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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended June 30, 2009; or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from to
Commission File Number
0-23511
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INTEGRATED HEALTHCARE HOLDINGS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
NEVADA 87-0573331
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
1301 NORTH TUSTIN AVENUE
SANTA ANA, CALIFORNIA 92705
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(714) 953-3503
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year, if
changed since last report)
----------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant 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 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" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [ ]
Non-accelerated filer [ ] Smaller reporting company [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes [ ] No [X]
There were 195,307,262 shares outstanding of the registrant's common stock as of
August 10, 2009.
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INTEGRATED HEALTHCARE HOLDINGS, INC.
FORM 10-Q
TABLE OF CONTENTS
Page
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of June 30, 2009 and March 31,
2009, adjusted - (unaudited) 3
Condensed Consolidated Statements of Operations for the three months
ended June 30, 2009 and 2008, adjusted - (unaudited) 4
Condensed Consolidated Statement of Deficiency for the three months
ended June 30, 2009 - (unaudited) 5
Condensed Consolidated Statements of Cash Flows for the three months
ended June 30, 2009 and 2008, adjusted - (unaudited) 6
Notes to Condensed Consolidated Financial Statements - (unaudited) 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 33
Item 3. Quantitative and Qualitative Disclosures About Market Risk 50
Item 4. Controls and Procedures 50
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 51
Item 1A. Risk Factors 55
Item 6. Exhibits 56
Signatures 56
2
PART I - FINANCIAL INFORMATION
Item 1. Financial statements
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(amounts in 000's, except par value)
(unaudited)
June 30, March 31,
2009 2009
--------- ---------
(adjusted)
ASSETS
Current assets:
Cash and cash equivalents $ 5,385 $ 3,514
Restricted cash 18 18
Accounts receivable, net of allowance for doubtful
accounts of $18,235 and $17,377, respectively 50,922 55,876
Inventories of supplies, at cost 5,888 5,742
Due from governmental payers 2,758 4,297
Due from lender 11,916 5,576
Prepaid insurance 4,486 339
Other prepaid expenses and current assets 4,432 5,097
--------- ---------
Total current assets 85,805 80,459
Property and equipment, net 54,549 55,414
Debt issuance costs, net 61 123
--------- ---------
Total assets $ 140,415 $ 135,996
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Debt $ 80,968 $ 80,968
Accounts payable 57,368 59,265
Accrued compensation and benefits 18,353 16,809
Accrued insurance retentions 11,602 11,212
Other current liabilities 9,475 6,265
--------- ---------
Total current liabilities 177,766 174,519
Capital lease obligations, net of current portion
of $801 and $416, respectively 6,498 6,703
--------- ---------
Total liabilities 184,264 181,222
--------- ---------
Commitments, contingencies and subsequent events
Deficiency:
Integrated Healthcare Holdings, Inc. stockholders' deficiency:
Common stock, $0.001 par value; 500,000 shares authorized;
195,307 shares issued and outstanding 195 195
Additional paid in capital 61,093 61,080
Accumulated deficit (105,353) (106,501)
--------- ---------
Total Integrated Healthcare Holdings, Inc. stockholders' deficiency (44,065) (45,226)
Noncontrolling interests 216 --
--------- ---------
Total deficiency (43,849) (45,226)
--------- ---------
Total liabilities and deficiency $ 140,415 $ 135,996
========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE UNAUDITED CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS.
3
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in 000's, except per share amounts)
(unaudited)
Three months ended June 30,
---------------------------
2009 2008
--------- ---------
(adjusted)
Net operating revenues $ 93,012 $ 93,562
--------- ---------
Operating expenses:
Salaries and benefits 51,356 52,672
Supplies 12,605 12,304
Provision for doubtful accounts 8,856 9,743
Other operating expenses 14,447 17,193
Depreciation and amortization 915 894
--------- ---------
88,179 92,806
--------- ---------
Operating income 4,833 756
--------- ---------
Other expense:
Interest expense, net (2,229) (3,003)
--------- ---------
(2,229) (3,003)
--------- ---------
Income (loss) before provision for income taxes 2,604 (2,247)
Provision for income taxes (1,240) --
--------- ---------
Net income (loss) 1,364 (2,247)
Less net income attributable to noncontrolling interests (Note 9) (216) (531)
--------- ---------
Net income (loss) attributable to Integrated Healthcare Holdings, Inc. $ 1,148 $ (2,778)
========= =========
Per Share Data:
Earnings (loss) per common share attributable to
Integrated Healthcare Holdings, Inc. stockholders
Basic $ 0.01 $ (0.02)
Diluted $ 0.01 $ (0.02)
Weighted average shares outstanding
Basic 195,307 137,096
Diluted 223,726 137,096
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE UNAUDITED CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS.
4
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIENCY
(amounts in 000's)
(unaudited)
Integrated Healthcare Holdings, Inc. Stockholders
--------------------------------------------------------------
Additional
Common Stock Paid-in Accumulated Noncontrolling
Shares Amount Capital Deficit Interests Total
----------------------------- ------------- -------------- -------------- ---------------
Balance, March 31, 2009, adjusted 195,307 $ 195 $ 61,080 $ (106,501) $ - $ (45,226)
Share-based compensation - - 13 - - 13
Net income - - - 1,148 216 1,364
-------------- ------------ ------------- -------------- -------------- ---------------
Balance, June 30, 2009 195,307 $ 195 $ 61,093 $ (105,353) $ 216 $ (43,849)
============== ============ ============= ============== ============== ===============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE UNAUDITED CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS.
5
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in 000's)
(unaudited)
Three months ended June 30,
---------------------------
2009 2008
------- -------
(adjusted)
Cash flows from operating activities:
Net income (loss) $ 1,364 $(2,247)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization of property and equipment 915 894
Provision for doubtful accounts 8,856 9,743
Amortization of debt issuance costs 62 125
Noncash share-based compensation expense 13 14
Recovery relating to impaired property and equipment (195) --
Changes in operating assets and liabilities:
Accounts receivable (3,902) (9,481)
Inventories of supplies (146) 23
Due from governmental payers 1,539 3,743
Prepaid insurance, other prepaid expenses and
current assets, and other assets (3,287) (1,353)
Accounts payable (1,897) 1,122
Accrued compensation and benefits 1,544 1,188
Due to governmental payers -- 1,377
Accrued insurance retentions and other current liabilities 3,600 1,678
------- -------
Net cash provided by operating activities 8,466 6,826
------- -------
Cash flows from investing activities:
Decrease in restricted cash -- 5
Additions to property and equipment (50) (304)
------- -------
Net cash used in investing activities (50) (299)
------- -------
Cash flows from financing activities:
Paydown on revolving line of credit, net -- (5,578)
Excess funds due from lender (6,340) --
Noncontrolling interests distributions -- (900)
Payments on capital lease obligations (205) (109)
------- -------
Net cash used in financing activities (6,545) (6,587)
------- -------
Net increase (decrease) in cash and cash equivalents 1,871 (60)
Cash and cash equivalents, beginning of period 3,514 3,141
------- -------
Cash and cash equivalents, end of period $ 5,385 $ 3,081
======= =======
Supplemental information:
Cash paid for interest $ 189 $ 2,860
======= =======
Cash paid for income taxes $ 240 $ --
======= =======
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE UNAUDITED CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS.
6
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2009
(UNAUDITED)
NOTE 1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
LIQUIDITY AND MANAGEMENT'S PLANS - The accompanying unaudited condensed
consolidated financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and settlement of obligations in
the normal course of business. As of June 30, 2009, Integrated Healthcare
Holdings, Inc. and its subsidiaries (the "Company") has a working capital
deficit of $92.0 million and accumulated total deficiency of $43.8 million. The
Company's $50.0 million Revolving Credit Agreement provides estimated liquidity
as of June 30, 2009 of $33.0 million based on eligible receivables, as defined.
However, due to significant delays in funding of advance requests by the Lender
as of June 30, 2009, the Lender had collected and retained $11.9 million in
excess of the amounts due to it under the $50 million Revolving Credit Agreement
(Notes 3 and 12).
As noted above, during the three months ended June 30, 2009, the
Company continued to experience 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 June 30, 2009, the unfulfilled advance requests
aggregated approximately $34.2 million. The $11.9 million is reflected as due
from Lender in the accompanying unaudited condensed consolidated balance sheet
as of June 30, 2009.
At June 30, 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 unaudited
condensed consolidated balance sheet as of June 30, 2009 (Note 3).
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 seeking to obtain
future increases and expedited payments. The Company is attempting 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. Should the Company be unsuccessful, there can be no
assurance that it will continue as a going concern.
DESCRIPTION OF BUSINESS - Effective March 8, 2005, the Company acquired
four hospitals (the "Hospitals") from subsidiaries of Tenet Healthcare
Corporation ("Tenet") (the "Acquisition"). The Company owns and operates the
four community-based hospitals located in southern California, which are:
o 282-bed Western Medical Center in Santa Ana, California;
o 188-bed Western Medical Center in Anaheim, California;
o 178-bed Coastal Communities Hospital in Santa Ana, California;
and
o 114-bed Chapman Medical Center in Orange, California.
7
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2009
(UNAUDITED)
BASIS OF PRESENTATION - The accompanying unaudited condensed
consolidated financial statements include the accounts of the Company and its
wholly owned subsidiaries.
The Company has also determined that Pacific Coast Holdings Investment,
LLC ("PCHI") (Note 9), 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
unaudited condensed consolidated financial statements.
All significant intercompany accounts and transactions have been
eliminated in consolidation. Unless otherwise indicated, all amounts included in
these notes to the unaudited condensed consolidated financial statements are
expressed in thousands (except per share amounts, percentages and stock option
prices and values).
RECLASSIFICATION FOR PRESENTATION - Certain immaterial amounts
previously reported have been reclassified to conform to the current period's
presentation.
CONCENTRATION OF CREDIT RISK - The Company has secured its working
capital and its long term debt from the same Lender (Note 3) 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 61.6%
and 57.6% of the net operating revenues for the three months ended June 30, 2009
and 2008, respectively. No other payers represent a significant concentration of
the Company's net operating revenues.
USE OF ESTIMATES - The accompanying unaudited condensed consolidated
financial statements have been prepared in accordance with 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 unaudited condensed 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.
8
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2009
(UNAUDITED)
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 $1,554
and $1,618 as of June 30 and March 31, 2009, 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.
9
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2009
(UNAUDITED)
The Hospitals received new provider numbers following the Acquisition
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 cost-to-charge ratios from the fiscal
intermediary, any variance between current payments and the estimated final
outlier settlement are examined by the Medicare fiscal intermediary. There were
no adjustments for Final Notice of Program Reimbursement received during the
three months ended June 30, 2009 and 2008. As of March 31, 2009, the Company
reversed all reserves for excess outlier payments.
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 $5,034 and $7,596 during the three months ended June
30, 2009 and 2008, respectively. The related revenue recorded for the three
months ended June 30, 2009 and 2008 was $3,559 and $3,854, respectively. As of
June 30 and March 31, 2009, estimated DSH receivables of $1,204 and $2,679 are
included in due from governmental payers in the accompanying unaudited condensed
consolidated balance sheets.
The following is a summary of due from governmental payers as of June
30 and March 31, 2009:
June 30, March 31,
2009 2009
----------- ----------
Due from government payers
Medicare $ 1,554 $ 1,618
Medicaid 1,204 2,679
----------- ----------
$ 2,758 $ 4,297
=========== ==========
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.
10
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2009
(UNAUDITED)
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 $1.6 million and $2.3 million for
the three months ended June 30, 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 June 30 and March 31, 2009.
Beginning in fiscal year 2008, the Company received payments for
indigent care under California section 1011. In the absence of prior collection
experience and due to the uncertainty of future payment, the Company was unable
to estimate receivables relating to this program. These payments were recorded
as income when received. In connection with an evaluation of eligibility
determination and collection experience for fiscal year 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 June 30 and
March 31, 2009, the Company established a receivable in the amount of $1.3
million and $1.4 million, respectively, related to discharges deemed eligible to
meet program criteria.
The Company is not aware of any material claims, disputes, or unsettled
matters with any payers that would affect revenues that have not been adequately
provided for in the accompanying unaudited condensed consolidated financial
statements.
PROVISION FOR DOUBTFUL ACCOUNTS - The Company provides for accounts
receivable that could become uncollectible by establishing an allowance to
reduce the carrying value of such receivables to their estimated net realizable
value. The Hospitals estimate this allowance based on the aging of their
accounts receivable, historical collections experience for each type of payer
and other relevant factors. There are various factors that can impact the
collection trends, such as changes in the economy, which in turn have an impact
on unemployment rates and the number of uninsured and underinsured patients,
volume of patients through the emergency department, the increased burden of
copayments to be made by patients with insurance and business practices related
to collection efforts. These factors continuously change and can have an impact
on collection trends and the estimation process.
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.
11
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2009
(UNAUDITED)
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 June 30 and March 31, 2009, cash and cash equivalents includes
approximately $0 and $3.5 million, respectively, deposited in lock box accounts
that were swept daily by the Lender under various credit agreements (Note 3). As
of June 30 and March 31, 2009, the Lender had collected and retained $11.9
million and $5.6 million, respectively, in excess of the amounts due to it under
the $50 million Revolving Credit Agreement (Note 3). Effective May 18, 2009, the
lockbox arrangements were terminated.
LETTERS OF CREDIT - At June 30 and March 31, 2009, the Company had
outstanding standby letters of credit totaling $1.5 million and $1.5 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. However, due to the Lender's default (Note 3), it is
uncertain if the Lender would be able to honor the outstanding standby letters
of credit, if presented for payment.
DEBT ISSUANCE COSTS - This deferred charge consists of the $750.0
origination fee for the Company's $50.0 million Revolving Line of Credit (new
debt) and $742.6 in legal and other expenses paid to third parties in connection
with the Company's refinancing (Note 4). These amounts are amortized over the
financing agreements' three year lives using the straight-line method, which
approximates the effective interest method. Other credit agreements (Note 4)
entered into on the October 9, 2007 effective date of the $50.0 million
Revolving Line of Credit were accounted for as extinguishment of existing debt
in accordance with EITF 96-19, "Debtor's Accounting for a Modification or
Exchange of Debt Instruments," and EITF 06-6, "Debtor's Accounting for a
Modification (or Exchange) of Convertible Debt Instruments." Accordingly, debt
issuance costs consisting of loan origination fees of $1.4 million paid to the
Lender associated with those credit agreements were expensed as an interest
charge at the time of refinancing. Debt issuance costs of $61.9 and $124.4 were
amortized during the three months ended June 30, 2009 and 2008, respectively. At
June 30 and March 31, 2009, prepaid expenses and other current assets in the
accompanying unaudited condensed consolidated balance sheets included $254.9 and
$254.9, respectively, as debt issuance costs.
12
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2009
(UNAUDITED)
FAIR VALUE MEASUREMENTS - The Company's financial assets recorded in
the unaudited condensed 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 liability for which the
Company is unable to reasonably determine the fair value.
SFAS No. 157, "Fair Value Measurements," ("SFAS No. 157") 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. 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
unaudited condensed consolidated financial position and results of operations
for the three months ended June 30, 2009 and 2008. The Company adopted SFAS No.
157 as of April 1, 2009 for nonfinancial assets and nonfinancial liabilities.
There was no material impact on the Company's unaudited condensed consolidated
financial position and results of operations for the three months ended June 30,
2009 and 2008.
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. 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 or nonfinancial assets or liabilities subject to fair
value measurement on a recurring basis.
13
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2009
(UNAUDITED)
In April 2009, the FASB issued Staff Position No. 157-4, "Determining
Fair Value When the Volume and Level of Activity for the Asset or Liability Have
Significantly Decreased and Identifying Transactions That Are Not Orderly,"
("FSP SFAS 157-4") which provides additional guidance for estimating fair value
in accordance with SFAS No. 157 when the volume and level of activity for the
asset or liability have significantly decreased. FSP SFAS 157-4 re-emphasizes
that regardless of market conditions the fair value measurement is an exit price
concept as defined in SFAS No. 157. FSP SFAS 157-4 clarifies and includes
additional factors to consider in determining whether there has been a
significant decrease in market activity for an asset or liability and provides
additional clarification on estimating fair value when the market activity for
an asset or liability has declined significantly. The scope of FSP SFAS 157-4
does not include assets and liabilities measured under level 1 inputs. FSP SFAS
157-4 is applied prospectively to all fair value measurements where appropriate
and will be effective for interim and annual periods ending after June 15, 2009.
The Company adopted the provisions of FSP SFAS 157-4 effective April 1, 2009.
There was no material impact on the Company's unaudited condensed consolidated
financial position and results of operations as of and for the three months
ended June 30, 2009.
In April 2009, the FASB issued FSP SFAS No. 107-1 and APB 28-1, which
amend SFAS No. 107, "Interim Disclosures about Fair Value of Financial
Instruments," and require publicly-traded companies, as defined in APB Opinion
No. 28, "Interim Financial Reporting," to provide disclosures on the fair value
of financial instruments in interim financial statements. FSP SFAS No. 107-1 and
APB 28-1 are effective for interim periods ending after June 15, 2009. The
Company adopted the provisions of FSP SFAS No. 107-1 and APB 28-1 effective
April 1, 2009, without a material impact to its condensed consolidated financial
statements. The carrying amounts reported in the accompanying unaudited
condensed consolidated balance sheets for cash, accounts receivable and accounts
payable approximate fair value because of the short-term maturity of these
instruments.
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 3 and 4).
14
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2009
(UNAUDITED)
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.
RECENTLY ADOPTED ACCOUNTING STANDARDS - 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.
15
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2009
(UNAUDITED)
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. Effective April 1, 2009, the Company adopted SFAS No. 160,
which had no material impact on the consolidated financial statements.
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. Effective April 1, 2009, the Company adopted SFAS No. 161, which had no
material impact on the Company's unaudited condensed consolidated financial
statements.
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. Effective April 1, 2009, the Company
adopted FSP APB 14-1, which had no material impact on the Company's unaudited
condensed consolidated financial statements.
16
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2009
(UNAUDITED)
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. Effective April 1, 2009, the Company adopted EITF 07-5, which had
no material impact on the Company's unaudited condensed consolidated financial
statements.
In June 2008, the FASB issued SFAS No. 168, "The FASB Accounting
Standards Codification and the Hierarchy of Generally Accepted Accounting
Principles," and, in doing so, authorized the Codification as the sole source
for authoritative U.S. GAAP. SFAS No. 168 will be effective for financial
statements issued for reporting periods that end after September 15, 2009. Once
it's effective, it will supersede all accounting standards in U.S. GAAP, aside
from those issued by the SEC. SFAS No. 168 replaces SFAS No. 162 to establish a
new hierarchy of GAAP sources for non-governmental entities under the FASB
Accounting Standards Codification.
In May 2009, the FASB issued SFAS No. 165, "Subsequent Events" to
establish general standards of accounting for, and disclosure of, events that
occur after the balance sheet date but before financial statements are issued or
available to be issued. The accompanying unaudited condensed consolidated
financial statements were available to be issued on August 13, 2009 and the
Company evaluated subsequent events known to it through that date (Note 12).
NOTE 2 - PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
JUNE 30, MARCH 31,
2009 2009
------------ ------------
Buildings $ 33,606 $ 33,606
Land and improvements 13,523 13,523
Equipment 11,273 11,223
Assets under capital leases 8,991 8,991
------------ ------------
67,393 67,343
Less accumulated depreciation (12,844) (11,929)
------------ ------------
Property and equipment, net $ 54,549 $ 55,414
============ ============
The Hospitals are located in an area near active and substantial
earthquake faults. The Hospitals carry earthquake insurance with a policy limit
of $50.0 million. A significant earthquake could result in material damage and
temporary or permanent cessation of operations at one or more of the Hospitals.
In addition, the State of California has imposed new hospital seismic
safety requirements. Under these new requirements, the Hospitals must meet
stringent seismic safety criteria in the future and must complete one set of
seismic upgrades to each facility by January 1, 2013. This first set of upgrades
is expected to require the Company to incur substantial seismic retrofit
expenses. In addition, there could be other remediation costs pursuant to this
seismic retrofit.
17
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2009
(UNAUDITED)
The State of California has introduced a new seismic review methodology
known as HAZUS. The HAZUS methodology may preclude the need for some structural
modifications. Three of the four Hospitals 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 3 - 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 June 30 and March 31, 2009.
June 30, March 31,
2009 2009
------- -------
Current:
Revolving line of credit, outstanding borrowings $ -- $ --
Convertible note 5,968 5,968
Secured term note 45,000 45,000
Secured non-revolving line of credit, outstanding
borrowings 30,000 30,000
------- -------
$80,968 $80,968
======= =======
The Company's 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.
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.
18
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2009
(UNAUDITED)
Each of the above credit agreements and notes (i) required a 1.5%
origination fee due at funding, (ii) matures in three years, at October 8, 2010
(Notes 4 and 11), (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 4).
Based on eligible receivables, as defined, the Company had
approximately $33.0 million of additional availability under its $50.0 million
Revolving Line of Credit at June 30, 2009. However, during the three months
ended June 30, 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 June 30, 2009, the unfulfilled
advance requests aggregated approximately $34.2 million and, as of June 30,
2009, the Lender had collected and retained $11.9 million in excess of the
amounts due to it ("Excess Amounts") under the $50 million Revolving Credit
Agreement (Note 11). The Lender applied monthly interest charges relating to all
of the credit facilities against the Excess Amounts. At June 30, 2009, the
Excess Amounts represented approximately 18 months of future interest charges or
as an offset to the outstanding current debt payable to the Lender. The Company
considers these funds immediately due. There can be no assurances that the
Company will not continue to 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.
The Company's 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. At June 30,
2009, the Minimum Fixed Charge Coverage Ratio reverted to 1.0. At June 30, 2009,
the Company was in compliance with all covenants. 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 in the accompanying unaudited condensed consolidated balance as of June
30, 2009.
As a condition of the credit facilities, the Company entered into an
Amended and Restated Triple Net Hospital Building Lease (the "Amended Lease")
with PCHI (Note 11). Concurrently with the execution of the Amended Lease, the
Company, PCHI, Ganesha Realty, LLC, ("Ganesha"), and West Coast entered into a
Settlement Agreement and Mutual Release (Note 11).
Effective April 2, 2009, the Company entered into the Global Settlement
Agreement (Note 11) which affected the terms of the credit facilities.
19
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2009
(UNAUDITED)
LENDER DEFAULT - On July 16, 2009, the SEC filed a complaint with the
United States District Court against the parent company and affiliates of the
Lender and their principal officers for violations of federal securities laws
(Note 12). On August 3, 2009 the Court appointed a temporary receiver over the
parent company of the Lender and barred it from entering into material
transaction pending presentation of the government's case.
On April 14, 2009, the Company had 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 ("Excess Amounts"), 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 Excess Amounts to the Company ($11.9
million as of June 30, 2009) and is not advancing any funds to the Company under
the $50 million Revolving Credit Agreement.
The $50 million Revolving Credit Agreement permits the Lender to apply
funds procured by the Lender under the Lockbox Agreement to defray the Company's
obligations under all other loan agreements between the Company and the Lender.
Since January 2009, the Lender has applied the Excess Amounts to payment of the
monthly interest charges due under all of the credit facilities. As of June 30,
2009, the Excess Amounts represented approximately 18 months of future interest
charges or as an offset to the outstanding current debt payable to the Lender.
The Company considers these funds immediately due. The Company believes that the
Lender's failure to return the Excess Amounts is an improper conversion of its
assets and a breach of the Lender's fiduciary and custodial obligations and
intends to vigorously pursue recovery of the remaining Excess Amounts from the
Lender in addition to other relief. There can be no assurance the Company will
be successful in pursuing its claims due to the apparent financial difficulties
the Lender is experiencing as well as the pending SEC action. Additionally,
there can be no assurance that the Lender will continue to apply interest
against the Excess Amounts or that the Excess Amounts will be ultimately
collectible. The Company has evaluated these matters in accordance with SFAS No.
5 and currently cannot determine with reasonable certainty as to the extent of
the possible loss contingency.
The Company currently 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.
NOTE 4 - 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
statements of operations.
20
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2009
(UNAUDITED)
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 3) 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 3), 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.
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).
21
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2009
(UNAUDITED)
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").
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 ("NOL") carryforwards (Note
5).
22
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2009
(UNAUDITED)
NOTE 5 - INCOME TAXES
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.
In fiscal year 2009, the Company entered into the Amended Purchase Agreement
(Note 4) which resulted in a change in control. The Company conducted an
analysis and determined that it is subject to significant IRC Section 382
limitations. For both Federal and state tax purposes, the Company's utilization
of NOL and credit carryforwards is subject to significant IRC Section 382
limitations, and these limitations have been incorporated into the tax provision
calculation.
The difference between the reported provision for income taxes and the
amount computed by multiplying income before provision for income taxes in the
accompanying unaudited condensed consolidated statement of operations for the
three months ended June 30, 2009 by the statutory federal income tax rate
relates to state and local income taxes, net of federal benefits, variable
interest entity, and deferred tax adjustments.
NOTE 6 - STOCK INCENTIVE PLAN
The Company's 2006 Stock Incentive Plan (the "Plan"), which is
shareholder-approved, permits the grant of share options to its employees and
board members for up to a maximum aggregate of 12.0 million shares of common
stock. In addition, as of the first business day of each calendar year in the
period 2007 through 2015, the maximum aggregate number of shares shall be
increased by a number equal to one percent of the number of shares of common
stock of the Company outstanding on December 31 of the immediately preceding
calendar year. Accordingly, as of June 30, 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.
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.
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 comparable publicly traded companies that own hospitals.
23
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2009
(UNAUDITED)
In accordance with SFAS No. 123R, the Company recorded $13.0 and $14.0
of compensation expense relative to stock options during the three months ended
June 30, 2009 and 2008, respectively. No options were granted or exercised
during the three months ended June 30, 2009 and 2008. A summary of stock option
activity for the three months ended June 30, 2009 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, 2009 8,835 $ 0.19
Granted - $ - $ -
Exercised - $ -
Forfeited or expired (60) $ 0.25
-----------------
Outstanding, June 30, 2009 8,775 $ 0.19 5.4 $ -
================= ================= ================== ================
Exercisable at June 30, 2009 6,929 $ 0.21 5.2 $ -
================= ================= ================== ================
A summary of the Company's nonvested options as of June 30, 2009, and
changes during the three months ended June 30, 2009 is presented as follows.
Weighted-
average
grant date
Shares fair value
------------------ -----------------
Nonvested at March 31, 2009 2,250 $ 0.03
Granted -- --
Vested (344) $ 0.03
Forfeited (60) $ 0.06
------------------ =================
Nonvested at June 30, 2009 1,846 $ 0.03
================== =================
As of June 30, 2009, there was $66.7 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 7 - RETIREMENT PLAN
The Company has a 401(k) plan for its employees. All employees with 90
days of service are eligible to participate, unless they are covered by a
collective bargaining agreement which precludes coverage. The Company matches
employee contributions up to 3% of the employee's compensation, subject to IRS
limits. During the three months ended June 30, 2009 and 2008, the Company
incurred expenses of $766.8 and $766.4, respectively, which are included in
salaries and benefits in the accompanying unaudited condensed consolidated
statements of operations.
NOTE 8 - INCOME (LOSS) PER SHARE
Income (loss) per share is calculated 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.
24
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2009
(UNAUDITED)
Income per share for the three months ended June 30, 2009 was computed
as shown below. Stock options and warrants aggregating 303.3 million shares were
not included in the diluted calculation since they were not in-the-money during
the three months ended June 30, 2009.
Numerator:
Net income attributable to
Integrated Healthcare Holdings, Inc. $ 1,148
Interest on $10.7 million Convertible Term Note 140
Adjusted net income attributable to
--------------
Integrated Healthcare Holdings, Inc. $ 1,288
==============
Denominator:
Weighted average common shares 195,307
Shares - $10.7 million Convertible Term Note 28,419
--------------
Denominator for diluted calculation 223,726
==============
Income per share - basic $ 0.01
Income per share - diluted $ 0.01
Since the Company incurred losses for the three months ended June 30,
2008, antidilutive potential shares of common stock, consisting of approximately
149 million shares issuable under warrants and stock options, have been excluded
from the calculations of diluted loss per share for that period.
NOTE 9 - VARIABLE INTEREST ENTITY
Concurrent with the close on the Acquisition, and pursuant to an
agreement dated September 28, 2004, as amended and restated on November 16,
2004, Dr. Chaudhuri and Dr. Shah exercised their options to purchase all of the
equity interests in PCHI, which simultaneously acquired title to substantially
all of the real property acquired by the Company in the Acquisition. The Company
received $5.0 million and PCHI guaranteed the Company's Acquisition Loan (the
Acquisition Loan was refinanced on October 9, 2007 with a $45.0 million Term
Note (Note 3)). 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 unaudited condensed consolidated balance sheet at June 30
and March 31, 2009.
25
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2009
(UNAUDITED)
Prior to consolidation with the Company, PCHI's assets, liabilities,
and accumulated deficient at June 30 and March 31, 2009 are set forth below.
June 30, March 31,
2009 2009
----------- -----------
Cash $ 203 $ 27
Property, net 43,366 43,688
Other 306 133
----------- -----------
Total assets $ 43,875 $ 43,848
=========== ===========
Debt $ 45,000 $ 45,000
Other 455 534
----------- -----------
Total liabilities 45,455 45,534
----------- -----------
Accumulated deficit (1,580) (1,686)
----------- -----------
Total liabilities and accumulated deficit $ 43,875 $ 43,848
=========== ===========
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 11). Additionally, the
Company is responsible for seismic remediation under the terms of the lease
agreement (Note 2).
NOTE 10 - RELATED PARTY TRANSACTIONS
PCHI - The Company leases substantially all of the real property of the
acquired Hospitals from PCHI. PCHI is owned by two 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 June 30 and
March 31, 2009. As described in Note 9, PCHI is a variable interest entity and,
accordingly, the Company has consolidated the financial statements of PCHI in
the accompanying unaudited condensed consolidated financial statements.
On September 25, 2008, the Company entered into an agreement with a
professional law corporation (the "Firm") controlled by a director and
shareholder of the Company. The agreement specifies that the Firm will provide
services for approximately twenty hours per week as Special Counsel to the
Company in connection with the supervision and coordination of various legal
matters. For its services, the Firm will be compensated at a flat rate of $20.0
per month, plus reimbursement of out-of-pocket costs. The agreement was
terminated in April 2009. During the three months ended June 30, 2009, the
Company incurred expenses under the agreement of $20.0.
During the three months ended June 30, 2009 and 2008, the Company paid
$3.6 million and $1.4 million, respectively, to a supplier that is also a
shareholder of the Company.
26
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2009
(UNAUDITED)
NOTE 11 - COMMITMENTS AND CONTINGENCIES
OPERATING LEASES - Concurrent with the closing of the Acquisition as of
March 8, 2005, the Company entered into a sale leaseback type agreement with a
related party entity, PCHI. The Company leases substantially all of the real
estate of the acquired Hospitals and medical office buildings from PCHI. As a
condition of the New Credit Facilities (Note 3), 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 9).
Concurrently with the execution of the Amended Lease, the Company,
PCHI, Ganesha, and West Coast entered into a Settlement Agreement and Mutual
Release (the "Settlement Agreement") whereby the Company agreed to pay to PCHI
$2.5 million as settlement for unpaid rents specified in the Settlement
Agreement, relating to the College Avenue Property, and for compensation
relating to the medical office buildings located at 999 North Tustin Avenue in
Santa Ana, California, under a previously executed Agreement to Compensation.
This transaction with PCHI is eliminated in consolidation (Note 9).
CAPITAL LEASES - In connection with the Hospital Acquisition, the
Company also assumed the leases for the Chapman facility, which include
buildings 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 $7,005 and $7,140 are included in
the accompanying unaudited condensed consolidated balance sheets as of June 30
and March 31, 2009, respectively. Interest rates used in computing the net
present value of the lease payments are based on the interest rates implicit in
the leases.
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 June 30 and March 31, 2009, the Company had
accrued $9.1 million and $8.7 million, respectively, which is comprised of $4.3
million and $4.1 million, respectively, in incurred and reported claims, along
with $4.8 million and $4.6 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 June 30 and March 31, 2009, the Company had
accrued $699 and $711, respectively, comprised of $209 and $202, respectively,
in incurred and reported claims, along with $490 and $509, respectively, in
estimated IBNR.
27
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2009
(UNAUDITED)
Effective May 1, 2007, the Company initiated a self-insured health
benefits plan for its employees. As a result, the Company has established and
maintains an accrual for IBNR claims arising from self-insured health benefits
provided to employees. The Company's IBNR accrual at June 30 and March 31, 2009
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 June 30 and March 31,
2009, the Company had accrued $1.8 million and $1.8 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 June 30 and March 31,
2009.
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 4.8% per annum. The Company incurred finance charges
relating to such policies of $32.6 and $22.9 during the three months ended June
30, 2009 and 2008, respectively. As of June 30 and March 31, 2009, the
accompanying unaudited condensed consolidated balance sheets include the
following balances relating to the financed insurance policies.
June 30, 2009 March 31, 2009
-------------- --------------
Prepaid insurance $ 4,486 $ 339
Accrued insurance premiums $ 3,461 $ 19
(Included in other current liabilities)
CLAIMS AND LAWSUITS - The Company and the Hospitals are subject to
various legal proceedings, most of which relate to routine matters incidental to
operations. The results of these claims cannot be predicted, and it is possible
that the ultimate resolution of these matters, individually or in the aggregate,
may have a material adverse effect on the Company's business (both in the near
and long term), financial position, results of operations, or cash flows.
Although the Company defends itself vigorously against claims and lawsuits and
cooperates with investigations, these matters (1) could require payment of
substantial damages or amounts in judgments or settlements, which individually
or in the aggregate could exceed amounts, if any, that may be recovered under
insurance policies where coverage applies and is available, (2) cause
substantial expenses to be incurred, (3) require significant time and attention
from the Company's management, and (4) could cause the Company to close or sell
the Hospitals or otherwise modify the way its business is conducted. The Company
accrues for claims and lawsuits when an unfavorable outcome is probable and the
amount is reasonably estimable.
From time to time, healthcare facilities receive requests for
information in the form of a subpoena from licensing entities, such as the
Medical Board of California, regarding members of their medical staffs. Also,
California state law mandates that each medical staff is required to perform
peer review of its members. As a result of the performance of such peer reviews,
action is sometimes taken to limit or revoke an individual's medical staff
membership and privileges in order to assure patient safety. In August 2007, the
Company received such a subpoena from the Medical Board of California concerning
a member of the medical staff of one of the Company's facilities. The facility
is in the process of responding to the subpoena and is in the process of
reviewing the matter. Since the matter is in the early stage, the Company is not
able to determine the impact, if any, it may have on the Company's consolidated
operations or financial position.
28
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2009
(UNAUDITED)
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 then 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.
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.
29
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2009
(UNAUDITED)
On June 19, 2008, the Company received correspondence from OC-PIN
demanding that the Company notice a special shareholders' meeting no later than
June 26, 2008, to occur during the week of July 21 - 25, 2008. The stated
purpose of the meeting was to (1) repeal a bylaws provision setting forth a
procedure for nomination of director candidates by shareholders, (2) remove the
Company's entire Board of Directors, and (3) elect a new Board of Directors. The
Company denied this request based on, among other reasons, failure to comply
with the appropriate bylaws and SEC procedures and failure to comply with
certain requirements under the Company's credit agreements with its primary
lender. OC-PIN repeated its request on July 29, 2008, and on July 30, 2008,
filed a petition for writ of mandate in the Orange County Superior Court seeking
a court order to compel the Company to hold a special shareholders' meeting. On
August 18, 2008, the Court denied OC-PIN's petition.
On September 17, 2008, OC-PIN filed another petition for writ of
mandate seeking virtually identical relief as the petition filed on July 30,
2008. 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.
On April 2, 2009, the Company, OC-PIN, Anil V. Shah, M.D. ("Shah"),
Bruce Mogel, Pacific Coast Holdings Investment, LLC ("PCHI"), West Coast
Holdings, LLC ("WCH"), Kali P. Chaudhuri, M.D., Ganesha Realty, LLC ("Ganesha"),
William E. Thomas and Medical Capital Corporation and related entities ("Medical
Capital") (together, the "Global Settlement Parties") entered into a global
settlement agreement and mutual release (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 trust account in
conjunction with payments and a guarantee 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 Shah to not accept any nomination, appointment, or service in any
capacity as a director, officer or employee of the Company for a two (2) year
period so long as the Company keeps the PCHI and Chapman leases current. Two
stock purchase agreements (the "Stock Purchase Agreements") were also executed
in conjunction with the Global Settlement Agreement, granting (1) OC-PIN and
Shah each a separate right to purchase up to 14,700,000 shares of Common Stock,
and (2) Kali P. Chaudhuri the right to purchase up to 30,600,000 shares Stock.
30
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2009
(UNAUDITED)
Purportedly pursuant to the Global Settlement Agreement, OC-PIN and/or
Shah placed a demand on the Company to seat 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 Shah
then filed a motion to enforce the Global Settlement Agreement under California
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
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, 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 and a prior stock issuance to OC-PIN's former
attorney, Hari Lal. 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 obligations under the Global
Settlement Agreement to issue stock to OC-PIN or appoint an OC-PIN
representative on the Company's Board of Directors 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 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 alleging the same wage claim as he previously alleged in
his claim with the California Department of Labor described above. Anderson's
petition also 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. On August 4, 2009, the Company filed a cross-complaint against
Anderson alleging, inter alia, Anderson breached paragraphs 4, 5 and 6 of the
Severance Agreement, and similar clauses in his December 31, 2008 Consulting
Agreement, by providing confidential and proprietary information to individuals
outside of the Company's management and voluntarily providing information to
individuals who intended to use the information to sue the Company. The Company
also alleges Anderson concealed material information from the Company in breach
of his overlapping fiduciary duties to the Company as an officer, Chief
Compliance Officer and its attorney. 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 and prosecuting this
lawsuit or the impact, if any, that these actions may have on its results of
operations.
31
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2009
(UNAUDITED)
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. AMVI/Prospect's ex
parte application was denied on May 26, 2009, AMVI/Prospect's regularly noticed
motion for writ of attachment was likewise denied on June 19, 2009. Pursuant to
an arbitration clause in the Risk Pool Agreement, the Company filed a motion to
compel arbitration, which was not opposed by AMVI/Prospect. The arbitration
proceeding is currently pending before the American Health Lawyer's Association.
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 expended in rental payments for the
Chapman Medical Center lease, including attorneys' fees, which has been accrued
in the accompanying unaudited condensed consolidated financial statements as of
and for the three months ended June 30, 2009.
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.
NOTE 12 - SUBSEQUENT EVENTS
On July 16, 2009, the SEC filed a complaint with the United States
District Court against the the parent company and affiliates of the Lender and
their principal officers for violations of federal securities laws. On August 3,
2009 the Court appointed a temporary receiver over the parent company of the
Lender and barred it from entering into material transaction pending
presentation of the government's case (Note 3).
In August 2009, the Company was contacted by the California Franchise
Tax Board ("FTB") for the possible examination of Enterprise Zone hiring tax
credits claimed on its California income tax returns filed for the open tax
years. A meeting in September 2009 between management of the Company and the FTB
has been arranged to discuss the scope and timing of the examination. However,
management of the Company does not anticipate that the examination will result
in any material impact to the amount of credits claimed and the Company's
consolidated financial statements.
32
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
FORWARD-LOOKING INFORMATION
This Quarterly Report on Form 10-Q contains forward-looking statements,
as that term is defined in the Private Securities Litigation Reform Act of 1995.
These statements relate to future events or our future financial performance. In
some cases, you can identify forward-looking statements by terminology such as
"may," "will," "should," "expects," "plans," "anticipates," "believes,"
"estimates," "predicts," "potential" or "continue" or the negative of these
terms or other comparable terminology. These statements are only predictions and
involve known and unknown risks, uncertainties and other factors, including the
risks discussed under the caption "Risk Factors" in our Annual Report on Form
10-K filed on June 29, 2009 that may cause our Company's or our industry's
actual results, levels of activity, performance or achievements to be materially
different from those expressed or implied by these forward-looking statements.
Although we believe that the expectations reflected in the
forward-looking statements are reasonable, we cannot guarantee future results,
levels of activity, performance or achievements. Except as may be required by
applicable law, we do not intend to update any of the forward-looking statements
to conform these statements to actual results.
As used in this report, the terms "we," "us," "our," "the Company,"
"Integrated Healthcare Holdings" or "IHHI" mean Integrated Healthcare Holdings,
Inc., a Nevada corporation, unless otherwise indicated.
Unless otherwise indicated, all amounts included in this Item 2 are
expressed in thousands (except percentages and per share amounts).
OVERVIEW
On March 8, 2005, we completed our 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. We 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, we 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 our 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, January 2009, and April 2009, we issued equity securities to existing
shareholders (see "SECURITIES PURCHASE AGREEMENT" and "GLOBAL SETTLEMENT
AGREEMENT").
33
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. Since 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. As a result of the Lender's default on our $50.0
million Revolving Credit Agreement, we currently rely 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 our ability to continue as
a going concern (see "LENDER DEFAULT").
34
LIQUIDITY AND CAPITAL RESOURCES
The accompanying unaudited condensed consolidated financial statements
have been prepared on a going concern basis, which contemplates the realization
of assets and settlement of obligations in the normal course of business. We had
a working capital deficit and total deficiency of $92.0 million and $43.8
million, respectively, at June 30, 2009.
During the three months ended June 30, 2009, we 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 our advance requests. As of June 30, 2009, the unfulfilled
advance requests aggregated approximately $34.2 million and, as of June 30,
2009, the Lender had collected and retained $11.9 million 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 June 30, 2009, the Excess
Amounts represented approximately 18 months of future interest charges or as an
offset to the outstanding current debt payable to the Lender (see "LENDER
DEFAULT"). We consider these funds immediately due, however, there can be no
assurance that we will be successful in recovering all Excess Amounts. We are
actively seeking alternate lending sources with sufficient liquidity to service
its financing requirements. There can be no assurance that we will be successful
in securing replacement financing.
These factors, among others, raise substantial doubt about our ability
to continue as a going concern and indicate a need for us to take action to
continue to operate its business as a going concern. There is no assurance that
we will be successful in improving reimbursements or reducing operating
expenses.
Key items for the three months ended June 30, 2009 included:
1. Net collectible revenues (net operating revenues less provision for
doubtful accounts) for the three months ended June 30, 2009 and 2008
were $84.2 million and $83.8 million, respectively, representing an
increase of 0.4%. 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 increased $3.3 million for the three
months ended June 30, 2009 compared to the three months ended June 30,
2008.
Inpatient admissions decreased by 5.2% to 6,262 for the three months
ended June 30, 2009 compared to 6,608 for the three months ended June
30, 2008. The decline in admissions is primarily related to the closure
of the unprofitable geriatric psychiatric unit at Western Medical
Center - Santa Ana, an aggressive process by the Orange County
Healthcare Agency to improve case management of inmate admissions to
Western Medical Center - Anaheim under a fixed fee arrangement, and a
decline in deliveries by unfunded immigrants due to the declining
economy.
Uninsured patients, as a percentage of gross charges, decreased to 5.2%
from 6.6% for the three months ended June 30, 2009 compared to the
three months ended June 30, 2008.
35
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 for the three months ended June 30, 2009 were $4.6 million, or
5.0%, lower than during the three months ended June 30, 2008. The most
significant factors of this decrease were the $2.7 million decrease in
other operating expenses and $1.3 million decrease in salaries and
benefits, both of which were directly the result of volume declines.
Financing costs: We completed the Acquisition of the Hospitals with a
high level of debt financing. Effective October 9, 2007, we entered
into new financing arrangements with Medical Capital Corporation and
its affiliates (see "REFINANCING").
Our $50.0 million Revolving Credit Agreement provides an estimated
additional liquidity as of June 30, 2009 of $33.0 million based on
eligible receivables, as defined. However, during the three months
ended June 30, 2009 we 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 our advance requests. As of June 30, 2009, the
unfulfilled advance requests aggregated approximately $34.2 million. As
noted above, as of June 30, 2009, the Lender had collected and retained
$11.9 million in excess of the amounts due to it under the $50 million
Revolving Credit Agreement (see "LENDER DEFAULT") and is no longer
making advances to us under the $50 million Revolving Credit Agreement.
As a result, we rely solely on our cash receipts from payers to fund
our operations, and any significant disruption in such receipts could
have a material adverse effect on our ability to continue as a going
concern. At June 30, 2009, we were in compliance with all covenants, as
amended. However, given the history of non-compliance and the high
unlikelihood of compliance in fiscal year 2010, our noncurrent debt of
$81.0 million will continue to be classified as current.
REFINANCING - Effective October 9, 2007, we 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 aggregating up to $140.7 million in principal amount (the "New
Credit Facilities"). The New Credit Facilities replaced our previous credit
facilities with the Lender, which matured on March 2, 2007. We had been
operating under an Agreement to Forbear with the Lender with respect to the
previous credit facilities.
36
The New Credit Facilities consist of the following instruments:
o An $80.0 million credit agreement, under which we 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 our 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 our 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 we 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 our existing
$10.7 million loan. The $10.7 million Convertible Term Note is
convertible into our common stock at $0.21 per share during the term
of the note.
o A $50.0 million Revolving Credit Agreement, under which we 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 our 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 our assets and our subsidiaries and
the real estate underlying our Hospitals (three of which are owned by PCHI and
leased to us), 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, we 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.
37
Based on eligible receivables, as defined, we had approximately $33.0
million of additional availability under our $50.0 million Revolving Line of
Credit at June 30, 2009. However, during the three months ended June 30, 2009,
we experienced significant delays in the funding of advances under our $50.0
million Revolving Credit Agreement. During this time, the Lender experienced
delays in funding advances in accordance with advance requests submitted by us.
As of June 30, 2009, the unfulfilled advance requests aggregated approximately
$34.2 million. As of June 30, 2009, the Lender had collected and retained $11.9
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 June 30, 2009, the Excess Amounts represented
approximately 18 months of future interest charges or as an offset to the
outstanding current debt payable to the Lender. We consider these funds
immediately due, however, there can be no assurances that we will be successful
in recovering all Excess Amounts (see "LENDER DEFAULT").
Our 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. At June 30, 2009, we were in compliance with all covenants, as
amended. However, given the history of non-compliance and uncertainty as to
future compliance, our noncurrent debt of $81.0 million has been classified as
current.
As a condition of the New Credit Facilities, we entered into an Amended
and Restated Triple Net Hospital Building Lease (the "Amended Lease") with PCHI.
Concurrently with the execution of the Amended Lease, we, PCHI, Ganesha Realty,
LLC, and West Coast entered into a Settlement Agreement and Mutual Release (the
"Settlement Agreement") whereby we 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.
LENDER DEFAULT - On July 16, 2009, the SEC filed a complaint with the
United States District Court against the parent company and affiliates of the
Lender and their principal officers for violations of federal securities laws
(Note 12). On August 3, 2009 the Court appointed a temporary receiver over the
parent company of the Lender and barred it from entering into material
transaction pending presentation of the government's case.
On April 14, 2009, we 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 ("Excess Amounts"), 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 our 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 us with full access to our bank accounts and the
accounts are no longer accessible by the Lender.
The Lender has not returned the Excess Amounts to the Company ($11.9
million as of June 30, 2009) and is not advancing any funds to us under the $50
million Revolving Credit Agreement.
38
The $50 million Revolving Credit Agreement permits the Lender to apply
funds procured by the Lender under the Lockbox Agreement to defray our
obligations under all other loan agreements between the Company and the Lender.
Since January, 2009, the Lender has applied the Excess Amounts to payment of the
monthly interest charges due under all of the New Credit Facilities. As of June
30, 2009, the Excess Amounts represented approximately 18 months of future
interest charges under the New Credit Facilities or as an offset to the
outstanding current debt payable to the Lender. We believe that the Lender's
failure to return the Excess Amounts is an improper conversion of its assets and
a breach of the Lender's fiduciary and custodial obligations and we intend to
vigorously pursue recovery of the remaining Excess Amounts from the Lender in
addition to other relief. There can be no assurance that we will be successful
in pursuing its claims due to the apparent financial difficulties the Lender is
experiencing as well as the pending SEC action. Accordingly, we are unable to
estimate its exposure, if any, to losses incurred by the Lender's default.
We currently rely 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 our ability to continue as a going concern.
RESTRUCTURING WARRANTS - We 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, we issued warrants to purchase up to 74.7 million shares of our
common stock (the "Restructuring Warrants") to Dr. Chaudhuri and Mr. Thomas (not
to exceed 24.9% of our fully diluted capital stock at the time of exercise). In
addition, we 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.
During February 2007, Dr. Chaudhuri and Mr. Thomas submitted an
exercise under these warrants to the Company. At March 31, 2007 we 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, we 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 our 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, we 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").
39
NEW WARRANTS - Concurrently with the execution of the New Credit
Facilities (see "REFINANCING"), we issued to an affiliate of the Lender a
five-year warrant to purchase the greater of approximately 16.9 million shares
of our common stock or up to 4.95% of our common stock equivalents, as defined,
at $0.21 per share (the "4.95% Warrant"). In addition, we 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 our common stock or up to 31.09% of our 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 we are in
default of our 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, we recorded warrant expense, and a related warrant liability, of $10.2
million relating to the New Warrants.
RECLASSIFICATION OF WARRANTS - On December 31, 2007, we amended our
Articles of Incorporation to increase our 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, we
revalued the 24.9 million Restructuring Warrants and the New Warrants resulting
in a change in the fair value of warrant liability of $2.9 million and $11.4
million, respectively, and reclassified the combined warrant liability balance
of $25.7 million to additional paid in capital in accordance with EITF 00-19.
SECURITIES PURCHASE AGREEMENT - On July 18, 2008, we 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 us 63.3 million shares of our 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
our common stock by acquiring additional equity securities concurrent with
future issuances by us 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, we 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"). We used the $3.7
million in proceeds from the warrant exercise described above to pay down the
$10.7 million Convertible Term Note. We are obligated under the Payoff Agreement
to use the proceeds we receive 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 we have fully repaid early the remaining balance of the $10.7
million Convertible Term Note, we have 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.
40
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 we pay 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, we 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 us 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 us 33.3 million shares 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 us of $30, under the Amended
Purchase Agreement we 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 our common stock at a purchase price
of $0.11 per share (the "Amended Purchase Right").
Concurrently with the execution of the Amended Purchase Agreement, we
and our 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 us on October 9, 2007.
Under the Amended Payoff Amendment, we 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. We are 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,
we are subject to limitations on the use of its net operating loss
carryforwards.
LONG TERM LEASE COMMITMENT WITH VARIABLE INTEREST ENTITY - Concurrent
with the closing of the Acquisition as of March 8, 2005, we entered into a sale
leaseback type agreement with a related party entity, PCHI. We lease
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"), we entered into an Amended Lease with PCHI. The Amended Lease
terminates on the 25-year anniversary of the original lease (March 8, 2005),
grants us the right to renew for one additional 25-year period, and requires
annual base rental payments of $8.3 million. However, until we refinance our
$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, we 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.
We remain primarily liable under the $45.0 million Term Note
notwithstanding its guarantee by PCHI, and this note is cross collateralized by
substantially all of our assets and all of the real property of the Hospitals.
All of our operating activities are directly affected by the real property that
was sold to PCHI.
41
COMMITMENTS AND CONTINGENCIES - The State of California has imposed new
hospital seismic safety requirements. We operate four hospitals located in an
area near active earthquake faults. Under these new requirements, we 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 us to incur substantial seismic retrofit costs.
There are additional requirements that must be complied with by 2030. We are
currently estimating the costs of meeting these requirements; however a total
estimated cost has not yet been determined.
CASH FLOW - Net cash provided by operating activities for the three
months ended June 30, 2009 and 2008 was $8.5 million and $6.8 million,
respectively. Net income (loss), adjusted for depreciation and other non-cash
items, excluding the provision for doubtful accounts and minority interest,
totaled $2.2 million and $(1.2) million for the three months ended June 30, 2009
and 2008, respectively. We produced $6.3 million and $8.0 million in working
capital for the three months ended June 30, 2009 and 2008, respectively. Net
cash produced by growth in accounts payable, accrued compensation and benefits
and other current liabilities was $3.2 million and $4.0 million for the three
months ended June 30, 2009 and 2008, respectively. Cash provided by accounts
receivable, net of provision for doubtful accounts, was $5.0 million and $0.3
million for the three months ended June 30, 2009 and 2008, respectively.
Net cash used in investing activities during the three months ended
June 30, 2009 and 2008 was $0.1 million and $0.3 million, respectively. During
the three months ended June 30, 2009 and 2008, we invested $0.1 million and $0.3
million in cash, respectively, in new equipment.
Net cash used in financing activities for the three months ended June
30, 2009 and 2008 was $6.5 million and $6.6 million, respectively. The decrease
in net cash used in financing activities for the three months ended June 30,
2009 was primarily due to $6.3 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.
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
THREE MONTHS ENDED JUNE 30, 2009 COMPARED TO THREE MONTHS ENDED JUNE
30, 2008
The following table sets forth, for the three months ended June 30,
2009 and 2008, our consolidated statements of operations expressed as a
percentage of net operating revenues.
42
Three months ended
June 30,
--------------------------------
2009 2008
-------------- ---------------
Net operating revenues 100.0% 100.0%
-------------- ---------------
Operating expenses:
Salaries and benefits 55.2% 56.3%
Supplies 13.6% 13.2%
Provision for doubtful accounts 9.5% 10.4%
Other operating expenses 15.5% 18.4%
Depreciation and amortization 1.0% 1.0%
-------------- ---------------
94.8% 99.2%
-------------- ---------------
Operating income 5.2% 0.8%
-------------- ---------------
Other expense:
Interest expense, net (2.4%) (3.2%)
-------------- ---------------
(2.4%) (3.2%)
-------------- ---------------
Income (loss) before provision for income taxes 2.8% (2.4%)
Provision for income taxes (1.3%) 0.0%
-------------- ---------------
Net income (loss) 1.5% (2.4%)
Less net income attributable to
noncontrolling interests (0.3%) (0.6%)
Net income (loss) attributable to -------------- ---------------
Integrated Healthcare Holdings, Inc. 1.2% (3.0%)
============== ===============
NET OPERATING REVENUES - Net operating revenues for the three months
ended June 30, 2009 decreased 0.6% compared to the same period in fiscal year
2009, from $93.6 million to $93.0 million. Admissions for the three months ended
June 30, 2009 decreased 5.2% compared to the same period in fiscal year 2009.
The decline in admissions is primarily related to the closure of the
unprofitable geriatric psychiatric unit at Western Medical Center - Santa Ana,
an aggressive process by the Orange County Healthcare Agency to improve case
management of inmate admissions to Western Medical Center - Anaheim under a
fixed fee arrangement, and a decline in deliveries by unfunded immigrants due to
the declining economy. Net operating revenues per admission improved by 4.9%
during the three months ended June 30, 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 three months ended June 30,
2009 and 2008 were $1.6 million and $2.3 million, respectively.
Essentially all net operating revenues come from external customers.
The largest payers are the Medicare and Medicaid programs accounting for 61.6%
and 57.6% of the net operating revenues for the three months ended June 30, 2009
and 2008, respectively.
43
Uninsured patients, as a percentage of gross charges, decreased to 5.2%
from 6.6% for the three months ended June 30, 2009 compared to the three months
ended June 30, 2008.
Although not a GAAP measure, we define "Net Collectible Revenues" as
net operating revenues less provision for doubtful accounts. This eliminates the
distortion caused by the changes in patient account classification. Net
Collectible Revenues were $84.1 million (net revenues of $93.0 million less $8.9
million in provision for doubtful accounts) and $83.8 million (net revenues of
$93.6 million less $9.8 million in provision for doubtful accounts) for the
three months ended June 30, 2009 and 2008, respectively, representing an
increase of $0.3 million. There was also an increase in Net Collectible Revenues
per admission of 6.0% for the three months ended June 30, 2009 compared to the
three months ended June 30, 2008.
OPERATING EXPENSES - Operating expenses for the three months ended June
30, 2009 decreased to $88.2 million from $92.8 million, an decrease of $4.6
million, or 5.0%, compared to the same period in fiscal year 2009. Operating
expenses expressed as a percentage of net operating revenues for the three
months ended June 30, 2009 and 2008 were 94.8% and 99.2%, respectively. On a per
admission basis, operating expenses increased 0.3%.
Salaries and benefits decreased $1.3 million (2.5%) for the three
months ended March 31, 2009 compared to the same period in fiscal year 20098,
primarily due to the decline in admissions.
Other operating expenses relative to net operating revenues for the
three months ended June 30, 2009 decreased $2.7 million, or 16.0%, compared to
the same period in fiscal year 2009, primarily due to the decline in admissions
and decreases in consulting fees, repairs and maintenance, and purchased
services.
The provision for doubtful accounts for the three months ended June 30,
2009 decreased to $8.9 million from $9.8 million, or 9.2%, compared to the same
period in fiscal year 2009. The decrease in the provision for doubtful accounts
for the three months ended June 30, 2009 is primarily due to improvement in
collections, which were 10.9% higher during the three months ended June 30, 2009
compared to the three months ended June 30, 2008.
OPERATING INCOME - The operating income for the three months ended June
30, 2009 and 2008 was $4.8 million and $0.8 million, respectively.
OTHER EXPENSE - Interest expense for the three months ended June 30,
2009 was $2.2 million compared to $3.0 million for the same period in fiscal
year 2009. The decrease primarily related to the reduction in the outstanding
balance of the Company's $50 million Revolving Line of Credit.
NET INCOME (LOSS) - Net income for the three months ended June 30, 2009
was $1.4 million compared to a net loss of $2.2 million for the same period in
fiscal year 2009.
44
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 $1,554
and $1,618 as of June 30 and March 31, 2009, 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.
45
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. There were no adjustments for Final Notice of Program
Reimbursement received during the three months ended June 30, 2009 and 2008. As
of March 31, 2009, the Company reversed all reserves for excess outlier
payments.
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 $5,034 and $7,596 during the three months ended June
30, 2009 and 2008, respectively. The related revenue recorded for the three
months ended June 30, 2009 and 2008 was $3,559 and $3,854, respectively. As of
June 30 and March 31, 2009, estimated DSH receivables were $1,204 and $2,679.
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 $1.6 million and $2.3 million for
the three months ended June 30, 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 June 30 and March 31, 2009.
46
The Company is not aware of any material claims, disputes, or unsettled
matters with any payers that would affect revenues that have not been adequately
provided for in the accompanying unaudited condensed consolidated financial
statements.
PROVISION FOR DOUBTFUL ACCOUNTS - The Company provides for accounts
receivable that could become uncollectible by establishing an allowance to
reduce the carrying value of such receivables to their estimated net realizable
value. The Hospitals estimate this allowance based on the aging of their
accounts receivable, historical collections experience for each type of payer
and other relevant factors. There are various factors that can impact the
collection trends, such as changes in the economy, which in turn have an impact
on unemployment rates and the number of uninsured and underinsured patients,
volume of patients through the emergency department, the increased burden of
copayments to be made by patients with insurance and business practices related
to collection efforts. These factors continuously change and can have an impact
on collection trends and the estimation process.
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.
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.
47
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 June 30 and March 31, 2009, the Company had
accrued $9.1 million and $8.7 million, respectively, which is comprised of $4.3
million and $4.1 million, respectively, in incurred and reported claims, along
with $4.8 million and $4.6 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 June 30 and March 31, 2009, the Company had
accrued $699 and $711, respectively, comprised of $209 and $202, respectively,
in incurred and reported claims, along with $490 and $509, respectively, in
estimated IBNR.
Effective May 1, 2007, the Company initiated a self-insured health
benefits plan for its employees. As a result, the Company has established and
maintains an accrual for IBNR claims arising from self-insured health benefits
provided to employees. The Company's IBNR accrual at June 30 and March 31, 2009
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 June 30 and March 31,
2009, the Company had accrued $1.8 million and $1.8 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 June 30 and March 31,
2009.
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).
RECENT ACCOUNTING STANDARDS
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.
48
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. Effective April 1, 2009, the
Company adopted SFAS No. 160, which had no material impact on the
Company's unaudited condensed consolidated financial statements.
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. Effective April 1, 2009, the Company adopted SFAS No. 161, which had no
material impact on the Company's unaudited condensed consolidated financial
statements.
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. Effective April 1, 2009, the Company
adopted FSP APB 14-1, which had no material impact on the Company's unaudited
condensed consolidated financial statements.
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. Effective April 1, 2009, the Company adopted EITF 07-5, which had
no material impact on the Company's unaudited condensed consolidated financial
statements.
In June 2008, the FASB issued SFAS No. 168, "The FASB Accounting
Standards Codification and the Hierarchy of Generally Accepted Accounting
Principles," and, in doing so, authorized the Codification as the sole source
for authoritative U.S. GAAP. SFAS No. 168 will be effective for financial
statements issued for reporting periods that end after September 15, 2009. Once
it's effective, it will supersede all accounting standards in U.S. GAAP, aside
from those issued by the SEC. SFAS No. 168 replaces SFAS No. 162 to establish a
new hierarchy of GAAP sources for non-governmental entities under the FASB
Accounting Standards.
In May 2009, the FASB issued SFAS No. 165, "Subsequent Events" to
establish general standards of accounting for, and disclosure of, events that
occur after the balance sheet date but before financial statements are issued or
available to be issued. The unaudited condensed consolidated financial
statements as of and for the three months ended June 30, 2009 and 2008 were
available to be issued on August 13, 2009 and the Company evaluated subsequent
events known to it through that date.
49
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
As of June 30 2009, we did not have any investment in or outstanding
liabilities under market rate sensitive instruments. We do not enter into
hedging instrument arrangements.
ITEM 4. CONTROLS AND PROCEDURES.
The Company maintains disclosure controls and procedures that are
designed to ensure that information required to be disclosed in the Company's
Exchange Act reports is recorded, processed, summarized and reported within the
time periods specified in the SEC's rules and forms, and that such information
is accumulated and communicated to the Company's management, including its Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosure based closely on the definition of
"disclosure controls and procedures" in Rule 15d-15(e). The Company's disclosure
controls and procedures are designed to provide a reasonable level of assurance
of reaching the Company's desired disclosure control objectives. In designing
and evaluating the disclosure controls and procedures, management recognized
that any controls and procedures, no matter how well designed and operated, can
provide only reasonable assurance of achieving the desired control objectives,
and management necessarily was required to apply its judgment in evaluating the
cost-benefit relationship of possible controls and procedures.
As of June 30, 2009, the end of the period of this report, the Company
carried out an evaluation, under the supervision and with the participation of
the Company's management, including the Company's Chief Executive Officer and
the Company's Chief Financial Officer, of the effectiveness of the design and
operation of the Company's disclosure controls and procedures. Based on the
foregoing, the Company's Chief Executive Officer and Chief Financial Officer
concluded that the Company's disclosure controls and procedures were effective.
During the quarter ended June 30, 2009, there were no changes in the
Company's internal control over financial reporting that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
50
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company and the Hospitals are subject to various legal proceedings,
most of which relate to routine matters incidental to operations. The results of
these claims cannot be predicted, and it is possible that the ultimate
resolution of these matters, individually or in the aggregate, may have a
material adverse effect on the Company's business (both in the near and long
term), financial position, results of operations, or cash flows. Although the
Company defends itself vigorously against claims and lawsuits and cooperates
with investigations, these matters (1) could require payment of substantial
damages or amounts in judgments or settlements, which individually or in the
aggregate could exceed amounts, if any, that may be recovered under insurance
policies where coverage applies and is available, (2) cause substantial expenses
to be incurred, (3) require significant time and attention from the Company's
management, and (4) could cause the Company to close or sell the Hospitals or
otherwise modify the way its business is conducted. The Company accrues for
claims and lawsuits when an unfavorable outcome is probable and the amount is
reasonably estimable.
From time to time, healthcare facilities receive requests for
information in the form of a subpoena from licensing entities, such as the
Medical Board of California, regarding members of their medical staffs. Also,
California state law mandates that each medical staff is required to perform
peer review of its members. As a result of the performance of such peer reviews,
action is sometimes taken to limit or revoke an individual's medical staff
membership and privileges in order to assure patient safety. In August 2007, the
Company received such a subpoena from the Medical Board of California concerning
a member of the medical staff of one of the Company's facilities. The facility
is in the process of responding to the subpoena and is in the process of
reviewing the matter. Since the matter is in the early stage, the Company is not
able to determine the impact, if any, it may have on the Company's consolidated
operations or financial position.
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.
51
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.
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.
52
On April 2, 2009, the Company, OC-PIN, Anil V. Shah, M.D. ("Shah"),
Bruce Mogel, Pacific Coast Holdings Investment, LLC ("PCHI"), West Coast
Holdings, LLC ("WCH"), Kali P. Chaudhuri, M.D., Ganesha Realty, LLC ("Ganesha"),
William E. Thomas and Medical Capital Corporation and related entities ("Medical
Capital") (together, the "Global Settlement Parties") entered into a global
settlement agreement and mutual release (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 trust account in
conjunction with payments and a guarantee 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 Shah to not accept any nomination, appointment, or service in any
capacity as a director, officer or employee of the Company for a two (2) year
period so long as the Company keeps the PCHI and Chapman leases current. Two
stock purchase agreements (the "Stock Purchase Agreements") were also executed
in conjunction with the Global Settlement Agreement, granting (1) OC-PIN and
Shah each a separate right to purchase up to 14,700,000 shares of Common Stock,
and (2) Kali P. Chaudhuri the right to purchase up to 30,600,000 shares Stock.
Purportedly pursuant to the Global Settlement Agreement, OC-PIN and/or
Shah placed a demand on the Company to seat 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 Shah
then filed a motion to enforce the Global Settlement Agreement under California
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
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, 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 and a prior stock issuance to OC-PIN's former
attorney, Hari Lal. 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 obligations under the Global
Settlement Agreement to issue stock to OC-PIN or appoint an OC-PIN
representative on the Company's Board of Directors 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 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.
53
On or about February 11, 2009, Anderson filed a petition for
arbitration before JAMS alleging the same wage claim as he previously alleged in
his claim with the California Department of Labor described above. 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. On August 4, 2009, the Company filed a cross-complaint against
Anderson alleging, inter alia, Anderson breached paragraphs 4, 5 and 6 of the
Severance Agreement, and similar clauses in his December 31, 2008 Consulting
Agreement, by providing confidential and proprietary information to individuals
outside of the Company's management and voluntarily providing information to
individuals who intended to use the information to sue the Company. The Company
also alleges Anderson concealed material information from the Company in breach
of his overlapping fiduciary duties to the Company as an officer, Chief
Compliance Officer and its attorney. 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 and prosecuting this
lawsuit or the impact, if any, that these actions may have on its results of
operations.
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. AMVI/Prospect's ex
parte application was denied on May 26, 2009, AMVI/Prospect's regularly noticed
motion for writ of attachment was likewise denied on June 19, 2009. Pursuant to
an arbitration clause in the Risk Pool Agreement, the Company filed a motion to
compel arbitration, which was not opposed by AMVI/Prospect. The arbitration
proceeding is currently pending before the American Health Lawyer's Association.
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 expended in rental payments for the
Chapman Medical Center lease, including attorneys' fees, which has been accrued
in the accompanying unaudited condensed consolidated financial statements as of
and for the three months ended June 30, 2009.
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.
54
ITEM 1A. RISK FACTORS
On July 16, 2009, the SEC filed a complaint with the United States
District Court against the parent company and affiliates of the Lender and their
principal officers for violations of federal securities laws. On August 3, 2009
the Court appointed a temporary receiver over the parent company of the Lender
and barred it from entering into material transaction pending presentation of
the government's case.
On April 14, 2009, the Company had 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 ("Excess Amounts"), 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 Excess Amounts to the Company ($11.9
million as of June 30, 2009) and is not advancing any funds to the Company under
the $50 million Revolving Credit Agreement.
The $50 million Revolving Credit Agreement permits the Lender to apply
funds procured by the Lender under the Lockbox Agreement to defray the Company's
obligations under all other loan agreements between the Company and the Lender.
Since January, 2009, the Lender has applied the Excess Amounts to payment of the
monthly interest charges due under all of the New Credit Facilities. As of June
30, 2009, the Excess Amounts represented approximately 18 months of future
interest charges under the New Credit Facilities or as an offset to the
outstanding current debt payable to the Lender. The Company believes that the
Lender's failure to return the Excess Amounts is an improper conversion of its
assets and a breach of the Lender's fiduciary and custodial obligations and
intends to vigorously pursue recovery of the remaining Excess Amounts from the
Lender in addition to other relief. There can be no assurance the Company will
be successful in pursuing its claims due to the apparent financial difficulties
the Lender is experiencing as well as the pending SEC action. Accordingly, the
Company is unable to estimate its exposure, if any, to losses incurred by the
Lender's default.
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.
Since our business is currently limited to the Southern California
area, any reduction in our revenues and profitability from a local economic
downturn would not be offset by operations in other geographic areas.
To date, we have developed our business within only one geographic area
to take advantage of economies of scale. Due to this concentration of business
in a single geographic area, we are exposed to potential losses resulting from
the risk of an economic downturn in Southern California. If economic conditions
deteriorate in Southern California, our patient volumes and revenues may
decline, which could significantly reduce our profitability.
There are no other material changes from the risk factors previously
disclosed in our Annual Report on Form 10-K for the fiscal year ended March 31,
2009.
55
ITEM 6. EXHIBITS
Exhibit
Number Description
- ------ -----------
31.1 Certification of Chief Executive Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of
1934, the registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
INTEGRATED HEALTHCARE HOLDINGS, INC.
Dated: August 13, 2009 By: /s/ Steven R. Blake
------------------------------
Steven R. Blake
Chief Financial Officer
(Principal Financial Officer)
56