UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 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
--------------------
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
incorporation or organization) Identification No.)
1301 N. Tustin Ave. 92705
Santa Ana, California (Zip Code)
(Address of principal executive offices)
(714) 953-3503
(Registrant's telephone number, including area code)
695 Town Center Drive, Suite 260, Costa Mesa,
California 92626
(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 |_| No |X|
Integrated Healthcare Holdings, Inc.
Form 10-Q
Table of Contents
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Page Number
PART I FINANCIAL INFORMATION
Item 1. Financial Statements:
Unaudited Condensed Consolidated Balance Sheet as of June 30, 2005 and December 31, 2004 2
Unaudited Condensed Consolidated Statement of Operations for the three and six months ended June 3
30, 2005 and June 30, 2004
Unaudited Condensed Consolidated Statement of Stockholders' Equity as of June 30, 2005 and 4
December 31, 2004
Unaudited Condensed Consolidated Statement of Cash Flows for the three and six months ended June 5
30, 2005 and June 30, 2004
Condensed Notes to Unaudited Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 23
Item 3. Quantitative and Qualitative Disclosures About Market Risk 30
Item 4. Controls and Procedures 30
PART II OTHER INFORMATION
Item 1. Legal Proceedings 31
Item 3. Defaults Upon Senior Securities 31
Item 6. Exhibits 32
SIGNATURES 33
- ---------------------------------------------------------------------------------------------------------------------------
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
The accompanying condensed notes are an integral part of these unaudited
condensed consolidated financial statements
INTEGRATED HEALTHCARE HOLDINGS, INC.
Condensed Consolidated Balance Sheet
(Unaudited)
ASSETS
June 30, December 31,
2005 2004
------------------------------
Current assets:
Cash and cash equivalents $ 7,396,828 $ 69,454
Accounts receivable, net of allowance for doubtful
accounts of $14,445,000 at June 30, 2005 40,441,658 --
Inventories of supplies, at cost 5,856,321 --
Prepaid expenses and other assets 6,866,733 63,489
------------------------------
60,561,540 132,943
Property and equipment, net 58,689,233 57,423
Investment in hospital asset purchase -- 11,142,145
Deferred loan fees, net of accumulated amortization of $268,238 1,625,790 --
------------------------------
Total assets $ 120,876,563 $ 11,332,511
==============================
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities
Notes payable $ 84,604,113 $ 11,264,013
Accounts payable 11,631,374 156,142
Accrued compensation and benefits 12,999,220 800,313
Income taxes payable 1,834,000 --
Other current liabilities 6,654,573 --
------------------------------
Total current liabilities 117,723,280 12,220,468
Capital lease obligations, net of current of $204,141 3,384,256 --
Commitments and contingencies -- --
Minority interest in variable interest entity 4,795,578 --
Stockholders' equity (deficiency):
Common stock, $0.001 par value; 250,000,000 shares
authorized; 124,559,000 and 20,780,000 shares
issued and outstanding, respectively 124,559 20,780
Common stock warrants; 74,700,000 outstanding
(41,292,892 exercisable at June 30, 2005) 27,987,100 --
Additional paid in capital 12,040,487 1,189,621
Deferred warrant expense (11,552,927) --
Accumulated deficit (33,625,770) (2,098,358)
------------------------------
Total stockholders' deficiency (5,026,551) (887,957)
------------------------------
Total liabilities and stockholders' deficiency $ 120,876,563 $ 11,332,511
==============================
The accompanying condensed notes are an integral part of these unaudited
condensed consolidated financial statements
2
INTEGRATED HEALTHCARE HOLDINGS, INC.
Condensed Consolidated Statement of Operations
(Unaudited)
Three Months Ended Six Months Ended
------------------------------ ------------------------------
June 30, 2005 June 30, 2004 June 30, 2005 June 30, 2004
------------- ------------- ------------- -------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
Net operating revenues $ 83,190,537 $ -- $ 104,937,566 $ --
Operating expenses:
Salaries and benefits 48,439,345 306,317 60,889,949 603,146
Supplies 11,521,967 -- 14,555,782 --
Provision for doubtful accounts 11,331,354 -- 14,472,760 --
Other operating expenses 17,283,135 108,763 21,183,354 288,887
Depreciation and amortization 902,845 15,528 1,165,057 30,707
Common stock warrant expense -- -- 16,434,173 --
------------- ------------- ------------- -------------
89,478,646 430,608 128,701,075 922,740
Operating loss (6,288,109) (430,608) (23,763,509) (922,740)
Interest expense 4,069,029 -- 4,734,325 --
------------- ------------- ------------- -------------
Loss including minority interest and
before provision for income taxes (10,357,138) (430,608) (28,497,834) (922,740)
Provision for income taxes 1,762,000 -- 3,234,000 --
Minority interest in variable interest entity (195,517) -- (204,422) --
------------- ------------- ------------- -------------
Net loss $ (11,923,621) $ (430,608) $ (31,527,412) $ (922,740)
============= ============= ============= =============
Per Share Data:
Basic and fully diluted
Loss per common share ($0.10) ($0.02) ($0.30) ($0.05)
Weighted average shares outstanding 124,539,000 19,590,000 106,518,528 19,510,778
The accompanying condensed notes are an integral part of these unaudited
condensed consolidated financial statements
3
INTEGRATED HEALTHCARE HOLDINGS, INC.
Condensed Consolidated Statement of Shareholders' Deficiency
(Unaudited)
Common Stock Common Stock Warrants Additional Deferred
------------------------- ----------------------- Paid-in Warrant Accumulated
Shares Amount Shares Amount Capital Expense Deficit Total
----------- ------------ ---------- ----------- ----------- ------------ ------------ ------------
Balance, December 31,
2003 19,380,000 $ 19,380 -- $ -- $ 551,021 $ -- $ (217,781) $ 352,620
Issuance of debt for
the acquisition of
MMG, Inc. -- -- -- -- -- -- (40,386) (40,386)
Issuance of common
stock for cash at
$0.25 per share 200,000 200 -- -- 49,800 -- -- 50,000
Issuance of common
stock for cash at
$0.50 per share 1,200,000 1,200 -- -- 588,800 -- -- 590,000
Net loss -- -- -- -- -- -- (1,840,191) (1,840,191)
----------- ------------ ---------- ----------- ----------- ------------ ------------ ------------
Balance, December 31,
2004 20,780,000 $ 20,780 -- $ -- $ 1,189,621 $ -- $ (2,098,358) $ (887,957)
=========== ============ ========== =========== =========== ============ ============ ============
Issuance of common
stock for cash at
$0.50 per share 1,179,000 1,179 -- -- 598,322 -- -- 599,501
Issuance of common
stock for cash to
OCPIN 102,600,000 102,600 -- -- 9,997,400 -- -- 10,100,000
Issuance of common
stock options -- -- -- -- 255,144 -- -- 255,144
Issuance of common
stock warrants -- -- 74,700,000 27,987,100 -- (27,987,100) -- --
Common stock
warrants expensed at
June 30, 2005 -- -- -- -- -- 16,434,173 -- 16,434,173
Net loss -- -- -- -- -- -- (31,527,412) (31,527,412)
----------- ------------ ---------- ----------- ----------- ------------ ------------ ------------
Balance, June 30, 2005 124,559,000 $ 124,559 74,700,000 $27,987,100 $12,040,487 $(11,552,927) $(33,625,770) $ (5,026,551)
=========== ============ ========== =========== =========== ============ ============ ============
The accompanying condensed notes are an integral part of these unaudited
condensed consolidated financial statements
4
INTEGRATED HEALTHCARE HOLDINGS, INC.
Condensed Consolidated Statement of Cash Flows
(Unaudited)
Six Months Ended Six Months Ended
June 30, 2005 Junes 30, 2004
------------ ------------
Cash flows from operating activities:
Net loss $(31,527,412) $ (922,740)
Adjustments to reconcile net loss to cash used in operating activities:
Depreciation and amortization expense 1,194,450 30,707
Common stock warrant and option expense 16,689,317 --
Minority interest in variable interest entity (204,422) --
Increase in prepaid expense and other assets (4,490,087) --
Increase in net accounts receivable (40,441,658) --
Increase (decrease) in accounts payable 11,475,232 (5,601)
Increase in accrued compensation and benefits 12,320,927 438,080
Increase in income taxes payable 1,834,000 --
Increase in other accrued liabilities 6,450,432 --
Decrease in inventories of supplies 162,674 --
------------ ------------
Net cash used in operating activities (26,536,547) (459,554)
------------ ------------
Cash flows from investing activities:
Acquisition of hospital assets, net of lease obligations (62,967,535) --
Proceeds from sale of property 5,000,000 --
Purchase of property and equipment -- (19,260)
Acquisition of MMG, Inc., net of cash acquired -- 8,534
------------ ------------
Net cash used in investing activities (57,967,535) (10,726)
Cash flows from financing activities:
Issuance of secured promissory notes, net of costs 48,067,000 --
Proceeds from lines of credit 34,604,113 --
Proceeds from issuance of stock 10,699,501 250,000
Repayment of secured notes (1,264,013) (100,000)
Payments on capital leases (275,145)
Advances from shareholders -- 73,285
------------ ------------
Net cash provided by financing activities 91,831,456 223,285
------------ ------------
Net increase (decrease) in cash 7,327,374 (246,995)
------------ ------------
Cash and cash equivalents, beginning of period 69,454 265,000
------------ ------------
Cash and cash equivalents, end of period $ 7,396,828 $ 18,005
============ ============
Supplemmental disclosure of noncash transactions:
Issuance of promissory notes for Acquisition $ 53,000,000 $ 60,000
Consolidation of variable interest entity $ 54,758,312 $ --
Expense of common stock warrants and options $ 16,689,317 $ --
Rescinded secured promissory note for the
return of initial deposit on hospital assets $ 10,000,000 $ --
Interest paid $ 2,511,411 $ --
Income taxes paid $ 1,400,000 $ --
5
INTEGRATED HEALTHCARE HOLDINGS, INC.
Condensed Notes to Unaudited Consolidated Financial Statements
June 30, 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 fee interest in 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 and six months ended June 30, 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, except for the fee
interest in the medical office building at 2617 East Chapman Avenue. 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
guarantee of $50 million in debt issued by the Company in the Acquisition.
Because, among other reasons, the Company remains primarily liable under the $50
million debt, 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 June 30, 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
June 30, 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, PCHI, the
majority of its financial support through various sources including lease
payments, remaining primarily liable under the $50 million debt, and
cross-collateralization of the Company's non real property assets to secure the
$50 million debt. Accordingly, the accompanying consolidated financial
statements include the accounts of PCHI from the date of the real estate sale,
March 8, 2005.
All significant intercompany accounts and transactions have been
eliminated in combination.
Company Operations - The Company, through the Hospitals, operates in a
single industry segment, 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 $11,923,621 and $31,527,412
(inclusive of a warrant issuance expense incurred in connection with the
Hospital acquisitions of $16,434,173) during the three months and six months
ended June 30, 2005, respectively and has negative working capital of
$(57,161,740) at June 30, 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 June 30, 2005. The default has caused the acquisition
loan to be classified as a current liability as of June 30, 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 and PCHI have agreed to
permit the Company and PCHI to use the assets of PCHI and the Hospitals as
collateral for the purposes of joint financing of Company's business operation
and PCHI's acquisition of real properties for an initial period of time.
Condensed Consolidated 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 June 30,
2005, and its consolidated results of operations for the three months and six
months ended June 30, 2005 and 2004, respectively and the statement of changes
in cash flows for the six months ended June 30, 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 June 30, 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
June 30, 2005
Use of Estimates - The accounting and reporting policies of the Company
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 condensed consolidated statements of
operations. Hospitals are typically paid amounts that are negotiated with
insurance companies or are set by the government. Gross charges are used to
calculate Medicare outlier payments and to determine certain elements of payment
under managed care contracts (such as stop-loss payments). Because Medicare
requires that a hospital's gross charges be the same for all patients
(regardless of payer category), gross charges are also what 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 six months ended June 30, 2005 were as follows:
Six months ended
June 30, 2005
----------------
Medicare 22%
Medicaid 16%
Managed care 42%
Indemnity, self-pay and other 20%
Revenues under the traditional fee-for-service Medicare and 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.
8
INTEGRATED HEALTHCARE HOLDINGS, INC.
Condensed Notes to Unaudited Consolidated Financial Statements
June 30, 2005
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.
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 combined 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 and six months ended June 30, 2005 were approximately $3,638,933
and $4,646,811 respectively.
9
INTEGRATED HEALTHCARE HOLDINGS, INC.
Condensed Notes to Unaudited Consolidated Financial Statements
June 30, 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 Company 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 Company's 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 and six months ended June 30, 2005, the Company
recorded provisions for doubtful accounts of $11,331,354 and $14,472,760
respectively.
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.
10
INTEGRATED HEALTHCARE HOLDINGS, INC.
Condensed Notes to Unaudited Consolidated Financial Statements
June 30, 2005
The Company uses 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 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 June 30, 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. During the three and six months
ended June 30, 2005, the Company recognized $255,144 of other operating expense
from the granting of 500,000 stock options to its public relations consultant.
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.
11
INTEGRATED HEALTHCARE HOLDINGS, INC.
Condensed Notes to Unaudited Consolidated Financial Statements
June 30, 2005
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 June 30, 2005, the Company has
determined that no impairment of its long-lived assets exists.
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. As
of June 30, 2005 no goodwill had been recorded on acquisitions.
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.
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).
12
INTEGRATED HEALTHCARE HOLDINGS, INC.
Condensed Notes to Unaudited Consolidated Financial Statements
June 30, 2005
NOTE 2 - ACQUISITION
The purchase price, after all purchase price adjustments, of the
Acquisition amounted to $66,042,680. 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
Capital lease obligations (3,659,401)
Other assumed liabilities (82,121)
------------
$ 66,042,680
============
The Company financed the asset purchase and related financing costs (Note
6) 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 $10.1
Million, and $5 million in proceeds from the sale of the real property of the
acquired Hospitals.
The Company recorded its initial deposit of $10 million on the 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 as of December 31, 2004.
The following unaudited pro forma information represents the Company's
consolidated results of operations as if the Acquisition had occurred on January
1, 2005 and after giving effect to certain adjustments including the elimination
of investment losses not attributable to on-going operations, interest expense,
depreciation expense, and related tax effects. Such pro forma information does
not purport to be indicative of operating results that would have been reported
had the Acquisition occurred on January 1, 2005 or future operating results.
Supplemental pro forma information disclosing the results of operations for the
comparative periods in 2004 was not available to the Company.
13
INTEGRATED HEALTHCARE HOLDINGS, INC.
Condensed Notes to Unaudited Consolidated Financial Statements
June 30, 2005
Pro Foma
--------------------------------
Three Months Six Months
Ended Ended
June 30, 2005 June 30, 2005
--------------------------------
Net operating revenues $ 83,190,537 $ 160,203,857
Net loss (11,923,621) (42,456,022)
Loss per common share
(basic and fully diluted) $ (0.10) $ (0.34)
Weighted average shares outstanding 124,539,000 124,308,528
NOTE 3 - PROPERTY AND EQUIPMENT
Property and equipment consist of the following as of June 30, 2005:
Buildings and improvements $ 32,844,916
Land 15,264,266
Equipment 7,915,164
Leasehold 3,659,401
--------------
59,683,747
Less accumulated depreciation (994,514)
--------------
Property and equipment, net $ 58,689,233
==============
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.
NOTE 4 - COMMON STOCK
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 six months
ended June 30, 2005, the Company issued a total of 102,600,000 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 acquisition of the Hospitals.
14
INTEGRATED HEALTHCARE HOLDINGS, INC.
Condensed Notes to Unaudited Consolidated Financial Statements
June 30, 2005
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 financing commitment to June 16, 2005, when
the Company entered into the following new agreements:
o First Amendment to the Stock Purchase Agreement, dated as of June 1,
2005 (the "First Amendment"); and
o Escrow Agreement, dated as of June 1, 2005, by and among IHHI,
OC-PIN and City National Bank (the "Escrow Amendment").
The following material terms, which were contained in the First Amendment and
the Escrow Agreement, are currently in process:
o A total of 57,250,000 shares of Company common stock previously
issued to OC-PIN were placed in an escrow account with City National
Bank. OC-PIN will have until September 1, 2005 to make aggregate
payments of up to approximately $15,000,000 in monthly installments
into the escrow account. Such portion of the escrowed shares which
are fully paid will be returned to OC-PIN and the balance will be
transferred back to the Company. If there is a shortfall, the
Company will use its reasonable best efforts to sell equity to new
investors to cover the shortfall;
o OC-PIN will reimburse the Company for certain of its additional debt
financing costs incurred since March 8, 2005;
o The Company will work to complete a new borrowing transaction with
Capital Source Finance LLC; and
o Upon receipt of at least $5,000,000 of new capital under the First
Amendment, the Company will call a shareholders meeting to re-elect
directors. The nominees for the Board will consist of two current
directors, two members of OC-PIN, two independent directors
unaffiliated with IHHI or OC-PIN, and Anil V. Shah, M.D.
NOTE 5 - COMMON STOCK WARRANTS
The Company entered into a Rescission, Restructuring and Assignment
Agreement with Dr. Chaudhuri and William Thomas on January 27, 2005 (the
"Restructuring Agreement"). Previously, the Company had obtained financing from
Dr. Chaudhuri and Mr. Thomas and had issued to them a $500,000 secured
convertible promissory note that was convertible into approximately 88.8% of the
Company's issued and outstanding common stock on a fully-diluted basis, a $10
million secured promissory note, and a stock option agreement, all of which
together with related accrued interest payable pursuant to the terms of the
notes were rescinded and cancelled. Pursuant to the Restructuring Agreement, the
Company released its initial deposit of $10 million plus accrued interest on the
Tenet Hospital Acquisition back to Dr. Chaudhuri and issued non-convertible
secured promissory notes totaling $1,264,014 and 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") to Dr. Chaudhuri and Mr.
Thomas.
15
INTEGRATED HEALTHCARE HOLDINGS, INC.
Condensed Notes to Unaudited Consolidated Financial Statements
June 30, 2005
The Warrants are exercisable beginning January 27, 2007 and expire in 3.5
years from the date of the issuance. The exercise price for the first 43 million
shares purchased under the Warrants is $0.003125 per share, and the exercise or
purchase price for the remaining 31.7 million shares is $0.078 per share if
exercised between January 27, 2007 and July 26, 2007, $0.11 per share if
exercised between July 27, 2007 and January 26, 2008, and $0.15 thereafter.
Based upon a valuation obtained by the Company from an independent
valuation firm, the Company has assigned a value to the 74,700,000 warrants of
$27,987,100 at the date of grant. As of June 30, 2005, the Company has
recognized an expense of $16,434,173 related to the issuance of the common stock
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 June 30, 2005 of 41,298,523 (which constitutes 24.9% of the
fully diluted stock that would have been outstanding as of June 30, 2005
assuming maximum possible exercise of the Warrants). The Company has recorded
the fair value of the remaining unexercisable Warrants as of June 30, 2005 of
$11,552,927 as deferred warrant expense in the accompanying consolidated balance
sheet as of June 30, 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 increase in the number of warrants that become exercisable.
The fair value of the Warrants was determined based on the Black-Scholes
option pricing model with the following assumptions:
Low, High
---------
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 the Company emerging from the development stage during the six
months ended June 30, 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
June 30, 2005:
Secured acquisition note payable $50,000,000
Secured line of credit note payable 13,200,000
Advances from accounts receivable
purchase agreement 21,404,113
-----------
$84,604,113
===========
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 will be in the form of a
non-revolving Line of Credit (the "Line of Credit") and $50,000,000 will be 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 3). 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.
16
INTEGRATED HEALTHCARE HOLDINGS, INC.
Condensed Notes to Unaudited Consolidated Financial Statements
June 30, 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 subsidiary Hospitals. In addition, (i) PCHI (see Note 1) 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 5) 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 of $1,933,000 over the two year term of the Obligations. During the
six months ended June 30, 2005, the Company recognized $307,210 of amortization
expense and has unamortized deferred loan fees of $1,625,790 as of June 30,
2005.
Accounts Receivable Purchase Agreement - In March 2005, the Hospitals
entered into an Accounts Purchase Agreement that allows the sale of their
accounts receivable to Medical Provider Financial Corp., an affiliate of the
Lender, 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 June 30, 2005, advances made under this agreement were $21,404,113. This
agreement has a term of two years.
17
INTEGRATED HEALTHCARE HOLDINGS, INC.
Condensed Notes to Unaudited Consolidated Financial Statements
June 30, 2005
Default Notice - On or about May 9, 2005, the Company received a notice of
default from the Lender. 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 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.
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.
Forbearance Agreement - In connection with the Company's First Amendment
(see Note 4), the Company entered into an Agreement to Forbear as of June 1,
2005 by and among the Company, OC-PIN, West Coast Holdings, LLC and the Lender
(the "Forbearance Agreement"). Without another default, the Lender agrees for
100 days to forbear from (i) recording Notices of Default, (ii) filing a
judicial foreclosure lawsuit against the Company, OC-PIN and West Coast
Holdings, LLC, and (iii) filing lawsuits against the Company, OC-PIN and West
Coast Holdings, LLC. The interest rate on the notes will be increased to the
Default Rate of 19%, as defined in the Credit Agreement, and all Obligations (as
defined in the Credit Agreement), will be forthwith due and payable, as long as
the events of default remain uncured. The Company's Line of Credit facility is
suspended to additional advances. During the forbearance period of 100 days,
OC-PIN and other investors will invest not less than $15 million in new equity
capital in the Company.
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 guaranteed the Company's acquisition debt
of $50 million.
The Company remains primarily liable under the $50 million acquisition
note notwithstanding its guarantee by PCHI, and this note is
cross-collateralized by substantially all of the Company's assets and all of the
real property of the Hospitals. All of the Company's operating activities are
directly affected by the real property that was sold to PCHI. Given these
factors, it appears that the Company has indirectly guaranteed the indebtedness
of PCHI. 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 six months ended June 30, 2005, the
Company included in its consolidated financial statements, the net assets of
PCHI, net of consolidation adjustments.
18
INTEGRATED HEALTHCARE HOLDINGS, INC.
Condensed Notes to Unaudited Consolidated Financial Statements
June 30, 2005
Selected information of PCHI's balance sheet as of June 30, 2005, and its
results of operations for the period March 8, 2005 to June 30, 2005 are as
follows:
Total assets $ 55,362,360
Total liabilities 50,566,782
Member's equity 4,795,578
Net revenues 3,353,508
Net loss 204,422
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
the real property of the Hospitals to 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 guarantee 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
variable interest entity in the accompanying consolidated balance
sheet.
o The Company's rent expense has been eliminated against PCHI's rental
income. Additionally, amounts assigned to land and buildings are
being depreciated and amortized over the 25 year initial term of the
lease with PCHI.
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. The provision
for income taxes consists of provisions for federal and state income taxes.
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires us to make estimates and
assumptions that affect the reported amount of tax-related assets and
liabilities and income tax provisions. The Company assesses the recoverability
of the deferred tax assets on an ongoing basis. In making this assessment the
Company is required to consider all available positive and negative evidence to
determine whether, based on such evidence, it is more likely than not that some
portion or all of our net deferred assets will be realized in future periods.
This assessment requires significant judgment. In addition, the Company has made
significant estimates involving current and deferred income taxes, tax
attributes relating to the interpretation of various tax laws, historical bases
of tax attributes associated with certain tangible and intangible assets and
limitations surrounding the realizability of our deferred tax assets. The
Company does not recognize current and future tax benefits until it is deemed
probable that certain tax positions will be sustained.
19
INTEGRATED HEALTHCARE HOLDINGS, INC.
Condensed Notes to Unaudited Consolidated Financial Statements
June 30, 2005
The Company recorded a provision for income taxes of $1,762,000 and $0 for
the three months ended June 30, 2005 and 2004, respectively. The Company
recorded a provision for income taxes of $3,234,000 and $0 for the six months
ended June 30, 2005 and 2004, respectively. The effective tax rate differs from
the statutory U.S. federal income tax rate of 35% primarily due to the
nondeductible common stock warrant expense, the taxable gain on sale of real
property to PCHI, and the change in allowance for doubtful accounts for the six
months ended June 30, 2005.
The Company has provided a valuation allowance of $10,804,000 and $800,000
as of June 30, 2005 and December 31, 2004, respectively, on 100% of its net
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 has determined that it was more likely than not that the deferred tax
assets were not realizable.
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.
20
INTEGRATED HEALTHCARE HOLDINGS, INC.
Condensed Notes to Unaudited Consolidated Financial Statements
June 30, 2005
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 June 30, 2005 in accordance with FIN 46(R) (see
Note 7). During the six month period ended June 30, 2005, the Company incurred a
liability for rent expense payable to PCHI of $3,353,508, which was eliminated
upon consolidation at June 30, 2005.
Management Agreements - 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. As of June 30, 2005, the Company has not issued any
stock options pursuant to the employment agreements.
NOTE 10 - LOSS PER SHARE
The following data show the amounts used in computing loss per share for the
periods presented:
Three Months Ended June 30, Six Months Ended June 30,
----------------------------- -----------------------------
2005 2004 2005 2004
------------- ------------- ------------- -------------
Loss from continuing operations available
to common shareholders (numerator) $ (11,923,621) $ (430,608) $ (31,527,412) $ (922,740)
Weighted average number of common
shares used in loss per share during
the period (denominator) 124,539,000 19,590,000 106,518,528 19,510,778
The Company's weighted average common stock equivalents related to the Warrants
(Note 6) were 41,291,892 for the six months ended June 30, 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 June 30, 2005.
21
INTEGRATED HEALTHCARE HOLDINGS, INC.
Condensed Notes to Unaudited Consolidated Financial Statements
June 30, 2005
NOTE 11 - COMMITMENTS AND CONTINGENCIES
Operating Leases - Concurrent with the closing of the Tenet Hospital
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 is approximately 25 years, commencing March 8, 2005
and terminating 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.
Additionally, 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 Related Party Lease has been
eliminated in the consolidation of PCHI in the accompanying consolidated
financial statements.
Claims and Lawsuits - The Company and the Hospitals are subject to a
significant number of claims and lawsuits. The results of these claims, lawsuits
and investigations cannot be predicted, and it is possible that the ultimate
resolution of these matters, individually or in the aggregate, may have a
material adverse effect on the Company's business (both in the near and long
term), financial position, results of operations or cash flows. Although the
Company defends itself vigorously against claims and lawsuits and cooperate with
investigations, these matters (1) could require payment of substantial damages
or amounts in judgments or settlements, which individually or in the aggregate
could exceed amounts, if any, that may be recovered under insurance policies
where coverage applies and is available, (2) cause substantial expenses to be
incurred, (3) require significant time and attention from management and (4)
could cause the Company to close or sell the Hospitals or otherwise modify the
way its business is conducted. Reserves for claims and lawsuits are recorded
when they are probable and reasonably estimable.
NOTE 12 - SUBSEQUENT EVENT
On August 1, 2005, Larry Anderson resigned as a director of the Company,
and the Board of Directors appointed the following four individuals to serve as
directors to fill current vacancies on the Board: Maurice J. DeWald, Fernando
Niebla, Syed J. Naqvi and Jaime Ludmir.
22
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations. Forward-Looking Information
This Quarterly Report on Form 10-Q contains forward-looking statements, as
that term is defined in the Private Securities Litigation Reform Act of 1995.
These statements relate to future events or our future financial performance. In
some cases, you can identify forward-looking statements by terminology such as
"may", "will", "should", "expects", "plans", "anticipates", "believes",
"estimates", "predicts", "potential" or "continue" or the negative of these
terms or other comparable terminology. These statements are only predictions and
involve known and unknown risks, uncertainties and other factors, including the
risks discussed under the caption "Risk Factors" in our Annual Report on Form
10-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., a Nevada corporation, 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 completed the
transaction on March 8, 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 reflect Hospital
operations for the full quarter ended June 30, 2005 and the 24 days of the
quarter ended March 31, 2005.
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 2005. California State Medicaid Program provider numbers
were received in June 2005.
23
Critical Accounting Policies and Estimates
Provisions For Doubtful Accounts
Our 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 policy, when appropriate, to verify insurance
prior to a patient being treated.
We provide for an allowance against 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 certain of our accounts receivables by hospital, our
historical collection experience by hospital and for each type of payer, and
other relevant factors. Our practice is to write-down self-pay accounts
receivable, including accounts related to the co-payments and deductibles due
from patients with insurance, to their estimated net realizable value at the
time of billing. Generally, uncollected balances are assigned to collection
agency between 90 to 120 days, once patient responsibility has been identified.
When accounts are assigned for collections by the hospitals, the accounts are
completely written off through provision for doubtful accounts. Any recoveries
from collection agencies thereafter are credited to the provision as received.
Common Stock Warrants
The Company entered into a Rescission, Restructuring and Assignment
Agreement with Dr. Chaudhuri and William Thomas on January 27, 2005 (the
"Restructuring Agreement"). Previously, the Company had obtained financing from
Dr. Chaudhuri and Mr. Thomas and had issued to them a $500,000 secured
convertible promissory note that was convertible into approximately 88.8% of the
Company's issued and outstanding common stock on a fully-diluted basis, a $10
million secured promissory note, and a stock option agreement, all of which
together with related accrued interest payable pursuant to the terms of the
notes were rescinded and cancelled. Pursuant to the Restructuring Agreement, the
Company released its initial deposit of $10 million plus accrued interest on the
Tenet Hospital Acquisition back to Dr. Chaudhuri and issued non-convertible
secured promissory notes totaling $1,264,014 and 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") to Dr. Chaudhuri and Mr.
Thomas.
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 June 30, 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 June 30, 2005 of 41,298,523(24.9% of
the fully diluted stock outstanding as of June 30, 2005). The Company recorded
the fair value of the remaining unexercisable Warrants as of June 30, 2005 of
$11.6 million as deferred warrant expense in the accompanying consolidated
balance sheet. The Company 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 the Company's fully diluted
common stock.
24
The Company computed the fair value of the Warrants based on the
Black-Scholes option pricing model with the following assumptions:
Low, High
---------
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
six months ended June 30, 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.
The Company remains primarily liable under the $50 million acquisition
note notwithstanding its guarantee by PCHI, and this note is
cross-collateralized by substantially all of the Company's assets and all of the
real property of the Hospitals. All of the Company's operating activities are
directly affected by the real property that was sold to PCHI. Given these
factors, it appears that the Company has indirectly guaranteed the indebtedness
of PCHI. 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 and six months ended June 30,
2005, the Company included in its consolidated financial statements, the net
assets of PCHI, net of consolidation adjustments.
25
Results of Operations
The following table summarizes our results of operations from continuing
operations for the three months ended June 30, 2005 and 2004. The 2004 period
reflects our results prior to ownership of the Hospitals, which began in March
2005.
Three Months Ended
------------- -------------
June 30, 2005 June 30, 2004
------------- -------------
(Unaudited) (Unaudited)
------------- -------------
Net operating revenues $ 83,190,537 $ --
Operating expenses:
Salaries and benefits 48,439,345 306,317
Supplies 11,521,967 --
Provision for doubtful accounts 11,331,354 --
Other operating expenses 17,283,135 108,763
Depreciation and amortization 902,845 15,528
Common stock warrant expense -- --
------------- -------------
89,478,646 430,608
Operating loss (6,288,109) (430,608)
Interest expense 4,069,029 --
------------- -------------
Loss including minority interest and
before provision for income taxes (10,357,138) (430,608)
Provision for income taxes 1,762,000 --
Minority interest in variable interest
entity (195,517) --
------------- -------------
Net loss $ (11,923,621) $ (430,608)
============= =============
Per Share Data:
Basic and fully diluted
Loss per common share ($ 0.10) ($ 0.02)
Weighted average shares outstanding 124,539,000 19,590,000
Three and Six Months Ended June 30, 2005 and 2004
Losses from continuing operations, before interest, taxes and common stock
warrant expense, increased to $6.0 million for the three months ended June 30,
2005 from $0.4 million for the three months ended June 30, 2004. Substantially
all of the losses from continuing operations during the three and six months
ended June 30, 2005 reflects the operational losses from our Hospitals, which
were acquired on March 8, 2005.
For the three months ended March 31, 2005 and the six months ended June
30, 2005, we recognized an expense of $16.4 million relating to the issuance of
common stock Warrants to Dr. Chaudhuri and Mr. 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 41,292,892 (24.9% of fully
diluted shares outstanding as of June 30, 2005). We recorded the fair value of
the remaining unexercisable Warrants at June 30, 2005 of $11.6 million as
deferred compensation in the accompanying condensed consolidated balance sheet.
We 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 our fully diluted common stock.
26
The income tax provision was $1.8 million for the three months ended June
30, 2005 and $3.2 million for the six months ended June 30, 2005, and consisted
primarily of a taxable gain on the sale of the real property of the Hospitals to
PCHI, the non-deductible Warrant expense and allowances for doubtful accounts,
offset with losses from operations. As of June 30, 2005, we had net deferred tax
assets of approximately $10.8 million for which a full valuation allowance has
been provided.
Managed care contracting
The prior owners the hospitals adopted a state wide managed care
contracting strategy that was designed to improve consolidated results with less
regard for the individual facilities financial needs. Those contracts have been
substantially all assigned to IHHI preserving the existing revenue base.
Management is committed to negotiating terms more closely aligned with the
services provided and the financial resources required to achieve that level of
service. Although management believes that substantial opportunity exists for
improving contracted reimbursement, there can be no assurance that this will be
achieved and failure to do so could have a material adverse impact on future
performance.
Salaries and benefits
We have experienced and expect to continue to experience significant wage
and benefit pressures created by the nursing shortages throughout the region. In
addition, approximately 24% of our employees were represented by labor unions as
of June 30, 2005. If union activity increases at our hospitals, our salaries and
benefits expense may increase more rapidly than our net operating revenues.
Labor costs remain a significant cost pressure facing us as well as the health
care industry in general. The nursing shortage continues and remains more
serious in key specialties. This has increased labor costs for nursing
personnel. In addition, state-mandated nurse-staffing ratios in California have
not only increased our labor costs, but may also adversely affect net operating
revenues due to volume limitations if the required number of nurses are
unavailable. In March 2005, increases to California's state-mandated
nurse-staffing ratios went into effect as provided by the original statute. The
vast majority of hospitals in California, including our hospitals, are not at
all times meeting these ratios. We have, however, gradually improved our monthly
compliance and expect that our compliance levels will continue to improve
throughout our hospitals in 2005.
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.
27
During the three months and six months ended June 30, 2005, we recorded
provisions for doubtful accounts of $11.3 million and $14.5 million,
respectively.
The breakdown of our billed hospital receivables (which is a component of
total receivables) at June 30, 2005 is summarized in the table below.
June 30, 2005
-------------
Insured receivables
78.3%
Uninsured receivables
21.7%
-------------
Total 100.0%
=============
Our allowance for doubtful accounts and the approximate percentages of
allowance for doubtful accounts to accounts receivable at June 30, 2005 are
summarized as follows (dollars in thousands):
June 30, 2005
Allowance for doubtful accounts $14,445
Percentage of accounts receivables 26.2%
Our reported accounts receivable as of June 30, 2005 were all under 115
days outstanding, due to the fact that our acquisition of Hospital assets from
Tenet on March 8, 2005 did not include patient accounts. Net days in AR
outstanding as of June 30, 2005 were 44.2 days.
Liquidity and Capital Resources
Cash used by operating activities was $26.5 million in the six months
ended June 30, 2005. Net accounts receivable increased to $40.4 million after a
full quarter of hospital operations. Accounts payable increased by $11.5 million
and payroll related accruals increased by $12.3 million. Estimated taxes payable
increased by $1.8 million. Other current liabilities increased by $6.5 million
and consist primarily of accrued interest, workers' compensation insurance, and
other miscellaneous accruals.
Cash used in investing activities of $58.0 million in the six months ended
June 30, 2005 was used to complete the Hospital acquisition and is net of
proceeds of $5 million from the sale of the real property of the Hospitals to
PCHI, a related party entity.
Cash provided by financing activities was $91.8 million in the six months
ended June 30, 2005. At June 30, 2005, our indebtedness consisted of a $50
million term loan for the purchase of our Hospitals, a $13.2 million drawn-down
from a $30 million line of credit. In addition, in March 2005, our 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 continue to
provide billing and collection services and the proceeds collected thereby are
applied to reduce amounts advanced under this agreement. As of June 30, 2005
$21.4 million had been advanced under this agreement.
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, and the
Company's secured line of credit note of up to $30 million. 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. 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.
28
As of June 1, 2005, the Company entered into an Agreement to Forbear with
Medical Provider. Without another default, Medical Provider agrees for 100 days
to forbear from (i) recording Notices of Default, (ii) filing a judicial
foreclosure lawsuit against the Company, OC-PIN and West Coast Holdings, LLC,
and (iii) filing lawsuits against the Company, OC-PIN and West Coast Holdings,
LLC. The interest rate on the notes will be increased from 14% to the Default
Rate of 19%, as defined in the Credit Agreement, and all Obligations (as defined
in the Credit Agreement), will be forthwith due and payable, as long as the
events of default remain uncured. The Company's Line of Credit facility is
suspended to additional advances. During the forbearance period of 100 days,
OC-PIN and other investors will invest not less than $15 million in new equity
capital in the Company.
In June 2005, in connection with the First Amendment to Stock Purchase
Agreement, dated as of June 1, 2005, by and among the Company, OC-PIN, PCHI,
West Coast Holdings, LLC, and Ganesha Realty LLC, OC-PIN placed into an escrow
account 57,250,000 shares of the Company's common stock. As of the date of this
Report, an aggregate of $12.5 million in cash has been deposited in the escrow
account.
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.
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 to the financial
statements regarding the Company's implementation of FIN 46 (R).
29
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
At June 30, 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.
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
From time to time, we are a party to claims and legal proceedings arising
in the ordinary course of our business. With the exception of a potentially
adverse outcome in the litigation described in the next paragraph, after taking
into consideration information furnished by our counsel as to the current status
of these claims and proceedings, we do not believe that the aggregate potential
liability resulting from such proceedings would have a material adverse effect
on our financial condition or results of operation.
On or about May 27, 2005, the Company, along with other defendants, was
served with a petition to compel arbitration with Judicial Arbitration and
Mediation Service (JAMS) by Andrew Weiss, a former consultant to the Company.
Mr. Weiss is claiming, among other things, that he was an employee of the
Company and was wrongfully terminated, and is requesting unspecified
compensatory, statutory and punitive damages relating to his claimed lost
earnings and benefits, stock options, and other special and general damages. The
Company is vigorously contesting this matter. The Company has filed a stay in
the arbitration proceedings and is requesting to move the claim to Los Angeles
County Superior Court. This matter is in an early stage and it is not possible
to assess the likely outcome of this litigation or the amount of damages that we
would be required to pay if this litigation is decided adverse to the Company.
30
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
("OC-PIN"), 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 OC-PIN'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
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 $64.2 million, 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 6. Exhibits.
Exhibit
Number Description
- ------ -----------
10.1 First Amendment to Stock Purchase Agreement, dated as of June
1, 2005, by and among the Registrant, Orange County Physicians
Investment Network, LLC, Pacific Coast Holdings Investment,
LLC, West Coast Holdings, LLC, and Ganesha Realty LLC
(incorporated herein by reference from Exhibit 99.1 to the
Registrant's Current Report on Form 8-K filed with the
Commission on June 22, 2005).
10.2 Escrow Agreement, dated as of June 1, 2005, by and among the
Registrant, Orange County Physicians Investment Network, LLC
and City National Bank (incorporated herein by reference from
Exhibit 99.2 to the Registrant's Current Report on Form 8-K
filed with the Commission on June 22, 2005).
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10.3 Agreement to Forbear, dated as of June 1, 2005, by and among
the Registrant, certain of its subsidiaries, Orange County
Physicians Investment Network, LLC, West Coast Holdings, LLC,
and 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 June
22, 2005).
10.4 Letter agreement, dated June 6, 2005, amending employment
agreements of Messrs. Anderson, Mogel and Ligon.
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.
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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: August 15, 2005 By: /s/ Steven R. Blake
-------------------------------------
Steven R. Blake
Chief Financial Officer
(Principal Financial Officer)
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