UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------
AMENDMENT NO.1 TO
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|
Explanatory Note
On March 28, 2006, the Company's Audit Committee, acting on a
recommendation from the Company's management and following accounting questions
reviewed with the Securities and Exchange Commission determined that the
Company's unaudited condensed consolidated quarterly financial statements for
the periods ended March 31, 2005, June 30, 2005, and September 30, 2005, should
be restated to revise the accounting and related disclosures for the expense of
warrants issued on January 27, 2005. In addition, the Company's Audit Committee,
acting on recommendation from the Company's management has concluded that the
quarterly provision for income taxes for the periods ended March 31, 2005, June
30, 2005 and September 30, 2005 should be restated to correct an error in the
calculation of the taxable gain on the sale of assets to PCHI. The restatements
impact each of the three months and the respective year to date periods ended
March 31, 2005, June 30, 2005, and September 30, 2005 presented herein and is
further discussed in Note 12 to the unaudited condensed consolidated financial
statements included herein.
This amendment to the Company's Quarterly Report on Form 10-Q/A is being
filed for the purpose of amending and restating Items 1, 2 and 4 of Part I and
Item 6 of Part II of the Form 10-Q originally filed solely to the extent
necessary (i) to reflect the restatement of the Company's unaudited condensed
consolidated financial statements as of and for the periods ended March 31,
2005, June 30, 2005, and September 30, 2005 as described in Note 12 to the
unaudited condensed consolidated financial statements and (ii) to make revisions
to "Management's Discussion and Analysis of Financial Condition and Results of
Operations" as warranted by the restatement, (iii) to make revisions to Item 4
of Part I to reflect our evaluation of controls and procedures as of the date of
filing this amended Quarterly Report on Form 10-Q/A, (iv) to include the
certifications required by the Sarbanes-Oxley Act of 2002 and (v) to update the
exhibits. This amended Quarterly Report on Form 10-Q/A is as of the date the
Quarterly Report on Form 10-Q was originally filed except for material
subsequent events more fully described in Note 13 to the unaudited condensed
consolidated financial statements and supplemental information provided to
enhance managements discussion of critical accounting estimates.
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 24
Item 3. Quantitative and Qualitative Disclosures About Market Risk 31
Item 4. Controls and Procedures 31
PART II OTHER INFORMATION
Item 1. Legal Proceedings 31
Item 3. Defaults Upon Senior Securities 32
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.
Unaudited Condensed Consolidated Balance Sheet
ASSETS
June 30, December 31,
2005 2004
------------------------------
(Unaudited)
(Restated)
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 810,000 --
Other current liabilities 6,654,573 --
------------------------------
Total current liabilities 116,699,280 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' 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 17,215,000 --
Additional paid in capital 12,040,487 1,189,621
Accumulated deficit (33,382,597) (2,098,358)
------------------------------
Total stockholders' deficiency (4,002,551) (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.
Unaudited Condensed Consolidated Statement of Operations
Three Months Ended Six Months Ended
------------------------------ ------------------------------
June 30, 2005 June 30, 2004 June 30, 2005 June 30, 2004
------------- ------------- ------------- -------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
(Restated) (Restated)
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 -- -- 17,215,000 --
------------- ------------- ------------- -------------
89,478,646 430,608 129,481,902 922,740
Operating loss (6,288,109) (430,608) (24,544,336) (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) (29,278,661) (922,740)
Provision for income taxes 1,266,000 -- 2,210,000 --
Minority interest in variable interest entity (195,517) -- (204,422) --
------------- ------------- ------------- -------------
Net loss $ (11,427,621) $ (430,608) $ (31,284,239) $ (922,740)
============= ============= ============= =============
Per Share Data:
Basic and fully diluted
Loss per common share ($0.09) ($0.02) ($0.29) ($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.
Unaudited Condensed Consolidated Statement of Shareholders' Deficiency
Common Stock Common Stock Warrants Additional
------------------------- ----------------------- Paid-in Accumulated
Shares Amount Shares Amount Capital Deficit Total
----------- ------------ ---------- ----------- ----------- ------------ ------------
(Restated) (Restated) (Restated)
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 17,215,000 -- -- 17,215,000
Net loss -- -- -- -- -- (31,284,239) (31,284,239)
----------- ------------ ---------- ----------- ----------- ------------ ------------
Balance, June 30, 2005 124,559,000 $ 124,559 74,700,000 $17,215,000 $12,040,487 $(33,382,597) $ (4,002,551)
=========== ============ ========== =========== =========== ============ ============
The accompanying condensed notes are an integral part of these unaudited
condensed consolidated financial statements
4
INTEGRATED HEALTHCARE HOLDINGS, INC.
Unaudited Condensed Consolidated Statement of Cash Flows
Six Months Ended Six Months Ended
June 30, 2005 Junes 30, 2004
------------ ------------
(Unaudited) (Unaudited)
(Restated)
Cash flows from operating activities:
Net loss $(31,284,239) $ (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 17,470,144 --
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 810,000 --
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 (63,171,676) --
Purchase of property and equipment -- (19,260)
Acquisition of MMG, Inc., net of cash acquired -- 8,534
------------ ------------
Net cash used in investing activities (63,171,676) (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
Proceeds from the sale of partnership interests in variable
interest entity used for the Acqusition 5,000,000 --
Repayment of secured notes (1,335,017) (100,000)
Advances from shareholders -- 73,285
------------ ------------
Net cash provided by financing activities 97,035,597 223,285
------------ ------------
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 $ 17,470,144 $ --
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 $11,427,621 and $31,284,239
(inclusive of a warrant issuance expense of $17,215,000 incurred in connection
with the Acquisition during the three months and six months ended June 30, 2005,
respectively and has negative working capital of $(56,137,740) 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 Medicare, Medicaid, managed care
and other health plans.
Gross charges are retail charges. They are not the same as actual pricing,
and they generally do not reflect what a hospital is ultimately paid and
therefore are not displayed in the 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 and certain other payments, which are based
on the hospitals' cost reports, are estimated based on relationships of costs to
charges subject to regulatory adjustments. For the six months ended June 30,
2005 retrospective revenues were $3.0 million. Cost report settlements for
retrospectively cost-based revenues under these programs will be 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. Medicare has reserved the option of adjusting
outlier payments, through the cost report, to the hospital's actual cost-to
charge ratio. Upon receipt of the current payment cost-to-charge ratios from the
fiscal intermediary, any variance between current payments and the estimated
final outlier settlement will be reported.
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 is contracted with
CalOptima, which is a county sponsored entity that operates similar to a HMO, to
provide health care services to indigent patients at a fixed amount per enrolled
member per month. The Company receives payments from CalOptima based on a fixed
fee and the number of enrolled members to the Company's specific hospitals. The
Company recognizes these capitation fees as revenues on a monthly basis for
providing comprehensive health care services for the period. The Company does
not have contractual obligations with HMO's.
In certain circumstances, members will receive health care services from
hospitals not owned by the Company. In these cases, the Company records
estimates of patient member claims incurred but not reported (IBNR) for services
provided by other health care institutions. The 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. There can be no assurance that the ultimate
liability will not exceed our estimates. Adjustments to the estimated IBNR
reserves are recorded in our results of operations in the periods when such
amounts are determined.
Per guidance under SFAS NO. 5, the Company accures for IBNR reserves when
it is probable that expected future health care costs and maintenance costs
under an existing contract have been incurred and the amount can be reasonably
estimable. The Company records these IBNR claim reserves against its net
operating revenues. During the six months ended June 30, 2005, the Company
recorded net revenues from CalOptima of approximately $1.5 million, net of IBNR
reserves of $2.1 million. The Company's direct cost of providing services to
patient members in IHHI facilities is recorded as an operating expense.
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.
Segment Reporting - The Company operates in one line of business, the
provision of health care services through the operation of general hospitals and
related health care facilities. Our general hospitals generated substantially
all of our net operating revenues during the six months ended June 30, 2005.
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 $66,246,821. 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 2,460,874
Deferred loan fees 1,933,000
Capital lease obligations (3,659,401)
------------
$ 66,246,821
============
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 supplemental pro forma information represents the
Company's consolidated results of operations as if the Acquisition had occurred
on January 1, 2004 and after giving effect to certain adjustments including
interest expense, depreciation expense, and related tax effects. In addition,
the following unaudited pro forma information includes the nonrecurring items
related to the issuance of 74,700,000 common stock warrants (Note 5), which
resulted in an expense of $17,250,000 that the Company recorded during the three
months ended March 31, 2005 and restructuring charges of $3,147,000 incurred by
Tenet during the three months ended March 31, 2005. 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, 2004 or future operating
results.
Pro Forma (Unaudited)
--------------------------------------------------------------------------
Three Months Ended Six Months Ended
--------------------------------------------------------------------------
June 30, 2005 June 30, 2004 June 30, 2005 June 30, 2004
--------------------------------------------------------------------------
Net operating revenues $ 83,190,537 $ 78,581,594 $ 160,203,857 $ 165,327,579
Net loss $ (11,427,621) $ (9,136,708) $ (42,212,849) $ (32,853,926)
Loss per common share
(basic and fully diluted) $ (0.09) $ (0.08) $ (0.34) $ (0.27)
Weighted average shares outstanding 124,539,000 122,190,000 124,308,528 122,110,778
============== ============== ============== ==============
13
INTEGRATED HEALTHCARE HOLDINGS, INC.
Condensed Notes to Unaudited Consolidated Financial Statements
June 30, 2005
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 OC-PIN's total stock purchase commitment under the Stock Purchase
Agreement was reduced from $30 million to $25 million.
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 in July 2005. 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. See the financial
impact of the shares placed into escrow at Note 10 - loss per share;
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 Real Estate Purchase Option agreement
originally dated September 28, 2004 to purchase 100% of substantially all of the
real property in the Acquisition for $5 million (the "Real Estate Option"), 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. In addition, the Company amended the Real Estate Option to provide that
Dr. Chaudhuri's option shall be to purchase 49% of substantially all of the real
property in the Acquisition for $2,450,000. Concurrent with the close of the
Acquisition, IHHI repaid the non-convertible secured promissory notes of
$1,264,014 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 recognized an expense of $17,215,000 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 estimated maximum number of shares exercisable of 43,254,715.
The fair value of the Warrants was determined based on the Black-Scholes
option pricing model with the following assumptions:
Risk-free interest rate 3.2%
Expected volatility 33.6%
Dividend yield --
Expected life (years) 3.5
Fair value of Warrants (fully diluted) $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. Based on
the market for the Company's stock not being reasonably efficient, the market
not expecting the significant warrant grant, and the Company not commensurately
benefiting from an exercise of the warrant, the Company determined that the
dilutive effect of the warrant should be reflected in estimating its fair value.
The Company calculated the dilutive effect by dividing the non-dilutive fair
value by 1.249, based on the maximum number of shares to be issued under the
warrant of 24.9% of total outstanding shares.
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 - 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 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 provision for income taxes consisted of the following for the six
months ended June 30,:
2005 2004
---------- ----------
Current income tax expense:
U.S. Federal and State $2,210,000 $ --
Deferred income taxes:
U.S. Federal and State -- --
---------- ----------
Total $2,210,000 $ --
========== ==========
A reconciliation between the amount of reported income tax expense
(benefit) and the amount computed by multiplying income (loss) from continuing
operations before income taxes by the statutory federal income tax rate is shown
below for the six months ended June 30, 2005:
Estimated tax benefit at federal and state statutory
rates on an annualized basis $(8,434,000)
Common stock warrant expense 3,774,000
Gain on sale of real estate 1,292,000
Change in valuation allowance 6,363,000
State credits (817,000)
Other 32,000
-----------
$ 2,210,000
===========
Deferred income taxes reflect the tax effects of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amount used for income tax purposes. The following table
discloses those significant components of our deferred tax assets and
liabilities, including any valuation allowance:
June 30, 2005 June 30, 2004
------------ ------------
Current deferred tax assets:
Allowance for doubtful accounts $ 5,911,500 $ --
Accrued vacation 2,429,490 --
Other accruals 1,886,369 --
Net operating losses 576,984 444,000
------------ ------------
Deferred tax assets 10,804,343 444,000
Valuation allowance (10,804,343) (444,000)
------------ ------------
Net deferred tax assets $ -- $ --
============ ============
20
A valuation allowance of $10.8 million was recorded as of June 30, 2005
based on an assessment of the realization of our deferred tax assets as
described below. We assess the realization of our deferred tax assets to
determine whether an income tax valuation allowance is required. Based on all
available evidence, both positive and negative, and the weight of that evidence
to the extent such evidence can be objectively verified, Company management
determines whether it is more likely than not that all or a portion of the
deferred tax assets will be realized. The main factors taken into consideration
include:
o cumulative losses in recent years;
o income/losses expected in future years;
o unsettled circumstances that, if unfavorably resolved, would adversely
affect future operations and profit levels;
o the availability, or lack there, of taxable income in prior carryback
periods that would limit realization of tax benefits;
o the carryforward period associated with the deferred tax assets and
liabilities; and
o prudent and feasible tax-planning strategies.
Through the second quarter of 2005, we concluded that it was more likely
than not that the deferred tax assets were not realizable. Therefore, we
determined that it was appropriate to record a valuation allowance after
considering and weighing all evidence in the second quarter of 2005.
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
Company's sale of its 100% 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.
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.
21
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) $ (11,427,621) $ (430,608) $ (31,284,239) $ (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.
If the First Amendment to the Stock Purchase Agreement and the Escrow
Agreement were entered into as of the date of the original Stock Purchase
Agreement dated January 28, 2005, the Company's future loss per share would be
greater than reported and the Company's loss per share would have been $(0.17)
and $(0.54) for the three and six months ended June 30, 2005, respectively.
22
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. The following is a schedule of the Company's future
minimum operating lease payments that have initial or remaining noncancelable
lease terms in excess of one year as of December 31, 2004:
Unrelated Third Related
Year Ended December 31, Parties Party (PCHI) Total
----------------------- ----------------------------------------------
2005 $ 2,038,365 $ 10,642,672 12,681,037
2006 2,008,102 13,153,611 15,161,713
2007 1,660,807 13,233,219 14,894,026
2008 1,162,675 13,315,216 14,477,891
2009 844,267 13,315,216 14,159,483
Thereafter 8,569,793 278,706,133 287,275,926
----------------------------------------------
$ 16,284,009 $342,366,067 $358,650,076
==============================================
Capital Leases - The Hospitals have long-term lease obligations for
certain equipment. For financial reporting purposes, the leases have been
classified as capital leases; accordingly, assets with a net book value of
approximately $3,529,109 are included in property and equipment in the
accompanying consolidated balance sheet. The following is a schedule of future
minimum lease payments under capitalized equipment leases together with the
present value of the net minimum lease payments as of June 30, 2005:
Year ending June 30,
--------------------
2005 $ 686,292
2006 686,292
2007 686,292
2008 686,292
2009 686,292
Thereafter 2,573,595
----------
Total minimum lease payments $6,005,055
Less amount representing interest 2,416,658
----------
Present value of net minimum lease payments 3,588,397
Less current portion 204,141
----------
Long-term portion $3,384,256
==========
Agreement for Compensation - In connection with the close of the Hospital
Acquisition, the Company entered into an Agreement for Compensation Related to
the 999 Medical Office Building (the "Compensation Agreement with PCHI, a
related party (see Note 7). In the amended Asset Sale Agreement with Tenet,
certain medical office condominium units (the "Condo Units") were excluded from
the Company's Hospital Acquisition due to the tenants of the Condo Units having
a first right of refusal to purchase such real property. The Company's purchase
price of the Hospitals from Tenet was reduced by $5 million. Pursuant to the
amended Asset Sale Agreement upon the expiration of the tenant's right of first
refusal, Tenet will transfer title to the Condo Units to the Company in exchange
for consideration of $5 million, pro rated if less than all of the Condo Units
are transferred.
Pursuant to the Compensation Agreement, the Company shall acquire title to
the Condo Units upon expiration of the tenant's right of first refusal and then
transfer such title to the Condo Units to PCHI. If some of the Condo Units are
acquired by the tenants, the Company shall provided compensation to PCHI and the
Company shall pay down its Acquisition Note (see Note 6) by $5 million or such
pro rata portion. In the event of the Company's failure to obtain title to the
Condo Units, the Company shall pay to PCHI a sum to be agreed upon between the
Company, PCHI, and the owners of PCHI, but not less than the product of
$2,500,000 multiplied by a fraction, the numerator of which shall be the number
of Condo Units not acquired the Company and transferred to PCHI, and the
denominator equal to the total Condo Units of twenty-two. The tenants are
currently in ligitation with Tenet related to the purchase price of the Condo
Units offered by Tenet to the tenants.
As the financial statements of the related party entity, PCHI (see Note
7), are included in the Company's accompanying consolidated financial
statements, management has determined that any future payment to PCHI under the
Compensation Agreement would reduce the Company's gain on sale of assets to PCHI
(see Note 7.) Although the gain on sale of assets is eliminated upon the
consolidation of the financial statements of PCHI, the Company's income tax
provision related to such gain would be reduced.
Claims and Lawsuits - The Company and the Hospitals are subject to various
legal proceedings, most of which relate to routine matters incidental to our
business. The results of these claims cannot be predicted, and it is possible
that the ultimate resolution of these matters, individually or in the aggregate,
may have a material adverse effect on the Company's business (both in the near
and long term), financial position, results of operations or cash flows.
Although the Company defends itself vigorously against claims and lawsuits and
cooperate with investigations, these matters (1) could require payment of
substantial damages or amounts in judgements 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 (f) 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 - RESTATEMENT OF PRIOR PERIODS
In March 2006, the Company restated its 2005 quarterly financial statements due
to the following adjustments:
o The Company revised its calculation of the Warrant expense incurred during
the six months ended June 30, 2005. The total adjustment required to
increase the Warrant expense to its proper balance was $780,827 pre-tax.
The adjustment was a result of the Company recognizing the warrant expense
as a nonrecurring settlement charge during the three months ended March
31, 2005 using a probability analysis to estimate the maximum number of
warrants exercisable at the date of issuance of 43,254,715 shares.
o The Company revised its provision for income taxes due to an error in the
calculation of the taxable gain on the sale of real property to PCHI (see
Note 7 Variable Interest Entity.) The total adjustment required to reduce
the provision for income taxes was $496,000 and $1,024,000 for the three
and six months ended June 30, 2005, respectively.
The effects of the restatement were as follows:
Three Months Ended Six Months Ended
------------------------------------ ------------------------------------
June 30, 2005 June 30, 2005
------------------------------------ ------------------------------------
As Previously As As Previously As
Reported Restated Reported Restated
---------------- ---------------- ---------------- ----------------
Net loss $ (11,923,621) $ (11,427,621) $ (31,527,412) $ (31,284,239)
Basic and fully diluted:
Net loss per common share $ (0.10) $ (0.09) $ (0.30) $ (0.29)
NOTE 13 - SUBSEQUENT EVENTS
On December 14, 2005, the Company and its subsidiaries collectively entered into
Amendment No. 1 to Credit Agreement dated as of December 12, 2005 (the
"Amendment"), that amends that certain credit agreement dated as of March 3,
2005 (the "March Credit Agreement"), with PCHI, OC-PIN, Ganesha Realty, LLC,
West Coast Holdings, LLC (the "Credit Parties") and Medical Provider Financial
Corporation II (the "Lender"). The Amendment (i) declares cured those certain
events of default set forth in the notices of default received on or about May
9, 2005, from the Lender, (ii) requires the Company to pay $5,000,000 to the
Lender for mandatory prepayment required under the March Credit Agreement, (iii)
requires the Company to obtain $10,700,000 in additional new capital
contributions to pay in full and retire all amounts due and owing under the new
Note evidenced by the Credit Agreement (as defined below) and (iv) includes
certain indemnities and releases in favor of the Lender.
On December 14, 2005, the Company also entered into a credit agreement (the
"Credit Agreement"), dated as of December 12, 2005, with the Credit Parties and
the Lender. Under the Credit Agreement, the Lender loaned a total of $10,700,000
to the Company as evidenced by that certain promissory note in favor of the
Lender (the "New Note") with a total principal balance of $10,700,000. The
Company will use the proceeds to operate the Hospital facilities. Interest is
payable monthly at the rate of 12% per annum and the New Note is due on December
12, 2006. The Company may not prepay the New Note in whole or in part.
The New Note is secured by substantially all of the Company's assets. In
addition, the Company issued a common stock warrant to the Lender as collateral
under the New Note. The warrant is exercisable by the Lender only in the event
of that a default has occurred and is continuing on the New Note. The warrant
provides the Lender to purchase the number of shares of the Company's common
stock equal in value to the amount of the New Note not repaid at maturity, plus
accrued interest and lender fees for an aggregate exercise price of $1.00,
regardless of the amount of shares acquired. The Warrant is exercisable from and
after December 12, 2005 until the occurrence of either a termination of the
Credit Agreement by the Lender or the Company's payment in full of all
obligations under the Credit Agreement. The Company is obligated to register the
estimated number of shares of common stock issuable upon exercise of the warrant
by filing a registration statement under the Securities Act of 1933, as amended
(the "Securities Act"), no later than ninety days prior to the maturity date of
the New Note. If the Company proposes to file a registration statement under the
Securities Act on or before the expiration date of the warrant, then the Company
must offer to the holder of the warrant the opportunity to include the number of
shares of common stock as the holder may request.
The Company has determined it appropriate to classify the warrant as a liability
at the date of issuance in accordance with EITF No. 00-19 "Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock," FAS 133 "Accounting for Derivative Instruments and Hedging
Activities," and FAS 150 "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity." In addition, the Company will
re-measure the warrants subsequent to the initial measurement date at fair value
with changes in fair value recognized in earnings.
As a result of the Company not being able to determine the maximum number of
shares that could be required to be issued under the warrants issued on December
12, 2005, the Company has also determined that share settlement of the Warrants
issued on January 27, 2005 is not within its control and will reclassify the
Warrants as a liability as of December 12, 2005.
PCHI and OC-PIN have each agreed to guaranty payment of the New Note. In
addition, West Coast Holdings, LLC and Ganesha Realty, LLC have each agreed to
pledge their membership interests in PCHI as security for payment of the New
Note.
On or about October 31, 2005, the Company and OC-PIN entered into the Second
Amendment to Stock Purchase Agreement (see Note 4).
Contingency - The Company is a defendant in a claim brought by Andrew
Weiss, a former consultant to the Company, filed with Judicial Arbitration and
Mediation Service in Orange County, California, alleging breach of contract,
wrongful discharge, failure to pay wages, fraud, and other related claims
relating to his services to the Company in 2004 and 2005. Mr. Weiss alleges that
he was an employee of the Company and was covered by a purported written
employment agreement dated March 3, 2005. Mr. Weiss is seeking unspecified
damages, including lost earnings and benefits, loss of future earnings,
penalties, punitive damages and attorneys fees and costs. The Company intends to
defend itself vigorously against these claims. Although the Company does not
believe it is probable that it will lose this case, it is possible that
resolution of this case could result in a loss. Management is not able to
estimate the amount of such loss as of September 30, 2005.
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.
23
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.
24
Provision for Doubtful Accounts
Accounts receivable primarily consist of amounts due from third-party
payors and patients. Our ability to collect outstanding receivables is critical
to our results of operations and cash flows. 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. Our allowance is based on the aging of certain of our accounts
receivables by hospital, the historical collection experience by hospital and
for each type of payer and other relevant factors. The percentages applied in
the calculation of the allowance are consistent with those used by Tenet.
The primary uncertainty lies with uninsured patient receivables and
deductibles, co-payments or other amounts due from individual patients, which
collectively represent the largest component of bad debts. 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. We 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.
Generally, uncollected balances are expected to be assigned to a
collection agency between 90 to 120 days past due, once patient responsibility
has been identified. As we did not acquire Tenet's accounts receivable in our
Acquisition on March 8, 2005, our accounts have been current up to the third
quarter. Accordingly, in September 2005 we engaged a collection agency and bad
debt assignments commenced. 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.
The process of determining the allowance requires us to estimate
uncollectible patient accounts that are highly uncertain and requires a high
degree of judgment. It is impacted by changes in regional economic conditions,
business office operations, payor mix and trends in federal or state
governmental healthcare coverage. Due to our limited historical information as a
result of our Acquisition occurring on March 8, 2005, the following represents
our significant categories of gross patient accounts receivable as of December
31, 2005 (in thousands and unaudited):
Governmental $ 16,809
Insured Patient Accounts, net of discounts 33,222
Uninsured and Self Pay Accounts 16,927
---------
$ 66,958
Also as of December 31, 2005, $20 million in accounts had been written off
and assigned for collection. Of the combined uninsured and self pay balances
(both active accounts and bad debt write-offs) 4.4% had been collected as of
December 31, 2005. The uninsured accounts category represented 78% of the
allowance for uncollectible accounts and net of this portion of the allowance
represented an estimated receivable of $1.4 million. Uninsured accounts are
reserved at 93.2% of the balance for all aging categories. Based on collection
experience through December 31, 2005, we expect to collect 65% or $0.9 million
of this prior to assignment. The remainder represents the expected recovery by
the outside collection agency after the active balances are assigned. Until we
obtain additional historical experience, this recovery is not assured.
Approximately $17 million of our accounts at December 31, 2005 are
governmental accounts reserved at 100% for potential denials after 180 days.
Insured patient accounts represent 22% of the allowance for doubtful
accounts as of December 31, 2005 calculated on a scale based on the age of the
accounts from date of service starting at 3.3% for current accounts and
progressing to 63% for accounts over 180 days. Our commercial insured accounts
of $22 million have an allowance of $4 million as of December 31, 2005. The
average age of these accounts from date of service to collection is 52 days. In
management's opinion this is reasonable as long as the accounts continue to be
current.
A significant increase in our provision for doubtful accounts (as a percentage
of revenues) would have a significant increase to our operating losses. This
would adversely affect our results of operations, financial condition, liquidity
and future access to capital.
Common Stock Warrants
As indicated in the notes to the financial statements, the Company entered
into a Rescission, Restructuring and Assignment Agreement with Dr. Chaudhuri and
William Thomas on January 27, 2005 (the "Restructuring Agreement"). 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. The warrants were limited not to exceed 24.9% of the Company's
Fully-Diluted capital stock.
The Company recognized an expense of $17.2 million related to the issuance of
the Warrants during the three months ended March 31, 2005. The Company computed
the expense of the Warrants based on the fair value of the Warrants at the date
of grant and the estimated maximum number of shares exercisable of 43,254,715.
The Company computed the fair value of the Warrants based on the Black-Scholes
option pricing model with the following assumptions:
Risk-free interest rate 3.2%
Expected volatility 33.6%
Dividend yield --
Expected life (years) 3.5
Fair value of Warrants (fully diluted) $0.398
Due to fact that the Company emerged from the development stage during the
three months ended March 31, 2005, the Company computed the volatility of its
stock based on an average of the following comparable public companies that own
hospitals:
Amsurg Inc (AMSG)
Community Health Systems (CYH)
Healhcare Company (HCA)
Health Management Associates Inc. (HMA)
Lifepoint (LPNT)
Tenet Healthcare Corp. (THC)
Triad Hospitals Corp. (TRI)
Universal (UHS)
Although management believes this is most reasonable and accurate methodology to
determine the Company's volatility, the circumstances affecting volatility of
the comparable companies selected may not be an accurate predictor of the
Company's volatility.
25
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.
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.
26
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)
(Restated)
------------- -------------
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
------------- -------------
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 1,266,000 --
Minority interest in variable interest
entity (195,517) --
------------- -------------
Net loss $ (11,427,621) $ (430,608)
============= =============
Per Share Data:
Basic and fully diluted
Loss per common share ($ 0.09) ($ 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 $6.3 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 $17.2 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 estimated
maximum number of shares exercisable of 43,254,715.
27
The income tax provision was $1.3 million for the three months ended June
30, 2005 and $2.2 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.
28
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 $0.8 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 $63.2 million in the six months ended
June 30, 2005 was used to complete the Hospital acquisition on March 8, 2005.
Cash provided by financing activities was $97 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. We received $5 million in net proceeds from
the sale of the real property of the Hospitals to PCHI, a related party entity.
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.
29
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).
30
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 periodic
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.
We conducted an evaluation under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures as of December 31, 2005. During previous
quarters we conducted evaluations of the effectiveness of our disclosure
controls and procedures as of March 31, June 30 and September 30, 2005 and found
them to be effective as of such dates. However, we have subsequently conducted a
re-evaluation of the effectiveness of our disclosure controls and procedures as
of March 31, June 30 and September 30, 2005, and identified certain material
weaknesses, discussed further below.
With the participation of the Company's Chief Executive Officer and Chief
Financial Officer, management conducted an evaluation of the effectiveness of
our system of internal control over financial reporting as of December 31, 2005,
based on the framework in Internal Control-Integrated Framework published by the
Committee of Sponsoring Organizations of the Treadway Commission.
Based on these evaluations and re-evaluations, management determined that
the Company's system of disclosure controls and procedures was not effective as
of March 31, June 30, September 30 and December 31, 2005, and the Company's
systems of internal control over financial reporting was not effective as of
December 31, 2005, due to the presence of certain material weaknesses. These
weaknesses contributed to the need for restatements of our financial statements
for the quarterly periods ending March 31, June 30 and September 30, 2005 as
follows.
1. As described in the notes to the accompanying restated financial
statements, the Company revised its calculation of Warrant expense
incurred during the three months ended March 31, 2005 after review of its
accounting treatment following receipt of comments from the Staff of the
Securities and Exchange Commission. The total adjustment required to
increase the Warrant expense to its proper balance was $780,827 pre-tax
for such period. This adjustment was necessary because the Company
recognized the Warrant expense as a nonrecurring settlement charge during
the three months ended March 31, 2005 using a probability analysis to
estimate the maximum number of warrants exercisable at the date of
issuance of 43,254,715 shares.
2. As described in the notes to the accompanying restated financial
statements, the Company revised its provision for income taxes due to an
error in the calculation of the taxable gain on the sale of real property
to PCHI (see Note 7 Variable Interest Entity). The total adjustment
required to reduce the provision for income taxes was $528,000 for the
three months ended March 31, 2005, $496,000 for the three months ended
June 30, 2005, $799,000 for the three months ended September 30, 2005 and
$1,823,000 for the nine months ended September 30, 2005.
Management has identified, as a material weakness contributing to these
restatements, that the Company's research and analysis of complex accounting
issues was inadequate. Although the type of complex transactions giving rise to
the restatements are expected to occur very infrequently, management believes
that its process of analyzing and accounting for complex financial transactions
requires improvement. In addition to inadequate expertise, due to business
exigencies there was a lack of complete accounting analysis of these
transactions until after they were completed, which contributed to an incomplete
accounting analysis. Under the direction of the Audit Committee, management
intends in the future to engage experts with sufficient expertise to advise on
accounting and financial reporting of complex financial transactions, and to do
so prior to or concurrently with the Company's commitment to these transactions.
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.
31
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).*
32
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.
* Previously filed.
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: April 6, 2006 By: /s/ Steven R. Blake
-------------------------------------
Steven R. Blake
Chief Financial Officer
(Principal Financial Officer)
33