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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the fiscal year ended March 31, 2009; or
[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File Number 0-23511
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INTEGRATED HEALTHCARE HOLDINGS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Nevada 87-0573331
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
1301 North Tustin Avenue, Santa Ana, California 92705
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code: (714) 953-3503
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
(TITLE OF CLASS)
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Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes[ ] No[X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes[ ] No[X]
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant has submitted electronically and
posted on its corporate Web site, if any, every Interactive Data File required
to be submitted and posted pursuant to Rule 405 of Regulation S-T during the
preceding 12 months (or for such shorter period that the registrant was required
to submit and post such files). Yes [ ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definition of "large accelerated filer, accelerated filer or smaller reporting
company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [ ]
Smaller reporting company [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes [ ] No [X]
The aggregate market value of voting stock held by non-affiliates of the
registrant was $923,740 as of September 30, 2008 (computed by reference to the
last sale price of a share of the registrant's common stock on that date as
reported by the Over the Counter Bulletin Board). For purposes of this
computation, it has been assumed that the shares beneficially held by directors
and officers of registrant were "held by affiliates"; this assumption is not to
be deemed to be an admission by such persons that they are affiliates of
registrant.
There were 195,307,262 shares outstanding of the registrant's common stock as of
June 15, 2009.
DOCUMENTS INCORPORATED BY REFERENCE:
No portions of other documents are incorporated by reference into this Annual
Report.
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INTEGRATED HEALTHCARE HOLDINGS, INC.
FORM 10-K
ANNUAL REPORT FOR THE YEAR ENDED MARCH 31, 2009
TABLE OF CONTENTS
PART I...................................................................... 1
ITEM 1. BUSINESS......................................................... 1
ITEM 1A. RISK FACTORS.................................................... 16
ITEM 2. PROPERTIES....................................................... 23
ITEM 3. LEGAL PROCEEDINGS................................................ 24
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.............. 27
PART II..................................................................... 30
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.. 30
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS...................................... 33
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA...................... 50
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE ...................................... 50
ITEM 9A(T). CONTROLS AND PROCEDURES...................................... 50
ITEM 9B. OTHER INFORMATION............................................... 51
PART III.................................................................... 52
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.......... 52
ITEM 11. EXECUTIVE COMPENSATION.......................................... 56
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS .............................. 60
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE.................................................. 62
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.......................... 66
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES...................... 67
SIGNATURES.................................................................. 71
PART I
FORWARD-LOOKING INFORMATION
This Annual Report on Form 10-K contains forward-looking statements, as
that term is defined in the Private Securities Litigation Reform Act of 1995.
These statements relate to future events or our future financial performance. In
some cases, you can identify forward-looking statements by terminology such as
"may," "will," "should," "expects," "plans," "anticipates," "believes,"
"estimates," "predicts," "potential" or "continue" or the negative of these
terms or other comparable terminology. These statements are only predictions and
involve known and unknown risks, uncertainties and other factors, including the
risks discussed under the caption "Risk Factors" herein that may cause our
Company's or our industry's actual results, levels of activity, performance or
achievements to be materially different from those expressed or implied by these
forward-looking statements.
Although we believe that the expectations reflected in the forward
looking statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Except as may be required by applicable
law, we do not intend to update any of the forward-looking statements to conform
these statements to actual results.
As used in this report, the terms "we," "us," "our," "the Company,"
"Integrated Healthcare Holdings" or "IHHI" mean Integrated Healthcare Holdings,
Inc., a Nevada corporation, unless otherwise indicated.
ITEM 1. BUSINESS
BACKGROUND
Integrated Healthcare Holdings, Inc. is a predominantly physician owned
company that, on March 8, 2005, acquired and began operating the following four
hospital facilities in Orange County, California (referred to as the
"Hospitals"):
o 282-bed Western Medical Center in Santa Ana
o 188-bed Western Medical Center in Anaheim
o 178-bed Coastal Communities Hospital in Santa Ana
o 114-bed Chapman Medical Center in Orange
Together we believe that the Hospitals represent approximately 12.6% of
all hospital available beds in Orange County, California (based on the most
recent data on the Office of Statewide Health Planning and Development for
California web site as of June 2, 2009).
Prior to March 8, 2005, we were primarily a development stage company
with no material operations. On November 18, 2003, members of our current and
former executive management purchased a controlling interest in the Company and
redirected its focus towards acquiring and operating hospitals and healthcare
facilities that are financially distressed and/or underperforming. On September
29, 2004, the Company entered into a definitive agreement to acquire the four
Hospitals from subsidiaries of Tenet Healthcare Corporation ("Tenet"), and the
transaction closed on March 8, 2005.
The transaction included operations of four licensed general acute care
hospitals with a total of 762 beds. All four hospitals are accredited by the
Joint Commission on Accreditation of Healthcare Organizations and other
appropriate accreditation agencies that accredit specific programs. All
properties are in Orange County California, and operate as described below.
1
WESTERN MEDICAL CENTER - SANTA ANA. Western Medical Center - Santa Ana,
located at 1001 North Tustin Avenue, Santa Ana, CA 92705, is Orange County's
first hospital, founded over 100 years ago. The hospital is one of IHHI's two
hospitals in Santa Ana, which are the only two general acute care hospitals in
this city of 350,000 people. The hospital has 282 beds and provides quaternary,
tertiary and secondary services. It serves the entire county as one of only
three designated trauma centers in Orange County along with other tertiary
services such as burn center, kidney transplantation, emergency and scheduled
neurosurgical care, cardiac surgical services, a paramedic base station and
receiving center. The hospital also maintains Intensive Care Units for adults
and pediatrics, and a Neonatal Intensive Care Unit. Additionally the hospital
offers telemetry, neurosurgical definitive observation, geriatric, psychiatric,
medical, surgical, pediatric and obstetric inpatient services. Supporting these
services the hospital offers operating and recovery rooms, radiology services,
respiratory therapy services, clinical laboratories, pharmacy, physical and
occupational therapy services on an inpatient and most on an outpatient basis.
The hospital has approximately 185 active physicians and 490 employee nurses,
and hospital staff.
WESTERN MEDICAL CENTER - ANAHEIM. Western Medical Center - Anaheim,
located at 1025 South Anaheim Boulevard, Anaheim, CA 92805, offers a full range
of acute medical and psychiatric care services serving northern Orange County
and providing tertiary services to Riverside County residents. The hospital
offers special expertise in the tertiary services of The Heart and Vascular
Institute, and Behavioral Health Services. Additionally, the hospital provides
the Women and Children Health Services, and 24-hour Emergency Services.
Supporting these services the hospital offers critical care, medical, surgical
and psychiatric services supported by operating and recovery rooms, radiology
services, respiratory therapy services, clinical laboratories, pharmacy,
physical and occupational therapy services on an inpatient and most on an
outpatient basis. The hospital has approximately 90 active physicians and 280
employee nurses, and hospital staff.
COASTAL COMMUNITIES HOSPITAL - SANTA ANA. Coastal Communities Hospital,
located in Santa Ana at 2701 South Bristol Street, Santa Ana, CA 92704, has
served the community for more than 30 years, providing comprehensive medical and
surgical services in a caring and compassionate environment. The hospital is one
of IHHI's two hospitals in Santa Ana, which are the only two general acute care
hospitals in this city of 350,000 people. The hospital has tailored its services
to meet the changing needs of the community. The hospital's staff reflects the
cultural diversity of the community and is particularly responsive and sensitive
to diverse healthcare needs. While services continue to expand, the 178-bed
facility is small enough to retain the family atmosphere associated with a
community hospital. The hospital offers critical care, medical, surgical
obstetric, psychiatric and sub acute services supported by operating and
recovery rooms, radiology services, respiratory therapy services, clinical
laboratories, pharmacy, physical and occupational therapy services on an
inpatient and most on an outpatient basis. The hospital has approximately 60
active physicians and 205 employee nurses, and hospital staff.
CHAPMAN MEDICAL CENTER - ORANGE. Founded in 1969, Chapman Medical
Center is a 114-bed acute care facility located at 2601 East Chapman Avenue,
Orange, CA 92869. The hospital's advanced capabilities position the facility as
a leader in specialty niche programs, including the following centers: Chapman
Center for Obesity (surgical weight loss program); Center for Heartburn and
Swallowing; Chapman Lung Center; Chapman Family Health Center; Doheny Eye
Center; House Ear Clinic; Center for Senior Mental Health; and Positive Action
Center (Adult and Adolescent Chemical Dependency Program). Supporting these
services the hospital offers critical care, medical, surgical and geriatric
psychiatric services supported by operating and recovery rooms, radiology
services, respiratory therapy services, clinical laboratories, pharmacy,
physical and occupational therapy services on an inpatient and most on an
outpatient basis. The hospital has approximately 40 active physicians and 115
employee nurses, and hospital staff.
On March 8, 2005, the Company assumed management responsibility and
control over the Hospitals. All primary systems and controls have been
successfully transitioned to our Company for the effective management of the
Hospitals.
2
EMPLOYEES AND MEDICAL STAFF
At March 31, 2009, the Company had approximately 3,225 employees. Of
these employees, approximately 1,160 are represented by two labor unions, the
California Nurses Association ("CNA") and Service Employee International Union
- -United Healthcare Workers ("SEIU"), who are covered by collective bargaining
agreements. We believe that our relations with our employees are good. The
Company also had approximately 50 individuals from contracting agencies at March
31, 2009, consisting primarily of nursing staff.
Our hospitals are fully staffed by physicians and other independently
practicing medical professionals licensed by the state, who have been admitted
to the medical staff of the individual hospital. Under state laws and licensing
standards, hospitals' medical staffs are self-governing organizations subject to
ultimate oversight by the hospital's local governing board. None of these
physicians are employees of the hospitals. Physicians are not limited to medical
staff membership at our hospitals, and many are on staff at our other hospitals,
or hospitals not owned or operated by us. Physicians on our medical staffs are
free to terminate their membership on our medical staffs and admit their
patients to other hospitals, owned, or not owned by us. Non-physician staff,
including nurses, therapists, technicians, finance, registration, maintenance,
clerical, housekeeping, and administrative staff are generally employees of the
hospital, unless the service is provided by a third party contracted entity. We
are subject to federal minimum wage and hour laws and various state labor laws
and maintain an employee benefit plan.
Our hospitals' operations depend on the abilities, efforts, experience
and loyalty of our employees and physicians, most of who have no long-term
contractual relationship. Our ongoing business relies on our attraction of
skilled, quality employees, physicians and other healthcare professionals in all
disciplines.
We strive to successfully attract and retain key employees, physicians
and healthcare professionals. Our operations, financial position and cash flows
could be materially adversely affected by the loss of key employees or
sufficient numbers of qualified physicians and other healthcare professionals.
The relations we have with our employees, physicians, and other healthcare
professionals are key to our success and they are a priority in our management
philosophy.
Nursing can have a significant effect on our labor costs. The national
nursing shortage continues and is serious in California. The result has been an
increase in the cost of nursing personnel, thus affecting our labor expenses.
Recently, there has been some lessening in the need for contract agency nurses
following the recession as nurses return to the work force. There is still no
basis to predict the longevity of this effect. Additionally, California
instituted mandatory nurse staffing ratios, thus setting a high level of nurses
to patients, but also requiring nursing staff ratios be maintained at all times
even when on breaks or lunch. These requirements in the environment of a severe
nursing shortage may cause the limiting of patient admissions with an adverse
effect on our revenues. The vast majority of hospitals in California, including
ours, are not at all times meeting the state mandated nurse staffing ratios. Our
plan is to improve compliance and reduce the cost of contract labor needed to
achieve the nurse staffing ratios.
COMPETITION
Hospital competition is a community issue and unique to each facility.
The first factor is the services the hospital offers and the other hospitals in
the area offering the same or similar service. The hospital is dependent on the
physicians to admit the patients to the hospital. The number of physicians
around the hospital, their specialties, and the quality of medicine they
practice will have a major impact on the hospital competition. The ability of
the hospital to employ and retain qualified nurses, other healthcare
professionals, and administrative staff will affect the hospitals'
competitiveness in the market place. A hospital's reputation and years of
service to the community affects its competitiveness with patients, physicians,
employees, and contracting health plans. Southern California is a highly
competitive managed healthcare market therefore the contracting relationships
with managed care organizations is a key factor in a hospital's competitiveness.
The hospital's location, the community immediately surrounding it and the access
to the hospital will affect the hospital's competitiveness. Other hospitals or
healthcare organizations serving the same locations determine the intensity of
the competition. The condition of the physical plant and the ability to invest
in new equipment and technology can affect the communities and physicians desire
to use the facility. The amount the hospital charges for services is also a
factor in the hospital's competitiveness. The funding sources of the competition
can also be a factor if a competitor is tax exempt; it has advantages not
available to our Hospitals, such as endowments, charitable contributions,
tax-exempt financing, and exemptions from taxes.
3
Finally, laws and regulations governing antitrust, anti-kickback, physician
referrals and other applicable regulations, such as requirements imposed on
physician-owned hospitals, impact a hospital's ability to compete. Since these
factors are individual to each hospital, and are subject to change, each
hospital must develop its own strategies, to address the competitive factors in
its local.
OUR STRATEGY
Our goal is to provide high quality healthcare services in a community
setting that are responsive to the needs of the communities that we serve. To
accomplish our mission in the complex and competitive healthcare industry, our
operating strategies are to (1) improve the quality of care provided at our
hospitals by identifying best practices and implementing those best practices,
(2) improve operating efficiencies and reduce operating costs while maintaining
or improving the quality of care provided, (3) improve patient, physician and
employee satisfaction, and (4) improve recruitment and retention of nurses and
other employees. We continue to integrate and efficiently operate the four
Hospitals in order to achieve profitability from operations. We may also seek
additional acquisitions of hospitals or health facilities in the future when
opportunities for profitable growth arise.
HEALTHCARE REGULATION
CERTAIN BACKGROUND INFORMATION. Health care, as one of the largest
industries in the United States, continues to attract much legislative interest
and public attention. The new Obama Administration is committed to passing
comprehensive health care reform legislation in order to extend care to
uninsured and substantially reduce government-sponsored health care costs.
Changes in the Medicare and Medicaid programs and other government healthcare
programs, hospital cost containment initiatives by public and private payers,
proposals to limit payments and healthcare spending, and industry wide
competitive factors greatly impact the healthcare industry. The industry is also
subject to extensive federal, state and local regulation relating to licensure,
conduct of operations, ownership of facilities, physician relationships,
addition of facilities and services, and charges and effective reimbursement
rates for services. The laws, rules and regulations governing the healthcare
industry are extremely complex, and the industry often has little or no
regulatory or judicial interpretation for guidance. Compliance with such
regulatory requirements, as interpreted and amended from time to time, can
increase operating costs and thereby adversely affect the financial viability of
our business. Failure to comply with current or future regulatory requirements
could also result in the imposition of various civil and criminal sanctions
including fines, restrictions on admission, denial of payment for all or new
admissions, the revocation of licensure, decertification, imposition of
temporary management or the closure of a facility.
MEDICARE
GENERALLY. Each of the Hospitals participates in the Medicare program.
Healthcare providers have been and will continue to be affected significantly by
changes that have occurred in the last several years in federal healthcare laws
and regulations pertaining to Medicare. The purpose of much of the recent and
proposed statutory and regulatory activity has been to seek to significantly
reduce the rate of increase in Medicare payments and to make such payments more
accurately reflect patient resource use and the effectiveness and quality of
care rendered. The Obama Administration's 2010 Budget includes over $300 billion
in Medicare and Medicaid savings over 10 years; more recently Obama indicated to
Congress that he intends to seek an additional $200-$300 billion in Medicare and
Medicaid cost savings over the 10 year period. Congress also passed the American
Recovery and Revitalization Act of 2009 (the "2009 ARRA") which provided new
monies in order to stimulate cost savings through increased use of technology
and provide coverage for the poor and uninsured through enhanced Medicaid
increases.
In addition, important amendments to the Medicare law were made by
the Medicare Prescription Drug, Improvement, and Modernization Act of 2003
("MMA") and the Deficit Reduction Act of 2005 ("DRA"). Although the most
significant provisions of MMA relate to an expansion of Medicare's coverage for
pharmaceuticals and changes intended to expand managed care under the Medicare
program, MMA also made many changes in the laws that are relevant to how
Medicare makes payments to hospitals, some of which could have an adverse impact
on the Hospitals' Medicare reimbursement. The MMA initiated increased quality of
care reporting, including penalties for not reporting, that is related to the
government's intensifying efforts to shift payments from a service-based model
to a "payment for performance" model based on outcomes. Since 2008, Medicare has
refused to pay for certain reported `never events,' i.e. hospital medical events
that never should have occurred.
4
INPATIENT OPERATING COSTS. Medicare pays acute care hospitals, such as
the Hospitals, for most services provided to inpatients under a system known as
the Prospective Payment System ("PPS") pursuant to which hospitals are paid for
services based on predetermined rates. Medicare payments under PPS are based on
the Diagnosis Related Group ("DRG") to which each Medicare patient is assigned.
The DRG is determined by the patient's primary diagnosis and other factors for
each particular Medicare inpatient stay. The amount to be paid for each DRG is
established prospectively by the Centers for Medicare and Medicaid Services
("CMS"). The DRG amounts are not related to a hospital's actual costs or
variations in service or length of stay. Therefore, if a hospital incurs costs
in treating Medicare inpatients that exceed the DRG level of reimbursement plus
any outlier payments, then that hospital will experience a loss from such
services, which will have to be made up from other revenue sources. Payment
limitations implemented by other third party payers may restrict the ability of
a hospital to engage in such "cost-shifting." In October 2006, CMS implemented
significant changes to the Medicare program's inpatient acute care PPS that (1)
altered the way that DRG weights are calculated, abandoning the charge-based
weight system in favor of a cost-based weight system and (2) expanded the number
of DRGs so that the severity of a given illness is taken into account for
purposes of payment. Such systemic changes took affect for discharges occurring
on and after October 1, 2006 and were phased in over a three year period through
federal fiscal year ("FFY") 2008 which began on October 1, 2007.
CMS determined that hospitals would respond to the new MS DRG system
with improvements in documentation and coding procedures that would result in a
4.8% national increase in payments (the impact on individual hospitals could not
be determined as it would vary based on the services provided by the hospital).
To offset this, the FFY 2008 final rule included reductions in payments of 1.2%
for FFY 2008, 1.8% for FFY 2009, and 1.8% for FFY 2010. In the final rule for
FFY 2009, CMS included an adjustment to the reduction for FFY 2009 from 1.8% to
0.9%. In their proposed FFY 2010 PPS rules, published May 22, 2009 in the
Federal Register, CMS has proposed a 1.9% reduction for FFY 2010 and additional
reductions for FFY 2011 and FFY 2012. At this time, it is not known if the
proposed reductions will be adopted, or if adopted, what the affect will be on
the Hospitals.
The 1.9% reduction noted above is a component of multiple payment
reductions in the proposed FFY 2010 that will result in reductions to total
payments to hospitals providing services to Medicare beneficiary inpatients.
Under the proposed rule, a total decrease of $979 million in combined operating
and capital payments to hospitals are estimated. The proposed rule would apply
to approximately 3,500 acute care hospitals paid under the IPPS, and implement
certain provisions made by the Medicare Improvements for Patients and Providers
Act of 2008 (MIPPA) and the American Recovery and Reinvestment Act of 2009
(ARRA), beginning with discharges occurring on or after October 1, 2009. The
estimated impact of the proposed rule is an overall .5% decrease in operating
payments and a 4.8% decrease in capital payments for services provided to
Medicare beneficiaries for inpatient hospital services. At this time, it is not
known if the proposed reductions will be adopted, or if adopted, what the affect
will be on the Hospitals.
For certain Medicare beneficiaries who have unusually costly hospital
stays (also known as "outliers"), CMS currently provides additional payments
above those specified for the DRG. To determine whether a case qualifies for
outlier payments, hospital-specific cost-to-charge ratios are applied to the
total covered charges for the case. Operating and capital costs for the case are
calculated separately by applying separate operating and capital cost-to-charge
ratios and combining these costs to compare them with a defined fixed-loss
outlier threshold for the specific DRG.
PPS payments are adjusted annually using an inflation index, based on
the change in a "market basket" of hospital costs of providing healthcare
services. There can be no assurance that future updates in PPS payments will
keep pace with inflation or with the increases in the cost of providing hospital
services. It is also possible that the prospective payment for capital costs at
a Hospital will not be sufficient to cover the actual capital-related costs of
the Hospital allocable to Medicare patients' stays.
5
OUTPATIENT SERVICES. All services paid under the outpatient PPS are
classified into groups called Ambulatory Payment Classifications ("APC").
Services in each APC are similar clinically and in terms of the resources they
require. A payment rate is established for each APC. Depending on the services
provided, hospitals may be paid for more than one APC for an encounter. CMS will
make additional payment adjustments under outpatient PPS, including "outlier"
payments for services where the hospital's cost exceeds 2.5 times the APC rate
for that service. In addition, certain other changes have reduced coinsurance
payments below what they would have originally been under outpatient PPS.
MEDICARE BAD DEBT. Medicare beneficiaries have a coinsurance payment
and annual deductible for most inpatient and outpatient hospital services.
Hospitals must first seek payment of any such coinsurance and deductible amounts
from the Medicare beneficiary. If, after reasonable collection efforts, a
hospital is unable to collect these coinsurance and deductible amounts, Medicare
currently reimburses hospitals 70 percent of the uncollected coinsurance and
deductible amount (known as "Medicare bad debt"). The Federal Government is
currently considering significant changes to the Medicare program. Accordingly,
as changes to the reimbursement of Medicare bad debts have not been specifically
outlined, it is not possible to determine at this time what the final changes
will be and what the impact of the changes will be on the hospitals.
MEDICARE CONDITIONS OF PARTICIPATION. Hospitals must comply with
provisions called "Conditions of Participation" in order to be eligible for
Medicare reimbursement. CMS is responsible for ensuring that hospitals meet
these regulatory Conditions of Participation. Under the Medicare rules,
hospitals accredited by the Joint Commission on Accreditation of Healthcare
Organizations ("JCAHO") are deemed to meet the Conditions of Participation. The
Hospitals are each currently accredited by JCAHO and are therefore deemed to
meet the Conditions of Participation.
MEDICARE AUDITS. Medicare participating hospitals are subject to audits
and retroactive audit adjustments with respect to reimbursement claimed under
the Medicare program. Medicare regulations also provide for withholding Medicare
payments in certain circumstances. Any such withholding with respect to the
Hospitals could have a material adverse effect on the Company. In addition,
contracts between hospitals and third party payers often have contractual audit,
setoff and withhold language that may cause substantial, retroactive
adjustments. Medicare requires certain financial information be reported on a
periodic basis, and with respect to certain types of classifications of
information, penalties are imposed for inaccurate reports. In addition, the MMA
of 2003 established the Recovery Audit Contractor ("RAC") program to intensify
its audit efforts. The RAC audits have already subjected those hospitals who
have been audited to significant repayments. As the requirements governing
audits, including the RAC audits, are numerous, technical and complex, there can
be no assurance that the Company will avoid incurring such penalties. Such
penalties could materially and adversely affect the Company.
MEDICARE MANAGED CARE. The Medicare program allows various managed care
plans, now known as Medicare Advantage Plans, offered by private companies to
engage in direct managed care risk contracting with the Medicare program. Under
the Medicare Advantage program, these private companies agree to accept a fixed,
per-beneficiary payment from the Medicare program to cover all care that the
beneficiary may require. The Obama Administration has announced initiatives to
scale back the number and funding of Medicare Advantage Plans; these initiatives
may have a direct fiscal impact on the Plans and an indirect financial impact to
the Hospitals. The effect of these recent changes and any future
legislation/regulation is unknown but could materially and adversely affect the
Company.
MEDI-CAL (CALIFORNIA'S MEDICAID PROGRAM)
FEE-FOR-SERVICE PROGRAM. The Medi-Cal program is a joint federal/state
program that provides healthcare services to certain persons who are financially
needy. Each of the Hospitals participates in the Medi-Cal program. The Medi-Cal
program includes both a fee-for-service component and a managed care component.
Inpatient hospital services under the fee-for-service component are reimbursed
primarily under the Selective Provider Contracting Program ("SPCP"), which are
negotiated by the California Medical Assistance Commission ("CMAC"). The SPCP
and CMAC system for payments to hospitals are designed to pay hospitals below
their costs of services to Medi-Cal beneficiaries. The Company is located in an
area which is currently a "closed area" under the SPCP. In SPCP closed areas,
private
6
hospitals must hold a contract with the Medi-Cal program in order to be paid for
their inpatient services (other than services performed in an emergency to
stabilize a patient so that they can be transferred to a contracting hospital
and additional care rendered to emergency patients who cannot be so stabilized
for transfer or where no contracting hospital accepts the patient). Contracting
hospitals are generally paid for these services on the basis of all inclusive
per diem rates they negotiate under their SPCP/CMAC contracts. Outpatient
hospital services under the fee-for service-component are paid for on the basis
of a fee schedule, and it is not necessary for hospitals to hold SPCP/CMAC
contracts in order to be paid for their outpatient services. Each Hospital
currently has an SPCP/CMAC contract in which it is contractually bound to
continue until November 26, 2009, and there can be no assurance that the
Hospital will maintain SPCP status thereafter or that the current Medi-Cal
payment arrangements will continue. There can be no assurance that the SPCP/CMAC
contract rates paid to the Hospitals will cover each Hospital's cost of
providing care. The Medi-Cal payment rates for outpatient services cover only a
small portion of a Hospital's cost of providing care. In addition, pursuant to
the DRA, CMS has developed a Medicaid Integrity Plan ("MIP") that requires
increased auditing of State Medicaid programs, and intensified efforts by State
Medicaid programs to investigate fraud and overpayments. If the Hospitals become
the subject to any of such audits and are required to refund any payments, those
refunds could financially affect the Company.
MEDI-CAL MANAGED CARE. In addition to the fee-for-service component of
Medi-Cal, Orange County, California (where the Hospitals are located)
participates in the Medi-Cal managed care program. Many Medi-Cal beneficiaries
in Orange County are covered under Medi-Cal managed care, and not under
fee-for-service Medi-Cal. Medi-Cal managed care in Orange County is provided
through a County Organized Health System known as CalOptima. An Orange County
hospital that wants to participate in Medi-Cal managed care on a capitated basis
must contract with CalOptima, and is typically paid a capitated amount each
month to provide, or arrange for the provision of, specified services to
CalOptima members assigned to the hospital. The capitated hospital is
financially responsible for a predetermined list of services, whether those
services are provided at the capitated hospital or another service provider,
provided during the term of the contract, including allowable claims received
after contract termination. Western Medical Center - Santa Ana had a capitated
contract with CalOptima which terminated as of June 2006. Coastal Communities
Hospital had a capitated contract with CalOptima which terminated in April 2007.
Mid-year 2006, CalOptima focused on entering into contracts with hospitals on a
fee-for-services basis for managed care Medi-Cal enrollees managed directly by
CalOptima and CalOptima's capitated hospitals. The rates in these contracts are
based on the greater of an Orange County average SPCP/CMAC rate or the
individual hospital's SPCP/CMAC rate. Chapman Medical Center, Coastal
Communities Hospital, Western Medical Center - Anaheim and Western Medical
Center - Santa Ana entered into these CalOptima fee for service contracts
effective June 2006. A hospital which does not have a contract with CalOptima
may provide covered services. However, there are ongoing disputes between
CalOptima and hospitals in Orange County concerning the amount CalOptima is
obligated to pay for emergency services furnished by non-contracting hospitals.
An amendment to the federal Medicaid Act which became effective January 1, 2007,
appears to set reimbursement from Medi-Cal managed care plans, like CalOptima,
to hospital providers of emergency services that do not have contracts with
those plans at an average SPCP/CMAC contracted rate for general acute care
hospitals or the average contract rate for tertiary hospitals. The State of
California has established a non-contracted tertiary hospitals definition, which
Western Medical Center - Santa Ana qualifies and the other three Hospitals
qualify as general acute care hospitals. Additionally, the State of California
adopted a mechanism to determine the rates that will be paid to non-contract
hospitals for emergency services and post emergency care. CalOptima has adjusted
the rates paid to contracted tertiary hospitals to equate to the non-contracted
tertiary hospital rates. CalOptima general acute care hospital rates are similar
to the State established non-contract rate, therefore CalOptima made no
adjustment to general acute care hospital rates. All four Hospitals maintained
their Medi-Cal managed care contract at the end of the fourth quarter. There can
be no assurance that the amount paid to any of the Hospitals for services
covered under CalOptima which are covered or not covered under a contract
between CalOptima and each Hospital will be adequate to reimburse a Hospital's
costs of providing care.
7
MEDI-CAL DSH PAYMENTS. Some of the Hospitals receive substantial
additional Medi-Cal reimbursement as a disproportionate share ("DSH") hospital
from the DSH Replacement Fund and the Private Hospital Supplemental Fund.
Hospitals qualify for this additional funding based on the proportion of
services they provide to Medi-Cal beneficiaries and other low-income patients.
Payments to a hospital from the State's DSH Replacement Fund are determined on a
formula basis set forth in California law and the Medi-Cal State Plan. Hospitals
receive funds from the Private Hospital Supplemental Fund pursuant to amendments
to their SPCP contracts negotiated with CMAC. The Medi-Cal funding for DSH
hospitals, however, is dependent on state general fund appropriations, and there
can be no assurance that the state will fully fund the Medi-Cal DSH payment
programs. There also can be no assurance that the Hospitals which qualify for
DSH will be able to negotiate SPCP contract amendments for Private Hospital
Supplemental Fund Payments, although state law currently provides that a
qualifying hospital may not receive less from the Private Hospital Supplemental
Fund than it received from predecessor funds in the State's 2002-03 fiscal year.
The state programs under which special payments are made to DSH hospitals are
set to expire as of June 30, 2010. There can be no assurance the programs will
be extended or replaced by similar programs. In addition, the federal government
has recently proposed regulations which could have a significant negative effect
on DSH reimbursement to California hospitals, including the Hospitals, if they
become effective. Such changes could materially and adversely affect the
Company.
WORKERS' COMPENSATION REIMBURSEMENT
FEE SCHEDULES. A portion of the Hospitals' revenues are expected to
come from Workers' Compensation program reimbursements. As part of an effort in
2003 to control costs under the Workers' Compensation program, the California
legislature enacted Labor Code Section 5307.1, which sets reimbursement for
hospital inpatient and outpatient services, including outpatient surgery
services, at a maximum of 120% of the current Medicare fee schedule for
hospitals. The Administrative Director of the Division of Workers' Compensation
is authorized to develop and, after public hearings, to adopt a fee schedule for
outpatient surgery services, but this schedule may not be more than 120% of the
current Medicare fee schedule for hospitals. This fee limitation limits the
amount that the Hospitals will be paid for their services provided to Workers'
Compensation patients. We can provide no assurance that the amount of revenues
attributable to these payments may not be reduced in the future, which
reductions may have an adverse financial impact on the Company.
PROVIDER NETWORKS. Under California law, employers may establish
medical provider networks for Workers' Compensation patients and may restrict
their employees' access to medical services to providers that are participants
in those networks. Employers are free to choose which providers will and will
not participate in their networks, and employers pay participating providers on
the basis of negotiated rates that may be lower than those that would otherwise
be provided for by the Workers' Compensation fee schedules. Employers may also
choose to contract with licensed Health Maintenance Organizations ("HMO") and
restrict access by their employees to participating providers of these HMOs. The
Hospitals are participating providers in several Workers' Compensation networks,
and to the extent that the Hospitals are required to negotiate and accept lower
reimbursement rates to participate in these networks, there may be an adverse
financial impact on the Company. Also, network providers are required to provide
treatment in accordance with utilization controls to be established by the
Department of Workers' Compensation. Therefore, as network participants, such
utilization controls may limit the services for which the Hospital is
reimbursed, which would have an adverse financial impact on the Company.
FURTHER REFORM. There will likely continue to be substantial activity
in the California Workers' Compensation reform area. In the past, the
legislature has considered a number of bills, some of which would further reduce
the maximum reimbursement for medical services, including hospital services. It
is expected that any revisions to the Workers' Compensation fee schedule, when
and if implemented, will reduce the fees the Hospitals receive for Workers'
Compensation patients. The impact of such possible future fee schedule changes
cannot be estimated at this time. It is also possible that the profitability of
the Company could be impacted by other future Workers' Compensation cost control
efforts.
8
COMMERCIAL INSURANCE
Many private insurance companies contract with hospitals on a
"preferred" provider basis, and many insurers have introduced plans known as
preferred provider organizations ("PPO"). Under preferred provider plans,
patients who use the services of contracted providers are subject to more
favorable copayments and deductibles than apply when they use non-contracted
providers. In addition, under most HMOs, private payers limit coverage to those
services provided by selected hospitals. With this contracting authority,
private payers direct patients away from nonselected hospitals by denying
coverage for services provided by them. The Hospitals currently have several
managed care contracts. If the Company's managed care contract rates are
unfavorable or are reduced in the future, this may negatively impact the
Company's profitability.
ELECTRONIC HEALTH RECORDS
The 2009 ARRA provides stimulus monies for hospitals and physicians
that are meaningful electronic health records ("EHR") users beginning in 2011,
and imposes penalties on providers who are not meaningful users by the end of
2015. The intent is to promote the use of electronic technology to improve
health outcomes and reduce health care costs. To become a meaningful EHR user, a
provider must adopt a "certified EHR system" according to Department of Health &
Human Services ("DHHS") standards, to be issued, that include e-prescribing.
Also, the user must demonstrate that it engages in the exchange of health
information to promote quality of care and coordination, and reports on clinical
quality efforts. DHHS intends to issue proposed meaningful EHR user regulations
in the near future. The Hospitals will endeavor to qualify for available
stimulus monies and avoid penalties, and to generally maximize the use of EHR.
However, the purchase and implementation of EHR systems can be expensive.
Further, as the health information becomes more pervasive, we anticipate
additional regulations and costs related to the exchange of health information
on a regional and national basis.
EMTALA
In response to concerns regarding inappropriate hospital transfers of
emergency patients based on the patient's inability to pay for the services
provided, Congress enacted the Emergency Medical Treatment and Labor Act
("EMTALA") in 1986. This so-called "anti-dumping" law imposes certain
requirements on hospitals with Medicare provider agreements to (1) provide a
medical screening examination for any individual who comes to the hospital's
emergency department, (2) provide necessary stabilizing treatment for emergency
medical conditions and labor, and (3) not transfer a patient until the
individual is stabilized, unless the benefits of transfer outweigh the risks or
the patient gives informed consent to the transfer. Since the Hospitals must
provide emergency services without regard to a patient's ability to pay,
complying with EMTALA could have an adverse impact on the profitability of the
Hospitals, depending upon the number of patients treated in or through the
emergency room who are unable to pay. Failure to comply with the law can result
in exclusion of the physician from the Medicare and/or Medicaid programs or
termination of the hospital's Medicare provider agreements, as well as civil
penalties.
9
ANTI-KICKBACK, FRAUD AND SELF-REFERRAL REGULATIONS
FEDERAL ANTI-KICKBACK LAW. The Social Security Act's illegal
remuneration provisions (the "Anti-kickback Statute") prohibit the offer,
payment, solicitation or receipt of remuneration (including any kickback, bribe
or rebate), directly or indirectly, overtly or covertly, in cash or in kind, for
(a) the referral of patients or arranging for the referral of patients to
receive services for which payment may be made in whole or in part under a
federal healthcare program, which includes Medicare, Medicaid and TRICARE
(formerly CHAMPUS, which provides benefits to dependents of members of the
uniformed services) and any state healthcare program, or (b) the purchase,
lease, order, or arranging for the purchase, lease or order of any good,
facility, service or item for which payment may be made under the above payment
programs. The Anti-kickback Statute contains both criminal and civil sanctions,
which are enforced by the Office of Inspector General ("OIG") of DHHS and the
United States Department of Justice. The criminal sanctions for a conviction
under the Anti-kickback Statute are imprisonment for not more than five years, a
fine of not more than $50,000 for each offense, or both, with higher penalties
potentially being imposed under the federal Sentencing Guidelines. In addition
to the imposition of criminal sanctions, the Secretary of DHHS may exclude any
person or entity that commits an act described in the Anti-kickback Statute from
participation in the Medicare program and direct states to also exclude that
person from participation in state healthcare programs. The Secretary of DHHS
can exercise this authority based on an administrative determination, without
obtaining a criminal conviction. The burden of proof for the exclusion would be
one that is customarily applicable to administrative proceedings, which is a
lower standard than that required for a criminal conviction. In addition,
violators of the Anti-kickback Statute may be subjected to civil money penalties
of $50,000 for each prohibited act and up to three times the total amount of
remuneration offered, paid, solicited, or received, without regard to whether a
portion of such remuneration was offered, paid, solicited, or received for a
lawful purpose.
There is ever-increasing scrutiny by federal and state law enforcement
authorities, OIG, DHHS, the courts, and Congress of arrangements between
healthcare providers and potential referral sources to ensure that the
arrangements are not designed as a mechanism to exchange remuneration for
patient care referrals and opportunities. The law enforcement authorities, the
courts, and Congress have also demonstrated a willingness to look behind the
formalities of an entity's structure to determine the underlying purpose of
payments between healthcare providers and potential referral sources.
Enforcement actions have been increased and, generally, the courts have broadly
interpreted the scope of the Anti-kickback Statute and have held, for example,
that the Anti-kickback Statute may be violated if merely one purpose of a
payment arrangement is to induce referrals. In addition, the OIG has long been
on record that it believes that physician investments in healthcare companies
can violate the Anti-kickback Statute and the OIG has demonstrated an aggressive
attitude toward enforcement of the Anti-kickback Statute in the context of
ownership relationships.
The OIG has issued regulations specifying certain payment practices
that will not be treated as a criminal offense under the Anti-kickback Statute
and that will not provide a basis for exclusion from the Medicare or Medicaid
programs (the "Safe Harbor Regulations"). These regulations include, among
others, safe harbors for certain investments in both publicly traded and
non-publicly traded companies. However, investments in the Company will not be
protected by either of these safe harbor regulations. Nevertheless, the fact
that a specific transaction does not meet all of the criteria of a "safe harbor"
does not mean that such transaction constitutes a violation of the Anti-kickback
Statute, and the OIG has indicated that any arrangement that does not meet all
of the elements of a safe harbor will be evaluated on its specific facts and
circumstances to determine whether the Anti-kickback Statute has been violated
and, thus, if prosecution is warranted.
The OIG is authorized to issue advisory opinions which interpret the
Anti- kickback Statute and has issued several advisory opinions addressing
investments by physicians in healthcare businesses. Based upon those opinions,
it appears unlikely that the OIG would be willing to issue an advisory opinion
protecting physician investments in the Company, and no such opinion has been
requested by the Company. The Company nevertheless believes, based upon a
federal court decision involving physician investments in clinical laboratories,
that investments in it by physicians are not automatically prohibited by the
Anti- kickback Statute, depending upon the circumstances surrounding such
investment. The Company has reviewed the terms of the purchase of ownership
interests in the Company by Orange County Physician Investment Network, LLC
("OC-PIN") (which is owned by physicians that refer patients to the Hospitals)
and has determined that the purchase should not violate the Anti-kickback
Statute.
10
The OIG also has identified many hospital-physician compensation
arrangements that are potential violations of the Anti-kickback Statute,
including: (a) payment of any incentive for the referral of patients; (b) use of
free or discounted office space or equipment; (c) provision of free or
discounted services, such as billing services; (d) free training; (e) income
guarantees; (f) loans which are not fair market value or which may be forgiven;
(g) payment for services which require few, if any substantive duties by the
physician or payment for services in excess of fair market value of the
services; and (h) purchasing goods or services from physicians at prices in
excess of fair market value. The Company has reviewed many of its compensation
relationships with physicians, and on-going reviews are occurring, in an effort
to ensure that such relationships do not violate the Anti-kickback Statute.
CALIFORNIA ANTI-KICKBACK PROHIBITIONS. California law prohibits
remuneration of any kind in exchange for the referral of patients regardless of
the nature of the payer of such services, and is therefore broader in this
regard than is the federal statute. Nevertheless, this statute specifically
provides that a medically necessary referral is not illegal solely because the
physician that is making the referral has an ownership interest in the
healthcare facility to which the referral is made if the physician's return on
investment is based upon the amount of the physician's capital investment or
proportional ownership and such ownership is not based upon the number or value
of patients referred. Further, opinions of the California Attorney General
indicate that distributions paid to physicians who invest in entities that
conduct health related businesses generally do not violate California's
anti-kickback law when the entity conducts a bona fide business, services
performed are medically needed, and profit distributions are based upon each
investor's proportional ownership interest, rather than the relative volume of
each investor's utilization of the entity's business. California has a separate
anti-kickback statute which applies only under the Medi-Cal program and which
largely parallels the prohibitions of the federal Anti-kickback Statute. The
Company believes that analysis under this Medi-Cal anti-kickback statue will be
the same as under the federal Anti-kickback Statute discussed above.
FALSE AND OTHER IMPROPER CLAIMS. The federal government is authorized
to impose criminal, civil, and administrative penalties on any person or entity
that files a false claim for payment from the Medicare or Medi-Cal programs. In
addition to other federal criminal and civil laws which punish healthcare fraud,
the federal government, over the past several years, has accused an increasing
number of healthcare providers of violating the federal Civil False Claims Act.
The False Claims Act imposes civil liability (including substantial monetary
penalties and damages) on any person or corporation which (1) knowingly presents
a false or fraudulent claim for payment to the federal government; (2) knowingly
uses a false record or statement to obtain payment; or (3) engages in a
conspiracy to defraud the federal government to obtain allowance for a false
claim. Recently, provisions of the False Claims Act were clarified under the
Fraud Enforcement and Recovery Act of 2009 to eliminate the requirement that a
false claim be presented to a federal official, or that it directly involves
federal funds (i.e., indirect payments to a subcontractor are covered). False
claims allegations could arise, for example, with respect to the Hospital's
billings to the Medicare program for its services or the submission by the
Hospital of Medicare cost reports. Specific intent to defraud the federal
government is not required to act with knowledge. Instead, the False Claims Act
defines "knowingly" to include not only actual knowledge of a claim's falsity,
but also reckless disregard for or intentional ignorance of the truth or falsity
of a claim. Because the Hospitals perform hundreds of procedures a year for
which they are paid by Medicare, and there is a relatively long statute of
limitations, a billing error or cost reporting error could result in significant
civil or criminal penalties.
Under the qui tam, or whistleblower, provisions of the False Claims
Act, private parties may bring actions on behalf of the federal government.
These private parties, often referred to as relators, are entitled to share in
any amounts recovered by the government through trial or settlement. Both direct
enforcement activity by the government and whistleblower lawsuits have increased
significantly in recent years and have increased the risk that a healthcare
company, like us, will have to defend a false claims action, pay fines or be
excluded from the Medicare and Medicaid programs as a result of an investigation
resulting from a whistleblower case. Although the Company intends that the
operations of the Hospitals will materially comply with both federal and state
laws related to the submission of claims, there can be no assurance that a
determination that we have violated these claims-related laws will not be made,
and any such determination would have a material adverse effect on the Company.
11
In addition to the False Claims Act, federal civil monetary penalties
provisions authorize the imposition of substantial civil money penalties against
an entity which engages in activities including, but not limited to, (1)
knowingly presenting or causing to be presented, a claim for services not
provided as claimed or which is otherwise false or fraudulent in any way; (2)
knowingly giving or causing to be given false or misleading information
reasonably expected to influence the decision to discharge a patient; (3)
offering or giving remuneration to any beneficiary of a federal healthcare
program likely to influence the selection of a particular provider, practitioner
or supplier for the ordering or receipt of reimbursable items or services; (4)
arranging for reimbursable services with an entity which is excluded from
participation from a federal healthcare program; (5) knowingly or willfully
soliciting or receiving remuneration for a referral of a federal healthcare
program beneficiary; or (6) using a payment intended for a federal healthcare
program beneficiary for another use.
The Secretary of DHHS, acting through the OIG, also has both mandatory
and permissive authority to exclude individuals and entities from participation
in federal healthcare programs pursuant to this statute. Also, it is a criminal
federal healthcare fraud offense to: (1) knowingly and willfully execute or
attempt to execute any scheme to defraud any healthcare benefit program,
including any private or governmental program; or (2) to obtain, by means of
false or fraudulent pretenses, any property owned or controlled by any
healthcare benefit program. Penalties for a violation of this federal law
include fines and/or imprisonment, and a forfeiture of any property derived from
proceeds traceable to the offense. In addition, if an individual is convicted of
a criminal offense related to participation in the Medicare program or any state
healthcare program, or is convicted of a felony relating to healthcare fraud,
the Secretary of DHHS is required to bar the individual from participation in
federal healthcare programs and to notify the appropriate state agencies to bar
the individuals from participation in state healthcare programs.
While the criminal statutes are generally reserved for instances of
fraudulent intent, the federal government is applying its criminal, civil, and
administrative penalty statutes in an ever-expanding range of circumstances. For
example, the government has taken the position that a pattern of claiming
reimbursement for unnecessary services violates these statutes if the claimant
merely should have known the services were unnecessary, even if the government
cannot demonstrate actual knowledge. The government has also taken the position
that claiming payment for low-quality services is a violation of these statutes
if the claimant should have known that the care was substandard. In addition,
some courts have held that a violation of the Stark Law or the Anti-kickback
Statute can result in liability under the federal False Claims Act.
Noncompliance with other regulatory requirements can also lead to liability
under the False Claims Act if it can be established that compliance with those
requirements are necessary in order for a hospital to be paid for its services.
Claims filed with private insurers can also lead to criminal and civil
penalties under federal law, including, but not limited to, penalties relating
to violations of federal mail and wire fraud statutes and of the Health
Insurance Portability and Accountability Act of 1996 and its implementing
regulations ("HIPAA") provisions which have made the defrauding of any
healthcare insurer, whether public or private, a crime. The Hospitals are also
subject to various state insurance statutes and regulations that prohibit the
Hospitals from submitting inaccurate, incorrect or misleading claims. The
Company intends that the Hospitals will comply with all state insurance laws and
regulations regarding the submission of claims. IHHI cannot assure, however,
that each Hospital's insurance claims will never be challenged or that the
Hospitals will in all instances comply with all laws regulating its claims. If a
Hospital were found to be in violation of a state insurance law or regulation,
the Hospital could be subject to fines and criminal penalties, which would have
an adverse effect on IHHI's business and operating results.
FEDERAL PHYSICIAN SELF-REFERRAL LAW. Provisions of the Social Security
Act commonly referred to as the Stark Law prohibit referrals by a physician of
Medicare patients to providers for a broad range of health services if the
physician (or his or her immediate family member) has an ownership or other
financial arrangement with the provider, unless an exception applies. The
"designated health services" to which the Stark Law applies include all
inpatient and outpatient services provided by hospitals. Hospitals cannot bill
for services they provide as a result of referrals that are made in violation of
the Stark Law. In addition, a violation of the Stark Law may result in a denial
of payment, require refunds to patients and to the Medicare program, civil
monetary penalties of up to $15,000 for each violation, civil monetary penalties
of up to $100,000 for certain "circumvention schemes" and exclusion from
participation in Medicare, Medicaid, and other federal programs. Violations of
the Stark Law may also be actionable as violations of the federal False Claims
Act.
12
Notwithstanding the breadth of the Stark Law's general prohibition, the
law contains an exception which protects ownership interests held by physicians
in hospitals where the referring physician is authorized to perform services at
the hospital and the physician's ownership is in the hospital itself, and not
merely in a subdivision of the hospital. The Hospitals intend to rely upon this
exception to protect the ownership interests that physicians hold in them.
Although the Company does not believe that any of its Hospitals will be
considered to be "specialty hospitals", changes in this area of the law that
would affect the classification of the Hospitals as "specialty hospitals" may
affect the Company's operations. CMS continues to review and evaluate the rules
related to ownership interests held in hospitals by physicians. The proposed
fiscal year 2010 Inpatient Prospective Payment Rule, published May 22, 2009,
does not contain any significant updates to the current regulations.
Additionally, similar disclosure requirements are imposed by California law (see
"DISCLOSURE OF FINANCIAL INTERESTS" section below). It is unlikely that
implementation of new CMS or California requirements would have a material
effect on the Company's operations.
In addition to physician ownership, the Hospitals have arrangements by
which they compensate various physicians for services. Payments by the Company
to such physicians will constitute financial relationships for purposes of the
Stark Law. Exemptions exist under the Stark Law and its implementing regulations
for various types of compensation relationships. Effective October, 2009,
certain exceptions for services obtained "under arrangement" from physicians
will end, and the Company will have to review and, if necessary, revise any
arrangements in this category. The Company will endeavor to ensure that all of
its financial relationships qualify for one or more exemptions under the Stark
Law. However, there can be no assurance that the Company will be successful in
structuring all of its relationships with physicians so as to qualify for
protection under one or more of the Stark Law's exceptions.
CALIFORNIA PHYSICIAN SELF-REFERRAL LAW RESTRICTIONS. Restrictions on
financial relationships between physicians and businesses to which they refer
patients for specified types of services, including some services which will be
provided by the Hospitals, also exist under California law. As is the case under
federal law, the California self-referral restrictions can be triggered by
financial relationships other than ownership. However, these laws contain a
broad exemption permitting referrals to be made to a hospital so long as the
referring physician is not compensated by the hospital for the referral and any
equipment lease between the hospital and the physician satisfies certain
requirements.
An additional requirement imposed by California's self-referral laws is
that any non-emergency imaging services performed for a Workers' Compensation
patient with equipment that, when new, had a value of $400,000 or more must be
pre-approved by the Workers' Compensation insurer or self-insured employer. This
provision may require that preauthorization be obtained for MRI services ordered
by the Hospitals' physician owners and others who have financial relationships
with the Company. It is possible that insurers may refuse to provide any
required preauthorizations in connection with referrals of Workers' Compensation
patients made to the Hospitals by physicians who have financial relationships
with it. However, given that MRI services for Workers' Compensation patients are
not anticipated to represent a material portion of the Hospitals' services, the
Company does not believe that any such refusals to provide required
preauthorizations would have a material impact upon it.
LICENSING
Health facilities, including the Hospitals, are subject to numerous
legal, regulatory, professional, and private licensing, certification, and
accreditation requirements. These include requirements relating to Medicare
participation and payment, state licensing agencies, private payers and the
Joint Commission on Accreditation of Healthcare Organizations ("Joint
Commission"). Renewal and continuance of certain of these licenses,
certifications and accreditations are based on inspections, surveys, audits,
investigations or other reviews, some of which may require or include
affirmative action or response by the Company. These activities generally are
conducted in the normal course of business of health facilities. Nevertheless,
an adverse determination could result in a loss or reduction in a Hospital's
scope of licensure, certification or accreditation, or could reduce the payment
received or require repayment of amounts previously remitted. Any failure to
obtain, renew or continue a license, certification or accreditation required for
operation of a Hospital could result in the loss of utilization or revenues, or
the loss of the Company's ability to operate all or a portion of a Hospital,
and, consequently, could have a material and adverse effect on the Company.
13
DISCLOSURE OF FINANCIAL INTERESTS
California law provides that it is unlawful for a physician to refer a
patient to an organization in which the physician or the physician's immediate
family has a significant beneficial interest unless the physician first
discloses in writing to the patient that there is such an interest and advises
the patient regarding alternative services, if such services are available. A
"significant beneficial interest" means any financial interest equal to or
greater than the lesser of five percent of the total beneficial interest or
$5,000. This disclosure requirement may be satisfied by the posting of a
conspicuous sign likely to be seen by all patients who use the facility or by
providing patients with written disclosure statements. Physicians must also make
disclosure of entities in which they hold significant financial interests to a
patient's payer upon the request of the payer (not to be made more than once a
year). A violation of this disclosure requirement constitutes "unprofessional
conduct," and is grounds for the suspension or revocation of the physician's
license. Further, it is deemed a misdemeanor punishable by imprisonment not to
exceed six months, or by a fine not to exceed $2,500.
In addition, California's general self-referral laws require that any
physician who refers a person to, or seeks consultation from an organization in
which the physician has a financial interest, must disclose the financial
interest to the patient, or the parent or legal guardian of the patient, in
writing, at the time of the referral or request for consultation. This
requirement applies regardless of whether the financial interest is otherwise
protected by one of the exemptions under the self-referral law. There is no
minimum threshold of ownership required in order for this disclosure requirement
to be triggered, and this disclosure requirement cannot be satisfied by the
posting of a sign. A violation of this disclosure requirement may be subject to
civil penalties of up to $5,000 for each offense. Physician investors in the
Company will be individually responsible for complying with these disclosure
requirements with respect to their referrals to the Hospital. The obligation of
physicians with financial interests in the Company to make such disclosures or
the effect of such disclosures on patients may have an adverse impact on the
Company.
HIPAA
HIPAA mandated the adoption of standards for the exchange of health
information in an effort to encourage overall administrative simplification and
enhance the effectiveness and efficiency of the healthcare industry. Under
HIPAA, healthcare providers and other "covered entities" such as health
insurance companies and other third-party payers, must adopt uniform standards
for the electronic transmission of billing statements and insurance claims
forms. These standards require the use of standard data formats and code sets
when electronically transmitting information in connection with health claims
and equivalent encounter information, healthcare payment and remittance advice
and health claim status.
On January 23, 2004, DHHS published a final rule that adopted the
National Provider Identifier ("NPI") as the standard unique health identifier
for healthcare providers. The NPI is a 10-digit all numeric number that is
assigned to eligible healthcare providers, including our hospitals, by the
National Provider System ("NPS"), an independent government contractor. Our
hospitals have obtained and are using NPIs in connection with the standard
electronic transactions. The NPI rule was implemented in 2008, requiring that
our Hospitals use only the NPI to identify themselves in connection with
electronic transactions. Legacy numbers, such as Medicaid numbers, CHAMPUS
numbers and Blue Cross-Blue Shield numbers, are not permitted. Healthcare
providers no longer have to keep track of multiple numbers to identify
themselves in the standard electronic transactions with one or more health
plans.
14
DHHS also has promulgated HIPAA security standards and privacy
standards which are aimed, in part, at protecting the confidentiality,
availability and integrity of health information by "covered entities,"
including health plans, healthcare clearinghouses and healthcare providers that
receive, store, maintain or transmit health and related financial information in
electronic form, regardless of format. Recently, the 2009 ARRA amended HIPAA to
include "business associates," i.e., those entities that perform business
functions for health plans, clearinghouses and providers, as covered entities
effective February 17, 2010 or a date set by DHHS. The privacy standards require
compliance with rules governing the use and disclosure of patient health and
billing information. They create rights for patients in their health
information, such as the right to amend their health information, and they
require us to impose these rules, by contract, on any business associate to
which we disclose such information to perform functions on our behalf. These
provisions required us to implement expensive computer systems, employee
training programs and business procedures to protect the privacy and security of
each patient health information and enable electronic billing and claims
submissions consistent with HIPAA.
The security standards require us to maintain reasonable and
appropriate administrative, technical, and physical safeguards to ensure the
integrity, confidentiality and the availability of electronic health and related
financial information. The security standards were designed to protect
electronic information against reasonably anticipated threats or hazards to the
security or integrity of the information and to protect the information against
unauthorized use or disclosure. Under the 2009 ARRA, covered entities, including
the Hospitals, must notify patients of most security breaches pursuant to DHHS
regulations and on the effective date established by DHHS.
HIPAA provides both criminal and civil fines and penalties for covered
entities that fail to comply. These fines and penalties were strengthened under
the 2009 ARRA to provide for a penalty in the amount of $1,000 per violation due
to "reasonable cause and not to willful neglect" (with a maximum penalty of
$100,000); up to $10,000 for each violation due to willful neglect that is
corrected (subject to a $250,000 maximum); and up to $50,000 for each willful
violation that is not corrected properly (subject to a maximum penalty of $1.5
million dollars during a calendar year). Hospitals are also subject to state
privacy laws, which depending on the circumstances may be more restrictive than
HIPAA and impose additional penalties.
CORPORATE PRACTICE OF MEDICINE
California has laws that prohibit non-professional corporations and
other entities from employing or otherwise controlling physicians or that
prohibits certain direct and indirect payment arrangements between healthcare
providers. Although we intend to exercise care in structuring our arrangements
with healthcare providers to comply with relevant California law, and we believe
that such arrangements will comply with applicable laws in all material
respects, we cannot provide any assurance that governmental officials charged
with responsibility for enforcing these laws will not assert that the Company,
or certain transactions that we are involved in, are in violation of such laws,
or that the courts will ultimately interpret such laws in a manner consistent
with our interpretations.
CERTAIN ANTITRUST CONSIDERATIONS
The addition of physician-investors in the Company could affect
competition in the geographic area in which its Hospitals operate in various
ways. Such effects on competition could give rise to claims that the Hospitals,
their arrangements with consumers and business entities or with physicians
violate federal and state antitrust and unfair competition laws under a variety
of theories. Accordingly, there can be no assurance that the activities or
operations of the Hospitals will comply with federal and state antitrust or
unfair competition laws, or that the Federal Trade Commission, the Antitrust
Division of the Department of Justice, or any other party, including a physician
participating in the Company's business, or a physician denied participation in
the Company's business, will not challenge or seek to delay or enjoin the
activities of the Company on antitrust or other grounds. If such a challenge is
made, there can be no assurance that such challenge would be unsuccessful. We
have not obtained an analysis of any possible antitrust implications of the
activities of the Company or of the continuing arrangements and anticipated
operations of the Hospitals.
15
ENVIRONMENTAL REGULATIONS
Our healthcare operations generate medical waste that must be disposed
of in compliance with federal, state, and local environmental laws, rules, and
regulations. Our operations, as well as our purchases and sales of facilities,
also are subject to compliance with various other environmental laws, rules, and
regulations. Remediation costs relating to toxic substances, if encountered
during construction, could be material to the Company.
CORPORATE HISTORY
The Company was originally incorporated under the laws of the State of
Utah on July 31, 1984 under the name "Aquachlor Marketing Inc." On December 23,
1988, the Company reincorporated in the State of Nevada. From 1989 until 2003,
the Company was a development stage company with no material assets, revenues or
business operations. On November 18, 2003, a group of investors purchased a
controlling interest in the Company (then known as First Deltavision) with the
objective of transforming the Company into a leading provider of high quality,
cost-effective health care through the acquisition and management of financially
distressed and/or underperforming hospitals and other healthcare facilities. On
September 29, 2004, the Company entered into a definitive agreement to acquire
the four Hospitals from Tenet and the transaction closed on March 8, 2005
In the first quarter of 2004, the Company changed its fiscal year end
from June 30 to December 31, and changed the Company's name to "Integrated
Healthcare Holdings, Inc." On December 21, 2006, the Company changed its fiscal
year end from December 31 to March 31. Our principal executive offices are
located at 1301 North Tustin Avenue, Santa Ana, California 92705, and our
telephone number is (714) 953-3503.
ITEM 1A. RISK FACTORS
An investment in our common stock involves a high degree of risk. You
should consider carefully the following information about these risks, together
with the other information contained in this report. Our business is subject to
a number of risks and uncertainties - many of which are beyond our control -
that may cause our actual operating results or financial performance to be
materially different from our expectations. You should consider carefully the
following information about these risks, together with the other information
contained in this report, before you decide to buy our common stock. The risks
and uncertainties described below are not the only ones we face. Additional
risks and uncertainties not presently known to us or that we currently deem
immaterial may also impair our operations. If any of the following risks
actually occur, our business would likely suffer and our results could differ
materially from those expressed in any forward-looking statements contained in
this Annual Report on Form 10-K including our consolidated financial statements
and related notes. In such case, the trading price of our common stock could
decline, and shareholders could lose all or part of their investment.
LENDER DEFAULT
Since approximately January, 2009, the Company has maintained a
negative balance under its $50 million Revolving Credit Agreement with Medical
Provider Financial Corporation I (the "Lender"). On April 14, 2009, the Company
issued a letter (the "Demand Letter") to the Lender notifying the Lender that it
was in default of the $50 million Revolving Credit Agreement, to make demand for
return of all amounts collected and retained by it in excess of the amounts due
to it under the $50 million Revolving Credit Agreement, and to reserve the
rights of the borrowers and credit parties with respect to other actions and
remedies available to them. On April 17, 2009, following receipt of a copy of
the Demand Letter, the bank that maintains the lock boxes pursuant to a
restricted account and securities account control agreement (the "Lockbox
Agreement") notified the Company and the Lender that it would terminate the
Lockbox Agreement within 30 days. On May 18, 2009, the Lockbox Agreement was
terminated and the Company's bank accounts were frozen. On May 19, 2009, the
Lender relinquished any and all control over the bank accounts pursuant to the
Lockbox Agreement. The Lender's relinquishment provided the Company with full
access to its bank accounts and the accounts are no longer accessible by the
Lender. However, the Lender has not returned the amounts collected and retained
by it in excess of the amounts due to it under the $50 million Revolving Credit
Agreement, which amounted to approximately $12.7 million as of June 15, 2009,
and the Lender is not advancing any funds to the Company under the $50 million
Revolving Credit Agreement. The Lender is currently applying monthly interest
charges arising under the $80 million and $10.7 million credit facilities issued
by its affiliated companies against the Excess Amounts. At June 15, 2009, the
Excess Amounts represented approximately 19 months of future interest charges.
There can be no assurances that the Company will be successful in recovering all
Excess Amounts from the Lender or its affiliates. Furthermore, since it no
longer has a functioning accounts receivable financing arrangement, the Company
is currently relying solely on its cash receipts from payers to fund its
operations. Any significant disruption in such recei pts could have a material
adverse effect on the Company's ability to pay its obligations when due and
continue as a going concern. As of March 31, 2009, the Report of Independent
Registered Public Accounting Firm concludes that there is substantial doubt
about the Company's ability to continue as a going concern.
16
WE MUST OBTAIN ADDITIONAL CAPITAL WHICH, IF AVAILABLE, WILL LIKELY RESULT IN
SUBSTANTIAL DILUTION TO OUR CURRENT SHAREHOLDERS.
We will require additional capital to fund our business. If we raise
additional funds through the issuance of common or preferred equity, warrants or
convertible debt securities, these securities will likely substantially dilute
the equity interests and voting power of our current shareholders, and may have
rights, preferences or privileges senior to those of the rights of our current
shareholders. We cannot predict whether additional financing will be available
to us on favorable terms or at all.
WE ARE CURRENTLY INVOLVED IN LITIGATION WITH VARIOUS CURRENT AND FORMER MEMBERS
OF OUR BOARD OF DIRECTORS AND A SIGNIFICANT SHAREHOLDER.
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 then largest shareholder, Orange County
Physicians Investment Network, LLCOC-PIN. The suit sought damages, injunctive
relief and the appointment of a provisional director. A discussion of this
litigation and a summary of the status of the litigation to date is set forth
below under "Item 3. Legal Proceedings - Orange County Physicians Investment
Network, LLC". Such litigation, was mostly resolved under a global settlement
agreement dated April 2, 2009. However, certain elements of the settlement are
the subject of ongoing litigation among the parties, and the Company has become
a party to new litigation among several members of OC-PIN. Therefore, these
matters may continue to require a substantial commitment of financial resources
and management's attention, and may have a material effect on our business and
results of operation.
WE HAVE EXPERIENCED SIGNIFICANT DIFFICULTIES WITH OUR LIQUIDITY AND THE
CONSOLIDATED FINANCIAL STATEMENTS HAVE BEEN PREPARED ON A GOING CONCERN BASIS.
The 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. As of March 31, 2009, the Company
has a working capital deficit of $94.1 million and accumulated stockholders'
deficiency of $45.2 million. The Company's $50.0 million Revolving Credit
Agreement provides estimated liquidity as of March 31, 2009 of $36.7 million
based on eligible receivables, as defined. However, as of March 31, 2009, the
Lender had collected and retained $5.6 million ($12.7 million as of June 15,
2009) in excess of the amounts due to it under the $50 million Revolving Credit
Agreement.
During the year ended March 31, 2009, the Company experienced
significant delays in the funding of advances under its $50.0 million Revolving
Credit Agreement. During this time, the Lender experienced delays in funding
advances in accordance with advance requests submitted by the Company. As of
March 31, 2009, the unfulfilled advance requests aggregated approximately $17.0
million. As noted above, as of March 31, 2009, the Lender had collected and
retained $5.6 million ($12.7 million as of June 15, 2009) in excess of the
amounts due to it under the $50 million Revolving Credit Agreement.
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 consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
WE HAVE INCURRED SIGNIFICANT LOSSES IN OPERATIONS TO DATE. IF OUR SUBSTANTIAL
LOSSES CONTINUE, THE MARKET VALUE OF OUR COMMON STOCK WILL LIKELY DECLINE
FURTHER. WE HAVE A HIGH DEGREE OF LEVERAGE AND SIGNIFICANT DEBT SERVICE
OBLIGATIONS. OUR LENDER HAS BEEN UNABLE TO MEET ITS COMMITMENTS UNDER EXISTING
CREDIT AGREEMENTS AND THE COMPANY MAY NOT BE ABLE TO SECURE REPLACEMENT
FINANCING.
As of March 31, 2009, we had an accumulated deficit of $106.5 million.
We incurred a net loss of $ 1.5 million for the year ended March 31, 2009. This
loss, among other things, has had a material adverse effect on our stockholders'
equity and working capital. We are attempting to improve our operating results
and financial condition through a combination of contract negotiations, expense
reductions, lowering the costs of borrowings through refinancing our debt, and
new issues of equity. However, new issues of equity are encumbered by warrant
anti-dilution provisions and there can be no assurance that we will achieve
profitability in the future. The Company's $50.0 million Revolving Credit
Agreement, if honored by the Lender, provides an estimated additional liquidity
as of March 31, 2009 of $36.7 million based on eligible receivables, as defined.
As of March 31, 2009, the unfulfilled advance requests aggregated approximately
$17.0 million and, as of March 31, 2009, the Lender had collected and retained
$5.6 million ($12.7 million as of June 15, 2009) in excess of the amounts due to
it ("Excess Amounts") under the $50 million Revolving Credit Agreement. The
Lender is currently applying monthly interest charges arising under the $80
million and $10.7 million credit facilities issued by its affiliated companies
against the Excess Amounts. At March 31, 2009, the Excess Amounts represented
approximately 8 months of future interest charges. If we are unable to achieve
and maintain profitability, the market value of our common stock will likely
decline further, and we will lack the ability to continue as a going concern.
17
As of March 31, 2009, the debt service requirements on our $81.0
million debt approximate $0.7 million per month. Our relatively high level of
debt and debt service requirements have several effects on our current and
future operations, including the following: (i) we will need to devote a
significant portion of our cash flow to service debt, reducing funds available
for operations and future business opportunities and increasing our
vulnerability to adverse economic and industry conditions and competition; (ii)
our leveraged position increases our vulnerability to competitive pressures;
(iii) the covenants and restrictions contained in agreements relating to our
indebtedness restrict our ability to borrow additional funds, dispose of assets,
issue additional equity or pay dividends on or repurchase common stock; and (iv)
funds available for working capital, capital expenditures, acquisitions and
general corporate purposes are limited. Any default under the documents
governing our indebtedness could have a significant adverse effect on our
business and the market value of our common stock.
The Company is actively seeking alternate lending sources with
sufficient liquidity to service its financing requirements. There can be no
assurance that the Company will be successful in securing replacement financing.
THE SUCCESS OF THE COMPANY WILL DEPEND ON PAYMENTS FROM THIRD PARTY PAYERS,
INCLUDING GOVERNMENT HEALTH CARE PROGRAMS. IF THESE PAYMENTS ARE REDUCED OR
DELAYED, AS A RESULT OF THE SIGNIFICANT CURRENT HEALTH CARE REFORM EFFORTS OR
OTHERWISE, OUR REVENUE WILL DECREASE.
Passing comprehensive health care reform legislation to drastically
reduce costs and expand coverage is a high priority for the Obama Administration
for 2009. Congress is also developing reform packages, including a draft bill
known as the American Health Care Choice Act circulated by Senator Edward
Kennedy on June 9, 2009. Even if comprehensive legislation does not pass, we
anticipate continued, intensive discussions at federal and state levels, and
within the private insurance and provider sectors, regarding how to
significantly reduce health care costs, by limiting or restructuring payments to
providers and plans. Whether or not health care reform is accomplished on a big
scale, or incremental changes are implemented, for example through Medicare
payment regulations, it is reasonable to predict that all payers will continue
to seek sizable reductions from hospitals and other providers. Through this time
of flux, our Hospitals will continue to be largely dependent upon private and
governmental third party sources of payment for the services provided to
patients in the Hospitals. The amount of payment a hospital receives for the
various services it renders will be affected by market and cost factors, as well
as other factors over which we have no control, including the significant
political concerns described above. Although we anticipate ongoing pressure to
accept reduced payment amounts, and any meaningful reduction in the amounts paid
by these third party payers for services rendered at the Hospitals will have a
material adverse effect on our revenues.
IF WE ARE UNABLE TO ENTER INTO MANAGED CARE PROVIDER ARRANGEMENTS ON ACCEPTABLE
TERMS, OR IF WE HAVE DIFFICULTY COLLECTING FROM MANAGED CARE PAYERS, OUR RESULTS
OF OPERATIONS COULD BE ADVERSELY AFFECTED.
It would harm our business if we were unable to enter into managed care
provider arrangements on acceptable terms. Any material reductions in the
payments that we receive for our services, coupled with any difficulties in
collecting receivables from managed care payers, could have a material adverse
effect on our financial condition, results of operations or cash flows.
CHANGES IN THE MEDICARE AND MEDICAID PROGRAMS OR OTHER GOVERNMENT HEALTH CARE
PROGRAMS COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS.
The Medicare and Medicaid programs are subject to statutory and
regulatory changes, administrative rulings, interpretations and determinations
concerning patient eligibility requirements, funding levels and the method of
calculating payments or reimbursements, among other things; requirements for
utilization review; and federal and state funding restrictions, all of which
could materially increase or decrease payments from these government programs in
the future, as well as affect the cost of providing services to our patients and
the timing of payments to our facilities. We are unable to predict the effect of
future government health care funding policy changes on our operations. If the
rates paid by governmental payers are reduced, if the scope of services covered
by governmental payers is limited or if we, or one or more of our subsidiaries'
hospitals, are excluded from participation in the Medicare or Medicaid program
or any other government health care program, there could be a material adverse
effect on our business, financial condition, results of operations or cash
flows.
OUR BUSINESS CONTINUES TO BE ADVERSELY AFFECTED BY A HIGH VOLUME OF UNINSURED
AND UNDERINSURED PATIENTS.
Like other organizations in the health care industry, we continue to
provide services to a high volume of uninsured patients and more patients than
in prior years with an increased burden of co-payments and deductibles as a
result of changes in their health care plans. We continue to experience a high
level of uncollectible accounts, and, unless our business mix shifts toward a
greater number of insured patients or the trend of higher co-payments and
deductibles reverses, we anticipate this high level of uncollectible accounts to
continue.
18
COST CONTAINMENT, PAY FOR PERFORMANCE, AND OTHER PROGRAMS IMPOSED BY THIRD-PARTY
PAYERS, INCLUDING GOVERNMENT HEALTH CARE PROGRAMS, MAY DECREASE THE COMPANY'S
REVENUE.
The health care industry is currently undergoing significant changes
and is regularly subject to regulatory and political intervention. We expect to
derive a considerable portion of the Company's revenue through the Hospitals
from government-sponsored health care programs and third-party payers (such as
employers, private insurers, HMOs or preferred provider organizations). The
health care industry may be subject to comprehensive reform in the next few
years, which likely would result in increased cost containment as government and
private third-party payers seek to impose lower payment and utilization rates
and negotiate reduced payment schedules with service providers. The Company
believes that these trends will continue to result in a reduction from
historical levels in per-patient revenue for hospitals. It is distinctly
possible that reimbursement from government and private third-party payers for
many procedures performed at the Hospital may be reduced in the future. Further
reductions in payments or other changes in reimbursement for health care
services could have a material adverse effect on the Company's business,
financial condition and/or results of operations. Further, rates paid by private
third-party payers are generally higher than Medicare, Medicaid and HMO payment
rates. Any decrease in the relative number of patients covered by private
insurance would have a material adverse effect on the Company's revenues and
operations.
PROVIDING QUALITY MEDICAL SERVICES FROM TALENTED PHYSICIANS IS CRITICAL
TO OUR BUSINESS.
Our business depends, in large part, upon the efforts and success of
the physicians who will perform services at the Hospitals and the strength of
our relationships with these physicians. Any failure of these physicians to
maintain the quality of medical care provided or to otherwise adhere to
professional guidelines at the Hospitals, or any damage to the reputation of a
key physician or group of physicians, could damage the Company's and the
Hospitals' reputations in the medical marketplace and may subject us to
liability and significantly reduce our revenue and increase our costs.
Like many hospitals, we face a growing shortage of primary care and
specialty physicians. Should this shortage continue or worsen, the utilization
of our hospitals may be adversely impacted. This could have a negative impact on
our revenues and profitability.
MEDICAL STAFF
The primary relationship between a hospital and physicians who practice
in it is through the hospital's organized medical staff. Medical staff bylaws,
rules and policies establish the criteria and procedures at acute care
hospitals, by which a physician may have his or her privileges, participation or
membership curtailed, denied or revoked. Physicians who are denied medical staff
membership or certain clinical privileges, or who have such membership,
participation or privileges curtailed, denied or revoked often file legal
actions against hospitals. Such actions may include a wide variety of claims,
some of which could result in substantial uninsured damages to a hospital. In
addition, failure of the governing body to adequately oversee the conduct of its
medical staff may result in hospital liability to third parties.
NURSING SHORTAGE
Health care providers depend on qualified nurses to provide quality
service to patients. There is currently a nationwide shortage of qualified
nurses. This shortage and the more stressful working conditions it creates for
those remaining in the profession are increasingly viewed as a threat to patient
safety and may trigger the adoption of state and federal laws and regulations
intended to reduce that risk. For example, California has adopted legislation
and regulations mandating a series of specific minimum patient-to-nurse ratios
in all acute care hospital nursing units. Any failure by the Hospital to comply
with nurse staff ratios could result in action by licensure authorities and may
constitute evidence of negligence per se in the event any patient is harmed as
the result of inadequate nurse staffing. The vast majority of hospitals in
California, including ours, are not at all times meeting the state mandated
nurse staffing ratios.
19
In response to the shortage of qualified nurses, health care providers
have increased-and could continue to increase-wages and benefits to recruit or
retain nurses; many providers have had to hire expensive contract nurses. The
shortage could also limit the operations of healthcare providers by limiting the
number of patient beds available. The Company has likewise increased and is
likely to have to continue to increase-wages and benefits to recruit and retain
nurses. The Company may also need to engage expensive contract nurses until
permanent staff nurses can be hired to replace any departing nurses. Recently,
there has been some lessening in the need for contract agency nurses following
the recession as nurses return to the work force. There is still no basis to
predict the longevity of this effect.
UNION CONTRACTS HAVE BEEN RENEWED BUT THERE CAN BE NO ASSURANCE THAT THE
CONTRACTS WILL BE RENEWED IN THE FUTURE.
Approximately 36% of the Company's employees are represented by labor
unions as of March 31, 2009. On December 31, 2006, the Company's collective
bargaining agreements with CNA covering certain of our nursing staff and with
SEIU expired. Negotiations with both the SEIU and CNA led to agreements being
reached on May 9, 2007, and October 16, 2007, for the respective unions. Both
contracts were ratified by their respective memberships. The new SEIU Agreement
will run until December 31, 2009, and the Agreement with the CNA will run until
February 28, 2011. Both Agreements have "no strike" provisions and compensation
caps which provide the Company with long term compensation and workforce
stability. We do not anticipate the new agreements will have a material adverse
effect on our results of operations.
Both unions filed grievances under the prior collective bargaining
agreements, in connection with allegations the agreements obligated the Company
to contribute to Retiree Medical Benefit Accounts. The Company does not agree
with this interpretation of the agreements but has agreed to submit the matters
to arbitration. Under the new agreements negotiated this year, the Company has
agreed to meet with each Union to discuss how to create a vehicle which would
have the purpose of providing a retiree medical benefit, not to exceed one
percent (1%) of certain employee's payroll. CNA has also filed grievances
related to the administration of increases at one facility, change in pay
practice at one facility and several wrongful terminations. Those grievances are
still pending as of this date, but the Company does not anticipate resolution of
the arbitrations will have a material adverse effect on our results of
operations.
IF EITHER THE COMPANY OR THE HOSPITALS FAIL TO COMPLY WITH APPLICABLE LAWS AND
REGULATIONS, WE MAY SUFFER PENALTIES OR BE REQUIRED TO MAKE SIGNIFICANT CHANGES
TO OUR OPERATIONS.
The Company and the Hospitals are subject to many laws and
regulations at the federal, state and local levels. These laws and regulations
require the Hospitals to meet various licensing, certification and other
requirements, including those relating to:
o physician ownership of the Hospital;
o payments to specialty hospitals, should any of the Hospitals
be determined to be a specialty hospital;
o prohibited inducements for patient referrals and restrictions
on payments for marketing;
o the adequacy of medical care, equipment, personnel, operating
policies and procedures;
o maintenance and protection of records;
o reimbursement audits; and o environmental protection.
If the Company fails to comply with applicable laws and regulations,
it could suffer civil or criminal penalties. A number of initiatives have been
proposed during the past several years to reform various aspects of the health
care system. In the future, different interpretations or enforcement of existing
or new laws and regulations could subject the current practices to allegations
of impropriety or illegality, or could require the Company to make changes in
its facilities, equipment, personnel, services, capital expenditure programs and
operating expenses. Current or future legislative initiatives or government
regulation may have a material adverse effect on the Hospitals' operations or
reduce the demand for their services.
20
THE COMPANY CONDUCTS ON-GOING REVIEWS OF ITS COMPLIANCE WITH VARIOUS LAWS
RELATED TO PHYSICIAN ARRANGEMENTS, WHICH MAY REVEAL VIOLATIONS THAT COULD
SUBJECT THE COMPANY TO FINES OR PENALTIES.
The Company and the Hospitals have entered into a variety of
relationships with physicians. In an increasingly complex legal and regulatory
environment, these relationships may pose a variety of legal or business risks.
The Company conducts reviews of its compliance with the federal Anti-kickback
Statute, Stark law and other applicable laws as they relate to the Company's
relationships with referring physicians.
One of the Company's largest shareholder, OC-PIN, is owned and
controlled by physicians who also refer to and practice at the Hospitals. OC-PIN
may receive dividends as a shareholder. In addition, one of the members of
OC-PIN served as Chairman of the Board of Directors of the Company. As a
director, he received payment from the Company for his service as Chairman. In
addition, the Hospitals have various relationships with physicians who are not
owners of the Company, as well as with OC-PIN physicians, including medical
directorships, sharing in risk pools and service arrangements.
The Company entered into a sale leaseback transaction for substantially
all of the real estate with Pacific Coast Holdings Investment, LLC ("PCHI")
whereby the Company leases substantially all of the real property of the
acquired Hospitals from PCHI. PCHI is owned by two LLC's, namely West Coast and
Ganesha; which are co-managed by physician investors.
The Company has undertaken a review of its agreements with physicians
and has a review process in place to ensure that such agreements are in writing
and comply with applicable laws. Although there may have been arrangements in
the past with physicians that may not have been memorialized in a written
agreement or may have expired and not been timely renewed or may have been
entered into after services commenced, each of which may have lead to violations
of the Stark law, the Company's current review process should prevent such
occurrences. Additionally, the Company has reviewed the terms of the purchase of
ownership interests in the Company by OC-PIN (which is owned by physicians that
refer patients to the Hospitals) and has determined that the purchase should be
determined to be permissible under applicable law. The Company has also reviewed
certain related party transactions, such as director fees for physician
directors and payment of the employment severance package to Dr. Anil Shah, an
OC-PIN member. If the Company or the Hospitals are not in compliance with
federal and state fraud and abuse laws and physician self-referral laws, the
Company could be subject to repayment obligations, fines, penalties, exclusive
from participation in federal health care programs, and other sanctions which
would have a material adverse effect on the Company's profitability.
LICENSING, SURVEYS, INVESTIGATIONS AND AUDITS
Health facilities, including the Hospitals, are subject to numerous
legal, regulatory, professional and private licensing, certification and
accreditation requirements. These include requirements relating to Medicare and
Medi-Cal participation and payment, state licensing agencies, private payers and
the Joint Commission. Renewal and continuance of certain of these licenses,
certifications and accreditations are based on inspections, surveys, audits,
investigations or other reviews, some of which may require or include
affirmative action or response by the Company. Some investigations by licensing
bodies can result in financial penalties to the Hospitals. These activities
generally are conducted in the normal course of business of health facilities.
Nevertheless, an adverse determination could result in a loss or reduction in a
Hospital's scope of licensure, certification or accreditation, or could reduce
the payment received or require repayment of amounts previously remitted. Any
failure to obtain, renew or continue a license, certification or accreditation
required for operation of a Hospital could result in the loss of utilization or
revenues, or the loss of the Company's ability to operate all or a portion of a
Hospital, and, consequently, could have a material and adverse effect on the
Company.
EARTHQUAKE SAFETY COMPLIANCE
The Hospitals are located in an area near active and substantial
earthquake faults. The Hospitals carry earthquake insurance with a policy limit
of $50 million. A significant earthquake could result in material damage and
temporary or permanent cessation of operations at one or more of the Hospitals.
In addition, the State of California has imposed new hospital seismic safety
requirements. Under these new requirements, the Hospitals must meet stringent
seismic safety criteria in the future, and, must complete one set of seismic
upgrades to each facility by January 1, 2013. This first set of upgrades is
expected to require the Company to incur substantial seismic retrofit expenses.
In addition, there could be other remediation costs pursuant to this seismic
retrofit.
21
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 requested HAZUS review and received
favorable notices pertaining to structural reclassification.
There are additional requirements that must be complied with by 2030.
The costs of meeting these requirements have not yet been determined. Compliance
with seismic ordinances will be a costly venture and could have a material
adverse effect on our cash flow.
WE FACE INTENSE COMPETITION IN OUR BUSINESS.
The healthcare industry is highly competitive. We compete with a
variety of other organizations in providing medical services, many of which have
greater financial and other resources and may be more established in their
respective communities than we are. Competing companies may offer newer or
different centers or services than we do and may thereby attract patients or
customers who are presently patients, customers or are otherwise receiving our
services.
Some of the hospitals that compete with our hospitals are owned by
government agencies or not-for-profit organizations. Tax-exempt competitors may
have certain financial advantages not available to our facilities, such as
endowments, charitable contributions, tax-exempt financing, and exemptions from
sales, property and income taxes. In certain states, including California, some
not-for-profit hospitals are permitted by law to directly employ physicians
while for-profit hospitals are prohibited from doing so. We also face increasing
competition from physician-owned specialty hospitals and freestanding surgery,
diagnostic and imaging centers for market share in high margin services and for
quality physicians and personnel. If competing health care providers are better
able to attract more patients, recruit and retain physicians, expand services or
obtain favorable managed care contracts at their facilities, we may continue to
experience a decline in patient volume levels.
A SIGNIFICANT PORTION OF OUR BUSINESS IS CONCENTRATED IN CERTAIN MARKETS AND THE
RESPECTIVE ECONOMIC CONDITIONS OR CHANGES IN THE LAWS AFFECTING OUR BUSINESS IN
THOSE MARKETS COULD HAVE A MATERIAL ADVERSE EFFECT ON THE COMPANY.
We receive all of our inpatient services revenue from operations in
Orange County, California. The economic condition of this market could affect
the ability of our patients and third-party payers to reimburse us for our
services, through its effect on disposable household income and the tax base
used to generate state funding for Medicaid programs. An economic downturn, or
changes in the laws affecting our business in our market and in surrounding
markets, could have a material adverse effect on the Company.
WE MAY BE LIABLE FOR LOSSES NOT COVERED BY OR IN EXCESS OF OUR INSURANCE.
An increasing trend in malpractice litigation claims, rising costs of
malpractice litigation, losses associated with these malpractice lawsuits and a
constriction of insurers have caused many insurance carriers to raise the cost
of insurance premiums or refuse to write insurance policies for hospital
facilities. Accordingly, we have increased on retention limits and our estimated
reserves may not be adequate.
22
ITEM 2. PROPERTIES
In March 2005, the Company completed the acquisition of the Hospitals
and their associated real estate from Tenet. At the closing of the acquisition,
the Company transferred all of the fee interests in the acquired real estate to
PCHI, a company owned indirectly by two of the Company's largest shareholders.
The Company entered into a Triple Net Lease dated March 7, 2005 (amended and
restated as of October 1, 2007) under which it leased back from PCHI all of the
real estate that it transferred to PCHI. Additionally, the Company leases
property from other lessors. As of March 31, 2009, the Company's principal
facilities are listed in the following table:
APPROXIMATE
AGGREGATE
SQUARE LEASE INITIAL LEASE
PROPERTY FOOTAGE RATE EXPIRATION
-------- ------- ---- ----------
Western Medical Center-Santa Ana 360,000 See note 1. February 28, 2030
1001 North Tustin Avenue
Santa Ana, CA 92705
Administrative Building 40,000 See note 1. February 28, 2030
1301 N. Tustin Avenue
Santa Ana, CA
Western Medical Center-Anaheim 132,000 See note 1. February 28, 2030
1025 South Anaheim Boulevard
Anaheim, CA 92805
Coastal Communities Hospital 115,000 See note 1. February 28, 2030
2701 South Bristol Street
Santa Ana, CA 92704
Chapman Medical Center 140,000 See note 2. December 31, 2023
2601 East Chapman Avenue
Orange, CA 92869
1. Effective October 1, 2007, the Company entered into an amended and
restated lease with PCHI. The amended lease terminates on the 25-year
anniversary of the original lease (March 8, 2005), grants the Company
the right to renew for one additional 25-year period, and requires
annual base rental payments of $8.3 million. However, until the Company
refinances its $50.0 million Revolving Line of Credit Loan with a
stated interest rate less than 14% per annum or PCHI refinances the
$45.0 million Term Note, the annual base rental payments are reduced to
$7.1 million. In addition, the Company may offset against its rental
payments owed to PCHI interest payments that it makes to the Lender
under certain of its indebtedness discussed above. The amended lease
also gives PCHI sole possession of the medical office buildings located
at 1901/1905 North College Avenue, Santa Ana, California that are
unencumbered by any claims by or tenancy of the Company. Lease payments
to PCHI are eliminated in consolidation.
2. Leased from an unrelated party. Monthly lease payments are
approximately $133,000. On March 11, 2009 Tenet Healthcare Corporation
("Tenet") filed an action against the Company seeking indemnification
and reimbursement for rental payments paid by Tenet pursuant to a
guarantee agreement contained in the original Asset Purchase Agreement
between the Company and Tenet. Tenet is seeking reimbursement for
approximately $370,000 expended in rental payments for the Chapman
Medical Center lease, including attorneys' fees, which has been accrued
in the Company's consolidated financial statements as of and for the
year ended March 31, 2009.
23
The State of California has established standards intended to ensure
that all hospitals in the state withstand earthquakes and other seismic activity
without collapsing or posing the threat of significant loss of life. The
Hospitals are located in an area near active and substantial earthquake faults.
The Hospitals carry earthquake insurance with a policy limit of $50 million. A
significant earthquake could result in material damage and temporary or
permanent cessation of operations at one or more of the Hospitals. In addition,
the State of California has imposed new hospital seismic safety requirements.
Under these new requirements, the Hospitals must meet stringent seismic safety
criteria in the future, and, must complete one set of seismic upgrades to each
facility by January 1, 2013. This first set of upgrades is expected to require
the Company to incur substantial seismic retrofit expenses. In addition, there
could be other remediation costs pursuant to this seismic retrofit.
The State of California has introduced a new seismic review methodology
known as HAZUS. The HAZUS methodology may preclude the need for some structural
modifications. Three of the four Hospitals have requested HAZUS review and one
of them has already received a favorable notice pertaining to structural
reclassification.
There are additional requirements that must be complied with by 2030.
The costs of meeting these requirements have not yet been determined. Compliance
with seismic ordinances will be a costly venture and could have a material
adverse effect on our cash flow.
The Company believes that its current leased space is adequate for its
current purposes and for the next fiscal year.
ITEM 3. LEGAL PROCEEDINGS
LABOR AND EMPLOYMENT
From time to time, health care facilities receive requests for
information in the form of a subpoena from licensing entities, such as the
Medical Board of California, regarding members of their medical staffs. Also,
California state law mandates that each medical staff is required to perform
peer review of its members. As a result of the performance of such peer reviews,
action is sometimes taken to limit or revoke an individual's medical staff
membership and privileges in order to assure patient safety. In August 2007, the
Company received such a subpoena from the Medical Board of California concerning
a member of the medical staff of one of the Company's facilities. The facility
has responded to the subpoena and is in the process of reviewing the matter.
Approximately 36% of the Company's employees are represented by labor
unions as of September 30, 2007. On December 31, 2006, the Company's collective
bargaining agreements with SEIU and CNA expired. Negotiations with both the SEIU
and CNA led to agreements being reached on May 9, 2007, and October 16, 2007,
for the respective unions. Both contracts were ratified by their respective
memberships. The new SEIU Agreement will run until December 31, 2009, and the
Agreement with the CNA will run until February 28, 2011. Both Agreements have
"no strike" provisions and compensation caps which provide the Company with long
term compensation and workforce stability.
Both unions filed grievances under the prior collective bargaining
agreements, in connection with allegations the agreements obligated the Company
to contribute to Retiree Medical Benefit Accounts. The Company does not agree
with this interpretation of the agreements but has agreed to submit the matters
to arbitration. Under the new agreements negotiated this year, the Company has
agreed to meet with each Union to discuss how to create a vehicle which would
have the purpose of providing a retiree medical benefit, not to exceed one
percent (1%) of certain employee's payroll. CNA has also filed grievances
related to the administration of increases at one facility, change in pay
practice at one facility, change in medical benefits at two facilities, and
several wrongful terminations. Those grievances are still pending as of this
date, but the Company does not anticipate resolution of the arbitrations will
have a material adverse effect on our results of operations.
On December 31, 2007, the Company entered into a severance agreement
with its then-President, Larry Anderson ("Anderson") (the "Severance
Agreement"). On or about September 5, 2008, based upon information and belief
that Anderson breached the Severance Agreement, the Company ceased making the
monthly severance payments. On September 3, 2008, Anderson filed a claim with
the California Department of Labor seeking payment of $243,000. A hearing date
has not yet been set.
24
On or about February 11, 2009, Anderson filed a petition for
arbitration before JAMS. Anderson's petition claims that the Company failed to
pay him a commission of $300,000 for his efforts toward securing financing from
the Company's lender to purchase an additional hospital. On May 20, 2009,
Anderson filed an amended petition with JAMS, incorporating allegations: (1) the
Company filed an incorrect IRS Form 1099 with respect to Company vehicle and (2)
that Anderson was constructively discharged as a result of reporting various
alleged violations of state and Federal law. While the Company is optimistic
regarding the outcome of these various related Anderson matters, at this early
stage, the Company is unable to determine the cost of defending this lawsuit or
the impact, if any, that these actions may have on its results of operations.
On June 5, 2009, the Company was sued in Orange County Superior Court
by a former employee in a purported class action alleging that the Company and
its subsidiaries failed to correctly calculate overtime wages paid to 12-hour
shift employees at the hospitals. The plaintiff is seeking restitution,
injunctive relief and penalties against the Company on behalf of the plaintiff
and the purported class. Although the Company has not yet had an opportunity to
fully study the complaint, the Company believes that it has meritorious defenses
and intends to defend itself vigorously against the claims asserted in the
complaint. The Company is unable to determine the cost of defending this lawsuit
or the impact, if any, this action may have on its financial condition or
results of operations.
ORANGE COUNTY PHYSICIANS INVESTMENT NETWORK, LLC
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 then largest shareholder, Orange County
Physicians Investment Network, LLC, or OC-PIN. The suit sought damages,
injunctive relief and the appointment of a provisional director. Among other
things, the Company alleged that the defendants breached their 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 alleged 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 alleged 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 alleged 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 were 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. 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. On July 31, 2008, the Company
entered into a settlement agreement with two of the three defendants, which
agreement became effective on December 1, 2008, upon the trial court's grant of
the parties motion for determination of a good faith settlement. On January 16,
2009, the Company dismissed its claims against these defendants.
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, were stayed by the Court
pending the resolution of the May 10, 2007 suit brought by the Company.
25
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. OC-PIN filed a petition for writ of mandate with the
Court of Appeals seeking to overturn this stay order, which was summarily denied
on November 18, 2008.
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. This petition was stayed by the Court on October 6, 2008 pending the
resolution of May 10, 2007 suit brought by the Company. OC-PIN subsequently
filed a petition for writ of mandate with the Court of Appeals, which was
summarily denied on November 18, 2008. OC-PIN then filed a petition for review
before the California Supreme Court, which was denied on January 14, 2009.
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 alleged that the Company issued stock
options under a Stock Incentive Plan and warrants to its lender in violation of
the Allegedly Omitted Provision. The complaint further alleged 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. On October 22, 2008, OC-PIN filed an amended complaint naming every
shareholder of IHHI as a defendant, in response to a ruling by the Court that
each shareholder was a "necessary party" to the action. OC-PIN filed a petition
for writ of mandate with the Court of Appeals which sought to overturn the stay
imposed by the trial court. This appeal was summarily denied on November 18,
2008.
On April 2, 2009, the Company, OC-PIN, Dr. Shah, Bruce Mogel, PCHI,
West Coast, Dr. Chaudhuri, Ganesha, Mr. Thomas and the Lender (together, the
"Global Settlement Parties") entered into a Settlement Agreement, General
Release and Covenant Not to Sue (the "Global Settlement Agreement"). Key
elements of the Global Settlement Agreement included: (1) a full release of
claims by and between the Global Settlement Parties, (2) a $1.5 million dollar
payment by the Company payable to a Callahan & Blaine a trust account in
conjunction with payments by other Global Settlement Parties, (3) a loan
interest and rent reduction provision resulting in a 3.75% interest rate
reduction on the $45 million real estate term note, (4) the Company's agreement
to bring the PCHI and Chapman leases current and pay all arrearages due, (5) the
Board of Directors' approval of bylaw amendments fixing the number of Director
seats to seven and, effective after the 2009 Annual Meeting of Shareholders,
allowing a 15% or more shareholder to call one special shareholders' meeting per
year, (6) the right of OC-PIN to appoint one director candidate to serve on the
Company's Board of Directors to fill the seat of Kenneth K. Westbrook until the
2009 Annual Meeting of Shareholders, and (7) the covenant of Dr. Shah to not
accept any nomination, appointment, or service in any capacity as a director,
officer or employee of the Company. Two stock purchase agreements (the "Stock
Purchase Agreements") were also executed in conjunction with the Global
Settlement Agreement, granting (1) OC-PIN and Dr. Shah each a separate right to
purchase up to 14.7 million shares of Common Stock, and (2) Dr. Chaudhuri the
right to purchase up to 30.6 million shares Stock.
26
Purportedly pursuant to the Global Settlement Agreement, OC-PIN and/or
Dr. Shah placed a demand on the Company to seat Dr. Shah's personal litigation
attorney, Daniel Callahan ("Callahan") on the Board of Directors. The Company
declined this request based on several identified conflicts of interest, as well
as a violation of the covenant of good faith and fair dealing. OC-PIN and/or Dr.
Shah then filed a motion to enforce the Global Settlement Agreement under Code
of Civil Procedure Section 664.6 and force the Company to appoint Callahan to
the Board of Directors. The Company opposed this motion, in conjunction with an
opposition by several members of OC-PIN, contesting Callahan as the duly
authorized representative of OC-PIN. On April 27, 2009, the Court denied Dr.
Shah/OC-PIN's motion, finding several conflicts of interest preventing Callahan
from serving on the Company's Board of Directors. On May 5, 2009, Dr.
Shah/OC-PIN filed a petition for writ of mandate with the Court of Appeals
seeking to reverse the Court's ruling and force Callahan's appointment as a
director, which was summarily denied on May 7, 2009.
On April 24, 2009, a conglomeration of several OC-PIN members led by
Ajay G. Meka, M.D. filed a lawsuit against Dr. Shah, other OC-PIN members, and
various attorneys, alleging breach of fiduciary duty and seeking damages as well
as declaratory and injunctive relief (the "First Meka Complaint"). While the
Company is named as a defendant in the action, plaintiffs are only seeking
declaratory and injunctive relief with respect to various provisions of the
Global Settlement Agreement. Due to the competing demands related to the Stock
Purchase Agreements placed upon the Company from factions within OC-PIN, on May
13, 2009, the Company filed a Motion for Judicial Instructions regarding
enforcement of the Global Settlement Agreement. On May 14, 2009, the Company,
Dr. Shah, as well as both "factions" of OC-PIN entered into a "stand still"
agreement regarding both the nomination of an OC-PIN Board representative as
well as the allocation of shares under the Stock Purchase Agreements.
Subsequently, on June 22, 2009, the Court granted a stay of the Company's
remaining obligations under the Global Settlement Agreement until the resolution
of the Amended Meka Complaint and related actions.
On June 1, 2009, a First Amended Complaint was filed to replace the
First Meka Complaint (the "Amended Meka Complaint"). It appears that the relief
sought against the Company in the Amended Meka Complaint does not materially
alter from the declaratory and injunctive relief sought in the First Meka
Complaint. The Company believes it is a neutral stakeholder in the action, and
that the results of the action will not have a material adverse impact on the
Company's results of operations.
OTHER LEGAL PROCEEDINGS
In 2003, the prior owner of Coastal Communities Hospital entered into a
risk pool agreement (the "Risk Pool Agreement") with AMVI/Prospect Health
Network d/b/a AMVI/Prospect Medical Group ("AMVI/Prospect"). On May 13, 2009,
AMVI/Prospect filed a complaint alleging that the Company failed to pay
approximately $745,000 in settlement of the Risk Pool Agreement. At the same
time, AMVI/Prospect filed an EX PARTE application seeking a temporary protective
order, a right to attach order, and a writ of attachment. While the EX PARTE
application was denied on May 26, 2009, AMVi/Prospect's regularly notice motion
for writ of attachment is scheduled for June 19, 2009. At this early stage, the
Company is unable to determine the cost of defending this lawsuit or the impact,
if any, this action and related writ petition may have on its results of
operations.
On March 11, 2009 Tenet Healthcare Corporation ("Tenet") filed an
action against the Company seeking indemnification and reimbursement for rental
payments paid by Tenet pursuant to a guarantee agreement contained in the
original Asset Purchase Agreement between the Company and Tenet. Tenet is
seeking reimbursement for approximately $370,000 expended in rental payments for
the Chapman Medical Center lease, including attorneys' fees, which has been
accrued as of and for the year ended March 31, 2009.
We and our subsidiaries are involved in various other legal proceedings
most of which relate to routine matters incidental to our business. We do not
believe that the outcome of these matters, individually or collectively, is
likely to have a material adverse effect on the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On February 27, 2009, the Company received the written consent, in lieu
of a meeting of stockholders, from the holders of a majority of the Company's
outstanding shares of common stock approving an amendment to the Company's
Articles of Incorporation to increase the number of authorized shares of common
stock from 400,000,000 to 500,000,000 shares. Stockholders holding a total of
107,749,832 shares of common stock voted to approve the amendment out of a total
of 195,307,262 shares issued and outstanding. After filing and mailing an
Information Statement on Schedule 14C to all stockholders, the Company amended
its Articles of Incorporation on April 8, 2009.
27
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
The Company's common stock is listed for trading on the OTC Bulletin
Board under the symbol "IHCH.OB." The trading market for the Company's common
stock has been extremely thin. In view of the extreme thinness of the trading
market, the prices reflected on the chart below as reported on the OTC Bulletin
Board may not be indicative of the price at which any prior or future
transactions were or may be effected in the Company's common stock. Stockholders
are cautioned against drawing any conclusions from the data contained herein, as
past results are not necessarily indicative of future stock performance.
The following table sets forth the quarterly high and low bid price for
the Company's common stock for each quarter for the period from April 1, 2007
through March 31, 2009, as quoted on the Over-the-Counter Bulletin Board. Such
Over-the-Counter market quotations reflect inter dealer prices, without retail
mark-up, mark-down or commission, and may not necessarily represent actual
transactions.
- --------------------- ------------------- -------------------
PERIOD HIGH LOW
------ ---- ---
- --------------------- ------------------- -------------------
Apr 2007 - Jun 2007 $0.32 $0.12
- --------------------- ------------------- -------------------
Jul 2007 - Sep 2007 $0.23 $0.12
- --------------------- ------------------- -------------------
Oct 2007 - Dec 2007 $0.33 $0.14
- --------------------- ------------------- -------------------
Jan 2008 - Mar 2008 $0.25 $0.10
- --------------------- ------------------- -------------------
Apr 2008 - Jun 2008 $0.12 $0.07
- --------------------- ------------------- -------------------
Jul 2008 - Sep 2008 $0.14 $0.01
- --------------------- ------------------- -------------------
Oct 2008 - Dec 2008 $0.06 $0.01
- --------------------- ------------------- -------------------
Jan 2009 - Mar 2009 $0.05 $0.01
- --------------------- ------------------- -------------------
As of the date of this report, there were approximately 208 record
holders of the Company's common stock; this number does not include an
indeterminate number of stockholders whose shares may be held by brokers in
street name. The Company has not paid and does not expect to pay any dividends
on its shares of common stock for the foreseeable future, as any earnings will
be retained for use in the business.
28
The following table provides summary information concerning the
Company's equity compensation plan as of March 31, 2009.
Equity Compensation Plan Information
- ------------------------------------------------------------------------------------------------------------
Plan Category Number of Securities to Weighted-average Number of securities
be issued upon exercise exercise price of remaining available for
of outstanding options, outstanding options, future issuance under
warrants and rights warrants and rights equity compensation
plans (excluding
securities reflected in
column (a))
(a) (b) (c)
- ------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------
Equity compensation
plans approved by 8,835,300 $ 0.19 7,030,971
security holders
- ------------------------------------------------------------------------------------------------------------
Equity compensation
plans not approved by - - -
security holders
- ------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------
Total 8,835,300 $ 0.19 7,030,971
- ------------------------------------------------------------------------------------------------------------
29
ITEM 6. SELECTED FINANCIAL DATA
Not applicable.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
FORWARD-LOOKING INFORMATION
This Annual Report on Form 10-K contains forward-looking statements, as
that term is defined in the Private Securities Litigation Reform Act of 1995.
These statements relate to future events or our future financial performance. In
some cases, you can identify forward-looking statements by terminology such as
"may," "will," "should," "expects," "plans," "anticipates," "believes,"
"estimates," "predicts," "potential" or "continue" or the negative of these
terms or other comparable terminology. These statements are only predictions and
involve known and unknown risks, uncertainties and other factors, including the
risks discussed under the caption "Risk Factors" herein that may cause our
Company's or our industry's actual results, levels of activity, performance or
achievements to be materially different from those expressed or implied by these
forward-looking statements.
Although we believe that the expectations reflected in the
forward-looking statements are reasonable, we cannot guarantee future results,
levels of activity, performance or achievements. Except as may be required by
applicable law, we do not intend to update any of the forward-looking statements
to conform these statements to actual results.
As used in this report, the terms "we," "us," "our," "the Company,"
"Integrated Healthcare Holdings" or "IHHI" mean Integrated Healthcare Holdings,
Inc., a Nevada corporation, unless otherwise indicated.
Unless otherwise indicated, all amounts included in this Item 7 are
expressed in thousands (except 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 consolidated
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 and January 2009, the Company issued equity securities to an existing
shareholder (see "SECURITIES PURCHASE AGREEMENT").
30
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.
31
LIQUIDITY AND CAPITAL RESOURCES
The accompanying consolidated financial statements have been prepared
on a going concern basis, which contemplates the realization of assets and
settlement of obligations in the normal course of business. The Company incurred
a net loss of $1.5 million for the year ended March 31, 2009 and had a working
capital deficit of $94.1 million at March 31, 2009.
During the year ended March 31, 2009, the Company experienced significant delays
in the funding of advances under its $50.0 million Revolving Credit Agreement.
During this time, the Lender experienced delays in funding advances in
accordance with advance requests submitted by the Company. As of March 31, 2009,
the unfulfilled advance requests aggregated approximately $17.0 million and, as
of March 31, 2009, the Lender had collected and retained $5.6 million ($12.7
million as of June 15, 2009) in excess of the amounts due to it ("Excess
Amounts") under the $50 million Revolving Credit Agreement. The Lender applies
monthly interest charges relating to all of the New Credit Facilities against
the Excess Amounts. At March 31, 2009, the Excess Amounts represented
approximately 8 months of future interest charges (see "LENDER DEFAULT"). There
can be no assurance that the Company will be successful in recovering all Excess
Amounts. The Company is actively seeking alternate lending sources with
sufficient liquidity to service its financing requirements. There can be no
assurance that the Company will be successful in securing replacement 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.
There is no assurance that the Company will be successful in improving
reimbursements or reducing operating expenses.
Key items for the year ended March 31, 2009 included:
1. During the year ended March 31, 2009 and 2008, the Company received a
lump sum amendment to the CMAC agreement for $3.7 and $4.8 million,
respectively. Adjusting for this, net collectible revenues (net
operating revenues less provision for doubtful accounts) for the year
ended March 31, 2009 and 2008 were $346.9 million and $332.0 million,
respectively, representing an increase of 4.5%. The Hospitals serve a
disproportionate number of indigent patients and receive governmental
revenues and subsidies in support of care for these patients.
Governmental revenues include payments from Medicaid, Medicaid DSH, and
Orange County, CA (CalOptima). Governmental revenues decreased $5.8
million for the year ended March 31, 2009 compared to the year ended
March 31, 2008.
Inpatient admissions decreased by 4.3% to 26.8 for the year ended March
31, 2009 compared to 28.0 for the year ended March 31, 2008. The
decline in admissions is the combined result of lower obstetrical
deliveries, psychiatric admissions, and managed care contracts that
have reached term and are pending renegotiation.
Uninsured patients, as a percentage of gross charges, increased to 6.0%
from 5.4% for the year ended March 31, 2009 compared to the year ended
March 31, 2008.
32
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 year ended
March 31, 2009 were $380.5 million, or 4.9%, higher than in fiscal year
2008. The most significant factors of this increase were the $11.3
million increase in the provision for doubtful accounts due to an
increase in assignment of insurance accounts for legal collection
efforts, $2.4 million paid by the Company pursuant to the Settlement
Agreement effective April 2, 2009 (see "SETTLEMENT AGREEMENT"), and
$3.1 million increase in salaries and benefits. Of the increase in
salaries and benefits, $2.4 million represents the servicing costs of
accounts receivable that had been sold pursuant to the Accounts
Purchase Agreement during fiscal year 2008 and subsequently reacquired
in October 2007 (see "ACCOUNTS PURCHASE AGREEMENT"). Excluding the $2.4
million in servicing costs noted above, salaries and benefits increased
0.3% during the year ended March 31, 2009 compared to year ended March
31, 2008.
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
$2.3 million during the year ended March 31, 2009 compared to the year
ended March 31, 2008. Additionally, the $50.0 million Revolving Credit
Agreement provides an estimated additional liquidity as of March 31,
2009 of $36.7 million based on eligible receivables, as defined.
However, during fiscal year 2009 the Company experienced significant
delays in the funding of advances under its $50.0 million Revolving
Credit Agreement. During this time, the Lender experienced delays in
funding advances in accordance with advance requests submitted by the
Company. As of March 31, 2009, the unfulfilled advance requests
aggregated approximately $17.0 million. 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. As noted above, as of March 31,
2009, the Lender had collected and retained $5.6 million ($12.7 million
as of June 15, 2009) in excess of the amounts due to it under the $50
million Revolving Credit Agreement (see "LENDER DEFAULT"). At March 31,
2009, the Company was in compliance with all covenants, as amended.
However, given the history of non-compliance and the high unlikelihood
of compliance in fiscal year 2010, the Company's noncurrent debt of
$81.0 million will continue to be classified as current.
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.
33
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"). Under the Settlement Agreement effective April 2, 2009, the maturity
date of the credit agreements has been extended to October 8, 2011 (see "GLOBAL
SETTLEMENT AGREEMENT").
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.
34
Based on eligible receivables, as defined, the Company had
approximately $36.7 million of additional availability under its $50.0 million
Revolving Line of Credit at March 31, 2009. However, during the year ended March
31, 2009, the Company experienced significant delays in the funding of advances
under its $50.0 million Revolving Credit Agreement. During this time, the Lender
experienced delays in funding advances in accordance with advance requests
submitted by the Company. As of March 31, 2009, the unfulfilled advance requests
aggregated approximately $17.0 million. As of March 31, 2009, the Lender had
collected and retained $5.6 million in excess of the amounts due to it ("Excess
Amounts") under the $50 million Revolving Credit Agreement (see "LENDER
DEFAULT"). The Lender applies monthly interest charges relating to all of the
New Credit Facilities against the Excess Amounts. At March 31, 2009, the Excess
Amounts represented approximately 8 months of future interest charges. There can
be no assurances that the Company will be successful in recovering all Excess
Amounts or that the Company will not continue to experience delays in receiving
advances from the Lender in the future (see "LENDER DEFAULT").
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.As of March 31,
2008, the Company was not in compliance with the amended Minimum Fixed Charge
Coverage Ratio of 0.4. 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
classified to current. At March 31, 2009, the Company was in compliance with all
covenants, as amended. However, given the history of non-compliance and
uncertainty as to future compliance, the Company's noncurrent debt of $81.0
million has been classified as current.
During the year ended March 31, 2009, 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 year ended March 31, 2009.
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 (see "GLOBAL SETTLEMENT AGREEMENT").
35
LENDER DEFAULT - On April 14, 2009, the Company issued a letter
("Demand Letter") to the Lender notifying the Lender that it was in default of
the $50 million Revolving Credit Agreement, to make demand for return of all
amounts collected and retained by it in excess of the amounts due to it under
the $50 million Revolving Credit Agreement, and to reserve the rights of the
borrowers and credit parties with respect to other actions and remedies
available to them. On April 17, 2009, following receipt of a copy of the Demand
Letter, the bank that maintains the lock boxes pursuant to a restricted account
and securities account control agreement ("Lockbox Agreement") notified the
Company and the Lender that it would terminate the Lockbox Agreement within 30
days. On May 18, 2009, the Lockbox Agreement was terminated and the Company's
bank accounts were frozen. On May 19, 2009, the Lender relinquished any and all
control over the bank accounts pursuant to the Lockbox Agreement. The Lender's
relinquishment provided the Company with full access to its bank accounts and
the accounts are no longer accessible by the Lender. The Lender has not returned
the amounts collected and retained by it in excess of the amounts due to it
under the $50 million Revolving Credit Agreement ($12.7 million as of June 15,
2009) and is not advancing any funds to the Company under the $50 million
Revolving Credit Agreement. The Lender applies monthly interest charges relating
to all of the New Credit Facilities against the Excess Amounts. At March 31 and
June 15, 2009, the Excess Amounts represented approximately 8 and 19 months,
respectively, of future interest charges. As a result, the Company relies solely
on its cash receipts from payers to fund its operations, and any significant
disruption in such receipts could have a material adverse effect on the
Company's ability to continue as a going concern.
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 expired on July 27, 2008. The exercise price for the first 43.0 million
shares purchased under the Restructuring Warrants was $0.003125 per share, and
the exercise or purchase price for the remaining 31.7 million shares was $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.
36
During February 2007, Dr. Chaudhuri and Mr. Thomas submitted an
exercise under these warrants to the Company. At March 31, 2007 the Company
recorded the issuance of 28.7 million net shares under this exercise following
resolution of certain legal issues relating thereto. The issuance of these
shares resulted in an addition to paid in capital and to common stock totaling
$9.2 million. These shares were issued to Dr. Chaudhuri and Mr. Thomas on July
2, 2007. The shares pursuant to this exercise were recorded as issued and
outstanding at March 31, 2007. Additionally, the remaining liability was
revalued at March 31, 2007 in the amount of $4.2 million relating to potential
shares (20.8 million shares) which could be issued, if the December Note warrant
was to become issuable, which occurred on June 13, 2007 upon receipt of a notice
of default from the Lender.
On July 2, 2007, the Company accepted, due to the default and
subsequent vesting of the December Note Warrant, an additional exercise under
the anti-dilution provisions the Restructuring Warrant Agreement by Dr.
Chaudhuri and Mr. Thomas. The exercise resulted in additional shares issuable of
20.8 million shares for consideration of $576 in cash. The effect of this
exercise resulted in additional warrant expense for the year ended March 31,
2007 of $693, which was accrued based on the transaction as of March 31, 2007.
The related warrant liability of $4.2 million (as of March 31, 2007) was
reclassified to additional paid in capital when the 20.8 million shares were
issued to Dr. Chaudhuri and Mr. Thomas in July 2007.
Upon the Company's refinancing (see "REFINANCING") and the issuance of
the New Warrants, the remaining 24.9 million Restructuring Warrants held by Dr.
Chaudhuri and Mr. Thomas became exercisable on the Effective Date. Accordingly,
as of the Effective Date, the Company recorded warrant expense, and a related
warrant liability, of $1.2 million relating to the Restructuring Warrants. 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 (and subsequently increased the
authorized shares to 500 million in April 2009). 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.
37
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 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 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.
On January 30, 2009, the Company entered into an amendment of the
Purchase Agreement ("Amended Purchase Agreement"). Under the Purchase Agreement,
Dr. Chaudhuri had the right to invest up to $7.0 million in the Company through
the purchase of 63.4 million shares of common stock at $0.11 per share. The
Purchase Right expired on January 10, 2009. Under the Amended Purchase
Agreement, Dr. Chaudhuri agreed to purchase immediately from the Company 33.3
million shares of Company common stock (the "Additional Shares") at a purchase
price of $0.03 per share, or an aggregate purchase price of $1.0 million. In
consideration for Dr. Chaudhuri's entry into the Amended Purchase Agreement and
payment to the Company of $30, under the Amended Purchase Agreement the Company
granted to Dr. Chaudhuri the right, in Dr. Chaudhuri's sole discretion (subject
to the Company having sufficient authorized capital), to invest at any time and
from time to time through January 30, 2010 up to $6.0 million through the
purchase of shares of the Company's common stock at a purchase price of $0.11
per share (the "Amended Purchase Right").
Concurrently with the execution of the Amended Purchase Agreement, the
Company and its subsidiaries entered into an amendment of the Payoff Agreement.
MPFC III, which is a party to the SPA Amendment, holds a convertible term note
in the original principal amount of $10.7 million issued by the Company on
October 9, 2007. Under the Amended Payoff Amendment, the Company agreed to pay
to its Lender $1.0 million as partial repayment of the $7.0 million outstanding
principal balance of the $10.7 million Convertible Term Note upon receipt of
$1.0 million from Dr. Chaudhuri's purchase of the Additional Shares. The Company
is also obligated under the Amended Payoff Agreement to use the proceeds it
receives from future exercises, if any, of Dr. Chaudhuri's Amended Purchase
Right under the Amended Purchase Agreement toward early payoff of the remaining
balance of the $10.7 million Convertible Term Note.
Since the Amended Purchase Agreement resulted in a change in control,
the Company is subject to limitations on the use of its net operating loss
carryforwards.
38
GLOBAL SETTLEMENT AGREEMENT - Effective April 2, 2009, the Company, Dr.
Shah, OC-PIN, Mr. Mogel, PCHI, West Coast, Dr. Chaudhuri, Ganesha, Mr. Thomas,
and the Lender entered into a Settlement Agreement, General Release and Covenant
Not to Sue ("Global Settlement Agreement") in connection with the settlement of
pending and threatened litigation, arbitration, appellate, and other legal
proceedings (the "Actions") among the various parties. Pursuant to the Global
Settlement Agreement, the Company agreed to pay to OC-PIN and Dr. Shah a total
sum of $2.4 million in two installments consisting of $1.6 million at closing
and $750, together with interest thereon at 8%, payable on September 25, 2009
(the "Second Payment $750"). The Company also agreed to pay the sum of $15 as
satisfaction of Dr. Shah's individual claims. Additionally, the Company and Mr.
Mogel agreed to stipulate to the release and return of a $50 bond which was
posted in connection with a shareholder derivative suit filed by OC-PIN against
both Mr. Mogel and the Company. All amounts payable by the Company under the
Global Settlement Agreement, totaling $2.4 million, are accrued at March 31,
2009.
In addition, Dr. Shah covenanted and agreed, that for a period of 2
years after the Closing, he will not accept any nomination, appointment or will
not serve in the capacity as a director, officer, or employee of the Company, so
long as the Company keeps the PCHI and Chapman Medical Center leases current by
making payments within 45 days of when payments are due.
Also pursuant to the Global Settlement Agreement, Dr. Shah and OC-PIN
covenant not to sue or to assist anyone else in suing, directly or derivatively
on behalf of the Company, Dr. Chaudhuri or the Lender, and Dr. Chaudhuri and the
Lender covenant not to sue or to assist anyone else in suing, directly or
derivatively on behalf of the Company, Dr. Shah and OC-PIN. Dr. Shah and OC-PIN
also agreed to sign and deliver dismissals with prejudice of all Dr. Shah and
OC-PIN's claims in the Actions, and the Company, PCHI, and Dr. Chaudhuri agreed
to sign and deliver dismissals with prejudice of all of the Company, PCHI and
Dr. Chaudhuri claims against Dr. Shah and/or OC-PIN in the Actions. Furthermore,
all of the parties agreed to general releases discharging each and all of the
other parties from, among other things, any and all rights, suits, claims or
actions arising out of or otherwise related to the Actions.
Pursuant to the Global Settlement Agreement, the Company agreed to
amend its Bylaws to provide (i) that the number of members of the Company's
Board of Directors shall be fixed at 7 and (ii) that, effective immediately
after the Company's 2009 Annual Meeting of Shareholders, a shareholder who owns
15% or more of the voting stock of the Company is entitled to call one special
shareholders meeting per year. The Company also agreed to appoint an OC-PIN
representative to fill the seat to be vacated by Ken Westbrook, effective April
2, 2009, until the September 2009 annual meeting of shareholders. As of June 15,
2009, Mr. Westbrook is still a Director since OC-PIN's representative has not
been duly appointed by OC-PIN (see "First Meka Complaint" below).
Also pursuant to the Global Settlement Agreement, the Company entered
into Stock Purchase Agreements (the "2009 Stock Purchase Agreements") with Dr.
Shah, Dr. Chaudhuri and OC-PIN respectively. Pursuant to these 2009 Stock
Purchase Agreements, Dr. Shah and OC-PIN will receive an aggregate of 14.7
million shares of the Company's common stock each and Dr. Chaudhuri will receive
an aggregate of 30.6 million shares of the Company's common stock, for a price
of $0.03 per share (the "2009 Stock Purchase Shares"). The purchase and sale of
the Company's common stock under these agreements is still pending(see "First
Meka Complaint" below).
Pursuant to the Global Settlement Agreement, if either OC-PIN or Dr.
Shah chooses not to purchase all of their respective 2009 Stock Purchase Shares,
those 2009 Stock Purchase Shares which either party elects not to purchase may
be purchased by the other party. In the event that OC-PIN and Dr. Shah purchase,
in the aggregate, fewer 2009 Stock Purchase Shares than the maximum they were
entitled to purchase under the terms of their 2009 Stock Purchase Agreements,
Dr. Chaudhuri agreed that the number of 2009 Stock Purchase Shares that he is
entitled to purchase under his 2009 Stock Purchase Agreement shall be
automatically reduced to an amount which is 51% of the aggregate number of 2009
Stock Purchase Shares which Dr. Chaudhuri, OC-PIN and Dr. Shah actually purchase
under their 2009 Stock Purchase Agreements. OC-PIN and Dr. Shah also agreed to
provide notice to the Company and Dr. Chaudhuri regarding their choice to use as
a credit all or a portion of the Second Payment $750, and any interest accrued
thereon, toward OC-PIN and Dr. Shah's payment to IHHI for their respective Stock
Purchase Shares. IHHI also agreed that IHHI will use the net proceeds of the
sale of the Stock Purchase Shares to pay down the principal balance of the
Company's $10.7 million Convertible Term Note held by the Lender, and the Lender
agreed to advance to the Company additional funds equal to such amount by which
the $10.7 million Convertible Term Note is paid down.
39
In conjunction with the Global Settlement Agreement, on April 2, 2009,
the Company and the Lender entered into the Amendment No. 1 to Credit Agreement
("Credit Amendment"). The Lender agreed to reduce the interest rate on the $45.0
million Term Note to simple interest of 10.25% (the "Debt Service Reduction")
and to maintain such interest rate up to and including the maturity date of the
Term Note, or any extension thereof, as defined in the $80 million credit
agreement, under which the $45.0 million Term Note was issued (the "Debt Service
Reduction Period"). The Credit Amendment also provided for an optional one year
extension of the maturity date of the $45.0 million Term Note and the $35.0
million Non-Revolving Line of Credit Note to October 8, 2011, provided that the
Company pay in full the unpaid principal balance due under the $10.7 million
Convertible Term Loan no later than January 30, 2010.
In conjunction with the Global Settlement Agreement, on April 2, 2009,
the Company and the Lender entered into the Amendment No. 1 to the $50.0 million
Revolving Credit Agreement which provides an optional one year extension of the
maturity date to October 8, 2011, provided that the Company pay in full the
unpaid principal balance due under the $10.7 million Convertible Term Loan no
later than January 30, 2010.
On April 2, 2009, the Company, OC-PIN, PCHI, West Coast, Ganesha, and
the Lender (the "Acknowledgement Parties") entered into the Acknowledgement,
Waiver and Consent and Amendment to Credit Agreements (the "Acknowledgement").
The Acknowledgement Parties agreed that if and to the extent that the
agreements, transactions and events contemplated in the Global Settlement
Agreement constitute, may constitute or will constitute a change of control,
default, event of default or other breach or default under the New Credit
Facilities, or any documents related to the New Credit Facilities, each
Acknowledgement Party waives and consents to the waiver of such event, breach or
default.
Pursuant to the Global Settlement Agreement, the Company and PCHI
entered into the Amendment to Amended and Restated Triple Net Hospital Building
Lease (the "2009 Lease Amendment"), whereby PCHI agreed to reduce the rent paid
by the Company under the Amended Lease by an amount equal to the Debt Service
Reduction (i.e., the difference between 14% and 10.25%) during the Debt Service
Reduction Period. The Company also agreed, pursuant to the Global Settlement
Agreement, to bring the PCHI lease and the Chapman Medical Center leases current
and to pay all arrearages due under the PCHI lease and the Chapman Medical
Center leases.
On April 24, 2009, a conglomeration of several OC-PIN members led by
Ajay G. Meka, M.D. filed a lawsuit against Dr.Shah, other OC-PIN members, and
various attorneys, alleging breach of fiduciary duty and seeking damages as well
as declaratory and injunctive relief (the "First Meka Complaint"). While the
Company is named as a defendant in the action, plaintiffs are only seeking
declaratory and injunctive relief with respect to various provisions of the
Global Settlement Agreement. Due to the competing demands related to the Stock
Purchase Agreements placed upon the Company from factions within OC-PIN, on May
13, 2009, the Company filed a Motion for Judicial Instructions regarding
enforcement of the Global Settlement Agreement. On May 14, 2009, the Company,
Dr. Shah, as well as both "factions" of OC-PIN entered into a "stand still"
agreement regarding both the nomination of an OC-PIN Board representative as
well as the allocation of shares under the Stock Purchase Agreements.
Subsequently, on June 22, 2009, the Court granted a stay of the Company's
remaining obligations under the Global Settlement Agreement until the resolution
of the Amended Meka Complaint and related actions.
On June 1, 2009, a First Amended Complaint was filed to replace the
First Meka Complaint (the "Amended Meka Complaint"). It appears that the relief
sought against the Company in the Amended Meka Complaint does not materially
alter from the declaratory and injunctive relief sought in the First Meka
Complaint. The Company believes it is a neutral stakeholder in the action, and
that the results of the action will not have a material adverse impact on the
Company's results of operations.
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").
40
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
(see "GLOBAL SETTLEMENT AGREEMENT").
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.
CASH FLOW - Net cash provided by (used in) operating activities for the
years ended March 31, 2009 and 2008 was $20.1 million and $(11.3) million,
respectively. Net loss, adjusted for depreciation and other non-cash items,
excluding the provision for doubtful accounts and minority interest, totaled
$3.1 million and $(10.4) million for the years ended March 31, 2009 and 2008,
respectively. The Company produced $17.0 million and used $0.8 million in
working capital for the year ended March 31, 2009 and 2008, respectively. Net
cash produced by growth in accounts payable, accrued compensation and benefits
and other current liabilities was $14.1 million and $4.6 million for year ended
March 31, 2009 and 2008, 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
$1.6 million and $(6.4) million for the years ended March 31, 2009 and 2008,
respectively.
Net cash provided by (used in) investing activities during the years
ended March 31, 2009 and 2008 was $(0.8) million and $4.0 million, respectively.
In the year ended March 31, 2009 and 2008, the Company invested $0.8 million and
$0.9 million in cash, respectively, in new equipment. During the year ended
March 31, 2009 and 2008, $0 and $4.9 million, respectively, in restricted cash
was released to the Company.
Net cash provided by (used in) financing activities for the year ended
March 31, 2009 and 2008 was $(18.9) million and $2.5 million, respectively. The
decrease in net cash used in financing activities for the year ended March 31,
2009 was primarily due to paydowns of $14.6 million on the Company's debt and
$5.6 million in amounts collected and retained by the Lender in excess of the
amounts due to the Lender under the $50.0 million Revolving Credit Agreement.
41
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The following table sets forth, for the years ended March 31, 2009 and
2008, our consolidated statements of operations expressed as a percentage of net
operating revenues.
Year ended
March 31,
-------------------------------
2009 2008
------------- --------------
Net operating revenues 100.0% 100.0%
------------- --------------
Operating expenses
Salaries and benefits 54.1% 57.0%
Supplies 13.1% 13.6%
Provision for doubtful accounts 10.7% 8.4%
Other operating expenses 17.9% 18.8%
Loss on sale of accounts receivable 0.0% 1.1%
Depreciation and amortization 0.9% 0.9%
------------- --------------
96.8% 99.8%
------------- --------------
Operating income 3.2% 0.2%
------------- --------------
Other expense:
Interest expense, net (3.2%) (3.6%)
Warrant liability expense (0.0%) (3.1%)
Change in fair value of warrant liability 0.0% (3.9%)
------------- --------------
(3.2%) (10.6%)
------------- --------------
Income (loss) before provision for income
taxes and minority interest 0.0% (10.4%)
Provision for income taxes (0.1%) (0.0%)
Minority interest (0.3%) (0.4%)
------------- --------------
Net loss (0.4%) (10.8%)
============= ==============
FISCAL YEAR ENDED MARCH 31, 2009 COMPARED TO FISCAL YEAR ENDED MARCH
31, 2008
NET OPERATING REVENUES - Net operating revenues for the year ended
March 31, 2009 increased 6.9% compared to fiscal year 2008, from $367.7 million
to $393.0 million. The increase in net operating revenues relating to one
managed care provider, whose contract with the Company expired in fiscal year
2009, increased $3.3 million compared to fiscal year 2008. Also, during the year
ended March 31, 2009, based on collection experience, the Company changed from
cash basis to accrual basis relating to payments it receives for indigent care
under California section 1011. As a result, the Company established a receivable
in the amount of $1.4 million as of March 31, 2009 compared to $0 as of March
31, 2008. Net operating revenues for the years ended March 31, 2009 and 2008
included lump sum amendments to the CMAC agreement for $3.7 million and $4.8
million, respectively. Admissions for the year ended March 31, 2009 decreased
4.3% compared to fiscal year 2008. The decline in admissions is the combined
result of lower obstetrical deliveries, psychiatric admissions, and managed care
contracts that have reached term and are pending renegotiation. Net operating
revenues per admission improved by 11.7% during the year ended March 31, 2009 as
a result of negotiated managed care and governmental payment rate increases.
Based on average revenue for comparable services from all other payers, revenues
foregone under the charity policy, including indigent care accounts, for the
years ended March 31, 2009 and 2008 were $8.2 million and $8.0 million,
respectively.
Essentially all net operating revenues come from external customers.
The largest payers are the Medicare and Medicaid programs accounting for 60.7%
and 66.4% of the net operating revenues for the years ended March 31, 2009 and
2008, respectively.
Uninsured patients, as a percentage of gross charges, increased to
6.0% from 5.4% for the year ended March 31, 2009 compared to the year ended
March 31, 2008.
42
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 $3.7 million and $4.8 million lump sum payments
referred to above during the years ended March 31, 2009 and 2008, respectively,
Net Collectible Revenues were $347.1 million (net revenues of $389.3 million
less $42.2 million in provision for doubtful accounts) and $331.9 million (net
revenues of $362.9 million less $31.0 million in provision for doubtful
accounts) for the years ended March 31, 2009 and 2008, respectively,
representing an increase of $15.2 million. There was also an increase in Net
Collectible Revenues per admission of 9.3% for the year ended March 31, 2009
compared to the year ended March 31, 2008. Obstetrical services represented 56%
of the admissions decline. Obstetrical services have lower revenue per case. In
addition, the termination of a managed care contract during the year contributed
to both lower volume and a reduction in discounts.
OPERATING EXPENSES - Operating expenses for the year ended March 31,
2009 increased to $380.5 million from $366.9 million, an increase of $13.6
million, or 3.7%, compared to fiscal year 2008. Operating expenses expressed as
a percentage of net operating revenues for the years ended March 31, 2009 and
2008 were 96.8% and 99.8%, respectively. On a per admission basis, operating
expenses increased 8.4%.
Salaries and benefits increased $3.1 million (1.5%) for the year ended
March 31, 2009 compared to 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 $2.4 million difference in
classification of accounts receivable servicing expense for the year ended March
31, 2008. Under the APA these costs were included in the loss on sale of
accounts receivable. Upon reacquisition of the accounts receivable, comparable
internal servicing costs are included in salaries and benefits.
During the year ended March 31, 2009, the Company recorded $2.4 million
in other operating expenses relating to the Settlement Agreement effective April
2, 2009 (see "GLOBAL SETTLEMENT AGREEMENT"). Other than the settlement payment
noted above, other operating expenses relative to net operating revenues for the
year ended March 31, 2009 were substantially unchanged compared to fiscal year
2008.
The provision for doubtful accounts for year ended March 31, 2009
increased to $42.2 million from $31.0 million, or 36.1%, compared to the same
period in fiscal year 2008. The increase in the provision for doubtful accounts
for the year ended March 31, 2009 is primarily due to an increase in assignment
of non-contracted 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 years ended March 31,
2009 and 2008 was $0 and $4.1 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 - The operating income for the years ended March 31,
2009 and 2008 was $12.5 million and $785, respectively.
OTHER EXPENSE - For the year ended March 31, 2009 there was a $14.3
million decrease in the change in fair value of warrant liability compared to
fiscal year 2008. For the year ended March 31, 2009 there was an $11.4 million
decrease in common stock warrant expense compared to fiscal year 2008. 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 reclassified the combined
warrant liability balance of $25.7 million to additional paid in capital in
accordance with EITF 00-19.
Interest expense for the year ended March 31, 2009 was $12.4 million
compared to $13.2 million for fiscal year 2008, which included $1.4 million in
loan origination fee expense associated with the Company's new financing
arrangement.
NET LOSS - Net loss for the year ended March 31, 2009 was $1.5 million
compared to a net loss of $39.6 million for fiscal year 2008.
43
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
REVENUE RECOGNITION - Net operating revenues are recognized in the
period in which services are performed and are recorded based on established
billing rates (gross charges) less estimated discounts for contractual
allowances, principally for patients covered by Medicare, Medicaid, managed care
and other health plans. Gross charges are retail charges. They are not the same
as actual pricing, and they generally do not reflect what a hospital is
ultimately paid and therefore are not displayed in the consolidated statements
of operations. Hospitals are typically paid amounts that are negotiated with
insurance companies or are set by the government. Gross charges are used to
calculate Medicare outlier payments and to determine certain elements of payment
under managed care contracts (such as stop-loss payments). Because Medicare
requires that a hospital's gross charges be the same for all patients
(regardless of payer category), gross charges are also what the Hospitals charge
all other patients prior to the application of discounts and allowances.
Revenues under the traditional fee-for-service Medicare and Medicaid
programs are based primarily on prospective payment systems. Discounts for
retrospectively cost based revenues and certain other payments, which are based
on the Hospitals' cost reports, are estimated using historical trends and
current factors. Cost report settlements for retrospectively cost-based revenues
under these programs are subject to audit and administrative and judicial
review, which can take several years until final settlement of such matters are
determined and completely resolved. Estimates of settlement receivables or
payables related to a specific year are updated periodically and at year end and
at the time the cost report is filed with the fiscal intermediary. Typically no
further updates are made to the estimates until the final Notice of Program
Reimbursement is received, at which time the cost report for that year has been
audited by the fiscal intermediary. There could be 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 receivables of $1,618
and settlement payables of $12 as of March 31, 2009 and 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, 2008 was a decrease from $22.185 to $20.045. CMS projects this will
result in an Outlier Percentage that is approximately 5.1% of total payments.
The Medicare fiscal intermediary calculates the cost of a claim by multiplying
the billed charges by the cost-to-charge ratio from the hospital's most recent
filed cost report.
44
The Hospitals received new provider numbers in 2005 and, because there
was no specific history, the Hospitals were reimbursed for outliers based on
published statewide averages. If the computed cost exceeds the sum of the DRG
payment plus the fixed threshold, a hospital receives 80% of the difference as
an outlier payment. Medicare has reserved the option of adjusting outlier
payments, through the cost report, to a hospital's actual cost-to-charge ratio.
Upon receipt of the current payment cost-to-charge ratios from the fiscal
intermediary, any variance between current payments and the estimated final
outlier settlement are examined by the Medicare fiscal intermediary. The Company
recorded $755 in Final Notice of Program Reimbursement settlements during the
year ended March 31, 2008. As of March 31, 2009, the Company has reversed all
reserves for excess outlier payments. As of March 31, 2008, the Company reserved
all reserves for excess outlier payments due to the difference between the
Hospitals actual cost to charge rates and the statewide average in the amount of
$1,678. These reserves are combined with third party settlement estimates and
are included in due to government payers as a net payable of $0 and $1,690 as of
March 31, 2009 and 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 SB 1100 and SB 1255 programs. The Hospitals received
supplemental payments of $21,859 and $16,175 during the years ended March 31,
2009 and 2008, respectively. The related revenue recorded for the years ended
March 31, 2009 and 2008 was $19,660 and $19,375, respectively. As of March 31,
2009 and 2008, estimated DSH receivables were $2,679 and $4,877.
Revenues under managed care plans are based primarily on payment terms
involving predetermined rates per diagnosis, per-diem rates, discounted
fee-for-service rates and/or other similar contractual arrangements. These
revenues are also subject to review and possible audit by the payers. The payers
are billed for patient services on an individual patient basis. An individual
patient's bill is subject to adjustment on a patient-by-patient basis in the
ordinary course of business by the payers following their review and
adjudication of each particular bill. The Hospitals estimate the discounts for
contractual allowances utilizing billing data on an individual patient basis. At
the end of each month, the Hospitals estimate expected reimbursement for
patients of managed care plans based on the applicable contract terms. These
estimates are continuously reviewed for accuracy by taking into consideration
known contract terms as well as payment history. Although the Hospitals do not
separately accumulate and disclose the aggregate amount of adjustments to the
estimated reimbursements for every patient bill, management believes the
estimation and review process allows for timely identification of instances
where such estimates need to be revised. The Company does not believe there were
any adjustments to estimates of individual patient bills that were material to
its net operating revenues.
The Hospitals provide charity care to patients whose income level is
below 300% of the Federal Poverty Level. Patients with income levels between
300% and 350% of the Federal Poverty Level qualify to pay a discounted rate
under AB774 based on various government program reimbursement levels. Patients
without insurance are offered assistance in applying for Medicaid and other
programs they may be eligible for, such as state disability, Victims of Crime,
or county indigent programs. Patient advocates from the Hospitals' Medical
Eligibility Program ("MEP") screen patients in the hospital and determine
potential linkage to financial assistance programs. They also expedite the
process of applying for these government programs. Based on average revenue for
comparable services from all other payers, revenues foregone under the charity
policy, including indigent care accounts, were $8.2 and $8.0 million for the
years ended March 31, 2009 and 2008, respectively.
45
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.
The Company is not aware of any material claims, disputes, or unsettled
matters with any payers that would affect revenues that have not been adequately
provided for in the accompanying consolidated financial statements.
PROVISION FOR DOUBTFUL ACCOUNTS - The Company provides for accounts
receivable that could become uncollectible by establishing an allowance to
reduce the carrying value of such receivables to their estimated net realizable
value. The Hospitals estimate this allowance based on the aging of their
accounts receivable, historical collections experience for each type of payer,
and other relevant factors. There are various factors that can impact the
collection trends, such as changes in the economy which in turn have an impact
on unemployment rates and the number of uninsured and underinsured patients,
volume of patients through the emergency department, the increased burden of
copayments to be made by patients with insurance, and business practices related
to collection efforts. These factors continuously change and can have an impact
on collection trends and the estimation process.
The Company's policy is to attempt to collect amounts due from
patients, including copayments and deductibles due from patients with insurance,
at the time of service while complying with all federal and state laws and
regulations, including, but not limited to, the Emergency Medical Treatment and
Labor Act ("EMTALA"). Generally, as required by EMTALA, patients may not be
denied emergency treatment due to inability to pay. Therefore, until the legally
required medical screening examination is complete and stabilization of the
patient has begun, services are performed prior to the verification of the
patient's insurance, if any. In nonemergency circumstances or for elective
procedures and services, it is the Hospitals' policy, when appropriate, to
verify insurance prior to a patient being treated.
TRANSFERS OF FINANCIAL ASSETS - Prior to 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.
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.
46
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, 2004 and December 31, 2003, 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.
INSURANCE - The Company accrues for estimated general and professional
liability claims, to the extent not covered by insurance, when they are probable
and reasonably estimable. The Company has purchased as primary coverage a
claims-made form insurance policy for general and professional liability risks.
Estimated losses within general and professional liability retentions from
claims incurred and reported, along with IBNR claims, are accrued based upon
projections and are discounted to their net present value using a weighted
average risk-free discount rate of 5%. To the extent that subsequent claims
information varies from estimates, the liability is adjusted in the period such
information becomes available. As of March 31, 2009 and 2008, the Company had
accrued $8.7 million and $9.9 million, respectively, which is comprised of $4.1
million and $3.0 million, respectively, in incurred and reported claims, along
with $4.6 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. The Company has a
"guaranteed cost" policy, under which the carrier pays all workers' compensation
claims, with no deductible or reimbursement required of the Company. The Company
accrues for estimated workers' compensation claims, to the extent not covered by
insurance, when they are probable and reasonably estimable. The ultimate costs
related to this program include expenses for deductible amounts associated with
claims incurred and reported in addition to an accrual for the estimated
expenses incurred in connection with IBNR claims. Claims are accrued based upon
projections and are discounted to their net present value using a weighted
average risk-free discount rate of 5%. To the extent that subsequent claims
information varies from estimates, the liability is adjusted in the period such
information becomes available. As of March 31, 2009 and 2008, the Company had
accrued $711 and $710, respectively, comprised of $202 and $169, respectively,
in incurred and reported claims, along with $509 and $541, respectively, in
estimated IBNR.
Effective May 1, 2007, the Company initiated a self-insured health
benefits plan for its employees. As a result, the Company has established and
maintains an accrual for IBNR claims arising from self-insured health benefits
provided to employees. The Company's IBNR accrual at March 31, 2008 was based
upon projections . The Company determines the adequacy of this accrual by
evaluating its limited historical experience and trends related to both health
insurance claims and payments, information provided by its insurance broker and
third party administrator and industry experience and trends. The accrual is an
estimate and is subject to change. Such change could be material to the
Company's consolidated financial statements. As of March 31, 2009 and 2008, the
Company had accrued $1.8 million and $1.7 million, respectively, in estimated
IBNR. The Company believes this is the best estimate of the amount of IBNR
relating to self-insured health benefit claims at March 31, 2009 and 2008.
The Company has also purchased umbrella liability policies with
aggregate limits of $25 million. The umbrella policies provide coverage in
excess of the primary layer and applicable retentions for insured liability
risks such as general and professional liability, auto liability, and workers
compensation (employers liability).
47
RECENT ACCOUNTING STANDARDS
In February 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 effect of the adoption of SFAS No. 141(R) will depend upon the nature and
terms of any future business combinations the Company undertakes.
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 is in the process of evaluating 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.
48
In May 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 and
requires retrospective implementation. Based on preliminary assessment,
application is not deemed to have a material impact.
In June 2008, the FASB issued EITF 07-5, "Determining Whether an
Instrument (or Embedded Feature) Is Indexed to an Entity's Own Stock" ("EITF
07-5"). The Issue requires entities to evaluate whether an equity-linked
financial instrument (or embedded feature) is indexed to its own stock in order
to determine if the instrument should be accounted for as a derivative under the
scope of FASB Statement No. 133, "Accounting for Derivative Instruments and
Hedging Activities." EITF 07-5 is effective for financial statements issued for
fiscal years beginning after December 15, 2008 and interim periods within those
fiscal years. The Company is currently evaluating the impact, if any, that the
adoption of EITF 07-5 will have on its consolidated financial statements.
OFF BALANCE SHEET ARRANGEMENTS
As of March 31, 2009 the Company had no off-balance sheet arrangements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
49
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following consolidated financial statements are filed as a part of
this report beginning on page F-1:
------ -------------------------------------------------------------------
PAGE DESCRIPTION
------ -------------------------------------------------------------------
F-1 Report of Independent Registered Public Accounting Firm
------ -------------------------------------------------------------------
F-2 Consolidated Balance Sheets as of March 31, 2009 and 2008
------ -------------------------------------------------------------------
F-3 Consolidated Statements of Operations for the years ended
March 31, 2009 and 2008
------ -------------------------------------------------------------------
F-4 Consolidated Statements of Stockholders' Deficiency for the years
ended March 31, 2009 and 2008
------ -------------------------------------------------------------------
F-5 Consolidated Statements of Cash Flows for the years ended
March 31, 2009 and 2008
------ -------------------------------------------------------------------
F-6 Notes to Consolidated Financial Statements
------ -------------------------------------------------------------------
F-40 Schedule II - Valuation and Qualifying Accounts for the years
ended March 31, 2009 and 2008
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
ITEM 9A(T). CONTROLS AND PROCEDURES
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of Integrated Healthcare Holdings, Inc. is responsible for
the preparation, integrity and fair presentation of its published consolidated
financial statements. The consolidated financial statements have been prepared
in accordance with U.S. generally accepted accounting principles and, as such,
include amounts based on judgments and estimates made by management. The Company
also prepared the other information included in the annual report and is
responsible for its accuracy and consistency with the consolidated financial
statements.
Management is also responsible for establishing and maintaining
effective internal control over financial reporting. The Company's internal
control over financial reporting includes those policies and procedures that
pertain to the Company's ability to record, process, summarize and report
reliable financial data. The Company maintains a system of internal control over
financial reporting, which is designed to provide reasonable assurance to the
Company's management and board of directors regarding the preparation of
reliable published consolidated financial statements and safeguarding of the
Company's assets. The system includes a documented organizational structure and
division of responsibility, established policies and procedures, including a
code of conduct to foster a strong ethical climate, which are communicated
throughout the Company, and the careful selection, training and development of
our people.
50
The Board of Directors, acting through its Audit Committee, is
responsible for the oversight of the Company's accounting policies, financial
reporting, and internal control. The Audit Committee of the Board of Directors
is comprised entirely of outside directors who are independent of management.
The Audit Committee is responsible for the appointment and compensation of the
independent registered public accounting firm. It meets periodically with
management, the independent registered public accounting firm, and the internal
auditors to ensure that they are carrying out their responsibilities. The Audit
Committee is also responsible for performing an oversight role by reviewing and
monitoring the financial, accounting and auditing procedures of the Company in
addition to reviewing the Company's financial reports. Internal auditors monitor
the operation of the internal control system and report findings and
recommendations to management and the Audit Committee. Corrective actions are
taken to address control deficiencies and other opportunities for improving the
internal control system as they are identified. The independent registered
public accounting firm and the internal auditors have full and unlimited access
to the Audit Committee, with or without management, to discuss the adequacy of
internal control over financial reporting, and any other matters which they
believe should be brought to the attention of the Audit Committee.
Management recognizes that there are inherent limitations in the
effectiveness of any system of internal control over financial reporting,
including the possibility of human error and the circumvention or overriding of
internal control. Accordingly, even effective internal control over financial
reporting can provide only reasonable assurance with respect to financial
statement preparation and may not prevent or detect misstatements. Further,
because of changes in conditions, the effectiveness of internal control over
financial reporting may vary over time.
The Company assessed its internal control system as of March 31, 2009
in relation to criteria for effective internal control over financial reporting
described in "Internal Control - Integrated Framework" issued by the Committee
of Sponsoring Organizations of the Treadway Commission. Based on its assessment,
the Company has determined that, as of March 31, 2009, its system of internal
control over financial reporting was effective.
This annual report does not include an attestation report of the
Company's registered public accounting firm regarding internal control over
financial reporting. Management's report was not subject to attestation by the
Company's registered public accounting firm pursuant to temporary rules of the
Securities and Exchange Commission that permit the Company to provide only
management's report in this annual report.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
During the quarter ended March 31, 2009, there were no changes in our
internal control over financial reporting that materially affected, or are
reasonably likely to affect, our internal control over financial reporting.
DISCLOSURE CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are designed to
ensure that information required to be disclosed in the Company's periodic
reports is recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms, and that such information is accumulated
and communicated to our management, including our Chief Executive Officer and
Chief Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure based closely on the definition of "disclosure controls and
procedures" in Rule 15d-15(e). Our disclosure controls and procedures are
designed to provide a reasonable level of assurance of reaching the Company's
desired disclosure control objectives. In designing and evaluating the
disclosure controls and procedures, management recognized that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives and management
necessarily was required to apply its judgment in evaluating the cost
benefitrelationship of possible controls and procedures.
We conducted an evaluation under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures as of March 31, 2009. This evaluation was
based on the framework in Internal Control Integrated Framework published by the
Committee of Sponsoring Organizations of the Treadway Commission. The evaluation
by management as of March 31, 2009 concluded that the Company's disclosure
controls and procedures are effective as of March 31, 2009.
ITEM 9B. OTHER INFORMATION
None.
51
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The following table contains certain information concerning our
directors and executive officers as of March 31, 2009:
---------------------------- ------ --------------------------------------- ----------------------
NAME AGE POSITION WITH COMPANY DATE BECAME DIRECTOR
---------------------------- ------ --------------------------------------- ----------------------
Maurice J. DeWald 69 Chairman of the Board August 1, 2005
---------------------------- ------ --------------------------------------- ----------------------
Hon. C. Robert Jameson 69 Director July 11, 2007
---------------------------- ------ --------------------------------------- ----------------------
Ajay G. Meka, M.D. 58 Director September 28, 2006
---------------------------- ------ --------------------------------------- ----------------------
Michael Metzler 63 Director September 5, 2007
---------------------------- ------ --------------------------------------- ----------------------
J. Fernando Niebla 69 Director August 1, 2005
---------------------------- ------ --------------------------------------- ----------------------
William E. Thomas 60 Director September 5, 2007
---------------------------- ------ --------------------------------------- ----------------------
Kenneth K. Westbrook 59 Director, Chief Executive Officer & December 2, 2008
President
---------------------------- ------ --------------------------------------- ----------------------
Steven R. Blake 57 Chief Financial Officer &
Executive Vice President, Finance
---------------------------- ------ --------------------------------------- ----------------------
Daniel J. Brothman 54 Chief Operating Officer &
Executive Vice President, Operations
---------------------------- ------ --------------------------------------- ----------------------
MAURICE J. DEWALD has served as a member of the Board of Directors of
the Company since August 1, 2005 and has served as Chairman of the Board of
Directors since October 7, 2008. Mr. DeWald sits on the Audit Committee,
Compensation Committee, Finance Committee and Special Committee. Mr. DeWald is
Chairman and Chief Executive Officer of Verity Financial Group, Inc., a private
investment firm that he founded in 1992. From 1962-1991, Mr. DeWald was with
KPMG LLP, one of the world's largest international accounting and tax consulting
firms, where he served at various times as director and as the Managing Partner
of the Chicago, Orange County and Los Angeles Offices. Mr. DeWald is a director
of Mizuho Corporate Bank of California, Advanced Materials Group, Inc., NNN
Healthcare/Office REIT, Inc., and FileScan, Inc., and is a former director of
Tenet Healthcare Corporation ("Tenet") and Quality Systems, Inc. He also sits on
the Advisory Council of the University of Notre Dame Mendoza School of Business.
Mr. DeWald is a past Chairman and director of United Way of Greater Los Angeles.
Mr. DeWald received a B.B.A. from the University of Notre Dame in 1962. He is
also a Certified Public Accountant.
HON. C. ROBERT JAMESON has been a director of the Company since July
11, 2007. Judge Jameson is a retired Orange County Superior judge now affiliated
with Judicate West, a provider of alternative dispute resolution, handling
complex alternative dispute resolution matters. Before leaving the bench, he was
Presiding Judge of the Orange County Superior Court Appellate Division. Judge
Jameson obtained his B.A. degree in Political Science from the University of
California, Davis in 1963 and his Juris Doctor degree at the University of
California, Hastings College of the Law in 1966. He served as a judge from
1984-2005 and also was President of the Banyard Inn of Court and an Adjunct
Professor of Law at Whittier Law School during his tenure. Judge Jameson was
awarded "Judge of the Year" nine times over the course of his career by
organizations such as: the Orange County Bar Association Business Litigation
section, Orange County Trial Lawyers, the American Board of Trial Advocates and
the Consumer Attorneys of California.
AJAY G. MEKA, M.D has served as a member of the Board of Directors of
the Company since September 28, 2006. Dr. Meka has been a licensed physician in
California for the past 23 years. He is a board certified physician practicing
in Orange County, California. Dr. Meka received his medical degree from Guntur
Medical College in Gunter, India. He performed his postgraduate training at
Brooklyn Jewish Hospital and Coney Island Hospital, both in Brooklyn, New York.
52
MICHAEL METZLER has served as President and Chief Executive Officer of
the Santa Ana Chamber of Commerce since January 1983. Mr. Metzler directs and
controls all activities of this multi-million dollar organization and its
subsidiaries, including SACPAC, the chamber's political action committee, and
the Greater Santa Ana Vitality Foundation, the chamber's charitable foundation.
He has led numerous community initiatives and campaigns that have grown the
local economy and advanced the prosperity of business, including a $145 million
local school bond campaign in 1999, a $100+ million private development
initiative in 2005, and a new career-oriented technical high school in 2006. He
also founded the chamber's nationally award-winning 73,000-circulation
newspaper, CityLine, in 1996, for which he serves as its publisher. Mr. Metzler
has served on numerous community boards, city commissions and county, regional,
state, and national task forces, and currently serves as Chairman of the Board
of Trustees of Coastal Communities Hospital. Metzler also was a founder of the
Santa Ana Business Bank and sits on its Board of Directors. Mr. Metzler is a
graduate of California State University, Fullerton, and attended Loyola
University School of Law and the Peter F. Drucker Graduate School of Management
at Claremont University.
J. FERNANDO NIEBLA has served as a member of the Board of Directors of
the Company since August 1, 2005 and sits on the Audit Committee, Compensation
Committee, Finance Committee and Special Committee. He has served as President
of International Technology Partners, LLC, an information technology and
business consulting services company based on Orange County, California since
August 1998. He is also a founder of Infotec Development Inc. and Infotec
Commercial Systems, two national information technology firms. He currently
serves on the Boards of Directors of Union Bank of California, Pacific Life
Corp. and Granite Construction Corp., the Board of Trustees of the Orange County
Health Foundation, and is the Chairman of the California Advisory Committee to
Nacional Financiera, a Mexican Government agency similar to the U.S. Government
Small Business Administration office. Mr. Niebla holds a B.S. degree in
Electrical Engineering from the University of Arizona and an M.S. QBA from the
University of Southern California.
WILLIAM E. THOMAS is the Executive Vice President and General Counsel
of Strategic Global Management, Inc., a healthcare ventures firm in Riverside,
California. Mr. Thomas has served in such capacity since October of 1998. Prior
to that Mr. Thomas was a founding and managing partner of a law firm in
Riverside, California specializing in business, real estate, and other
transactional matters. Mr. Thomas graduated from the University of California at
Santa Barbara with a Bachelor of Arts degree in History and Political Science.
He holds a Juris Doctor degree from the University of California, Hastings
College of the Law, and a Master of Laws degree from New York University. He is
a member of the California Bar Association.
KENNETH K. WESTBROOK has served as President and Chief Executive
Officer of the Company since December 2, 2008. He is a highly experienced
healthcare executive with unique operational responsibilities for the four
hospitals that comprise the Company; first as the Senior Vice President for
Operations for OrNda HealthCorp (1996) and then as Senior Vice President of
Operations for Tenet (1997 through 2004). Mr. Westbrook sold the four hospitals
that created the Company as he left Tenet. During the years at OrNda and Tenet,
Mr. Westbrook also had the experience of acting as each of the four hospitals'
interim CEO when vacancies occurred. Prior to OrNda, Mr. Westbrook was the Chief
Operating Officer for Hospital Corporation of America's Pacific Division and was
previously a hospital CEO at several Southern California hospitals. He has
graduate and undergraduate degrees in business from the University of Redlands
and is currently a member of several healthcare professional associations.
STEVEN R. BLAKE has served as Chief Financial Officer of the Company
since July 1, 2005 and Executive Vice President, Finance since March 21, 2008.
He is a California licensed Certified Public Accountant. Mr. Blake came to the
Company with over 20 years of experience in multi-hospital financial management.
He also has extensive experience serving in financial roles with public
companies. Most recently, he served as Regional Vice President of Finance for
Tenet, a position he held for over 17 years. In this position, Mr. Blake was
responsible for the financial management of numerous Tenet assets covering five
western states (California, Arizona, Washington, Nebraska and Texas). Mr.
Blake's strong hospital financial background combined with his knowledge of
public company requirements made him a strong addition to the Company's
corporate team.
53
DANIEL J. BROTHMAN has served as Chief Operating Officer & Executive
Vice President, Operations since May 6, 2008 and as Chief Executive Officer of
Western Medical Center - Santa Ana since March 8, 2005. Mr. Brothman also served
as Senior Vice President, Operations of the Company from March 8, 2005 to May 6,
2008. Mr. Brothman is an experienced single and multi-hospital operations
executive. Since 1999, prior to the acquisition of the Hospitals by the Company
he helped build the Western Medical Center in Santa Ana for Tenet. Mr. Brothman
also ran Columbia Healthcare's Utah Division from 1996 to 1998. Mr. Brothman has
in excess of 30 years experience in hospital administration. Mr. Brothman earned
his Bachelor of Arts degree from Washington University at St. Louis and his
Master's in Health Care Administration from the University of Colorado at
Denver.
Directors DeWald, Metzler, and Niebla constitute the Audit Committee of
the Board of Directors. The Company does not have a Nominating Committee as the
entire Board of Directors performs the functions of this committee and this
process has been adequate to handle the Board nomination process to date.
Directors DeWald, Meka, Metzler, and Niebla each satisfy the definition of
"independent director" established in the NASDAQ listing standards. The Board of
Directors has determined that Director DeWald is an "audit committee financial
expert" as defined in the SEC rules.
Directors are elected at our annual meeting and serve until the
following annual meeting.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires our
officers and directors, and persons who own more than 10% of a registered class
of our equity securities, to file reports of ownership and changes in ownership
with the SEC. Officers, directors and greater than 10% stockholders are required
by SEC regulation to furnish us with copies of all Section 16(a) reports they
file.
Based solely upon the copies of Section 16(a) reports which we received
from such persons or written representations from them regarding their
transactions in our common stock, we believe that, during the year ended March
31, 2009, all such forms were filed in a timely fashion.
CODE OF ETHICS
We have adopted a Code of Business Conduct and Ethics that applies to
our employees (including our principal executive officer, principal financial
officer, principal accounting officer, and controller) and our directors. Our
Code of Business Conduct and Ethics can be obtained free of charge by sending a
request to our Corporate Secretary at the following address: Integrated
Healthcare Holdings, Inc., Attn: J. Scott Schoeffel, 1301 North Tustin Avenue,
Santa Ana, California 92705.
STOCKHOLDER RECOMMENDATION OF NOMINEES
While there are no formal procedures for stockholders to recommend
nominations, the Board of Directors will consider stockholder recommendations.
Such recommendations should be addressed to the Corporate Secretary at the
address listed above.
54
STOCKHOLDER COMMUNICATIONS
In order to facilitate communications with the Board of Directors, or
any individual members or any committees of the Board of Directors, stockholders
should direct all communication in writing to our General Counsel at Integrated
Healthcare Holdings, Inc., 1301 North Tustin Avenue, Santa Ana, California
92705, who will forward all such correspondence to the Board of Directors,
individual members of the Board of Directors or applicable chairpersons of any
committee of the Board of Directors, as appropriate and as directed in the
communication.
AUDIT COMMITTEE
The Audit Committee of the Board of Directors was formed in August 2005
and consists of three of our independent directors, Maurice DeWald and J.
Fernando Niebla, who joined the Board of Directors in August 2005, and Michael
Metzler, who joined the Board of Directors in September 2007. The Board of
Directors has determined that Maurice DeWald is an "audit committee financial
expert" as defined in the rules and regulations of the SEC. The Audit Committee
of the Board of Directors preapproves all audit and permissible non-audit
services to be performed by the independent auditors. The Audit Committee will
also advise management on the engagement of experts with sufficient expertise to
advise on accounting and financial reporting of complex financial transactions.
Of the ten audit committee meetings held during the year ended March 31, 2009,
Messrs DeWald, Niebla, and Metzler attended 10, 8, and 10 meetings,
respectively. The Audit Committee Charter was filed previously as APPENDIX A to
the Company's Proxy Statement dated November 14, 2006.
Management is responsible for the Company's internal controls and
financial reporting process. The independent registered public accounting firm
is responsible for performing an independent audit of the Company's consolidated
financial statements in accordance with the standards of the Public Company
Accounting Oversight Board (United States) and to issue a report on these
consolidated financial statements. The Audit Committee's responsibility is to
oversee these activities.
In this context, the Audit Committee has met and held discussions with
management and the independent registered public accounting firm. Management
represented to the Audit Committee that the Company's consolidated financial
statements were prepared in accordance with accounting principals generally
accepted in the United States and the Audit Committee has reviewed and discussed
the consolidated financial statements with management and the independent
registered public accounting firm. The Audit Committee also discussed with the
independent registered public accounting firm matters required to be discussed
by Statement on Auditing Standards No. 114, "Communication with Audit
Committees," as modified or supplemented, including the auditor's judgment about
the quality, as well as the acceptability, of our accounting principles as
applied in the financial reporting.
Our independent registered public accounting firm also provided to the
Audit Committee the written disclosures required by Rule 3520 of the Public
Company Accounting Oversight Board (Independence Discussions with Audit
Committees), and the Audit Committee discussed with the independent registered
public accounting firm that firm's independence as well as internal quality
control procedures.
Based on the Audit Committee's discussions with management and the
independent registered public accounting firm and the Audit Committee's review
of the representations of management and the report of the independent
registered public accounting firm to the Audit Committee, the Audit Committee
recommended to the Board of Directors, and the Board has approved, that the
audited consolidated financial statements be included in the Company's Annual
Report on Form 10-K for the year ended March 31, 2009 for filing with the
Securities and Exchange Commission. This report was submitted by Mr. DeWald,
Chair, and Messrs. Metzler and Niebla.
55
ITEM 11. EXECUTIVE COMPENSATION
The Compensation Committee of the Board of Directors was formed in
October 2005 and consists of three directors, Mr. Maurice DeWald, Mr. J.
Fernando Niebla, chair, and Mr. William E. Thomas. In our fiscal year ended
March 31, 2009, the Compensation Committee held three meetings. The
Compensation Committee is responsible for overseeing the administration of the
Company's executive compensation programs, establishing and interpreting the
Company's compensation policies and approving all compensation paid to executive
officers, including the named executive officers listed in the Summary
Compensation Table.
The following table sets forth summary information regarding
compensation to (i) our Chief Executive Officer during the fiscal year ended
March 31, 2009; (ii) our two other most highly compensated executive officers
employed by us as of March 31, 2009 whose salary and bonus for the fiscal year
ended March 31, 2009 was in excess of $100,000 for their services rendered in
all capacities to us; and (iii) one additional individual for whom disclosure
would be required to be provided but for the fact that the individual was not
serving as an executive officer at March 31, 2009. The listed individuals are
referred to as the "Named Executive Officers."
SUMMARY COMPENSATION TABLE
Option All other
Name and Salary Bonus awards compensation Total
Principal Position Year ($) ($) ($)(5) ($) ($)
- -------------------------------------- ------- --------- --------- --------- ------------ -----------
Kenneth K. Westbrook 2009 144,231 - 2,850 6,000 153,081
Principal Executive Officer (1) 2008 - - - -
Steven R. Blake 2009 422,000 - 5,600 15,476 443,076
Principal Financial Officer & 2008 350,000 46,375 - 46,206 442,581
Executive Vice President, Finance (2)
Daniel J. Brothman 2009 422,000 - - 18,750 440,750
Chief Operating Officer (3) 2008 377,692 46,375 21,000 19,248 464,315
Bruce Mogel 2009 529,038 - - 102,314 631,352
President & Chief Executive Officer 2008 438,154 70,000 - 67,578 575,732
(1) Salary commenced on December 1, 2008. All other compensation for 2009
consists of auto allowance of $6,000.
(2) All other compensation for 2009 includes auto allowance of $12,000 and the
balance is Company contribution to the 401(k) plan. All other compensation
for 2008 includes auto allowance of $12,000, MTO pay out of $25,375 for
accrued and untaken vacation hours and the balance is Company contribution
to the 401(k) plan.
(3) All other compensation for 2009 includes auto allowance of $12,000 and the
balance is Company contribution to the 401(k) plan. All other compensation
for 2008 includes auto allowance of $12,000 and the balance is Company
contribution to the 401(k) plan.
(4) Salary for 2009 consists of $403,846 pre-severance and $125,192
post-severance payments. All other compensation for 2009 includes auto
allowance of $26,000, a MTO pay out of $74,590 for accrued and untaken
vacation hours and the balance is Company contribution to the 401(k) plan.
All other compensation for 2008 includes auto allowance of $16,000,
Manager's Time Off (MTO) pay out of $40,385 for accrued and untaken
vacation hours and the balance is Company contribution to the 401(k) plan.
(5) Values in this column represent the amounts expensed by the Company in
2009 for portions of awards granted. These amounts do not represent the
intrinsic or market value of the awards on the date of grant, at year end
or at present. For grant date values of all outstanding options at March
31, 2009, please see table entitled "Outstanding Equity Awards at Fiscal
Year-End."
56
The following table sets forth summary information regarding stock
options the Company has granted to the Named Executive Officers as of March 31,
2009 under the Company's 2006 Stock Incentive Plan.
OUTSTANDING STOCK OPTIONS AWARDS AT FISCAL YEAR-END
Equity
incentive
plan awards:
Number of Number of Number of
securities securities securities
underlying underlying underlying Option Grant date
unexercised unexercised unexercised exercise Option fair value
Grant options options unearned price expiration per share
Name date exercisable unexercisable options ($) date ($)
- -------------------- ------------------- -------------- --------------- -------------- ----------- ----------------- ------------
Kenneth K. Westbrook (1) December 2, 2008 833,334 1,166,666 1,166,666 0.01 December 2, 2015 0.00
Steven R. Blake (2) August 6, 2007 175,000 125,000 125,000 0.26 August 6, 2014 0.03
Daniel J. Brothman (3) August 6, 2007 1,000,000 - - 0.26 August 6, 2014 0.02
(1) 1/3 of the shares vested on the grant date, and an additional 1/12 of
the shares vest on each subsequent fiscal quarter-end of the Company
beginning on March 31, 2009.
(2) 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.
(3) Vesting retroactively commenced on March 8, 2005, all options were
fully vested as of March 31, 2008.
EMPLOYMENT CONTRACTS, SEVERANCE AGREEMENTS AND CHANGE OF CONTROL ARRANGEMENTS
Effective May 6, 2008, the Company amended the employment agreement
with its COO, Daniel Brothman, to increase his base salary from $350,000 per
year to $422,000 per year. The agreement also specifies that he is eligible to
receive performance based incentive compensation during each fiscal year as
determined by the Company's Board of Directors and CEO. Mr. Brothman's agreement
also provides for stock options (1,000,000 options were granted as of March 31,
2008), auto allowance ($1,000 per month), medical and dental insurance, and up
to four weeks vacation annually.
On November 4, 2008, the Company entered into a Resignation Agreement
and General Release ("Resignation Agreement") with Bruce Mogel, President and
Chief Executive Officer of the Company. Under the Resignation Agreement: (i) Mr.
Mogel served as President and Chief Executive Officer of the Company through
December 31, 2008, at which time he resigned those positions (the "Resignation
Date"); (ii) after December 31, 2008, Mr. Mogel provided consulting services to
the Company for 4 months after the Resignation Date (the "Consulting Period");
(iii) during the Consulting Period, Mr. Mogel will receive a monthly salary
equal to the monthly salary he received immediately prior to the Resignation
Date; (iv) for 8 months after the conclusion of the Consulting Period, Mr. Mogel
will receive payments of $43,750 per month (less deductions required by law),
the sum of which will equal 8 months' salary; (v) the Agreement contains other
benefits, including without limitation, medical and dental coverage for Mr.
Mogel; (vi) Mr. Mogel's employment agreement with the Company was terminated as
of the Resignation Date; (vii) Mr. Mogel resigned from the Boards of Directors
of the Company and its subsidiaries effective November 4, 2008; and (viii) Mr.
Mogel agreed to release and discharge the Company from claims related to his
employment with the Company, among other provisions customary to such
agreements. Under the Resignation Agreement, consideration is currently valued
at approximately $545.2.
57
On December 31, 2007, the Company entered into a Severance Agreement
With Mutual Releases ("Severance Agreement") and a Consulting Agreement with
Larry B. Anderson. Under the Severance Agreement, Mr. Anderson terminated his
employment as President of the Company by mutual agreement, effective December
31, 2007. Under the Severance Agreement, Mr. Anderson could have received
consideration initially valued at approximately $480,000. Under the Severance
Agreement, Mr. Anderson was to receive compensation equivalent to fourteen equal
monthly installments. The amount of each monthly installment was to be the sum
of Mr. Anderson's base monthly salary, net of required deductions, plus the
monthly value of his health and dental insurance, plus the monthly value of his
automobile allowance. The schedule of payments is as follows: (i) one lump sum
upfront payment equivalent to eight monthly installments, and (ii) the remaining
six equal installments was to be paid to him on or before the first business day
of each month, commencing on September 1, 2008. The lump sum payment was made to
Mr. Anderson, but the remaining six equal installments have not been made due to
Mr. Anderson's breach of the Severance Agreement (see "Item 3. LEGAL
PROCEEDINGS"). In addition, the Company paid a year end (December 31, 2007)
bonus of $30,000 to Mr. Anderson. The Severance Agreement also includes mutual
releases, specific waivers and releases, nondisclosure of confidential
information, return of property, future cooperation, non disparagement, and
general provisions customary in such agreements. Under the terms of the
Consulting Agreement, which was effective from January 1, 2008 through June 30,
2008, the Company was to pay Mr. Anderson $180,000 consisting of one upfront
payment of $60,000 and four equal monthly installments of $30,000 each,
commencing April 1, 2008, with the last payment due on July 1, 2008. The upfront
payment of $60,000 was paid to Mr. Anderson, but further payments have not been
made due to Mr. Anderson's breach of the Settlement Agreement (see "Item 3.
LEGAL PROCEEDINGS"). As additional compensation for special projects, such as
his services relating to the then-proposed acquisition of a specifically
identified hospital by the Company, Mr. Anderson would be entitled to receive
0.5% of the total value of the purchase, minus $30,000, or an estimated $310,000
if the acquisition was consummated at the then-proposed price. Such acquisition
was not consummated by the Company and therefore the estimated $310,000 is not
due or payable. The Consulting Agreement contains other provisions customary to
such agreements.
Pension benefits and Nonqualified Deferred Compensation tables are not
included as there are no items to report.
POTENTIAL PAYMENTS UPON TERMINATION
Each of the Company's Named Executive Officers have employment
agreements which provide, generally, for payments in the event of resignation
for cause. Cause includes, among other items, changes in job duties, reporting
relationships, bankruptcy of the Company or change in shareholders of over 50%
of the stock. Unless otherwise note, each Named Executive Officer would be
entitled to twelve months salary, benefits and health insurance, but not any
additional accruals of paid time off, vacation or sick pay.
The following table provides information concerning the estimated
payments and benefits that would be provided in the circumstances described
above for each of the Named Executive Officers. Payments and benefits are
estimated assuming that the triggering event took place on the last business day
of fiscal 2009 (March 31, 2009), and the price per share of the Company's common
stock is the closing price on the OTCBB as of that date ($0.02). There can be no
assurance that a triggering event would produce the same or similar results as
those estimated below if such event occurs on any other date or at any other
price, of if any other assumption used to estimate potential payments and
benefits is not correct. The amounts which would be due the Named Executive
Officers as of year end, if they resigned for cause is as follows.
58
PAYMENTS DUE UPON TERMINATION
Name
and Employee
Principal Health Car Other
Position Salary Insurance Allowance Benefits Total
-------- --------- --------- --------- -------- -----
Kenneth K. Westbrook $ 500,000 $ 3,631 $ 18,000 - $ 521,631
Chief Executive Officer(1)
Steven R. Blake $ 422,000 $ 9,657 $ 12,000 - $ 443,657
Chief Financial Officer &
Executive Vice President,
Finance(1)
Daniel J. Brothman $ 422,000 $ 4,397 $ 12,000 - $ 438,397
Senior Vice President,
Operations(1)
(1) Represents payments for 12 months per employment agreement.
COMPENSATION OF DIRECTORS
The following table provides information concerning the compensation of
our non-management directors during the fiscal year ended March 31, 2009.
DIRECTOR COMPENSATION
Fees earned Stock
or paid in cash options Total
Name ($) ($) ($)
- ------------------------ ----------------- --------------- -------------
Maurice J. DeWald 45,000 3,067 48,067
Hon. C. Robert Jameson 67,500 4,133 71,633
Ajay G. Meka, M.D. 28,750 3,200 31,950
Michael Metzler 56,970 4,133 61,103
J. Fernando Niebla 47,500 3,067 50,567
William E. Thomas 38,500 4,133 42,633
Our current compensation and reimbursement policy for Directors is as follows:
i. Cash - Each non-employee Director receives an annual fee of
$30,000 and an attendance fee of $1,500 for each Board meeting
attended, and a separate $1,000 fee for each committee meeting
attended. Committee Chairmen receive an additional annual
retainer of $5,000. The above fees were received in cash by
the named Directors during the year ended March 31, 2009.
ii. Stock - Options were granted to Directors during the year
ended March 31, 2008. Values for stock options represent the
amounts expensed by the Company in 2009. These amounts do not
represent the intrinsic or market value of the awards on the
date of grant, at year end or at present.
iii. Travel Reimbursement - All travel and related expenses
incurred by Directors to attend Board meetings, committee
meetings and other Company activities are reimbursed by the
Company.
Employee directors receive no compensation for Board service and the
Company does not provide any retirement benefits to non-employee directors.
Director Westbrook is not included above as all compensation paid to him is
included in the Summary Compensation Table.
59
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
For a discussion of securities authorized for issuance under equity
compensation plans, please refer to Item 5 above.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information known to us with respect to
the beneficial ownership of our common stock as of June 15, 2009, unless
otherwise noted, by:
o each shareholder known to us to own beneficially more than 5%
of our common stock;
o each of our directors and each of our executive officers at
March 31, 2009; and
o all of our current directors and executive officers as a
group.
Except as otherwise noted below, the address of each person or entity
listed on the table is 1301 North Tustin Avenue, Santa Ana, California 92705.
The address of Dr. Kali Chaudhuri and William E. Thomas is 6800 Indiana Avenue,
Suite 130, Riverside, CA 92506. The address of Dr. Anil V. Shah and Orange
County Physicians Investment Network, LLC is 2621 Bristol Street, Suite 108,
Santa Ana, CA 92704. The address for Healthcare Financial Management &
Acquisitions, Inc. and Medical Provider Financial Corporation III is c/o Medical
Capital Corporation, 15101 Red Hill Avenue, Tustin, CA 92780.
Beneficial Percentage
Name ownership (1) of total (2)
- -------------------------------------------------------------------------------------------
Directors and Executive Officers
Maurice J. DeWald 350,000 (3) *
Hon. C. Robert Jameson 116,666 (4) *
Ajay G. Meka, M.D. 233,333 (5) *
Michael Metzler 116,666 (6) *
J. Fernando Niebla 350,000 (7) *
William E. Thomas 9,865,164 (8) 5.0%
Kenneth K. Westbrook 1,000,000 (9) *
Steven R. Blake 200,000 (10) *
Daniel J. Brothman 1,000,000 (11) *
- -------------------------------------------------------------------------------------------
All current directors and
executive officers as a group (9 persons) 13,231,829 6.8%
PRINCIPAL SHAREHOLDERS (other than
those named above)
Orange County Physicians Investment Network, LLC 73,798,430 (12) 37.8%
Kali Chaudhuri, M.D. 182,858,316 (13) 65.3%
Anil V. Shah, M.D. 14,700,000 (14) 7.0%
Healthcare Financial Management
& Acquisitions,Inc. 179,692,444 (15) 47.9%
Medical Provider Financial
Corporation III 28,420,324 (16) 12.7%
* Less than 1%
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or investment
power with respect to securities. Shares of Common Stock subject to options,
warrants and convertible instruments that are exercisable or convertible
currently or within 60 days of June 15, 2009 are deemed outstanding for
computing the percentage of the person holding such option, warrant or
convertible instrument, but are not deemed outstanding for computing the
percentage of any other person. Except as reflected in the footnotes or pursuant
to applicable community property laws, the persons named in the table have sole
voting and investment power with respect to all shares of Common Stock
beneficially owned.
(2) Percentages are based on 195,307,262 shares of Common Stock outstanding as
of June 15, 2009, which does not include up to 15,866,271 shares of Common Stock
which may be issued under the Company's 2006 Stock Incentive Plan.
60
(3) Consists of a portion of a stock option award approved by the Board of
Directors which is exercisable within 60 days of June 16, 2008 pursuant to the
Company's 2006 Stock Incentive Plan.
(4) Consists of a portion of a stock option award approved by the Board of
Directors which is exercisable within 60 days of June 16, 2008 pursuant to the
Company's 2006 Stock Incentive Plan.
(5) Consists of a portion of a stock option award approved by the Board of
Directors which is exercisable within 60 days of June 16, 2008, pursuant to the
Company's 2006 Stock Incentive Plan. Dr. Meka is a member of Orange County
Physicians Investment Network, LLC ("OC-PIN") and disclaims beneficial ownership
of shares held by OC-PIN except to the extent of his pecuniary interest therein.
(6) Consists of a portion of a stock option award approved by the Board of
Directors which is exercisable within 60 days of June 16, 2008 pursuant to the
Company's 2006 Stock Incentive Plan.
(7) Consists of a portion of a stock option award approved by the Board of
Directors which is exercisable within 60 days of June 16, 2008 pursuant to the
Company's 2006 Stock Incentive Plan.
(8) Consists of 9,748,498 issued and outstanding shares and a portion of a stock
option award approved by the Board of Directors which is exercisable within 60
days of June 16, 2008 pursuant to the Company's 2006 Stock Incentive Plan.
(9) Consists of a portion of a stock option award approved by the Board of
Directors which is exercisable within 60 days of June 16, 2008 pursuant to the
Company's 2006 Stock Incentive Plan.
(10) Consists of a portion of a stock option award approved by the Board of
Directors which is exercisable within 60 days of June 16, 2008 pursuant to the
Company's 2006 Stock Incentive Plan.
(11) Consists of a stock option award approved by the Board of Directors which
is exercisable within 60 days of June 16, 2008 pursuant to the Company's 2006
Stock Incentive Plan.
(12) Consists of 59,098,430 issued and outstanding shares plus 14,700,000 shares
which may be acquired upon exercise of a stock purchase right.
(13) Consists of 98,001,334 issued and outstanding shares plus 84,856,982 shares
which may be acquired upon exercise of a warrant and stock purchase right.
(14) Consists of 14,700,000 shares which may be acquired upon exercise of a
stock purchase right.
(15) Healthcare Financial Management & Acquisitions, Inc., which is affiliated
with the Company's principal lender, Medical Capital Corporation, holds two
warrants to acquire 31.09% and 4.95% of the outstanding shares of Common Stock
of the Company.
(16) Medical Provider Financial Corporation III, which is affiliated with the
Company's principal lender, Medical Capital Corporation, holds a convertible
term note with a principal balance of $6.0 million convertible into Common Stock
of the Company at the rate of $0.21 per share.
61
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
TRANSACTIONS WITH RELATED PARTIES
GLOBAL SETTLEMENT AGREEMENT - Effective April 2, 2009, the Company, Dr.
Shah, OC-PIN, Mr. Mogel, PCHI, West Coast, Dr. Chaudhuri, Ganesha, Mr. Thomas,
and the Lender entered into a Settlement Agreement, General Release and Covenant
Not to Sue ("Global Settlement Agreement") in connection with the settlement of
pending and threatened litigation, arbitration, appellate, and other legal
proceedings (the "Actions") among the various parties. Pursuant to the Global
Settlement Agreement, the Company agreed to pay to OC-PIN and Dr. Shah a total
sum of $2.4 million in two installments consisting of $1.6 million at closing
and $750,000, together with interest thereon at 8%, payable on September 25,
2009 (the "Second Payment $750,000"). The Company also agreed to pay the sum of
$15,000 as satisfaction of Dr. Shah's individual claims. Additionally, the
Company and Mr. Mogel agreed to stipulate to the release and return of a $50,000
bond which was posted in connection with a shareholder derivative suit filed by
OC-PIN against both Mr. Mogel and the Company. All amounts payable by the
Company under the Global Settlement Agreement, totaling $2.4 million, are
accrued at March 31, 2009.
In addition, Dr. Shah covenanted and agreed, that for a period of 2
years after the Closing, he will not accept any nomination, appointment or will
not serve in the capacity as a director, officer, or employee of the Company, so
long as the Company keeps the PCHI and Chapman Medical Center leases current by
making payments within 45 days of when payments are due.
Also pursuant to the Global Settlement Agreement, Dr. Shah and OC-PIN
covenant not to sue or to assist anyone else in suing, directly or derivatively
on behalf of the Company, Dr. Chaudhuri or the Lender, and Dr. Chaudhuri and the
Lender covenant not to sue or to assist anyone else in suing, directly or
derivatively on behalf of the Company, Dr. Shah and OC-PIN. Dr. Shah and OC-PIN
also agreed to sign and deliver dismissals with prejudice of all Dr. Shah and
OC-PIN's claims in the Actions, and the Company, PCHI, and Dr. Chaudhuri agreed
to sign and deliver dismissals with prejudice of all of the Company, PCHI and
Dr. Chaudhuri claims against Dr. Shah and/or OC-PIN in the Actions. Furthermore,
all of the parties agreed to general releases discharging each and all of the
other parties from, among other things, any and all rights, suits, claims or
actions arising out of or otherwise related to the Actions.
Pursuant to the Global Settlement Agreement, the Company agreed to
amend its Bylaws to provide (i) that the number of members of the Company's
Board of Directors shall be fixed at 7 and (ii) that, effective immediately
after the Company's 2009 Annual Meeting of Shareholders, a shareholder who owns
15% or more of the voting stock of the Company is entitled to call one special
shareholders meeting per year. The Company also agreed to appoint an OC-PIN
representative to fill the seat to be vacated by Ken Westbrook, effective April
2, 2009, until the September 2009 annual meeting of shareholders. As of June 15,
2009, Mr. Westbrook is still a Director since OC-PIN's representative has not
been duly appointed by OC-PIN (see "First Meka Complaint" below).
Also pursuant to the Global Settlement Agreement, the Company entered
into Stock Purchase Agreements (the "2009 Stock Purchase Agreements") with Dr.
Shah, Dr. Chaudhuri and OC-PIN respectively. Pursuant to these 2009 Stock
Purchase Agreements, Dr. Shah and OC-PIN will receive an aggregate of 14.7
million shares of the Company's common stock each and Dr. Chaudhuri will receive
an aggregate of 30.6 million shares of the Company's common stock, for a price
of $0.03 per share (the "2009 Stock Purchase Shares"). The purchase and sale of
the Company's common stock under these agreements is still pending (see "First
Meka Complaint" below).
62
Pursuant to the Global Settlement Agreement, if either OC-PIN or Dr.
Shah chooses not to purchase all of their respective 2009 Stock Purchase Shares,
those 2009 Stock Purchase Shares which either party elects not to purchase may
be purchased by the other party. In the event that OC-PIN and Dr. Shah purchase,
in the aggregate, fewer 2009 Stock Purchase Shares than the maximum they were
entitled to purchase under the terms of their 2009 Stock Purchase Agreements,
Dr. Chaudhuri agreed that the number of 2009 Stock Purchase Shares that he is
entitled to purchase under his 2009 Stock Purchase Agreement shall be
automatically reduced to an amount which is 51% of the aggregate number of 2009
Stock Purchase Shares which Dr. Chaudhuri, OC-PIN and Dr. Shah actually purchase
under their 2009 Stock Purchase Agreements. OC-PIN and Dr. Shah also agreed to
provide notice to the Company and Dr. Chaudhuri regarding their choice to use as
a credit all or a portion of the Second Payment $750,000, and any interest
accrued thereon, toward OC-PIN and Dr. Shah's payment to IHHI for their
respective Stock Purchase Shares. IHHI also agreed that IHHI will use the net
proceeds of the sale of the Stock Purchase Shares to pay down the principal
balance of the Company's $10.7 million Convertible Term Note held by the Lender,
and the Lender agreed to advance to the Company additional funds equal to such
amount by which the $10.7 million Convertible Term Note is paid down. If
necessary, the Company agreed to use these additional funds to bring current the
PCHI and Chapman Medical Center leases (see "First Meka Complaint" below).
In conjunction with the Global Settlement Agreement, on April 2, 2009,
the Company and the Lender entered into the Amendment No. 1 to Credit Agreement
("Credit Amendment"). The Lender agreed to reduce the interest rate on the $45.0
million Term Note to simple interest of 10.25% (the "Debt Service Reduction")
and to maintain such interest rate up to and including the maturity date of the
Term Note, or any extension thereof, as defined in the $80 million credit
agreement, under which the $45.0 million Term Note was issued (the "Debt Service
Reduction Period"). The Credit Amendment also provided for an optional one year
extension of the maturity date of the $45.0 million Term Note and the $35.0
million Non-Revolving Line of Credit Note to October 8, 2011, provided that the
Company pay in full the unpaid principal balance due under the $10.7 million
Convertible Term Loan no later than January 30, 2010.
In conjunction with the Global Settlement Agreement, on April 2, 2009,
the Company and the Lender entered into the Amendment No. 1 to the $50.0 million
Revolving Credit Agreement which provides an optional one year extension of the
maturity date to October 8, 2011, provided that the Company pay in full the
unpaid principal balance due under the $10.7 million Convertible Term Loan no
later than January 30, 2010.
On April 2, 2009, the Company, OC-PIN, PCHI, West Coast, Ganesha, and
the Lender (the "Acknowledgement Parties") entered into the Acknowledgement,
Waiver and Consent and Amendment to Credit Agreements (the "Acknowledgement").
The Acknowledgement Parties agreed that if and to the extent that the
agreements, transactions and events contemplated in the Global Settlement
Agreement constitute, may constitute or will constitute a change of control,
default, event of default or other breach or default under the New Credit
Facilities, or any documents related to the New Credit Facilities, each
Acknowledgement Party waives and consents to the waiver of such event, breach or
default.
Pursuant to the Global Settlement Agreement, the Company and PCHI
entered into the Amendment to Amended and Restated Triple Net Hospital Building
Lease (the "2009 Lease Amendment"), whereby PCHI agreed to reduce the rent paid
by the Company under the Amended Lease by an amount equal to the Debt Service
Reduction (i.e., the difference between 14% and 10.25%) during the Debt Service
Reduction Period. The Company also agreed, pursuant to the Global Settlement
Agreement, to bring the PCHI lease and the Chapman Medical Center leases current
and to pay all arrearages due under the PCHI lease and the Chapman Medical
Center leases.
63
On April 24, 2009, a conglomeration of several OC-PIN members led by
Ajay G. Meka, M.D. filed a lawsuit against Dr. Shah, other OC-PIN members, and
various attorneys, alleging breach of fiduciary duty and seeking damages as well
as declaratory and injunctive relief (the "First Meka Complaint"). While the
Company is named as a defendant in the action, plaintiffs are only seeking
declaratory and injunctive relief with respect to various provisions of the
Global Settlement Agreement. Due to the competing demands related to the Stock
Purchase Agreements placed upon the Company from factions within OC-PIN, on May
13, 2009, the Company filed a Motion for Judicial Instructions regarding
enforcement of the Global Settlement Agreement. On May 14, 2009, the Company,
Dr. Shah, as well as both "factions" of OC-PIN entered into a "stand still"
agreement regarding both the nomination of an OC-PIN Board representative as
well as the allocation of shares under the Stock Purchase Agreements.
Subsequently, on June 22, 2009, the Court granted a stay of the Company's
remaining obligations under the Global Settlement Agreement until the resolution
of the Amended Meka Complaint and related actions.
On June 1, 2009, a First Amended Complaint was filed to replace the
First Meka Complaint (the "Amended Meka Complaint"). It appears that the relief
sought against the Company in the Amended Meka Complaint does not materially
alter from the declaratory and injunctive relief sought in the First Meka
Complaint. The Company believes it is a neutral stakeholder in the action, and
that the results of the action will not have a material adverse impact on the
Company's results of operations.
On April 14, 2009, the Company issued a letter (the "Demand Letter") to
the Lender notifying the Lender that it was in default of the $50 million
Revolving Credit Agreement, to make demand for return of all amounts collected
and retained by it in excess of the amounts due to it under the $50 million
Revolving Credit Agreement, and to reserve the rights of the borrowers and
credit parties with respect to other actions and remedies available to them. On
April 17, 2009, following receipt of a copy of the Demand Letter, the bank that
maintains the lock boxes pursuant to a restricted account and securities account
control agreement (the "Lockbox Agreement") notified the Company and the Lender
that it would terminate the Lockbox Agreement within 30 days. On May 18, 2009,
the Lockbox Agreement was terminated and the Company's bank accounts were
frozen. On May 19, 2009, the Lender relinquished any and all control over the
bank accounts pursuant to the Lockbox Agreement. The Lender's relinquishment
provided the Company with full access to its bank accounts and the accounts are
no longer accessible by the Lender. The Lender has not returned the amounts
collected and retained by it in excess of the amounts due to it under the $50
million Revolving Credit Agreement ($12.7 million as of June 15, 2009) and is
not advancing any funds to the Company under the $50 million Revolving Credit
Agreement. As a result, the Company relies solely on its cash receipts from
payers to fund its operations, and any significant disruption in such receipts
could have a material adverse effect on the Company's ability to continue as a
going concern.
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
$20,000 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 year ended March 31, 2009, the Company incurred expenses under
the agreement of $120,000.
During the years ended March 31, 2009 and 2008, the Company paid $6.2
million and $5.1 million, respectively, to a supplier that is also a shareholder
of the Company. The Company paid $170 and $114 to a physician investor during
the years ended March 31, 2009 and 2008, respectively.
REVIEW, APPROVAL OR RATIFICATION OF TRANSACTIONS WITH RELATED PARTIES
The Company's human resource written policies and procedures provide
guidance for conflicts of interest and their relation to the standards of
ethical behavior expected of employees. The policies specifically require
immediate written disclosure of any business, financial, or other relationship
that either creates, or is perceived to create a conflict of interest. The
Corporate Compliance Officer is responsible for monitoring compliance with this
policy.
64
As part of the quarterly disclosure control procedures, the Chief
Financial Officer and Chief Executive Officer for each hospital disclose or
certify that employees or officers have not acted in a manner inconsistent with
the Company policy related to Conflict of Interest. The CFO and Director of
Internal Audit monitor certifications for potential disclosure events.
Company policy requires the General Counsel to review and approve all
contracts involving related parties, including contracts with related parties
who are considered potential referral sources. The Audit Committee has requested
that the General Counsel provide periodic updates of such transactions to the
Committee.
During the acquisition, the Company entered into agreements with the
Medical Executive committee ("MEC") at the largest hospital, Western Medical
Center - Santa Ana ("WMC-SA") requiring MEC's advance consent for all agreements
involving hospital operations with related parties, excluding the lease
arrangements between the Company and PCHI. The same agreement was subsequently
offered to each of the other hospitals' medical staffs, but not ultimately
executed by them. Notwithstanding this fact, the Company applies the disclosure
provisions applicable to WMC-SA to all of its facilities.
DIRECTOR INDEPENDENCE
Directors DeWald, Meka, Metzler, and Niebla each satisfy the definition
of "independent director" as established in the NASDAQ listing standards.
Directors DeWald, Metzler, and Niebla constitute the Audit Committee of the
Board of Directors. The Company does not have a Nominating Committee as the
entire Board of Directors performs the functions of this committee and this
process has been adequate to handle the Board nomination process to date. The
Board of Directors has determined that Director DeWald is an "audit committee
financial expert" as defined in the SEC rules.
65
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The following table sets forth the aggregate fees that we incurred for
audit and non-audit services provided by BDO Seidman, LLP, which acted as our
independent registered public accounting firm for the years ended March 31, 2009
and 2008, and performed audit services for us during those periods. The audit
fees include only fees that are customary under generally accepted auditing
standards and are the aggregate fees that we incurred for professional services
rendered for the years ended March 31, 2009 and 2008.
For the year ended March 31,
----------------------------
2009 2008
------------ ------------
Audit fees (financial) $ 1,100,000 $ 1,293,000
Audit related fees 16,000 -
Tax fees 50,000 -
All other - -
------------ ------------
Total fees $ 1,166,000 $ 1,293,000
============ ============
The Audit Committee of the Board of Directors pre-approves all audit
and permissible non-audit services to be performed by the independent auditors.
The Board of Directors of the Company considered that the provision of the
services and the payment of the fees described above are compatible with
maintaining the auditors' independence.
66
ITEM 15. EXHIBITS; FINANCIAL STATEMENT SCHEDULES
Exhibits required to be filed are listed below and except where
incorporated by reference, immediately follow the Financial Statements. Each
document filed with this report is marked with an asterisk (*). References to
the "Commission" mean the U.S. Securities and Exchange Commission.
- -------------- -----------------------------------------------------------------
Exhibit
Number Description
- ------ -----------
- -------------- -----------------------------------------------------------------
3.1 Amended and Restated Articles of Incorporation (incorporated by
reference to Appendix A to the Registrant's Report on Form 14C
filed on March 17, 2009).
- -------------- -----------------------------------------------------------------
3.2 Amended and Restated Bylaws (incorporated by reference to Exhibit
3.1 to the Registrant's Current Report on Form 8-K filed with the
Commission on April 7, 2009).
- -------------- -----------------------------------------------------------------
4.1 Integrated Healthcare Holdings, Inc. 2006 Stock Incentive Plan
(incorporated by reference to Appendix B to the Registrant's
Definitive Proxy Statement on Schedule 14A filed by the
Registrant on November 14, 2006).
- -------------- -----------------------------------------------------------------
4.2 Form of Notice of Stock Option Award and Stock Option Agreement.
(incorporated herein by reference from Exhibit 4.5 to the
Registrant's Registration Statement under the Securities and
Exchange Act of 1933 on Form S-8 filed with the Commission on
February 2, 2007).
- -------------- -----------------------------------------------------------------
10.1 Employment Agreement, dated as of December 1, 2008, by and
between the Registrant and Mr. Kenneth K. Westbrook
(incorporated by reference to Exhibit 99.2 to the Registrant's
Report on Form 8-K filed on December 4, 2008).
- -------------- -----------------------------------------------------------------
10.2 Amendment #2 to Employment Agreement between Integrated
Healthcare Holdings, Inc. and Steven R. Blake (incorporated by
reference to Exhibit 99.1 to the Registrant's Report on Form 8-K
filed on April 8, 2008).
- -------------- -----------------------------------------------------------------
10.2.1 Amended Employment Agreement between Integrated Healthcare
Holdings, Inc. and Steven R. Blake(incorporated by reference to
Exhibit 99.1 to the Registrant's Report on Form 8-K filed on May
23, 2008).
- -------------- -----------------------------------------------------------------
10.3 Amended Employment Agreement between Integrated Healthcare
Holdings, Inc. and Daniel J. Brothman(incorporated by reference
to Exhibit 99.2 to the Registrant's Report on Form 8-K filed on
May 23, 2008).
- -------------- -----------------------------------------------------------------
10.4 Employment Agreement between Integrated Healthcare Holdings, Inc.
and Jeremiah R. Kanaly, dated as of September 10, 2007
(incorporated by reference to Exhibit 99.1 to the Registrant's
Report on Form 8-K filed on September 13, 2007).
- -------------- -----------------------------------------------------------------
10.5 Amended Employment Agreement of Bruce Mogel, dated as of
November 15, 2007 (incorporated by reference to Exhibit 99.1 to
the Registrant's Report on Form 8-K filed on November 19, 2007).
- -------------- -----------------------------------------------------------------
10.5.1 Resignation Agreement and General Release, dated as of
November 4, 2008, by and between the Registrant and Mr. Bruce
Mogel (incorporated by reference to Exhibit 99.1 to the
Registrant's Report on Form 8-K filed on November 7, 2008).
- -------------- -----------------------------------------------------------------
10.6 Severance Agreement with Mutual Releases of Larry B. Anderson,
as of December 31, 2007 (incorporated by reference to Exhibit
99.1 to the Registrant's Report on Form 8-K filed on January 7,
2008).
- -------------- -----------------------------------------------------------------
10.6.1 Consulting Agreement of Larry B. Anderson, as of December 31,
2007(incorporated by reference to Exhibit 99.2 to the
Registrant's Report on Form 8-K filed on January 7, 2008).
67
- -------------- -----------------------------------------------------------------
10.7 Legal representation agreement between Integrated Healthcare
Holdings, Inc. and William E. Thomas, Inc. (a Professional Law
Corporation) (incorporated by reference to Exhibit 99.1 to the
Registrant's Report on Form 8-K filed on September 26, 2008).
- -------------- -----------------------------------------------------------------
10.8 Full and Final Settlement and Mutual Release Agreement, effective
as of December 1, 2008, by and between the Registrant and Ajay
Meka, M.D. and Salman Naqvi, M.D. (incorporated by reference to
Exhibit 99.1 to the Registrant's Report on Form 8-K filed on
December 4, 2008).
- -------------- -----------------------------------------------------------------
10.9 Triple Net Hospital and Medical Office Building Lease dated March
7, 2005, as amended by Amendment No. 1 To Triple Net Hospital and
Medical Office Building Lease (incorporated herein by reference
from Exhibit 99.9 to the Registrant's Current Report on Form 8-K
filed with the Commission on March 14, 2005).
- -------------- -----------------------------------------------------------------
10.9.1 Amended and Restated Triple Net Hospital Building Lease
(incorporated by reference to Exhibit 99.10 to the Registrant's
Report on Form 8-K filed on October 15, 2007).
- -------------- -----------------------------------------------------------------
10.9.2 Amendment to Amended and Restated Triple Net Hospital Building
Lease, dated as of March 27, 2009, by and between Pacific Coast
Holdings Investment, LLC, and Integrated Healthcare Holdings,
Inc. (incorporated by reference to Exhibit 10.8 to the
Registrant's Report on Form 8-K filed on April 7, 2009).
- -------------- -----------------------------------------------------------------
10.10 $80,000,000 Credit Agreement, dated October 9, 2007 (incorporated
by reference to Exhibit 99.1 to the Registrant's Report on Form
8-K filed on October 15, 2007).
- -------------- -----------------------------------------------------------------
10.10.1 $45,000,000 Term Note, dated October 9, 2007 (incorporated by
reference to Exhibit 99.2 to the Registrant's Report on Form 8-K
filed on October 15, 2007).
- -------------- -----------------------------------------------------------------
10.10.2 $35,000,000 Non-Revolving Line of Credit Note, dated October 9,
2007 (incorporated by reference to Exhibit 99.3 to the
Registrant's Report on Form 8-K filed on October 15, 2007).
- -------------- -----------------------------------------------------------------
10.10.3 Amendment to $80,000,000 Credit Agreement, dated as of April 2,
2009, by and among Integrated Healthcare Holdings, Inc., WMC-SA,
Inc., WMC-A, Inc., Chapman Medical Center, Inc., Coastal
Communities Hospital, Inc., Pacific Coast Holdings Investment,
LLC, Orange County Physicians Investment Network, LLC, Ganesha
Realty, LLC, West Coast Holdings, LLC, and Medical Provider
Financial Corporation II (incorporated by reference to Exhibit
10.6 to the Registrant's Report on Form 8-K filed on April 7,
2009).
- -------------- -----------------------------------------------------------------
10.11 $50,000,000 Revolving Credit Agreement, dated October 9, 2007
(incorporated by reference to Exhibit 99.4 to the Registrant's
Report on Form 8-K filed on October 15, 2007).
- -------------- -----------------------------------------------------------------
10.11.1 $50,000,000 Revolving Line of Credit Note, dated October 9, 2007
(incorporated by reference to Exhibit 99.5 to the Registrant's
Report on Form 8-K filed on October 15, 2007).
- -------------- -----------------------------------------------------------------
10.11.2 Amendment No. 1 to $50,000,000 Revolving Credit Agreement, dated
June 10, 2008 (incorporated by reference to Exhibit 10.11.1 to
the Registrant's Annual Report on Form 10-K filed on July 14,
2008).
- -------------- -----------------------------------------------------------------
10.11.3 Amendment No. 2 to $50,000,000 Revolving Credit Agreement, dated
June 20, 2008 (incorporated by reference to Exhibit 10.11.2 to
the Registrant's Annual Report on Form 10-K filed on July 14,
2008).
68
- -------------- -----------------------------------------------------------------
10.11.4 Amendment to $50,000,000 Revolving Credit Agreement, dated as of
April 2, 2009, by and among Integrated Healthcare Holdings, Inc.,
WMC-SA, Inc., WMC-A, Inc., Chapman Medical Center, Inc., Coastal
Communities Hospital, Inc., Pacific Coast Holdings Investment,
LLC, Orange County Physicians Investment Network, LLC, Ganesha
Realty, LLC, West Coast Holdings, LLC, and Medical Provider
Financial Corporation I (incorporated by reference to Exhibit
10.5 to the Registrant's Report on Form 8-K filed on April 7,
2009).
- -------------- -----------------------------------------------------------------
10.12 $10,700,000 Credit Agreement, dated October 9, 2007 (incorporated
by reference to Exhibit 99.6 to the Registrant's Report on Form
8-K filed on October 15, 2007).
- -------------- -----------------------------------------------------------------
10.12.1 $10,700,000 Convertible Term Note, dated October 9, 2007
(incorporated by reference to Exhibit 99.7 to the Registrant's
Report on Form 8-K filed on October 15, 2007).
- -------------- -----------------------------------------------------------------
10.13 4.95% Common Stock Warrant, dated October 9, 2007 (incorporated
by reference to Exhibit 99.8 to the Registrant's Report on Form
8-K filed on October 15, 2007).
- -------------- -----------------------------------------------------------------
10.13.1 Amendment No. 1 to Common Stock Warrant, dated effective as of
July 18, 2008 (4.95% Warrant), between the Company and Healthcare
Financial Management & Acquisitions, Inc. (incorporated by
reference to Exhibit 10.2.1 to the Registrant's Report on Form
8-K filed on July 21, 2008).
- -------------- -----------------------------------------------------------------
10.14 31.09% Common Stock Warrant, dated December 12, 2005
(incorporated by reference to Exhibit 99.4 to the Registrant's
Report on Form 8-K filed on December 20, 2005).
- -------------- -----------------------------------------------------------------
10.14.1 Amendment No. 1 to 31.09% Common Stock Warrant, dated April 26,
2006 (incorporated by reference to Exhibit 10.16.1 to the
Registrant's Annual Report on Form 10-K filed on July 14, 2008).
- -------------- -----------------------------------------------------------------
10.14.2 Amendment No. 2 to 31.09% Common Stock Warrant, dated October 9,
2007 (incorporated by reference to Exhibit 99.9 to the
Registrant's Report on Form 8-K filed on October 15, 2007).
- -------------- -----------------------------------------------------------------
10.14.3 Amendment No. 3 to Common Stock Warrant, dated effective as of
July 18, 2008 (31.09% Warrant), between the Company and
Healthcare Financial Management & Acquisitions, Inc.
(incorporated by reference to Exhibit 10.2.2 to the Registrant's
Report on Form 8-K filed on July 21, 2008).
- -------------- -----------------------------------------------------------------
10.15 Settlement Agreement and Mutual Release (incorporated by
reference to Exhibit 99.11 to the Registrant's Report on Form
8-K filed on October 15, 2007).
- -------------- -----------------------------------------------------------------
10.16 Securities Purchase Agreement, dated effective as of July 18,
2008, among the Company, Kali P. Chaudhuri, M.D., and William E.
Thomas (incorporated by reference to Exhibit 10.1 to the
Registrant's Report on Form 8-K filed on July 21, 2008).
- -------------- -----------------------------------------------------------------
10.16.1 Amendment No. 1 to Securities Purchase Agreement, dated as of
January 30, 2009, among the Company, Kali P. Chaudhuri, M.D., and
William E. Thomas (incorporated by reference to Exhibit 10.1 to
the Registrant's Report on Form 8-K filed on February 2, 2009).
- -------------- -----------------------------------------------------------------
10.16.2 Amendment No. 2 to Securities Purchase Agreement, dated as of
March 6, 2009, among the Company, Kali P. Chaudhuri, M.D., and
William E. Thomas (incorporated by reference to Exhibit 10.1 to
the Registrant's Report on Form 8-K filed on March 10, 2009).
- -------------- -----------------------------------------------------------------
10.17 Early Loan Payoff Agreement, dated effective as of July 18, 2008,
among the Company; WMC-SA, Inc.; WMC-A, Chapman Medical Center,
Inc.; Coastal Communities Hospital, Inc.; Medical Provider
Financial Corporation I; Medical Provider Financial Corporation
II, Medical Provider Financial Corporation III; and Healthcare
Financial Management & Acquisitions, Inc. (incorporated by
reference to Exhibit 10.2 to the Registrant's Report on Form 8-K
filed on July 21, 2008).
69
- -------------- -----------------------------------------------------------------
10.17.1 Amendment No. 1 to Early Loan Payoff Agreement, dated as of
January 30, 2009, among the Company; WMC-SA, Inc.; WMC-A, Chapman
Medical Center, Inc.; Coastal Communities Hospital, Inc.; Medical
Provider Financial Corporation I; Medical Provider Financial
Corporation II, Medical Provider Financial Corporation III; and
Healthcare Financial Management & Acquisitions, Inc.
(incorporated by reference to Exhibit 10.2 to the Registrant's
Report on Form 8-K filed on February 2, 2009).
- -------------- -----------------------------------------------------------------
10.18 Settlement Agreement, General Release and Covenant Not to Sue,
dated March 25, 2009, by and among the Registrant, Anil V. Shah,
M.D., Orange County Physicians Investment Network, LLC, Bruce
Mogel, Pacific Coast Holdings Investment, LLC, West Coast
Holdings, LLC, Dr. Kali P. Chaudhuri, Ganesha Realty, LLC,
William E. Thomas, Medical Capital Corporation, Medical Provider
Financial Corporation I, Medical Provider Financial Corporation
II and Medical Provider Financial Corporation III (incorporated
by reference to Exhibit 10.1 to the Registrant's Report on Form
8-K filed on April 7, 2009).
- -------------- -----------------------------------------------------------------
10.19 Stock Purchase Agreement, dated as of April 2, 2009, by and
between Integrated Healthcare Holdings, Inc. and Dr. Kali P.
Chaudhuri (incorporated by reference to Exhibit 10.2 to the
Registrant's Report on Form 8-K filed on April 7, 2009).
- -------------- -----------------------------------------------------------------
10.20 Stock Purchase Agreement, dated as of April 2, 2009, by and
between Integrated Healthcare Holdings, Inc. and Dr. Anil V. Shah
(incorporated by reference to Exhibit 10.3 to the Registrant's
Report on Form 8-K filed on April 7, 2009).
- -------------- -----------------------------------------------------------------
10.21 Stock Purchase Agreement, dated as of April 2, 2009, by and
between Integrated Healthcare Holdings, Inc. and Orange County
Physicians Investment Network, LLC (incorporated by reference to
Exhibit 10.4 to the Registrant's Report on Form 8-K filed on
April 7, 2009).
- -------------- -----------------------------------------------------------------
10.22 Acknowledgement, Waiver and Consent and Amendment to Credit
Agreements, dated as of April 2, 2009, by and among Integrated
Healthcare Holdings, Inc., Anil V. Shah, M.D., Orange County
Physicians Investment Network, LLC, Bruce Mogel, Pacific Coast
Holdings Investment, LLC, West Coast Holdings, LLC, Dr. Kali P.
Chaudhuri, Ganesha Realty, LLC, William E. Thomas, Medical
Capital Corporation, Medical Provider Financial Corporation I,
Medical Provider Financial Corporation II and Medical Provider
Financial Corporation III (incorporated by reference to Exhibit
10.7 to the Registrant's Report on Form 8-K filed on April 7,
2009).
- -------------- -----------------------------------------------------------------
21.1 The subsidiaries of the Registrant are WMC-SA, Inc., a California
corporation, WMC-A, Inc., a California corporation, Chapman
Medical Center, Inc., a California corporation, Coastal
Communities Hospital, Inc., a California corporation, and Mogel
Management, Inc., a Nevada corporation.
- -------------- -----------------------------------------------------------------
23.1 Consent of BDO Seidman, LLP *
- -------------- -----------------------------------------------------------------
31.1 Certification of Chief Executive Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002 *
- -------------- -----------------------------------------------------------------
31.2 Certification of Chief Financial Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002 *
- -------------- -----------------------------------------------------------------
32.1 Certification of Chief Executive Officer Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002 *
- -------------- -----------------------------------------------------------------
32.2 Certification of Chief Financial Officer Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002 *
- -------------- -----------------------------------------------------------------
70
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
INTEGRATED HEALTHCARE HOLDINGS, INC.
Dated: June 26, 2009 /s/ Kenneth K. Westbrook
----------------------------------------
Kenneth K. Westbrook
Chief Executive Officer & President
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Dated: June 26, 2009 /s/ Kenneth K. Westbrook
----------------------------------------
Kenneth K. Westbrook
Chief Executive Officer, President & Director
(Principal Executive Officer)
Dated: June 26, 2009 /s/ Steven R. Blake
----------------------------------------
Steven R. Blake
Chief Financial Officer
(Principal Financial Officer)
Dated: June 26, 2009 /s/ Jeremiah R. Kanaly
----------------------------------------
Jeremiah R. Kanaly
Chief Accounting Officer and Treasurer
(Principal Accounting Officer)
Dated: June 26, 2009 /s/ Maurice J. DeWald
----------------------------------------
Maurice J. DeWald
Chairman of the Board of Directors
Dated: June 26, 2009 /s/ Hon. C. Robert Jameson
----------------------------------------
Hon. C. Robert Jameson
Director
Dated: June 26, 2009 /s/ Ajay Meka, M.D.
----------------------------------------
Ajay Meka, M.D
Director
Dated: June 26, 2009 /s/ Michael Metzler
----------------------------------------
Michael Metzler
Director
Dated: June 26, 2009 /s/ J. Fernando Niebla
----------------------------------------
J. Fernando Niebla
Director
Dated: June 26, 2009 /s/ William E. Thomas
----------------------------------------
William E. Thomas
Director
71
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
Integrated Healthcare Holdings, Inc.
Santa Ana, California
We have audited the accompanying consolidated balance sheets of Integrated
Healthcare Holdings, Inc. ("Company") as of March 31, 2009 and 2008 and the
related consolidated statements of operations, stockholders' deficiency, and
cash flows for each of the two years in the period ended March 31, 2009. In
connection with our audits of the consolidated financial statements, we have
also audited the financial statement schedules listed as Schedule II in the
accompanying index (Item 8). These consolidated financial statements and
schedules are the responsibility of the Company's management. Our responsibility
is to express an opinion on these consolidated financial statements and
schedules based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. The Company
is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audits included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company's internal control
over financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements, assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall presentation of the consolidated financial statements and
schedules. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Integrated Healthcare Holdings, Inc. at March 31, 2009 and 2008, and the
consolidated results of its operations and its cash flows for each of the two
years in the period ended March 31, 2009, in conformity with accounting
principles generally accepted in the United States of America.
Also, in our opinion, the financial statement schedules, when considered in
relation to the basic consolidated financial statements taken as a whole,
present fairly, in all material respects, the information set forth therein.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has suffered recurring losses
from operations, has a significant working capital deficit and has a net
stockholder's deficiency at March 31, 2009. These factors raise substantial
doubt about its ability to continue as a going concern. Management's plans in
regard to these matters are also described in Note 1. The consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
/s/ BDO Seidman, LLP
Costa Mesa, CA
June 26, 2009
F-1
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
(amounts in 000's, except par value)
March 31, March 31,
2009 2008
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents $ 3,514 $ 3,141
Restricted cash 18 20
Accounts receivable, net of allowance for doubtful
accounts of $17,377 and $14,383, respectively 55,876 57,482
Inventories of supplies, at cost 5,742 5,853
Due from governmental payers 4,297 4,877
Due from lender 5,576 --
Prepaid insurance 339 721
Other prepaid expenses and current assets 5,097 5,811
--------- ---------
Total current assets 80,459 77,905
Property and equipment, net 55,414 56,917
Debt issuance costs, net 123 759
--------- ---------
Total assets $ 135,996 $ 135,581
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Debt $ 80,968 $ 95,579
Accounts payable 59,265 46,681
Accrued compensation and benefits 16,809 14,701
Due to governmental payers -- 1,690
Accrued insurance retentions 11,212 12,332
Other current liabilities 6,265 5,781
--------- ---------
Total current liabilities 174,519 176,764
Capital lease obligations, net of current portion
of $835 and $406, respectively 6,703 6,375
Minority interest in variable interest entity -- 1,150
--------- ---------
Total liabilities 181,222 184,289
--------- ---------
Commitments, and contingencies and subsequent events
Stockholders' deficiency:
Common stock, $0.001 par value; 400,000 shares authorized;
195,307 and 137,096 shares issued and outstanding, respectively 195 137
Additional paid in capital 61,080 56,148
Accumulated deficit (106,501) (104,993)
--------- ---------
Total stockholders' deficiency (45,226) (48,708)
--------- ---------
Total liabilities and stockholders' deficiency $ 135,996 $ 135,581
========= =========
The accompanying notes are an integral part of these consolidated financial statements.
F-2
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in 000's, except per share amounts)
For the years ended March 31,
--------------------------
2009 2008
--------- ---------
Net operating revenues $ 393,015 $ 367,721
--------- ---------
Operating expenses:
Salaries and benefits 212,764 209,680
Supplies 51,431 50,126
Provision for doubtful accounts 42,241 30,958
Other operating expenses 70,495 68,959
Loss on sale of accounts receivable -- 4,079
Depreciation and amortization 3,593 3,134
--------- ---------
380,524 366,936
--------- ---------
Operating income 12,491 785
--------- ---------
Other expense:
Interest expense, net (12,437) (13,209)
Warrant expense (22) (11,404)
Change in fair value of derivative -- (14,273)
--------- ---------
(12,459) (38,886)
--------- ---------
Income (loss) before provision for income
taxes and minority interest 32 (38,101)
Provision for income taxes (290) (28)
Minority interest (Note 11) (1,250) (1,474)
--------- ---------
Net loss $ (1,508) $ (39,603)
========= =========
Per Share Data:
Loss per common share
Basic ($ 0.01) ($ 0.30)
Diluted ($ 0.01) ($ 0.30)
Weighted average shares outstanding
Basic 160,183 131,869
Diluted 160,183 131,869
The accompanying notes are an integral part of these consolidated financial statements.
F-3
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIENCY
(amounts in 000's)
Additional
Common Stock Paid-in Accumulated
Shares Amount Capital Deficit Total
----------- ----------- ----------- ----------- -----------
Balance, March 31, 2007 116,304 $ 116 $ 25,589 $ (65,390) $ (39,685)
Exercise of warrants 20,792 21 4,761 -- 4,782
Issuance of warrants -- -- 25,677 -- 25,677
Share-based compensation -- -- 121 -- 121
Net loss -- -- -- (39,603) (39,603)
----------- ----------- ----------- ----------- -----------
Balance, March 31, 2008 137,096 137 56,148 (104,993) (48,708)
Exercise of warrants 58,211 58 4,674 -- 4,732
Issuance of right to purchase stock -- -- 80 -- 80
Issuance of warrants -- -- 22 -- 22
Share-based compensation -- -- 156 -- 156
Net loss -- -- -- (1,508) (1,508)
----------- ----------- ----------- ----------- -----------
Balance, March 31, 2009 195,307 $ 195 $ 61,080 $ (106,501) $ (45,226)
=========== =========== =========== =========== ===========
The accompanying notes are an integral part of these consolidated financial statements.
F-4
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in 000's)
For the year ended March 31,
--------------------------
2009 2008
----------- -----------
Cash flows from operating activities:
Net loss $ (1,508) $ (39,603)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization of property and equipment 3,593 3,134
Provision for doubtful accounts 42,241 30,958
Amortization of debt issuance costs 879 236
Common stock warrant expense 22 11,404
Change in fair value of warrant liability -- 14,273
Minority interest in net loss of variable interest entity 1,250 1,474
Noncash share-based compensation expense 156 121
Loss on disposition of property and equipment 195 --
Changes in operating assets and liabilities:
Accounts receivable (40,635) (69,070)
Security reserve funds -- 7,990
Deferred purchase price receivable -- 23,765
Inventories of supplies 111 91
Due from governmental payers 580 (3,499)
Prepaid insurance, other prepaid expenses and
current assets, and other assets 853 2,063
Accounts payable 12,584 5,238
Accrued compensation and benefits 2,108 2,127
Due to governmental payers (1,690) 768
Accrued insurance retentions and other current liabilities (636) (2,729)
----------- -----------
Net cash provided by (used in) operating activities 20,103 (11,259)
----------- -----------
Cash flows from investing activities:
Decrease in restricted cash 2 4,948
Additions to property and equipment (842) (921)
----------- -----------
Net cash (used in) provided by investing activities (840) 4,027
----------- -----------
Cash flows from financing activities:
Proceeds from (paydown on) revolving line of credit, net (9,879) 3,090
Excess funds due from lender (5,576) --
Proceeds from (paydown on) convertible note (4,732) 2,658
Long term debt issuance costs -- (1,493)
Issuance of common stock 4,732 --
Issuance of right to purchase common stock 80 576
Variable interest entity distribution (2,400) (2,040)
Payments on capital lease obligations, net (1,115) (262)
----------- -----------
Net cash (used in) provided by financing activities (18,890) 2,529
----------- -----------
Net increase (decrease) in cash and cash equivalents 373 (4,703)
Cash and cash equivalents, beginning of period 3,141 7,844
----------- -----------
Cash and cash equivalents, end of period $ 3,514 $ 3,141
=========== ===========
The accompanying notes are an integral part of these consolidated financial statements.
F-5
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
NOTE 1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
LIQUIDITY AND MANAGEMENT'S PLANS - The accompanying consolidated
financial statements have been prepared on a going concern basis, which
contemplates the realization of assets and settlement of obligations in the
normal course of business. As of March 31, 2009, Integrated Healthcare Holdings,
Inc. (the "Company") has a working capital deficit of $94.1 million and
accumulated stockholders' deficiency of $45.2 million. The Company's $50.0
million Revolving Credit Agreement provides estimated liquidity as of March 31,
2009 of $36.7 million based on eligible receivables, as defined. However, as of
March 31, 2009, the Lender had collected and retained $5.6 million ($12.7
million as of June 15, 2009) in excess of the amounts due to it under the $50
million Revolving Credit Agreement (Notes 5 and 14).
During the year ended March 31, 2009, the Company experienced
significant delays in the funding of advances under its $50.0 million Revolving
Credit Agreement. During this time, the Lender experienced delays in funding
advances in accordance with advance requests submitted by the Company. As of
March 31, 2009, the unfulfilled advance requests aggregated approximately $17.0
million. As noted above, as of March 31, 2009, the Lender had collected and
retained $5.6 million ($12.7 million as of June 15, 2009) in excess of the
amounts due to it under the $50 million Revolving Credit Agreement (Notes 5 and
14). The $5.6 million is reflected as due from Lender in the accompanying
consolidated balance sheet as of March 31, 2009.
At March 31, 2009, the Company was in compliance with all covenants, as
amended. However, given the history of non-compliance and high unlikelihood of
compliance in fiscal year 2010, the Company's noncurrent debt of $81.0 million
will continue to be classified as current in the accompanying consolidated
balance sheet as of March 31, 2009 (Note 5).
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 and expedited reimbursements from
governmental payers and managed care over the past year and is aggressively
seeking to obtain future increases and expedited payments. The Company is
seeking to reduce operating expenses while continuing to maintain service
levels. The Company is actively seeking alternate lending sources with
sufficient liquidity to service its financing requirements. There can be no
assurance that the Company will be successful in improving reimbursements,
reducing operating expenses or securing replacement financing.
DESCRIPTION OF BUSINESS - The Company was organized under the laws of
the State of Utah on July 31, 1984 under the name of Aquachlor Marketing.
Aquachlor Marketing never engaged in business activities. In December 1988,
Aquachlor Marketing merged with Aquachlor, Inc., a Nevada corporation
incorporated on December 20, 1988. The Nevada Corporation became the surviving
entity and changed its name to Deltavision, Inc. In March 1997, Deltavision,
Inc. received a Certificate of Revival from the State of Nevada using the name
First Deltavision, Inc. In March 2004, First Deltavision, Inc. changed its name
to Integrated Healthcare Holdings, Inc. In these consolidated financial
statements, the Company refers to Integrated Healthcare Holdings, Inc. and its
subsidiaries.
Prior to March 8, 2005, the Company was a development stage enterprise
with no material operations and no revenues from operations. On September 29,
2004, the Company entered into a definitive agreement to acquire four hospitals
(the "Hospitals") from subsidiaries of Tenet Healthcare Corporation ("Tenet"),
and completed the transaction on March 8, 2005 (the "Acquisition") (Note 2). The
Hospitals are:
o 282-bed Western Medical Center in Santa Ana, California;
o 188-bed Western Medical Center in Anaheim, California;
o 178-bed Coastal Communities Hospital in Santa Ana, California;
and
o 114-bed Chapman Medical Center in Orange, California.
F-6
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
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.
BASIS OF PRESENTATION - The accompanying consolidated financial
statements include the accounts of the Company and its wholly owned
subsidiaries.
The Company has also determined that Pacific Coast Holdings Investment,
LLC ("PCHI") (Note 11), is a variable interest entity as defined in Financial
Accounting Standards Board ("FASB") Interpretation Number ("FIN") 46R, and,
accordingly, the financial statements of PCHI are included in the accompanying
consolidated financial statements.
All significant intercompany accounts and transactions have been
eliminated in consolidation. Unless otherwise indicated, all amounts included in
these notes to the consolidated financial statements are expressed in thousands
(except per share amounts, percentages and stock option prices and values).
RECLASSIFICATION FOR PRESENTATION - Certain immaterial amounts
previously reported have been reclassified to conform to the current period's
presentation.
CONCENTRATION OF CREDIT RISK - The Company has secured its working
capital and its long term debt from the same Lender (Note 5) and, thus, is
subject to significant credit risk if they are unable to perform.
The Hospitals are subject to licensure by the State of California and
accreditation by the Joint Commission on Accreditation of Healthcare
Organizations. Loss of either licensure or accreditation would impact the
ability to participate in various governmental and managed care programs, which
provide the majority of the Company's revenues.
Essentially all net operating revenues come from external customers.
The largest payers are the Medicare and Medicaid programs accounting for 60.7%
and 66.4% of the net operating revenues for the years ended March 31, 2009 and
2008, respectively. No other payers represent a significant concentration of the
Company's net operating revenues.
USE OF ESTIMATES - The accompanying consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
in the United States of America ("U.S. GAAP") and prevailing practices for
investor owned entities within the healthcare industry. The preparation of
consolidated financial statements in conformity with U.S. GAAP requires
management to make estimates and assumptions that affect the amounts reported in
the consolidated financial statements and accompanying notes. Principal areas
requiring the use of estimates include third-party cost report settlements, risk
sharing programs, and patient receivables. 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.
During the year ended March 31, 2008 the Company received payments for
indigent care under California section 1011. In the absence of prior experience
and due to the uncertainty of future payment, these were recorded as income when
received. In connection with an evaluation of eligibility determination and
collection experience for the year ended March 31, 2009, the Company concluded
that the expected payments constituted a receivable that was reasonably certain
and recorded this as a change in estimate in accordance with SFAS No. 154,
"Accounting Changes and Error Corrections." As of March 31, 2009, the Company
established a receivable in the amount of $1.4 million related to discharges
from July 1, 2008 through March 31, 2009 deemed eligible to meet program
criteria.
F-7
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
REVENUE RECOGNITION - Net operating revenues are recognized in the
period in which services are performed and are recorded based on established
billing rates (gross charges) less estimated discounts for contractual
allowances, principally for patients covered by Medicare, Medicaid, managed care
and other health plans. Gross charges are retail charges. They are not the same
as actual pricing, and they generally do not reflect what a hospital is
ultimately paid and therefore are not displayed in the consolidated statements
of operations. Hospitals are typically paid amounts that are negotiated with
insurance companies or are set by the government. Gross charges are used to
calculate Medicare outlier payments and to determine certain elements of payment
under managed care contracts (such as stop-loss payments). Because Medicare
requires that a hospital's gross charges be the same for all patients
(regardless of payer category), gross charges are also what the Hospitals charge
all other patients prior to the application of discounts and allowances.
Revenues under the traditional fee-for-service Medicare and Medicaid
programs are based primarily on prospective payment systems. Discounts for
retrospectively cost based revenues and certain other payments, which are based
on the Hospitals' cost reports, are estimated using historical trends and
current factors. Cost report settlements for retrospectively cost-based revenues
under these programs are subject to audit and administrative and judicial
review, which can take several years until final settlement of such matters are
determined and completely resolved. Estimates of settlement receivables or
payables related to a specific year are updated periodically and at year end and
at the time the cost report is filed with the fiscal intermediary. Typically no
further updates are made to the estimates until the final Notice of Program
Reimbursement is received, at which time the cost report for that year has been
audited by the fiscal intermediary. There could be 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 receivables of $1,618
and settlement payables of $12 as of March 31, 2009 and 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, 2008 was a decrease from $22.185 to $20.045. CMS projects this will
result in an Outlier Percentage that is approximately 5.1% of total payments.
The Medicare fiscal intermediary calculates the cost of a claim by multiplying
the billed charges by the cost-to-charge ratio from the hospital's most recent
filed cost report.
F-8
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
The Hospitals received new provider numbers following the acquisition
in 2005 and, because there was no specific history, the Hospitals were
reimbursed for outliers based on published statewide averages. If the computed
cost exceeds the sum of the DRG payment plus the fixed threshold, a hospital
receives 80% of the difference as an outlier payment. Medicare has reserved the
option of adjusting outlier payments, through the cost report, to a hospital's
actual cost-to-charge ratio. Upon receipt of the current payment cost-to-charge
ratios from the fiscal intermediary, any variance between current payments and
the estimated final outlier settlement are examined by the Medicare fiscal
intermediary. The Company recorded $755 in Final Notice of Program Reimbursement
settlements during the year ended March 31, 2008. As of March 31, 2009, the
Company has reversed all reserves for excess outlier payments. As of March 31,
2008, the Company reserved all amounts for excess outlier payments due to the
difference between the Hospitals actual cost to charge rates and the statewide
average in the amount of $1,678. These reserves are combined with third party
settlement estimates and are included in due to government payers as a net
payable of $0 and $1,690 as of March 31, 2009 and 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 SB 1100 and SB 1255 programs. The Hospitals received
supplemental payments of $21,859 and $16,175 during the years ended March 31,
2009 and 2008, respectively. The related revenue recorded for the years ended
March 31, 2009 and 2008 was $19,660 and $19,375, respectively. As of March 31,
2009 and 2008, estimated DSH receivables of $2,679 and $4,877 are included in
due from governmental payers in the accompanying consolidated balance sheets.
During the year ended March 31, 2009 and 2008, the Company received a lump sum
amendment to the CMAC agreement for $3.7 and $4.8 million, respectively.
The following is a summary of due from and due to governmental payers
as of March 31:
March 31 March 31
2009 2008
----------- -----------
Due from government payers
Medicare $ 1,618 $ --
Medicaid 2,679 4,877
----------- -----------
$ 4,297 $ 4,877
=========== ===========
Due to government payers
Medicare $ -- $ (12)
Outlier -- (1,678)
----------- -----------
$ -- $ (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.
F-9
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
The Hospitals provide charity care to patients whose income level is
below 300% of the Federal Poverty Level. Patients with income levels between
300% and 350% of the Federal Poverty Level qualify to pay a discounted rate
under AB774 based on various government program reimbursement levels. Patients
without insurance are offered assistance in applying for Medicaid and other
programs they may be eligible for, such as state disability, Victims of Crime,
or county indigent programs. Patient advocates from the Hospitals' Medical
Eligibility Program ("MEP") screen patients in the hospital and determine
potential linkage to financial assistance programs. They also expedite the
process of applying for these government programs. Based on average revenue for
comparable services from all other payers, revenues foregone under the charity
policy, including indigent care accounts, were $8.2 and $8.0 million for the
years ended March 31, 2009 and 2008, respectively.
Receivables from patients who are potentially eligible for Medicaid are
classified as Medicaid pending under the MEP, with appropriate contractual
allowances recorded. If the patient does not qualify for Medicaid, the
receivables are reclassified to charity care and written off, or they are
reclassified to self-pay and adjusted to their net realizable value through the
provision for doubtful accounts. Reclassifications of Medicaid pending accounts
to self-pay do not typically have a material impact on the results of operations
as the estimated Medicaid contractual allowances initially recorded are not
materially different than the estimated provision for doubtful accounts recorded
when the accounts are reclassified. All accounts classified as pending Medicaid,
as well as certain other governmental receivables, over the age of 180 days were
fully reserved in contractual allowances as of March 31, 2009 and 2008. In June
2007, the Company evaluated its historical experience and changed to a graduated
reserve percentage based on the age of governmental accounts. The impact of the
change was not material.
The Company is not aware of any material claims, disputes, or unsettled
matters with any payers that would affect revenues that have not been adequately
provided for in the accompanying consolidated financial statements.
PROVISION FOR DOUBTFUL ACCOUNTS - The Company provides for accounts
receivable that could become uncollectible by establishing an allowance to
reduce the carrying value of such receivables to their estimated net realizable
value. The Hospitals estimate this allowance based on the aging of their
accounts receivable, historical collections experience for each type of payer
and other relevant factors. There are various factors that can impact the
collection trends, such as changes in the economy, which in turn have an impact
on unemployment rates and the number of uninsured and underinsured patients,
volume of patients through the emergency department, the increased burden of
copayments to be made by patients with insurance and business practices related
to collection efforts. These factors continuously change and can have an impact
on collection trends and the estimation process.
The Company's policy is to attempt to collect amounts due from
patients, including copayments and deductibles due from patients with insurance,
at the time of service while complying with all federal and state laws and
regulations, including, but not limited to, the Emergency Medical Treatment and
Labor Act ("EMTALA"). Generally, as required by EMTALA, patients may not be
denied emergency treatment due to inability to pay. Therefore, until the legally
required medical screening examination is complete and stabilization of the
patient has begun, services are performed prior to the verification of the
patient's insurance, if any. In nonemergency circumstances or for elective
procedures and services, it is the Hospitals' policy, when appropriate, to
verify insurance prior to a patient being treated.
F-10
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
TRANSFERS OF FINANCIAL ASSETS - Prior to the refinancing (Note 5)
effective October 9, 2007 (when the Company terminated its Accounts Purchase
Agreement (Note 3) and repurchased all its previously sold receivables), the
Company sold substantially all of its billed accounts receivable to a financial
institution. The Company accounted for its sale of accounts receivable in
accordance with SFAS No. 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities - A replacement of SFAS No.
125." A transfer of financial assets in which the Company had surrendered
control over those assets was accounted for as a sale to the extent that
consideration other than beneficial interests in the transferred assets was
received in exchange. Control over transferred assets was surrendered only if
all of the following conditions were met:
1. The transferred assets have been isolated from the transferor (i.e.,
they are beyond the reach of the transferor and its creditors);
2. Each transferee has the unconditional right to pledge or exchange
the transferred assets it received; and
3. The Company does not maintain effective control over the transferred
assets either (a) through an agreement that entitles and obligates
the transferor to repurchase or redeem the transferred assets before
their maturity or (b) through the ability to unilaterally cause the
holder to return specific assets, other than through a cleanup call.
If a transfer of financial assets did not meet the criteria for a sale
as described above, the Company and transferee accounted for the transfer as a
secured borrowing with pledge of collateral and, accordingly, the Company was
prevented from derecognizing the transferred financial assets. Where
derecognizing criteria were met and the transfer was accounted for as a sale,
the Company removed financial assets from the consolidated balance sheet and a
net loss was recognized in income at the time of sale. There were no transfers
of financial assets during the year ended March 31, 2009.
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. Cash balances held at limited financial institutions at times are
in excess of federal depository insurance limits. The Company has not
experienced any losses on cash and cash equivalents.
As of March 31, 2009, cash and cash equivalents includes approximately
$3.5 million deposited in lock box accounts that are swept daily by the Lender
under various credit agreements (Note 5). As of March 31, 2009, the Lender had
collected and retained $5.6 million ($12.7 million as of June 15, 2009) in
excess of the amounts due to it under the $50 million Revolving Credit Agreement
(Notes 5 and 14).
LETTERS OF CREDIT - At March 31, 2009 and 2008, the Company had
outstanding standby letters of credit totaling $1.5 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 5).
INVENTORIES OF SUPPLIES - Inventories of supplies are valued at the
lower of weighted average cost or market.
PROPERTY AND EQUIPMENT - Property and equipment are stated at cost,
less accumulated depreciation and any impairment write-downs related to assets
held and used. Additions and improvements to property and equipment are
capitalized at cost. Expenditures for maintenance and repairs are charged to
expense as incurred. Capital leases are recorded at the beginning of the lease
term as property and equipment and a corresponding lease liability is
recognized. The value of the property and equipment under capital lease is
recorded at the lower of either the present value of the minimum lease payments
or the fair value of the asset. Such assets, including improvements, are
amortized over the shorter of either the lease term or their estimated useful
life, where applicable.
The Company uses the straight-line method of depreciation for buildings
and improvements, and equipment over their estimated useful lives of 25 years
and 3 to 15 years, respectively.
F-11
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
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. During the
year ended March 31, 2009, the Company recorded an impairment in the carrying
value of the Company's property and equipment at March 31, 2009 (Note 4).
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 5). 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 5)
entered into on the October 9, 2007 effective date of the $50.0 million
Revolving Line of Credit were accounted for as extinguishment of existing debt
in accordance with EITF 96-19, "Debtor's Accounting for a Modification or
Exchange of Debt Instruments," and EITF 06-6, "Debtor's Accounting for a
Modification (or Exchange) of Convertible Debt Instruments." Accordingly, debt
issuance costs consisting of loan origination fees of $1.4 million paid to the
Lender associated with those credit agreements were expensed as an interest
charge during the year ended March 31, 2008. Debt issuance costs of $878.8 and
$236.3 were amortized during the years ended March 31, 2009 and 2008,
respectively (including $17.8 in unamortized costs related to the $4.7 million
paydown on the Convertible Note (Note 5) and $370.0 related to the Lender's non
performance under the $50 million Revolving Line of Credit (Note 14)). At March
31, 2009 and 2008, prepaid expenses and other current assets in the accompanying
consolidated balance sheets included $254.9 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 8).
FAIR VALUE OF FINANCIAL INSTRUMENTS - The Company's financial
instruments recorded in the consolidated balance sheets include cash and cash
equivalents, restricted cash, receivables, accounts payable, and other
liabilities, all of which are recorded at current value which equals fair value.
The Company's debt is also considered a financial instrument for which the
Company is unable to reasonably determine the 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 year ended
March 31, 2009. 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.
F-12
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
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 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 5 and 6), which were subsequently required to be
accounted for as derivative liabilities. A derivative is an instrument whose
value is derived from an underlying instrument or index such as a future,
forward, swap, or option contract, or other financial instrument with similar
characteristics, including certain derivative instruments embedded in other
contracts ("embedded derivatives") and for hedging activities. As a matter of
policy, the Company does not invest in separable financial derivatives or engage
in hedging transactions. However, the Company may engage in complex transactions
in the future that also may contain embedded derivatives. Derivatives and
embedded derivatives, if applicable, are measured at fair value and marked to
market through earnings.
WARRANTS - In connection with its Acquisition of the Hospitals and
credit agreements, the Company entered into complex transactions that contain
warrants requiring accounting treatment in accordance with SFAS No. 133,
"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 5 and 6).
INCOME (LOSS) PER COMMON SHARE - Income (loss) per share is calculated
in accordance with SFAS No. 128, "Earnings per Share." Basic income (loss) per
share is based upon the weighted average number of common shares outstanding
(Note 10). 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 in the accompanying consolidated statements of
operations.
SUPPLEMENTAL CASH FLOW INFORMATION - Interest paid during the years
ended March 31, 2009 and 2008 was $11.4 million and $11.3 million, respectively.
The Company made cash payments for taxes of $37 during the year ended
March 31, 2009 and $3 during the year ended March 31, 2008.
The Company entered into new capital lease obligations of $1.5 million
and $958 during the years ended March 31, 2009 and 2008, respectively. During
the year ended March 31, 2008, the Company reclassified warrant liability of
$25,677 to equity. The Company had non cash exercises of warrants of $0 and
$4,206 during the years ended March 31, 2009 and 2008, respectively. During the
year ended March 31, 2008, in conjunction with the Company's refinancing
effective, October 9, 2007, the Accounts Purchase Agreement was terminated and
the Company repurchased the remaining outstanding accounts that been sold, for
$6.8 million (funded through the initial advance on the $50.0 million Revolving
Line of Credit) in addition to the release of security reserve funds and
deferred purchase price receivables.
F-13
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
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, 2004 and December 31, 2003, 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.
F-14
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
RECENTLY ENACTED ACCOUNTING STANDARDS - In February 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 effect of the adoption of SFAS No. 141(R) will depend upon the nature and
terms of any future business combinations the Company undertakes.
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 is in the process of evaluating 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.
F-15
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
In May 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 and
requires retrospective implementation. Based on preliminary assessment,
application is not deemed to have a material impact.
In June 2008, the FASB issued EITF 07-5, "Determining Whether an
Instrument (or Embedded Feature) Is Indexed to an Entity's Own Stock" ("EITF
07-5"). The Issue requires entities to evaluate whether an equity-linked
financial instrument (or embedded feature) is indexed to its own stock in order
to determine if the instrument should be accounted for as a derivative under the
scope of FASB Statement No. 133, "Accounting for Derivative Instruments and
Hedging Activities." EITF 07-5 is effective for financial statements issued for
fiscal years beginning after December 15, 2008 and interim periods within those
fiscal years. The Company is currently evaluating the impact, if any, that the
adoption of EITF 07-5 will have on its consolidated financial statements.
NOTE 2 - ACQUISITION
On March 8, 2005, the Company completed the Acquisition of its
Hospitals for $66.2 million. 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.
F-16
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
NOTE 3 - ACCOUNTS RECEIVABLE
In March 2005, the Company entered into an Accounts Purchase Agreement
(the "APA") for a minimum of two years with Medical Provider Financial
Corporation I, an unrelated party (the "Buyer"). The Buyer is an affiliate of
the Lender (Note 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 for $6.8 million in
addition to the release of security reserve funds and deferred purchase price
receivables.
The loss on sale of accounts receivable for the year ended March 31,
2008 is comprised of the following.
Transaction Fees deducted from Security
Reserve Funds - closed purchases $ 2,395
Change in accrued Transaction Fees - open purchases (712)
--------------
Total Transaction Fees incurred 1,683
--------------
Servicing expense for sold accounts receivable
- closed purchases 3,186
Change in accrued servicing expense for sold accounts
receivable - open purchases (790)
--------------
Total servicing expense incurred 2,396
--------------
Loss on sale of accounts receivable $ 4,079
==============
NOTE 4 - PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
March 31, March 31,
2009 2008
--------------- ---------------
Buildings $ 33,606 $ 33,791
Land and improvements 13,523 13,523
Equipment 11,223 10,520
Assets under capital leases 8,991 7,464
--------------- ---------------
67,343 65,298
Less accumulated depreciation (11,929) (8,381)
--------------- ---------------
Property and equipment, net $ 55,414 $ 56,917
=============== ===============
Essentially all land and buildings are owned by PCHI (Notes 12, 13 and
14). In October 2008, a building owned by PCHI was partially destroyed by a
fire. The Company has recorded an impairment of property and equipment for
$194.8 in the accompanying consolidated statement of operations for the year
ended March 31, 2009. PCHI's insurance carrier is continuing its review of the
loss.
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.
F-17
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
In addition, the State of California has imposed new hospital seismic
safety requirements. Under these new requirements, the Hospitals must meet
stringent seismic safety criteria in the future and must complete one set of
seismic upgrades to each facility by January 1, 2013. This first set of upgrades
is expected to require the Company to incur substantial seismic retrofit
expenses. In addition, there could be other remediation costs pursuant to this
seismic retrofit.
The State of California has introduced a new seismic review methodology
known as HAZUS. The HAZUS methodology may preclude the need for some structural
modifications. Three of the four Hospitals requested HAZUS review and 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 5 - DEBT
The Company's debt payable to affiliates of Medical Capital
Corporation, namely Medical Provider Financial Corporation I, Provider Financial
Corporation II, and Medical Provider Financial Corporation III (collectively,
the "Lender") consists of the following as of March 31.
2009 2008
------- -------
Current:
Revolving line of credit, outstanding borrowings $ -- $ 9,879
Convertible note 5,968 10,700
Secured term note 45,000 45,000
Secured non-revolving line of credit, outstanding
borrowings 30,000 30,000
------- -------
$80,968 $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, subsequently amended (Note 14).
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.
F-18
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
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
(Note 14), (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 6).
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 6) resulted in the effective borrowing rate of the New Credit
Facilities to significantly exceed the effective rate of the previous credit
facilities.
The nondetachable conversion feature of the $10.7 million Convertible
Term Note is out-of-the-money on the Effective Date. Pursuant to EITF 05-2, "The
Meaning of `Conventional Convertible Debt Instrument' in Issue No. 00-19," the
$10.7 million Convertible Term Note is considered conventional for purposes of
applying EITF 00-19.
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 $36.7 million of additional availability under its $50.0 million
Revolving Line of Credit at March 31, 2009. However, during the year ended March
31, 2009, the Company experienced significant delays in the funding of advances
under its $50.0 million Revolving Credit Agreement. During this time, the Lender
experienced delays in funding advances in accordance with advance requests
submitted by the Company. As of March 31, 2009, the unfulfilled advance requests
aggregated approximately $17.0 million and, as of March 31, 2009, the Lender had
collected and retained $5.6 million in excess of the amounts due to it ("Excess
Amounts") under the $50 million Revolving Credit Agreement (Note 14). The Lender
applies monthly interest charges relating to all of the New Credit Facilities
against the Excess Amounts. At March 31, 2009, the Excess Amounts represented
approximately 8 months of future interest charges. 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.
F-19
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
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.As of March 31,
2009, the Company was not in compliance with the amended Minimum Fixed Charge
Coverage Ratio of 0.4. 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. The Company's noncurrent debt of $81.0 million
continues to be classified as current in the accompanying consolidated balance
sheet as of March 31, 2009.
During the year ended March 31, 2009, 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 year ended March 31, 2009.
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 13). 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 13).
Effective April 2, 2009, the Company entered into the Global Settlement
Agreement (Note 14) which affected the terms of the New Credit Facilities.
Additionally, on April 14, 2009, the Company notified the Lender that the Lender
was in default of the $50 million Revolving Credit Agreement (Note 14).
NOTE 6 - COMMON STOCK WARRANTS
RESTRUCTURING WARRANTS - The Company entered into a Rescission,
Restructuring and Assignment Agreement with Dr. Kali Chaudhuri and Mr. William
Thomas on January 27, 2005 (the "Restructuring Agreement"). Pursuant to the
Restructuring Agreement, the Company issued warrants to purchase up to 74.7
million shares of the Company's common stock (the "Restructuring Warrants") to
Dr. Chaudhuri and Mr. Thomas (not to exceed 24.9% of the Company's fully diluted
capital stock at the time of exercise). In addition, the Company amended the
Real Estate Option to provide for Dr. Chaudhuri's purchase of a 49% interest in
PCHI for $2.45 million.
The Restructuring Warrants were exercisable beginning January 27, 2007
and expire on July 27, 2008. The exercise price for the first 43.0 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. 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.
F-20
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
During February 2007, Dr. Chaudhuri and Mr. Thomas submitted an
exercise under these warrants to the Company. At March 31, 2007 the Company
recorded the issuance of 28.7 million net shares under this exercise following
resolution of certain legal issues relating thereto. The issuance of these
shares resulted in an addition to paid in capital and to common stock totaling
$9.2 million. These shares were issued to Dr. Chaudhuri and Mr. Thomas on July
2, 2007. The shares pursuant to this exercise were recorded as issued and
outstanding at March 31, 2007. Additionally, the remaining liability was
revalued at March 31, 2007 in the amount of $4.2 million relating to potential
shares (20.8 million shares) which could be issued, if the December Note warrant
was to become issuable, which occurred on June 13, 2007 upon receipt of a notice
of default from the Lender.
On July 2, 2007, the Company accepted, due to the default and
subsequent vesting of the December Note Warrant, an additional exercise under
the anti-dilution provisions the Restructuring Warrant Agreement by Dr.
Chaudhuri and Mr. Thomas. The exercise resulted in additional shares issuable of
20.8 million shares for consideration of $576 in cash. The effect of this
exercise resulted in additional warrant expense for the year ended March 31,
2007 of $693, which was accrued based on the transaction as of March 31, 2007.
The related warrant liability of $4.2 million (as of March 31, 2007) was
reclassified to additional paid in capital when the 20.8 million shares were
issued to Dr. Chaudhuri and Mr. Thomas in July 2007.
Upon the Company's refinancing (Note 5) and the issuance of the New
Warrants, the remaining 24.9 million Restructuring Warrants held by Dr.
Chaudhuri and Mr. Thomas became exercisable on the Effective Date. Accordingly,
as of the Effective Date, the Company recorded warrant expense, and a related
warrant liability, of $1.2 million relating to the Restructuring Warrants. 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 5), the Company issued to an affiliate of the Lender a
five-year warrant to purchase the greater of approximately 16.9 million shares
of the Company's common stock or up to 4.95% of the Company's common stock
equivalents, as defined, at $0.21 per share (the "4.95% Warrant"). In addition,
the Company and the Lender entered into Amendment No. 2 to Common Stock Warrant,
originally dated December 12, 2005, which entitles an affiliate of the Lender to
purchase the greater of 26.1 million shares of the Company's common stock or up
to 31.09% of the Company's common stock equivalents, as defined, at $0.21 per
share (the "31.09% Warrant"). Amendment No. 2 to the 31.09% Warrant extended the
expiration date of the Warrant to October 9, 2017, removed the condition that it
only be exercised if the Company is in default 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.
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. On February 27, 2009, the shareholders of the
Company approved an increase in the Company's authorized shares of common stock
from 400 million to 500 million. After filing and mailing an Information
Statement on Schedule 14C to all stockholders, the Company amended its Articles
of Incorporation on April 8, 2009.
F-21
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
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 fair value as of July 18, 2008 was $22).
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 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.
On January 30, 2009, the Company entered into an amendment of the
Purchase Agreement ("Amended Purchase Agreement"). Under the Purchase Agreement,
Dr. Chaudhuri had the right to invest up to $7.0 million in the Company through
the purchase of 63.4 million shares of common stock at $0.11 per share. The
Purchase Right expired on January 10, 2009. Under the Amended Purchase
Agreement, Dr. Chaudhuri agreed to purchase immediately from the Company 33.3
million shares of Company common stock (the "Additional Shares") at a purchase
price of $0.03 per share, or an aggregate purchase price of $1.0 million (the
fair value as of January 30, 2009 was less than $1). In consideration for Dr.
Chaudhuri's entry into the Amended Purchase Agreement and payment to the Company
of $30, under the Amended Purchase Agreement the Company granted to Dr.
Chaudhuri the right, in Dr. Chaudhuri's sole discretion (subject to the Company
having sufficient authorized capital), to invest at any time and from time to
time through January 30, 2010 up to $6.0 million through the purchase of shares
of the Company's common stock at a purchase price of $0.11 per share (the
"Amended Purchase Right").
F-22
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
Concurrently with the execution of the Amended Purchase Agreement, the
Company and its subsidiaries entered into an amendment of the Payoff Agreement.
MPFC III, which is a party to the SPA Amendment, holds a convertible term note
in the original principal amount of $10.7 million issued by the Company on
October 9, 2007. Under the Amended Payoff Amendment, the Company agreed to pay
to its Lender $1.0 million as partial repayment of the $7.0 million outstanding
principal balance of the $10.7 million Convertible Term Note upon receipt of
$1.0 million from Dr. Chaudhuri's purchase of the Additional Shares. The Company
is also obligated under the Amended Payoff Agreement to use the proceeds it
receives from future exercises, if any, of Dr. Chaudhuri's Amended Purchase
Right under the Amended Purchase Agreement toward early payoff of the remaining
balance of the $10.7 million Convertible Term Note.
Since the Amended Purchase Agreement resulted in a change in control as
defined by the Internal Revenue Code ("IRC") Section 382, the Company is subject
to limitations on the use of its net operating loss carryforwards (Note 7).
NOTE 7 - INCOME TAXES
The preparation of consolidated financial statements in conformity with
U.S. GAAP requires the Company to make estimates and assumptions that affect the
reported amount of tax-related assets and liabilities and income tax provisions.
The Company assesses the recoverability of the deferred tax assets on an ongoing
basis. In making this assessment the Company is required to consider all
available positive and negative evidence to determine whether, based on such
evidence, it is more likely than not that some portion or all of the net
deferred assets will be realized in future periods. This assessment requires
significant judgment. In addition, the Company has made significant estimates
involving current and deferred income taxes, tax attributes relating to the
interpretation of various tax laws, historical bases of tax attributes
associated with certain tangible and intangible assets and limitations
surrounding the realization of the deferred tax assets. The Company does not
recognize current and future tax benefits until it is deemed probable that
certain tax positions will be sustained.
The provision for income taxes consisted of the following:
For the years ended
-----------------------------------
March 31, 2009 March 31, 2008
-------------- -----------------
Current income tax provision
Federal $ 130 $ 23
State 160 5
-------------- -----------------
290 28
-------------- -----------------
Deferred income tax benefit
Federal - -
State - -
-------------- -----------------
- -
-------------- -----------------
Income tax provision $ 290 $ 28
============== =================
F-23
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
A reconciliation between the amount of reported income tax expense and
the amount computed by multiplying loss from continuing operations before income
taxes by the statutory federal income tax rate is as follows:
For the years ended
-----------------------------------
March 31, 2009 March 31, 2008
-------------- -----------------
U.S. federal statutory income taxes $ (513) $ (13,238)
State and local income taxes, net
of federal benefits (87) (2,258)
Change in valuation allowance 766 2,180
Warrants - 8,730
Enterprise zone credits 41 (4,023)
Variable interest entity 425 501
Deferred tax adjustments (356) 8,107
Other 14 29
-------------- -----------------
Income tax provision $ 290 $ 28
============== =================
Deferred income taxes reflect the tax effects of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amount used for income tax purposes. The following table
discloses those significant components of deferred tax assets and liabilities,
including the valuation allowance at March 31:
2009 2008
-------------- --------------
Deferred tax assets:
Allowance for doubtful accounts $ 7,501 $ 6,219
Accrued vacation 2,262 2,169
Tax credits 18,896 18,936
Net operating losses 12,032 11,924
State taxes (7,821) (7,743)
Accrued insurance 3,827 4,210
Other (26) 190
-------------- --------------
36,671 35,905
Valuation allowance (36,671) (35,905)
-------------- --------------
Total deferred tax assets $ - $ -
============== ==============
The company has two Hospitals located in the State of California
Enterprise Zone which has provided significant state tax credits ($18,905 as of
March 31, 2009) which are allowable to reduce California income tax on a
dollar-for-dollar basis. The credits, which are not subject to expiration, are
granted by a State agency whose issuance can be reviewed by the California
Franchise Tax Board.
The valuation allowances above were recorded based on an assessment of
the realization of deferred tax assets as described below. The Company assesses
the realization of deferred tax assets to determine whether an income tax
valuation allowance is required. The Company recorded a 100% valuation allowance
on its deferred tax based primarily on the following factors:
o cumulative losses in recent years;
o income/losses expected in future years;
o unsettled circumstances that, if unfavorably resolved, would
adversely affect future operations and profit levels;
o the availability, or lack thereof, of taxable income in
prior carryback periods that would limit realization of tax
benefits;
o the carryforward period associated with the deferred tax
assets and liabilities.
F-24
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
ACQUISITION - The Acquisition was an asset purchase transaction and the
Company will not benefit from the net operating losses of the acquired Hospitals
prior to the date of acquisition. In connection with the Company's completion of
the Acquisition in March 2005, the Company sold substantially all of the real
estate of the acquired hospitals to PCHI. For income tax purposes, the sale of
the real estate of the acquired hospitals is subject to review by the Internal
Revenue Service. The IRS could require the Company to report dividend and/or
interest income. If the Company is required to report dividend and/or interest
income in connection with this transaction, the Company would be required to
withhold 28% on any deemed dividend or interest income. The Company's sale of
real estate to PCHI on March 8, 2005 for $5 million plus the assumption of the
Acquisition Loan is a taxable event to the Company.
PCHI TAX STATUS - PCHI is a limited liability corporation. PCHI's
owners plan to make tax elections for it to be treated as a disregarded entity
for tax reporting whereby, in a manner similar to a partnership. PCHI's taxable
income or loss will flow through to its owners and be their separate
responsibility. Accordingly, the accompanying consolidated financial statements
do not include any amounts for the income tax expense or benefit, or liabilities
related to PCHI's income or loss.
The Company has net operating loss ("NOL") carryfowards which expire as
follows:
Tax year ending Federal State
March 31, amount expiring amount expiring
-------------------- ------------------- -------------------
2013 $ - $ 2
2014 $ - $ 1,552
2015 $ - $ 70
2016 $ - $ 12,569
2017 $ - $ 571
2025 $ 9,255 $ -
2026 $ 20,307 $ -
2027 $ 592 $ -
2028 $ 1,396 $ -
The utilization of NOL and credit carryforwards are limited under the
provisions of the Internal Revenue Code (IRC) Section 382 and similar state
provisions. Section 382 of the IRC of 1986 generally imposes an annual
limitation on the amount of NOL carryforwards that may be used to offset taxable
income where a corporation has undergone significant changes in stock ownership.
During the year ended March 31, 2009, the Company entered into the Amended
Purchase Agreement (Note 6) which resulted in a change in control. The Company
completed an analysis as of March 31, 2009, and determined that it is subject to
significant IRC Section 382 limitations. For Federal tax purposes, the Company's
utilization of NOL carryforwards is subject to significant IRC Section 382
limitations, and these limitations have been incorporated into the tax provision
calculation.
F-25
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
NOTE 8 - 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 March 31, 2009, the maximum aggregate number
of shares under the Plan was 15.9 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 December 2, 2008, the Board of Directors approved the granting of
options with the right to purchase 2.0 million shares of the Company's common
stock to the CEO pursuant to the Plan. The grant price approved on that day is
$0.01 per share. One-third of the options vested on the grant date and the
remaining options will vest in eight equal quarterly installments on each fiscal
quarter-end of the Company beginning with the quarter ending March 31, 2009. The
aggregate fair value of these options were estimated at $6.8 using the
Black-Scholes valuation model.
On August 6, 2007, the Board of Directors approved the initial granting
of options with the right to purchase an aggregate of 4,795 shares of the
Company's common stock to eligible employees pursuant to the Plan. The grant
price approved on that date is $0.26 per share. For options granted to employees
who have been employed by the Company since its March 8, 2005 inception, vesting
retroactively commenced on March 8, 2005. Of the total options granted, 3,500
are subject to this retroactive vesting. Vesting of the remaining 1,295 granted
options commenced on the August 6, 2007 grant date.
On October 10, 2007, the Board of Directors approved the granting of
options with the right to purchase an aggregate of 1,750 shares of the Company's
common stock to members of the Board pursuant to the Plan. The grant price
approved on that date is $0.18 per share. Of the total options granted, 883.33
were subject to immediate vesting on the grant date. Vesting of the remaining
866.67 granted options commenced on the October 10, 2007 grant date.
On December 13, 2007, the Company granted options to employees with the
right to purchase an aggregate of 210 shares at an exercise prices of $0.30 per
share. All options granted on December 13, 2007 commenced vesting on the grant
date.
On January 8, 2008, the Company granted options to employees with the
right to purchase an aggregate of 760 shares at an exercise prices of $0.26 per
share. For options granted to employees who have been employed by the Company
since its March 8, 2005 inception, vesting retroactively commenced on March 8,
2005. Of the total options granted on January 8, 2008, 130 are subject to
retroactive vesting commencing on March 8, 2005. Vesting of the remaining 630
granted options commenced on the January 8, 2008 grant date.
F-26
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
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)
The risk-free interest rate is based on the average yield on U.S.
Treasury zero-coupon issues with remaining terms equal to the expected terms of
the options. The dividend yield reflects that the Company has not paid any cash
dividends since inception and does not anticipate paying cash dividends in the
foreseeable future.
Expected dividend yield 0.0%
Risk-free interest rate 1.4% - 4.4%
Expected volatility 30.6% - 42.4%
Expected term (in years) 3.5 - 5.8
In accordance with SFAS No. 123R, the Company recorded $156.0 and
$120.9 of compensation expense relative to stock options during the years ended
March 31, 2009 and 2008, respectively. No options were granted prior to August
6, 2007. No options were exercised during the years ended March 31, 2009 and
2008. A summary of stock option activity for the years ended March 31, 2009 and
2008 is presented as follows.
Weighted-
average
Weighted- Weighted remaining
average average contractual Aggregate
exercise grant date term intrinsic
Shares price fair value (years) value
----------------- ----------------- ----------- ------------------ ---------------
Outstanding, March 31, 2007 - $ -
Granted 7,515 $ 0.24 $ 0.04
Exercised - $ -
Forfeited or expired (70) $ 0.26
-----------------
Outstanding, March 31, 2008 7,445 $ 0.24
Granted 2,600 $ 0.03 $ 0.01
Exercised - $ -
Forfeited or expired (1,210) $ 0.18
-----------------
Outstanding, March 31, 2009 8,835 $ 0.19 5.5 $ -
================= ================= ========== ================== ================
Exercisable at March 31, 2009 6,585 $ 0.21 5.4 $ -
================= ================= ========== ================== ================
A summary of the Company's nonvested options as of March 31, 2009, and changes
during the years ended March 31, 2009 and 2008 is presented as follows.
Weighted-
average
grant date
Shares fair value
------------------ -----------------
Nonvested at March 31, 2007 - $ -
Granted 7,515 $ 0.04
Vested (4,463) $ 0.03
Forfeited (70) $ 0.08
------------------
Nonvested at March 31, 2008 2,982 $ 0.03
Granted 2,600 $ 0.01
Vested (2,406) $ 0.03
Forfeited (926) $ 0.04
------------------ =================
Nonvested at March 31, 2009 2,250 $ 0.03
================== =================
F-27
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
As of March 31, 2009, there was $79.7 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
2.1 years.
NOTE 9 - 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 years ended March 31, 2009 and 2008, the Company incurred
expenses of $3,039 and $2,982, respectively, which are included in salaries and
benefits in the accompanying consolidated statements of operations.
NOTE 10 - INCOME (LOSS) PER SHARE
Income (loss) per share has been calculated under SFAS No. 128,
"Earnings per Share." SFAS No. 128 requires companies to compute income (loss)
per share under two different methods, basic and diluted. Basic income (loss)
per share is calculated by dividing the net income (loss) by the weighted
average shares of common stock outstanding during the period. Diluted income
(loss) per share is calculated by dividing the net income (loss) by the weighted
average shares of common stock outstanding during the period and dilutive
potential shares of common stock. Dilutive potential shares of common stock, as
determined under the treasury stock method, consist of shares of common stock
issuable upon exercise of stock warrants or options, net of shares of common
stock assumed to be repurchased by the Company from the exercise proceeds.
Since the Company incurred losses for the years ended March 31, 2009
and 2008, antidilutive potential shares of common stock, consisting of
approximately 332 million and 200 million, respectively, issuable under warrants
and stock options have been excluded from the calculations of diluted loss per
share for those periods.
NOTE 11 - 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 5)). The Company remains primarily liable as the borrower 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. PCHI is a related
party entity that is affiliated with the Company through common ownership and
control. As of March 31, 2009, it was owned 51% by West Coast Holdings, LLC (Dr.
Shah and investors) and 49% by Ganesha Realty, LLC (Dr. Chaudhuri and Mr.
Thomas). Under FIN 46R (Note 1), a company is required to consolidate the
financial statements of any entity that cannot finance its activities without
additional subordinated financial support, and for which one company provides
the majority of that support through means other than ownership. Effective March
8, 2005, the Company determined that it provided the majority of financial
support to PCHI through various sources including lease payments, remaining
primarily liable under the $45.0 million Term Note, and cross-collateralization
of the Company's non-real estate assets to secure the $45.0 million Term Note.
Accordingly, the Company included the net assets of PCHI, net of consolidation
adjustments, in its consolidated balance sheet at March 31, 2009 and 2008.
F-28
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
At March 31, 2009, the minority interest related to PCHI was in a
deficit position, resulting in a charge to the Company's earnings of $1,337.5,
consisting of a net loss of $137.5 and distributions of $1,200.0 incurred by
PCHI since its members' equity went into a deficit position during the year
ended March 31, 2009.
Year ended March 31,
--------------------------
2009 2008
-------- --------
Minority interest in (income) loss
of variable interest entity $ 88 $ (1,474)
Minority interest deficiency
absorbed by the Company (1,338) --
-------- --------
Minority interest $ (1,250) $ (1,474)
======== ========
Prior to consolidation with the Company, PCHI's assets and liabilities
at March 31, 2009 and 2008 are set forth below.
March 31, March 31,
2009 2008
----------- -----------
Cash 27 $ 126
Property, net 43,688 45,170
Other 133 221
----------- -----------
Total assets $ 43,848 $ 45,517
=========== ===========
Debt $ 45,000 $ 45,000
Other 534 363
----------- -----------
Total liabilities $ 45,534 $ 45,363
=========== ===========
As noted above, the Company is a guarantor on the $45.0 million Term
Note should PCHI not be able to perform. PCHI's total liabilities represent the
Company's maximum exposure to loss.
The Company has a lease commitment to PCHI (Note 13). Based on the
existing arrangements, aggregate payments as of March 31, 2009, are estimated to
be approximately $113.7 million over the remainder of the initial term.
Additionally, the Company is responsible for seismic remediation under the terms
of the lease agreement (Note 4).
NOTE 12 - RELATED PARTY TRANSACTIONS
PCHI - The Company leases substantially all of the real property of the
acquired Hospitals from PCHI. PCHI is owned by two LLC's, namely West Coast and
Ganesha; which are co-managed by Dr. Sweidan and Dr. Chaudhuri, respectively.
Dr. Chaudhuri and Mr. Thomas are constructively the holders of 107.7 million and
49.5 million shares of the outstanding stock of the Company as of March 31, 2009
and 2008, respectively. As described in Note 11, PCHI is a variable interest
entity and, accordingly, the Company has consolidated the financial statements
of PCHI in the accompanying consolidated financial statements.
F-29
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
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 year ended March 31, 2009, the Company incurred expenses under
the agreement of $120.0.
During the years ended March 31, 2009 and 2008, the Company paid $6.2
million and $5.1 million, respectively, to a supplier that is also a shareholder
of the Company. The Company paid $170 and $114 to a physician investor during
the years ended March 31, 2009 and 2008, respectively.
NOTE 13 - COMMITMENTS AND CONTINGENCIES
OPERATING LEASES - Concurrent with the closing of the Acquisition as of
March 8, 2005, the Company entered into a sale leaseback type agreement with a
related party entity, PCHI. The Company leases substantially all of the real
estate of the acquired Hospitals and medical office buildings from PCHI. As a
condition of the New Credit Facilities (Note 5), the Company entered into an
Amended Lease with PCHI. The Amended Lease terminates on the 25-year anniversary
of the original lease (March 8, 2005), grants the Company the right to renew for
one additional 25-year period, and requires annual base rental payments of $8.3
million. However, until the Company refinances its $50.0 million Revolving Line
of Credit Loan with a stated interest rate less than 14% per annum or PCHI
refinances the $45.0 million Term Note, the annual base rental payments are
reduced to $7.1 million. In addition, the Company may offset against its rental
payments owed to PCHI interest payments that it makes to the Lender under
certain of its indebtedness discussed above. The Amended Lease also gives PCHI
sole possession of the medical office buildings located at 1901/1905 North
College Avenue, Santa Ana, California (the "College Avenue Property") that are
unencumbered by any claims by or tenancy of the Company. This lease commitment
with PCHI is eliminated in consolidation (Note 11).
Concurrently with the execution of the Amended Lease, the Company,
PCHI, Ganesha, and West Coast entered into a Settlement Agreement and Mutual
Release (the "Settlement Agreement") whereby the Company agreed to pay to PCHI
$2.5 million as settlement for unpaid rents specified in the Settlement
Agreement, relating to the College Avenue Property, and for compensation
relating to the medical office buildings located at 999 North Tustin Avenue in
Santa Ana, California, under a previously executed Agreement to Compensation.
This transaction with PCHI is eliminated in consolidation (Note 11).
Following is a schedule of the Company's future minimum operating lease
payments, excluding the triple net lease with PCHI, that have initial or
remaining non-cancelable lease terms in excess of one year as of March 31, 2009:
Year ended
March 31,
---------------
2010 $ 1,206
2011 996
2012 993
2013 989
2014 886
Thereafter 13,457
------------
Total $ 18,527
============
Total rental expense for the years ended March 31, 2009 and 2008 was
$2,064 and $1,754, respectively. The Company received sublease rental income in
relation to certain leases of approximately $647 and $638 for the years ended
March 31, 2009 and 2008, respectively.
F-30
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
CAPITAL LEASES - In connection with the Hospital Acquisition, the
Company also assumed the leases for the Chapman facility, which include
buildings and land with terms that were extended concurrently with the
assignment of the leases to December 31, 2023. The Company leases equipment
under capital leases expiring at various dates through January 2013. Assets
under capital leases with a net book value of $7,140 and $6,335 are included in
the accompanying consolidated balance sheets as of March 31, 2009 and 2008,
respectively. Interest rates used in computing the net present value of the
lease payments are based on the interest rates implicit in the leases.
The following is a schedule of future minimum lease payments under the
capitalized leases with the present value of the minimum lease payments as of
March 31, 2009:
Year ended
March 31,
- ------------------------
2010 $ 1,718
2011 1,618
2012 1,493
2013 1,117
2014 744
Thereafter 7,254
------------------
Total minimum lease payments 13,944
Less amount representing interest
(weighted average interest rate of 9.8%) (6,406)
------------------
Net present value of net minimum lease payments 7,538
Less current portion (835)
------------------
Noncurrent portion $ 6,703
==================
INSURANCE - The Company accrues for estimated general and professional
liability claims, to the extent not covered by insurance, when they are probable
and reasonably estimable. The Company has purchased as primary coverage a
claims-made form insurance policy for general and professional liability risks.
Estimated losses within general and professional liability retentions from
claims incurred and reported, along with IBNR claims, are accrued based upon
projections and are discounted to their net present value using a weighted
average risk-free discount rate of 5%. To the extent that subsequent claims
information varies from estimates, the liability is adjusted in the period such
information becomes available. As of March 31, 2009 and 2008, the Company had
accrued $8.7 million and $9.9 million, respectively, which is comprised of $4.1
million and $3.0 million, respectively, in incurred and reported claims, along
with $4.6 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. The Company has a
"guaranteed cost" policy, under which the carrier pays all workers' compensation
claims, with no deductible or reimbursement required of the Company. The Company
accrues for estimated workers' compensation claims, to the extent not covered by
insurance, when they are probable and reasonably estimable. The ultimate costs
related to this program include expenses for deductible amounts associated with
claims incurred and reported in addition to an accrual for the estimated
expenses incurred in connection with IBNR claims. Claims are accrued based upon
projections and are discounted to their net present value using a weighted
average risk-free discount rate of 5%. To the extent that subsequent claims
information varies from estimates, the liability is adjusted in the period such
information becomes available. As of March 31, 2009 and 2008, the Company had
accrued $711 and $710, respectively, comprised of $202 and $169, respectively,
in incurred and reported claims, along with $509 and $541, respectively, in
estimated IBNR.
F-31
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
Effective May 1, 2007, the Company initiated a self-insured health
benefits plan for its employees. As a result, the Company has established and
maintains an accrual for IBNR claims arising from self-insured health benefits
provided to employees. The Company's IBNR accrual at March 31, 2009 and 2008 was
based upon projections . The Company determines the adequacy of this accrual by
evaluating its limited historical experience and trends related to both health
insurance claims and payments, information provided by its insurance broker and
third party administrator and industry experience and trends. The accrual is an
estimate and is subject to change. Such change could be material to the
Company's consolidated financial statements. As of March 31, 2009 and 2008, the
Company had accrued $1.8 million and $1.7 million, respectively, in estimated
IBNR. The Company believes this is the best estimate of the amount of IBNR
relating to self-insured health benefit claims at March 31, 2009 and 2008.
The Company has also purchased umbrella liability policies with
aggregate limits of $25 million. The umbrella policies provide coverage in
excess of the primary layer and applicable retentions for insured liability
risks such as general and professional liability, auto liability, and workers
compensation (employers liability).
The Company finances various insurance policies at interest rates
ranging from 4.23% to 5.25% per annum. The Company incurred finance charges
relating to such policies of $64.8 and $122.7 during the years ended March 31,
2009 and 2008, respectively. As of March 31, 2009 and 2008, the accompanying
consolidated balance sheets include the following balances relating to the
financed insurance policies.
March 31, 2009 March 31, 2008
-------------- --------------
Prepaid insurance $ 339 $ 721
Accrued insurance premiums $ 19 $ 299
(Included in other current liabilities)
PURCHASE COMMITMENTS - The Company has commitments with two unrelated
party service provider vendors extending over one year. Commitments total
$3,965, $3,342, $3,342, $0, and $0 for the years ending March 31, 2010, 2011,
2012, 2013, and 2014, respectively.
BONUSES - During the year ended March 31, 2008, the Company implemented
the Corporate Team Bonus Plan for 2007/2008. Under this discretionary plan,
eligible employees could receive bonuses based on the Company's performance and
individual performances. For the year ended March 31, 2008, the Company awarded
eligible employees an aggregate of $494.7, which is included in accrued
compensation and benefits in the accompanying consolidated balance sheet as of
March 31, 2008. The bonuses were approved by the Company's Board of Directors
and were paid in June 2008. No bonuses were awarded for the year ended March 31,
2009.
RESIGNATION AND SEVERANCE AGREEMENTS - On November 4, 2008, the Company
entered into a Resignation Agreement and General Release ("Resignation
Agreement") with Bruce Mogel, President and Chief Executive Officer of the
Company. Under the Resignation Agreement: (i) Mr. Mogel served as President and
Chief Executive Officer of the Company through December 31, 2008, at which time
he resigned those positions (the "Resignation Date"); (ii) after December 31,
2008, Mr. Mogel will provide consulting services to the Company, including
performing the functions of Chief Executive Officer as requested by the Board of
Directors, for a period of up to 4 months after the Resignation Date (the
"Consulting Period"); (iii) during the Consulting Period, Mr. Mogel will receive
a monthly salary equal to the monthly salary he received immediately prior to
the Resignation Date; (iv) for 8 months after the conclusion of the Consulting
Period, Mr. Mogel will receive payments of $43.8 per month (less deductions
required by law), the sum of which will equal 8 months' salary; (v) the
Agreement contains other benefits, including without limitation, medical and
dental coverage for Mr. Mogel; (vi) Mr. Mogel's employment agreement with the
Company was terminated as of the Resignation Date; (vii) Mr. Mogel resigned from
the Boards of Directors of the Company and its subsidiaries effective November
4, 2008; and (viii) Mr. Mogel agreed to release and discharge the Company from
claims related to his employment with the Company, among other provisions
customary to such agreements.
F-32
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
Under the Resignation Agreement, consideration currently valued at
approximately $545.2, has been accrued in the accompanying consolidated
financial statements as of and for the year ended March 31, 2009 since payment
is not dependent on future service.
On December 31, 2007, the Company entered into a Severance Agreement
With Mutual Releases ("Severance Agreement") and a Consulting Agreement with
Larry B. Anderson. Under the Severance Agreement, Mr. Anderson terminated his
employment as President of the Company by mutual agreement, effective December
31, 2007.
Under the Severance Agreement, Mr. Anderson could have received
consideration initially valued at approximately $480.0. Under the Severance
Agreement, Mr. Anderson was to receive compensation equivalent to fourteen equal
monthly installments. The amount of each monthly installment was to be the sum
of Mr. Anderson's base monthly salary, net of required deductions, plus the
monthly value of his health and dental insurance, plus the monthly value of his
automobile allowance. The schedule of payments is as follows: (i) one lump sum
upfront payment equivalent to eight monthly installments, and (ii) the remaining
six equal installments was to be paid to him on or before the first business day
of each month, commencing on September 1, 2008. The lump sum payment was made to
Mr. Anderson, but the remaining six equal installments have not been made due to
Mr. Anderson's breach of the Severance Agreement (see "CLAIMS AND LAWSUITS"). In
addition, the Company paid a year end (December 31, 2007) bonus of $30.0 to Mr.
Anderson. The Severance Agreement also includes mutual releases, specific
waivers and releases, nondisclosure of confidential information, return of
property, future cooperation, non disparagement, and general provisions
customary in such agreements.
Under the terms of the Consulting Agreement, which was effective from
January 1, 2008 through June 30, 2008, the Company was to pay Mr. Anderson
$180.0 consisting of one upfront payment of $60.0 and four equal monthly
installments of $30.0 each, commencing April 1, 2008, with the last payment due
on July 1, 2008. The upfront payment of $60.0 was paid to Mr. Anderson, but
further payments have not been made due to Mr. Anderson's breach of the
Severance Agreement (see "CLAIMS AND LAWSUITS"). As additional compensation for
special projects, such as his services relating to the then-proposed acquisition
of a specifically identified hospital by the Company, Mr. Anderson would be
entitled to receive 0.5% of the total value of the purchase, minus $30.0, or an
estimated $310.0 if the acquisition was consummated at the then-proposed price.
Such acquisition was not consummated by the Company and therefore the estimated
$310.0 is not due or payable. The Consulting Agreement contains other provisions
customary to such agreements.
All amounts due to Mr. Anderson have been accrued in the accompanying
consolidated financial statements as of and for the year ended March 31, 2009
since payment is not dependent on future service.
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.
F-33
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
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 consolidated
operations or financial position.
Approximately 36% of the Company's employees are represented by labor
unions as of March 31, 2009. On December 31, 2006, the Company's collective
bargaining agreements with SEIU and CNA expired. Negotiations with both the SEIU
and CNA led to agreements being reached on May 9, 2007, and October 16, 2007,
for the respective unions. Both contracts were ratified by their respective
memberships. The new SEIU Agreement will run until December 31, 2009, and the
Agreement with the CNA will run until February 28, 2011. Both Agreements have
"no strike" provisions and compensation caps which provide the Company with long
term compensation and workforce stability.
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 alleged that the defendants breached their 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 alleged 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 alleged 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 alleged 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 were 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. 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. On July 31, 2008, the Company
entered into a settlement agreement with two of the three defendants, which
agreement became effective on December 1, 2008, upon the trial court's grant of
the parties motion for determination of a good faith settlement. On January 16,
2009, the Company dismissed its claims against these defendants.
F-34
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
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, were stayed by the Court
pending the resolution of the May 10, 2007 suit brought by the Company.
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. OC-PIN filed a petition for writ of mandate with the
Court of Appeals seeking to overturn this stay order, which was summarily denied
on November 18, 2008.
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. This petition was stayed by the Court on October 6, 2008 pending the
resolution of May 10, 2007 suit brought by the Company. OC-PIN subsequently
filed a petition for writ of mandate with the Court of Appeals, which was
summarily denied on November 18, 2008. OC-PIN then filed a petition for review
before the California Supreme Court, which was denied on January 14, 2009.
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 alleged that the Company issued stock
options under a Stock Incentive Plan and warrants to its lender in violation of
the Allegedly Omitted Provision. The complaint further alleged that the issuance
of warrants to purchase the Company's stock to Dr. Chaudhuri and Mr.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. On
October 22, 2008, OC-PIN filed an amended complaint naming every shareholder of
as a defendant, in response to a ruling by the Court that each shareholder was a
"necessary party" to the action. OC-PIN filed a petition for writ of mandate
with the Court of Appeals which sought to overturn the stay imposed by the trial
court. This appeal was summarily denied on November 18, 2008.
F-35
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
On December 31, 2007, the Company entered into a severance agreement
with its then-President, Larry Anderson ("Anderson") (the "Severance
Agreement"). On or about September 5, 2008, based upon information and belief
that Anderson breached the Severance Agreement, the Company ceased making the
monthly severance payments. On September 3, 2008, Anderson filed a claim with
the California Department of Labor seeking payment of $243,000. A hearing date
has not yet been set.
On or about February 11, 2009, Anderson filed a petition for
arbitration before JAMS. Anderson's petition claims that the Company failed to
pay him a commission of $300,000 for his efforts toward securing financing from
the Company's lender to purchase an additional hospital. On May 20, 2009,
Anderson filed an amended petition with JAMS, incorporating allegations: (1) the
Company filed an incorrect IRS Form 1099 with respect to Company vehicle and (2)
that Anderson was constructively discharged as a result of reporting various
alleged violations of state and Federal law. While the Company is optimistic
regarding the outcome of these various related Anderson matters, at this early
stage, the Company is unable to determine the cost of defending this lawsuit or
the impact, if any, that these actions may have on its results of operations.
On March 11, 2009 Tenet Healthcare Corporation ("Tenet") filed an
action against the Company seeking indemnification and reimbursement for rental
payments paid by Tenet pursuant to a guarantee agreement contained in the
original Asset Purchase Agreement between the Company and Tenet. Tenet is
seeking reimbursement for approximately $370 expended in rental payments for the
Chapman Medical Center lease, including attorneys' fees, which has been accrued
in the accompanying consolidated financial statements as of and for the year
ended March 31, 2009.
NOTE 14 - SUBSEQUENT EVENTS
GLOBAL SETTLEMENT AGREEMENT - Effective April 2, 2009, the Company, Dr.
Shah, OC-PIN, Mr. Mogel, PCHI, West Coast, Dr. Chaudhuri, Ganesha, Mr. Thomas,
and the Lender entered into a Settlement Agreement, General Release and Covenant
Not to Sue ("Global Settlement Agreement") in connection with the settlement of
pending and threatened litigation, arbitration, appellate, and other legal
proceedings (the "Actions") among the various parties. Pursuant to the Global
Settlement Agreement, the Company agreed to pay to OC-PIN and Dr. Shah a total
sum of $2.4 million in two installments consisting of $1.6 million at closing
and $750, together with interest thereon at 8%, payable on September 25, 2009
(the "Second Payment $750"). The Company also agreed to pay the sum of $15 as
satisfaction of Dr. Shah's individual claims. Additionally, the Company and Mr.
Mogel agreed to stipulate to the release and return of a $50 bond which was
posted in connection with a shareholder derivative suit filed by OC-PIN against
both Mr. Mogel and the Company. All amounts payable by the Company under the
Global Settlement Agreement, totaling $2.4 million, are accrued at March 31,
2009.
In addition, Dr. Shah covenanted and agreed, that for a period of 2
years after the Closing, he will not accept any nomination, appointment or will
not serve in the capacity as a director, officer, or employee of the Company, so
long as the Company keeps the PCHI and Chapman Medical Center leases current by
making payments within 45 days of when payments are due.
Also pursuant to the Global Settlement Agreement, Dr. Shah and OC-PIN
covenant not to sue or to assist anyone else in suing, directly or derivatively
on behalf of the Company, Dr. Chaudhuri or the Lender, and Dr. Chaudhuri and the
Lender covenant not to sue or to assist anyone else in suing, directly or
derivatively on behalf of the Company, Dr. Shah and OC-PIN. Dr. Shah and OC-PIN
also agreed to sign and deliver dismissals with prejudice of all Dr. Shah and
OC-PIN's claims in the Actions, and the Company, PCHI, and Dr. Chaudhuri agreed
to sign and deliver dismissals with prejudice of all of the Company, PCHI and
Dr. Chaudhuri claims against Dr. Shah and/or OC-PIN in the Actions. Furthermore,
all of the parties agreed to general releases discharging each and all of the
other parties from, among other things, any and all rights, suits, claims or
actions arising out of or otherwise related to the Actions.
F-36
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
Pursuant to the Global Settlement Agreement, the Company agreed to
amend its Bylaws to provide (i) that the number of members of the Company's
Board of Directors shall be fixed at 7 and (ii) that, effective immediately
after the Company's 2009 Annual Meeting of Shareholders, a shareholder who owns
15% or more of the voting stock of the Company is entitled to call one special
shareholders meeting per year. The Company also agreed to appoint an OC-PIN
representative to fill the seat to be vacated by Ken Westbrook, effective April
2, 2009, until the September 2009 annual meeting of shareholders. As of June 15,
2009, Mr. Westbrook is still a Director since OC-PIN's representative has not
been duly appointed by OC-PIN (see "First Meka Complaint" below).
Also pursuant to the Global Settlement Agreement, the Company entered
into Stock Purchase Agreements (the "2009 Stock Purchase Agreements") with Dr.
Shah, Dr. Chaudhuri and OC-PIN respectively. Pursuant to these 2009 Stock
Purchase Agreements, Dr. Shah and OC-PIN will receive an aggregate of 14.7
million shares of the Company's common stock each and Dr. Chaudhuri will receive
an aggregate of 30.6 million shares of the Company's common stock, for a price
of $0.03 per share (the "2009 Stock Purchase Shares"). The purchase and sale of
the Company's common stock under these agreements is still pending (see "First
Meka Complaint" below).
Pursuant to the Global Settlement Agreement, if either OC-PIN or Dr.
Shah chooses not to purchase all of their respective 2009 Stock Purchase Shares,
those 2009 Stock Purchase Shares which either party elects not to purchase may
be purchased by the other party. In the event that OC-PIN and Dr. Shah purchase,
in the aggregate, fewer 2009 Stock Purchase Shares than the maximum they were
entitled to purchase under the terms of their 2009 Stock Purchase Agreements,
Dr. Chaudhuri agreed that the number of 2009 Stock Purchase Shares that he is
entitled to purchase under his 2009 Stock Purchase Agreement shall be
automatically reduced to an amount which is 51% of the aggregate number of 2009
Stock Purchase Shares which Dr. Chaudhuri, OC-PIN and Dr. Shah actually purchase
under their 2009 Stock Purchase Agreements. OC-PIN and Dr. Shah also agreed to
provide notice to the Company and Dr. Chaudhuri regarding their choice to use as
a credit all or a portion of the Second Payment $750, and any interest accrued
thereon, toward OC-PIN and Dr. Shah's payment to IHHI for their respective Stock
Purchase Shares. IHHI also agreed that IHHI will use the net proceeds of the
sale of the Stock Purchase Shares to pay down the principal balance of the
Company's $10.7 million Convertible Term Note held by the Lender, and the Lender
agreed to advance to the Company additional funds equal to such amount by which
the $10.7 million Convertible Term Note is paid down. If necessary, the Company
agreed to use these additional funds to bring current the PCHI and Chapman
Medical Center leases (see "First Meka Complaint" below).
In conjunction with the Global Settlement Agreement, on April 2, 2009,
the Company and the Lender entered into the Amendment No. 1 to Credit Agreement
("Credit Amendment"). The Lender agreed to reduce the interest rate on the $45.0
million Term Note to simple interest of 10.25% (the "Debt Service Reduction")
and to maintain such interest rate up to and including the maturity date of the
Term Note, or any extension thereof, as defined in the $80 million credit
agreement, under which the $45.0 million Term Note was issued (the "Debt Service
Reduction Period"). The Credit Amendment also provided for an optional one year
extension of the maturity date of the $45.0 million Term Note and the $35.0
million Non-Revolving Line of Credit Note to October 8, 2011, provided that the
Company pay in full the unpaid principal balance due under the $10.7 million
Convertible Term Loan no later than January 30, 2010.
In conjunction with the Global Settlement Agreement, on April 2, 2009,
the Company and the Lender entered into the Amendment No. 1 to the $50.0 million
Revolving Credit Agreement which provides an optional one year extension of the
maturity date to October 8, 2011, provided that the Company pay in full the
unpaid principal balance due under the $10.7 million Convertible Term Loan no
later than January 30, 2010.
F-37
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
On April 2, 2009, the Company, OC-PIN, PCHI, West Coast, Ganesha, and
the Lender (the "Acknowledgement Parties") entered into the Acknowledgement,
Waiver and Consent and Amendment to Credit Agreements (the "Acknowledgement").
The Acknowledgement Parties agreed that if and to the extent that the
agreements, transactions and events contemplated in the Global Settlement
Agreement constitute, may constitute or will constitute a change of control,
default, event of default or other breach or default under the New Credit
Facilities, or any documents related to the New Credit Facilities, each
Acknowledgement Party waives and consents to the waiver of such event, breach or
default.
Pursuant to the Global Settlement Agreement, the Company and PCHI
entered into the Amendment to Amended and Restated Triple Net Hospital Building
Lease (the "2009 Lease Amendment"), whereby PCHI agreed to reduce the rent paid
by the Company under the Amended Lease by an amount equal to the Debt Service
Reduction (i.e., the difference between 14% and 10.25%) during the Debt Service
Reduction Period. The Company also agreed, pursuant to the Global Settlement
Agreement, to bring the PCHI lease and the Chapman Medical Center leases current
and to pay all arrearages due under the PCHI lease and the Chapman Medical
Center leases.
LENDER DEFAULT - On April 14, 2009, the Company issued a letter (the
"Demand Letter") to the Lender notifying the Lender that it was in default of
the $50 million Revolving Credit Agreement, to make demand for return of all
amounts collected and retained by it in excess of the amounts due to it under
the $50 million Revolving Credit Agreement, and to reserve the rights of the
borrowers and credit parties with respect to other actions and remedies
available to them. On April 17, 2009, following receipt of a copy of the Demand
Letter, the bank that maintains the lock boxes pursuant to a restricted account
and securities account control agreement (the "Lockbox Agreement") notified the
Company and the Lender that it would terminate the Lockbox Agreement within 30
days. On May 18, 2009, the Lockbox Agreement was terminated and the Company's
bank accounts were frozen. On May 19, 2009, the Lender relinquished any and all
control over the bank accounts pursuant to the Lockbox Agreement. The Lender's
relinquishment provided the Company with full access to its bank accounts and
the accounts are no longer accessible by the Lender. The Lender has not returned
the amounts collected and retained by it in excess of the amounts due to it
under the $50 million Revolving Credit Agreement ($12.7 million as of June 15,
2009) and is not advancing any funds to the Company under the $50 million
Revolving Credit Agreement. The Lender applies monthly interest charges relating
to all of the New Credit Facilities against the Excess Amounts. At June 15,
2009, the Excess Amounts represented approximately 19 months of future interest
charges. The Company relies solely on its cash receipts from payers to fund its
operations, and any significant disruption in such receipts could have a
material adverse effect on the Company's ability to continue as a going concern.
CLAIMS AND LAWSUITS - On April 24, 2009, a conglomeration of several
OC-PIN members led by Ajay G. Meka, M.D. filed a lawsuit against Dr. Shah, other
OC-PIN members, and various attorneys, alleging breach of fiduciary duty and
seeking damages as well as declaratory and injunctive relief (the "First Meka
Complaint"). While the Company is named as a defendant in the action, plaintiffs
are only seeking declaratory and injunctive relief with respect to various
provisions of the Global Settlement Agreement. Due to the competing demands
related to the Stock Purchase Agreements placed upon the Company from factions
within OC-PIN, on May 13, 2009, the Company filed a Motion for Judicial
Instructions regarding enforcement of the Global Settlement Agreement. On May
14, 2009, the Company, Dr. Shah, as well as both "factions" of OC-PIN entered
into a "stand still" agreement regarding both the nomination of an OC-PIN Board
representative as well as the allocation of shares under the Stock Purchase
Agreements. Subsequently, on June 22, 2009, the Court granted a stay of the
Company's remaining obligations under the Global Settlement Agreement until the
resolution of the Amended Meka Complaint and related actions.
F-38
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2009
On June 1, 2009, a First Amended Complaint was filed to replace the
First Meka Complaint (the "Amended Meka Complaint"). It appears that the relief
sought against the Company in the Amended Meka Complaint does not materially
alter from the declaratory and injunctive relief sought in the First Meka
Complaint. The Company believes it is a neutral stakeholder in the action, and
that the results of the action will not have a material adverse impact on the
Company's results of operations.
Purportedly pursuant to the Global Settlement Agreement, OC-PIN and/or
Dr. Shah placed a demand on the Company to seat Dr. Shah's personal litigation
attorney, Daniel Callahan ("Callahan") on the Board of Directors. The Company
declined this request based on several identified conflicts of interest, as well
as a violation of the covenant of good faith and fair dealing. OC-PIN and/or Dr.
Shah then filed a motion to enforce the Global Settlement Agreement under Code
of Civil Procedure Section 664.6 and force the Company to appoint Callahan to
the Board of Directors. The Company opposed this motion, in conjunction with an
opposition by several members of OC-PIN, contesting Callahan as the duly
authorized representative of OC-PIN. On April 27, 2009, the Court denied Dr.
Shah/OC-PIN's motion, finding several conflicts of interest preventing Callahan
from serving on the Company's Board of Directors. On May 5, 2009, Dr.
Shah/OC-PIN filed a petition for writ of mandate with the Court of Appeals
seeking to reverse the Court's ruling and force Callahan's appointment as a
director, which was summarily denied on May 7, 2009.
In 2003, the prior owner of Coastal Communities Hospital entered into a
risk pool agreement (the "Risk Pool Agreement") with AMVI/Prospect Health
Network d/b/a AMVI/Prospect Medical Group ("AMVI/Prospect"). On May 13, 2009,
AMVI/Prospect filed a complaint alleging that the Company failed to pay
approximately $745 in settlement of the Risk Pool Agreement. At the same time,
AMVI/Prospect filed an EX PARTE application seeking a temporary protective
order, a right to attach order, and a writ of attachment. While the EX PARTE
application was denied on May 26, 2009, AMVi/Prospect's regularly notice motion
for writ of attachment is scheduled for June 19, 2009. At this early stage, the
Company is unable to determine the cost of defending this lawsuit or the impact,
if any, this action and related writ petition may have on its results of
operations.
On June 5, 2009, a class action lawsuit was filed against the Company
by certain hourly employees alleging restitution for unfair business practices,
injunctive relief for unfair business practices, failure to pay overtime wages,
and penalties associated therewith. At this early stage, the Company is unable
to determine the cost of defending this lawsuit or the impact, if any, this
action may have on its results of operations.
F-39
The following financial statement schedule is the only schedule
required to be filed under the applicable accounting regulations of the
Securities and Exchange Commission.
INTEGRATED HEALTHCARE HOLDINGS, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
[amounts in 000's]
BALANCE AT
BEGINNING OF BALANCE AT
PERIOD DESCRIPTION PERIOD ADDITIONS DEDUCTIONS END OF PERIOD
- ------ ----------- ---------- ------------ ---------- -------------
Accounts Receivable:
Year ended March 31, 2009 Allowance for doubtful accounts $ 14,383 $ 49,269 $ 46,275 $ 17,377
Year ended March 31, 2008 Allowance for doubtful accounts $ 2,355 $ 49,679(1) $ 37,651 $ 14,383
Deferred tax assets:
Year ended March 31, 2009 Valuation allowance $ 35,905 $ 766 $ - $ 36,671
Year ended March 31, 2008 Valuation allowance $ 33,725 $ 2,180 $ - $ 35,905
(1) Includes additions to allowance related to repurchased accounts receivable.
F-40