convertible Debt and Debt Issued with
Stock Purchase Warrants." Additionally, FSP APB 14-1 specifies that issuers of
such instruments should separately account for the liability and equity
components in a manner that will reflect the entity's nonconvertible debt
borrowing rate when interest cost is recognized in subsequent periods. FSP APB
14-1 is effective for financial statements issued for fiscal years beginning
after December 15, 2008, and interim periods within those fiscal years. The
Company has not yet evaluated the impact that FSP APB 14-1 will have on its
consolidated results of operations or financial position.
NOTE 2 - ACQUISITION
On March 8, 2005, the Company completed the Acquisition of its
Hospitals. The Hospitals were assigned to four wholly owned subsidiaries of the
Company formed for the purpose of completing the Acquisition. The Company also
acquired the following real estate, leases and assets associated with the
Hospitals:
i. a fee interest in the Western Medical Center at 1001 North
Tustin Avenue, Santa Ana, CA, a fee interest in the
administration building at 1301 North Tustin Avenue, Santa
Ana, CA, certain rights to acquire condominium suites located
in the medical office building at 999 North Tustin Avenue,
Santa Ana, CA, and the business known as the West Coast Breast
Cancer Center;
ii. a fee interest in the Western Medical Center at 1025 South
Anaheim Blvd., Anaheim, CA;
iii. a fee interest in the Coastal Communities Hospital at 2701
South Bristol Street, Santa Ana, CA, and a fee interest in the
medical office building at 1901 North College Avenue, Santa
Ana, CA;
iv. a lease for the Chapman Medical Center at 2601 East Chapman
Avenue, Orange, CA, and a fee interest in the medical office
building at 2617 East Chapman Avenue, Orange, CA; and
v. equipment and contract rights.
Subsequently, the Company entered into a sale leaseback transaction for
substantially all of the real estate with PCHI (Note 12).
The operating results of the Hospitals have been included in the
Company's consolidated statements of operations from the date of acquisition
(March 8, 2005).
The purchase price, after all purchase price adjustments, of the
Acquisition amounted to $66,247. The fair value of the assets acquired and
related costs consisted of the following:
Property and equipment $55,834
Inventories 6,019
Prepaid expenses 2,461
-------
64,314
Debt issuance costs 1,933
-------
$66,247
=======
The Company financed the Acquisition and related financing costs (Note
5) by obtaining a $50 million Acquisition Loan, drawing $3.0 million on a
working capital line of credit, selling shares of the Company's common stock for
$10.1 million, and receiving $5.0 million in proceeds from minority investments
in PCHI.
F-17
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
The following unaudited supplemental pro forma information represents
the Company's consolidated results of operations as if the Acquisition had
occurred on January 1, 2005 and after giving effect to certain adjustments
including interest expense, depreciation expense, and related tax effects. In
addition, the following unaudited pro forma information includes the
nonrecurring items related to the issuance of 74,700 common stock warrants (Note
6), which resulted in an expense of $17,604 that the Company recorded during the
year ended December 31, 2005 and restructuring charges of $3,147 incurred by
Tenet during the three months ended March 31, 2005. Such unaudited pro forma
information does not purport to be indicative of operating results that would
have been reported had the Acquisition occurred on January 1, 2005 or future
operating results.
Pro forma (unaudited)
For the year ended December 31, 2005
Net operating revenues $ 338,994
Net loss $ (59,464)
Per share data:
Basic and fully diluted loss per common
per common share $ (0.71)
Weighted average shares outstanding 83,817
NOTE 3 - 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 5). 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
5), the APA was terminated and the Company repurchased the remaining outstanding
accounts that been sold, for $6.8 million (funded through the initial advance on
the $50.0 million Revolving Line of Credit) in addition to the release of
security reserve funds and deferred purchase price receivables. This resulted in
a gain on repurchase of accounts receivable of $918 which was offset against the
loss on sale of accounts receivable recorded during the year ended March 31,
2008, resulting in a total net loss on the sale of accounts receivable of $4.1
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.
F-18
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
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 on sale of accounts receivable is comprised
of the following.
For the year ended For the three
------------------------------------------------------- months ended
March 31, 2008 March 31, 2007 December 31, 2005 March 31, 2006
---------------- ---------------- ---------------- ----------------
Transaction Fees deducted from Security
Reserve Funds - closed purchases $ 2,395 $ 4,568 $ 3,330 $ 1,394
Change in accrued Transaction Fees - open purchases (712) 262 863 108
---------------- ---------------- ---------------- ----------------
Total Transaction Fees incurred 1,683 4,830 4,193 1,502
---------------- ---------------- ---------------- ----------------
Servicing expense for sold accounts receivable
- closed purchases 3,186 5,525 3,597 1,231
Change in accrued servicing expense for sold accounts
receivable - open purchases (790) 33 680 75
---------------- ---------------- ---------------- ----------------
Total servicing expense incurred 2,396 5,558 4,277 1,306
---------------- ---------------- ---------------- ----------------
Loss on sale of accounts receivable $ 4,079 $ 10,388 $ 8,470 $ 2,808
================ ================ ================ ================
The related accrued Transaction Fee and accrued servicing liabilities included
in other current liabilities on the accompanying consolidated balance sheet as
of March 31, 2007 are as follows.
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.
F-19
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
NOTE 4 - PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
March 31, March 31,
2008 2007
-------- --------
Buildings $ 33,791 $ 33,697
Land and improvements 13,523 13,523
Equipment 10,520 9,694
Assets under capital leases 7,464 6,505
-------- --------
65,298 63,419
Less accumulated depreciation (8,381) (5,247)
-------- --------
Property and equipment, net $ 56,917 $ 58,172
======== ========
Essentially all land and buildings are owned by PCHI (Notes 12, 13 and
14).
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.
The State of California has introduced a new seismic review methodology
known as HAZUS. The HAZUS methodology may preclude the need for some structural
modifications. Three of the four Hospitals have requested HAZUS review and one
of them has already received a favorable notice pertaining to structural
reclassification.
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.
F-20
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
NOTE 5 - 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 March 31.
2008 2007
(restated)
-------- --------
Current:
Revolving line of credit, outstanding borrowings $ 9,879 $ --
Convertible note 10,700 --
Secured term note 45,000 --
Secured non-revolving line of credit, outstanding
borrowings 30,000 --
Secured note -- 10,700
Less derivative - warrant liability, current -- (10,700)
Secured acquisition loan -- 45,000
Secured line of credit, outstanding borrowings -- 27,341
-------- --------
$ 95,579 $ 72,341
======== ========
F-21
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
Effective October 9, 2007, 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.
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 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, at October 8, 2010,
(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 6).
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 6)
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."
F-22
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
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 year ended March 31, 2008, and legal fees
and other expenses are being amortized over three years (Note 1).
Based on eligible receivables, as defined, the Company had
approximately $26.9 million of additional availability under its $50.0 million
Revolving Line of Credit at March 31, 2008.
The Company's New Credit Facilities are subject to certain financial
and restrictive covenants including debt service coverage ratio, minimum cash
collections, dividend restrictions, mergers and acquisitions, and other
corporate activities common to such financing arrangements. Effective for the
period from January 1, 2008 through June 30, 2009, the Lender amended the New
Credit Facilities whereby the minimum fixed charge coverage ratio, as defined,
was reduced from 1.0 to 0.4. This Amendment allowed the $85.7 million debt to be
classified as non current at March 31, 2008 in the Original Filing of the
Company's Form 10-K. However, as a result of the error identified subsequent to
the Original Filing of the Company's Form 10-K (Note 16), the Company was not in
compliance with the amended Minimum Fixed Charge Coverage Ratio of 0.4 at March
31, 2008. As a result of this technical default, the comparative consolidated
balance sheet at March 31, 2008 has been reclassified to reflect all the debt as
current in accordance with SFAS 78, "Classification of Obligations That Are
Callable by the Creditor - An Amendment to ARB 43, Chapter 3A." This has been
reviewed with the Lender who has responded that the variance is not material to
the Lender. The Company has not received and does not expect to receive a notice
of default from the Lender.
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 14). 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 14).
NOTE 6 - COMMON STOCK WARRANTS
NEW WARRANTS - Concurrently with the execution of the New Credit
Facilities (Note 5), the Company issued to an affiliate of the Lender a
five-year warrant to purchase the greater of approximately 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, as defined, at $0.21 per
share (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"). 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.
F-23
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
The Restructuring Warrants were exercisable beginning January 27, 2007
and expire on July 27, 2008. The exercise price for the first 43.0 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
$9.2 million. 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 in cash. The effect of this
exercise resulted in additional warrant expense for the year ended March 31,
2007 of $693, 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 5) 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
amended its Articles of Incorporation to increase its authorized shares of
common stock from 250 million to 400 million. 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.
The Company recorded common stock warrant expense of $11.4 million,
$693, and $17.6 million during the years ended March 31, 2008 and 2007, and
December 31, 2005. There was no common stock warrant expense recorded during the
three months ended March 31, 2006. The Company recorded a change in the fair
value of warrant liability of $14.3 million, $(133), $3.5 million, and $(8.2)
million for the years ended March 31, 2008 and 2007 and December 31, 2005, and
the three months ended March 31, 2006, respectively.
F-24
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
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 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 warrants. 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.
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.
F-25
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
NOTE 7 - INCOME TAXES
The Company accounts for income taxes in accordance with SFAS No. 109
"Accounting for Income Taxes" which requires the liability approach for the
effect of income taxes. Under the liability method, deferred tax assets and
liabilities are recognized using tax rates for the effect of temporary
differences between book and tax basis of recorded assets and liabilities. The
provision for income taxes consists of provisions for federal and state income
taxes.
The preparation of consolidated financial statements in conformity with
U.S. GAAP requires the Company to make estimates and assumptions that affect the
reported amount of tax-related assets and liabilities and income tax provisions.
The Company assesses the recoverability of the deferred tax assets on an ongoing
basis. In making this assessment the Company is required to consider all
available positive and negative evidence to determine whether, based on such
evidence, it is more likely than not that some portion or all of the net
deferred assets will be realized in future periods. This assessment requires
significant judgment. In addition, the Company has made significant estimates
involving current and deferred income taxes, tax attributes relating to the
interpretation of various tax laws, historical bases of tax attributes
associated with certain tangible and intangible assets and limitations
surrounding the realization of the deferred tax assets. The Company does not
recognize current and future tax benefits until it is deemed probable that
certain tax positions will be sustained.
The provision for income taxes consisted of the following:
For the years ended For the three
------------------------------------------------------ months ended
March 31, 2008 March 31, 2007 December 31, 2005 March 31, 2006
-------------- ----------------- ----------------- --------------
Current income tax provision
Federal $ 23 $ - $ - $ -
State 5 5 5 5
-------------- ----------------- ----------------- --------------
28 5 5 5
-------------- ----------------- ----------------- --------------
Deferred income tax benefit
Federal - - - -
State - - - -
-------------- ----------------- ----------------- --------------
- - - -
-------------- ----------------- ----------------- --------------
Income tax provision $ 28 $ 5 $ 5 $ 5
============== ================= ================= ==============
F-26
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
A reconciliation between the amount of reported income tax expense and
the amount computed by multiplying loss from continuing operations before income
taxes by the statutory federal income tax rate is as follows:
For the years ended For the three
------------------------------------------------------ months ended
March 31, 2008 March 31, 2007 December 31, 2005 March 31, 2006
-------------- ----------------- ----------------- --------------
U.S. federal statutory income taxes $ (13,238) $ (7,184) $ (15,358) $ 789
State and local income taxes, net
of federal benefits (2,258) (1,226) (2,665) (348)
Change in valuation allowance 2,180 14,684 14,841 4,446
Warrants 8,730 45 7,162 (2,794)
Enterprise zone credits (4,023) (6,666) (6,580) (1,666)
Other 8,637 352 2,605 (422)
-------------- ----------------- ----------------- --------------
Income tax provision $ 28 $ 5 $ 5 $ 5
============== ================= ================= ==============
Deferred income taxes reflect the tax effects of temporary differences between
the carrying amount of assets and liabilities for financial reporting purposes
and the amount used for income tax purposes. The following table discloses those
significant components of deferred tax assets and liabilities, including the
valuation allowance at March 31:
2008 2007
-------------- --------------
Deferred tax assets:
Allowance for doubtful accounts $ 6,219 $ 1,052
Accrued vacation 2,169 2,542
Tax credits 18,936 14,913
Net operating losses 11,924 12,334
Other (3,343) 2,885
-------------- --------------
35,905 33,726
Valuation allowance (35,905) (33,726)
-------------- --------------
Total deferred tax assets $ - $ -
============== ==============
The company has two Hospitals located in the State of California
Enterprise Zone which has provided significant state tax credits ($18,936 as of
March 31, 2008) which are allowable to reduce California income tax on a
dollar-for-dollar basis. The credits, which are not subject to expiration, are
granted by a State agency whose issuance can be reviewed by the California
Franchise Tax Board.
The valuation allowances above were recorded based on an assessment of
the realization of deferred tax assets as described below. The Company assesses
the realization of deferred tax assets to determine whether an income tax
valuation allowance is required. The Company recorded a 100% valuation allowance
on its deferred tax based primarily on the following factors:
o cumulative losses in recent years;
o income/losses expected in future years;
o unsettled circumstances that, if unfavorably resolved, would
adversely affect future operations and profit levels;
o the availability, or lack thereof, of taxable income in
prior carryback periods that would limit realization of tax
benefits;
o the carryforward period associated with the deferred tax
assets and liabilities.
F-27
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
ACQUISITION - The Acquisition was an asset purchase transaction and the
Company will not benefit from the net operating losses of the acquired Hospitals
prior to the date of acquisition. In connection with the Company's completion of
the Acquisition in March 2005, the Company sold substantially all of the real
estate of the acquired hospitals to PCHI. For income tax purposes, the sale of
the real estate of the acquired hospitals is subject to review by the Internal
Revenue Service. The IRS could require the Company to report dividend and/or
interest income. If the Company is required to report dividend and/or interest
income in connection with this transaction, the Company would be required to
withhold 28% on any deemed dividend or interest income. The Company's sale of
real estate to PCHI on March 8, 2005 for $5 million plus the assumption of the
Acquisition Loan is a taxable event to the Company.
PCHI TAX STATUS - PCHI is a limited liability corporation. PCHI's
owners plan to make tax elections for it to be treated as a disregarded entity
for tax reporting whereby, in a manner similar to a partnership. PCHI's taxable
income or loss will flow through to its owners and be their separate
responsibility. Accordingly, the accompanying consolidated financial statements
do not include any amounts for the income tax expense or benefit, or liabilities
related to PCHI's income or loss.
The Company has Net Operating Loss carryfowards which expire as
follows:
Tax year ended Federal State
December 31, amount expiring amount expiring
-------------------- ------------------- -------------------
2016 $ - $ 3,647
2021 $ - $ 8,734
2024 $ 10 $ -
2025 $ 9,818 $ -
2026 $ 20,307 $ -
NOTE 8 - 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.
F-28
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
NOTE 9 - STOCK INCENTIVE 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 a maximum aggregate of 12.0 million shares of common
stock. In addition, as of the first business day of each calendar year in the
period 2007 through 2015, the maximum aggregate number of shares shall be
increased by a number equal to one percent of the number of shares of common
stock of the Company outstanding on December 31 of the immediately preceding
calendar year. As of March 31, 2008, the maximum aggregate number of shares
under the Plan was increased by approximately 1.4 million shares for a total of
13.4 million. 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 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
are subject to this retroactive vesting. Vesting of the remaining 1,295 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 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
were subject to immediate vesting on the grant date. Vesting of the remaining
866.67 granted options commenced on the October 10, 2007 grant date.
On December 13, 2007, the Company granted options to employees with the
right to purchase an aggregate of 210 shares at an exercise prices of $0.30 per
share. All options granted on December 13, 2007 commenced vesting on the grant
date.
On January 8, 2008, the Company granted options to employees with the
right to purchase an aggregate of 760 shares at an exercise prices of $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 on January 8, 2008, 130 are subject to
retroactive vesting commencing on March 8, 2005. Vesting of the remaining 630
granted options commenced on the January 8, 2008 grant date.
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 of the Company's stock
and the stock of the following publicly traded companies that own hospitals.
F-29
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
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.
Expected dividend yield 0.0%
Risk-free interest rate 2.8% - 4.4%
Expected volatility 30.6% - 37.1%
Expected term (in years) 3.5 - 5.8
In accordance with SFAS No. 123R, the Company recorded $120.9 of
compensation expense relative to stock options during the year ended March 31,
2008. No options were granted prior to August 6, 2007. A summary of stock option
activity for the period from June 30, 2007 through March 31, 2008 is presented
as follows (there was no prior stock option activity).
Weighted-
average
Weighted- remaining
average contractual Aggregate
exercise term intrinsic
Shares price (years) value
-------- ---------- ----------- ---------
Outstanding, March 31, 2007 - $ -
Granted 7,515 $ 0.24
Exercised - $ -
Forfeited or expired (70) $ 0.26
--------
Outstanding, March 31, 2008 7,445 $ 0.24 6.4 $ -
======== ========== =========== =========
Exercisable at March 31, 2008 4,463 $ 0.24 6.4 $ -
======== ========== =========== =========
No options were exercised during the year ended March 31, 2008.
A summary of the Company's nonvested shares as of March 31, 2008, and
changes during the year ended March 31, 2008 (there was no prior stock option
activity), is presented as follows.
Weighted-
average
grant date
Shares fair value
------------- -------------
Nonvested at March 31, 2007 - $ -
Granted 7,515 $ 0.04
Vested (4,463) $ 0.03
Forfeited (70) $ 0.08
------------- =============
Nonvested at March 31, 2008 2,982 $ 0.05
============= =============
As of March 31, 2008, there was $152.0 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 2.6 years.
F-30
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
NOTE 10 - RETIREMENT PLAN
The Company has a 401(k) plan for its employees. All employees with 90
days of service are eligible to participate, unless they are covered by a
collective bargaining agreement which precludes coverage. The Company matches
employee contributions up to 3% (5% prior to May 1, 2006) of the employee's
compensation, subject to IRS limits. During the years ended March 31, 2008 and
2007, December 31, 2005, and the three months ended March 31, 2006, the Company
incurred expenses of $2,982, $3,053, $3,522, and $1,128, respectively, which are
included in salaries and benefits in the accompanying consolidated statements of
operations.
NOTE 11 - INCOME (LOSS) PER SHARE
Income (loss) per share has been calculated under SFAS No. 128,
"Earnings per Share." SFAS No. 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 years ended March 31, 2008
and 2007, and December 31, 2005, antidilutive potential shares of common stock,
consisting of approximately 200 million, 83 million, and 43 million shares
issuable under warrants and stock options, respectively, have been excluded from
the calculations of diluted loss per share for those periods.
Income per share for the three months ended March 31, 2006 was computed
as follows:
Numerator:
Net income $ 2,422
==============
Denominator:
Weighted average common shares 84,281
Warrants 42,947
--------------
Denominator for diluted calculation 127,228
==============
Income per share - basic $ 0.03
Income per share - diluted $ 0.02
The number of shares into which the December Note warrant could convert
is not included in the calculation of diluted income per share, as the related
December Note was in default and thus the warrant had vested. The inclusion of
the warrant on an as converted basis would not change the amount of reported
diluted income per share.
F-31
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
NOTE 12 - VARIABLE INTEREST ENTITY
Concurrent with the close on the Acquisition, and pursuant to an
agreement dated September 28, 2004, as amended and restated on November 16,
2004, Dr. Chaudhuri and Dr. Shah exercised their option to purchase all of the
equity interests in PCHI, which simultaneously acquired title to substantially
all of the real property acquired by the Company in the Acquisition. The Company
received $5.0 million and PCHI guaranteed the Company's Acquisition Loan (the
Acquisition Loan was refinanced on October 9, 2007 with a $45.0 million Term
Note (Note 5)). 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 a guarantor 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. PCHI is a related party entity that
is affiliated with the Company through common ownership and control. It is owned
51% by West Coast Holdings, LLC (Dr. Shah and investors) and 49% by Ganesha
Realty, LLC (Dr. Chaudhuri and Mr. Thomas). Under FIN 46R (Note 1), a company is
required to consolidate the financial statements of any entity that cannot
finance its activities without additional subordinated financial support, and
for which one company provides the majority of that support through means other
than ownership. Effective March 8, 2005, the Company determined that it provided
the majority of financial support to PCHI through various sources including
lease payments, remaining primarily liable under the $45.0 million Term Note,
and cross-collateralization of the Company's non-real estate assets to secure
the $45.0 million Term Note. Accordingly, the Company included the net assets of
PCHI, net of consolidation adjustments, in its consolidated financial statements
at March 31.
2008 2007
-------------- --------------
Total assets $ 45,517 $ 46,464
Total liabilities $ 45,363 $ 45,537
Members' equity $ 154 $ 927
Selected information from PCHI's results of operations for the years
ended March 31, 2008 and 2007 and December 31, 2005, and for the three months
ended March 31, 2006 is as follows:
Year ended Three months
--------------------------------------------------- ended
March 31, 2008 March 31, 2007 December 31, 2005 March 31, 2006
-------------- -------------- ----------------- --------------
Net revenues $ 8,965 $ 6,554 $ 7,277 $ 1,545
Net income (loss) $ 1,474 $ (593) $ (1,658) $ (100)
Consolidation adjustments to reflect the effects of the following matters are
included in the accompanying consolidated financial statements:
The Company's rental income and expense in the Hospitals has been
eliminated, consolidating PCHI's ownership of the land and buildings in the
accompanying consolidated financial statements. The amount of rent incurred and
eliminated for the years ended March 31, 2008 and 2007 and December 31, 2005,
and the three months ended March 31, 2006 was $8,965, $6,554, $7,277, and
$1,545, respectively.
Additionally, a gain of $4,433 arising from the Company's sale of the
real property of the Hospitals to PCHI has been eliminated to record the land
and buildings at the Company's cost. Essentially all land and buildings in the
accompanying consolidated balance sheets are owned by PCHI.
F-32
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
PCHI's equity accounts have been classified as a minority interest in a
variable interest entity.
The Company has a lease commitment to PCHI (Note 14). Based on the
existing arrangements, aggregate payments are estimated to be approximately
$156.0 million over the remainder of the initial term. Additionally, the Company
is responsible for seismic remediation under the terms of the lease agreement
(Note 4).
NOTE 13 - 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 co-managed by Dr. Sweidan and Dr. Chaudhuri, respectively. 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 March 31, 2008 and 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 antidilution feature of the warrant (Note 6). As described in
Note 12, PCHI is a variable interest entity and, accordingly, the Company has
consolidated the financial statements of PCHI in the accompanying condensed
financial statements.
During the years ended March 31, 2008 and 2007 and December 31, 2005,
and the three months ended March 31, 2006, the Company paid $5.1 million, $2.2
million, $1.3 million, and $0.6 million, respectively, to a supplier that is
also a shareholder of the Company.
NOTE 14 - 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 5), 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 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 12).
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 12).
F-33
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
Following is a schedule of the Company's future minimum operating lease
payments, excluding the triple net lease with PCHI, that have initial or
remaining non-cancelable lease terms in excess of one year as of March 31, 2008:
Year ended
March 31,
---------------
2009 $ 1,549
2010 1,274
2011 1,278
2012 1,270
2013 1,259
Thereafter 16,963
------------
Total $ 23,593
============
Total rental expense for the years ended March 31, 2008 and 2007 and
December 31, 2005 was $1,754, $1,839, and $2,276, respectively, and $393 for the
three months ended March 31, 2006. The Company received sublease rental income
in relation to certain leases of approximately $638, $759, and $536 for the
years ended March 31, 2008 and 2007 and December 31, 2005, respectively, and
$190 for the three months ended March 31, 2006.
CAPITAL LEASES - In connection with the Hospital Acquisition, the
Company also assumed the leases for the Chapman facility, which include
buildings and land with terms that were extended concurrently with the
assignment of the leases to December 31, 2023. The Company leases equipment
under capital leases expiring at various dates through January 2013. Assets
under capital leases with a net book value of $6,335 and $5,872 are included in
the accompanying consolidated balance sheets as of March 31, 2008 and 2007,
respectively. Interest rates used in computing the net present value of the
lease payments are based on the interest rates implicit in the leases.
The following is a schedule of future minimum lease payments under the
capitalized leases with the present value of the minimum lease payments as of
March 31, 2008:
Year ended
March 31,
- ------------------------
2009 $ 1,240
2010 1,240
2011 1,219
2012 1,094
2013 984
Thereafter 7,999
------------------
Total minimum lease payments 13,776
Less amount representing interest (6,995)
------------------
Net present value of net minimum lease payments 6,781
Less current portion (406)
------------------
Noncurrent portion $ 6,375
==================
F-34
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
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 and are discounted to their net present value using a weighted
average risk-free discount rate of 5%. To the extent that subsequent claims
information varies from estimates, the liability is adjusted in the period such
information becomes available. As of March 31, 2008 and 2007, the Company had
accrued $9.9 million and $4.9 million, respectively, which is comprised of $3.0
million and $1.4 million, respectively, in incurred and reported claims, along
with $6.9 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. Effective May 2006, the
Company secured 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 and are discounted to their net
present value using a weighted average risk-free discount rate of 5%. To the
extent that subsequent claims information varies from estimates, the liability
is adjusted in the period such information becomes available. As of March 31,
2008 and 2007, the Company had accrued $710 and $1,000, respectively, comprised
of $169 and $200, respectively, in incurred and reported claims, along with $541
and $800, 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 March 31, 2008 was based
upon projections . 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 March 31, 2008, the Company
had accrued $1.7 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 March 31, 2008. 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 umbrella liability policies with
aggregate limits of $25 million. The umbrella policies provide coverage in
excess of the primary layer and applicable retentions for insured liability
risks such as general and professional liability, auto liability, and workers
compensation (employers liability).
The Company finances various insurance policies at interest rates
ranging from 4.23% to 6.35% per annum. The Company incurred finance charges
relating to such policies of $123, $248, $89, and $1 during the years ended
March 31, 2008 and 2007 and December 31, 2005, and the three months ended March
31, 2006, respectively. As of March 31, 2008 and 2007, the accompanying
consolidated balance sheets include the following balances relating to the
financed insurance policies.
F-35
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
March 31, 2008 March 31, 2007
---------------- ----------------
Prepaid insurance $ 721 $ 5,004
Accrued insurance premiums $ 299 $ 3,808
(Included in other current liabilities)
PURCHASE COMMITMENTS - The Company has commitments with two unrelated
party service provider vendors extending over one year with two suppliers.
Commitments total $3,663, $3,613, $3,064, $3,064, and $0 for the years ending
March 31, 2009, 2010, 2011, 2012, and 2013, respectively.
BONUSES - During the year ended March 31, 2008, the Company implemented
the Corporate Team Bonus Plan for 2007/2008. Under this discretionary plan,
eligible employees could receive bonuses based on the Company's performance and
individual performances. For the year ended March 31, 2008, the Company awarded
eligible employees an aggregate of $494,669, which is included in accrued
compensation and benefits in the accompanying consolidated balance sheet as of
March 31, 2008. The bonuses were approved by the Company's Board of Directors
and were paid in June 2008.
SEVERANCE AGREEMENT - On December 31, 2007, the Company entered into a
Severance Agreement With Mutual Releases ("Severance Agreement") and a
Consulting Agreement with Larry B. Anderson. Under the Severance Agreement, Mr.
Anderson terminated his employment as President of the Company by mutual
agreement, effective December 31, 2007.
Under the Severance Agreement, Mr. Anderson could receive consideration
currently valued at approximately $465,000. The Company will pay Mr. Anderson
compensation equivalent to fourteen equal monthly installments. The amount of
each monthly installment shall be the sum of Mr. Anderson'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 upfront payment equivalent to eight
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 Mr. Anderson. 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.
F-36
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
Under the terms of the Consulting Agreement, which is effective from
January 1, 2008 through June 30, 2008, the Company will pay Mr. Anderson
$180,000 consisting of one upfront 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 special projects, such as
his services relating to the then-proposed acquisition of a specifically
identified hospital by the Company, Mr. Anderson would be entitled to receive
0.5% of the total value of the purchase, minus $30,000, or an estimated $310,000
if the acquisition was consummated at the then-proposed price. Such acquisition
was not consummated by the Company. The Consulting Agreement contains other
provisions customary to such agreements.
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, healthcare 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 20% of the Company's employees are represented by labor
unions as of March 31, 2008. 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 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, change in medical benefits at two facilities, 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.
F-37
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
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. On April
16, 2008, the Company filed an amended complaint, alleging that the defendant
directors' failure to timely approve a refinancing package offered by the
Company's largest lender caused the Company to default on its then-existing
loans. Also on April 16, 2008, these directors filed cross-complaints against
the Company for alleged failures to honor its indemnity obligations to them in
this litigation. 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. A trial date has been set for January 26, 2009, and the parties are
currently moving forward with discovery. The Company does not anticipate the
resolution of these ongoing claims for damages will have a material adverse
effect on its results of operations.
NOTE 15 - SUBSEQUENT EVENTS
On June 19, 2008 the Company received a demand from OC-PIN requesting
that it provide notice of a special shareholders meeting by no later than June
26, 2008, with the meeting to occur on a date during the week of July 21-25,
2008. OC PIN stated that the business to be conducted at the special
shareholders meeting is to (1) repeal the amendment to the Company's bylaws on
June 3, 2008 establishing a procedure for nominating candidates for election as
director, (2) remove the entire Board of Directors of the Company, and (3)
nominate and elect a new slate of individuals to the Board of Directors. On June
24, 2008, OC-PIN's counsel sent the Company an additional letter demanding that
the Company immediately close its stock transfer books or immediately set the
Record Date for the requested special shareholders meeting, and waive the record
search required under Rule 14a-13(a)(3) of the Securities and Exchange
Commission.
F-38
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
On June 26, 2008, the Company sent OC-PIN a letter indicating that the
Company could not comply with this demand because, among other reasons, OC-PIN
has not furnished the consent of the Company's principal lender, which consent
is required under the Company's Credit Agreements, aggregating up to $140.7
million, prior to taking any of the actions proposed to be taken by OC-PIN at
the special shareholders meeting. In the absence of the lender's consent, the
actions proposed by OC-PIN would entitle the lender to certain remedies which
would have a material adverse effect on the Company and its shareholders.
Further, OC-PIN had not followed the procedures contained in the Company's
bylaws for nominating and electing directors of the Company, making the demand
defective under the bylaws. Regarding the setting of a record date, the Company
is obligated under Rule 14a-13(a)(3) to provide at least 20 business days prior
notice to all banks, brokers and other "street name" holders of its stock in
advance of the record date for any shareholder meeting at which the Company
intends to solicit proxies or consents, and the Company would be in violation of
this requirement if it acceded to the demand of OC-PIN's counsel to waive this
requirement. The Company believes its positions are justified, and intends to
vigorously oppose any attempt by OC-PIN to force the Company to take actions
that would put it in default with its lender or cause it to violate the federal
securities laws.
On July 8, 2008, in a separate action, OC-PIN filed a complaint against
the Company in Orange County Superior Court alleging causes of action for breach
of contract, specific performance, reformation, fraud, negligent
misrepresentation and declaratory relief. The complaint alleges that the Stock
Purchase Agreement that the Company executed with OC-PIN on January 28, 2005
"inadvertently omitted" an anti-dilution provision (the "Allegedly Omitted
Provision") which would have allowed OC-PIN a right of first refusal to purchase
common stock of the Company on the same terms as any other investor in order to
maintain OC-PIN's holding at no less than 62.4% of the common stock on a fully
diluted basis. The complaint further alleges that the Company has issued stock
options under a Stock Incentive Plan and warrants to its lender in violation of
the Allegedly Omitted Provision. The complaint further alleges that the issuance
of warrants to purchase the Company's stock to Dr. Kali P. Chaudhuri and William
Thomas, and their exercise of a portion of those warrants, were improper under
the Allegedly Omitted Provision. The Company believes that this lawsuit is
wholly without merit and intends to contest these claims vigorously. However, at
this early stage, the Company is unable to determine the cost of defending this
lawsuit or the impact, if any, that this lawsuit may have on the Company's
results of operations or financial condition.
F-39
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
NOTE 16 - RESTATEMENT OF CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE
YEAR ENDED MARCH 31, 2008
On August 20, 2008, the Company's Audit Committee determined that the
Company's consolidated financial statements as of and for the year ended March
31, 2008 should be restated due to an error in the overstatement of net revenues
and accounts receivable and other operating expenses and accounts payable. More
specifically, the Company determined that the restatements with respect to its
financial statements for the year ended March 31, 2008 were necessary to
correctly reflect the contractual discounts for patient accounts receivable and
revenue related to the Company's subactute unit at its Chapman facility. The
correction of this error resulted in the noncompliance of the Company's debt
service coverage ratio at that date (Note 5). This has been reviewed with the
Lender who has responded that the variance is not material to the Lender.
However, SFAS 78 does not permit recognition of amendments or waivers that occur
after the issuance of the Company's Form 10-K on July 14, 2008. Accordingly, in
this filing the Company has restated its consolidated financial statements as of
and for the year ended March 31, 2008.
The correction of these errors resulted in the following adjustments to
the accumulated deficit at March 31, 2008.
Accumulated deficit as previously reported $(104,553)
Overstatement of accounts receivable (508)
Overstatement of accounts payable 68
---------
Accumulated deficit as restated $(104,993)
=========
The following table sets forth the amounts as originally reported in
the Company's consolidated balance sheet as of March 31, 2008, and the
consolidated statement of operations for year then ended and the effects of the
correction of the errors as described above:
As of and for the
year ended March 31, 2008
--------------------------
As
previously As
reported restated
--------- ---------
Balance sheet:
Accounts receivable $ 57,990 $ 57,482
Total assets 136,089 135,581
Debt, current 9,879 95,579
Debt, non current 85,700 --
Accounts payable 46,749 46,681
Total liabilities 184,357 184,289
Accumulated deficit (104,553) (104,993)
Total stockholders' deficiency (48,268) (48,708)
Statement of operations
Net operating revenues 368,229 367,721
Operating income (loss) 1,225 785
Loss before minority interest and
provision for income taxes (37,661) (38,101)
Net loss (39,163) (39,603)
Earnings (loss) per common share $ (0.30) $ (0.30)
Earnings (loss) per common share $ (0.30) $ (0.30)
F-40
<page>
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
NOTE 17 - QUARTERLY RESULTS (UNAUDITED)
The following tables contain selected unaudited consolidated statements of
operations and income (loss) per share data for each quarter in the years ended
March 31, 2008 and 2007:
For the three months ended
March 31, 2008 December 31, 2007 September 30, 2007 June 30, 2007
----------------- ----------------- ------------------ ---------------
(restated)
Net operating revenues $ 97,396 $ 88,158 $ 95,376 $ 86,791
Operating income (loss) $ 2,061 $ (2,558) $ 4,090 $ (2,808)
Net income (loss) $ (1,655) $ (33,299) $ 1,126 $ (5,775)
Income (loss) per common share
Basic $ (0.01) $ (0.24) $ 0.01 $ (0.05)
Diluted $ (0.01) $ (0.24) $ 0.01 $ (0.05)
Weighted average shares outstanding
Basic 137,096 137,096 136,870 116,304
Diluted 137,096 137,096 190,370 116,304
For the three months ended
March 31, 2007 December 31, 2006 September 30, 2006 June 30, 2006
----------------- ----------------- ------------------ ---------------
Net operating revenues $ 87,200 $ 87,137 $ 85,343 $ 90,992
Operating income (loss) $ (402) $ (4,317) $ (4,681) $ 926
Net income (loss) $ (2,320) $ (13,402) $ (7,004) $ 2,188
Income (loss) per common share
Basic $ (0.02) $ (0.15) $ (0.08) $ 0.03
Diluted $ (0.02) $ (0.15) $ (0.08) $ 0.02
Weighted average shares outstanding
Basic 104,486 87,557 85,013 84,351
Diluted 104,486 87,557 85,013 127,297
F-41
<page>
The following financial statement schedule is the only schedule required to be
filed under the applicable accounting regulations of the Securities and Exchange
Commission.
INTEGRATED HEALTHCARE HOLDINGS, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
[amounts in 000's]
BALANCE AT
BEGINNING OF BALANCE AT
PERIOD DESCRIPTION PERIOD ADDITIONS DEDUCTIONS END OF PERIOD
- ------ ----------- ------ --------- ---------- -------------
Accounts Receivable:
Year ended March 31, 2008 Allowance for doubtful accounts $ 2,355 $ 49,679(1) $ 37,651 $ 14,383
Year ended March 31, 2007 (2) Allowance for doubtful accounts $ 2,463 $ 37,408 $ 37,516 $ 2,355
Three months ended March 31, 2006 Allowance for doubtful accounts $ 3,148 $ 8,330 $ 9,015 $ 2,463
Year ended December 31, 2005 Allowance for doubtful accounts $ - $ 37,349 $ 34,201 $ 3,148
Deferred tax assets:
Year ended March 31, 2008 Valuation allowance $ 33,725 $ 2,180 $ - $ 35,905
Year ended March 31, 2007 Valuation allowance $ 19,041 $ 14,684 $ - $ 33,725
Three months ended March 31, 2006 Valuation allowance $ 14,775 $ 4,266 $ - $ 19,041
Year ended December 31, 2005 Valuation allowance $ 800 $ 13,975 $ - $ 14,775
Year ended December 31, 2004 Valuation allowance $ 41 $ 759 $ - $ 800
(1) Includes additions to allowance related to repurchased accounts
receivable.
(2) Additions and deductions for the year ended March 31, 2007 have been
reclassified. Such reclassifications have no effect on the beginning or
ending balances.
F-42