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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 2008; or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from to
Commission File Number 0-23511
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INTEGRATED HEALTHCARE HOLDINGS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
NEVADA 87-0573331
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
1301 NORTH TUSTIN AVENUE
SANTA ANA, CALIFORNIA 92705
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(714) 953-3503
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year, if
changed since last report)
----------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [ ]
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]
There were 161,973,929 shares outstanding of the registrant's common stock as of
November 7, 2008.
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INTEGRATED HEALTHCARE HOLDINGS, INC.
FORM 10-Q
TABLE OF CONTENTS
Page
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of September 30, 2008
and March 31, 2008 - (unaudited) 3
Condensed Consolidated Statements of Operations for the three
and six months ended September 30, 2008 and 2007 - (unaudited) 4
Condensed Consolidated Statement of Stockholders' Deficiency
for the six months ended September 30, 2008 - (unaudited) 5
Condensed Consolidated Statements of Cash Flows for the six
months ended September 30, 2008 and 2007 - (unaudited) 6
Notes to Condensed Consolidated Financial Statements -
(unaudited) 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 28
Item 3. Quantitative and Qualitative Disclosures About Market Risk 42
Item 4. Controls and Procedures 42
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 43
Item 1A. Risk Factors 44
Item 4. Submission of Matters to a Vote of Submission of Matters
to a Vote of Security Holders 45
Item 6. Exhibits 45
Signatures 45
2
PART I - FINANCIAL INFORMATION
Item 1. Financial statements
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(amounts in 000's, except par value)
(unaudited)
September 30, March 31,
2008 2008
----------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 9,416 $ 3,141
Restricted cash 15 20
Accounts receivable, net of allowance for doubtful
accounts of $18,469 and $14,383, respectively 50,566 57,482
Inventories of supplies, at cost 5,986 5,853
Due from governmental payers 5,172 4,877
Prepaid insurance 2,313 721
Other prepaid expenses and current assets 5,254 5,811
----------- -----------
Total current assets 78,722 77,905
Property and equipment, net 57,296 56,917
Debt issuance costs, net 495 759
----------- -----------
Total assets $ 136,513 $ 135,581
=========== ===========
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Debt, due on demand $ 95,348 $ 95,579
Accounts payable 50,537 46,681
Accrued compensation and benefits 15,007 14,701
Due to governmental payers 982 1,690
Accrued insurance retentions 12,273 12,332
Other current liabilities 7,590 5,781
----------- -----------
Total current liabilities 181,737 176,764
Capital lease obligations, net of current portion
of $883 and $406, respectively 7,110 6,375
Minority interest in variable interest entity -- 1,150
----------- -----------
Total liabilities 188,847 184,289
----------- -----------
Commitments, contingencies and subsequent event
Stockholders' deficiency:
Common stock, $0.001 par value; 400,000 shares authorized;
161,974 and 137,096 shares issued and outstanding 162 137
Additional paid in capital 59,957 56,148
Accumulated deficit (112,453) (104,993)
----------- -----------
Total stockholders' deficiency (52,334) (48,708)
----------- -----------
Total liabilities and stockholders' deficiency $ 136,513 $ 135,581
=========== ===========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
3
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in 000's, except per share amounts)
(unaudited)
Three months ended Six months ended
September 30, September 30,
---------------------- ----------------------
2008 2007 2008 2007
--------- --------- --------- ---------
Net operating revenues $ 95,466 $ 95,376 $ 189,029 $ 182,168
--------- --------- --------- ---------
Operating expenses:
Salaries and benefits 53,875 51,122 106,547 99,951
Supplies 12,137 12,277 24,441 24,580
Provision for doubtful accounts 11,918 7,353 21,661 15,584
Other operating expenses 18,987 17,323 36,180 34,180
Loss on sale of accounts receivable -- 2,411 -- 4,997
Depreciation and amortization 889 800 1,783 1,593
--------- --------- --------- ---------
97,806 91,286 190,612 180,885
--------- --------- --------- ---------
Operating income (loss) (2,340) 4,090 (1,583) 1,283
--------- --------- --------- ---------
Other expense:
Interest expense, net (2,785) (3,081) (5,788) (6,168)
Warrant expense (22) -- (22) --
--------- --------- --------- ---------
(2,807) (3,081) (5,810) (6,168)
--------- --------- --------- ---------
Income (loss) before provision for income
taxes and minority interest (5,147) 1,009 (7,393) (4,885)
Provision for income taxes (17) -- (17) --
Minority interest in (income) loss of
variable interest entity 481 117 (50) 236
--------- --------- --------- ---------
Net income (loss) $ (4,683) $ 1,126 $ (7,460) $ (4,649)
========= ========= ========= =========
Per Share Data:
Income (loss) per common share
Basic $ (0.03) $ 0.01 $ (0.05) $ (0.04)
Diluted $ (0.03) $ 0.01 $ (0.05) $ (0.04)
Weighted average shares outstanding
Basic 157,377 136,870 147,292 126,643
Diluted 157,377 190,370 147,292 126,643
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
4
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIENCY
(amounts in 000's)
(unaudited)
Common Stock Additional
----------------------------- Paid-in Accumulated
Shares Amount Capital Deficit Total
------------- ------------- ------------- ------------- -------------
Balance, March 31, 2008 137,096 $ 137 $ 56,148 $ (104,993) $ (48,708)
Exercise of warrants 24,878 25 3,707 -- 3,732
Issuance of Purchase Right -- -- 50 -- 50
Issuance of warrants -- -- 22 -- 22
Share-based compensation -- -- 30 -- 30
Net loss -- -- -- (7,460) (7,460)
------------- ------------- ------------- ------------- -------------
Balance, September 30, 2008 161,974 $ 162 $ 59,957 $ (112,453) $ (52,334)
============= ============= ============= ============= =============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
5
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in 000's)
(unaudited)
For the six months ended
September 30,
--------------------
2008 2007
-------- --------
Cash flows from operating activities:
Net loss $ (7,460) $ (4,649)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization of property and equipment 1,783 1,593
Provision for doubtful accounts 21,661 15,584
Amortization of debt issuance costs and intangible assets 264 --
Common stock warrant expense 22 --
Minority interest in net income (loss) of variable interest entity 50 (236)
Noncash share-based compensation expense 30 58
Changes in operating assets and liabilities:
Accounts receivable (14,745) (17,680)
Security reserve funds -- (10,342)
Deferred purchase price receivable -- 4,432
Inventories of supplies (133) 26
Due from governmental payers (295) (6,179)
Prepaid insurance, other prepaid expenses and
current assets, and other assets (1,035) (1,363)
Accounts payable 3,856 6,234
Accrued compensation and benefits 306 818
Due to governmental payers (708) 981
Accrued insurance retentions and other current liabilities 1,263 (675)
-------- --------
Net cash provided by (used in) operating activities 4,859 (11,398)
-------- --------
Cash flows from investing activities:
Decrease in restricted cash 5 4,948
Additions to property and equipment (719) (372)
-------- --------
Net cash provided by (used in) investing activities (714) 4,576
-------- --------
Cash flows from financing activities:
Drawdown on revolving line of credit, net 3,501 --
Paydown on convertible note (3,732) --
Issuance of common stock 3,732 576
Issuance of Purchase Right 50 --
Variable interest entity distribution (1,200) --
Payments on capital lease obligations, net (221) (128)
-------- --------
Net cash provided by financing activities 2,130 448
-------- --------
Net increase (decrease) in cash and cash equivalents 6,275 (6,374)
Cash and cash equivalents, beginning of period 3,141 7,844
-------- --------
Cash and cash equivalents, end of period $ 9,416 $ 1,470
======== ========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
6
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2008
(UNAUDITED)
NOTE 1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying unaudited condensed consolidated financial statements
of Integrated Healthcare Holdings, Inc. and its subsidiaries (the "Company")
have been prepared in conformity with generally accepted accounting principles
in the United States of America ("U.S. GAAP")for interim consolidated financial
information and with the instructions for Form 10-Q and Article 10 of Regulation
S-X. In accordance with the instructions and regulations of the Securities and
Exchange Commission ("SEC") for interim reports, certain information and
footnote disclosures normally included in financial statements prepared in
conformity with U.S. GAAP for annual reports have been omitted or condensed. All
adjustments (consisting of normal recurring adjustments) and disclosures
considered necessary for a fair presentation have been included in the
accompanying unaudited condensed consolidated financial statements.
The results of operations for the three and six months ended September
30, 2008 are not necessarily indicative of the results to be expected for the
full year. The information included in this Quarterly Report on Form 10-Q should
be read in conjunction with the audited consolidated financial statements for
the year ended March 31, 2008 and notes thereto included in the Company's Annual
Report on Form 10-K/A filed with the SEC on August 22, 2008.
LIQUIDITY AND MANAGEMENT'S PLANS - The accompanying unaudited condensed
consolidated financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and settlement of obligations in
the normal course of business. The Company has incurred significant losses to
date including a net loss of $7.5 million for the six months ended September 30,
2008 and has a working capital deficit of $103.0 million and accumulated
stockholders' deficiency of $52.3 million at September 30, 2008. The Company's
$50.0 million Revolving Credit Agreement provides an estimated additional
liquidity as of September 30, 2008 of $19.3 million based on eligible
receivables, as defined (Note 4). At September 30, 2008, the Company was in
compliance with all covenants, as amended, except for the amended Minimum Fixed
Charge Coverage Ratio of 0.4 and Minimum EBITDA, as defined. The Lender declined
the Company's request for temporary waivers relating to such noncompliance and
has requested additional information; accordingly, the Company's noncurrent debt
of $82.0 million will continue to be classified as current debt due on demand in
the accompanying unaudited condensed consolidated balance sheet as of September
30, 2008 (Note 4). The Company's liquidity is highly dependent upon the
continued availability under this financing.
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. Aquachlor, Inc. 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.
Prior to March 8, 2005, the Company was a development stage enterprise
with no material operations and no revenues from operations. On September 29,
2004, the Company entered into a definitive agreement to acquire four hospitals
(the "Hospitals") from subsidiaries of Tenet Healthcare Corporation ("Tenet")
and completed the transaction on March 8, 2005 (the "Acquisition"). The
Hospitals are:
o 282-bed Western Medical Center in Santa Ana, California;
o 188-bed Western Medical Center in Anaheim, California;
o 178-bed Coastal Communities Hospital in Santa Ana, California; and
o 114-bed Chapman Medical Center in Orange, California.
7
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2008
(UNAUDITED)
The Company enters into agreements with third-party payers, including
government programs and managed care health plans, under which rates are based
upon established charges, the cost of providing services, predetermined rates
per diagnosis, fixed per diem rates, or discounts from established charges.
During the 24 days ended March 31, 2005, substantially all of Tenet's negotiated
rate agreements were assigned to the Hospitals. The Company received Medicare
provider numbers in April 2005 and California State Medicaid Program provider
numbers were received in June 2005.
BASIS OF PRESENTATION - The accompanying unaudited condensed
consolidated financial statements include the accounts of the Company and its
wholly owned subsidiaries.
The Company has also determined that Pacific Coast Holdings Investment,
LLC ("PCHI") is a variable interest entity (Note 9) as defined in Financial
Accounting Standards Board ("FASB") Interpretation Number ("FIN") 46R, and,
accordingly, the financial statements of PCHI are included in the accompanying
unaudited condensed 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 unaudited condensed 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 debt from the same Lender (Note 4) and, thus, is subject to
significant credit risk if they are unable to perform.
The Hospitals are subject to licensure by the State of California and
accreditation by the Joint Commission on Accreditation of Healthcare
Organizations. Loss of either licensure or accreditation would impact the
ability to participate in various governmental and managed care programs, which
provide the majority of the Company's revenues.
Essentially all net operating revenues come from external customers.
The largest payers are the Medicare and Medicaid programs accounting for 63% and
68% of the net operating revenues for the three months ended September 30, 2008
and 2007, respectively, and 60% and 66% for the six months ended September 30,
2008 and 2007, respectively. No other payers represent a significant
concentration of the Company's net operating revenues.
USE OF ESTIMATES - The accompanying unaudited condensed consolidated
financial statements have been prepared in accordance with U.S. GAAP and
prevailing practices for investor owned entities within the healthcare industry.
The preparation of financial statements in conformity with U.S. GAAP requires
management to make estimates and assumptions that affect the amounts reported in
the unaudited condensed 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 generally
do not reflect what a hospital is ultimately paid and therefore are not
displayed in the unaudited condensed consolidated statements of operations.
Hospitals are typically paid amounts that are negotiated with insurance
companies or are set by the government. Gross charges are used to calculate
Medicare outlier payments and to determine certain elements of payment under
managed care contracts (such as stop-loss payments). Because Medicare requires
that a hospital's gross charges be the same for all patients (regardless of
payer category), gross charges are also what a hospital charges all other
patients prior to the application of discounts and allowances.
8
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2008
(UNAUDITED)
Revenues under the traditional fee-for-service Medicare and Medicaid
programs are based primarily on prospective payment systems. Discounts for
retrospectively cost-based revenues and certain other payments, which are based
on the Hospitals' cost reports, are estimated using historical trends and
current factors. Cost report settlements for retrospectively cost-based revenues
under these programs are subject to audit and administrative and judicial
review, which can take several years until final settlement of such matters are
determined and completely resolved. Estimates of settlement receivables or
payables related to a specific year are updated periodically and at year end and
at the time the cost report is filed with the fiscal intermediary. Typically no
further updates are made to the estimates until the final Notice of Program
Reimbursement is received, at which time the cost report for that year has been
audited by the fiscal intermediary. There could be 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 $904 and
$12 as of September 30 and March 31, 2008, 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 $24.5 to $22.2. 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 a 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. During the
three and six months ended September 30, 2008, the Company recorded $171.0 in
Final Notice of Program Reimbursement settlements. During the three and six
months ended September 30, 2007, the Company recorded $755.4 in Final Notice of
Program Reimbursement settlements. During the three and six months ended
September 30, 2008, the Company reversed $1,429.6 in reserves related to excess
outlier payments based on the receipt of the Final Notice of Program
Reimbursement for 2006. During the three and six months ended September 30,
2008, the Company recorded $117.2 in settlement receivables due to the reopening
of the 2005 cost reports reflecting a change in the Supplemental Security Income
ratio. As of September 30 and March 31, 2008, 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 $78 and $1,678,
respectively. These reserves are combined with third party settlement estimates
and are included in due to government payers as a net payable of $982 and $1,690
as of September 30 and March 31, 2008, 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") under the SB1100 and SB1255 programs. The Hospitals received
supplemental payments of $38 and $74 during the three months ended September 30,
2008 and 2007, respectively, and $7,634 and $3,828 during the six months ended
September 30, 2008 and 2007, respectively. The related revenue recorded for the
three months ended September 30, 2008 and 2007 was $4,075 and $6,511,
respectively, and $7,929 and $10,007 for the six months ended September 30, 2008
and 2007, respectively. As of September 30 and March 31, 2008, estimated DSH
receivables of $5,172 and $4,877 are included in due from governmental payers in
the accompanying unaudited condensed consolidated balance sheets.
9
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2008
(UNAUDITED)
The following is a summary of due from and due to governmental payers:
September 30, March 31,
2008 2008
------------ ------------
Due from government payers
Medicaid $ 5,172 $ 4,877
------------ ------------
$ 5,172 $ 4,877
============ ============
Due to government payers
Medicare $ 904 $ 12
Outlier 78 1,678
------------ ------------
$ 982 $ 1,690
============ ============
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 Hospitals and determine
potential linkage to financial assistance programs. They also expedite the
process of applying for these government programs. Based on average revenue for
comparable services from all other payers, revenues foregone under the charity
policy, including indigent care accounts, were $2.1 million and $2.0 million for
the three months ended September 30, 2008 and 2007, respectively, and $4.4
million and $3.6 million for the six months ended September 30, 2008 and 2007,
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 September 30 and March 31, 2008.
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 unaudited condensed consolidated financial
statements.
10
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2008
(UNAUDITED)
PROVISION FOR DOUBTFUL ACCOUNTS - The Company provides for accounts
receivable that could become uncollectible by establishing an allowance to
reduce the carrying value of such receivables to their estimated net realizable
value. The Hospitals estimate this allowance based on the aging of their
accounts receivable, historical collections experience for each type of payer,
and other relevant factors. There are various factors that can impact the
collection trends, such as changes in the economy which in turn have an impact
on unemployment rates and the number of uninsured and underinsured patients,
volume of patients through the emergency department, the increased burden of
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 refinancing its debt (Note 4),
the Company sold substantially all of its billed accounts receivable to a
financial institution. This arrangement terminated on October 9, 2007. 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.
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 September 30 and March 31, 2008, cash and cash equivalents
includes $9.4 million and $3.0 million, respectively, deposited in lock box
accounts that are swept daily by the Lender under various credit agreements
(Note 4).
LETTERS OF CREDIT - At September 30 and March 31, 2008, the Company had
outstanding standby letters of credit totaling $1.2 million and $1.4 million,
respectively. These letters of credit were issued by the Company's Lender and
correspondingly reduce the Company's borrowing availability under its credit
agreements with the Lender (Note 4).
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.
11
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 September 30, 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 paid to third parties in connection
with the Company's refinancing (Note 4). These amounts are amortized over the
financing agreements' three year lives using the straight-line method, which
approximates the effective interest method. Other credit agreements (Note 4)
entered into on the October 9, 2007 effective date of the $50.0 million
Revolving Line of Credit were accounted for as extinguishment of existing debt
in accordance with EITF 96-19, "Debtor's Accounting for a Modification or
Exchange of Debt Instruments," and EITF 06-6, "Debtor's Accounting for a
Modification (or Exchange) of Convertible Debt Instruments." Accordingly, debt
issuance costs consisting of loan origination fees of $1.4 million paid to the
Lender associated with those credit agreements were expensed as an interest
charge during the year ended March 31, 2008. Debt issuance costs of $139.3 and
$263.7 were amortized during the three and six months ended September 30, 2008
(including $14.9 in unamortized costs related to the $3.7 million paydown on the
Convertible Note (Note 4)). At September 30 and March 31, 2008, prepaid expenses
and other current assets in the accompanying unaudited condensed consolidated
balance sheets included $497.5 and $497.5, respectively, as the current portion
of the debt issuance costs.
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 6).
12
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2008
(UNAUDITED)
FAIR VALUE OF FINANCIAL INSTRUMENTS - The Company's financial
instruments recorded in the unaudited condensed consolidated balance sheets
include cash and cash equivalents, restricted cash, receivables, accounts
payable, and other liabilities including debt. The recorded carrying value of
such financial instruments approximates a reasonable estimate of their fair
value.
SFAS No. 157, "Fair Value Measurements," establishes a common
definition for fair value to be applied to U.S. GAAP requiring use of fair
value, establishes a framework for measuring fair value, and expands disclosures
about such fair value measurements. Issued in February 2008, FASB Staff Position
No. 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," removed
leasing transactions accounted for under Statement No. 13 and related guidance
from the scope of SFAS No. 157. FASB Staff Position No. 157-2, "Partial Deferral
of the Effective Date of Statement 157," deferred the effective date of SFAS No.
157 for all nonfinancial assets and nonfinancial liabilities to fiscal years
beginning after November 15, 2008.
The Company adopted SFAS No. 157 as of April 1, 2008 for financial
assets and financial liabilities. There was no material impact on the Company's
consolidated financial position and results of operations for the three and six
months ended September 30, 2008. The Company is currently assessing the impact
of SFAS No. 157 for nonfinancial assets and nonfinancial liabilities on our
consolidated financial position and results of operations.
SFAS No. 157 establishes a hierarchy for ranking the quality and
reliability of the information used to determine fair values. The statement
requires that assets and liabilities carried at fair value be classified and
disclosed in one of the following three categories:
Level 1: Unadjusted quoted market prices in active markets for
identical assets or liabilities.
Level 2: Unadjusted quoted prices in active markets for similar
assets or liabilities, unadjusted quoted prices for
identical or similar assets or liabilities in markets that
are not active, or inputs other than quoted prices that
are observable for the asset or liability.
Level 3: Unobservable inputs for the asset or liability.
The Company will endeavor to utilize the best available information in
measuring fair value. Financial assets and liabilities are classified based on
the lowest level of input that is significant to the fair value measurement. The
Company has determined that its debt is Level 3 in the fair value hierarchy
above. The Company currently has no financial instruments subject to fair value
measurement on a recurring basis.
To finance the Acquisition, the Company entered into agreements that
contained warrants (Notes 4 and 5), which were subsequently required to be
accounted for as derivative liabilities. A derivative is an instrument whose
value is derived from an underlying instrument or index such as a future,
forward, swap, or option contract, or other financial instrument with similar
characteristics, including certain derivative instruments embedded in other
contracts ("embedded derivatives") and for hedging activities. As a matter of
policy, the Company does not invest in separable financial derivatives or engage
in hedging transactions. However, the Company may engage in complex transactions
in the future that also may contain embedded derivatives. Derivatives and
embedded derivatives, if applicable, are measured at fair value and marked to
market through earnings.
WARRANTS - In connection with its Acquisition of the Hospitals and
credit agreements, the Company entered into complex transactions that contain
warrants requiring accounting treatment in accordance with SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," SFAS No. 150,
"Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity," and EITF No. 00-19, "Accounting for Derivative
Financial Instruments Indexed to, and Potentially Settled in, a Company's Own
Stock" (Notes 4 and 5).
13
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2008
(UNAUDITED)
INCOME (LOSS) PER COMMON SHARE - Income (loss) per share is calculated
in accordance with SFAS No. 128, "Earnings per Share." Basic income (loss) per
share is based upon the weighted average number of common shares outstanding
(Note 8). 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 unaudited
condensed consolidated statements of operations with net losses.
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. The Company
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 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("Disclosures about Segments of an Enterprise and Related Information").
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 - 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"). FSP FAS 157-1 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 No. 141 or SFAS No. 141(R), "Business
Combinations," regardless of whether those assets and liabilities are related to
leases.
14
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2008
(UNAUDITED)
On February 12, 2008, the FASB issued FSP FAS 157-2, "Effective Date of
FASB Statement No. 157." 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 accordance with
the provisions of FSP FAS 157-2, the Company has elected to defer implementation
of SFAS No. 157 until April 1, 2009 as it relates to our nonfinancial assets and
nonfinancial liabilities that are not permitted or required to be measured at
fair value on a recurring basis. The Company is evaluating the impact, if any,
SFAS No. 157 will have on those nonfinancial assets and liabilities.
In December 2007, the FASB issued SFAS No. 141(R), "Business
Combinations." 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 No. 141(R) 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 No. 141(R) 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. Effective April 1, 2008, the Company
adopted SFAS No. 159, which had no impact on the Company's consolidated
financial statements.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling
Interests in Consolidated Financial Statements - An Amendment of ARB No. 51."
SFAS No. 160 requires all entities to report noncontrolling (minority) interests
in subsidiaries as equity in the consolidated financial statements. Also, SFAS
No. 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 No. 160 is effective
for fiscal years beginning on or after December 15, 2008. Earlier adoption is
prohibited. SFAS No. 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 No.
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 No. 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 No. 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.
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.
15
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2008
(UNAUDITED)
NOTE 2 - ACCOUNTS RECEIVABLE
In March 2005, the Company entered into an Accounts Purchase Agreement
(the "APA") for a minimum of two years with Medical Provider Financial
Corporation I, an unrelated party (the "Buyer"). The Buyer is an affiliate of
the Lender (Note 4). The APA provided for the sale of 100% of the Company's
eligible accounts receivable, as defined, without recourse. The APA required the
Company to provide billing and collection services, maintain the individual
patient accounts, and resolve any disputes that arose between the Company and
the patient or other third party payer for no additional consideration.
Effective October 9, 2007, the APA was terminated and the Company repurchased
the remaining outstanding accounts that had been sold.
The loss on sale of accounts receivable for the three and six months
ended September 30, 2007 is comprised of the following.
For the three For the six
months ended months ended
September 30, 2007 September 30, 2007
------------------ ------------------
Transaction Fees deducted from Security
Reserve Funds - closed purchases $ 1,145 $ 2,230
Change in accrued Transaction Fees - open purchases (72) (104)
------------------ ------------------
Total Transaction Fees incurred 1,073 2,126
------------------ ------------------
Servicing expense for sold accounts receivable
- closed purchases 1,487 3,021
Change in accrued servicing expense for sold accounts
receivable - open purchases (149) (150)
------------------ ------------------
Total servicing expense incurred 1,338 2,871
------------------ ------------------
Loss on sale of accounts receivable
for the period $ 2,411 $ 4,997
================== ==================
NOTE 3 - PROPERTY AND EQUIPMENT
Property and equipment consists of the following.
September 30, March 31,
2008 2008
------------ ------------
Buildings $ 33,791 $ 33,791
Land and improvements 13,523 13,523
Equipment 11,155 10,520
Assets under capital leases 8,991 7,464
------------ ------------
67,460 65,298
Less accumulated depreciation (10,164) (8,381)
------------ ------------
Property and equipment, net $ 57,296 $ 56,917
============ ============
Essentially all land and buildings are owned by PCHI (Notes 9, 10 and
11).
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.
16
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2008
(UNAUDITED)
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 two
of them have 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.
NOTE 4 - DEBT
The Company's debt payable to affiliates of Medical Capital
Corporation, namely Medical Provider Financial Corporation I, Provider Financial
Corporation II, and Medical Provider Financial Corporation III (collectively,
the "Lender") consists of the following.
September 30, March 31,
2008 2008
------------- -------------
Current:
Revolving line of credit, outstanding borrowings $ 13,380 $ 9,879
Convertible note 6,968 10,700
Secured term note 45,000 45,000
Secured line of credit, outstanding borrowings 30,000 30,000
------------- -------------
$ 95,348 $ 95,579
============= =============
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.
17
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2008
(UNAUDITED)
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 Hospitals (three of
which are owned by PCHI and leased to the Company), and (v) are guaranteed by
Orange County Physicians Investment Network, LLC ("OC-PIN") and West Coast
Holdings, LLC ("West Coast"), a member of PCHI, pursuant to separate Guaranty
Agreements in favor of the Lender. Concurrently with the execution of the New
Credit Facilities, the Company issued new and amended warrants (Note 5).
The refinancing did not meet the requirements for a troubled debt
restructuring in accordance with SFAS No. 15, "Accounting by Debtors and
Creditors for Troubled Debt Restructuring." Under SFAS No. 15, a debtor must be
granted a concession by the creditor for a refinancing to be considered a
troubled debt restructuring. Although the New Credit Facilities have lower
interest rates than the previous credit facilities, the fair value of the New
Warrants (Note 5) resulted in the effective borrowing rate of the New Credit
Facilities to significantly exceed the effective rate of the previous credit
facilities.
The nondetachable conversion feature of the $10.7 million Convertible
Term Note is out-of-the-money on the Effective Date. Pursuant to EITF 05-2, "The
Meaning of `Conventional Convertible Debt Instrument' in Issue No. 00-19," the
$10.7 million Convertible Term Note is considered conventional for purposes of
applying EITF 00-19.
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 $19.3 million of additional availability under its $50.0 million
Revolving Line of Credit at September 30, 2008.
The Company's New Credit Facilities are subject to certain financial
and restrictive covenants including minimum fixed charge coverage ratio, minimum
cash collections, minimum EBITDA, 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 noncurrent at March 31, 2008.
However, as a result of an error identified by the Company during the three
months ended June 30, 2008, the Company was not in compliance with the amended
Minimum Fixed Charge Coverage Ratio of 0.4 at March 31, 2008. Due to this
technical deficiency, and in accordance with SFAS No. 78, "Classification of
Obligations That Are Callable by the Creditor - An Amendment to ARB 43, Chapter
3A," all debt as of March 31, 2008 was reclassified to current and the Company
filed Form 10-K/A with the SEC on August 22, 2008. This was reviewed with the
Lender who responded that the error identified by management was not material to
the Lender. At September 30, 2008, the Company was in compliance with all
covenants, as amended, except for the amended Minimum Fixed Charge Coverage
Ratio of 0.4 and Minimum EBITDA, as defined. The Lender declined the Company's
request for temporary waivers relating to such noncompliance and has requested
additional information; as a result, the Company's noncurrent debt of $82.0
million has been classified as current debt due on demand in the accompanying
unaudited condensed consolidated balance sheet as of September 30, 2008.
During the three months ended September 30, 2008, the Lender granted
the Company a reduction in the interest rate from 24% per year to 12% per year
for certain additional borrowings under the $50.0 million Revolving Line of
Credit. The additional borrowings resulted from delays in Medi-Cal payments from
the State of California. The reduction in the interest rate for the additional
borrowings was terminated by the Lender when the Company received the delayed
payments, aggregating $7.5 million, from the State at the end of September 2008.
The reduction in the interest rate resulted in a $97.7 credit to the Company
during the three months ended September 30, 2008.
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 11). 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 11).
18
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2008
(UNAUDITED)
NOTE 5 - COMMON STOCK TRANSACTIONS
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 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 4) and the issuance of the New
Warrants, the remaining 24.9 million Restructuring Warrants held by Dr.
Chaudhuri and Mr. Thomas became exercisable on the Effective Date. Accordingly,
as of the Effective Date, the Company recorded warrant expense, and a related
warrant liability, of $1.2 million relating to the Restructuring Warrants. These
remaining Restructuring Warrants were exercised on July 18, 2008 (see
"SECURITIES PURCHASE AGREEMENT").
NEW WARRANTS - Concurrently with the execution of the New Credit
Facilities (Note 4), the Company issued to an affiliate of the Lender a
five-year warrant to purchase the greater of 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 on 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.
19
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2008
(UNAUDITED)
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.
SECURITIES PURCHASE AGREEMENT - On July 18, 2008, the Company entered
into a Securities Purchase Agreement (the "Purchase Agreement") with Dr.
Chaudhuri and Mr. Thomas. Pursuant to the Purchase Agreement, Dr. Chaudhuri paid
$50 (recorded as additional paid in capital) for the right to purchase
("Purchase Right") from the Company 63.3 million shares of its common stock for
consideration of $0.11 per share, aggregating $7.0 million. Accordingly, in
accordance with EITF 00-19, as of July 18, 2008, the Company recorded warrant
expense, and related additional paid in capital, of $22 relating to the
estimated fair value of the shares of common stock that can be acquired under
the Purchase Right. The Purchase Right expires on January 10, 2009.
The Purchase Agreement provides Dr. Chaudhuri and Mr. Thomas with
certain pre-emptive rights to maintain their respective levels of ownership of
the Company's common stock by acquiring additional equity securities concurrent
with future issuances by the Company of equity securities or securities or
rights convertible into or exercisable for equity securities and also provides
them with demand registration rights. These pre-emptive rights and registration
rights superseded and replaced their existing pre-emptive rights and
registration rights. The Purchase Agreement also contains a release, waiver and
covenant not to sue Dr. Chaudhuri in connection with his entry into the Option
and Standstill Agreement described below and the consummation of the
transactions contemplated under that agreement. Concurrent with the execution of
the Purchase Agreement, Dr. Chaudhuri exercised in full outstanding
Restructuring Warrants to purchase 24.9 million shares of common stock at an
exercise price of $0.15 per share, for a total purchase price of $3.7 million.
Concurrent with the execution of the Purchase Agreement, the Company
and the Lender, and its affiliate, Healthcare Financial Management &
Acquisitions, Inc., a Nevada corporation ("HFMA" and collectively with the
Lender, "MCC") entered into an Early Loan Payoff Agreement (the "Payoff
Agreement"). The Company used the $3.7 million in proceeds from the warrant
exercise described above to pay down the $10.7 million Convertible Term Note.
The Company is obligated under the Payoff Agreement to use the proceeds it
receives from the future exercise, if any, of the Investor's purchase right
under the Purchase Agreement, plus additional Company funds as may then be
necessary, to pay down the remaining balance of the $10.7 million Convertible
Term Note under the Payoff Agreement. Under the Payoff Agreement, once the
Company has fully repaid early the entire $10.7 million Convertible Term Note,
the Company has an option to extend the maturity dates of the $80.0 million
Credit Agreement and the $50.0 million Revolving Credit Agreement from October
8, 2010 to October 8, 2011.
Concurrent with the execution of the Purchase Agreement, Dr. Chaudhuri
and MCC entered into an Option and Standstill Agreement pursuant to which MCC
agreed to sell the New Warrants. The New Warrants will not be sold to Dr.
Chaudhuri unless he so elects within six years after the Company pays off all
remaining amounts due to MPFC II and MPFC I pursuant to (i) the $80.0 million
Credit Agreement and (ii) the $50.0 million Revolving Credit Agreement. MCC also
agreed not to exercise or transfer the New Warrants unless a payment default
occurs and remains uncured for a specified period. The Option and Standstill
Agreement further provides that if the full early payoff of the remaining
balance of the $10.7 million Convertible Term Note does not occur by January 10,
2009, then that agreement and Dr. Chaudhuri's right to purchase the New Warrants
will terminate.
20
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2008
(UNAUDITED)
NOTE 6 - 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. Accordingly, as of September 30, 2008, the maximum aggregate
number of shares under the Plan was 14.2 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, nonqualified
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 7, 2008, the Board of Directors approved the granting of
options with the right to purchase 600 shares of the Company's common stock to
the CEO pursuant to the Plan. The grant price approved on that day is $0.105 per
share. The options vest in twelve equal quarterly installments on each fiscal
quarter-end of the Company following the date of grant.
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, "Share-Based Payment"("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.
Amsurg Inc. (AMSG)
Community Health Systems (CYH)
Health Management Associates Inc. (HMA)
Lifepoint Hospitals Inc. (LPNT)
Medcath Corp. (MDTH)
Tenet Healthcare Corp. (THC)
Universal Health Services Inc. Class B (USH)
In accordance with SFAS No. 123R, the Company recorded $15.6 and $57.8
of compensation expense relative to stock options during the three months ended
September 30, 2008 and 2007, respectively, and $29.6 and $57.8 during the six
months ended September 30, 2008 and 2007, respectively. No options were granted
prior to August 6, 2007. No options were exercised during the six months ended
September 30, 2008. A summary of stock option activity for the period from March
31 through September 30, 2008 is presented as follows.
21
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2008
(UNAUDITED)
Weighted-
average
Weighted- remaining
average contractual Aggregate
exercise term intrinsic
Shares price (years) value
----------- -------------- ------------ ----------
Outstanding, March 31, 2008 7,445 $ 0.24
Granted 600 $ 0.11
Exercised -- $ --
Forfeited or expired (500) $ 0.26
-----------
Outstanding, September 30, 2008 7,545 $ 0.23 5.9 $ --
=========== ============== ============ ==========
Exercisable at September 30, 2008 4,780 $ 0.24 5.9 $ --
=========== ============== ============ ==========
A summary of the Company's nonvested shares as of September 30, 2008,
and changes during the six months ended September 30, 2008 is presented as
follows.
Weighted-
average
grant date
Shares fair value
----------- --------------
Nonvested at March 31, 2008 2,982 $ 0.05
Granted 600 $ 0.03
Vested (482) $ 0.03
Forfeited (335) $ 0.05
----------- --------------
Nonvested at September 30, 2008 2,765 $ 0.05
=========== ==============
As of September 30, 2008, there was $119.9 of total unrecognized
compensation expense related to nonvested share-based compensation arrangements
granted under the Plan. That cost is expected to be recognized over a
weighted-average period of 2.2 years.
NOTE 7 - 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% of the employee's compensation, subject to IRS
limits. During the three months ended September 30, 2008 and 2007, the Company
incurred expenses of $794.4 and $736.4, respectively, and $1,560.8 and $1,453.8
for the six months ended September 30, 2008,respectively, which are included in
salaries and benefits in the accompanying unaudited condensed consolidated
statements of operations.
NOTE 8 - 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 three months ended September
30, 2008 and for the six months ended September 30, 2008 and 2007, antidilutive
potential shares of common stock, consisting of approximately 203 million, 205
million, and 62 million shares, respectively, issuable under warrants and stock
options have been excluded from the calculations of diluted loss per share for
those periods.
22
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2008
(UNAUDITED)
Income per share for the three months ended September 30, 2007 was
computed as follows. Stock options were not included in the diluted calculation
since they were not in-the-money during the three months ended September 30,
2007.
Numerator:
Net income $ 1,126
========
Denominator:
Weighted average common shares 136,870
Warrants 53,500
--------
Denominator for diluted calculation 190,370
========
Income per share - basic $ 0.01
Income per share - diluted $ 0.01
NOTE 9 - 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 options 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 4)). 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 unaudited condensed consolidated
balance sheet at September 30 and March 31, 2008.
NOTE 10 - RELATED PARTY TRANSACTIONS
PCHI - The Company leases substantially all of the real property of the
acquired Hospitals from PCHI. PCHI is owned by two LLCs, namely West Coast and
Ganesha; which are co-managed by Dr. Sweidan and Dr. Chaudhuri, respectively.
Dr. Chaudhuri holds 64.7 million and 39.8 million shares of the outstanding
stock of the Company as of September 30 and March 31, 2008. In addition, Dr.
Chaudhuri has a Purchase Right to acquire 63.3 million shares under the Purchase
Agreement (Note 5). As described in Note 9, PCHI is a variable interest entity
and, accordingly, the Company has consolidated the financial statements of PCHI
in the accompanying unaudited condensed consolidated financial statements.
On September 25, 2008, the Company entered into an agreement with a
professional law corporation (the "Firm") controlled by a director and
shareholder of the Company. The agreement specifies that the Firm will provide
services for approximately twenty hours per week as Special Counsel to the
Company in connection with the supervision and coordination of various legal
matters. For its services, the Firm will be compensated at a flat rate of $20
per month, plus reimbursement of out-of-pocket costs. The agreement does not
have a termination date and either party can terminate the agreement at any
time. During the three months ended September 30, 2008, the Company incurred
expenses under the agreement of $20.
23
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2008
(UNAUDITED)
During the three months ended September 30, 2008 and 2007, the Company
paid $1.5 million and $1.1 million, respectively, and $2.9 million and $2.1
million during the six months ended September 30, 2008 and 2007, respectively,
to a supplier that is also a shareholder of the Company.
NOTE 11 - COMMITMENTS AND CONTINGENCIES
OPERATING LEASES - Concurrent with the closing of the Acquisition as of
March 8, 2005, the Company entered into a sale leaseback type agreement with a
related party entity, PCHI. The Company leases substantially all of the real
estate of the acquired Hospitals and medical office buildings from PCHI. As a
condition of the New Credit Facilities (Note 4), the Company entered into an
Amended Lease with PCHI. The Amended Lease terminates on the 25-year anniversary
of the original lease entered into on 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. The lease
commitment with PCHI is eliminated in consolidation (Note 9).
Concurrently with the execution of the Amended Lease, the Company,
PCHI, Ganesha, and West Coast entered into a Settlement Agreement and Mutual
Release (the "Settlement Agreement") whereby the Company agreed to pay to PCHI
$2.5 million as settlement for unpaid rents specified in the Settlement
Agreement, relating to the College Avenue Property, and for compensation
relating to the medical office buildings located at 999 North Tustin Avenue in
Santa Ana, California, under a previously executed Agreement to Compensation. In
October 2008, the Company made its final payment to PCHI in accordance with the
Settlement Agreement. This transaction with PCHI is eliminated in consolidation
(Note 9).
CAPITAL LEASES - In connection with the Hospital Acquisition, the
Company also assumed the leases for the Chapman facility, which include
buildings and land with terms that were extended concurrently with the
assignment of the leases to December 31, 2023. The Company also leases certain
equipment under capital leases expiring at various dates through January 2013.
Effective July 1, 2008, the Company entered into a four year capital lease
obligation of $1,490 for equipment. The lease has a nominal rate of interest of
11.6% per year and minimum monthly payments of $53.0 during the first year and
$33.2 during the remaining three years.
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 September 30 and March 31, 2008, the
Company had accrued $9.5 million and $9.9 million, respectively, which is
comprised of $3.0 million and $3.0 million, respectively, in incurred and
reported claims, along with $6.5 million and $6.9 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 September 30
and March 31, 2008, the Company had accrued $928.1 and $710.0, respectively,
comprised of $320.5 and $169.0, respectively, in incurred and reported claims,
along with $607.6 and $541.0, respectively, in estimated IBNR.
24
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2008
(UNAUDITED)
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 September 30 and 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 September 30 and March
31, 2008, the Company had accrued $1.8 million and $1.7 million, respectively,
in estimated IBNR. 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 (employer's liability).
The Company finances various insurance policies at interest rates
ranging from 4.23% to 5.25% per annum. The Company incurred finance charges
relating to such policies of $24.3 and $36.3 during the three months ended
September 30, 2008 and 2007, respectively, and $47.2 and $88.8 for the six
months ended September 30, 2008 and 2007, respectively. As of September 30 and
March 31, 2008, the accompanying unaudited condensed consolidated balance sheets
include the following balances relating to the financed insurance policies.
September 30, 2008 March 31, 2008
------------------ ------------------
Prepaid insurance $ 2,313 $ 721
Accrued insurance premiums $ 1,640 $ 299
(Included in other current liabilities)
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.
25
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2008
(UNAUDITED)
On May 10, 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 or financial position.
On April 3, 2008, the Company received correspondence from OC-PIN
demanding that the Company's Board of Directors investigate and terminate the
employment agreement of the Company's Chief Executive Officer, Bruce Mogel.
Without waiting for the Company to complete its investigations of the
allegations in OC-PIN's letter, on July 15, 2008 OC-PIN filed a derivative
lawsuit naming Mr. Mogel and the Company as defendants. All allegations
contained in this suit, with the exception of OC-PIN's claims against Mr. Mogel
as it pertains to the Company's refinancing efforts, have been stayed by the
Court pending the resolution of the May 10, 2007 suit brought by the Company.
The complaint seeks no affirmative relief against the Company specifically, but
at this early stage in the proceedings, the Company is unable to determine the
impact, if any, the suit may have on its results of operations or financial
position.
On May 2, 2008, the Company received correspondence from OC-PIN
demanding an inspection of various broad categories of Company documents. In
turn, the Company filed a complaint for declaratory relief in the Orange County
Superior Court seeking instructions as to how and/or whether the Company should
comply with the inspection demand. In response, OC-PIN filed a petition for writ
of mandate seeking to compel its inspection demand. On October 6, 2008, the
Court stayed this action pending the resolution of the lawsuit filed by the
Company on May 10, 2007. The Company does not believe that the Company's
compliance with any resulting court order will have a material effect on its
results of operations or financial position.
26
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2008
(UNAUDITED)
On June 19, 2008, the Company received correspondence from OC-PIN
demanding that the Company notice a special shareholders' meeting no later than
June 26, 2008, to occur during the week of July 21 - 25, 2008. The stated
purpose of the meeting was to (1) repeal a bylaws provision setting forth a
procedure for nomination of director candidates by shareholders, (2) remove the
Company's entire Board of Directors, and (3) elect a new Board of Directors. The
Company denied this request based on, among other reasons, failure to comply
with the appropriate bylaws and SEC procedures and failure to comply with
certain requirements under the Company's credit agreements with its primary
lender. OC-PIN repeated its request on July 29, 2008, and on July 30, 2008,
filed a petition for writ of mandate in the Orange County Superior Court seeking
a court order to compel the Company to hold a special shareholders' meeting. On
August 18, 2008, the Court denied OC-PIN's petition.
On September 17, 2008, OC-PIN filed another petition for writ of
mandate seeking virtually identical relief as the petition filed on July 30,
2008. IHHI has not yet formally responded to the complaint, as it was stayed by
the Court on October 6, 2008 pending the resolution of the May 10, 2007 suit
brought by the Company. However, in an October 20, 2008 minute order, the court
acknowledged that OC-PIN's subsequent petition is materially identical to its
previous petition.
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. On October 6, 2008, the Court placed a stay on
this lawsuit pending the resolution of the action filed by the Company on May
10, 2007. 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 its results of operations or financial
position.
NOTE 12 - SUBSEQUENT EVENT
On October 27, 2008, an arbitrator ruled that PCHI is ordered to pay
$880.5 to Dr. Anil Shah, a former co-manager of PCHI, for legal fees and other
costs incurred through July 31, 2008 by Dr. Shah in connection with litigation
involving the Company and Dr. Shah. In addition to the $880.5 award, PCHI is
ordered to pay a monthly retainer to Dr. Shah's legal counsel of $75.0 beginning
on November 1, 2008 through the conclusion of the related trial, which is
scheduled to begin on January 26, 2009, for legal fees incurred subsequent to
July 2008. Accordingly, the Company has recorded $1,030.5 in other operating
expenses and the related liability in other current liabilities in the
accompanying unaudited condensed consolidated statements of operations and
balance sheet as of and for the three and six months ended September 30, 2008.
27
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
FORWARD-LOOKING INFORMATION
This Quarterly Report on Form 10-Q contains forward-looking statements,
as that term is defined in the Private Securities Litigation Reform Act of 1995.
These statements relate to future events or our future financial performance. In
some cases, you can identify forward-looking statements by terminology such as
"may," "will," "should," "expects," "plans," "anticipates," "believes,"
"estimates," "predicts," "potential" or "continue" or the negative of these
terms or other comparable terminology. These statements are only predictions and
involve known and unknown risks, uncertainties and other factors, including the
risks discussed under the caption "Risk Factors" in our Annual Report on Form
10-K/A filed on August 22, 2008 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 2 are
expressed in thousands (except percentages and 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.
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 or for any other reasons, existing stockholders will likely be
substantially diluted, which could affect the market price of our stock. In July
2008, the Company issued equity securities to an existing shareholder (see
"SECURITIES PURCHASE AGREEMENT").
28
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 our patients or 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,
vehicle, 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. The Company's liquidity is highly dependent upon
the continued availability under its existing credit facilities.
29
LIQUIDITY AND CAPITAL RESOURCES
The accompanying unaudited condensed consolidated financial statements
have been prepared on a going concern basis, which contemplates the realization
of assets and settlement of obligations in the normal course of business. The
Company incurred a net loss of $7.5 million for the six months ended September
30, 2008 and had a working capital deficit of $103.0 million at September 30,
2008.
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.
Key items for the six months ended September 30, 2008 included:
1. Net operating revenues: Due primarily to the impact of
improved contracts, commercial, managed care and other patient
revenues improved $6.9 million during the six months ended
September 30, 2008 compared to the same period in fiscal year
2008.
During the six months ended September 30, 2008 and 2007, the
Company received a lump sum amendment to the CMAC agreement
for $0 and $3.0 million, respectively. Adjusting for this, net
collectible revenues (net operating revenues less provision
for doubtful accounts) for the six months ended September 30,
2008 and 2007 were $167.4 million and $163.6 million,
respectively, representing an increase of 2.1%. 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
from Medicaid, Medicaid DSH, and Orange County, CA
(CalOptima). Governmental revenues decreased $7.5 million for
the six months ended September 30, 2008 compared to the six
months ended September 30, 2007.
Inpatient admissions decreased by 2.2% to 13.5 for the six
months ended September 30, 2008 compared to 13.8 for the six
months ended September 30, 2007.
Uninsured patients, as a percentage of gross charges,
increased to 6.3% from 5.3% for the six months ended September
30, 2008 compared to the six months ended September 30, 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 loss on sale
of accounts receivable for the six months ended September 30,
2008 were $190.6 million, or 5.4%, higher than for the same
period in fiscal year 2008. The most significant factors of
this increase were the $6.1 million increase in the provision
for doubtful accounts due to an increase in assignment of
insurance accounts for legal collection efforts, $1.0 million
recorded relating to an arbitration award requiring such
amount to be paid by PCHI to one of its former co-managers for
legal fees incurred in connection with litigation involving
the Company and the former co-manager, and $6.6 million
increase in salaries and benefits. Of the increase in salaries
and benefits, $2.2 million represents the servicing costs of
accounts receivable that had been sold pursuant to the
Accounts Purchase Agreement in the six months ended September
30, 2007 and subsequently reacquired in October 2007 (see
"ACCOUNTS PURCHASE AGREEMENT"). Excluding the $2.2 million in
servicing costs noted above, salaries and benefits increased
4.3% during the six months ended September 30, 2008 compared
to the six months ended September 30, 2007.
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 reduced the Company's cost of
capital by $2.2 million during the six months ended September
30, 2008 compared to the six months ended September 30, 2007.
Additionally, the $50.0 million Revolving Credit Agreement
provides an estimated additional liquidity as of September 30,
2008 of $19.3 million based on eligible receivables, as
defined. The Company's liquidity is highly dependent upon the
continued availability under this financing.
The foregoing analysis presumes that capital expenditures to replace
equipment can be kept to an immaterial amount in the short term.
30
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, 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 Hospitals (three of
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 No. 15, "Accounting by Debtors and
Creditors for Troubled Debt Restructuring." Under SFAS No. 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.
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.
31
Based on eligible receivables, as defined, the Company had
approximately $19.3 million of additional availability under its $50.0 million
Revolving Line of Credit at September 30, 2008.
The Company's New Credit Facilities are subject to certain financial
and restrictive covenants including minimum fixed charge coverage ratio, minimum
cash collections, minimum EBITDA, 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 noncurrent at March 31, 2008.
However, as a result of an error identified by the Company during the three
months ended June 30, 2008, the Company was not in compliance with the amended
Minimum Fixed Charge Coverage Ratio of 0.4 at March 31, 2008. Due to this
technical deficiency, and in accordance with SFAS No. 78, "Classification of
Obligations That Are Callable by the Creditor - An Amendment to ARB 43, Chapter
3A," all debt as of March 31, 2008 was reclassified to current and the Company
filed Form 10-K/A with the SEC on August 22, 2008. This was reviewed with the
Lender who responded that the error identified by management was not material to
the Lender. At September 30, 2008, the Company was in compliance with all
covenants, as amended, except for the amended Minimum Fixed Charge Coverage
Ratio of 0.4 and Minimum EBITDA, as defined. The Lender declined the Company's
request for temporary waivers relating to such noncompliance and has requested
additional information; as a result, the Company's noncurrent debt of $82.0
million has been classified as current debt due on demand in the accompanying
unaudited condensed consolidated balance sheet as of September 30, 2008.
During the three months ended September 30, 2008, the Lender granted
the Company a reduction in the interest rate from 24% per year to 12% per year
for certain additional borrowings under the $50.0 million Revolving Line of
Credit. The additional borrowings resulted from delays in Medi-Cal payments from
the State of California. The reduction in the interest rate for the additional
borrowings was terminated by the Lender when the Company received the delayed
payments, aggregating $7.5 million, from the State at the end of September 2008.
The reduction in the interest rate resulted in a $97.7 credit to the Company
during the three months ended September 30, 2008.
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. 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.
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 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.
32
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. These
remaining Restructuring Warrants were exercised on July 18, 2008 (see
"SECURITIES PURCHASE AGREEMENT").
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 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.
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.
SECURITIES PURCHASE AGREEMENT - On July 18, 2008, the Company entered
into a Securities Purchase Agreement (the "Purchase Agreement") with Dr.
Chaudhuri and Mr. Thomas. Pursuant to the Purchase Agreement, Dr. Chaudhuri has
a right to purchase ("Purchase Right") from the Company 63.3 million shares of
its common stock for consideration of $0.11 per share, aggregating $7.0 million.
The Purchase Right expires on January 10, 2009.
The Purchase Agreement provides Dr. Chaudhuri and Mr. Thomas with
certain pre-emptive rights to maintain their respective levels of ownership of
the Company's common stock by acquiring additional equity securities concurrent
with future issuances by the Company of equity securities or securities or
rights convertible into or exercisable for equity securities and also provides
them with demand registration rights. These pre-emptive rights and registration
rights superseded and replaced their existing pre-emptive rights and
registration rights. The Purchase Agreement also contains a release, waiver and
covenant not to sue Dr. Chaudhuri in connection with his entry into the Option
and Standstill Agreement described below and the consummation of the
transactions contemplated under that agreement. Concurrent with the execution of
the Purchase Agreement, Dr. Chaudhuri exercised in full outstanding
Restructuring Warrants to purchase 24.9 million shares of common stock at an
exercise price of $0.15 per share, for a total purchase price of $3.7 million.
33
Concurrent with the execution of the Purchase Agreement, the Company
and the Lender, and its affiliate, Healthcare Financial Management &
Acquisitions, Inc., a Nevada corporation ("HFMA" and collectively with the
Lender, "MCC") entered into an Early Loan Payoff Agreement (the "Payoff
Agreement"). The Company used the $3.7 million in proceeds from the warrant
exercise described above to pay down the $10.7 million Convertible Term Note.
The Company is obligated under the Payoff Agreement to use the proceeds it
receives from the future exercise, if any, of the Investor's purchase right
under the Purchase Agreement, plus additional Company funds as may then be
necessary, to pay down the remaining balance of the $10.7 million Convertible
Term Note under the Payoff Agreement. Under the Payoff Agreement, once the
Company has fully repaid early the remaining balance of the $10.7 million
Convertible Term Note, the Company has an option to extend the maturity dates of
the $80.0 million Credit Agreement and the $50.0 million Revolving Credit
Agreement from October 8, 2010 to October 8, 2011.
Concurrent with the execution of the Purchase Agreement, Dr. Chaudhuri
and MCC entered into an Option and Standstill Agreement pursuant to which MCC
agreed to sell the New Warrants. The New Warrants will not be sold to Dr.
Chaudhuri unless he so elects within six years after the Company pays off all
remaining amounts due to MPFC II and MPFC I pursuant to (i) the $80.0 million
Credit Agreement and (ii) the $50.0 million Revolving Credit Agreement. MCC also
agreed not to exercise or transfer the New Warrants unless a payment default
occurs and remains uncured for a specified period. The Option and Standstill
Agreement further provides that if the full early payoff of the $10.7 million
Convertible Term Note does not occur by January 10, 2009, then that agreement
and Dr. Chaudhuri's right to purchase the New Warrants will terminate.
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").
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.
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.
34
CASH FLOW - Net cash provided by (used in) operating activities for the
six months ended September 30, 2008 and 2007 was $4.8 million and $(11.4)
million, respectively, including net losses, adjusted for depreciation and other
non-cash items, excluding the provision for doubtful accounts and minority
interest, of $5.4 million and $3.0 million, respectively. The Company produced
$10.2 million and used $8.4 million in working capital for the six months ended
September 30, 2008 and 2007, respectively. Cash produced by growth in accounts
payable, accrued compensation and benefits and other current liabilities was
$5.4 million and $6.4 million for the six months ended September 30, 2008 and
2007, respectively. Cash provided by (used in) accounts receivable, including
security reserve fund and deferred purchase price receivable in fiscal year 2008
(net of provision for doubtful accounts), was $6.9 million and $(8.0) million
for the six months ended September 30, 2008 and 2007, respectively.
Net cash provided by (used in) investing activities during the six
months ended September 30, 2008 and 2007 was $(0.7) million and $4.6 million,
respectively. In the six months ended September 30, 2008 and 2007, the Company
invested $0.7 million and $0.4 million in cash, respectively, in new equipment.
During the six months ended September 30, 2008 and 2007, $5.0 thousand and $4.9
million, respectively, in restricted cash was released to the Company.
Net cash provided by financing activities for the six months ended
September 30, 2008 and 2007 was $2.1 million and $0.4 million, respectively. The
increase in net cash provided by financing activities for the six months ended
September 30, 2008 was primarily represented by $3.7 million from the issuance
of common stock.
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The following table sets forth, for the three and six months ended
September 30, 2008 and 2007, our unaudited condensed consolidated statements of
operations expressed as a percentage of net operating revenues.
Three months ended Six months ended
September 30, September 30,
----------------- ---------------
2008 2007 2008 2007
------- ----- ----- -----
Net operating revenues 100.0% 100.0% 100.0% 100.0%
------- ----- ----- -----
Operating expenses
Salaries and benefits 56.5% 53.6% 56.4% 54.9%
Supplies 12.7% 12.9% 12.9% 13.5%
Provision for doubtful accounts 12.5% 7.7% 11.5% 8.6%
Other operating expenses 19.9% 18.2% 19.1% 18.8%
Loss on sale of accounts receivable 0.0% 2.5% 0.0% 2.7%
Depreciation and amortization 0.9% 0.8% 0.9% 0.9%
------- ----- ----- -----
102.5% 95.7% 100.8% 99.4%
------- ----- ----- -----
Operating income (loss) (2.5%) 4.3% (0.8%) 0.6%
------- ----- ----- -----
Other income (expense):
Interest expense, net (2.9%) (3.2%) (3.1%) (3.4%)
Warrant expense (0.0%) 0.0% (0.0%) 0.0%
------- ----- ----- -----
(2.9%) (3.2%) (3.1%) (3.4%)
------- ----- ----- -----
Income (loss) before provision for income
taxes and minority interest (5.4%) 1.1% (3.9%) (2.8%)
Provision for income taxes (0.0%) 0.0% (0.0%) 0.0%
Minority interest in variable interest entity 0.5% 0.1% 0.0% 0.1%
------- ----- ----- -----
Net income (loss) (4.9%) 1.2% (3.9%) (2.7%)
======= ===== ===== =====
35
THREE MONTHS ENDED SEPTEMBER 30, 2008 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2007
NET OPERATING REVENUES - Net operating revenues for the three months
ended September 30, 2008 increased 0.1% compared to the same period in fiscal
year 2008, from $95.4 million to $95.5 million. Net operating revenues for the
three months ended September 30, 2007 included a lump sum amendment to the CMAC
agreement for $3.0 million. Admissions for the three months ended September 30,
2008 decreased 2.7% compared to the same period in fiscal year 2008. Revenue per
admission improved by 2.9% during the three months ended September 30, 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
three months ended September 30, 2008 and 2007 were $2.1 million and $2.0
million, respectively.
Essentially all net operating revenues come from external customers.
The largest payers are the Medicare and Medicaid programs accounting for 63% and
68% of the net operating revenues for the three months ended September 30, 2008
and 2007, respectively.
Uninsured patients, as a percentage of gross charges, increased to 6.1%
from 5.5% for the three months ended September 30, 2008 compared to the three
months ended September 30, 2007.
Although not a GAAP measure, the Company defines "Net Collectible
Revenues" as net operating revenues less provision for doubtful accounts. This
eliminates the distortion caused by the changes in patient account
classification. Excluding the $3.0 million one-time grant referred to above
during the three months ended September 30, 2007, Net Collectible Revenues were
$83.6 million (net revenues of $95.5 million less $11.9 million in provision for
doubtful accounts) and $85.0 million (net revenues of $92.4 million less $7.4
million in provision for doubtful accounts) for the three months ended September
30, 2008 and 2007, respectively, representing a decrease of $1.4 million. There
was however an increase in Net Collectible Revenues per admission of 1.0% for
the three months ended September 30, 2008 compared to the three months ended
September 30, 2007.
OPERATING EXPENSES - Operating expenses for the three months ended
September 30, 2008 increased to $97.8 million from $91.3 million, an increase of
$6.5 million, or 7.1%, compared to the same period in fiscal year 2008.
Operating expenses expressed as a percentage of net operating revenues for the
three months ended September 30, 2008 and 2007 were 102.5% and 95.7%,
respectively. On a per admission basis, operating expenses increased 10.2%.
Salaries and benefits increased $2.8 million (5.4%) for the three
months ended September 30, 2008 compared to the same period in fiscal year 2008,
primarily due to wage increases, benefit accruals, and increases in headcount
that replaced higher cost contract service providers. This increase also
reflects a $1.0 million difference in classification of accounts receivable
servicing expense for the three months ended September 30, 2008 and 2007. Under
the APA these costs were included in the loss on sale of accounts receivable.
Upon reacquisition of the accounts receivable, comparable servicing costs are
included in salaries and benefits.
During the three months ended September 30, 2008, the Company recorded
$1,030.5 in other operating expenses relating to an arbitration award requiring
such amount to be paid by PCHI to one of its former co-managers for legal fees
incurred in connection with litigation involving the Company and the former
co-manager. Other than the arbitration award noted above, other operating
expenses relative to net operating revenues for the three months ended September
30, 2008 were substantially unchanged compared to the same period in fiscal year
2008.
The provision for doubtful accounts for the three months ended
September 30, 2008 increased to $11.9 million from $7.4 million, or 60.8%,
compared to the same period in fiscal year 2008. The increase in the provision
for doubtful accounts for the three months ended September 30, 2008 is primarily
due to an increase in assignment of insurance accounts for legal collection
efforts, an increase in uninsured patients, and delays in payments and potential
non-payments by managed care companies.
The loss on sale of accounts receivable for the three months ended
September 30, 2008 and 2007 was $0 and $2.4 million, respectively. The decrease
is 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) - The operating loss for the three months ended
September 30, 2008 was $2.3 million compared to operating income of $4.1 million
for the three months ended September 30, 2007.
OTHER INCOME (EXPENSE) - Interest expense for the three months ended
September 30, 2008 ($2.8 million) was comparable to the same period in fiscal
year 2008 ($3.1 million).
NET LOSS - Net loss for the three months ended September 30, 2008 was
$4.7 million compared to net income of $1.1 million for the same period in
fiscal year 2008.
36
SIX MONTHS ENDED SEPTEMBER 30, 2008 COMPARED TO SIX MONTHS ENDED SEPTEMBER 30,
2007
NET OPERATING REVENUES - Net operating revenues for the six months
ended September 30, 2008 increased 3.7% compared to the same period in fiscal
year 2008, from $182.2 million to $189.0 million. Net operating revenues for the
six months ended September 30, 2007 included a lump sum amendment to the CMAC
agreement for $3.0 million. Admissions for the six months ended September 30,
2008 decreased 2.2% compared to the same period in fiscal year 2008. Revenue per
admission improved by 6.1% during the six months ended September 30, 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 six
months ended September 30, 2008 and 2007 were $4.4 million and $3.6 million,
respectively.
Essentially all net operating revenues come from external customers.
The largest payers are the Medicare and Medicaid programs accounting for 60% and
66% of the net operating revenues for the six months ended September 30, 2008
and 2007, respectively.
Uninsured patients, as a percentage of gross charges, increased to 6.3%
from 5.3% for the six months ended September 30, 2008 compared to the six months
ended September 30, 2007.
Although not a GAAP measure, the Company defines "Net Collectible
Revenues" as net operating revenues less provision for doubtful accounts. This
eliminates the distortion caused by the changes in patient account
classification. Excluding the $3.0 million one-time grant referred to above
during the six months ended September 30, 2007, Net Collectible Revenues were
$167.3 million (net revenues of $189.0 million less $21.7 million in provision
for doubtful accounts) and $163.6 million (net revenues of $179.2 million less
$15.6 million in provision for doubtful accounts) for the six months ended
September 30, 2008 and 2007, respectively, an increase of $3.7 million, or 4.6%
per admission.
OPERATING EXPENSES - Operating expenses for the six months ended
September 30, 2008 increased to $190.6 million from $180.9 million, an increase
of $9.7 million, or 5.4%, compared to the same period in fiscal year 2008.
Operating expenses expressed as a percentage of net operating revenues for the
six months ended September 30, 2008 and 2007 were 100.8% and 99.4%,
respectively. On a per admission basis, operating expenses increased 7.8%.
Salaries and benefits increased $6.6 million (6.6%) for the six months
ended September 30, 2008 compared to the same period in fiscal year 2008,
primarily due to wage increases, benefit accruals, and increases in headcount
that replaced higher cost contract service providers. This increase also
reflects a $2.2 million difference in classification of accounts receivable
servicing expense for the six months ended September 30, 2008 and 2007. Under
the APA these costs were included in the loss on sale of accounts receivable.
Upon reacquisition of the accounts receivable, comparable servicing costs are
included in salaries and benefits.
During the six months ended September 30, 2008, the Company recorded
$1,030.5 in other operating expenses relating to an arbitration award requiring
such amount to be paid by PCHI to one of its former co-managers for legal fees
incurred in connection with litigation involving the Company and the former
co-manager. Other than the arbitration award noted above, other operating
expenses relative to net operating revenues for the six months ended September
30, 2008 were substantially unchanged compared to the same period in fiscal year
2008.
The provision for doubtful accounts for the six months ended September
30, 2008 increased to $21.7 million from $15.6 million, or 39.1%, compared to
the same period in fiscal year 2008. The increase in the provision for doubtful
accounts for the six months ended September 30, 2008 is primarily due to an
increase in assignment of insurance accounts for legal collection efforts, an
increase in uninsured patients, and delays in payments by managed care
companies.
The loss on sale of accounts receivable for the six months ended
September 30, 2008 and 2007 was $0 and $5.0 million, respectively. The decrease
is 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) - The operating loss for the six months ended
September 30, 2008 was $1.6 million compared to operating income of $1.3 million
for the six months ended September 30, 2007.
OTHER INCOME (EXPENSE) - Interest expense for the six months ended
September 30, 2008 ($5.8 million) was comparable to the same period in fiscal
year 2008 ($6.2 million).
NET LOSS - Net loss for the six months ended September 30, 2008 was
$7.5 million compared to a net loss of $4.6 million for the same period in
fiscal year 2008.
37
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 generally
do not reflect what a hospital is ultimately paid and therefore are not
displayed in the unaudited condensed consolidated statements of operations.
Hospitals are typically paid amounts that are negotiated with insurance
companies or are set by the government. Gross charges are used to calculate
Medicare outlier payments and to determine certain elements of payment under
managed care contracts (such as stop-loss payments). Because Medicare requires
that a hospital's gross charges be the same for all patients (regardless of
payer category), gross charges are also what a hospital charges 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 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 $904 and
$12 as of September 30 and March 31, 2008, 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 $24.5 to $22.2. 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 a 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. During the
three and six months ended September 30, 2008, the Company recorded $171.0 in
Final Notice of Program Reimbursement settlements. During the three and six
months ended September 30, 2007, the Company recorded $755.4 in Final Notice of
Program Reimbursement settlements. During the three and six months ended
September 30, 2008, the Company reversed $1,429.6 in reserves related to excess
outlier payments based on the receipt of the Final Notice of Program
Reimbursement for 2006. During the three and six months ended September 30,
2008, the Company recorded $117.2 in settlement receivables due to the reopening
of the 2005 cost reports reflecting a change in the Supplemental Security Income
ratio. As of September 30 and March 31, 2008, 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 $78 and $1,678,
respectively. These reserves are combined with third party settlement estimates
and are included in due to government payers as a net payable of $982 and $1,690
as of September 30 and March 31, 2008, respectively.
38
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 SB1100 and SB1255 programs. The Hospitals received
supplemental payments of $38 and $74 during the three months ended September 30,
2008 and 2007, respectively, and $7,634 and $3,828 during the six months ended
September 30, 2008 and 2007, respectively. The related revenue recorded for the
three months ended September 30, 2008 and 2007 was $4,075 and $6,511,
respectively, and $7,929 and $10,007 for the six months ended September 30, 2008
and 2007, respectively. As of September 30 and March 31, 2008, estimated DSH
receivables of $5,172 and $4,877 are included in due from governmental payers in
the accompanying unaudited condensed consolidated balance sheets.
Revenues under managed care plans are based primarily on payment terms
involving predetermined rates per diagnosis, per-diem rates, discounted
fee-for-service rates and/or other similar contractual arrangements. These
revenues are also subject to review and possible audit by the payers. The payers
are billed for patient services on an individual patient basis. An individual
patient's bill is subject to adjustment on a patient-by-patient basis in the
ordinary course of business by the payers following their review and
adjudication of each particular bill. The Hospitals estimate the discounts for
contractual allowances utilizing billing data on an individual patient basis. At
the end of each month, the Hospitals estimate expected reimbursement for
patients of managed care plans based on the applicable contract terms. These
estimates are continuously reviewed for accuracy by taking into consideration
known contract terms as well as payment history. Although the Hospitals do not
separately accumulate and disclose the aggregate amount of adjustments to the
estimated reimbursements for every patient bill, management believes the
estimation and review process allows for timely identification of instances
where such estimates need to be revised. The Company does not believe there were
any adjustments to estimates of individual patient bills that were material to
its net operating revenues.
The 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 Hospitals and determine
potential linkage to financial assistance programs. They also expedite the
process of applying for these government programs. Based on average revenue for
comparable services from all other payers, revenues foregone under the charity
policy, including indigent care accounts, were $2.1 million and $2.0 million for
the three months ended September 30, 2008 and 2007, respectively, and $4.4
million and $3.6 million for the six months ended September 30, 2008 and 2007,
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 September 30 and March 31, 2008.
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 unaudited condensed 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.
39
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 refinancing its debt (see
"REFINANCING"), the Company sold substantially all of its billed accounts
receivable to a financial institution. This arrangement terminated on October 9,
2007. 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.
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 September 30 and March 31, 2008, the
Company had accrued $9.5 million and $9.9 million, respectively, which is
comprised of $3.0 million and $3.0 million, respectively, in incurred and
reported claims, along with $6.5 million and $6.9 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 September 30
and March 31, 2008, the Company had accrued $928.1 and $710.0, respectively,
comprised of $320.5 and $169.0, respectively, in incurred and reported claims,
along with $607.6 and $541.0, 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 September 30 and 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 September 30 and March
31, 2008, the Company had accrued $1.8 million and $1.7 million, respectively,
in estimated IBNR. 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 (employer's liability).
40
RECENT ACCOUNTING STANDARDS
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"). FSP
FAS 157-1 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
No. 141 or SFAS No. 141(R), "Business Combinations," regardless of whether those
assets and liabilities are related to leases.
On February 12, 2008, the FASB issued FSP FAS 157-2, "Effective Date of
FASB Statement No. 157." 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 accordance with
the provisions of FSP FAS 157-2, the Company has elected to defer implementation
of SFAS No. 157 until April 1, 2009 as it relates to our nonfinancial assets and
nonfinancial liabilities that are not permitted or required to be measured at
fair value on a recurring basis. The Company is evaluating the impact, if any,
SFAS No. 157 will have on those nonfinancial assets and liabilities.
In December 2007, the FASB issued SFAS No. 141(R), "Business
Combinations." 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 No. 141(R) 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 No. 141(R) 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. Effective April 1, 2008, the Company
adopted SFAS No. 159, which had no impact on the Company's consolidated
financial statements.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling
Interests in Consolidated Financial Statements - An Amendment of ARB No. 51."
SFAS No. 160 requires all entities to report noncontrolling (minority) interests
in subsidiaries as equity in the consolidated financial statements. Also, SFAS
No. 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 No. 160 is effective
for fiscal years beginning on or after December 15, 2008. Earlier adoption is
prohibited. SFAS No. 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 No.
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 No. 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 No. 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.
41
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
As of September 30 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 4. CONTROLS AND PROCEDURES.
The Company maintains disclosure controls and procedures that are
designed to ensure that information required to be disclosed in the Company's
Exchange Act reports is recorded, processed, summarized and reported within the
time periods specified in the SEC's rules and forms, and that such information
is accumulated and communicated to the Company's management, including its Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosure based closely on the definition of
"disclosure controls and procedures" in Rule 15d-15(e). The Company's disclosure
controls and procedures are designed to provide a reasonable level of assurance
of reaching the Company's desired disclosure control objectives. In designing
and evaluating the disclosure controls and procedures, management recognized
that any controls and procedures, no matter how well designed and operated, can
provide only reasonable assurance of achieving the desired control objectives,
and management necessarily was required to apply its judgment in evaluating the
cost-benefit relationship of possible controls and procedures.
As of September 30, 2008, the end of the period of this report, the
Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Company's Chief
Executive Officer and the Company's Chief Financial Officer, of the
effectiveness of the design and operation of the Company's disclosure controls
and procedures. Based on the foregoing, the Company's Chief Executive Officer
and Chief Financial Officer concluded that the Company's disclosure controls and
procedures were effective.
During the quarter ended September 30, 2008, there were no changes in
the Company's internal control over financial reporting that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
42
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
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.
On May 10, 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 or financial position.
43
On April 3, 2008, the Company received correspondence from OC-PIN
demanding that the Company's Board of Directors investigate and terminate the
employment agreement of the Company's Chief Executive Officer, Bruce Mogel.
Without waiting for the Company to complete its investigations of the
allegations in OC-PIN's letter, on July 15, 2008 OC-PIN filed a derivative
lawsuit naming Mr. Mogel and the Company as defendants. All allegations
contained in this suit, with the exception of OC-PIN's claims against Mr. Mogel
as it pertains to the Company's refinancing efforts, have been stayed by the
Court pending the resolution of the May 10, 2007 suit brought by the Company.
The complaint seeks no affirmative relief against the Company specifically, but
at this early stage in the proceedings, the Company is unable to determine the
impact, if any, the suit may have on its results of operations or financial
position.
On May 2, 2008, the Company received correspondence from OC-PIN
demanding an inspection of various broad categories of Company documents. In
turn, the Company filed a complaint for declaratory relief in the Orange County
Superior Court seeking instructions as to how and/or whether the Company should
comply with the inspection demand. In response, OC-PIN filed a petition for writ
of mandate seeking to compel its inspection demand. On October 6, 2008, the
Court stayed this action pending the resolution of the lawsuit filed by the
Company on May 10, 2007. The Company does not believe that the Company's
compliance with any resulting court order will have a material effect on its
results of operations or financial position.
On June 19, 2008, the Company received correspondence from OC-PIN
demanding that the Company notice a special shareholders' meeting no later than
June 26, 2008, to occur during the week of July 21 - 25, 2008. The stated
purpose of the meeting was to (1) repeal a bylaws provision setting forth a
procedure for nomination of director candidates by shareholders, (2) remove the
Company's entire Board of Directors, and (3) elect a new Board of Directors. The
Company denied this request based on, among other reasons, failure to comply
with the appropriate bylaws and SEC procedures and failure to comply with
certain requirements under the Company's credit agreements with its primary
lender. OC-PIN repeated its request on July 29, 2008, and on July 30, 2008,
filed a petition for writ of mandate in the Orange County Superior Court seeking
a court order to compel the Company to hold a special shareholders' meeting. On
August 18, 2008, the Court denied OC-PIN's petition.
On September 17, 2008, OC-PIN filed another petition for writ of
mandate seeking virtually identical relief as the petition filed on July 30,
2008. IHHI has not yet formally responded to the complaint, as it was stayed by
the Court on October 6, 2008 pending the resolution of May 10, 2007 suit brought
by the Company. However, in an October 20, 2008 minute order, the court
acknowledged that OC-PIN's subsequent petition is materially identical to its
previous petition.
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. On October 6, 2008, the Court placed a stay on
this lawsuit pending the resolution of the action filed by the Company on May
10, 2007. 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 its results of operations or financial
position.
ITEM 1A. RISK FACTORS
During the three months ended September 30, 2008, the Company
experienced delays in the funding of some advances under its $50.0 million
Revolving Line of Credit. During this time, the Lender experienced delays in
funding advances in accordance with advance requests submitted by the Company.
There can be no assurances that the Company will not experience delays in
receiving advances from the Lender in the future. The Company relies on the
Revolving Line of Credit for funding its operations, and any significant
disruption in such funding could have a material adverse effect on the Company's
ability to continue as a going concern.
44
There are no other material changes from the risk factors previously
disclosed in our Annual Report on Form 10-K/A for the fiscal year ended March
31, 2008.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our Annual Meeting of Stockholders was held on September 2, 2008. Of
the 161,973,929 shares eligible to vote, 149,567,933 appeared in person or by
proxy and established a quorum for the meeting. The matters listed in the table
below were approved by the stockholders at the meeting.
ELECTION OF DIRECTORS VOTES FOR VOTES AGAINST VOTES WITHHELD NOT VOTED
--------------------- --------- ------------- -------------- ---------
Maurice J. DeWald 83,668,468 -- 65,899,465 12,405,996
Ajay Meka, M.D. 83,668,468 -- 65,899,465 12,405,996
Michael Metzler 83,668,468 -- 65,899,465 12,405,996
Bruce Mogel 83,654,268 -- 65,913,665 12,405,996
J. Fernando Niebla 83,668,468 -- 65,899,465 12,405,996
William E. Thomas 83,665,968 -- 65,901,965 12,405,996
ITEM 6. EXHIBITS
Exhibit
Number Description
- ------ -----------
3.1 Bylaws of Integrated Healthcare Holdings, Inc., as amended on August
22, 2008 (incorporated herein by reference to Exhibit 3.1 to the
Registrant's Report on Form 8-K filed on August 28, 2008).
10.1 Legal representation agreement between the Registrant and William E.
Thomas, Inc. (a Professional Law Corporation) (incorporated herein
by reference to Exhibit 99.1 to the Registrant's Report on Form 8-K
filed on September 26, 2008).
10.2 Resignation Agreement and General Release, dated as of November 4,
2008, by and between the Registrant and Mr. Bruce Mogel
(incorporated herein by reference to Exhibit 99.1 to the
Registrant's Report on Form 8-K filed on November 7, 2008).
31.1 Certification of Chief Executive Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of
1934, the registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
INTEGRATED HEALTHCARE HOLDINGS, INC.
Dated: November 14, 2008 By: /s/ Steven R. Blake
------------------------------
Steven R. Blake
Chief Financial Officer
(Principal Financial Officer)
45