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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 December 31, 2009; or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from to
Commission File Number 0-23511
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INTEGRATED HEALTHCARE HOLDINGS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
NEVADA 87-0573331
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
1301 NORTH TUSTIN AVENUE
SANTA ANA, CALIFORNIA 92705
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(714) 953-3503 (Registrant's telephone number, including area code)
(Former name, former address and former fiscal year, if
changed since last report)
----------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant has submitted electronically and
posted on its corporate Web site, if any, every Interactive Data File required
to be submitted and posted pursuant to Rule 405 of Regulation S-T during the
preceding 12 months (or for such shorter period that the registrant was required
to submit and post such files). Yes [ ] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definition of "large accelerated filer", "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [ ]
Non-accelerated filer [ ] Smaller reporting company [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes [ ] No [X]
There were 195,307,262 shares outstanding of the registrant's common stock as of
February 8, 2010.
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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 December 31, 2009
and March 31, 2009, adjusted - (unaudited) 3
Condensed Consolidated Statements of Operations for the three and
nine months ended December 31, 2009 and 2008, adjusted - (unaudited) 4
Condensed Consolidated Statement of Deficiency
for the nine months ended December 31, 2009 - (unaudited) 5
Condensed Consolidated Statements of Cash Flows for the nine
months ended December 31, 2009 and 2008, adjusted - (unaudited) 6
Notes to Condensed Consolidated Financial Statements - (unaudited) 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 33
Item 3. Quantitative and Qualitative Disclosures About Market Risk 50
Item 4. Controls and Procedures 50
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 51
Item 1A. Risk Factors 56
Item 6. Exhibits 57
Signatures 57
2
PART I - FINANCIAL INFORMATION
Item 1. Financial statements
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(amounts in 000's, except par value)
December 31, March 31,
2009 2009
------------------ -----------------
(adjusted)
ASSETS
Current assets:
Cash and cash equivalents $ 4,268 $ 3,514
Restricted cash 16 18
Accounts receivable, net of allowance for doubtful
accounts of $14,839 and $17,377, respectively 53,923 55,876
Inventories of supplies, at cost 6,302 5,742
Due from governmental payers 4,257 4,297
Due from lender - 5,576
Prepaid insurance 1,782 339
Other prepaid expenses and current assets 6,893 5,097
------------------ -----------------
Total current assets 77,441 80,459
Property and equipment, net 54,210 55,414
Debt issuance costs, net - 123
------------------ -----------------
Total assets $ 131,651 $ 135,996
================== =================
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Debt $ 80,968 $ 80,968
Accounts payable 49,882 59,265
Accrued compensation and benefits 18,335 16,809
Accrued insurance retentions 13,337 11,212
Other current liabilities 8,762 6,265
------------------ -----------------
Total current liabilities 171,284 174,519
Capital lease obligations, net of current portion
of $832 and $835, respectively 6,069 6,703
------------------ -----------------
Total liabilities 177,353 181,222
------------------ -----------------
Commitments, contingencies and subsequent events
Deficiency:
Integrated Healthcare Holdings, Inc. stockholders' deficiency:
Common stock, $0.001 par value; 500,000 shares authorized;
195,307 shares issued and outstanding 195 195
Additional paid in capital 61,119 61,080
Accumulated deficit (108,021) (106,501)
------------------ -----------------
Total Integrated Healthcare Holdings, Inc. stockholders' deficiency (46,707) (45,226)
Noncontrolling interests 1,005 -
------------------ -----------------
Total deficiency (45,702) (45,226)
------------------ -----------------
Total liabilities and deficiency $ 131,651 $ 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 Nine months ended
December 31, December 31,
----------------------------------- -----------------------------------
2009 2008 2009 2008
---------------- ----------------- ----------------- ----------------
(adjusted) (adjusted)
Net operating revenues $ 94,627 $ 100,323 $ 288,996 $ 289,352
---------------- ----------------- ----------------- ----------------
Operating expenses:
Salaries and benefits 53,335 52,972 157,183 159,519
Supplies 13,909 12,657 39,712 37,098
Provision for doubtful accounts 8,108 10,663 24,620 32,324
Other operating expenses 16,012 16,399 44,640 52,579
Depreciation and amortization 974 898 2,794 2,681
Impairment - due from Lender (Notes 1 and 3) - - 11,253 -
---------------- ----------------- ----------------- ----------------
92,338 93,589 280,202 284,201
---------------- ----------------- ----------------- ----------------
Operating income 2,289 6,734 8,794 5,151
---------------- ----------------- ----------------- ----------------
Other expense:
Interest expense, net (2,394) (3,411) (7,018) (9,199)
Warrant expense - - - (22)
---------------- ----------------- ----------------- ----------------
(2,394) (3,411) (7,018) (9,221)
---------------- ----------------- ----------------- ----------------
Income (loss) before provision for income taxes (105) 3,323 1,776 (4,070)
Income tax benefit (provision) 621 - - (17)
---------------- ----------------- ----------------- ----------------
Net income (loss) 516 3,323 1,776 (4,087)
Net income attributable to
noncontrolling interests (Note 9) (2,343) (950) (3,296) (1,000)
---------------- ----------------- ----------------- ----------------
Net income (loss) attributable to
Integrated Healthcare Holdings, Inc. $ (1,827) $ 2,373 $ (1,520) $ (5,087)
================ ================= ================= ================
Per Share Data:
Earnings (loss) per common share attributable to
Integrated Healthcare Holdings, Inc. stockholders
Basic ($0.01) $0.01 ($0.01) ($0.03)
Diluted ($0.01) $0.01 ($0.01) ($0.03)
Weighted average shares outstanding
Basic 195,307 161,974 195,307 152,204
Diluted 195,307 195,156 195,307 152,204
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 - - 39 - - 39
Net income (loss) - - - (1,520) 3,296 1,776
Noncontrolling interests distributions - - - - (2,291) (2,291)
------------- ------------ ------------ ------------- ---------------- ------------
Balance, December 31, 2009 195,307 $ 195 $ 61,119 $ (108,021) $ 1,005 $ (45,702)
============= ============ ============ ============= ================ ============
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)
Nine months ended December 31,
----------------------------------------
2009 2008
------------------ ------------------
(adjusted)
Cash flows from operating activities:
Net income (loss) $ 1,776 $ (4,087)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization of property and equipment 2,794 2,681
Provision for doubtful accounts 24,620 32,324
Amortization of debt issuance costs 186 386
Common stock warrant expense - 22
Impairment - due from Lender 11,253 -
Noncash share-based compensation expense 39 143
(Recovery) charge relating to impaired property and equipment (195) 195
Changes in operating assets and liabilities:
Accounts receivable (22,667) (28,680)
Inventories of supplies (560) (150)
Due from governmental payers 40 (1,850)
Prepaid insurance, other prepaid expenses and
current assets, and other assets (3,107) (151)
Accounts payable (9,383) 9,293
Accrued compensation and benefits 1,526 (1,520)
Due to governmental payers - (1,690)
Accrued insurance retentions and other current liabilities 4,622 273
------------------ ------------------
Net cash provided by operating activities 10,944 7,189
------------------ ------------------
Cash flows from investing activities:
Decrease in restricted cash 2 4
Additions to property and equipment (1,590) (763)
------------------ ------------------
Net cash used in investing activities (1,588) (759)
------------------ ------------------
Cash flows from financing activities:
Drawdown on revolving line of credit, net - (6,354)
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 (2,291) (2,150)
Payments on capital lease obligations (634) (917)
------------------ ------------------
Net cash used in financing activities (8,602) (9,371)
------------------ ------------------
Net increase (decrease) in cash and cash equivalents 754 (2,941)
Cash and cash equivalents, beginning of period 3,514 3,141
------------------ ------------------
Cash and cash equivalents, end of period $ 4,268 $ 200
================== ==================
Supplemental information:
Cash paid for interest $ 518 $ 8,503
================== ==================
Cash paid for income taxes $ 1,512 $ -
================== ==================
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
DECEMBER 31, 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 nine months ended December 31, 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. The prior year's financial
statements have been adjusted to reflect the Company's adoption of the Financial
Accounting Standards Board's ("FASB") Accounting Standards Codification Topic
810, "Consolidation".
DESCRIPTION OF BUSINESS - Effective March 8, 2005, the Company acquired
four hospitals (the "Hospitals") from subsidiaries of Tenet Healthcare
Corporation (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 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. In connection with the adoption of this standard 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 fraud
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 Receiver") by 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 Receiver included in these notes
to the unaudited condensed consolidated financial statements.
7
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 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 on 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 December 31, 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 had 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 and intends
to pursue the recovery of Excess Amounts from the Lender. The Company believes
that the Lender's failure to return the Excess Amounts is an improper conversion
of its assets and a breach of the Lender's fiduciary and custodial obligations
and intends to vigorously pursue recovery of the remaining Excess Amounts from
the Lender in addition to other relief. There can be no assurance the Company
will be successful in pursuing its claims due to the 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 nine months ended December 31, 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 December 31, 2009, the Company has a
working capital deficit of $93.8 million and accumulated total deficiency of
$45.7 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 (Notes 3 and
12). 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 December 31, 2009, the Company was in not in compliance with all debt
covenants and, as noted above, the Lender is in default of the $50 million
Revolving Credit Agreement. As a result, the Company's noncurrent debt of
approximately $81.0 million will continue to be classified as current in the
accompanying unaudited condensed consolidated balance sheet as of December 31,
2009 (Notes 3 and 12). Not withstanding the uncured default by the Lender on the
$50 million Revolving Credit Agreement, as of December 31, 2009, the Company has
accrued, but not paid, interest totaling $4.2 million for the period from July 1
through December 31, 2009, which could give the Lender cause to place the debt
in default.
8
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 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 57% and 56%
of the net operating revenues for the three months ended December 31, 2009 and
2008, respectively, and 58% and 56% for the nine months ended December 31, 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, income taxes, self-insurance reserves, and
net 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
DECEMBER 31, 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 $332 and
$1,618 as of December 31 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, 2009 was an increase from $20.045 to $23.140. 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 nine months ended December 31, 2009, the Company recorded $0 and
$215.3, respectively, in Final Notice of Program Reimbursement settlements.
During the three and nine months ended December 31, 2008, the Company recorded
$172.5 and $460.7, respectively, in Final Notice of Program Reimbursement
settlements. During the three and nine months ended December 31, 2008, the
Company reversed $78.4 and $1,678.0, respectively, 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
DECEMBER 31, 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
$8.2 million and $6.8 million during the three months ended December 31, 2009
and 2008, respectively, and $13.2 million and $14.5 million during the nine
months ended December 31, 2009 and 2008, respectively. The related revenue
recorded for the three months ended December 31, 2009 and 2008 was $3.9 million
and $8.2 million, respectively, and $14.4 million and $16.2 million for the nine
months ended December 31, 2009 and 2008, respectively. As of December 31 and
March 31, 2009, estimated DSH receivables of $3.9 million and $2.7 million 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 December
31 and March 31, 2009:
December 31, March 31,
2009 2009
------------ ------------
Due from government payers
Medicare $ 332 $ 1,618
Medicaid 3,925 2,679
------------ ------------
$ 4,257 $ 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 $2.0 million and $2.0 million for the three months ended
December 31, 2009 and 2008, respectively, and $6.5 million and $6.4 million for
the nine months ended December 31, 2009 and 2008, respectively.
11
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 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 90 days were
reserved in contractual allowances as of December 31 and March 31, 2009 based on
historical collections experience.
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 December 31 and March 31, 2009, the Company established a receivable
in the amount of $1.2 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 December 31 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 December 31 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 (Notes 3 and 12).
12
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(UNAUDITED)
LETTERS OF CREDIT - At December 31 and March 31, 2009, the Company had
outstanding standby letters of credit totaling $1.5 million. These letters of
credit were issued by the Company's Lender and correspondingly reduce the
Company's borrowing availability under its credit agreements with the Lender.
However, due to the Lender's receivership and 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 debt (Note 3). 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 3) 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 $185.7 were amortized during the three months and nine months ended December
31, 2009, respectively. Debt issuance costs of $122.4 and $386.1 were amortized
during the three and nine months ended December 31, 2008 (including $14.9 in
unamortized costs related to the $3.7 million paydown on the Convertible Note).
At December 31 and March 31, 2009, prepaid expenses and other current assets in
the accompanying unaudited condensed consolidated balance sheets included $191.8
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 book value which
approximates 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
DECEMBER 31, 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. Because the Company's accompanying unaudited condensed
consolidated financial statements are considered issued when filed with the SEC,
it has evaluated subsequent events to the filing date of this Form 10-Q with the
SEC.
In June 2008, the FASB issued a new standard that addresses the
determination of whether an instrument (or an embedded feature) is indexed to an
entity's own stock. If an instrument (or an embedded feature) that has the
characteristics of a derivative instrument under this standard is indexed to an
entity's own stock, it is still necessary to evaluate whether it is classified
in stockholders' equity (or would be classified in stockholders' equity if it
were a freestanding instrument). 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
DECEMBER 31, 2009
(UNAUDITED)
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.
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:
DECEMBER 31, MARCH 31,
2009 2009
----------------- ----------------
Buildings $ 33,606 $ 33,606
Land and improvements 13,523 13,523
Equipment 12,196 11,223
Construction in progress 617 -
Assets under capital leases 8,991 8,991
----------------- ----------------
68,933 67,343
Less accumulated depreciation (14,723) (11,929)
----------------- ----------------
Property and equipment, net $ 54,210 $ 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.
15
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(UNAUDITED)
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. However, subsequent new review methodologies have caused an
inability to fully determine the estimate of these costs at December 31, 2009.
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 fraud 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
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 on 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 December 31, 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 had 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 and intends
to pursue the recovery of Excess Amounts from the Lender. The Company believes
that the Lender's failure to return the Excess Amounts is an improper conversion
of its assets and a breach of the Lender's fiduciary and custodial obligations
and intends to vigorously pursue recovery of the remaining Excess Amounts from
the Lender in addition to other relief. There can be no assurance the Company
will be successful in pursuing its claims due to the 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, during the prior quarter ended
September 30, 2009, the Company fully reserved the amount Due from Lender ($11.3
million in Excess Amounts). See Note 12.
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
DECEMBER 31, 2009
(UNAUDITED)
The Company's debt payable, all current, to the Lender consists of the
following as of December 31 and March 31, 2009.
December 31, 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, subject to certain dilution
adjustments.
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).
17
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(UNAUDITED)
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 December 31, 2009, the
Company was not in compliance with all debt covenants and, as noted above, the
Lender is in default of the $50 million Revolving Credit Agreement. As a result,
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
December 31, 2009. Not withstanding the uncured default by the Lender on the $50
million Revolving Credit Agreement, as of December 31, 2009, the Company has
accrued, but not paid, interest totaling $4.2 million for the period from July 1
through December 31, 2009, which could give the Lender cause to place the debt
in default (see Note 12).
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, at which time
the exercise price would be an aggregate of one dollar. 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 (see Note 12). 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).
18
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(UNAUDITED)
The Purchase Agreement provides Dr. Chaudhuri and Mr. Thomas with certain
pre-emptive rights to maintain their respective levels of ownership of the
Company's common stock by acquiring additional equity securities concurrent with
future issuances by the Company of equity securities or securities or rights
convertible into or exercisable for equity securities and also provides them
with demand registration rights. These pre-emptive rights and registration
rights superseded and replaced their existing pre-emptive rights and
registration rights. The Purchase Agreement also contains a release, waiver and
covenant not to sue Dr. Chaudhuri in connection with his entry into the Option
and Standstill Agreement described below and the consummation of the
transactions contemplated under that agreement. Concurrent with the execution of
the Purchase Agreement, Dr. Chaudhuri exercised in full outstanding warrants to
purchase 24.9 million shares of common stock at an exercise price of $0.15 per
share, for a total purchase price of $3.7 million.
Concurrent with the execution of the Purchase Agreement, the Company and
the Lender, and its affiliate, Healthcare Financial Management & Acquisitions,
Inc., a Nevada corporation ("HFMA" and collectively with the Lender, "MCC")
entered into an Early Loan Payoff Agreement (the "Payoff Agreement"). The
Company used the $3.7 million in proceeds from the warrant exercise described
above to pay down the $10.7 million Convertible Term Note. The Company is
obligated under the Payoff Agreement to use the proceeds it receives from the
future exercise, if any, of the investor's purchase right under the Purchase
Agreement, plus additional Company funds as may then be necessary, to pay down
the remaining balance of the $10.7 million Convertible Term Note under the
Payoff Agreement. Under the Payoff Agreement, once the Company has fully repaid
early the remaining balance of the $10.7 million Convertible Term Note, the
Company has an option to extend the maturity dates of the $80.0 million Credit
Agreement and the $50.0 million Revolving Credit Agreement from October 8, 2010
to October 8, 2011.
Concurrent with the execution of the Purchase Agreement, Dr. Chaudhuri and
MCC entered into an Option and Standstill Agreement pursuant to which MCC agreed
to sell the New Warrants. The New Warrants will not be sold to Dr. Chaudhuri
unless he so elects within six years after the Company pays off all remaining
amounts due to MPFC II and MPFC I pursuant to (i) the $80.0 million Credit
Agreement and (ii) the $50.0 million Revolving Credit Agreement. MCC also agreed
not to exercise or transfer the New Warrants unless a payment default occurs and
remains uncured for a specified period.
On January 30, 2009, the Company entered into an amendment of the Purchase
Agreement ("Amended Purchase Agreement"). Under the Purchase Agreement, Dr.
Chaudhuri had the right to invest up to $7.0 million in the Company through the
purchase of 63.4 million shares of common stock at $0.11 per share. The Purchase
Right expired on January 10, 2009. Under the Amended Purchase Agreement, Dr.
Chaudhuri agreed to purchase immediately from the Company 33.3 million shares of
Company common stock (the "Additional Shares") at a purchase price of $0.03 per
share, or an aggregate purchase price of $1.0 million (the fair value as of
January 30, 2009 was less than $1). In consideration for Dr. Chaudhuri's entry
into the Amended Purchase Agreement and payment to the Company of $30, under the
Amended Purchase Agreement the Company granted to Dr. Chaudhuri the right, in
Dr. Chaudhuri's sole discretion (subject to the Company having sufficient
authorized capital), to invest at any time and from time to time through January
30, 2010 up to $6.0 million through the purchase of shares of the Company's
common stock at a purchase price of $0.11 per share (the "Amended Purchase
Right").
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.
19
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(UNAUDITED)
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).
RECLASSIFICATION OF WARRANTS - On December 31, 2007, the Company amended
its Articles of Incorporation to increase its authorized shares of common stock
from 250 million to 400 million (and subsequently increased the authorized
shares to 500 million in April 2009). The increase in authorized shares resulted
in the share settlement being within the control of the Company, as a result,
effective December 31, 2007, the Company revalued the 24.9 million 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.
Also see Notes 11 and 12.
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 nine months ended December 31, 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 and allowances. Due to
the Company's losses incurred during the nine months ended December 31, 2009,
the Company fully reversed the income tax expense previously recorded during the
three months ended June 30, 2009. 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.
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.
20
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 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 December 31, 2009, the maximum aggregate
number of shares under the Plan was 15.9 million. The Company believes that such
awards better align the interests of its employees with those of its
shareholders. In accordance with the Plan, incentive stock options, nonqualified
stock options, and performance based compensation awards may not be granted at
less than 100 percent of the estimated fair market value of the common stock on
the date of grant. Incentive stock options granted to a person owning more than
10 percent of the voting power of all classes of stock of the Company may not be
issued at less than 110 percent of the fair market value of the stock on the
date of grant. Option awards generally vest based on 3 years of continuous
service (1/3 of the shares vest on the twelve month anniversary of the grant
date, and an additional 1/12 of the shares vest on each subsequent fiscal
quarter-end of the Company following such twelve month anniversary). Certain
option awards provide for accelerated vesting if there is a change of control,
as defined. The option awards have 7-year contractual terms.
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 $39.0 of compensation expense relative to
stock options during the three and nine months ended December 31, 2009,
respectively, and $18.0 and $48.0 during the three and nine months ended
December 31, 2008, respectively. No options were exercised during the three and
nine months ended December 31, 2009 and 2008. A summary of stock option activity
for the nine months ended December 31, 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 (150) $ 0.24
-------------
Outstanding, December 31, 2009 8,685 $ 0.19 5.0 $ -
============= ============ ============= =============
Exercisable at December 31, 2009 7,473 $ 0.20 4.7 $ -
============= ============ ============= =============
21
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(UNAUDITED)
A summary of the Company's nonvested options as of December 31, 2009, and
changes during the nine months ended December 31, 2009 is presented as follows.
Weighted-
average
grant date
Shares fair value
------------ ------------
Nonvested at March 31, 2009 2,250 $ 0.03
Granted - $ -
Vested (990) $ 0.04
Forfeited (48) $ 0.07
------------ ------------
Nonvested at December 31, 2009 1,212 $ 0.03
============ ============
As of December 31, 2009, there was $40.7 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 1.4 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 December 31, 2009 and 2008, the Company
incurred expenses of $753.3 and $761.7, respectively, and $2,288.2 and $2,322.5
during the nine months ended December 31, 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.
Since the Company incurred losses for the three and nine months ended
potential shares of common stock, consisting of approximately 303 million
shares, 303 million shares, and 125 million shares, respectively, issuable under
warrants and stock options, have been excluded from the calculations of diluted
loss per share for that period.
22
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(UNAUDITED)
Income per share for the three ended December 31, 2008 was computed as
shown below. Stock options and warrants aggregating approximately 125 million
shares were not included in the diluted calculation since they were not
in-the-money during the three months ended December 31, 2008.
Numerator:
Net income attributable to
Integrated Healthcare Holdings, Inc. $ 2,373
Interest on $10.7 million Convertible Term Note 165
Adjusted net income attributable to
----------------
Integrated Healthcare Holdings, Inc. $ 2,538
================
Denominator:
Weighted average common shares 161,974
Shares - $10.7 million Convertible Term Note 33,182
----------------
Denominator for diluted calculation 195,156
================
Income per share - basic $ 0.01
Income per share - diluted $ 0.01
NOTE 9 - VARIABLE INTEREST ENTITY
Concurrent with the close on the Acquisition, and pursuant to an agreement
dated September 28, 2004, as amended and restated on November 16, 2004, Dr.
Chaudhuri and Dr. Shah exercised their options to purchase all of the equity
interests in PCHI, which simultaneously acquired title to substantially all of
the real property acquired by the Company in the Acquisition. The Company
received $5.0 million and PCHI guaranteed the Company's Acquisition Loan (the
Acquisition Loan was refinanced on October 9, 2007 with a $45.0 million Term
Note (Note 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 financial statements of PCHI are included in the accompanying
unaudited condensed consolidated financial statements.
23
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(UNAUDITED)
Prior to consolidation with the Company, PCHI's assets, liabilities, and
accumulated deficit at December 31 and March 31, 2009 are set forth below.
December 31, March 31,
2009 2009
----------- -----------
Cash $ 850 $ 27
Property, net 43,340 43,688
Other 251 133
----------- -----------
Total assets $ 44,441 $ 43,848
=========== ===========
Debt $ 45,000 $ 45,000
Other 2,554 534
----------- -----------
Total liabilities 47,554 45,534
Accumulated deficit (3,113) (1,686)
----------- -----------
Total liabilities and accumulated deficit $ 44,441 $ 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 December 31
and March 31, 2009. As described in Note 9, PCHI is a variable interest entity
and, accordingly, the Company has consolidated the financial statements of PCHI
in the accompanying unaudited condensed consolidated financial statements.
On September 25, 2008, the Company entered into an agreement with a
professional law corporation (the "Firm") controlled by a director and
shareholder of the Company. The agreement specifies that the Firm will provide
services for approximately twenty hours per week as Special Counsel to the
Company in connection with the supervision and coordination of various legal
matters. For its services, the Firm will be compensated at a flat rate of $20.0
per month, plus reimbursement of out-of-pocket costs. The agreement was
terminated in April 2009. During the three months ended December 31, 2009 and
2008, the Company incurred expenses under the agreement of $0 and $60.0,
respectively, and $20.0 and $80.0 during the nine months ended December 31, 2009
and 2008, respectively.
During the three months ended December 31, 2009 and 2008, the Company paid
$2.6 million and $1.7 million, respectively, and $8.4 million and $4.6 million
for the nine months ended December 31, 2009 and 2008, respectively, to a
supplier that is also a shareholder of the Company.
24
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 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 2007, 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 (see "CLAIMS AND LAWSUITS"). 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 $6.6 million and $7.1 million are included in the
accompanying unaudited condensed consolidated balance sheets as of December 31
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 December 31 and March 31, 2009, the Company
had accrued $10.7 million and $8.7 million, respectively, which is comprised of
$4.5 million and $4.1 million, respectively, in incurred and reported claims,
along with $6.2 million and $4.6 million, respectively, in estimated IBNR.
25
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 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 December 31 and March 31, 2009, the Company
had accrued $804 and $711, respectively, comprised of $285 and $202,
respectively, in incurred and reported claims, along with $519 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 December 31 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 December 31 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 December 31 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 $21.4 and $14.0 during the three months ended December 31, 2009
and 2008, respectively, and $89.9 and $61.2 during the nine months ended
December 31, 2009 and 2008, respectively. As of December 31 and March 31, 2009,
the accompanying unaudited condensed consolidated balance sheets include the
following balances relating to the financed insurance policies.
December 31, 2009 March 31, 2009
----------------- --------------
Prepaid insurance $ 1,782 $ 339
Accrued insurance premiums $ 500 $ 19
(Included in other current liabilities)
CLAIMS AND LAWSUITS - The Company and the Hospitals are subject to various
legal proceedings, most of which relate to routine matters incidental to
operations. The results of these claims cannot be predicted, and it is possible
that the ultimate resolution of these matters, individually or in the aggregate,
may have a material adverse effect on the Company's business (both in the near
and long term), financial position, results of operations, or cash flows.
Although the Company defends itself vigorously against claims and lawsuits and
cooperates with investigations, these matters (1) could require payment of
substantial damages or amounts in judgments or settlements, which individually
or in the aggregate could exceed amounts, if any, that may be recovered under
insurance policies where coverage applies and is available, (2) cause
substantial expenses to be incurred, (3) require significant time and attention
from the Company's management, and (4) could cause the Company to close or sell
the Hospitals or otherwise modify the way its business is conducted. The Company
accrues for claims and lawsuits when an unfavorable outcome is probable and the
amount is reasonably estimable.
26
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(UNAUDITED)
On May 10, 2007, the Company filed suit in Orange County Superior Court
against three of the six members of its Board of Directors (as then constituted)
and also against the Company's 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' 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.
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.
27
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(UNAUDITED)
On June 19, 2008, the Company received correspondence from OC-PIN
demanding that the Company notice a special shareholders' meeting no later than
June 26, 2008, to occur during the week of July 21 - 25, 2008. The stated
purpose of the meeting was to (1) repeal a bylaws provision setting forth a
procedure for nomination of director candidates by shareholders, (2) remove the
Company's entire Board of Directors, and (3) elect a new Board of Directors. The
Company denied this request based on, among other reasons, failure to comply
with the appropriate bylaws and SEC procedures and failure to comply with
certain requirements under the Company's credit agreements with its primary
lender. OC-PIN repeated its request on July 29, 2008, and on July 30, 2008,
filed a petition for writ of mandate in the Orange County Superior Court seeking
a court order to compel the Company to hold a special shareholders' meeting. On
August 18, 2008, the Court denied OC-PIN's petition.
On September 17, 2008, OC-PIN filed another petition for writ of mandate
seeking virtually identical relief as the petition filed on July 30, 2008. This
petition was stayed by the Court on October 6, 2008 pending the resolution of
May 10, 2007 suit brought by the Company. OC-PIN subsequently filed a petition
for writ of mandate with the Court of Appeals, which was summarily denied on
November 18, 2008. OC-PIN then filed a petition for review before the California
Supreme Court, which was denied on January 14, 2009.
On July 8, 2008, in a separate action, OC-PIN filed a complaint against
the Company in Orange County Superior Court alleging causes of action for breach
of contract, specific performance, reformation, fraud, negligent
misrepresentation and declaratory relief. The complaint alleges that the Stock
Purchase Agreement that the Company executed with OC-PIN on January 28, 2005
"inadvertently omitted" an anti-dilution provision (the "Allegedly Omitted
Provision") which would have allowed OC-PIN a right of first refusal to purchase
common stock of the Company on the same terms as any other investor in order to
maintain OC-PIN's holding at no less than 62.4% of the common stock on a fully
diluted basis. The complaint further alleged that the Company issued stock
options under a Stock Incentive Plan and warrants to its lender in violation of
the Allegedly Omitted Provision. The complaint further alleged that the issuance
of warrants to purchase the Company's stock to Dr. Chaudhuri and Mr. Thomas, and
their exercise of a portion of those warrants, were improper under the Allegedly
Omitted Provision. On October 6, 2008, the Court placed a stay on this lawsuit
pending the resolution of the action filed by the Company on May 10, 2007. On
October 22, 2008, OC-PIN filed an amended complaint naming every shareholder of
the Company as a defendant, in response to a ruling by the Court that each
shareholder was a "necessary party" to the action. OC-PIN filed a petition for
writ of mandate with the Court of Appeals which sought to overturn the stay
imposed by the trial court. This appeal was summarily denied on November 18,
2008.
On April 2, 2009, the Company, OC-PIN, Anil V. Shah, M.D. ("Shah"), Bruce
Mogel, Pacific Coast Holdings Investment, LLC ("PCHI"), West Coast Holdings, LLC
("WCH"), Kali P. Chaudhuri, M.D., Ganesha Realty, LLC ("Ganesha"), William E.
Thomas and Medical Capital Corporation and related entities ("Medical Capital")
(together, the "Global Settlement Parties") entered into a global settlement
agreement and mutual release (the "Global Settlement Agreement"). Key elements
of the Global Settlement Agreement included: (1) a full release of claims by and
between the Global Settlement Parties, (2) 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.
28
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(UNAUDITED)
Purportedly pursuant to the Global Settlement Agreement, OC-PIN and/or
Shah placed a demand on the Company to seat Shah's personal litigation attorney,
Daniel Callahan ("Callahan"), on the Board of Directors. The Company declined
this request based on several identified conflicts of interest, as well as a
violation of the covenant of good faith and fair dealing. OC-PIN and/or Shah
then filed a motion to enforce the Global Settlement Agreement under California
Code of Civil Procedure Section 664.6 and force the Company to appoint Callahan
to the Board of Directors. The Company opposed this motion, in conjunction with
an opposition by several members of OC-PIN, contesting Callahan as the duly
authorized representative of OC-PIN. On April 27, 2009, the Court denied
Shah/OC-PIN's motion, finding several conflicts of interest preventing Callahan
from serving on the Company's Board of Directors. On May 5, 2009, Shah/OC-PIN
filed a petition for writ of mandate with the Court of Appeals seeking to
reverse the Court's ruling and force Callahan's appointment as a director, which
was summarily denied on May 7, 2009.
On 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. On December 7, 2009, Judge Lewis concurred with Judge
Taylor's recommendation to postpone entering judgment on the Global Settlement
Agreement pending a resolution of the action among the members of OC-PIN. The
court has scheduled a status conference on April 5, 2010 for further
consideration 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.
On June 1, 2009, a First Amended Complaint was filed to replace the First
Meka Complaint (the "Amended Meka Complaint"). On October 9, 2009, the
newly-assigned judge, Hon. Nancy Wieben-Stock, sustained a demurrer to the
Amended Meka Complaint. On or about November 23, 2009, Dr. Meka ET AL. filed a
Second Amended Complaint (the "Second Amended Meka Complaint"). It appears that
the relief sought against the Company in the Second Amended Meka Complaint does
not materially alter from the declaratory and injunctive relief sought in the
First Meka Complaint. The Company filed its answer to the Second Amended Meka
Complaint on December 23, 2009. 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 did not rule on
PCHI's or the Company's motions, but left intact a prior injunction essentially
staying the arbitration of Dr. Shah's indemnity claim.
29
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(UNAUDITED)
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, 2007 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. Arbitration of this matter is set to
commence on June 7, 2010. 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. On December 2, 2009,
the Company and AMVI/Prospect entered into a settlement whereby the Company
agreed to pay AMVI/Prospect a total of $800 over seventeen months. The case has
accordingly been dismissed with prejudice. The liability for this settlement has
been accrued in the accompanying unaudited condensed consolidated balance sheet
as of December 31, 2009.
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. The liability for this settlement has been
accrued in the accompanying unaudited condensed consolidated balance sheet as of
December 31, 2009.
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. On December 23, 2009, the Company filed an answer to the complaint,
generally denying all of the plaintiff's allegations. 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.
30
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(UNAUDITED)
On January 25, 2010, a potential class action lawsuit was filed against
the company by Julie Ross. Ms. Ross purports to represent all similarly-situated
employees and the complaint alleges causes of action for violation of the
California Labor Code and unfair competition law. At this early stage in the
proceedings, 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, was issued 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.
On January 25, 2010, the Company received correspondence purportedly on
behalf of OC-PIN challenging the MOU with KPC Resolution Company (Note 12). The
letter demanded that the Company take certain action in response to the MOU. The
Company issued a response to the letter on February 9, 2010 contesting several
factual and legal conclusions therein and is currently awaiting confirmation
from the court as to who properly represents OC-PIN.
On or about August 1, 1996, Southern California Specialty Care, Inc.
("SCSC") entered into a property lease agreement with PCHI whereby SCSC agreed
to pay 10 percent of its net income to PCHI each quarter (the "Percentage
Rent"). In April 2008, PCHI brought a complaint in arbitration against SCSC
alleging SCSC's failure to pay the Percentage Rent since 2005. In November 2009,
PCHI and SCSC reached a settlement pursuant to which PCHI received $1.9 million
for unpaid Percentage Rent through December 31, 2008, including late fees and
litigation expenses, and $407 for Percentage Rent for the first three calendar
quarters of 2009. Such amounts were recorded in net operating revenues during
the three months ended December 31, 2009.
31
INTEGRATED HEALTHCARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(UNAUDITED)
NOTE 12 - SUBSEQUENT EVENTS
On January 13, 2010, the Company entered into an Amended and Restated
Memorandum of Understanding (the "MOU") with Dr. Chaudhuri and KPC Resolution
Company, LLC ("KPC"), an affiliate of Dr. Chaudhuri. The MOU amends and restates
the original Memorandum of Understanding entered into by the Company and Dr.
Chaudhuri on or about August 12, 2009.
Concurrently with entering into the MOU, KPC entered into a definitive
loan purchase agreement with the court-appointed receiver for the Lender to
purchase all of the Company's credit facilities with the Lender and the New
Warrants to purchase common stock of the Company that were issued to the Lender.
Other potential buyers of the credit facilities will have an opportunity to
submit competitive bids exceeding the value of the Lender's agreement with KPC
through a process referred to as "overbidding." The Company anticipates that the
receiver will entertain qualified overbids through March 2010. Any final sale
transaction must be approved by the Honorable David O. Carter, Judge of the
United States District Court.
The MOU provides the Company with certain benefits and obligations upon
the completion of the acquisition of the credit facilities and the New Warrants
by KPC. The following are the material terms of the MOU:
o The Company will cooperate exclusively with the efforts of Dr.
Chaudhuri and KPC to acquire the credit facilities from the Lender.
o Dr. Chaudhuri will support, subject to the conditions and
limitations set forth in the MOU, the continuation through October
2011 of the rent abatement from the Company's landlord, PCHI.
o The Company has asserted certain claims against the Lender in
connection with the Excess Amounts in favor of the Company under the
credit facilities, and such claims have been refuted by the Lender.
Under the MOU, (i) the Company will furnish to the Lender a release
of the Lender, its affiliates and the Lender's Receiver from claims
arising out of the credit facilities and certain other claims,
including a release of the Excess Amounts, and (ii) Dr. Chaudhuri
will pay to the Company an amount equal to the value that such
claims would have had as an unsecured claim in the receivership
estate of the Lender.
o The Lender has asserted certain contractual claims against the
Company in connection with the credit facilities. Under the MOU, (i)
the Company will receive from the Lender a limited release of such
claims, and (ii) KPC will waive any right to assert such claims as
the successor lender under the credit facilities (including the
right to any interest, penalties or fees under the credit facilities
for the period prior to KPC's acquisition of the credit facilities).
o The Company agreed to cooperate with Dr. Chaudhuri and KPC in good
faith to restructure the credit facilities in a mutually beneficial
manner upon completion of KPC's acquisition of the credit
facilities. Among other things, (i) the Company will assist Dr.
Chaudhuri and KPC in modifying the Company's $80.0 million Credit
Agreement and $10.7 million Credit Agreement to remove accounts
receivable as security for those loans, (ii) the $50.0 million
Revolving Credit Agreement, under which there is no outstanding
balance owing by the Company, will automatically terminate, and
(iii) if requested by KPC, the Company will extend the maturity date
of the $80.0 million Credit Agreement and $10.7 million Credit
Agreement for up to three years past their current maturity date of
October 8, 2010.
o The Company will issue a five-year warrant to Dr. Chaudhuri to
acquire up to 170.0 million shares of the Company's common stock at
an exercise price of $0.05 per share.
On January 20, 2010, the Board of Directors approved an amendment to the
Company's Articles of Incorporation to increase the number of authorized shares
of the Company's common stock from 500 million shares to 800 million shares.
32
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
FORWARD-LOOKING INFORMATION
This Quarterly Report on Form 10-Q contains forward-looking statements, as
that term is defined in the Private Securities Litigation Reform Act of 1995.
These statements relate to future events or our future financial performance. In
some cases, you can identify forward-looking statements by terminology such as
"may," "will," "should," "expects," "plans," "anticipates," "believes,"
"estimates," "predicts," "potential" or "continue" or the negative of these
terms or other comparable terminology. These statements are only predictions and
involve known and unknown risks, uncertainties and other factors, including the
risks discussed under the caption "Risk Factors" in our Annual Report on Form
10-K filed on June 29, 2009 that may cause our Company's or our industry's
actual results, levels of activity, performance or achievements to be materially
different from those expressed or implied by these forward-looking statements.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Except as may be required by applicable
law, we do not intend to update any of the forward-looking statements to conform
these statements to actual results.
As used in this report, the terms "we," "us," "our," "the Company,"
"Integrated Healthcare Holdings" or "IHHI" mean Integrated Healthcare Holdings,
Inc., a Nevada corporation, unless otherwise indicated.
Unless otherwise indicated, all amounts included in this Item 2 are
expressed in thousands (except percentages and per share amounts).
OVERVIEW
On March 8, 2005, we completed our acquisition (the "Acquisition") of four
Orange County, California hospitals and associated real estate, including: (i)
282-bed Western Medical Center - Santa Ana, CA; (ii) 188-bed Western Medical
Center - Anaheim, CA; (iii) 178-bed Coastal Communities Hospital in Santa Ana,
CA; and (iv) 114-bed Chapman Medical Center in Orange, CA (collectively, the
"Hospitals") from Tenet Healthcare Corporation. 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 and January 2009 we issued equity securities to existing shareholders
(see "SECURITIES PURCHASE AGREEMENT" and "GLOBAL SETTLEMENT AGREEMENT").
33
INDUSTRY - Our Hospitals receive a substantial portion of their revenues
from Medicare and Medicaid. The healthcare industry is experiencing a strong
trend toward cost containment, as the government seeks to impose lower
reimbursement and resource utilization group rates, limit the scope of covered
services and negotiate reduced payment schedules with providers. These cost
containment measures generally have resulted in a reduced rate of growth in the
reimbursement for the services that we provide relative to the increase in our
cost to provide such services.
Changes to Medicare and Medicaid reimbursement programs have limited, and
are expected to continue to limit, payment increases under these programs. Also,
the timing of payments made under the Medicare and Medicaid programs is subject
to regulatory action and governmental budgetary constraints resulting in a risk
that the time period between submission of claims and payment could increase.
Further, within the statutory framework of the Medicare and Medicaid programs, a
substantial number of areas are subject to administrative rulings and
interpretations which may further affect payments.
Our business is subject to extensive federal, state and, in some cases,
local regulation with respect to, among other things, participation in the
Medicare and Medicaid programs, licensure and certification of facilities, and
reimbursement. These regulations relate, among other things, to the adequacy of
physical property and equipment, qualifications of personnel, standards of care,
government reimbursement and operational requirements. Compliance with these
regulatory requirements, as interpreted and amended from time to time, can
increase operating costs and thereby adversely affect the financial viability of
our business. Since these regulations are amended from time to time and are
subject to interpretation, we cannot predict when and to what extent liability
may arise. Failure to comply with current or future regulatory requirements
could also result in the imposition of various remedies including (with respect
to inpatient care) fines, restrictions on admission, denial of payment for all
or new admissions, the revocation of licensure, decertification, imposition of
temporary management or the closure of a facility or site of service.
We are subject to periodic audits by the Medicare and Medicaid programs,
which have various rights and remedies against us if they assert that we have
overcharged the programs or failed to comply with program requirements. Rights
and remedies available to these programs include repayment of any amounts
alleged to be overpayments or in violation of program requirements, or making
deductions from future amounts due to us. These programs may also impose fines,
criminal penalties or program exclusions. Other third-party payer sources also
reserve rights to conduct audits and make monetary adjustments in connection
with or exclusive of audit activities.
The healthcare industry is highly competitive. We compete with a variety
of other organizations in providing medical services, many of which have greater
financial and other resources and may be more established in their respective
communities than we are. Competing companies may offer newer or different
centers or services than we do and may thereby attract patients or customers who
are presently our patients or customers or are otherwise receiving our services.
An increasing trend in malpractice litigation claims, rising costs of
malpractice litigation, losses associated with these malpractice lawsuits and a
constriction of insurers have caused many insurance carriers to raise the cost
of insurance premiums or refuse to write insurance policies for hospital
facilities. Also, a tightening of the reinsurance market has affected property,
vehicle, and excess liability insurance carriers. Accordingly, the costs of all
insurance premiums have increased.
We receive all of our inpatient services revenue from operations in Orange
County, California. The economic condition of this market could affect the
ability of our patients and third-party payers to reimburse us for our services,
through its effect on disposable household income and the tax base used to
generate state funding for Medicaid programs. An economic downturn, or changes
in the laws affecting our business in our market and in surrounding markets,
could have a material adverse effect on our financial position, results of
operations, and cash flows. As a result of the Lender's default on our $50.0
million Revolving Credit Agreement, we currently rely solely on its cash
receipts from payers to fund its operations, and any significant disruption in
such receipts could have a material adverse effect on our ability to continue as
a going concern (see "LENDER RECEIVERSHIP AND DEFAULT").
34
LIQUIDITY AND CAPITAL RESOURCES
The accompanying unaudited condensed consolidated financial statements
have been prepared on a going concern basis, which contemplates the realization
of assets and settlement of obligations in the normal course of business. We had
a working capital deficit and total deficiency of $93.8 million and $45.7
million, respectively, at December 31, 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 Receiver") by 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 Receiver included in this Item 2.
On April 14, 2009, we issued a letter (the "Demand Letter") to the Lender
notifying the Lender that it was in default on 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 us with full access to its bank accounts and the accounts are no longer
accessible by the Lender.
As of December 31, 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 our obligations
under all other loan agreements between us and the Lender. Since January 2009,
the Lender had 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.
We consider these funds immediately due and intend to pursue the recovery of
Excess Amounts from the Lender. We believe that the Lender's failure to return
the Excess Amounts is an improper conversion of its assets and a breach of the
Lender's fiduciary and custodial obligations and 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. As a result, the $11.3
million in Excess Amounts is fully reserved.
Due to the Lender's inability to perform on its commitments to us, it has
not advanced funds to us since May 2009 or returned $11.3 million of improperly
converted funds to us under the $50 million Revolving Credit Agreement,
therefore, we 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.
See "AMENDED AND RESTATED MEMORANDUM OF UNDERSTANDING."
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.
35
AMENDED AND RESTATED MEMORANDUM OF UNDERSTANDING - On January 13, 2010,
the Company entered into an Amended and Restated Memorandum of Understanding
(the "MOU") with Dr. Chaudhuri and KPC Resolution Company, LLC ("KPC"), an
affiliate of Dr. Chaudhuri. The MOU amends and restates the original Memorandum
of Understanding entered into by us and Dr. Chaudhuri on or about August 12,
2009.
Concurrently with entering into the MOU, KPC entered into a definitive
loan purchase agreement with the court-appointed receiver for the Lender to
purchase all of our credit facilities with the Lender and the New Warrants to
purchase our common stock that were issued to the Lender. Other potential buyers
of the credit facilities will have an opportunity to submit competitive bids
exceeding the value of the Lender's agreement with KPC through a process
referred to as "overbidding." We anticipate that the receiver will entertain
qualified overbids through March 2010. Any final sale transaction must be
approved by the Honorable David O. Carter, Judge of the United States District
Court.
The MOU provides us with certain benefits and obligations upon the
completion of the acquisition of the credit facilities and the New Warrants by
KPC. The following are the material terms of the MOU:
o We will cooperate exclusively with the efforts of Dr. Chaudhuri and
KPC to acquire the credit facilities from the Lender.
o Dr. Chaudhuri will support, subject to the conditions and
limitations set forth in the MOU, the continuation through October
2011 of the rent abatement from our landlord, PCHI.
o We had asserted certain claims against the Lender in connection with
the Excess Amounts in favor of the Company under the credit
facilities, and such claims have been refuted by the Lender. Under
the MOU, (i) we will furnish to the Lender a release of the Lender,
its affiliates and the Lender's Receiver from claims arising out of
the credit facilities and certain other claims, including a release
of the Excess Amounts, and (ii) Dr. Chaudhuri will pay to the
Company an amount equal to the value that such claims would have had
as an unsecured claim in the receivership estate of the Lender.
o The Lender has asserted certain contractual claims against us in
connection with the credit facilities. Under the MOU, (i) we will
receive from the Lender a limited release of such claims, and (ii)
KPC will waive any right to assert such claims as the successor
lender under the credit facilities (including the right to any
interest, penalties or fees under the credit facilities for the
period prior to KPC's acquisition of the credit facilities).
o We agreed to cooperate with Dr. Chaudhuri and KPC in good faith to
restructure the credit facilities in a mutually beneficial manner
upon completion of KPC's acquisition of the credit facilities. Among
other things, (i) we will assist Dr. Chaudhuri and KPC in modifying
our $80.0 million Credit Agreement and $10.7 million Credit
Agreement to remove accounts receivable as security for those loans,
(ii) the $50.0 million Revolving Credit Agreement, under which there
is no outstanding balance owing by us, will automatically terminate,
and (iii) if requested by KPC, the Company will extend the maturity
date of the $80.0 million Credit Agreement and $10.7 million Credit
Agreement for up to three years past their current maturity date of
October 8, 2010.
o We will issue a five-year warrant to Dr. Chaudhuri to acquire up to
170 million shares of our common stock at an exercise price of $0.05
per share.
36
Key items for the nine months ended December 31, 2009 included:
1. During the nine months ended December 31, 2009 and 2008, we received $2.3
million and $0, respectively, in a settlement between PCHI and a third
party for additional back rent. In addition, during the nine months ended
December 31, 2009 and 2008, we received a lump sum amendment to the CMAC
agreement for $0 and $3.5 million, respectively. Adjusting for these
items, net collectible revenues (net operating revenues less provision for
doubtful accounts) for the nine months ended December 31, 2009 and 2008
were $262.1 million and $253.5 million, respectively, representing an
increase of 3.4%. The Hospitals serve a disproportionate number of
indigent patients and receive governmental revenues and subsidies in
support of care for these patients. Governmental revenues include payments
from Medicaid, Medicaid DSH, and Orange County, CA (CalOptima).
Governmental net revenues increased $6.8 million for the nine months ended
December 31, 2009 compared to the nine months ended December 31, 2008.
Inpatient admissions decreased by 3.0% to 19.5 for the nine months ended
December 31, 2009 compared to 20.1 for the nine months ended December 31,
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 5.4%
from 6.1% for the nine months ended December 31, 2009 compared to the nine
months ended December 31, 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 nine months ended December 31, 2009 were $280.2 million, or 1.4%,
lower than during the nine months ended December 31, 2008. The most
significant factors of this decrease were the $7.7 million decrease in the
provision for doubtful accounts and the $7.9 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 $4.8 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" and "AMENDED AND RESTATED MEMORANDUM OF
UNDERSTANDING").
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 "DEBT").
At December 31, 2009, we were in not in compliance with all debt covenants
and the Lender is in default of the $50 million Revolving Credit Agreement
Lender (see "LENDER RECEIVERSHIP AND DEFAULT" and "AMENDED AND RESTATED
MEMORANDUM OF UNDERSTANDING"). As a result, our noncurrent debt of $81.0
million will continue to be classified as current in the accompanying
unaudited condensed consolidated balance sheet as of December 31, 2009.
DEBT - Effective October 9, 2007, we and our Lender executed agreements to
refinance the 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.
37
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, subject to certain dilution adjustments.
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 December 31, 2009, we were not in compliance
with all debt covenants and the Lender is in default of the $50 million
Revolving Credit Agreement (see "LENDER RECEIVERSHIP AND DEFAULT" and "AMENDED
AND RESTATED MEMORANDUM OF UNDERSTANDING"). As a result, our noncurrent debt of
$81.0 million will continue to be classified as current in the accompanying
unaudited condensed consolidated balance sheet as of December 31, 2009.
38
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
"DEBT"), 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 on 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, at which time the exercise price would be an aggregate of one
dollar. 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). The increase in authorized shares resulted in the
share settlement being within our control, as a result, effective December 31,
2007, we revalued the 24.9 million 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, we amended our Articles
of Incorporation to increase our authorized shares of common stock from 400
million to 500 million. On July 18, 2008, we entered into a Securities Purchase
Agreement (the "Purchase Agreement") with Dr. Chaudhuri and Mr. Thomas. Pursuant
to the Purchase Agreement, Dr. Chaudhuri has a right to purchase ("Purchase
Right") from us 63.3 million shares of our common stock for consideration of
$0.11 per share, aggregating $7.0 million (the 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 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.
39
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.
40
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
"DEBT"), 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 nine months
ended December 31, 2009 and 2008 was $10.9 million and $7.2 million,
respectively. Net income (loss), adjusted for depreciation and other non-cash
items, excluding the provision for doubtful accounts and minority interest,
totaled $1.3 million and $(1.9) million for the nine months ended December 31,
2009 and 2008, respectively. We used $1.6 million and produced $8.8 million in
working capital for the nine months ended December 31, 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
$(3.2) million and $8.0 million for the nine months ended December 31, 2009 and
2008, respectively. Cash provided by accounts receivable, net of provision for
doubtful accounts, was $2.0 million and $3.6 million for the nine months ended
December 31, 2009 and 2008, respectively.
Net cash used in investing activities during the nine months ended
December 31, 2009 and 2008 was $1.6 million and $0.8 million, respectively.
During the nine months ended December 31, 2009 and 2008, we invested $1.6
million and $0.8 million in cash, respectively, in new equipment.
Net cash used in financing activities for the nine months ended December
31, 2009 and 2008 was $8.6 million and $9.4 million, respectively. The net cash
used in financing activities for the nine months ended December 31, 2009 was
primarily due to an additional $5.7 million in amounts collected and retained by
the Lender for a cumulative $11.3 million in excess of the amounts due to the
Lender under the $50.0 million Revolving Credit Agreement. The net cash used in
financing activities for the nine months ended December 31, 2008 was primarily
due to reduction of $10.1 million on debt.
41
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The following table sets forth, for the three and nine months ended
December 31, 2009 and 2008, our consolidated statements of operations expressed
as a percentage of net operating revenues.
Three months ended Nine months ended
December 31, December 31,
--------------------------- ---------------------------
2009 2008 2009 2008
------------ ------------ ------------ ------------
Net operating revenues 100.0% 100.0% 100.0% 100.0%
------------ ------------ ------------ ------------
Operating expenses:
Salaries and benefits 56.4% 52.8% 54.4% 55.1%
Supplies 14.7% 12.6% 13.7% 12.8%
Provision for doubtful accounts 8.6% 10.6% 8.5% 11.2%
Other operating expenses 16.9% 16.4% 15.5% 18.2%
Depreciation and amortization 1.0% 0.9% 1.0% 0.9%
Impairment - due from Lender 0.0% 0.0% 3.9% 0.0%
------------ ------------ ------------ ------------
97.6% 93.3% 97.0% 98.2%
------------ ------------ ------------ ------------
Operating income 2.4% 6.7% 3.0% 1.8%
------------ ------------ ------------ ------------
Other expense:
Interest expense, net (2.5%) (3.4%) (2.4%) (3.2%)
------------ ------------ ------------ ------------
(2.5%) (3.4%) (2.4%) (3.2%)
------------ ------------ ------------ ------------
Income (loss) before provision for income taxes (0.1%) 3.3% 0.6% (1.4%)
Provision for income taxes 0.7% 0.0% 0.0% 0.0%
------------ ------------ ------------ ------------
Net income (loss) 0.6% 3.3% 0.6% (1.4%)
Net income attributable to
noncontrolling interests (2.5%) (0.9%) (1.1%) (0.3%)
------------ ------------ ------------ ------------
Net income (loss) attributable to
Integrated Healthcare Holdings, Inc. (1.9%) 2.4% (0.5%) (1.7%)
============ ============ ============ ============
THREE MONTHS ENDED DECEMBER 31, 2009 COMPARED TO THREE MONTHS ENDED DECEMBER 31,
2008
NET OPERATING REVENUES - Net operating revenues for the three months ended
December 31, 2009 decreased 5.7% compared to the same period in fiscal year
2009, from $100.3 million to $94.6 million. Net operating revenues for the three
months ended December 31, 2009 included $2.3 million received by PCHI in a
settlement with a third party for additional back rent. Net operating revenues
for the three months ended December 31, 2008 included a lump sum amendment to
the CMAC agreement for $3.5 million. Admissions decreased by 3.5% for the three
months ended December 31, 2009 compared to the three months ended December 31,
2008. Net operating revenues per admission decreased by 2.2% during the three
months ended December 31, 2009 as a result of a lump sum amendment to the CMAC
agreement for $3.5 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 December 31, 2009 and 2008
were $2.0 million and $2.0 million, respectively.
Essentially all net operating revenues come from external customers. The
largest payers are the Medicare and Medicaid programs accounting for 57% and 56%
of the net operating revenues for the three months ended December 31, 2009 and
2008, respectively.
Uninsured patients, as a percentage of gross charges, decreased to 4.9%
from 5.5% for the three months ended December 31, 2009 compared to the three
months ended December 31, 2008.
42
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. Excluding
the $2.3 million settlement noted above during the three months ended December
31, 2009 and the $3.5 million one-time grant noted above during the three months
ended December 31, 2008, Net Collectible Revenues were $84.2 million (net
revenues of $92.3 million less $8.1 million in provision for doubtful accounts)
and $86.1 million (net revenues of $96.8 million less $10.7 million in provision
for doubtful accounts) for the three months ended December 31, 2009 and 2008,
respectively, representing a decrease of $1.9 million. There was an increase in
Net Collectible Revenues per admission of 1.3% for the three months ended
December 31, 2009 compared to the three months ended December 31, 2008.
OPERATING EXPENSES - Operating expenses for the three months ended
December 31, 2009 decreased to $92.3 million from $93.6 million, a decrease of
$1.3 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
three months ended December 31, 2009 and 2008 were 97.6% and 93.3%,
respectively. On a per admission basis, operating expenses increased 2.3%.
Salaries and benefits increased $0.4 million (0.7%) for the three months
ended December 31, 2009 compared to the same period in fiscal year 2009.
Other operating expenses for the three months ended December 31, 2009
decreased $0.4 million, or 2.4%, compared to the same period in fiscal year
2009, primarily due to a $1.2 million decrease in professional fees during the
three months ended December 31, 2009 compared to the three months ended December
31, 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 December
31, 2009 decreased to $8.1 million from $10.7 million, or 24.3%, 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.
OPERATING INCOME - The operating income for the three months ended
December 31, 2009 was $2.3 million compared to $6.7 million for the three months
ended December 31, 2008 primarily due to a lump sum amendment to the CMAC
agreement for $3.5 million in fiscal year 2009. This was partially offset by a
$2.3 million settlement between PCHI and a third party for additional back rent
received during the three months ended December 31, 2009.
OTHER EXPENSE - Interest expense for the three months ended December 31,
2009 was $2.4 million compared to $3.4 million for the same period in fiscal
year 2009. The decrease primarily related to the elimination of the outstanding
balance of the Company's $50 million Revolving Line of Credit.
NET INCOME (LOSS) - Net loss for the three months ended December 31, 2009
was $1.8 million compared to net income of $2.4 million for the same period in
fiscal year 2009. Due to losses incurred during the nine months ended December
31, 2009, we fully reversed the income tax expense previously recorded during
the three months ended June 30, 2009. This resulted in a tax benefit of $621 for
the three months ended December 31, 2009.
NINE MONTHS ENDED DECEMBER 31, 2009 COMPARED TO NINE MONTHS ENDED DECEMBER 31,
2008
NET OPERATING REVENUES - Net operating revenues for the nine months ended
December 31, 2009 decreased 0.1% compared to the same period in fiscal year
2009, from $289.3 million to $289.0 million. Net operating revenues for the nine
months ended December 31, 2009 included $2.3 million received by PCHI in a
settlement with a third party for additional back rent. Net operating revenues
for the nine months ended December 31, 2008 included a lump sum amendment to the
CMAC agreement for $3.5 million. Admissions decreased by 3.0% for the nine
months ended December 31, 2009 compared to the nine months ended December 31,
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 2.7%
during the nine months ended December 31, 2009 as a result of negotiated managed
care and governmental payment rate increases. Based on average revenue for
comparable services from all other payers, revenues foregone under the charity
policy, including indigent care accounts, for the nine months ended December 31,
2009 and 2008 were $6.5 million and $6.4 million, respectively.
43
Essentially all net operating revenues come from external customers. The
largest payers are the Medicare and Medicaid programs accounting for 58% and 56%
of the net operating revenues for the nine months ended December 31, 2009 and
2008, respectively.
Uninsured patients, as a percentage of gross charges, decreased to 5.4%
from 6.1% for the nine months ended December 31, 2009 compared to the nine
months ended December 31, 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. Excluding
the $2.3 million settlement noted above during the nine months ended December
31, 2009 and the $3.5 million one-time grant noted above during the nine months
ended December 31, 2008, Net Collectible Revenues were $262.1 million (net
revenues of $286.7 million less $24.6 million in provision for doubtful
accounts) and $253.5 million (net revenues of $285.8 million less $32.3 million
in provision for doubtful accounts) for the nine months ended December 31, 2009
and 2008, respectively, representing an increase of $8.6 million. There was also
an increase in Net Collectible Revenues per admission of 6.3% for the nine
months ended December 31, 2009 compared to the nine months ended December 31,
2008.
OPERATING EXPENSES - Operating expenses for the nine months ended December
31, 2009 decreased to $280.2 million from $284.2 million, a decrease of $4.0
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 nine months
ended December 31, 2009 and 2008 were 97.0% and 98.2%, respectively. On a per
admission basis, operating expenses increased 1.4%.
Salaries and benefits decreased $2.3 million (1.5%) for the nine months
ended December 31, 2009 compared to the same period in fiscal year 2009,
primarily due to the decline in admissions. Contract labor decreased $5.6
million as nurses returned to the workforce in response to the current economic
downturn.
Other operating expenses relative to net operating revenues for the nine
months ended December 31, 2009 decreased $7.9 million, or 15.1%, compared to the
same period in fiscal year 2009, primarily due to the decline in admissions and
decreases in professional fees ($4.8 million decrease), repairs and maintenance
($0.6 million decrease), and purchased services ($1.7 million decrease).
The provision for doubtful accounts for the nine months ended December 31,
2009 decreased to $24.6 million from $32.3 million, or 23.8%, compared to the
same period in fiscal year 2009. The decrease in the provision for doubtful
accounts for the nine months ended December 31, 2009 is primarily due to
improvement in collections, which were 3.6% higher during the nine months ended
December 31, 2009 compared to the nine months ended December 31, 2008. Other
factors contributing to the decrease include improved recovery from a
non-contracted managed care payer and decrease in self-pay.
During the nine months ended December 31, 2009, the Company recorded an
impairment loss of $11.3 million relating to the amounts due from Lender (see
"LENDER RECEIVERSHIP AND DEFAULT" and "AMENDED AND RESTATED MEMORANDUM OF
UNDERSTANDING").
OPERATING INCOME - The operating income for the nine months ended December
31, 2009 was $8.8 million compared to $5.2 million for the nine months ended
December 31, 2008.
OTHER EXPENSE - Interest expense for the nine months ended December 31,
2009 was $7.0 million compared to $9.2 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 nine months ended December 31, 2009 was $1.5
million compared to $5.1 million for the same period in fiscal year 2009.
44
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
REVENUE RECOGNITION - Net operating revenues are recognized in the period
in which services are performed and are recorded based on established billing
rates (gross charges) less estimated discounts for contractual allowances,
principally for patients covered by Medicare, Medicaid, managed care, and other
health plans. Gross charges are retail charges. They are not the same as actual
pricing, and they generally do not reflect what a hospital is ultimately paid
and therefore are not displayed in the consolidated statements of operations.
Hospitals are typically paid amounts that are negotiated with insurance
companies or are set by the government. Gross charges are used to calculate
Medicare outlier payments and to determine certain elements of payment under
managed care contracts (such as stop-loss payments). Because Medicare requires
that a hospital's gross charges be the same for all patients (regardless of
payer category), gross charges are also what the Hospitals charge all other
patients prior to the application of discounts and allowances.
Revenues under the traditional fee-for-service Medicare and Medicaid
programs are based primarily on prospective payment systems. Discounts for
retrospectively cost based revenues and certain other payments, which are based
on the Hospitals' cost reports, are estimated using historical trends and
current factors. Cost report settlements for retrospectively cost-based revenues
under these programs are subject to audit and administrative and judicial
review, which can take several years until final settlement of such matters are
determined and completely resolved. Estimates of settlement receivables or
payables related to a specific year are updated periodically and at year end and
at the time the cost report is filed with the fiscal intermediary. Typically no
further updates are made to the estimates until the final Notice of Program
Reimbursement is received, at which time the cost report for that year has been
audited by the fiscal intermediary. There could be several years time lag
between the submission of a cost report and receipt of the Final Notice of
Program Reimbursement. Since the laws, regulations, instructions and rule
interpretations governing Medicare and Medicaid reimbursement are complex and
change frequently, the estimates recorded by the Hospitals could change by
material amounts. The Company has established settlement receivables of $332 and
$1,618 as of December 31 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, 2009 was an increase from $20.045 to $23.140. 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 nine months ended December 31, 2009, the Company recorded $0 and
$215.3, respectively, in Final Notice of Program Reimbursement settlements.
During the three and nine months ended December 31, 2008, the Company recorded
$172.5 and $460.7, respectively, in Final Notice of Program Reimbursement
settlements. During the three and nine months ended December 31, 2008, the
Company reversed $78.4 and $1,678.0, respectively, 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.
45
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
$8.2 million and $6.8 million during the three months ended December 31, 2009
and 2008, respectively, and $13.2 million and $14.5 million during the nine
months ended December 31, 2009 and 2008, respectively. The related revenue
recorded for the three months ended December 31, 2009 and 2008 was $3.9 million
and $8.2 million, respectively, and $14.4 million and $16.2 million for the nine
months ended December 31, 2009 and 2008, respectively. As of December 31 and
March 31, 2009, estimated DSH receivables were $3.9 million and $2.7 million,
respectively.
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 $2.0 million and $2.0 million for the three months ended
December 31, 2009 and 2008, respectively, and $6.5 million and $6.4 million for
the nine months ended December 31, 2009 and 2008, respectively.
Receivables from patients who are potentially eligible for Medicaid are
classified as Medicaid pending under the MEP, with appropriate contractual
allowances recorded. If the patient does not qualify for Medicaid, the
receivables are reclassified to charity care and written off, or they are
reclassified to self-pay and adjusted to their net realizable value through the
provision for doubtful accounts. Reclassifications of Medicaid pending accounts
to self-pay do not typically have a material impact on the results of operations
as the estimated Medicaid contractual allowances initially recorded are not
materially different than the estimated provision for doubtful accounts recorded
when the accounts are reclassified. All accounts classified as pending Medicaid,
as well as certain other governmental receivables, over the age of 90 days were
reserved in contractual allowances as of December 31 and March 31, 2009 based on
historical collections experience.
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 December 31 and March 31, 2009, the Company established a receivable
in the amount of $1.2 million and $1.4 million, respectively, related to
discharges deemed eligible to meet program criteria.
46
The Company is not aware of any material claims, disputes, or unsettled
matters with any payers that would affect revenues that have not been adequately
provided for in the accompanying unaudited condensed consolidated financial
statements.
PROVISION FOR DOUBTFUL ACCOUNTS - The Company provides for accounts
receivable that could become uncollectible by establishing an allowance to
reduce the carrying value of such receivables to their estimated net realizable
value. The Hospitals estimate this allowance based on the aging of their
accounts receivable, historical collections experience for each type of payer
and other relevant factors. There are various factors that can impact the
collection trends, such as changes in the economy, which in turn have an impact
on unemployment rates and the number of uninsured and underinsured patients,
volume of patients through the emergency department, the increased burden of
copayments to be made by patients with insurance and business practices related
to collection efforts. These factors continuously change and can have an impact
on collection trends and the estimation process.
The Company's policy is to attempt to collect amounts due from patients,
including copayments and deductibles due from patients with insurance, at the
time of service while complying with all federal and state laws and regulations,
including, but not limited to, the Emergency Medical Treatment and Labor Act
("EMTALA"). Generally, as required by EMTALA, patients may not be denied
emergency treatment due to inability to pay. Therefore, until the legally
required medical screening examination is complete and stabilization of the
patient has begun, services are performed prior to the verification of the
patient's insurance, if any. In nonemergency circumstances or for elective
procedures and services, it is the Hospitals' policy, when appropriate, to
verify insurance prior to a patient being treated.
INCOME TAXES - 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 December 31 and March 31, 2009, the Company
had accrued $10.7 million and $8.7 million, respectively, which is comprised of
$4.5 million and $4.1 million, respectively, in incurred and reported claims,
along with $6.2 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 December 31 and March 31, 2009, the Company
had accrued $804 and $711, respectively, comprised of $285 and $202,
respectively, in incurred and reported claims, along with $519 and $509,
respectively, in estimated IBNR.
47
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 December 31 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 December 31 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 December 31 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. In connection with the
adoption of this standard 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 February 11, 2010 and the Company
evaluated subsequent events known to it through that date.
In June 2008, the FASB issued a new standard that addresses the
determination of whether an instrument (or an embedded feature) is indexed to an
entity's own stock. If an instrument (or an embedded feature) that has the
characteristics of a derivative instrument under this standard is indexed to an
entity's own stock, it is still necessary to evaluate whether it is classified
in stockholders' equity (or would be classified in stockholders' equity if it
were a freestanding instrument). Effective April 1, 2009, the Company adopted
this standard, which had no material impact on the Company's unaudited condensed
consolidated financial statements.
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.
48
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.
49
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
As of December 31 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 December 31, 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 December 31, 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 December 31, 2009, there were no changes in the
Company's internal control over financial reporting that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
50
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company and the Hospitals are subject to various legal proceedings,
most of which relate to routine matters incidental to operations. The results of
these claims cannot be predicted, and it is possible that the ultimate
resolution of these matters, individually or in the aggregate, may have a
material adverse effect on the Company's business (both in the near and long
term), financial position, results of operations, or cash flows. Although the
Company defends itself vigorously against claims and lawsuits and cooperates
with investigations, these matters (1) could require payment of substantial
damages or amounts in judgments or settlements, which individually or in the
aggregate could exceed amounts, if any, that may be recovered under insurance
policies where coverage applies and is available, (2) cause substantial expenses
to be incurred, (3) require significant time and attention from the Company's
management, and (4) could cause the Company to close or sell the Hospitals or
otherwise modify the way its business is conducted. The Company accrues for
claims and lawsuits when an unfavorable outcome is probable and the amount is
reasonably estimable.
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' 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.
51
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
the Company as a defendant, in response to a ruling by the Court that each
shareholder was a "necessary party" to the action. OC-PIN filed a petition for
writ of mandate with the Court of Appeals which sought to overturn the stay
imposed by the trial court. This appeal was summarily denied on November 18,
2008.
52
On April 2, 2009, the Company, OC-PIN, Anil V. Shah, M.D. ("Shah"), Bruce
Mogel, Pacific Coast Holdings Investment, LLC ("PCHI"), West Coast Holdings, LLC
("WCH"), Kali P. Chaudhuri, M.D., Ganesha Realty, LLC ("Ganesha"), William E.
Thomas and Medical Capital Corporation and related entities ("Medical Capital")
(together, the "Global Settlement Parties") entered into a global settlement
agreement and mutual release (the "Global Settlement Agreement"). Key elements
of the Global Settlement Agreement included: (1) a full release of claims by and
between the Global Settlement Parties, (2) 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. On December 7, 2009, Judge Lewis concurred with Judge
Taylor's recommendation to postpone entering judgment on the Global Settlement
Agreement pending a resolution of the action among the members of OC-PIN. The
court has scheduled a status conference on April 5, 2010 for further
consideration 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.
53
On June 1, 2009, a First Amended Complaint was filed to replace the First
Meka Complaint (the "Amended Meka Complaint"). On October 9, 2009, the
newly-assigned judge, Hon. Nancy Wieben-Stock, sustained a demurrer to the
Amended Meka Complaint. On or about November 23, 2009, Dr. Meka ET AL. filed a
Second Amended Complaint (the "Second Amended Meka Complaint"). It appears that
the relief sought against the Company in the Second Amended Meka Complaint does
not materially alter from the declaratory and injunctive relief sought in the
First Meka Complaint. The Company filed its answer to the Second Amended Meka
Complaint on December 23, 2009. 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 did not rule on
PCHI's or the Company's motions, but left intact a prior injunction essentially
staying the arbitration of Dr. Shah's indemnity claim.
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, 2007 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. Arbitration of this matter is set to
commence on June 7, 2010. 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. On December 2, 2009,
the Company and AMVI/Prospect entered into a settlement whereby the Company
agreed to pay AMVI/Prospect a total of $800 over seventeen months. The case has
accordingly been dismissed with prejudice. The liability for this settlement has
been accrued in the accompanying unaudited condensed consolidated balance sheet
as of December 31, 2009.
54
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. The liability for this settlement has been
accrued in the accompanying unaudited condensed consolidated balance sheet as of
December 31, 2009.
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. On December 23, 2009, the Company filed an answer to the complaint,
generally denying all of the plaintiff's allegations. 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 January 25, 2010, a potential class action lawsuit was filed against
the company by Julie Ross. Ms. Ross purports to represent all similarly-situated
employees and the complaint alleges causes of action for violation of the
California Labor Code and unfair competition law. At this early stage in the
proceedings, 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, was issued 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.
On January 25, 2010, the Company received correspondence purportedly on
behalf of OC-PIN challenging the MOU with KPC Resolution Company (Note 12). The
letter demanded that the Company take certain action in response to the MOU. The
Company issued a response to the letter on February 9, 2010 contesting several
factual and legal conclusions therein and is currently awaiting confirmation
from the court as to who properly represents OC-PIN.
On or about August 1, 1996, Southern California Specialty Care, Inc.
("SCSC") entered into a property lease agreement with PCHI whereby SCSC agreed
to pay 10 percent of its net income to PCHI each quarter (the "Percentage
Rent"). In April 2008, PCHI brought a complaint in arbitration against SCSC
alleging SCSC's failure to pay the Percentage Rent since 2005. In November 2009,
PCHI and SCSC reached a settlement pursuant to which PCHI received $1.9 million
for unpaid Percentage Rent through December 31, 2008, including late fees and
litigation expenses, and $407 for Percentage Rent for the first three calendar
quarters of 2009. Such amounts were recorded in net operating revenues during
the three months ended December 31, 2009.
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ITEM 1A. RISK FACTORS
LENDER DEFAULT - On July 16, 2009, the SEC filed a complaint with the
United States District Court against the parent company and affiliates of the
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 Receiver") 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 Receiver 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 on 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 December 31, 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 December 31, 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.
CONCENTRATION OF BUSINESS - 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.
56
ITEM 6. EXHIBITS
Exhibit
Number Description
- ------ -----------
10.1 Amended and Restated Memorandum of Understanding, effective as of
January 13, 2010, by and between the Registrant and Dr. Kali P.
Chaudhuri and KPC Resolution Company, LLC (incorporated herein by
reference to Exhibit 99.1 to the Registrant's Report on Form 8-K filed
on January 20, 2010).
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: February 11, 2010 By: /s/ Steven R. Blake
------------------------------
Steven R. Blake
Chief Financial Officer
(Principal Financial Officer)
57