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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 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)
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant 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
November 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 September 30, 2009 and
March 31, 2009, adjusted - (unaudited) 3
Condensed Consolidated Statements of Operations for the three and six
months ended September 30, 2009 and 2008, adjusted - (unaudited) 4
Condensed Consolidated Statement of Deficiency
for the six months ended September 30, 2009 - (unaudited) 5
Condensed Consolidated Statements of Cash Flows for the six months
ended September 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 31
Item 3. Quantitative and Qualitative Disclosures About Market Risk 47
Item 4. Controls and Procedures 47
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 48
Item 1A. Risk Factors 53
Item 6. Exhibits 54
Signatures 54
2
PART I - FINANCIAL INFORMATION
Item 1. Financial statements
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(amounts in 000's, except par value)
(unaudited)
September 30, March 31,
2009 2009
--------- ---------
(adjusted)
ASSETS
Current assets:
Cash and cash equivalents $ 5,129 $ 3,514
Restricted cash 21 18
Accounts receivable, net of allowance for doubtful
accounts of $15,409 and $17,377, respectively 52,704 55,876
Inventories of supplies, at cost 5,954 5,742
Due from governmental payers 8,478 4,297
Due from lender -- 5,576
Prepaid insurance 3,164 339
Other prepaid expenses and current assets 6,859 5,097
--------- ---------
Total current assets 82,309 80,459
Property and equipment, net 54,331 55,414
Debt issuance costs, net -- 123
--------- ---------
Total assets $ 136,640 $ 135,996
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Debt $ 80,968 $ 80,968
Accounts payable 56,022 59,265
Accrued compensation and benefits 17,156 16,809
Accrued insurance retentions 11,562 11,212
Other current liabilities 8,585 6,265
--------- ---------
Total current liabilities 174,293 174,519
Capital lease obligations, net of current portion
of $807 and $416, respectively 6,287 6,703
--------- ---------
Total liabilities 180,580 181,222
--------- ---------
Commitments and contingencies
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 61,106 61,080
Accumulated deficit (106,194) (106,501)
--------- ---------
Total Integrated Healthcare Holdings, Inc. stockholders' deficiency (44,893) (45,226)
Noncontrolling interests 953 --
--------- ---------
Total deficiency (43,940) (45,226)
--------- ---------
Total liabilities and deficiency $ 136,640 $ 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 Six months ended
September 30, September 30,
---------------------- ----------------------
2009 2008 2009 2008
--------- --------- --------- ---------
(adjusted) (adjusted)
Net operating revenues $ 101,356 $ 95,466 $ 194,368 $ 189,029
--------- --------- --------- ---------
Operating expenses:
Salaries and benefits 52,492 53,875 103,847 106,547
Supplies 13,198 12,137 25,803 24,441
Provision for doubtful accounts 7,656 11,918 16,512 21,661
Other operating expenses 14,181 18,987 28,628 36,180
Depreciation and amortization 905 889 1,820 1,783
Impairment - due from Lender (Notes 1 and 3) 11,253 -- 11,253 --
--------- --------- --------- ---------
99,685 97,806 187,863 190,612
--------- --------- --------- ---------
Operating income (loss) 1,671 (2,340) 6,505 (1,583)
--------- --------- --------- ---------
Other expense:
Interest expense, net (2,395) (2,785) (4,624) (5,788)
Warrant expense -- (22) -- (22)
--------- --------- --------- ---------
(2,395) (2,807) (4,624) (5,810)
--------- --------- --------- ---------
Income (loss) before provision for income taxes (724) (5,147) 1,881 (7,393)
Income tax benefit (provision) 619 (17) (621) (17)
--------- --------- --------- ---------
Net income (loss) (105) (5,164) 1,260 (7,410)
Net loss (income) attributable to
noncontrolling interests (Note 9) (737) 481 (953) (50)
--------- --------- --------- ---------
Net income (loss) attributable to
Integrated Healthcare Holdings, Inc. $ (842) $ (4,683) $ 307 $ (7,460)
========= ========= ========= =========
Per Share Data:
Earnings (loss) per common share attributable to
Integrated Healthcare Holdings, Inc. stockholders
Basic $ (0.00) $ (0.03) $ 0.00 $ (0.05)
Diluted $ (0.00) $ (0.03) $ 0.00 $ (0.05)
Weighted average shares outstanding
Basic 195,307 157,377 195,307 147,292
Diluted 195,307 157,377 224,726 147,292
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 -- -- 26 -- -- 26
Net income -- -- -- 307 953 1,260
--------- --------- ----------- ----------- ------------- ---------
Balance, September 30, 2009 195,307 $ 195 $ 61,106 $ (106,194) $ 953 $ (43,940)
========= ========= =========== =========== ============= =========
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)
Six months ended September 30,
------------------------------
2009 2008
------------- -------------
(adjusted)
Cash flows from operating activities:
Net income (loss) $ 1,260 $ (7,410)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization of property and equipment 1,820 1,783
Provision for doubtful accounts 16,512 21,661
Amortization of debt issuance costs 124 264
Common stock warrant expense -- 22
Impairment - due from Lender 11,253 --
Noncash share-based compensation expense 26 30
Noncash recovery relating to impaired property and equipment (195) --
Changes in operating assets and liabilities:
Accounts receivable (13,340) (14,745)
Inventories of supplies (212) (133)
Due from governmental payers (4,181) (295)
Prepaid insurance, other prepaid expenses and
current assets, and other assets (4,393) (1,035)
Accounts payable (3,243) 3,856
Accrued compensation and benefits 347 306
Due to governmental payers -- (708)
Accrued insurance retentions and other current liabilities 2,670 1,263
------------- -------------
Net cash provided by operating activities 8,448 4,859
------------- -------------
Cash flows from investing activities:
Decrease in restricted cash (3) 5
Additions to property and equipment (737) (719)
------------- -------------
Net cash used in investing activities (740) (714)
------------- -------------
Cash flows from financing activities:
Drawdown on revolving line of credit, net -- 3,501
Paydown on convertible note -- (3,732)
Excess funds withheld by Lender (5,677) --
Issuance of common stock -- 3,732
Issuance of purchase right -- 50
Noncontrolling interests distributions -- (1,200)
Payments on capital lease obligations (416) (221)
------------- -------------
Net cash provided by (used in) financing activities (6,093) 2,130
------------- -------------
Net increase in cash and cash equivalents 1,615 6,275
Cash and cash equivalents, beginning of period 3,514 3,141
------------- -------------
Cash and cash equivalents, end of period $ 5,129 $ 9,416
============= =============
Supplemental information:
Cash paid for interest $ 348 $ 5,576
============= =============
Cash paid for income taxes $ 1,505 $ 37
============= =============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
6
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2009
(UNAUDITED)
NOTE 1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION - The accompanying unaudited condensed
consolidated financial statements of Integrated Healthcare Holdings, Inc. and
its wholly owned subsidiaries (the "Company") have been prepared in accordance
with U.S. generally accepted accounting principles ("GAAP") and the rules and
regulations of the Securities and Exchange Commission ("SEC") for interim
financial reporting. Accordingly, the accompanying statements do not include all
of the information and notes required by GAAP for complete financial statements.
In the opinion of management, these statements include all adjustments that are
of a normal and recurring nature necessary to present fairly the Company's
consolidated financial position, results of operations and cash flows. The
results of operations for the three and six months ended September 30, 2009 are
not necessarily indicative of the results for the entire 2010 fiscal year. These
unaudited condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and accompanying notes
included in the Company's Annual Report on Form 10-K for the year ended March
31, 2009 filed with the SEC on June 26, 2009.
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.
The Company has also determined that Pacific Coast Holdings Investment,
LLC ("PCHI") (Note 9), is a variable interest entity as defined by GAAP 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).
CODIFICATION - In June 2009, the Financial Accounting Standards Board
("FASB") issued a new standard that changes the referencing and organization of
accounting guidance and establishes the FASB Accounting Standards Codification
as the single source of authoritative nongovernmental GAAP. Rules and
interpretive releases of the SEC under the authority of federal securities laws
are also sources of authoritative GAAP for SEC registrants. Due to the adoption
of this standard during the three months ended September 30, 2009, the Company's
financial statements will no longer cite specific GAAP references. The adoption
of this standard did not have an effect on the Company's financial condition,
results of operations or cash flows.
LENDER RECEIVERSHIP AND DEFAULT - On July 16, 2009, the SEC filed a
complaint with the United States District Court against the parent company and
affiliates of the Company's Lender (Medical Capital Corporation, namely Medical
Provider Financial Corporation I, Provider Financial Corporation II, and Medical
Provider Financial Corporation III) and their principal officers for violations
of federal securities laws and barred it from entering into material
transactions pending presentation of the government's case. On August 3, 2009,
Mr. Thomas A. Seaman was appointed receiver ("Lender's Estate") by the Honorable
David O. Carter, Judge of the United States District Court in this securities
fraud enforcement action (Note 11).
Hereafter, unless otherwise indicated, the term "Lender" will be used
in all references to the Lender and the Lender's Estate included in these notes
to the unaudited condensed consolidated financial statements.
7
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2009
(UNAUDITED)
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 maintained 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.
As of September 30, 2009, the Lender had collected and retained $11.3
million in Excess Amounts 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. The Lender
ceased applying the Excess Amounts to payment of the monthly interest charges as
of June 30, 2009. 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 Lender's
receivership and ongoing securities fraud enforcement action against the Lender
by the SEC. Additionally, there can be no assurance that the Excess Amounts will
be ultimately recovered by the Company. As a result, the Company has impaired
the $11.3 million balance in the accompanying unaudited condensed consolidated
financial statements as of and for the periods ended September 30, 2009.
Due to the Lender's inability to perform on its commitments to the
Company, it has not advanced funds to the Company since May 2009 or returned
$11.3 million of improperly converted funds to the Company under the $50 million
Revolving Credit Agreement, therefore, 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.
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 September 30, 2009, the Company has a
working capital deficit of $92.0 million and accumulated total deficiency of
$43.9 million. As noted above, the Lender collected and retained $11.3 million
in excess of the amounts due to it, and the Lender is no longer advancing funds
to the Company, under the $50 million Revolving Credit Agreement (Note 3). As a
result, 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.
At September 30, 2009, the Company was in compliance with all debt
covenants. 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 September 30, 2009 (Note 3). Not
withstanding the uncured default by the Lender on the $50 million Revolving
Credit Agreement, as of September 30, 2009, the Company has accrued, but not
paid, interest totaling $2.0 million for the three months ended September 30,
2009, which could give the Lender cause to place the debt in default.
8
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2009
(UNAUDITED)
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.
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 as a result of the Lender's inability 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 68.8%
and 62.6% of the net operating revenues for the three months ended September 30,
2009 and 2008, respectively, and 65.4% and 60.1% for the six months ended
September 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 GAAP and prevailing
practices for investor owned entities within the healthcare industry. The
preparation of consolidated financial statements in conformity with 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.
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.
9
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2009
(UNAUDITED)
Revenues under the traditional fee-for-service Medicare and Medicaid
programs are based primarily on prospective payment systems. Discounts for
retrospectively cost based revenues and certain other payments, which are based
on the Hospitals' cost reports, are estimated using historical trends and
current factors. Cost report settlements for retrospectively cost-based revenues
under these programs are subject to audit and administrative and judicial
review, which can take several years until final settlement of such matters are
determined and completely resolved. Estimates of settlement receivables or
payables related to a specific year are updated periodically and at year end and
at the time the cost report is filed with the fiscal intermediary. Typically no
further updates are made to the estimates until the final Notice of Program
Reimbursement is received, at which time the cost report for that year has been
audited by the fiscal intermediary. There could be several years time lag
between the submission of a cost report and receipt of the Final Notice of
Program Reimbursement. Since the laws, regulations, instructions and rule
interpretations governing Medicare and Medicaid reimbursement are complex and
change frequently, the estimates recorded by the Hospitals could change by
material amounts. The Company has established settlement receivables of $153 and
$1,618 as of September 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.
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. During the
three and six months ended September 30, 2009, the Company recorded $44.0 and
$215.3, respectively, in Final Notice of Program Reimbursement settlements.
During the three and six months ended September 30, 2008, the Company recorded
$171.0 in Final Notice of Program Reimbursement settlements. During the three
and six months ended September 30, 2008, the Company reversed $1,429.6 in
reserves related to excess outlier payments based on the receipt of the Final
Notice of Program Reimbursement for 2006. As of March 31, 2009, the Company had
reversed all reserves for excess outlier payments.
10
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2009
(UNAUDITED)
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 $0 and $38 during the three months ended September 30,
2009 and 2008, respectively, and $5,034 and $7,634 during the six months ended
September 30, 2009 and 2008, respectively. The related revenue recorded for the
three months ended September 30, 2009 and 2008 was $7,026 and $4,075,
respectively, and $10,585 and $7,929 for the six months ended September 30, 2009
and 2008, respectively. As of September 30 and March 31, 2009, estimated DSH
receivables of $8,229 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
September 30 and March 31, 2009:
September 30, March 31,
2009 2009
----------- -----------
Due from government payers
Medicare $ 249 $ 1,618
Medicaid 8,229 2,679
----------- -----------
$ 8,478 $ 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.
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 $3.0 million and $2.1 million for
the three months ended September 30, 2009 and 2008, respectively, and $4.5
million and $4.4 million for the six months ended September 30, 2009 and 2008,
respectively.
11
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2009
(UNAUDITED)
Receivables from patients who are potentially eligible for Medicaid are
classified as Medicaid pending under the MEP, with appropriate contractual
allowances recorded. If the patient does not qualify for Medicaid, the
receivables are reclassified to charity care and written off, or they are
reclassified to self-pay and adjusted to their net realizable value through the
provision for doubtful accounts. Reclassifications of Medicaid pending accounts
to self-pay do not typically have a material impact on the results of operations
as the estimated Medicaid contractual allowances initially recorded are not
materially different than the estimated provision for doubtful accounts recorded
when the accounts are reclassified. All accounts classified as pending Medicaid,
as well as certain other governmental receivables, over the age of 180 days were
fully reserved in contractual allowances as of September 30 and March 31, 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
GAAP. As of September 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.
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 September 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 September 30 and March 31, 2009, the Lender had collected and
retained $11.3 million and $5.6 million, respectively, in excess of the amounts
due to it under the $50 million Revolving Credit Agreement (Note 3).
12
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2009
(UNAUDITED)
LETTERS OF CREDIT - At September 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 (Notes 1 and
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 GAAP. 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 $123.8 were amortized during the three months and
six months ended September 30, 2009, respectively. Debt issuance costs of $139.3
and $263.7 were amortized during the three and six months ended September 30,
2008 (including $14.9 in unamortized costs related to the $3.7 million paydown
on the Convertible Note). At September 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.
FAIR VALUE MEASUREMENTS - The Company's financial and nonfinancial
assets and liabilities 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.
In September 2006, the FASB issued a standard that established a common
definition for fair value to be applied to GAAP requiring use of fair value,
established a framework for measuring fair value, and expanded disclosures about
such fair value measurements. The standard also established a hierarchy for
ranking the quality and reliability of the information used to determine fair
values and 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
SEPTEMBER 30, 2009
(UNAUDITED)
In April 2009, the FASB issued a standard which provides additional
guidance for estimating fair value when the volume and level of activity for the
asset or liability have significantly decreased. The standard re-emphasizes that
regardless of market conditions the fair value measurement is an exit price
concept. The standard 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 the standard does not include assets and liabilities
measured under level 1 inputs. The standard is applied prospectively to all fair
value measurements where appropriate and is effective for interim and annual
periods ending after June 15, 2009. The Company adopted the standards'
provisions effective April 1, 2009, without a material impact to its condensed
consolidated financial statements.
In April 2009, the FASB issued standards that require publicly-traded
companies to provide disclosures on the fair value of financial instruments in
interim financial statements. These standards are effective for interim periods
ending after June 15, 2009. The Company adopted the standards' provisions
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 (Notes 3 and 4).
INCOME TAXES - GAAP requires the liability approach for the effect of
income taxes. In accordance with GAAP, 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.
Effective April 1, 2007, the Company implemented a standard issued by
the FASB which clarifies the accounting and disclosure for uncertain tax
positions. The Company implemented this standard as of April 1, 2007. The
standard 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. It also provides guidance on de-recognition, classification,
interest and penalties, accounting in interim periods, disclosure and
transition.
NEW ACCOUNTING STANDARDS - In June 2009, the FASB issued a new standard
that eliminates the previously allowed exceptions of consolidating qualifying
special purpose entities, contains new criteria for determining the primary
beneficiary and increases the frequency of required reassessments to determine
whether a company is the primary beneficiary of a variable interest entity. The
adoption of this standard, which is effective for fiscal years beginning after
November 15, 2009, is not expected to have a material effect on the unaudited
condensed consolidated financial statements.
In May 2009, the FASB issued a new standard that establishes general
standards of accounting for and disclosure of events that occur after the
balance sheet date but before financial statements are issued or are available
to be issued. The accompanying unaudited condensed consolidated financial
statements were available to be issued on November 13, 2009 and the Company
evaluated subsequent events known to it through that date.
In May 2008, the FASB issued a new standard that clarifies that
convertible debt instruments that may be settled in cash upon conversion
(including partial cash settlement). Additionally, the statement 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. Effective
April 1, 2009, the Company adopted this standard, which had no material impact
on the Company's unaudited condensed consolidated financial statements.
14
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2009
(UNAUDITED)
In March 2008, the FASB issued a new standard that requires enhanced
disclosures about an entity's derivative and hedging activities. The Company
does not currently have derivatives or enter into hedging activities; therefore,
the adoption of this standard as of April 1, 2009 did not have an effect on the
Company's unaudited condensed consolidated financial statements.
In December 2007, the FASB issued a new standard that requires the
noncontrolling interest in a subsidiary be reported as a separate component of
stockholders' equity in the consolidated financial statements. The standard also
requires net income attributable to the noncontrolling interest in a subsidiary
be reported separately on the face of the consolidated statements of earnings.
Changes in ownership interest are to be accounted for as equity transactions
and, when a subsidiary is deconsolidated, any retained noncontrolling equity
investment in the former subsidiary is to be measured at fair value with any
gain or loss recognized in earnings. The adoption of this standard as of April
1, 2009 did not have a material effect on the Company's unaudited condensed
consolidated financial statements. In connection with the adoption of this new
standard, the prior year financial statements have been adjusted to conform to
the new required presentation.
In December 2007, the FASB issued a new standard that changes the
accounting treatment for business combinations on a prospective basis. It
requires that all assets, liabilities, contingent considerations and
contingencies of an acquired business be recorded at fair value at the
acquisition date. The standard also requires that acquisition costs be expensed
as incurred and restructuring costs be expensed in periods after the acquisition
date. The Company had no business combinations during the current reporting
periods; therefore, the adoption of this standard as of April 1, 2009 did not
have an effect on the Company's unaudited condensed consolidated financial
statements. The effect of the adoption of this standard will depend upon the
nature and terms of any future business combinations the Company undertakes.
NOTE 2 - PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
SEPTEMBER 30, MARCH 31,
2009 2009
------------- -------------
Buildings $ 33,606 $ 33,606
Land and improvements 13,523 13,523
Equipment 11,960 11,223
Assets under capital leases 8,991 8,991
------------- -------------
68,080 67,343
Less accumulated depreciation (13,749) (11,929)
------------- -------------
Property and equipment, net $ 54,331 $ 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. The Company is unable to estimate these costs at September 30,
2009.
15
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 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
LENDER RECEIVERSHIP AND DEFAULT - As described in Note 1, on July 16,
2009, the SEC filed a complaint with the United States District Court against
the parent company and affiliates of the Company's Lender and their principal
officers for violations of federal securities laws and barred it from entering
into material transactions pending presentation of the government's case. On
August 3, 2009, Mr. Thomas A. Seaman was appointed receiver by the Honorable
David O. Carter, Judge of the United States District Court in this securities
fraud enforcement action.
On April 14, 2009, the Company had issued a 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 Excess Amounts collected and
retained by it under the $50 million Revolving Credit Agreement, and to reserve
the rights of the borrowers and credit parties with respect to other actions and
remedies available to them. On April 17, 2009, following receipt of a copy of
the Demand Letter, the bank that maintained the lock boxes pursuant to 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.
As of September 30, 2009, the Lender had collected and retained $11.3
million in Excess Amounts 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. The Lender
ceased applying the Excess Amounts to payment of the monthly interest charges as
of June 30, 2009. 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 Lender's
receivership and ongoing securities fraud enforcement action against the Lender
by the SEC. Additionally, there can be no assurance that the Excess Amounts will
be ultimately recovered by the Company. As a result, the Company has fully
reserved the $11.3 million balance in the accompanying unaudited condensed
consolidated financial statements as of and for the periods ended September 30,
2009.
Due to the Lender's inability to perform on its commitments to the
Company, it has not advanced funds to the Company since May 2009 or returned
$11.3 million of improperly converted funds to the Company under the $50 million
Revolving Credit Agreement, therefore, 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.
16
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2009
(UNAUDITED)
The Company's debt payable, all current, to the Lender consists of the
following as of September 30 and March 31, 2009.
September 30, March 31,
2009 2009
------------ ------------
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, effective in October 2007, consist of the
following instruments:
o An $80.0 million credit agreement, under which the Company issued a
$45.0 million Term Note. Currently, the note bears a fixed interest
rate of 10.25% per year.
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.
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. 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. As noted above, the Lender is in
default under this agreement.
Each of the above credit agreements and notes (i) required a 1.5%
origination fee due at funding, (ii) matures at October 8, 2011, (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. Concurrent with the execution of these credit facilities, the Company
issued new and amended warrants (Note 4).
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 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 September 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
September 30, 2009. Not withstanding the uncured default by the Lender on the
$50 million Revolving Credit Agreement, as of September 30, 2009, the Company
has accrued, but not paid, interest totaling $2.0 million for the three months
ended September 30, 2009, which could give the Lender cause to place the debt in
default.
17
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2009
(UNAUDITED)
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). Concurrent 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.
NOTE 4 - COMMON STOCK WARRANTS
Concurrent with the execution of the 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 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.
SECURITIES PURCHASE AGREEMENT - On April 8, 2009, the Company amended
its Articles of Incorporation to increase its authorized shares of common stock
from 400 million to 500 million. On July 18, 2008, the Company entered into a
Securities Purchase Agreement (the "Purchase Agreement") with Dr. Chaudhuri and
Mr. Thomas. Pursuant to the Purchase Agreement, Dr. Chaudhuri has a right to
purchase ("Purchase Right") from the Company 63.3 million shares of its common
stock for consideration of $0.11 per share, aggregating $7.0 million (the fair
value as of July 18, 2008 was $22).
The Purchase Agreement provides Dr. Chaudhuri and Mr. Thomas with
certain pre-emptive rights to maintain their respective levels of ownership of
the Company's common stock by acquiring additional equity securities concurrent
with future issuances by the Company of equity securities or securities or
rights convertible into or exercisable for equity securities and also provides
them with demand registration rights. These pre-emptive rights and registration
rights superseded and replaced their existing pre-emptive rights and
registration rights. The Purchase Agreement also contains a release, waiver and
covenant not to sue Dr. Chaudhuri in connection with his entry into the Option
and Standstill Agreement described below and the consummation of the
transactions contemplated under that agreement. Concurrent with the execution of
the Purchase Agreement, Dr. Chaudhuri exercised in full outstanding
Restructuring Warrants to purchase 24.9 million shares of common stock at an
exercise price of $0.15 per share, for a total purchase price of $3.7 million.
Concurrent with the execution of the Purchase Agreement, the Company
and the Lender, and its affiliate, Healthcare Financial Management &
Acquisitions, Inc., a Nevada corporation ("HFMA" and collectively with the
Lender, "MCC") entered into an Early Loan Payoff Agreement (the "Payoff
Agreement"). The Company used the $3.7 million in proceeds from the warrant
exercise described above to pay down the $10.7 million Convertible Term Note.
The Company is obligated under the Payoff Agreement to use the proceeds it
receives from the future exercise, if any, of the investor's purchase right
under the Purchase Agreement, plus additional Company funds as may then be
necessary, to pay down the remaining balance of the $10.7 million Convertible
Term Note under the Payoff Agreement. Under the Payoff Agreement, once the
Company has fully repaid early the remaining balance of the $10.7 million
Convertible Term Note, the Company has an option to extend the maturity dates of
the $80.0 million Credit Agreement and the $50.0 million Revolving Credit
Agreement from October 8, 2010 to October 8, 2011.
18
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2009
(UNAUDITED)
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").
Concurrent 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).
NOTE 5 - INCOME TAXES
The utilization of NOL and credit carryforwards are limited under the
provisions of the 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 and six months ended September 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.
The California Franchise Tax Board has been conducting an ongoing
examination of Enterprise Zone hiring tax credits claimed on the Company's
California income tax returns filed for the open tax years. 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.
19
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2009
(UNAUDITED)
NOTE 6 - STOCK INCENTIVE PLAN
The Company's 2006 Stock Incentive Plan (the "Plan"), which is
shareholder-approved, permits the grant of share options to its employees and
board members for up to a maximum aggregate of 12.0 million shares of common
stock. In addition, as of the first business day of each calendar year in the
period 2007 through 2015, the maximum aggregate number of shares shall be
increased by a number equal to one percent of the number of shares of common
stock of the Company outstanding on December 31 of the immediately preceding
calendar year. Accordingly, as of September 30, 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.
The Company recorded $13.0 and $26.0 of compensation expense relative
to stock options during the three and six months ended September 30, 2009,
respectively, and $15.6 and $29.5 during the three and six months ended
September 30, 2008, respectively. No options were granted or exercised during
the three and six months ended September 30, 2009 and 2008. A summary of stock
option activity for the six months ended September 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 (130) $ 0.24
-------- ---------
Outstanding, September 30, 2009 8,705 $ 0.19 5.1 $ --
======== ========= ========= ============
Exercisable at September 30, 2009 6,918 $ 0.20 4.9 $ --
======== ========= ========= ============
20
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2009
(UNAUDITED)
A summary of the Company's nonvested options as of September 30, 2009,
and changes during the six months ended September 30, 2009 is presented as
follows.
Weighted-
average
grant date
Shares fair value
------------ ---------------
Nonvested at March 31, 2009 2,250 $ 0.03
Granted -- --
Vested (450) $ 0.02
Forfeited (13) $ 0.06
------------ ===============
Nonvested at September 30, 2009 1,787 $ 0.03
============ ===============
As of September 30, 2009, there was $53.7 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 1.6 years.
NOTE 7 - RETIREMENT PLAN
The Company has a 401(k) plan for its employees. All employees with 90
days of service are eligible to participate, unless they are covered by a
collective bargaining agreement which precludes coverage. The Company matches
employee contributions up to 3% of the employee's compensation, subject to IRS
limits. During the three months ended September 30, 2009 and 2008, the Company
incurred expenses of $768.1 and $794.4, respectively, and $1,534.9 and $1,560.8
during the six months ended September 30, 2009 and 2008, respectively, which are
included in salaries and benefits in the accompanying unaudited condensed
consolidated statements of operations.
NOTE 8 - INCOME (LOSS) PER SHARE
Income (loss) per share 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.
21
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2009
(UNAUDITED)
Income per share for the three months ended September 30, 2009 was
computed as shown below. Stock options and warrants aggregating 301 million
shares were not included in the diluted calculation since they were not
in-the-money during the three months ended September 30, 2009.
Numerator:
Net income attributable to
Integrated Healthcare Holdings, Inc. $ 307
Interest on $10.7 million Convertible Term Note 281
--------
Adjusted net income attributable to
Integrated Healthcare Holdings, Inc. $ 588
========
Denominator:
Weighted average common shares 195,307
Shares - $10.7 million Convertible Term Note 28,419
Options in the money, net 1,000
--------
Denominator for diluted calculation 224,726
========
Income per share - basic $ 0.00
Income per share - diluted $ 0.00
Since the Company incurred losses for the three months ended September
30, 2009 and the three and six months ended September 30, 2008, antidilutive
potential shares of common stock, consisting of approximately 303 million, 203
million and 205 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). In accordance with GAAP, a company is required to consolidate the
financial statements of any entity that cannot finance its activities without
additional subordinated financial support, and for which one company provides
the majority of that support through means other than ownership. Effective March
8, 2005, the Company determined that it provided the majority of financial
support to PCHI through various sources including lease payments, remaining
primarily liable under the $45.0 million Term Note, and cross-collateralization
of the Company's non-real estate assets to secure the $45.0 million Term Note.
Accordingly, the Company included the net assets of PCHI, net of consolidation
adjustments, in its unaudited condensed consolidated balance sheet at September
30 and March 31, 2009.
22
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2009
(UNAUDITED)
Prior to consolidation with the Company, PCHI's assets, liabilities,
and accumulated deficit at September 30 and March 31, 2009 are set forth below.
September 30, March 31,
2009 2009
---------- ----------
Cash $ 1,166 $ 27
Property, net 43,136 43,688
Other 90 133
---------- ----------
Total assets $ 44,392 $ 43,848
========== ==========
Debt $ 45,000 $ 45,000
Other 1,204 534
---------- ----------
Total liabilities 46,204 45,534
Accumulated deficit (1,812) (1,686)
---------- ----------
Total liabilities and accumulated deficit $ 44,392 $ 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 September 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 and six months ended September 30,
2009, the Company incurred expenses under the agreement of $0 and $20.0,
respectively.
During the three months ended September 30, 2009 and 2008, the Company
paid $2.2 million and $1.5 million, respectively, and $5.8 million and $2.9
million for the six months ended September 30, 2009 and 2008, respectively, to a
supplier that is also a shareholder of the Company.
23
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 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.
Effective October As a condition of the 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. Effective April 2,
2009, the base rental payments were further reduced pursuant to the Global
Settlement Agreement (Note 11). 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).
Concurrent 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 $6.8 million and $7.1 million are
included in the accompanying unaudited condensed consolidated balance sheets as
of September 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 September 30 and March 31, 2009, the
Company had accrued $9.1 million and $8.7 million, respectively, which is
comprised of $4.4 million and $4.1 million, respectively, in incurred and
reported claims, along with $4.7 million and $4.6 million, respectively, in
estimated IBNR.
24
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2009
(UNAUDITED)
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 September 30 and March 31, 2009, the
Company had accrued $624 and $711, respectively, comprised of $174 and $202,
respectively, in incurred and reported claims, along with $450 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 accruals at September 30 and March 31,
2009 were based upon projections. The Company determines the adequacy of this
accrual by evaluating its limited historical experience and trends related to
both health insurance claims and payments, information provided by its insurance
broker and third party administrator and industry experience and trends. The
accrual is an estimate and is subject to change. Such change could be material
to the Company's consolidated financial statements. As of September 30 and March
31, 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 September 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 3.88% to 4.80% per annum. The Company incurred finance charges
relating to such policies of $35.9 and $24.3 during the three months ended
September 30, 2009 and 2008, respectively, and $68.5 and $47.2 during the six
months ended September 30, 2009 and 2008, respectively. As of September 30 and
March 31, 2009, the accompanying unaudited condensed consolidated balance sheets
include the following balances relating to the financed insurance policies.
September 30, 2009 March 31, 2009
------------------ --------------
Prepaid insurance $ 3,164 $ 339
Accrued insurance premiums $ 2,032 $ 19
(Included in other current liabilities)
25
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2009
(UNAUDITED)
CLAIMS AND LAWSUITS - The Company and the Hospitals are subject to
various legal proceedings, most of which relate to routine matters incidental to
operations. The results of these claims cannot be predicted, and it is possible
that the ultimate resolution of these matters, individually or in the aggregate,
may have a material adverse effect on the Company's business (both in the near
and long term), financial position, results of operations, or cash flows.
Although the Company defends itself vigorously against claims and lawsuits and
cooperates with investigations, these matters (1) could require payment of
substantial damages or amounts in judgments or settlements, which individually
or in the aggregate could exceed amounts, if any, that may be recovered under
insurance policies where coverage applies and is available, (2) cause
substantial expenses to be incurred, (3) require significant time and attention
from the Company's management, and (4) could cause the Company to close or sell
the Hospitals or otherwise modify the way its business is conducted. The Company
accrues for claims and lawsuits when an unfavorable outcome is probable and the
amount is reasonably estimable.
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.
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.
26
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2009
(UNAUDITED)
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.
27
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2009
(UNAUDITED)
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) two payments of $750
each (the second of which may be applied toward the purchase of stock by OC-PIN
and Shah) 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 shares of Common Stock, and
(2) Kali P. Chaudhuri the right to purchase up to 30,600 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 August 20, 2009, Judge Lewis ordered all parties to the Global
Settlement Agreement to meet and confer with Hon. Gary Taylor regarding the
issue of entering the Global Settlement Agreement as final judgment. On or about
November 1, 2009, Judge Taylor issued a written recommendation to the court
acknowledging several complications with entering the Global Settlement
Agreement as judgment, largely based upon the pending litigation among the
members of OC-PIN. The court has scheduled a hearing on December 7, 2009 for
further adjudication of this issue.
28
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2009
(UNAUDITED)
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 June 17, 2009, Dr. Shah demanded that both the Company and PCHI
indemnify him for his defense of the Amended Meka Complaint. In response, both
the Company and PCHI filed motions to enforce the releases contained in the
Global Settlement Agreement, which the Company and PCHI believe waive Dr. Shah's
claim for indemnification in the Meka v. Shah lawsuit. The court has not yet
ruled on these motions.
On October 9, 2009, the newly-assigned judge, Hon. Nancy Wieben-Stock,
sustained a demurrer to the Amended Meka Complaint with leave to amend.
Plaintiffs have not yet filed a second amended complaint.
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. 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 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.
29
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 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 scheduled to be heard before the American Health Lawyer's
Association on December 16, 2009. The Company does not believe that the results
of this arbitration will have a material adverse impact on the Company's 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. On October 22,
2009, the Company and Tenet entered into a settlement and mutual release with
respect to the guarantee agreement.
On June 5, 2009, a potential class action lawsuit was filed against the
Company by Alexandra Avery. Ms. Avery purports to represent all 12-hourly
employees and the complaint alleges causes of action for restitution of unpaid
wages as a result of unfair business practices, injunctive relief for unfair
business practices, failure to pay overtime wages, and penalties associated
therewith. The parties are currently exchanging initial discovery in the action.
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.
On June 16, 2008, Michael Fitzgibbons, M.D., filed a complaint against
the Company alleging malicious prosecution, intentional interference with
prospective economic advantage, defamation, and intentional infliction of
emotional distress. Most of the causes of action in the June 16, 2008 complaint
derive from events precipitating a lawsuit filed by the Company against Dr.
Fitzgibbons in 2005. On September 9, 2008, the Company filed a "SLAPP Back"
motion seeking to remove the malicious prosecution cause of action from Dr.
Fitzgibbons' complaint, as well as an Anti-SLAPP motion directed to the
remaining causes of action. The Court denied both motions on October 20, 2008.
The Company appealed the denial of the Anti-SLAPP motion, which was denied by
the Court of Appeal on October 27, 2009. The remittitur, releasing jurisdiction
back to the trial court, is scheduled to issue on December 31, 2009. At this
early stage in the litigation, 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.
30
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").
31
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 RECEIVERSHIP AND DEFAULT").
32
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 $43.9
million, respectively, at September 30, 2009.
LENDER RECEIVERSHIP AND DEFAULT - On July 16, 2009, the SEC filed a
complaint with the United States District Court against the parent company and
affiliates of the Company's Lender (Medical Capital Corporation, namely Medical
Provider Financial Corporation I, Provider Financial Corporation II, and Medical
Provider Financial Corporation III) and their principal officers for violations
of federal securities laws and barred it from entering into material
transactions pending presentation of the government's case. On August 3, 2009,
Mr. Thomas Seaman was appointed receiver ("Lender's Estate") by the Honorable
David O. Carter, Judge of the United States District Court in this securities
fraud enforcement action.
Hereafter, unless otherwise indicated, the term "Lender" will be used
in all references to the Lender and the Lender's Estate included in this Item 2.
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 maintained 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.
As of September 30, 2009, the Lender had collected and retained $11.3
million in Excess Amounts 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. The Lender
ceased applying the Excess Amounts to payment of the monthly interest charges as
of June 30, 2009. 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 Lender's
receivership and ongoing securities fraud enforcement action against the Lender
by the SEC. Additionally, there can be no assurance that the Excess Amounts will
be ultimately recovered by the Company. As a result, the Company fully reserved
the $11.3 million balance as of September 30, 2009.
Due to the Lender's inability to perform on its commitments to the
Company, it has not advanced funds to the Company since May 2009 or returned
$11.3 million of improperly converted funds to the Company under the $50 million
Revolving Credit Agreement, therefore, 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.
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.
33
Key items for the six months ended September 30, 2009 included:
1. Net collectible revenues (net operating revenues less provision for
doubtful accounts) for the six months ended September 30, 2009 and
2008 were $177.9 million and $167.3 million, respectively,
representing an increase of 6.3%. 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 net revenues
increased $13.4 million for the six months ended September 30, 2009
compared to the six months ended September 30, 2008.
Inpatient admissions decreased by 2.2% to 13.2 for the six months
ended September 30, 2009 compared to 13.5 for the six months ended
September 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
5.6% from 6.3% for the six months ended September 30, 2009 compared
to the six months ended September 30, 2008.
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 six months ended September 30, 2009 were $2.7
million, or 1.4%, lower than during the six months ended September
30, 2008. The most significant factors of this decrease were the $5.1
million decrease in the provision for doubtful accounts and the $7.6
million decrease in other operating expenses. The largest factor in
the decrease in the provision for doubtful accounts was the result of
improved recovery from a non-contracted managed care payer. The
decrease in other operating expenses was due primarily to a $3.6
million decrease in professional fees, largely the result of improved
dispute resolution. However, these decreases were offset by a loss of
$11.3 million resulting from the impairment of the amounts due to us
from our Lender (see "LENDER RECEIVERSHIP AND DEFAULT").
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").
At September 30, 2009, we were in compliance with all of our debt
covenants. 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 our Lender executed
agreements to refinance the Lender's credit facilities aggregating up to $140.7
million in principal amount. The 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.
34
Our credit facilities consist of the following instruments:
o An $80.0 million credit agreement, under which we issued a $45.0
million Term Note. Currently, the note bears a fixed interest rate of
10.25% per year.
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.
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.
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 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. As noted above, the Lender is in default under this
agreement.
Each of the above credit agreements and notes (i) required a 1.5%
origination fee due at funding, (ii) matures at October 8, 2011, (iii) requires
monthly payments of interest and repayment of principal upon maturity, (iv) are
collateralized by all of our and our subsidiaries' assets 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. Concurrent with
the execution of these credit facilities, we issued new and amended warrants.
Our 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 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 September 30, 2009, we were in compliance
with all covenants. 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 in our consolidated balance
sheet as of September 30, 2009.
35
As a condition of the credit facilities, we entered into an Amended and
Restated Triple Net Hospital Building Lease (the "Amended Lease") with PCHI.
Concurrent 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.
NEW WARRANTS - Concurrent with the execution of the 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 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.
SECURITIES PURCHASE AGREEMENT - On April 8, 2009, the Company amended
its Articles of Incorporation to increase its authorized shares of common stock
from 400 million to 500 million. On July 18, 2008, the Company entered into a
Securities Purchase Agreement (the "Purchase Agreement") with Dr. Chaudhuri and
Mr. Thomas. Pursuant to the Purchase Agreement, Dr. Chaudhuri has a right to
purchase ("Purchase Right") from the Company 63.3 million shares of its common
stock for consideration of $0.11 per share, aggregating $7.0 million (the fair
value as of July 18, 2008 was $22).
The Purchase Agreement provides Dr. Chaudhuri and Mr. Thomas with
certain pre-emptive rights to maintain their respective levels of ownership of
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.
36
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.
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").
Concurrent 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.
37
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 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. Effective April 2,
2009, the base rental payments were further reduced pursuant to the Global
Settlement Agreement (see "Part II - OTHER INFORMATION, Item 1. LEGAL
PROCEEDINGS"). 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.
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 six
months ended September 30, 2009 and 2008 was $8.4 million and $4.8 million,
respectively. Net income (loss), adjusted for depreciation and other non-cash
items, excluding the provision for doubtful accounts and minority interest,
totaled $3.0 million and $(5.4) million for the six months ended September 30,
2009 and 2008, respectively. We used $5.8 million and produced $10.2 million in
working capital for the six months ended September 30, 2009 and 2008,
respectively. Net cash produced by growth in (used in payment of) accounts
payable, accrued compensation and benefits and other current liabilities was
$(0.2) million and $5.4 million for the six months ended September 30, 2009 and
2008, respectively. Cash provided by accounts receivable, net of provision for
doubtful accounts, was $3.2 million and $6.9 million for the six months ended
September 30, 2009 and 2008, respectively.
Net cash used in investing activities during the six months ended
September 30, 2009 and 2008 was $0.7 million and $0.7 million, respectively.
During the six months ended September 30, 2009 and 2008, we invested $0.7
million and $0.7 million in cash, respectively, in new equipment.
Net cash provided by (used in) financing activities for the six months
ended September 30, 2009 and 2008 was $(6.1) million and $2.1 million,
respectively. The net cash used in financing activities for the six months ended
September 30, 2009 was primarily due to $5.7 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.
38
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The following table sets forth, for the three and six months ended
September 30, 2009 and 2008, our consolidated statements of operations expressed
as a percentage of net operating revenues.
Three months ended Six months ended
September 30, September 30,
----------------- -----------------
2009 2008 2009 2008
------- ------- ------- -------
Net operating revenues 100.0% 100.0% 100.0% 100.0%
------- ------- ------- -------
Operating expenses:
Salaries and benefits 51.8% 56.4% 53.4% 56.4%
Supplies 13.0% 12.7% 13.3% 12.9%
Provision for doubtful accounts 7.6% 12.5% 8.5% 11.5%
Other operating expenses 14.0% 19.9% 14.7% 19.1%
Depreciation and amortization 0.9% 0.9% 0.9% 0.9%
Impairment - due from Lender 11.0% 0.0% 5.8% 0.0%
------- ------- ------- -------
98.3% 102.5% 96.6% 100.8%
------- ------- ------- -------
Operating income (loss) 1.7% (2.5%) 3.4% (0.8%)
------- ------- ------- -------
Other expense:
Interest expense, net (2.4%) (2.9%) (2.4%) (3.1%)
------- ------- ------- -------
(2.4%) (2.9%) (2.4%) (3.1%)
------- ------- ------- -------
Income (loss) before provision for income taxes (0.7%) (5.4%) 1.0% (3.9%)
Provision for income taxes 0.6% (0.0%) (0.3%) 0.0%
------- ------- ------- -------
Net income (loss) (0.1%) (5.4%) 0.7% (3.9%)
Net loss (income) attributable to
noncontrolling interests (0.7%) 0.5% (0.5%) 0.0%
------- ------- ------- -------
Net income (loss) attributable to
Integrated Healthcare Holdings, Inc. (0.8%) (4.9%) 0.2% (3.9%)
======= ======= ======= =======
THREE MONTHS ENDED SEPTEMBER 30, 2009 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2008
NET OPERATING REVENUES - Net operating revenues for the three months
ended September 30, 2009 increased 6.2% compared to the same period in fiscal
year 2009, from $95.5 million to $101.4 million. Admissions increased by 0.3%
for the three months ended September 30, 2009 compared to the three months ended
September 30, 2008. Net operating revenues per admission improved by 5.8% during
the three months ended September 30, 2009 as a result of negotiated managed care
and governmental payment rate increases (most significantly, state
disproportionate share, county and county organized plan revenues improved $7.7
million). Based on average revenue for comparable services from all other
payers, revenues foregone under the charity policy, including indigent care
accounts, for the three months ended September 30, 2009 and 2008 were $3.0
million and $2.1 million, respectively.
Essentially all net operating revenues come from external customers.
The largest payers are the Medicare and Medicaid programs accounting for 68.8%
and 62.6% of the net operating revenues for the three months ended September 30,
2009 and 2008, respectively.
Uninsured patients, as a percentage of gross charges, decreased to 6.0%
from 6.1% for the three months ended September 30, 2009 compared to the three
months ended September 30, 2008.
39
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 $93.7 million (net revenues of $101.4 million less
$7.7 million in provision for doubtful accounts) and $83.6 million (net revenues
of $95.5 million less $11.9 million in provision for doubtful accounts) for the
three months ended September 30, 2009 and 2008, respectively, representing an
increase of $10.1 million. There was also an increase in Net Collectible
Revenues per admission of 11.8% for the three months ended September 30, 2009
compared to the three months ended September 30, 2008.
OPERATING EXPENSES - Operating expenses for the three months ended
September 30, 2009 increased to $99.7 million from $97.8 million, an increase of
$1.9 million, or 1.9%, compared to the same period in fiscal year 2009.
Operating expenses expressed as a percentage of net operating revenues for the
three months ended September 30, 2009 and 2008 were 98.3% and 102.5%,
respectively. On a per admission basis, operating expenses increased 1.6%.
Salaries and benefits decreased $1.4 million (2.6%) for the three
months ended September 30, 2009 compared to the same period in fiscal year 2009.
Contract labor decreased $2.2 million as nurses returned to the workforce in
response to the current economic downturn.
Other operating expenses for the three months ended September 30, 2009
decreased $4.8 million, or 25.3%, compared to the same period in fiscal year
2009, primarily due to a $2.9 million decrease in professional fees during the
three months ended September 30, 2009 compared to the three months ended
September 30, 2008. The decrease in professional fees was due primarily to the
result of improved dispute resolution.
The provision for doubtful accounts for the three months ended
September 30, 2009 decreased to $7.7 million from $11.9 million, or 35.3%,
compared to the same period in fiscal year 2009. The decrease was primarily the
result of improved recovery from a non-contracted managed care payer.
During the three months ended September 30, 2009, the Company recorded
an impairment loss of $11.3 million relating to the amounts due from Lender (see
"LENDER RECEIVERSHIP AND DEFAULT").
OPERATING INCOME (LOSS) - The operating income for the three months
ended September 30, 2009 was $1.7 million compared to an operating loss of $2.3
million for the three months ended September 30, 2008.
OTHER EXPENSE - Interest expense for the three months ended September
30, 2009 was $2.4 million compared to $2.8 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 LOSS - Net loss for the three months ended September 30, 2009 was
$0.8 million compared to $4.7 million for the same period in fiscal year 2009.
SIX MONTHS ENDED SEPTEMBER 30, 2009 COMPARED TO SIX MONTHS ENDED SEPTEMBER 30,
2008
NET OPERATING REVENUES - Net operating revenues for the six months
ended September 30, 2009 increased 2.9% compared to the same period in fiscal
year 2009, from $189.0 million to $194.4 million. Admissions decreased by 2.2%
for the six months ended September 30, 2009 compared to the six months ended
September 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. Net operating revenues per admission
improved by 5.4% during the six months ended September 30, 2009 as a result of
negotiated managed care and governmental payment rate increases (most
significantly, state disproportionate share, county and county organized plan
revenues improved $7.6 million). Based on average revenue for comparable
services from all other payers, revenues foregone under the charity policy,
including indigent care accounts, for the six months ended September 30, 2009
and 2008 were $4.5 million and $4.4 million, respectively.
40
Essentially all net operating revenues come from external customers.
The largest payers are the Medicare and Medicaid programs accounting for 65.4%
and 60.1% of the net operating revenues for the six months ended September 30,
2009 and 2008, respectively.
Uninsured patients, as a percentage of gross charges, decreased to 5.6%
from 6.3% for the six months ended September 30, 2009 compared to the six months
ended September 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 $177.9 million (net revenues of $194.4 million less
$16.5 million in provision for doubtful accounts) and $167.3 million (net
revenues of $189.0 million less $21.7 million in provision for doubtful
accounts) for the six months ended September 30, 2009 and 2008, respectively,
representing an increase of $10.6 million. There was also an increase in Net
Collectible Revenues per admission of 8.9% for the six months ended September
30, 2009 compared to the six months ended September 30, 2008.
OPERATING EXPENSES - Operating expenses for the six months ended
September 30, 2009 decreased to $187.9 million from $190.6 million, a decrease
of $2.7 million, or 1.4%, compared to the same period in fiscal year 2009.
Operating expenses expressed as a percentage of net operating revenues for the
six months ended September 30, 2009 and 2008 were 96.6% and 100.8%,
respectively. On a per admission basis, operating expenses increased 1.0%.
Salaries and benefits decreased $2.7 million (2.5%) for the six months
ended September 30, 2009 compared to the same period in fiscal year 2009,
primarily due to the decline in admissions. Contract labor decreased $4.6
million as nurses returned to the workforce in response to the current economic
downturn.
Other operating expenses relative to net operating revenues for the six
months ended September 30, 2009 decreased $7.6 million, or 20.9%, compared to
the same period in fiscal year 2009, primarily due to the decline in admissions
and decreases in professional fees ($3.6 million decrease), repairs and
maintenance ($0.7 million decrease), and purchased services ($1.3 million
decrease).
The provision for doubtful accounts for the six months ended September
30, 2009 decreased to $16.5 million from $21.7 million, or 24.0%, compared to
the same period in fiscal year 2009. The decrease in the provision for doubtful
accounts for the six months ended September 30, 2009 is primarily due to
improvement in collections, which were 3.0% higher during the six months ended
September 30, 2009 compared to the six months ended September 30, 2008.
During the six months ended September 30, 2009, the Company recorded an
impairment loss of $11.3 million relating to the amounts due from Lender (see
"LENDER RECEIVERSHIP AND DEFAULT").
OPERATING INCOME (LOSS) - The operating income for the six months ended
September 30, 2009 was $6.5 million compared to an operating loss of $1.6
million for the six months ended September 30, 2008.
OTHER EXPENSE - Interest expense for the six months ended September 30,
2009 was $4.6 million compared to $5.8 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 six months ended September 30,
2009 was $0.3 million compared to a net loss of $7.5 million for the same period
in fiscal year 2009.
41
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 $153 and
$1,618 as of September 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.
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. During the
three and six months ended September 30, 2009, the Company recorded $44.0 and
$215.3, respectively, in Final Notice of Program Reimbursement settlements.
During the three and six months ended September 30, 2008, the Company recorded
$171.0 in Final Notice of Program Reimbursement settlements. During the three
and six months ended September 30, 2008, the Company reversed $1,429.6 in
reserves related to excess outlier payments based on the receipt of the Final
Notice of Program Reimbursement for 2006. As of March 31, 2009, the Company
reversed all reserves for excess outlier payments.
42
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 $0 and $38 during the three months ended September 30,
2009 and 2008, respectively, and $5,034 and $7,634 during the six months ended
September 30, 2009 and 2008, respectively. The related revenue recorded for the
three months ended September 30, 2009 and 2008 was $7,026 and $4,075,
respectively, and $10,585 and $7,929 for the six months ended September 30, 2009
and 2008, respectively. As of September 30 and March 31, 2009, estimated DSH
receivables of $8,229 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 $3.0 million and $2.1 million for
the three months ended September 30, 2009 and 2008, respectively, and $4.5
million and $4.4 million for the six months ended September 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 September 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
GAAP. As of September 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.
43
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 - GAAP requires the liability approach for the effect of
income taxes. In accordance with GAAP, 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.
Effective April 1, 2007, the Company implemented a standard issued by
the FASB which clarifies the accounting and disclosure for uncertain tax
positions. The Company implemented this standard as of April 1, 2007. The
standard 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. It also provides guidance on de-recognition, classification,
interest and penalties, accounting in interim periods, disclosure and
transition.
INSURANCE - The Company accrues for estimated general and professional
liability claims, to the extent not covered by insurance, when they are probable
and reasonably estimable. The Company has purchased as primary coverage a
claims-made form insurance policy for general and professional liability risks.
Estimated losses within general and professional liability retentions from
claims incurred and reported, along with IBNR claims, are accrued based upon
projections and are discounted to their net present value using a weighted
average risk-free discount rate of 5%. To the extent that subsequent claims
information varies from estimates, the liability is adjusted in the period such
information becomes available. As of September 30 and March 31, 2009, the
Company had accrued $9.1 million and $8.7 million, respectively, which is
comprised of $4.4 million and $4.1 million, respectively, in incurred and
reported claims, along with $4.7 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 September 30 and March 31, 2009, the
Company had accrued $624 and $711, respectively, comprised of $174 and $202,
respectively, in incurred and reported claims, along with $450 and $509,
respectively, in estimated IBNR.
44
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 accruals at September 30 and March 31,
2009 were based upon projections. The Company determines the adequacy of this
accrual by evaluating its limited historical experience and trends related to
both health insurance claims and payments, information provided by its insurance
broker and third party administrator and industry experience and trends. The
accrual is an estimate and is subject to change. Such change could be material
to the Company's consolidated financial statements. As of September 30 and March
31, 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 September 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 June 2009, the Financial Accounting Standards Board ("FASB") issued
a new standard that changes the referencing and organization of accounting
guidance and establishes the FASB Accounting Standards Codification as the
single source of authoritative nongovernmental GAAP. Rules and interpretive
releases of the SEC under the authority of federal securities laws are also
sources of authoritative GAAP for SEC registrants. Due to the adoption of this
standard during the three months ended September 30, 2009, the Company will no
longer cite specific GAAP references in this Item 2. The adoption of this
standard did not have an effect on the Company's financial condition, results of
operations or cash flows.
In June 2009, the FASB issued a new standard that eliminates the
previously allowed exceptions of consolidating qualifying special purpose
entities, contains new criteria for determining the primary beneficiary and
increases the frequency of required reassessments to determine whether a company
is the primary beneficiary of a variable interest entity. The adoption of this
standard, which is effective for fiscal years beginning after November 15, 2009,
is not expected to have a material effect on the unaudited condensed
consolidated financial statements.
In May 2009, the FASB issued a new standard that establishes general
standards of accounting for and disclosure of events that occur after the
balance sheet date but before financial statements are issued or are available
to be issued. The accompanying unaudited condensed consolidated financial
statements were available to be issued on November 13, 2009 and the Company
evaluated subsequent events known to it through that date.
In May 2008, the FASB issued a new standard that clarifies that
convertible debt instruments that may be settled in cash upon conversion
(including partial cash settlement). Additionally, the statement 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. Effective
April 1, 2009, the Company adopted this standard, which had no material impact
on the Company's unaudited condensed consolidated financial statements.
In March 2008, the FASB issued a new standard that requires enhanced
disclosures about an entity's derivative and hedging activities. The Company
does not currently have derivatives or enter into hedging activities; therefore,
the adoption of this standard as of April 1, 2009 did not have an effect on the
Company's unaudited condensed consolidated financial statements.
45
In December 2007, the FASB issued a new standard that requires the
noncontrolling interest in a subsidiary be reported as a separate component of
stockholders' equity in the consolidated financial statements. The standard also
requires net income attributable to the noncontrolling interest in a subsidiary
be reported separately on the face of the consolidated statements of earnings.
Changes in ownership interest are to be accounted for as equity transactions
and, when a subsidiary is deconsolidated, any retained noncontrolling equity
investment in the former subsidiary is to be measured at fair value with any
gain or loss recognized in earnings. The adoption of this standard as of April
1, 2009 did not have a material effect on the Company's unaudited condensed
consolidated financial statements. In connection with the adoption of this new
standard, the prior year financial statements have been adjusted to conform to
the new required presentation.
In December 2007, the FASB issued a new standard that changes the
accounting treatment for business combinations on a prospective basis. It
requires that all assets, liabilities, contingent considerations and
contingencies of an acquired business be recorded at fair value at the
acquisition date. The standard also requires that acquisition costs be expensed
as incurred and restructuring costs be expensed in periods after the acquisition
date. The Company had no business combinations during the current reporting
periods; therefore, the adoption of this standard as of April 1, 2009 did not
have an effect on the Company's unaudited condensed consolidated financial
statements. The effect of the adoption of this standard will depend upon the
nature and terms of any future business combinations the Company undertakes.
46
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
As of September 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
reports under the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), 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) under the Exchange Act. The Company's
disclosure controls and procedures are designed to provide a reasonable level of
assurance of reaching the Company's desired disclosure control objectives. In
designing and evaluating the disclosure controls and procedures, management
recognized that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives, and management necessarily was required to apply its judgment in
evaluating the cost-benefit relationship of possible controls and procedures.
As of September 30, 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 that evaluation, the Company's Chief Executive Officer
and Chief Financial Officer concluded that as of September 30, 2009 the
Company's disclosure controls and procedures were effective to ensure that the
information required to be disclosed in our 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 our Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions regarding required
disclosure.
During the quarter ended September 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.
47
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.
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.
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.
48
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.
49
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) two payments of $750
each (the second of which may be applied toward the purchase of stock by OC-PIN
and Shah) 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 shares of Common Stock, and
(2) Kali P. Chaudhuri the right to purchase up to 30,600 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 August 20, 2009, Judge Lewis ordered all parties to the Global
Settlement Agreement to meet and confer with Hon. Gary Taylor regarding the
issue of entering the Global Settlement Agreement as final judgment. On or about
November 1, 2009, Judge Taylor issued a written recommendation to the court
acknowledging several complications with entering the Global Settlement
Agreement as judgment, largely based upon the pending litigation among the
members of OC-PIN. The court has scheduled a hearing on December 7, 2009 for
further adjudication of this issue.
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.
50
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 June 17, 2009, Dr. Shah demanded that both the Company and PCHI
indemnify him for his defense of the Amended Meka Complaint. In response, both
the Company and PCHI filed motions to enforce the releases contained in the
Global Settlement Agreement, which the Company and PCHI believe waive Dr. Shah's
claim for indemnification in the MEKA V. SHAH lawsuit. The court has not yet
ruled on these motions.
On October 9, 2009, the newly-assigned judge, Hon. Nancy Wieben-Stock,
sustained a demurrer to the Amended Meka Complaint with leave to amend.
Plaintiffs have not yet filed a second amended complaint.
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. 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 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 scheduled to be heard before the American Health Lawyer's
Association on December 16, 2009. The Company does not believe that the results
of this arbitration will have a material adverse impact on the Company's 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. On October 22,
2009, the Company and Tenet entered into a settlement and mutual release with
respect to the guarantee agreement.
51
On June 5, 2009, a potential class action lawsuit was filed against the
Company by Alexandra Avery. Ms. Avery purports to represent all 12-hourly
employees and the complaint alleges causes of action for restitution of unpaid
wages as a result of unfair business practices, injunctive relief for unfair
business practices, failure to pay overtime wages, and penalties associated
therewith. The parties are currently exchanging initial discovery in the action.
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.
On June 16, 2008, Michael Fitzgibbons, M.D., filed a complaint against
the Company alleging malicious prosecution, intentional interference with
prospective economic advantage, defamation, and intentional infliction of
emotional distress. Most of the causes of action in the June 16, 2008 complaint
derive from events precipitating a lawsuit filed by the Company against Dr.
Fitzgibbons in 2005. On September 9, 2008, the Company filed a "SLAPP Back"
motion seeking to remove the malicious prosecution cause of action from Dr.
Fitzgibbons' complaint, as well as an Anti-SLAPP motion directed to the
remaining causes of action. The Court denied both motions on October 20, 2008.
The Company appealed the denial of the Anti-SLAPP motion, which was denied by
the Court of Appeal on October 27, 2009. The remittitur, releasing jurisdiction
back to the trial court, is scheduled to issue on December 31, 2009. At this
early stage in the litigation, 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.
52
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 Company's Lender
(Medical Capital Corporation, namely Medical Provider Financial Corporation I,
Provider Financial Corporation II, and Medical Provider Financial Corporation
III) and their principal officers for violations of federal securities laws and
barred it from entering into material transactions pending presentation of the
government's case. On August 3, 2009, Mr. Thomas Seaman was appointed receiver
("Lender's Estate") by the Honorable David O. Carter, Judge of the United States
District Court in this securities fraud enforcement action.
Hereafter, unless otherwise indicated, the term "Lender" will be used
in all references to the Lender and the Lender's Estate included in this Item
1A.
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 maintained 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.
As of September 30, 2009, the Lender had collected and retained $11.3
million in Excess Amounts 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. The Lender
ceased applying the Excess Amounts to payment of the monthly interest charges as
of June 30, 2009. 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 Lender's
receivership and ongoing securities fraud enforcement action against the Lender
by the SEC. Additionally, there can be no assurance that the Excess Amounts will
be ultimately recovered by the Company. As a result, the Company has fully
reserved the $11.3 million balance as of September 30, 2009.
Due to the Lender's inability to perform on its commitments to the
Company, it has not advanced funds to the Company since May 2009 or returned
$11.3 million of improperly converted funds to the Company under the $50 million
Revolving Credit Agreement, therefore, 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.
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.
53
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: November 13, 2009 By: /s/ Steven R. Blake
------------------------------
Steven R. Blake
Chief Financial Officer
(Principal Financial Officer)
54