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 March 31, 2005
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 small business issuer as specified in its charter)
Nevada 87-0412182
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
695 Town Center Drive, Suite 260, Costa Mesa, 92626
California (Zip Code)
(Address of principal executive offices)
(714) 434-9191
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year,
if changed since last report)
------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes |X| No |_|
INTEGRATED HEALTHCARE HOLDINGS, INC.
FORM 10-Q
TABLE OF CONTENTS
Page
Number
PART I FINANCIAL INFORMATION
Item 1. Financial Statements:
Unaudited Consolidated Balance Sheet as of March 31, 2005 and
December 31, 2004 2
Unaudited Consolidated Statement of Operations for the three
months ended March 31, 2005 and March 31, 2004 3
Unaudited Consolidated Statement of Stockholders' Equity as of
March 31, 2005 and December 31, 2004 4
Unaudited Consolidated Statement of Cash Flows for the three
months ended March 31, 2005 and March 31, 2004 5
Condensed Notes to Unaudited Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 25
Item 3. Quantitative and Qualitative Disclosures About Market Risk 32
Item 4. Controls and Procedures 32
PART II OTHER INFORMATION
Item 1. Legal Proceedings 33
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 34
Item 3. Defaults Upon Senior Securities 36
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits 42
SIGNATURES 45
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
1
INTEGRATED HEALTHCARE HOLDINGS, INC.
UNAUDITED CONSOLIDATED BALANCE SHEET
ASSETS
MARCH 31, DECEMBER 31,
2005 2004
----------------------------
Current assets: (Unaudited)
Cash and cash equivalents $ 6,414,122 $ 69,454
Accounts receivable, net of allowance for doubtful
accounts of $3,141,406 at March 31, 2005 16,968,328 --
Inventories of supplies, at cost 5,947,127 --
Prepaid expenses and other assets 3,854,474 18,519
----------------------------
33,184,051 87,973
Property and equipment, net 59,321,425 57,423
Investment in hospital asset purchase -- 11,142,145
Deferred loan fees, net of accumulated amortization of $62,355 1,870,645 --
Intangible asset, net of accumulated amortization of $70,668 and $57,819 32,122 44,970
----------------------------
Total assets $ 94,408,243 $ 11,332,511
============================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Secured line of credit note $ 13,200,000 $ --
Secured acquisition note 50,000,000 11,264,013
Income taxes payable 1,472,000 --
Accounts payable 5,145,396 156,142
Accrued compensation and benefits 1,063,677 800,313
Accrued contract labor costs 6,810,000 --
Other current liabilities 1,643,292 --
----------------------------
Total current liabilities 79,334,365 12,220,468
Capital lease obligations, net of current of $204,141 3,440,858 --
Commitments and contingencies -- --
Minority interest in variable interest entity 4,991,095 --
Stockholders' equity:
Common stock, $0.001 par value; 250,000,000 shares
authorized; 118,039,000 and 20,780,000 shares
issued and outstanding, respectively 124,539 20,780
Common stock warrants; 41,291,892 outstanding 27,987,100 --
Additional paid in capital 11,785,363 1,189,621
Deferred warrant expense (11,552,927) --
Accumulated deficit (21,702,150) (2,098,358)
----------------------------
Total stockholders' equity 6,641,925 (887,957)
----------------------------
Total liabilities and stockholders' equity $ 94,408,243 $ 11,332,511
============================
The accompanying condensed notes are an integral part of
these unaudited condensed consolidated financial statements
2
INTEGRATED HEALTHCARE HOLDINGS, INC.
UNAUDITED CONSOLIDATED STATEMENT OF OPERATIONS
THREE MONTHS ENDED
-------------------------------
MARCH 31, 2005 MARCH 31, 2004
-------------- --------------
(Unaudited) (Unaudited)
Net operating revenues $ 21,747,029 $ --
Operating expenses:
Salaries and benefits 12,450,604 296,829
Supplies 3,033,815 --
Provision for doubtful accounts 3,141,406 --
Other operating expenses 3,900,220 180,124
Depreciation and amortization 262,212 15,179
Common stock warrant expense 16,434,173 --
------------ ------------
39,222,430 492,132
Operating loss (17,475,401) (492,132)
Interest expense 665,296 --
------------ ------------
Loss including minority interest and
before provision for income taxes (18,140,697) (492,132)
Provision for income taxes 1,472,000 --
Minority interest in variable interest entity (8,905) --
------------ ------------
Net loss $(19,603,792) $ (492,132)
============ ============
Per Share Data:
Basic and fully diluted
Loss per common share $ (0.22) $ (0.03)
Weighted average shares outstanding 88,493,611 19,582,667
3
INTEGRATED HEALTHCARE HOLDINGS, INC.
UNAUDITED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Common Stock Common Stock Warrants Additional Deferred
------------------------- ------------------------ Paid-in Warrant Accumulated
Shares Amount Shares Amount Capital Expense Deficit
----------- ----------- ---------- ----------- ----------- ------------ ------------
Balance, December 31, 2003 19,380,000 $ 19,380 -- $ -- $ 551,021 $ -- $ (217,781)
Issuance of debt for the
acquisition of MMG, Inc. -- -- -- -- -- -- (40,386)
Issuance of common stock for
cash at $0.25 per share 200,000 200 -- -- 49,800 -- --
Issuance of common stock for
cash at $0.50 per share 1,200,000 1,200 -- -- 588,800 -- --
Net loss -- -- -- -- -- -- (1,840,191)
----------- ----------- ---------- ----------- ----------- ------------ ------------
Balance, December 31, 2004 20,780,000 $ 20,780 -- $ -- $ 1,189,621 $ -- $ (2,098,358)
=========== =========== ========== =========== =========== ============ ============
Issuance of common stock for
cash at $0.50 per share 1,159,000 1,159 -- -- 598,342 -- --
Issuance of common stock for
cash to OCPIN 102,600,000 102,600 -- -- 9,997,400 -- --
Issuance of common stock
warrants -- -- 41,291,892 27,987,100 -- (27,987,100) --
Common stock warrants
expensed at March 31, 2005 16,434,173
Net loss -- -- -- -- -- -- (19,603,792)
----------- ----------- ---------- ----------- ----------- ------------ ------------
Balance, March 31, 2005 124,539,000 $ 124,539 41,291,892 $27,987,100 $11,785,363 $(11,552,927) $(21,702,150)
=========== =========== ========== =========== =========== ============ ============
Total
------------
Balance, December 31, 2003 $ 352,620
Issuance of debt for the
acquisition of MMG, Inc. (40,386)
Issuance of common stock for
cash at $0.25 per share 50,000
Issuance of common stock for
cash at $0.50 per share 590,000
Net loss (1,840,191)
------------
Balance, December 31, 2004 $ (887,957)
============
Issuance of common stock for
cash at $0.50 per share 599,501
Issuance of common stock for
cash to OCPIN 10,100,000
Issuance of common stock
warrants --
Common stock warrants
expensed at March 31, 2005 16,434,173
Net loss (19,603,792)
------------
Balance, March 31, 2005 $ 6,641,925
============
4
INTEGRATED HEALTHCARE HOLDINGS, INC.
UNAUDITED CONSOLIDATED STATEMENT OF CASH FLOWS
Three Three
Months Ended Months Ended
March 31, 2005 March 31, 2004
-------------- --------------
Cash flows from operating activities:
Net loss $(19,603,792) $ (492,132)
Adjustments to reconcile net loss to cash used in operating activities:
Depreciation and amortization expense 324,566 15,179
Common stock warrant expense 16,434,173 --
Increase in prepaid expense and other assets (1,497,101) --
Increase in net accounts receivable (16,968,328) (8,827)
Increase in income taxes payable 1,472,000 --
Increase in accounts payable 4,989,254 209,908
Increase in accrued compensation and benefits 385,384 --
Increase in accrued contract labor costs 6,810,000 --
Increase in other accrued liabilities 1,439,151 --
Decrease in inventories of supplies 71,868 --
------------ ------------
Net cash used in operating activities (6,142,825) (275,872)
------------ ------------
Cash flows from investing activities:
Acquisition of hospital assets, net (63,214,995) --
Proceeds from sale of property (5,000,000) --
Purchase of property and equipment -- (14,877)
Acquisition of MMG, Inc., net of cash acquired -- 8,534
------------ ------------
Net cash used in investing activities (58,214,995) (6,343)
Cash flows from financing activities:
Issuance of secured promissory notes, net of costs 48,067,000 (71,715)
Proceeds from line of credit 13,200,000 --
Proceeds from issuance of stock 10,699,501 200,000
Repayment of secured notes (1,264,013) --
------------ ------------
Net cash provided by financing activities 70,702,488 128,285
------------ ------------
Net increase (decrease) in cash 6,344,668 (153,930)
------------ ------------
Cash and cash equivalents, beginning of period 69,454 265,000
------------ ------------
Cash and cash equivalents, end of period $ 6,414,122 $ 111,070
============ ============
Supplemmental disclosure of noncash transactions:
Issuance of promissory notes for Acquisition $ 53,000,000 $ --
Consolidation of variable interest entity $ 54,758,312 $ --
Expense of common stock warrants $ 16,434,173 $ --
Rescinded secured promissory note for the
return of initial deposit on hospital assets $ 10,000,000 $ --
Interest paid $ 1,629,000 $ --
Income taxes paid $ -- $ --
The accompanying condensed notes are an integral part of
these unaudited condensed consolidated financial statements
5
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Acquisition - On March 8, 2005, the Company completed its acquisition (the
"Acquisition") of four Orange County, California hospitals and associated real
estate, including: (i) 282-bed Western Medical Center--Santa Ana, CA; (ii)
188-bed Western Medical Center--Anaheim, CA; (iii) 178-bed Coastal Communities
Hospital in Santa Ana, CA; and (iv) 114-bed Chapman Medical Center in Orange, CA
(collectively, the "Hospitals") from Tenet Healthcare Corporation ("Tenet"). The
Hospitals were assigned to four wholly-owned subsidiaries of the Company (the
"Subsidiaries") formed for the purpose of completing the Hospital Acquisition.
The Company also acquired the following real estate, leases and assets
associated with the Hospitals: (i) a fee interest in the Western Medical Center
at 1001 North Tustin Avenue, Santa Ana, CA 92705, a fee interest in the
administration building at 1301 North Tustin Avenue, Santa Ana, CA 92705,
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 92805; (iii) a fee interest in
the Coastal Communities Hospital at 2701 South Bristol Street, Santa Ana, CA
92704, 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 92869, and a lease for the medical office building at
2617 East Chapman Avenue, Orange, CA; and (v) the furniture, fixtures and
contract rights associated with the Hospitals.
The results of operations of the acquired assets from the acquisition date
(March 8, 2005) have been included in the Company's consolidated statement of
operations for the three months ended March 31, 2005. As a result of the
Acquisition the Company has commenced its planned principal operations and
accordingly is no longer considered a development stage enterprise.
As discussed further in Note 7, concurrent with the close of the
Acquisition the Company entered into a sale-leaseback transaction with a Pacific
Coast Holdings Investment, LLC ("PCHI"), a then wholly owned subsidiary,
involving all the real property acquired in the Acquisition. PCHI was then
immediately sold to certain major equity holders in the Company. In this
transaction the Company received consideration of $5 million in cash plus PCHI's
guaranty of the Company's acquisition note of $50 million. Because, among other
reasons, the Company remains primarily liable under the $50 million debt
notwithstanding its guaranty by PCHI, this transaction does not qualify for
sale-leaseback accounting and the $50 million in debt has not been removed from
the Company's consolidated balance sheet at March 31, 2005. However, because
PCHI now holds title to the real property, the Company's interest in the real
estate was converted to a lease interest pursuant to the lease entered into
between PCHI, as lessor, and the Company, as lessee as part of the
sale-leaseback transaction. Additionally, as further discussed under
Consolidation below, Company management has determined that generally accepted
accounting principles require that the financial statements of PCHI must be
included in the consolidated financial statements of the Company under generally
accepted accounting principles.
Consolidation - The consolidated financial statements include the accounts
of Integrated Healthcare Holdings, Inc. ("the Company") and its wholly owned
subsidiaries, Mogel Management Group, Inc. ("MMG") and its four hospital
subsidiaries located in Orange County, California (collectively, the
"Hospitals"):
Western Medical Center - Anaheim Anaheim, CA 188 beds
Western Medical Center - Santa Ana Santa Ana, CA 282 beds
Coastal Communities Hospital Santa Ana, CA 178 beds
Chapman Medical Center Orange, CA 114 beds
6
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
Additionally, generally accepted accounting principles require that a
company 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. As discussed further in Note 9, the Company has
determined that it provides to the entity that purchased the Hospitals' real
estate the majority of its financial support through various sources
including lease payments, cross-collateralization of the Company's assets to
secure the transferred debt, and the use of the Company's equity financing.
Accordingly, the accompanying consolidated financial statements include the
accounts of this entity from the date of the real estate sale.
All significant intercompany accounts and transactions have been
eliminated in combination.
Company Operations - The Company through the Hospitals is primarily
engaged in the operation of general hospitals and related healthcare facilities.
The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and settlement of
obligations in the normal course of business. The Company generated losses from
continuing operations of $19,603,792 (inclusive of warrant expenses incurred in
connection with the Hospital acquisitions of $16,434,173) during the three
months ended March 31, 2005 and has negative working capital of $46,150,314 at
March 31, 2005. In addition, on or around May 9, 2005, the Company received a
notice of default from Medical Provider Financial Corporation II ("Medical
Provider"), which is the lender under the $50 million acquisition loan and under
a working capital line of credit that has an outstanding balance of $13.2
million as of March 31, 2005. The default has caused the acquisition loan to be
classified as a current liability as of March 31, 2005. These factors, among
others, indicate a need for the Company to take action to resolve its financing
issues and operate its business on a profitable basis.
Management is working to restructure the debt with Medical Provider and
believes that the Company's existing cash flow from operations and the Company's
ability to raise additional capital will be sufficient to meet its continuing
obligations for the foreseeable future. The Company has requested and PCHI has
agreed to permit the Company to use the Hospitals' real property as collateral
for the purposes of joint financing of Company's business operation for an
initial period of time.
Condensed Financial Statements - The accompanying financial statements
have been prepared by the Company without audit. In the opinion of management,
all adjustments (which include only normal recurring adjustments) necessary to
present fairly its consolidated financial position at March 31, 2005, and its
consolidated results of operations and cash flows for the three months ended
March 31, 2005 and 2004 have been made.
Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles in the United States of America have been condensed or omitted. It is
suggested that these condensed financial statements be read in conjunction with
the financial statements and notes thereto included in the Company's December
31, 2004 audited consolidated financial statements. The results of operations
for the periods ended March 31, 2005 and 2004 are not necessarily indicative of
the operating results for the full year.
Organization - Integrated Healthcare Holdings, Inc. (the "Company") was
organized under the laws of the State of Utah on July 31, 1984 under the name of
Aquachlor Marketing. The Company never engaged in business activities and was
suspended for failure to file annual reports and tax returns. In December 1988,
all required reports and tax returns were filed and the Company was reinstated
by the State of Utah. In December 1988, the Company merged with Aquachlor, Inc.,
a Nevada corporation incorporated on December 20, 1988. The Nevada corporation
became the surviving entity and changed its name to Deltavision, Inc. In March
1997, the Company received a Certificate of Revival from the State of Nevada
using the name First Deltavision, Inc. In March 2004, the Company changed its
name to Integrated Healthcare Holdings, Inc.
7
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
Use of Estimates - The accounting and reporting policies of the Hospitals
conform to accounting principles generally accepted in the United State of
American and prevailing practices for investor-owned entities within the
healthcare industry. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of American
requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Management
regularly evaluates the accounting policies and estimates that are used. In
general, management bases the estimates on historical experience and on
assumptions that it believes to be reasonable given the particular circumstances
in which the Hospitals operate. Although management believes that adjustments
considered necessary for fair presentation have been included, actual results
may vary from those estimates.
Net Patient Service Revenue - Net patient service revenue is recognized in
the period in which services are performed and is recorded based on established
billing rates (gross charges) less estimated discounts for contractual
allowances, principally for patients covered by Medicate, 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 combined statements of operations and changes
in ownership equity. 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 hospitals charge all
other patients prior to the application of discounts and allowances.
Percentages of net patient service revenue, by payer type, for the
Hospitals for the quarter ended March 31, 2005 were as follows:
QUARTER ENDED
MARCH 31, 2005
--------------
Medicare 22%
Medicaid 14%
Managed care 43%
Indemnity, self-pay and other 21%
Revenues under the traditional fee-for-service Medicare and the California
Medi-Cal ("Medicaid") programs are based primarily on prospective payment
systems. Discounts for retrospectively cost-based revenues, which were more
prevalent in earlier periods, 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. Because 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.
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 State Department of Health and
Human Services (CMS). 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. If the computed cost exceeds the sum
of the DRG payment plus the fixed threshold, the hospital receives 80% of the
difference as an outlier payment.
8
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
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, 2004 was a decrease from
$31,000 to $25,800, which CMS projects will result in an Outlier Percentage of
5.1%.
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 the month, the Hospitals estimate expected reimbursement for patient
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. Management does not believe there were
any adjustments to estimates of individual patient bills that were material to
its net patient service revenue.
Management is not aware of any material claims, disputes, or unsettled
matters with any payers that would affect revenues that have not been adequately
provided for in the accompanying consolidated financial statements.
The Hospitals provide charity care to patients whose income level is below
200% of the Federal Poverty Level with only a co-payment charged to the patient.
The Hospitals' policy is to not pursue collection of amounts determined to
qualify as charity care; and accordingly, the Hospitals do not report the
amounts in net patient service revenue or in the provision for doubtful
accounts. Patients whose income level is between 200% and 300% of the Federal
Poverty Level may also be considered under a catastrophic provision of the
charity care policy. Patients without insurance who do not meet the Federal
Poverty Level guidelines 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. The amount of gross charges
foregone under the charity policy, including indigent care accounts, for the
three months ended March 31, 2005 was approximately $1,007,878.
9
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
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 quality 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 of 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
are fully reserved when they reach 180 days old.
Provision for Doubtful Accounts- The Hospitals provide 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
co-payments 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 Hospitals' policy is to attempt to collect amounts due from patients,
including co-payments 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 non-emergency circumstances or for elective procedures and services, it
is the Hospitals' policy, when appropriate, to verify insurance prior to a
patient being treated.
During the three months ended March 31, 2005, the Hospitals recorded
provisions for doubtful accounts of $3,141,406.
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.
Property and Equipment - Property and equipment are stated at cost, less
accumulated depreciation and any impairment write-downs related to assets held
and used. Additions and improvements to property and equipment are capitalized
at cost. Expenditures for maintenance and repairs are charged to expense as
incurred. Capital leases are recorded at the beginning of the lease term as
assets and liabilities. The value recorded is the lower of either the present
value of the minimum lease payments or the fair value of the asset. Such assets,
including improvements, are amortized over the shorter of either the lease term
or their estimated useful life.
The Company use the straight-line method of depreciation for buildings,
building improvements, and equipment over their estimated useful lives as
follows:
Buildings and improvements 4 to 25 years
Equipment 3 to 15 years
The Company evaluates its long-lived assets for possible impairment
whenever circumstances indicate that the carrying amount of the asset, or
related group of assets, may not be recoverable from estimated future cash
flows. However, there is an evaluation performed at least annually. Fair
value estimates are derived from independent appraisals, established market
values of comparable assets or
10
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
internal calculations of estimated future net cash flows. The estimates of
future net cash flows are based on assumptions and projections believed by
management to be reasonable and supportable. These assumptions take into account
patient volumes, changes in payer mix, revenue, and expense growth rates and
changes in legislation and other payer payment patterns. The Company believes
there has been no impairment in the carrying value of its property and equipment
at March 31, 2005.
Medical Claims Incurred but not Reported - The Company record estimates of
claims incurred but not reported (IBNR) to the Hospitals for its obligations
under agreements with various HMOs. Claims incurred but not reported are
estimated using historical claims patterns, current enrollment trends, hospital
pre-authorizations, member utilization patterns, timeliness of claims
submissions, and other factors. These estimates are periodically reviewed and
any adjustments are reflected prospectively in operations.
The Company believes that IBNR claims reserves are adequate to satisfy
ultimate claims liabilities; however, establishment of IBNR claims estimates is
an inherently uncertain process and actual experience could result in
prospective revisions to these estimated reserves.
Stock-Based Compensation - Statement of Financial Accounting Standards No.
123, Accounting for Stock Based Compensation, encourages, but does not require,
companies to record compensation cost for stock-based employee compensation
plans at fair value. The Company has chosen to account for stock-based
compensation using the intrinsic value method prescribed in previously issued
standards. Accordingly, compensation cost for stock options issued to employees
is measured as the excess, if any, of the fair market value of the Company's
stock at the date of grant over the amount an employee must pay to acquire the
stock. Compensation is charged to expense over the shorter of the service or
vesting period. Stock options issued to non-employees are recorded at the fair
value of the services received or the fair value of the options issued,
whichever is more reliably measurable, and charged to expense over the service
period.
Fair Value of Financial Instruments - The Company considers all liquid
interest-earning investments with a maturity of three months or less at the date
of purchase to be cash equivalents. Short-term investments generally mature
between three months and six months from the purchase date. All cash and
short-term investments are classified as available for sale and are recorded at
market using the specific identification method; unrealized gains and losses are
reflected in other comprehensive income. Cost approximates market for all
classifications of cash and short-term investments.
Net Loss per Common Share - Net loss per share is calculated in accordance
with Statement of Financial Accounting Standards No. 128, Earnings Per Share.
Basic net loss per share is based upon the weighted average number of common
shares outstanding. Diluted net loss per share is based on the assumption that
options and warrants are included in the calculation of diluted earnings per
share, except when their effect would be anti-dilutive. Dilution is computed by
applying the treasury stock method. Under this method, options and warrants are
assumed to be exercised at the beginning of the period (or at the time of
issuance, if later), and as if funds obtained thereby were used to purchase
common stock at the average market price during the period.
Impairment of Long-Lived Assets - The Company continually monitors events
or changes in circumstances that could indicate that the carrying amount of
long-lived assets to be held and used, including intangible assets, may not be
recoverable. The determination of recoverability is based on an estimate of
undiscounted future cash flows resulting from the use of the asset and its
eventual disposition. When impairment is indicated for a long-lived asset, the
amount of impairment loss is the excess of net book value over fair value.
Long-lived assets to be disposed of are reported at the lower of carrying amount
or fair value less costs to sell. As of March 31, 2005, the Company has
determined that no impairment of its long-lived assets exists.
11
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
Goodwill and Intangible Assets - On July 20, 2001, the Financial
Accounting Standards Board (FASB) issued Statement of Financial Accounting
Standards ("SFAS") 141, Business Combinations, and SFAS 142, Goodwill and
Intangible Assets. Under these new standards, all acquisitions subsequent to
June 30, 2001 must be accounted for using the purchase method of accounting. The
cost of intangible assets with indefinite lives and goodwill are no longer
amortized, but are subject to an annual impairment test based upon its fair
value.
Goodwill and intangible assets principally result from business
acquisitions. The Company accounts for business acquisitions by assigning the
purchase price to tangible and intangible assets and liabilities. Assets
acquired and liabilities assumed are recorded at their fair values; the excess
of the purchase price over the net assets acquired is recorded as goodwill.
Recently Enacted Accounting Standards - On October 13, 2004, the Financial
Accounting Standards Board issued Statement 123R, Share-Based Payment, which
requires all companies to measure compensation cost for all share-based
payments, including employee stock options, at fair value. The statement is
effective for the Company as of the fiscal year commencing January 1, 2006. The
statement generally requires that such transactions be accounted for using a
fair-value-based method and recognized as expenses in the consolidated
statements of operations. This standard also requires that the modified
prospective transition method be used, under which the Company will recognize
compensation cost for (1) the fair value of new awards granted, modified or
settled after the effective date of the SFAS 123R; and (2) a portion of the fair
value of each option and stock grant made to employees or directors prior to the
implementation date that represents the unvested portion of these share-based
awards as of such date.. The measurement of compensation cost for awards that
are not fully vested as of the effective date of the SFAS 123R would be based on
the same estimate that the Company used to previously value its grants under
SFAS 123.
As a result of SFAS 123R, the Company will be required to expense the fair
value of its stock option grants rather than disclose the impact on its
consolidated statement of operations within the Company's footnotes, as is
current practice. Additionally, if it chooses to do so, SFAS 123(R) permits the
Company to adopt the new share-based award accounting by retrospectively
restating results for all periods presented to facilitate period-to-period
comparison. The Company has not yet made a determination as to whether it will
adopt SFAS 123(R) retrospectively and is currently assessing the potential
impact of the new standard on its consolidated financial statements and is
evaluating alternative equity compensation arrangements.
In January 2003, the Financial Accounting Standards Board issued FIN 46,
"Consolidation of Variable Interest Entities," which requires consolidation of
certain entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. Paragraph 1 of ARB 51 states that consolidated
financial statements are usually necessary for a fair presentation when one of
the companies in the group directly or indirectly has a controlling financial
interest in the other companies. Paragraph 2 states that "the usual condition
for a controlling financial interest is ownership of a majority voting
interest..." However, application of the majority voting interest requirement in
ARB 51 to certain types of entities may not identify the party with a
controlling financial interest because the controlling financial interest may be
achieved through arrangements that do not involve voting interests. Application
of Interpretation 46 or Interpretation 46(R) is required in financial statements
of public entities that have interests in variable interest entities or
potential variable interest entities commonly referred to as special-purpose
entities for periods ending after December 15, 2003. See Note 8 regarding the
Company's implementation of FIN 46(R).
12
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
NOTE 2 - ACQUISITION
The purchase price, after all purchase price adjustments, of the Acquisition
amounted to $69,784,202. The fair value of the tangible assets acquired and
liabilities assumed consisted of the following:
Property and equipment $ 59,493,353
Inventories of supplies 6,018,995
Prepaid expenses and other current assets 2,338,854
Debt issuance costs 1,933,000
-------------
$69,784,202
=============
The Company financed the asset purchase by obtaining a $50 million acquisition
debt, drawing $3 million on a working capital line of credit, the sale of the
Company's common stock for $10,100,000, and $5 million in proceeds from the sale
of the real property of the acquired Hospitals.
Supplemental pro forma information disclosing the results of operations for the
current interim period and the corresponding period in the preceding year as
though the Acquisition had been completed as of the beginning of each period is
not presently available. The Company anticipates it will furnish such
information in its condensed consolidated financial statements for the period
ended June 30, 2005.
As of December 31, 2004, the Company recorded its initial deposit of $10
million on the Tenet Hospital Acquisition and direct acquisition costs of
$1,142,145, consisting primarily of legal fees, as an Investment in hospital
asset purchase in the accompanying consolidated balance sheet.
NOTE 3 - PROPERTY AND EQUIPMENT
Property and equipment consist of the following as of March 31, 2005:
Land $28,839,098
Buildings and improvements 19,270,104
Equipment 7,808,774
Leasehold 3,659,401
-----------
59,577,377
Less accumulated depreciation (255,952)
-----------
Property and equipment, net $59,321,425
===========
The Hospitals are affected by State of California Senate Bill 1953 (SB
1953), which requires certain seismic safety building standards for acute care
hospital facilities. The Hospitals are currently reviewing the SB 1953
compliance requirements and developing multiple plans of action to achieve such
compliance, the estimated time frame for complying with such requirements, and
the cost of performing necessary remediation of certain of the properties. The
Hospitals cannot currently estimate with reasonable accuracy the remediation
costs that will need to be incurred in order to make the facilities SB
1953-compliant, but such remediation costs could be significant.
13
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
NOTE 4 - COMMON STOCK
2005 Stock Transactions
Stock Purchase Agreement with OC-PIN - On January 28, 2005, the Company
entered into a Stock Purchase Agreement (the "Stock Purchase Agreement") with
Orange County Physicians Investment Network, LLC ("OC-PIN"), a company founded
by Dr. Anil V. Shah and owned by a number of physicians practicing at the
acquired hospitals, pursuant to which OC-PIN committed to invest $30,000,000 in
the Company for an aggregate of 108,000,000 shares of the Company's common
stock. In addition, a prior Purchase Option Agreement, dated November 16, 2004,
between the Company and Dr. Anil V. Shah was terminated.
During the three months ended March 31, 2005, the Company issued 96.1
million shares of its common stock in consideration of $10.1 million from OC-PIN
under the Stock Purchase Agreement. The Company used the proceeds from this
stock sale as part of the consideration paid to Tenet for the Hospital
acquisition.
Under the Stock Purchase Agreement, no later than six calendar days before
the closing of Acquisition, OC-PIN was to deliver to the Company additional
financing totaling $20,000,000. Upon receipt of the $20,000,000, the Company was
to issue an additional 5.4 million shares of its common stock to OC-PIN. The
Company extended OC-PIN's additional $20 million financing commitment to March
31, 2005, but as of May 22, 2005, OC-PIN has not made any additional stock
purchases. See "Note 12 - Subsequent Events" for information concerning the
current status of this matter.
During the three months ended March 31, 2005, the Company issued 1,179,000
shares of its common stock at $0.50 per share for cash proceeds of $589,500.
NOTE 5 - COMMON STOCK WARRANTS
In connection with the Company's Rescission, Restructuring and Assignment
Agreement entered into on January 27, 2005, the Company issued to Dr. Kali
Chaudhuri ("Chaudhuri") and Mr. William Thomas ("Thomas") stock purchase
warrants to purchase up to 74,700,000 shares of the Company's Common Stock (but
not to exceed 24.9% of the Company's fully-diluted capital stock) (the
"Warrants"). The Company's financing agreements entered into with Dr. Chaudhuri
in 2004, which provided Dr. Chaudhuri and Thomas with a $500,000 secured
convertible promissory note, a $10 million secured promissory note and a stock
option agreement, were rescinded and cancelled. The $500,000 convertible
promissory note was originally convertible into approximately 88.8% of the
Company's issued and outstanding common stock on a fully-diluted basis. In
addition, the Company released its initial deposit of $10 million plus accrued
interest for the Tenet hospital acquisition back to Dr. Chaudhuri. The Company
issued to Dr. Chaudhuri and Thomas non-convertible secured promissory notes
totaling $1,264,013 and the Warrants.
The warrants are exercisable beginning January 27, 2007 and expire 3.5
years from the date of issuance. The exercise price for the first 43 million
shares purchasable under the Warrants is $0.003125 per share, and the exercise
price for the remaining 31.7 million shares is $0.078 per share if exercised
between January 27, 2007 and July 26, 2007, $0.11 per share if exercised between
July 27, 2007 and January 26, 2008, and $0.15 thereafter.
14
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
Based upon a valuation obtained by the Company from an independent
valuation firm, the Company assigned a value to the 74,700,000 warrants of
$27,987,100 at the date of grant. As of March 31, 2005, the Company recognized
an expense of $16,434,173 related to the issuance of the Warrants. The Company
computed the expense of the Warrants based on the fair value of the Warrants at
the date of grant and the maximum number of shares exercisable as of March 31,
2005 of 41,291,892 (which constitutes 24.9% of the fully diluted stock that
would have been outstanding as of March 31, 2005 assuming maximum possible
exercise of the Warrants). The Company recorded the fair value of the remaining
unexercisable Warrants as of March 31, 2005 of $11,552,927 as deferred warrant
expense in the accompanying consolidated balance sheet as of March 31, 2005. The
Company will recognize additional Warrant expense in subsequent quarters over
the term of the Warrants of 3.5 years based on any future increases in the
number of outstanding shares of the Company's fully diluted common stock.
The Company computed the fair value of the Warrants based on the
Black-Scholes option pricing model with the following assumptions:
Risk-free interest rate 3.2%, 3.33%
Expected volatility 33.6%, 35.7%
Dividend yield --
Expected life (years) 2, 2.5
Fair value of Warrants (fully diluted) $0.343, $0.398
Due to fact that the Company emerged from the development stage during the
three months ended March 31, 2005, the Company computed the volatility of its
stock based on an average of comparable public companies that own hospitals.
NOTE 6 - DEBT
The current portion of the Company's debt consists of the following notes
as of March 31, 2005:
Secured line of credit note $ 13,200,000
Second aquisition note 50,000,000
-------------
$ 63,200,000
=============
Acquisition Loan and Line of Credit - In connection with the Tenet
Hospital Acquisition, the Company obtained borrowings to complete the Hospital
Acquisition from affiliates of Medical Capital Corporation of Anaheim, CA.
Effective March 3, 2005, the Company and its Subsidiaries collectively entered
into a Credit Agreement (the "Credit Agreement") with Medical Provider Financial
Corporation II ("the Lender"), whereby the Company has obtained initial
financing in the form of a loan with interest at the rate of 14% per annum in
the amount of $80,000,000 of which $30,000,000 is in the form of a non-revolving
Line of Credit (the "Line of Credit") and $50,000,000 is in the form of a real
estate loan (the "Acquisition Loan") (collectively, the "Obligations"). The
Company used the proceeds from the $50 million Acquisition Loan and $3 million
from the Line of Credit to complete the Acquisition (See Notes 1 and 2). The
Line of Credit is to be used for the purpose of providing: (a) working capital
financing for the Company and its Subsidiaries, (b) funds for other general
corporate purposes of the Company and its Subsidiaries, and (c) other permitted
purposes.
15
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
Interest payments are due on the Obligations on the first business day of
each calendar month to occur while any Obligation is outstanding at the interest
rate of 14% per annum. The Obligations mature at the first to occur of (i) the
Commitment Termination Date for the Line of Credit Loan, (ii) March 2, 2007, or
(iii) the occurrence or existence of a continuing Event of Default under any of
the Obligations. The Commitment Termination Date means the earliest of (a)
thirty calendar days prior to March 2, 2007; (b) the date of termination of
Lender's obligations to make Advances under the Line of Credit Note or permit
existing Obligations to remain outstanding pursuant to Section 8.2(b), (c) the
date of prepayment in full by the Company and its Subsidiaries of the
Obligations and the permanent reduction of all Commitments to zero dollars; (d)
March 2, 2007. Per the Credit Agreement, all future capital contributions to the
Company by OC-PIN shall be used by the Company as mandatory prepayments of the
Line of Credit.
The Acquisition Loan and Line of Credit are secured by a lien on
substantially all of the assets of the Company and its Subsidiaries, including
without limitation, a pledge of the capital stock by the Company in its wholly
owned subsidiaries. In addition, (i) PCHI (see Note 7) has agreed to guaranty
the payment and performance of the Obligations, (ii) West Coast and Ganesha (see
Note 7) have each agreed to pledge their membership interests in PCHI as
security for repayment of the Obligations, (iii) the members of West Coast have
agreed to pledge their membership interests in PCHI as security for repayment of
the Obligations, and (iv) OC-PIN (see Note 4) has agreed to guaranty the payment
and performance of all the Obligations.
Credit Agreement Fees - Concurrently with the execution and delivery of
the Credit Agreement and as a condition to the funding of the Acquisition Loan,
Company and its Subsidiaries agreed to pay to the Lender an origination fee in
an amount equal to 2% of the Credit Line Commitment or $600,000, and 2% of the
Acquisition Loan or $1,000,000, to be payable out of Company and its
Subsidiaries own funds, which fee shall be deemed earned in full upon receipt by
Lender. Upon the completion of the Acquisition on March 8, 2005, the Company
paid the lender a total of $1,600,000 in origination fees and paid the Lender's
legal fees of approximately $333,000. The Company is amortizing the deferred
loan fees over the two year term of the Obligations. During the three months
ended March 31, 2005, the Company recognized $62,355 of amortization expense and
has unamortized deferred loan fees of $1,870,645 as of March 31, 2005.
Former Secured Promissory Note - In t an effort to obtain financing to
permit thehe Acquisition to occur, the Company entered into a Secured Promissory
Note with Dr. Chaudhuri, effective September 29, 2004. The Company used the
proceeds of $10 million as its good faith deposit in connection with the
Acquisition. The terms of the Secured Note included interest at 7.25% per annum
payable on the first business day of each calendar quarter beginning January 2,
2005. In connection with the Restructuring and Payment Agreements discussed in
Note 5, the $10 million initial deposit and accrued interest was returned to Dr.
Chaudhuri during the three months ended March 31, 2005 and Dr. Chaudhuri
rescinded and cancelled the $10 million secured promissory note with the
Company.
Former Secured Convertible Promissory Note - The Company also entered into
a Secured Convertible Note Purchase Agreement, dated September 29, 2004 and
amended November 16, 2004, with Dr. Chaudhuri. The original face amount of the
Secured Convertible Note was $500,000 and Dr. Chaudhuri was to assist the
Company with the payment of necessary transactional costs incurred in connection
with the Acquisition, including fees necessary to secure financing in connection
with the Acquisition, which transaction costs and fees could not otherwise be
paid by the Company. In connection with the Restructuring Agreement noted above,
the Company entered into the following new promissory notes dated January 31,
2005, which replaced the Secured Convertible Promissory Note dated September 29
, 2004 and amended November 16, 2004:
16
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
o Secured Promissory Note in the amount of $963,186 payable to Dr.
Chaudhuri
o Unsecured Promissory Note in the amount of $60,031 payable to Dr.
Chaudhuri
o Secured Promissory Note in the amount of $240,797 payable to William
E. Thomas
Concurrent with the completion of the Acquisition, in March 2005, the
Company repaid these three promissory notes plus accrued interest.
Accounts Receivable Purchase Agreement - In March 2005, the subsidiary
hospitals of the Company entered into an Accounts Purchase Agreement [that
allows or requires? the sale of] their accounts receivable to Medical Provider
Financial Corp as they become billable to third parties. The Company will
continue to provide billing and collection services and the proceeds collected
from the accounts receivable are applied to reduce amounts advanced under this
agreement. As of March 31, 2005, there were no advances made under this
agreement. This agreement has a term of two years.
NOTE 7 - SALE OF REAL ESTATE AND VARIABLE INTEREST ENTITY
Concurrent with the close on the acquisition of the Hospitals, Dr.
Chaudhuri and Dr. Shah exercised their option to purchase all of the real
property of the Hospitals pursuant to an Option agreement dated September 28,
2004, as amended and restated on November 16, 2004 ("LLC Option Agreement"). The
option was exercised by the option holders purchasing from the Company all of
the equity interests in PCHI, which holds title to the real property. The
Company received $5 million and PCHI guranteed the Company's acquisition debt of
$50 million.
The Company remains primarily liable under the $50 million acquisition
note notwithstanding its assumption by PCHI, and this note is
cross-collateralized by substantially all of the Company's assets and all of the
real property of the Hospitals. All of the Company's operating activities are
directly affected by the real property that was sold to PCHI. Given these
factors, it appears that the Company has indirectly guaranteed the indebtedness
of PCHI. In substance, the Company is standing ready to perform on the
acquisition debt should PCHI not be able to perform and has undertaken a
contingent obligation to make future payments if those triggering events or
conditions occur.
In connection with the sale of all of the real property of the Hospitals,
the Company entered into a triple net lease with PCHI to leaseback this real
property for an initial term of 25 years. Per the triple net lease, PCHI will
receive rent that covers the cost of the underlying debt, plus a guaranteed
spread up to 2.5%. Additionally, the Company has a right to renew the leases for
periods up to an additional 25 years.
PCHI is a related party entity that is affiliated with the Company through
common ownership and control. It is owned 51% by West Coast Holdings, LLC (Dr.
Shah and investors - see Note 4) and 49% by Ganesha Realty, LLC (Dr. Chaudhuri
and William Thomas - see Note 5). Generally accepted accounting principles
require that a company 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 $50 million debt,
and cross-collateralization of the Company's non-real estate assets to secure
the $50 million debt. Accordingly, during the three months ended March 31, 2005,
the Company included in its consolidated financial statements, the net assets of
PCHI, net of consolidation adjustments.
Selected information of PCHI's balance sheet as of March 31, 2005, and its
results of operations for the period March 8, 2005 to March 31, 2005 are as
follows:
17
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
Total assets $ 56,063,376
Total liabilites $ 51,072,281
Member's equity $ 4,991,095
Net revenues $ 617,564
Net loss $ (8,905)
Consolidation adjustments to reflect the effects of the following matters
are included in the accompanying consolidated financial statements:
o The Company's lease interest in the hospitals has been eliminated
leaving PCHI's ownership of the land and buildings being presented
in the accompanying consolidated financial statements. Additionally,
a deferred gain of $12,157,808 arising from the Company's sale of
PCHI has been eliminated to state the land and buildings at the
Company's cost.
o Because the Company remains primarily liable under the $50 million
debt notwithstanding its assumption by PCHI, generally accepted
accounting principles do not allow the Company to remove this
liability from its balance sheet. Therefore, it is necessary to
eliminate the same item from PCHI's balance sheet in consolidation.
o PCHI's equity accounts have been classified as minority interest in
variable interest entity in the accompanying consolidated balance
sheet.
o The Company's rent expense to the extent of debt servicing on the
underlying debt has been eliminated against PCHI's rental income.
Amounts payable by the Company to PCHI as rent expense that are in
excess of debt servicing on the underlying debt are accounted for as
an element of minority interest in variable interest entity expense
in the accompanying consolidated statement of operations.
Additionally, amounts assigned to land and buildings under lease
from PCHI are being depreciated and amortized over the 25 year
initial term of the lease.
NOTE 8 - INCOME TAXES
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109 "Accounting for Income Taxes" which
requires the liability approach for the effect of income taxes. A valuation
allowance has been used to offset the recognition of any deferred tax assets
related to net operating loss carryforwards due to the uncertainty of future
realization.
The Company's provision for income taxes is composed of the following for
the three months ended March 31:
2005 2004
------------ ------------
Current income tax expense:
U.S. Federal and State $ 1,472,000 $ --
Deferred income taxes:
U.S. Federal and State $ -- $ --
------------ ------------
Total $ 1,472,000 $ --
============ ============
18
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
The provision for income taxes differs from the federal and state
statutory tax expense as follows for the three months ended March 31, 2005:
Estimated tax benefit at federal and state statutory
rates on an annualized basis $ (2,759,000)
Common stock warrant expense 1,636,000
Gain on sale of assets 1,151,000
Change in valuation allowance 1,435,000
Other 9,000
-----------
$ 1,472,000
===========
Deferred income tax assets and liabilities consist of the tax effects of
temporary differences related to the following at March 31:
2005 2004
------------ ------------
Current deferred tax assets:
Allowance for doubtful accounts $ 5,263,440 $ --
Accured vacation 770,011 --
Other accruals 484,048 --
Net operating losses -- 252,000
------------ ------------
Deferred tax assets 6,517,499 252,000
Valuation allowance (6,517,499) (252,000)
------------ ------------
Net deferred tax assets $ -- $ --
============ ============
A valuation allowance of $6.5 million was recorded in the first quarter of
2005 based on an assessment of the realization of the Company's deferred tax
assets. The Company assesses the realization of its deferred tax assets to
determine whether an income tax valuation allowance is required. Based on all
available evidence, both positive and negative, and the weight of that evidence
to the extent such evidence can be objectively verified, Company management
determines whether it is more likely than not that all or a portion of the
deferred tax assets will be realized. The main factors taken into consideration
include:
o cumulative losses in recent years;
o income/losses expected in future years;
o unsettled circumstances that, if unfavorably resolved, would adversely
affect future operations and profit levels;
o the availability, or lack there, of taxable income in prior carryback
periods that would limit realization of tax benefits;
o the carryforward period associated with the deferred tax assets and
liabilities; and
o prudent and feasible tax-planning strategies.
19
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
As of March 31, 2005, Company management concluded that it was more likely
than not that the deferred tax assets were not realizable. Therefore, it was
appropriate to record a 100% valuation allowance after considering and weighing
all evidence in the first quarter of 2005. The Company established the valuation
allowance as a result of assessing the realization of the deferred tax assets
based on the above facts.
Tenet Hospital Acquisition - The Acquisition was an asset purchase
transaction and the Company will not benefit from the net operating losses of
the acquired Hospitals. In connection with the Company's completion of the Tenet
Hospital Acquisition in March 2005, the Company sold all of the real estate of
the acquired hospitals to its majority shareholders. For income tax purposes,
the sale of the real estate of the acquired hospitals could require the Company
to report dividend and/or interest income. If the Company is required to report
dividend and/or interest income in connection with this transaction, the Company
would be required to withhold 28% on any deemed dividend or interest income.
The March 8, 2005 contribution of the real estate acquired in the Tenant
Hospital Acquisition to Pacific Coast Holdings Investment LLC ("PCHI"), a 100%
owned subsidiary of the Company, was intended to be a non-taxable event. The
Company's sale of 100% of the membership interest in PCHI on March 8, 2005, to
West Coast Holdings LLC and Ganesha Realty LLC in consideration of $5 million
plus the assumption of the $50 million Acquisition Loan on the real property
debt is a taxable event to the Company. The Company is currently assessing the
potential impact of this taxable event in 2005.
PCHI Tax Status - PCHI is a limited liability corporation. PCHI's owners
plan to make tax elections for it be treated as a disregarded entity for tax
reporting, whereby similar to a partnership PCHI's taxable income or loss will
flow through to its owners and be their separate responsibility. Accordingly,
the accompanying consolidated financial statements do not include any amounts
for the income tax expense or benefit of PCHI's income or loss.
NOTE 9 - RELATED PARTY TRANSACTIONS
PCHI - The Company leases all of the real property of the acquired Tenet
Hospitals from PCHI. PCHI is owned by two LLC's, which are owned and co-managed
by Dr. Shah, Dr. Chaudhuri, and Mr. William Thomas. Dr. Shah is the chairman of
the Company and is also the co-manager an investor in OC-PIN, which is the
majority shareholder of the Company. Dr. Chaudhuri and Mr. Thomas are the
holders of the Warrants to purchase up to 24.9% of the Company's fully diluted
capital stock. The Company has consolidated the financial statements of PCHI for
the period March 8, 2005 through March 31, 2005 in accordance with FIN 46(R).
See Note 8.
Due to/from Shareholders and Officers -As of the quarter ended March 31,
2003, the Company had advanced $60,000 to the officers and majority shareholders
of the Company. The amounts due to/from shareholders and officers bore no
interest and were subsequently forgiven during the year ended 12/31/04.
Management Compensation - Effective January 1, 2004, the Company entered
into employment agreements with each of its three executive officers. The
employment agreements provide among other terms, each officer a base salary of
$250,000 per year, a bonus of $50,000 per year, and an employment term of five
years. During the year ended December 31, 2004, the Company incurred total
compensation expense of $1,205,640 related to these three employment agreements
and the Company had accrued compensation of $913,388 at December 31, 2004.
During the year ended December 31, 2003, the Company did not pay any
compensation to its officers and directors.
20
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
In December 2004, February 2005, and March 2005, the Company entered into
seven employment agreements with its executive officers. Among other terms the
three year employment agreements in aggregate provide for annual salaries
totaling $2,290,000, total stock option grants to purchase 6,650,000 shares of
the Company's common stock at an exercise price equal to the mean average per
share for the ten days following the date of issuance with vesting at 33% per
year, and an annual bonus to be determined by the Board of Directors.
NOTE 10 - LOSS PER SHARE
The following data show the amounts used in computing loss per share for
the periods presented:
Three Months Ended March 31,
----------------------------
2005 2004
----------------------------
Loss from continuing operations available
to common shareholders (numerator) $(19,603,792) $ (492,132)
Weighted average number of common
shares used in loss per share during
the period (denominator) $ 88,493,611 $ 19,582,667
The Company's weighted average common stock equivalents related to the
Warrants (Note 5) were 38,892,161 for the three months ended March 31, 2005.
These common stock equivalents have been excluded from the Company's weighted
average number of common shares outstanding due to their anti-dilutive effect
for the three months ended March 31, 2005.
NOTE 11 - COMMITMENTS AND CONTINGENCIES
Capital Leases - The Hospitals have long-term lease obligations for
certain equipment. For financial reporting purposes, the leases have been
classified as capital leases; accordingly, assets with a net book value of
approximately $3,659,401 are included in property and equipment in the
accompanying consolidated balance sheet. The following is a schedule of future
minimum lease payments under capitalized equipment leases together with the
present value of the net minimum lease payments as of March 31, 2005:
21
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
Year ending March 31:
2005 $ 686,292
2006 686,292
2007 686,292
2008 686,292
2009 686,292
Thereafter 2,745,168
-----------
Total minimum lease payments $ 6,176,628
Less amount representing interest 2,517,227
-----------
Present value of net minimum
lease payments 3,659,401
Less current portion 204,141
-----------
Long-term portion $ 3,455,260
===========
Concurrent with the closing of the Acquisition as of March 7, 2005, the
Company entered into a sale leaseback type agreement with a related party
entity, PCHI (the "Related Party Lease"). The Company leases all of the real
estate of the acquired Hospitals properties (the "Hospital Properties") and
medical office buildings and a long term acute care facility (collectively the
"MOB Properties") from PCHI. The term of the Lease for the Hospital Properties
shall be for approximately 25 years, commencing March 8, 2005 and terminates on
February 28, 2030. The Company has the option to extend the term of this triple
net lease for an additional term of twenty-five years. The Related Party Lease
is required to be capitalized in accordance with Statement of Financial
Accounting Standard No. 13 ("SFAS 13"). This related party capital lease has
been eliminated upon consolidation with PCHI.
Operating Leases - In connection with the acquisition of the Hospitals,
the Company also assumed the operating leases for the Chapman facility, which
include buildings, land, and other equipment. The following is a schedule of the
Company's future minimum operating lease payments that have initial or remaining
noncancelable lease terms in excess of one year as of December 31, 2004:
Unrelated Third Related
Year Ended December 31, Parties Party (PCHI) Total
- ----------------------- ------------------------------------------------
2005 $ 2,038,365 $ 10,642,672 12,681,037
2006 2,008,102 13,153,611 15,161,713
2007 1,660,807 13,233,219 14,894,026
2008 1,162,675 13,315,216 14,477,891
2009 844,267 13,315,216 14,159,483
Thereafter 8,569,793 278,706,133 287,275,926
------------------------------------------------
$ 16,284,009 $342,366,067 $358,650,076
================================================
22
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
The Company's related party lease transactions related to the Triple Net
Hospital and Medical Office Building Lease are eliminated with PCHI in the
accompanying consolidated financial statements.
The Company and its subsidiaries are involved in various legal proceedings
most of which relate to routine matters incidental to the Company's business.
The Company does not believe that the outcome of these matters are likely to
have a material adverse effect on the Company.
NOTE 12 - SUBSEQUENT EVENTS
Default Notice - On or about May 9, 2005, the Company received a notice of
default from its lender, Medical Provider Financial Corporation II ("Medical
Provider"). Medical Provider is the lender for the secured acquisition note of
$50 million, which was assumed by PCHI and the Company's secured line of credit
note of up to $30 million, each of which was issued pursuant to a Credit
Agreement dated as of March 3, 2005. In addition, each of OC-PIN, PCHI, Ganesha
Realty, LLC, and West Coast Holdings, LLC, which are parties to the Credit
Agreement, has received a notice of default under the Credit Agreement.
The notice of default asserts that (i) the Company failed to provide
satisfactory evidence that the Company has received capital contributions of not
less than $15,000,000, as required under the Credit Agreement, (ii) the Company
failed to prepay $5,000,000 by the Mandatory Prepay Date as required under the
Credit Agreement, and (iii) a Material Adverse Effect has occurred under the
Credit Agreement for reasons relating primarily to OC-PIN's failure to fully
fund its obligations under its Stock Purchase Agreement with the Company dated
January 28, 2005.
Medical Provider has indicated that, as a consequence of the alleged
events of default and for so long as such events are continuing, the interest
rates applicable to the outstanding loans under the Credit Agreement will be
increased to the Default Rate of 19%, the line of credit facility is suspended
as to additional advances (with any additional advances made at its discretion
at the Default Rate of 19%), and all Obligations (as defined in the Credit
Agreement), will be forthwith due and payable. The total principal and interest
due and payable under the loans made under the Credit Agreement currently amount
to approximately $63,937,333 as of the date of the default letter, which does
not include possible additional amounts claimed by Medical Provider for unpaid
interest at the Default Rate, attorneys' fees and costs, costs of collection,
trustee's fees and costs, and other fees, charges and expenses paid or incurred
by Medical Provide.
The Company has recorded the acquisition note of $50 million and
outstanding draws on the line of credit of $13.2 million as current liabilities
in the accompanying consolidated financial statements.
First Amendment to stock Purchase Agreement - As of May 18, 2005, the
Company entered into the First Amendment to Stock Purchase Agreement, which
amends the Stock Purchase Agreement dated January 28, 2005, with OC-PIN.
Concurrent with the execution of this amendment, the Company and OC-PIN entered
into an Escrow Agreement as of May 17, 2005 ("Escrow"). Significant terms of
this Stock Purchase Agreement Amendment include:
23
INTEGRATED HEALTHCARE HOLDINGS, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
o OC-PIN shall submit 57,250,000 shares of the Company's common stock to
Escrow (the "Escrowed Shares"). Following this deposit of shares into
Escrow, the Company will not interfere or challenge in any manner,
OC-PIN's or Hari Lal's ownership of an aggregate of 45,350,000 shares of
the Company's common stock.
o The Company may sell or cancel the Escrowed Shares. OC-PIN will have the
right of first refusal to purchase the Escrowed Shares if the Company
decides to sell the Escrowed Shares within 12 months from the date of the
amendment, May 18, 2005.
o OC-PIN agrees to purchase up to 5.4 million additional shares of the
Company's common stock for payments totaling $15 million plus financing
costs. On or before June 17, 2005, OC-PIN shall make a payment of $5
million, less $190,981, to the Company. On or before July 18, 2005, OC-PIN
shall deliver $5 million to the Company. On or before August 17, 2005, the
OC-PIN shall deliver $5 million to the Company. OC-PIN also agrees to pay
the Company's direct and indirect financing costs incurred as a result of
OC-PIN's failure to timely fund the balance of the Stock Purchase
Agreement dated January 28, 2005.
o During the 45 days subsequent to May 18, 2005, the Company will work in
good faith with Capital Source Finance LLC to refinance the debt with
Medical Providers.
o If within 45 days from May 18, 2005, the Company is able to complete its
refinancing with Capital Source Finance LLC, the Company will reduce the
third payment due from OC-PIN from $5 million to $2.5 million.
o Upon the Company's receipt of $5 million from OC-PIN pursuant to the Stock
Purchase Agreement dated January 28, 2005 and the Company's purchase of
certain real property referred to as the 999 Medical Office Building, the
Company shall transfer such real property to PCHI for no further
compensation.
o The employment agreements for the Company's CEO, CFO, and President shall
be amended to provide for 3 year severance payments, payable in a lump sum
at employees request, if any of them are terminated without cause or if
they resign for good cause. The severance shall be three years
compensation from the date of this amendment and shall be reduced by one
month for each month employed, not to be reduced less than one year.
24
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
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-KSB filed on March 31, 2005, 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., unless otherwise indicated.
OVERVIEW
Prior to March 8, 2005, we were primarily a development stage company with
no material operations and no revenues from operations. On September 29, 2004,
the Company entered into a definitive agreement to acquire four hospitals from
subsidiaries of Tenet Healthcare Corporation ("Tenet"), and the transaction
closed in March 2005. Effective March 8, 2005, we acquired and began operating
the following four hospital facilities in Orange County, California (referred to
in this report as our "Hospitals"):
o 282-bed Western Medical Center in Santa Ana;
o 188-bed Western Medical Center in Anaheim;
o 178-bed Coastal Communities Hospital in Santa Ana; and
o 114-bed Chapman Medical Center in Orange.
Our results of operations discussed in this report primarily reflect the
last 24 days of the quarter ended March 31, 2005 during which we owned the
Hospitals, and so are not indicative of an entire quarter of operations.
We entered into agreements with third-party payers, including government
programs and managed care health plans, under which rates are based upon
established charges, the cost of providing services, predetermined rates per
diagnosis, fixed per diem rates or discounts from established charges. During
the 24 days ended March 31, 2005, substantially all of Tenet's negotiated rate
agreements were assigned to our Hospitals. Our own Medicare provider numbers
were received in April. California State Medicaid Program provider numbers are
outstanding, but we believe that these will be received shortly.
25
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
COMMON STOCK WARRANTS
In connection with the Company's Rescission, Restructuring and Assignment
Agreement entered into on January 27, 2005, the Company issued to Dr. Kali
Chaudhuri ("Chaudhuri") and Mr. William Thomas ("Thomas") stock purchase
warrants to purchase up to 74,700,000 shares of the Company's Common Stock (but
not to exceed 24.9% of the Company's fully-diluted capital stock) (the
"Warrants"). The Company's financing agreements entered into with Dr. Chaudhuri
in 2004, which provided Dr. Chaudhuri and Thomas with a $500,000 secured
convertible promissory note, a $10 million secured promissory note and a stock
option agreement, were rescinded and cancelled. The $500,000 convertible
promissory note was originally convertible into approximately 88.8% of the
Company's issued and outstanding common stock on a fully-diluted basis. In
addition, the Company released its initial deposit of $10 million plus accrued
interest for the Tenet hospital acquisition back to Dr. Chaudhuri. The Company
issued to Dr. Chaudhuri and Thomas non-convertible secured promissory notes
totaling $1,264,013 and the Warrants.
The warrants are exercisable beginning January 27, 2007 and expire 3.5
years from the date of issuance. The exercise price for the first 43 million
shares purchasable under the Warrants is $0.003125 per share, and the exercise
price for the remaining 31.7 million shares is $0.078 per share if exercised
between January 27, 2007 and July 26, 2007, $0.11 per share if exercised between
July 27, 2007 and January 26, 2008, and $0.15 thereafter.
As of March 31, 2005, the Company recognized an expense of $16.4 million
related to the issuance of the Warrants. The Company computed the expense of the
Warrants based on the fair value of the Warrants at the date of grant and the
maximum number of shares exercisable as of March 31, 2005 of 41,291,892 (24.9%
of the fully diluted stock outstanding as of March 31, 2005). The Company
recorded the fair value of the remaining unexercisable Warrants as of March 31,
2005 of $11.5 million as deferred warrant expense in the accompanying
consolidated balance sheet. The Company will amortize the deferred warrant
expense in subsequent quarters over the term of the Warrants of 3.5 years based
on any future increases in the number of outstanding shares of the Company's
fully diluted common stock.
The Company computed the fair value of the Warrants based on the
Black-Scholes option pricing model with the following assumptions:
Risk-free interest rate 3.2%, 3.33%
Expected volatility 33.6%, 35.7%
Dividend yield --
Expected life (years) 2, 2.5
Fair value of Warrants (fully diluted) $0.343, $0.398
Due to fact that the Company emerged from the development stage during the
three months ended March 31, 2005, the Company computed the volatility of its
stock based on an average of comparable public companies that own hospitals.
SALE OF REAL ESTATE AND VARIABLE INTEREST ENTITY
Concurrent with the close of the Company's acquisition of the Hospitals,
Dr. Chaudhuri and Dr. Anil Shah exercised their options to purchase the
Company's interest in a limited liability company holding the real property
underlying the Hospitals pursuant to an option agreement dated September 28,
2004, as amended and restated on November 16, 2004 (the "LLC Option Agreement").
The option holders purchased all of the Company's interests in Pacific Coast
Holdings Investment LLC ("PCHI"), which acquired title to the real property. The
Company received $5 million and PCHI guaranteed the Company's acquisition debt
of $50 million.
26
The Company remains primarily liable under the $50 million acquisition
note notwithstanding its guaranty by PCHI, and this note is cross-collateralized
by substantially all of the Company's assets and all of the real property of the
Hospitals. All of the Company's operating activities are directly affected by
the real property that was sold to PCHI. Given these factors, it appears that
the Company has indirectly guaranteed the indebtedness of PCHI. In substance,
the Company is standing ready to perform on the acquisition debt should PCHI not
be able to perform and has undertaken a contingent obligation to make future
payments if those triggering events or conditions occur.
In connection with the sale of all of the real property of the Hospitals,
the Company entered into a triple net lease with PCHI to leaseback this real
property for an initial term of 25 years. Per the triple net lease, PCHI will
receive rent that covers the cost of the underlying debt, plus a guaranteed
spread up to 2.5%. Additionally, the Company has a right to renew the leases for
periods up to an additional 25 years.
PCHI is a related party entity that is affiliated with the Company through
common ownership and control. It is owned 51% by West Coast Holdings, LLC (Dr.
Shah and investors), and 49% by Ganesha Realty, LLC (Dr. Chaudhuri and William
Thomas). Generally accepted accounting principles require that a company
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 $50 million debt, and
cross-collateralization of the Company's non-real estate assets to secure the
$50 million debt. Accordingly, during the three months ended March 31, 2005, the
Company included in its consolidated financial statements, the net assets of
PCHI, net of consolidation adjustments.
RESULTS OF OPERATIONS
The following table summarizes our results of operations from continuing
operations for the three months ended March 31, 2005 and 2004. For the 2005
period, these results reflect only 24 days of operations from the Hospitals.
27
THREE MONTHS ENDED
--------------------------------
MARCH 31, 2005 MARCH 31, 2004
-------------- --------------
(Unaudited) (Unaudited)
Net operating revenues $ 21,747,029 $ --
Operating expenses:
Salaries and benefits 12,450,604 296,829
Supplies 3,033,815 --
Provision for doubtful accounts 3,141,406 --
Other operating expenses 3,900,220 180,124
Depreciation and amortization 262,212 15,179
Common stock warrant expense 16,434,173 --
------------ ------------
39,222,430 492,132
Operating loss: (17,145,401) (492,132)
Interest expense 665,296 --
------------ ------------
Loss including minority interest and
before provision for income taxes (18,140,697) (492,132)
Provision for income taxes 1,472,000
Minority interest in variable interest entity (8,905) --
-----------------------------
Net loss $(19,603,792) $ (492,132)
============ ============
Per Share Data:
Basic and fully diluted
Loss per common share $ (0.22) $ (0.03)
Weighted average shares outstanding 88,493,611 19,582,667
THREE MONTHS ENDED MARCH 31, 2005 AND 2004
Losses from continuing operations, before interest, taxes and common stock
warrant expense, increased to $1.0 million for the three months ended March 31,
2005 from $492,000 for the three months ended March 31, 2004. Substantially all
of the 2005 loss reflects the operational losses from 24 days of operations from
the newly acquired hospitals.
For the three months ended March 31, 2005, we recognized an expense of
$16.4 million relating to the issuance of common stock Warrants to Chaudhuri and
Thomas. We computed the expense of the Warrants based on their fair value at the
date of grant and the maximum number of shares exercisable as of March 31, 2005
of 39,136,766 (24.9% of fully diluted shares outstanding as of March 31, 2005).
We recorded the fair value of the remaining unexercisable Warrants at March 31,
2005 of $11.6 million as deferred compensation in the accompanying consolidated
balance sheet. We will amortize the deferred compensation in subsequent quarters
over the term of the Warrants of 3.5 years, based on any future increases in the
number of outstanding shares of our fully diluted common stock.
28
We computed the fair value of the Warrants based on the Black-Scholes
option pricing model with the following assumptions:
Risk-free interest rate 3.2% - 3.33%
Expected volatility 33.6% - 35.7%
Dividend yield --
Expected life (years) 2 and 2.5
Fair value of Warrants (fully diluted) $0.343 - $0.398
Income tax provision was $1.5 million for the three months ended March 31,
2005, which was primarily the result of the deferred gain on sale of property
(see financial statement notes), which we believe may be a taxable gain,
offsetting the remaining loss from operations.
PROVISION FOR DOUBTFUL ACCOUNTS
We provide 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. We estimate this allowance based on the
aging of accounts receivable, historical collections experience for each type of
payer and other relevant factors. Various factors that can impact our collection
trends, including 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
co-payments 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.
Our Hospitals' policy is to attempt to collect amounts due from patients,
including co-payments 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 non-emergency circumstances or for elective procedures and services, it
is our Hospitals' policy, when appropriate, to verify insurance prior to a
patient being treated.
During the three months ended March 31, 2005, we recorded provisions for
doubtful accounts of $3.1 million.
The breakdown of our billed hospital receivables (which is a component of
total receivables) at March 31, 2005 is summarized in the table below. Included
in insured receivables are accounts that are pending provider numbers from
Medicaid. These receivables totaled approximately 38.9% of our billable hospital
receivables at March 31, 2005.
MARCH 31, 2005
--------------
Insured receivables 84.4%
Uninsured receivables 15.6%
--------------
Total 100.0%
==============
29
Our allowance for doubtful accounts and the approximate percentages of
allowance for doubtful accounts to accounts receivable at March 31, 2005 are
summarized as follows (dollars in thousands):
MARCH 31, 2005
--------------
Allowance for doubtful accounts $ 3,141
Percentage of accounts receivables 15.6%
Our reported accounts receivable as of March 31, 2005 were all under 30
days outstanding, due to the fact that our acquisition of Hospital assets from
Tenet in March 2005 did not include patient accounts.
LIQUIDITY AND CAPITAL RESOURCES
Cash used by operating activities was $6.1 million in the three months
ended March 31, 2005. Net accounts receivable increased to $17.0 million from 24
days of hospital operation. Prepaid expenses and other assets increased to $1.5
million. Accounts payable increased to $5.0 million and payroll related
accruals, including contract labor, increased to $7.2 million. Income taxes
payable of $1.5 million were accrued.
Cash used in investing activities was $58.2 million in the three months
ended March 31, 2005 to acquire the hospitals from Tenet.
Cash provided by financing activities was $70.7 million in the three
months ended March 31, 2005.
At March 31, 2005, our indebtedness consisted of a $50 million, 2-year
term loan for the purchase of hospitals and a $13.2 million drawn-down from a
$30 million line of credit (also 2-year term), both of which bear interest at
14%. Payments are interest only for the 2-year term. In addition, in March 2005,
our subsidiary hospitals entered into a 2-year Accounts Purchase Agreement to
sell Accounts Receivable to a lending institution as they become billable to
third parties. We will continue to provide billing and collection services and
the proceeds collected thereby are applied to reduce amounts advanced under this
agreement. As of March 31, 2005 there were no advances made to purchase Accounts
Receivable.
RECENT ACCOUNTING PRONOUNCEMENTS
On October 13, 2004, the Financial Accounting Standards Board issued
Statement 123R, Share-Based Payment, which requires all companies to measure
compensation cost for all share-based payments, including employee stock
options, at fair value. The statement is effective for all public companies for
interim or annual periods after June 15, 2005. The statement eliminates the
ability to account for share-based compensation transactions using APB No. 25,
and generally requires that such transactions be accounted for using a
fair-value-based method and recognized as expenses in our consolidated
statements of operations. The standard also requires that the modified
prospective transition method be used, which would necessitate the Company to
recognize compensation cost for the fair value of new awards granted, modified
or settled after the effective date of the SFAS 123R. In addition, the
measurement of compensation cost for awards that are not fully vested as of the
effective date of the SFAS 123R would be based on the same estimate that the
Company used to previously value its grants under SFAS 123.
30
As a result of SFAS 123R, the Company will be required to expense the fair
value of any stock option grants that it may make in the future, rather than
disclose the impact on its consolidated statement of operations within the
Company's footnotes.
In January 2003, the Financial Accounting Standards Board issued FIN 46,
"Consolidation of Variable Interest Entities," which requires consolidation of
certain entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. Paragraph 1 of ARB 51 states that consolidated
financial statements are usually necessary for a fair presentation when one of
the companies in the group directly or indirectly has a controlling financial
interest in the other companies. Paragraph 2 states that "the usual condition
for a controlling financial interest is ownership of a majority voting
interest..." However, application of the majority voting interest requirement in
ARB 51 to certain types of entities may not identify the party with a
controlling financial interest because the controlling financial interest may be
achieved through arrangements that do not involve voting interests. Application
of Interpretation 46 or Interpretation 46(R) is required in financial statements
of public entities that have interests in variable interest entities or
potential variable interest entities commonly referred to as special-purpose
entities for periods ending after December 15, 2003. See Note 7 regarding the
Company's implementation of FIN 46 (R).
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
At March 31, 2005, we did not have any investment in or outstanding
liabilities under market rate sensitive instruments. We do not enter into
hedging or derivative instrument arrangements. We have no off-balance sheet
arrangements.
ITEM 4. CONTROLS AND PROCEDURES.
The Company maintains disclosure controls and procedures that are designed
to ensure that information required to be disclosed in the Company's Exchange
Act reports is recorded, processed, summarized and reported within the time
periods specified in the SEC's rules and forms, and that such information is
accumulated and communicated to the Company's management, including its Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosure based closely on the definition of
"disclosure controls and procedures" in Rule 15d-15(e). The Company's disclosure
controls and procedures are designed to provide a reasonable level of assurance
of reaching the Company's desired disclosure control objectives. In designing
and evaluating the disclosure controls and procedures, management recognized
that any controls and procedures, no matter how well designed and operated, can
provide only reasonable assurance of achieving the desired control objectives,
and management necessarily was required to apply its judgment in evaluating the
cost-benefit relationship of possible controls and procedures. The Company's
certifying officers have concluded that the Company's disclosure controls and
procedures are effective in reaching that level of assurance.
As of the end of the period of this report, the Company carried out an
evaluation, under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer and the Company's
Chief Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures. Based on the foregoing, the
Company's Chief Executive Officer and Chief Financial Officer concluded that the
Company's disclosure controls and procedures were effective.
31
There have been no significant changes in the Company's internal controls
or in other factors that could significantly affect the internal controls
subsequent to the date the Company completed its evaluation.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company and its subsidiaries are involved in various legal proceedings
most of which relate to routine matters incidental to the Company's business.
The Company does not believe that the outcome of these matters are likely to
have a material adverse effect on the Company.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
During the quarter ended March 31, 2005, the Company issued (i) to Kali P.
Chaudhuri, M.D. and William E. Thomas warrants to acquire up to 24.9% of the
common stock of the Company exercisable for a period of 18 months beginning 2
years after issuance of the warrants, a general pre-emptive right to participate
in future sales of equity securities by the Company up to 24.9% and a tag-along
right relating to future issuances of stock to Dr. Shah or OC-PIN; (ii) to
Orange County Physicians Investment Network, LLC 96,100,000 shares of common
stock; and (iii) to Hari S. Lal 6,500,000 shares of common stock.
The aforementioned common stock, warrants and rights were issued without
registration under the Securities Act in reliance upon the exemption from the
registration requirements of the Securities Act of 1933, as amended, set forth
in Section 4(2) of the Securities Act, and Regulation D promulgated thereunder.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
On or about May 9, 2005, the Company received a notice of default from
Medical Provider Financial Corporation II ("Medical Provider"). Medical Provider
is the lender to the Company under a $50 million acquisition loan, and a working
capital non-revolving line of credit of up to $30 million, each of which has
been issued pursuant to a Credit Agreement, dated as of March 3, 2005, to which
the Company and Medical Provider are parties (the "Credit Agreement").
In addition, each of Orange County Physicians Investment Network, LLC
("OCPIN"), Pacific Coast Holdings Investment, LLC, Ganesha Realty, LLC, and West
Coast Holdings, LLC, which are parties to the Credit Agreement, has received a
notice of default under the Credit Agreement.
The notice of default asserts that (i) the Company failed to provide
satisfactory evidence that the Company has received capital contributions of not
less than $15,000,000, as required by Section 2.1(s) of the Credit Agreement,
(ii) the Company failed to prepay $5,000,000 by the Mandatory Prepay Date as
required under Section 1.2(b)(ii) of the Credit Agreement, and (iii) a Material
Adverse Effect has occurred under the Credit Agreement for reasons relating
primarily to OCPIN's failure to fully fund its obligations under its Stock
Purchase Agreement with the Company dated January 28, 2005 (as discussed further
below in Item 8.01).
Medical Provider has indicated that, as a consequence of the alleged
events of default and for so long as such events are continuing, the interest
rates applicable to the outstanding loans under the Credit Agreement will be
increased to the Default Rate (as defined in the Credit Agreement), the line of
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credit facility is suspended as to additional advances (with any additional
advances made at its discretion at the Default Rate), and all Obligations (as
defined in the Credit Agreement), will be forthwith due and payable. The total
principal and interest due and payable under the loans made under the Credit
Agreement currently amount to approximately $63,937,333, which does not include
possible additional amounts claimed by Medical Provider for unpaid interest at
the Default Rate, attorneys' fees and costs, costs of collection, trustee's fees
and costs, and other fees, charges and expenses paid or incurred by Medical
Provider.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
In January 2005 the Company entered into a Stock Purchase Agreement (the
"SPA") with Orange County Physicians Investment Network, LLC ("OCPIN") pursuant
to which OCPIN agreed to invest $30,000,000 in the Company in exchange for
108,000,000 shares of common stock of the Company. OCPIN has, to date, funded
only $10,100,000 of this obligation under the SPA. The Company has, to date,
issued 102,600,000 shares of common stock to OCPIN or others on its behalf.
The Company has been negotiating with OCPIN to reach an agreement under
which OCPIN's remaining obligations under the SPA will be paid; however, to date
no such agreement has been reached. In the event that no settlement is reached
with OCPIN, the Company anticipates that it will initiate litigation and/or
arbitration against OCPIN to seek recovery of all amounts due to the Company
under the SPA, return of shares, and other remedies. In addition, the Company
may pursue actions available under Nevada and other applicable law, including
but not limited to possible sale at public auction and/or forfeiture of shares
already issued to OCPIN.
ITEM 6. EXHIBITS.
Exhibit
Number Description
- ------ -----------
2.1 First Amendment to Asset Sale Agreement, dated January 28, 2005, by
and among the Registrant and certain subsidiaries of Tenet
Healthcare Corporation (incorporated herein by reference from
Exhibit 99.4 to the Registrant's Current Report on Form 8-K filed
with the Commission on February 2, 2005).
2.2 Second Amendment to Asset Sale Agreement, effective as of January 1,
2005, by and among the Registrant and certain subsidiaries of Tenet
Healthcare Corporation (incorporated herein by reference from
Exhibit 99.1 to the Registrant's Current Report on Form 8-K filed
with the Commission on March 14, 2005).
2.3 Third Amendment to Asset Sale Agreement, effective as of March 8,
2005, by and among the Registrant and certain subsidiaries of Tenet
Healthcare Corporation (incorporated herein by reference from
Exhibit 99.2 to the Registrant's Current Report on Form 8-K filed
with the Commission on March 14, 2005).
2.4 Letter Agreement, dated January 28, 2005, by and between the
Registrant and certain subsidiaries of Tenet Healthcare Corporation
(incorporated herein by reference from Exhibit 99.3 to the
Registrant's Current Report on Form 8-K filed with the Commission on
February 2, 2005).
33
10.1 Rescission, Restructuring and Assignment Agreement, dated January
27, 2005, by and among the Registrant, Kali P. Chaudhuri, M.D.,
William E. Thomas, Anil V. Shah, M.D., and Orange County Physicians
Investment Network, LLC (incorporated herein by reference from
Exhibit 99.1 to the Registrant's Current Report on Form 8-K filed
with the Commission on February 2, 2005).
10.2 Stock Purchase Agreement, dated January 28, 2005, by and between the
Registrant and Orange County Physicians Investment Network, LLC
(incorporated herein by reference from Exhibit 99.2 to the
Registrant's Current Report on Form 8-K filed with the Commission on
February 2, 2005).
10.3 Guaranty Agreement, dated as of March 3, 2005, by Orange County
Physicians Investment Network, LLC in favor of Medical Provider
Financial Corporation II (incorporated herein by reference from
Exhibit 99.3 to the Registrant's Current Report on Form 8-K filed
with the Commission on March 14, 2005).
10.4 Guaranty Agreement, dated as of March 3, 2005, by Pacific Coast
Holdings Investments, LLC in favor of Medical Provider Financial
Corporation II (incorporated herein by reference from Exhibit 99.4
to the Registrant's Current Report on Form 8-K filed with the
Commission on March 14, 2005).
10.5 Subordination Agreement, dated as of March 3, 2005, by and among the
Registrant and its subsidiaries, Pacific Coast Holdings Investments,
LLC, and Medical Provider Financial Corporation II (incorporated
herein by reference from Exhibit 99.5 to the Registrant's Current
Report on Form 8-K filed with the Commission on March 14, 2005).
10.6 Credit Agreement, dated as of March 3, 2005, by and among the
Registrant and its subsidiaries, Pacific Coast Holdings Investments,
LLC and its members, and Medical Provider Financial Corporation II
(incorporated herein by reference from Exhibit 99.6 to the
Registrant's Current Report on Form 8-K filed with the Commission on
March 14, 2005).
10.7 Form of $50 million acquisition note by the Registrant and its
subsidiaries (incorporated herein by reference from Exhibit 99.7 to
the Registrant's Current Report on Form 8-K filed with the
Commission on March 14, 2005).
10.8 Form of $30 million line of credit note by the Registrant and its
subsidiaries (incorporated herein by reference from Exhibit 99.8 to
the Registrant's Current Report on Form 8-K filed with the
Commission on March 14, 2005).
10.9 Triple Net Hospital and Medical Office Building Lease dated March 7,
2005, as amended by Amendment No. 1 To Triple Net Hospital and
Medical Office Building Lease (incorporated herein by reference from
Exhibit 99.9 to the Registrant's Current Report on Form 8-K filed
with the Commission on March 14, 2005).
10.10 Employment Agreement with Bruce Mogel, dated February 25, 2005
(incorporated herein by reference from Exhibit 10.16 to the
Registrant's Annual Report on Form 10-KSB filed with the Commission
on March 31, 2005).
10.11 Employment Agreement with Larry B. Anderson, dated February 25, 2005
(incorporated herein by reference from Exhibit 10.17 to the
Registrant's Annual Report on Form 10-KSB filed with the Commission
on March 31, 2005).
10.12 Employment Agreement with James T. Ligon, dated February 25, 2005
(incorporated herein by reference from Exhibit 10.18 to the
Registrant's Annual Report on Form 10-KSB filed with the Commission
on March 31, 2005).
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10.13 Employment Agreement with Milan Mehta, dated February 25, 2005
(incorporated herein by reference from Exhibit 10.19 to the
Registrant's Annual Report on Form 10-KSB filed with the Commission
on March 31, 2005).
10.14 Employment Agreement with Hari S. Lal, dated February 25, 2004
(incorporated herein by reference from Exhibit 10.20 to the
Registrant's Annual Report on Form 10-KSB filed with the Commission
on March 31, 2005).
10.15 Employment Agreement with Daniel J. Brothman, dated December 31,
2004 (incorporated herein by reference from Exhibit 10.21 to the
Registrant's Annual Report on Form 10-KSB filed with the Commission
on March 31, 2005).
10.16 Employment Agreement with Steve Blake, dated March 21, 2005
(incorporated herein by reference from Exhibit 10.22 to the
Registrant's Annual Report on Form 10-KSB filed with the Commission
on March 31, 2005).
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.
35
SIGNATURE
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: May 23, 2005 By: /s/ James T. Ligon
----------------------------------------
James T. Ligon
Chief Financial Officer and Secretary
(Principal Financial Officer)
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